Fiat Monetary System

Under a modern fiat monetary system:

1) The total amount of money is not constrained by some fixed amount of gold. Instead, it is constrained by the total output of the national economy. There should be enough money in circulation to run the economy at full steam and buy up every product and service available. A fiat currency moves the theoretical boundary of economic activity beyond some arbitrary threshold dictated by lumps of precious metal and pushes it out to “what the system can bear” based on actual, physical capacity.

2) Spending beyond the economy’s total productive capacity is what leads to inflation. This additional money cannot buy any new products or services (there’s no way to make them since we’re at full capacity), so it goes toward bidding on existing products and services and therefore raises their prices.

3) Your taxes do not pay for any federal government expenditures. Taxes are instead a form of private sector demand reduction. Remember, the economy can only hold a certain amount of money dictated by its maximum productive capacity. If the government wants to spend more money to purchase goods and services, it should tax more to reduce the amount of money in the private sector. If it doesn’t tax more then it risks inflation from having too much money in circulation. Likewise, if it wants to spend less, it should tax less and let the private sector do more spending. If it doesn’t tax less, then the amount of money in circulation is too low and productive capacity sits unused. The idea here is to keep the total amount of money chasing goods and services near an optimum, maximum level. Again, taxes reduce demand in the private sector to make room for government spending.

Note that this turns our normal reasoning on its head. The federal government does not tax you so that it can then spend your money on buying or providing goods and services. It taxes you so that you cannot spend as much of your money on goods and services, which then makes room for it to spend money on them instead.

4) Sovereign governments that issue their own currency are never insolvent. Put another way, there is no such thing as debt to be repaid at the federal level. Why does the government have to issue debt (as under the gold currency regime) when it doesn’t need the money in the first place? It generates money, so neither taxes nor loans made via debt contribute to government coffers.

There are other implications of a fiat currency regime, but these are the most interesting. This is what Modern Monetary Theory is all about—the actual implications of a sovereign government issuing its own fiat currency.

Bolo on The Agonist

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15 responses to “Fiat Monetary System

  1. This post complements the previous one rather nicely (3 modern money facts at work), I’d say.

    There’s a point I’d like to inquire further: on item 3 the reason for taxation, assuming MMT, is stated as “Taxes are instead a form of private sector demand reduction”.

    I believe there could be more to this than simply demand management. Taxes can be targeted at particular agents; therefore, taxation could be used to favour one part of the population over another.

    Is that correct?

    In fact, and in spite of all the rhetoric about “fiscal conservatism”, this is how taxes are used now: some groups are targeted and other groups are excluded from carrying the fiscal burden.

  2. Magpie, first of all thank you. It was the idea to have this one to complement the others. Second of all, you are correct. The role of taxes under MMT is to affect purchasing power parity.

  3. I probably should have explained it better.

    As taxes selectively affect demand, they also selectively affect savings and, by extension, investment, debts and wealth accumulation.

    As I believe MMT is seen as a value-neutral scheme, a group could (due to ideological reasons) propose an MMT-based scheme to enhance current investment and wealth distribution patterns; another group could propose an MMT-based scheme with the aim of reversing current trends.

    Is that accurate?

    PS: Thanks to you!

  4. I guess, Prof. Wray post (Towards a Libertarian/Austrian Modern Money Theory) answers my question:

    “1. MMT is consistent with any size of government. It can be a small libertarian government if you like. But it issues a sovereign floating currency. It supports the currency by imposing a tax payable in that currency.”

    See also point 2: “If you want a big private sector and small government sector, keep taxes and government spending low.”

    Time to digest the info.

  5. You wrote: “It taxes you so that you cannot spend as much of your money on goods and services, which then makes room for it to spend money on them instead.”

    Some could construe this as a contradiction. In either case the amount of the tax gets spent. The perception is that if you want me to spend less as a brake on inflation, why then is the government spending that amount? And when does it spend it?

    Would it be more accurate to say that the government doesn’t do anything with tax receipts because it doesn’t need revenue? It can create all the units of account it need.

  6. Much as would like to agree with this explanation about taxation and government spending, I find it completely haywire!

    Regardless as to whether a government taxes its citizens heavily or lightly, the same total amount of money is circulating. With heavy taxation the householders (and workers) have less to spend and reduce on their purchases. But the government has more to spend so it increases on its purchases and employment of otherwise unemployed private industrial workers. The overall result is NIL! Regardless as to where the money goes it still circulates at about the same rate and is used in a very similar way. The progress of the overall macroeconomy will be unchanged by what ever taxation policy the government takes. Of course certain sectors of the public will be greatly affected, and they will make a big fuss about what they are loosing!

    By printing more currency and injecting this into the social system (as J.M.Keynes would do in times of slump) the value of the money becomes smaller and inflation occurs. This makes goods more costly, but this is compensated by there being more cash to purchase them. However, all those who have saved money without cost-of-living linkage will loose and all those who are in debt, particularly the government, will gain because these sums will buy less and have less real spending-power. This governmental behaviour is dishonnest and is like adding another kind of tax!

    • “Regardless as to whether a government taxes its citizens heavily or lightly, the same total amount of money is circulating. With heavy taxation the householders (and workers) have less to spend and reduce on their purchases. But the government has more to spend so it increases on its purchases and employment of otherwise unemployed private industrial workers. The overall result is NIL!”

      Please read or reread Warren Mosler’s 7 Deadly Innocent Frauds of Economic Policy.
      http://moslereconomics.com/2009/12/10/7-deadly-innocent-frauds/

      • I looked it over and I find it illogical and somewhat unable to analyse the big picture. It was Henry Hazlit in his 1945 book “Economics in One lesson” who first drew our attantion to the need to look at the at least both sides of the way the system works. (I prefer to add that one should consider all sides, when there are actually 6 entities involved in the model). Mosler does not argue in this maner and If you follow his lead the answers you get will not be realistic. Of course there are political interests in all of these kinds of postings and the purpose of mosler-eco is to continue to promote the Keynesian theory of raising national debt because “its only a paper debt and nobody looses”. This is simply not the true situation. There is no such thing as a free lunch! Keynes himself even stated in one place, that the use of the theory was to prove his policies were good and not that if the theory was correct then the right policy would follow. On this basis any theory is OK provided it gives the right result!

        As debt rises and interest is used to cover it, more money to cover the interest must be printed and stored. Soon these sums will be so huge that even the cost of accurately calculating them will employ too much of the finance department. So to reduce storage space and ease the note counting and recording, larger and larger denominates of note will be introduced and inflation must inevitably follow. Keynes does not concern himself about this, but with inflation the purchasing power of money falls. Debtors gain whist savers loose. Result, a run on the banks to change home-money into a foreign currency or gold. There is an undefined limit for the credit, which is felt whenever the fear of inflation is in the air.

        The claim that the purpose of a tax is to give money value is absurd. Without taxation the government must either inflate the currency of borrow more money in order to support its public expenses. When it does either of these things the earnings become less effective and the public becomes poorer.

  7. I am upset to see the use which a useful way of looking at the money situation, namely MMT is being used by the Keynrsians for promoting their political nonsense. Please always examing the big picture, as for example in Google Images DiagFuncMacroSyst.pdf , even if it is harder to properly understand, and accept the fact that without this picture or its equivalent the arguements about parts of the system are incomplete. In keynes case they are even worse and will actually make things worse.

    • You are working under several assumptions which I can only attempt to unpack out of what you have written.
      1. Money has intrinsic value.
      2. The sovereign nature of the backer of our money is irrelevant.
      3 Taxes are used to pay for things.
      All of these are false, and this shows that the texts and theory of MMT have been violently misread.

      • 1. If you’re unpacking what is written then you have either misread or completely misinterpreted what is written.
        2. The value is in the exchange of the real good or service obtained.
        3. The sovereign nature does matter as there is a difference between currency issuer, currency user and pegged exchanged rates.
        4. Taxes are used to move goods from the private sector to the public sector and as a thermostat on the economy to curb potential inflationary threats.
        5. Please note the source link at the bottom of posts.
        6. Please also note where most of the documents are culled from in the About link
        7. All of your concerns and my responses to them are addressed in future blogs – I’ve attempted to put them in a chronologically coherent order so one thing leads to another.
        8. However if you are saying what is written is wrong and you’re attempting to say things happen as suggested in your ordered list, you are mistaken.

    • New to this site and perspective. Just wrapping my head around it. But even I can see that Macrocompassion is missing the whole point.

      Macrocompassion: you say that “by printing money and injecting it” into the system, this causes inflation. But clearly you didn’t read the post carefully. This can only happen if the system is already running at full capacity. Inflation will occur when there is money to buy things that are already being bought. So naturally, the prices will go up because there’s more money to be had. But in a depressed economy with high unemployment, the money that is “injected” into the system, goes in to buying something that is desperately needed, which is labor for services! This will create jobs!

      BOTTOM LINE: There’s no reason to have a person willing to do work that somebody else needs in a country that issues its own fiat currency.

      Can somebody else confirm that I am understanding this properly?

      • Louis Lavery

        (a) What is an “economy’s total productive capacity”?

        (b) If an economy’s running along at its total productive capacity (or what I think you mean by that) and we suck say half the money out, why would that lead to unemployment and not prices and wages etc dropping by half?

      • Macrocompassion

        Our present economy is based on deficit finances and bank loans. This means that when new money is inserted into the system, there will be reductions in the total sums needing to be loaned out, but without any resulting increase in the numbers employed. Only when the opportunity for more jobs is caused by allowing some of the 3 Smithian factors of production to grow (and this particularly means the opportunities caused by land no longer being withheld for purposes of speculation in its value), will there be some progress in the numbers employed.
        Should the government print and spend more money on employing people (on its public land) in improving the infrastructure, will this provide these workers with more to spend and the existing stocks of goods will have to be shared as before. This implies that inflation must follow. The better infrastructure will cause the land to be more productive so that these speculators will benefit as the land value rises, due to the new money and its distribution.
        To stimulate the economy by printing more money is a sham–Keynes was wrong! It only hurts those who have honestly saved for hard times, because they will find that their savings can buy less. It is a kind of tax.
        Instead, by taxing land values and reducing the taxes on earnings, purchases and capital gains, will the cost of speculation become significant and the resulting cost of access to land and the cost of production go down, which benefits all, including the speculators!

        TAX LAND NOT PEOPLE; TAX TAKINGS NOT MAKINGS!

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