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MMT Nutshell: Diagrams and Dollars


MMT vs. Mainstream

The Civilized Money View (aka MMT, or Modern Monetary Theory) has historical precedents:

First, the notion—developed by Adam Smith—that the wealth of a nation is measured not by monetary values, but by its capacity to produce goods and services.

Second, the notion of money—developed by John Maynard Keynes—that any modern state claims the right to declare what money is.

While Smith’s concept hints to full employment as the primary policy objective, Keynes’s concept hints to the management of money as instrumental to reach such objective. Furthermore, MMT explicitly recognizes that the currency itself is a public monopoly.

This leads to an appreciation of the monetary system fundamentally different from the traditional Monetarist-Keynesian paradigm.

What follows is a summary of eight key differences between these two models: the Monetarist-Keynesian paradigm (MK) and the Civilized Money View (or MMT)

MK – The central bank controls the money supply indirectly through its power to control the monetary base.

MMT – The private sector uses bank deposits as money, and bank deposits are not directly controlled by the central bank: they get created by government spending and bank loans.

MK – Because the central bank controls the money supply, it also controls the nominal interest rate in the money market.

MMT – Because it is the monopolist of money, the central bank controls the interest rate.

MK – The long-term nominal interest rate is determined by private preferences about real saving and investment, as well as by inflation expectations.

MMT – The central bank has the power to control the interest rate at any maturity: the interest rate is a purely monetary phenomenon.

MK – A monetary expansion can expand output and employment temporarily and yet, at some point, it generates inflation.

MMT – Any operation by which the central bank buys or sells financial assets does not make the private sector any richer and has little or no consequence on private spending decisions.

MK – Government decisions are largely driven by short-term personal goals of politicians, and thus the management of money should be the responsibility of an independent institution with a long-run horizon.

MMT – While monetary policy can only set interest rates, fiscal policy is much more powerful, since any deficit of the public sector generates an equivalent financial surplus of the private sector, and thus affects spending decisions.

MK – Taxes serve the purpose of financing government spending.

MMT – Because government spending takes resources off the private sector and simultaneously generates income and wealth in the private sector, it will cause inflation from excess demand unless a sufficient amount of taxes is levied on the private sector.

MK – If the government spends more than its tax revenue, it must borrow funds from the private sector, and this reduces funding to the private sector.

MMT – Unless it loses its power to define what money is, the government is the currency issuer: It faces no funding constraint, and it must spend or lend first, before the economy has the funds needed to pay taxes and buy government debt.

MK – Price stability is a precondition for economic growth and job creation.

MMT – A government deficit of a size that matches the private sector’s desire to accumulate financial savings is a precondition for full employment.

This post is Creative Commons Attribution-Noncommercial-Share Alike 2.5 Switzerland License and I dare say any other country as well. It first appeared here via Franklin College’s Andrea Terzi.

I felt it was that important it had to be shared with a larger audience.  Of note is that the MK paradigm mentioned throughout is the traditional current orthodox neoclassical approach used in mainstream economics today.

Debt & Deficit in a Nutshell

A Summation of what we have learnt