Modern monetary theory

A couple of weeks ago, in response to a comment that expressed the common view that taxes pay for public services, I made what I thought was a rather uncontroversial point. The point I made was that taxes and spending are independent and that taxes fulfill a role that has no bearing on the ability of a state with a sovereign currency to spend. Apparently making such a point marks me out as a bad person

The position is core to modern monetary theory, a theory on modern (i.e. fiat) currency systems. I was under the impression that people were reasonably well versed in the principles, but apparently my little corner of the internet is less visible than I thought. Most of the principles of MMT arise from what are essentially accounting identities around the functioning of currency and banking systems.

In any case, given the importance of a good understanding of taxes and spending to our shared dialogue, I wanted to kick off a discussion on MMT, starting with the following article, which explains the relationship between taxation and spending better than I ever could:

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MMT is very controversial within the field of economics and is still considered to be on the fringes of public policy, so I am not all that surprised by the reaction that you received. The idea that taxes and spending are entirely independent is not mainstream and, more importantly, it does not reflect actual monetary policy.

I am by no means an expert on economics, but as far as I am aware, MMT is entirely theoretical (in that it has never been implemented by any government), and I am skeptical as to whether it would actually work in a global economy, where transactions often involve a spectrum of sovereign currencies.

In any case, I think that it would be more accurate to say, “Taxes and spending could be independent of each other if a government decided to run things that way (but we are not sure how that would work out).” In the strictest sense, I suppose that you could say that governments actually can spend money without making appropriations through taxes or debt issuance. The question is: should they?

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A few interesting points. IMO mainstream economics is largely a non discipline; a branch of bad philosophy. Neoclassical economics is essentially broken at every level, and Steve Keen did a great job of elucidating that. As such, non acceptance by the mainstream is almost a requirement for an economics position to be sensible.

In response to your final question about should they?, the specific answer is absolutely they should run a fiscal deficit in most developed economies. The reason for this is obvious when considered from a sectoral balances perspective. In essence private sector money only can come from government spending, which means given the propensity of the private sector to save, if the country runs a trade deficit, then the government must spend more than it takes in. If it doesn’t then the money supply in the private sector contracts, which results in a debt problem or a recession. This is what has historically happened in the US whenever it has been tried. The mechanical detail of this can be studied by examining the functioning of the central bank and is hard to dispute.

To your point about evidence, that’s not really true. Japan is a great case study as to what happens when the government pays off bonds (debt). The answer is essentially nothing of consequence, as predicted by MMT, unlike mainstream economics which products rampant inflation.

Other evidence is historical, like an understanding of sectoral balances as their impacts on private sector spending.

Probably worth addressing this directly. MMT is a description of how a modern monetary system works. It really isn’t purely theoretical, and is implemented by every developed economy. Here is the Bank of England’s description. The issue is the government (and certainly the electorate) don’t necessarily realise the policy consequences of that.

Japan has one of the highest debt-to-GDP ratios in the developed world, if not the highest. Are you talking about what happened during the bubble years?

Do you mean in the sense that, by borrowing money at interest, the government is, in effect, issuing new money without appropriating for it? My understanding of MMT is that it would make government borrowing fully redundant. Why would the government borrow money when they can just make it?

You have not really addressed my point about the global economy though. You are talking about macroeconomics as though it is simply a matter of the public sector and the private sector, but that point of view ignores the existence of other countries. And it is much more complicated than trade deficits. If Coca-Cola manufactures soft drinks in Thailand (generating first costs in Baht) with raw materials sourced from multiple countries and then sells them in Indonesia (with revenues in Rupiah) after paying a freight shipper in USD, how does MMT square that? I am not wholly against the idea, but I do not understand how it can stand up when the private sector is actually dealing with a whole host of different currencies.

The following posts on the excellent New Wayland blog describe how foreign transactions work and their relationship with MMT. All are well worth a read, as are the rest of the posts on that blog:

I’m talking about the 20 years of policy to buy-back the debt. The conclusion of this paper that discusses contains the telling “the unconventional policy measures adopted by the BOJ have not succeeded in reversing the persistent deflationary tendency, and there has been limited effect on aggregate demand.”, which is in direct contradiction to mainstream economics expectations.

QE has also been used extensively in the UK and US since 2008 and we’ve had very low inflation.

Do you have an article that explains the kind of multicurrency transaction that I am talking about? These articles are all describing binary transactions as though they are between one country and another, when I am saying that transactions are actually much more complex than that.

Are you saying that, by practicing quantitative easing, these governments are practicing MMT in their monetary policy? Are you talking about MMT in descriptive terms or in normative terms here?

I am sorry; I think that there has been some conflation here. When I said that MMT is untested, what I meant was that no government has implemented a monetary policy that is in accordance with MMT.

The following three statements are independently different.
“Governments should set monetary policy in accordance with MMT.”
“Governments do in fact already set monetary policy in accordance with MMT.”
“This is simply how money works whether governments understand it or not.”
I was referring simply to the second one when I said “untested.”
My other questions were primarily about how the first one can work among countries with varying economic policies, especially countries that are already prone to deflation. (How could this system possibly work in Venezuela?)

I do not believe that QE is necessarily consistent with MMT or inconsistent with Keynesian economics; it is largely a question of how it is implemented.

I’m not sure what you’re looking for here. The final post “Anatomy of an FX transaction” describes a generic foreign currency transaction. What do you mean by a “multicurrency transaction”? How is that different to a set of individual currency transactions?

In answer to this and your other post, the point really is that MMT makes some strong predictions about the consequences of QE or bond purchasing and so far those predictions have been upheld (which is not what can be said for mainstream economics). The BoJ were actually looking to increase inflation, which didn’t happen (so really not exercising an MMT worldview at all). The US and UK were also trying to stimulate economic activity (again, MMT says the effect would be limited, and may even be counter-productive since it removes interest payments from very-low-risk investments).

MMT is more a statement about how the system is. Most MMT academics often profess a policy position in light of that, but MMT is really policy agnostic.

Quick aside, MMT says governments should set fiscal policy in accordance with MMT. The MMT position is monetary policy is super weak sauce at achieving policy objectives.

That’s a tricky question and is the subject of much discussion. I suppose the MMT position is that policy should be made with a view to (a) understanding the actual mechanics of the monetary system and (b) effecting change on real-world factors rather than monetary factors (e.g. develop local capabilities as much as possible to build a solid economy, rather than borrow money to fuel local consumption).

This topic came up a lot more often when Cory was still around.


Yeah, that’s why I thought people knew about it!

Thank you for clarifying. I suppose I was conflating fiscal policy and monetary policy there.

We have finally gotten back to where we started: “Governments do not currently set fiscal policy according to MMT, but should they?” We spent some time running in circles about the difference between “governments do vs. governments should,” but now that that’s settled, I think we are in a good place to discuss the should, particularly the implications of such a policy.

Let me get into my main concern: I can see how a fiscal policy based on MMT would work for a country like the US or the UK, which already have strong currencies. However, I do not see how such a policy framework could work in a country with a weaker currency. It is true that a country cannot go broke in its own currency, but a country that has a weak currency can see that currency reduced to worthlessness if money supply exceeds the value of goods/services that the country produces.

The fact is that, in a global economy, many countries, governments and corporations are forced to operate in other currencies than their own sovereign currency. Thailand cannot go broke in Baht, but what difference does that make when Thailand is expected to pay its debts in dollars, rather than Baht? Thailand has to earn dollars with its Baht, but to ensure that those Baht continue to get as many dollars as possible, they cannot afford deficit spending.

More importantly, what does it say about the state of the world when the US or the UK can just print more money that has value, while Thailand cannot? It seems to me that MMT fiscal policy is a great way for already rich countries to get the most out of their strong currencies, but I don’t see how it is great for other countries and, by extension, I don’t see how it is great for a global economy. Why should only rich countries be able to afford deficit spending?

They’re really good points, but don’t really impact on what viewing the world through an MMT lens looks like. If countries fail to recognise their ethical obligations, then MMT can’t fix that. What it can do though is to help understand what fiscal space and constraints are there to both implement effective foreign policy for the wealthy nations and effective domestic policy for the developing ones. It also gives us a way to understand what the effect of debt forgiveness might be.

Another point is to realise that export driven growth is really extractive, insomuch as it removes real resources from the export country and moves it to the import country. The wealthy countries have done very well out of that (despite what the usual commentary is on running trade deficits).

But the fact of the matter is that the United States has a fiscal policy in which expenditures are backed by tax and other revenues as well as bonds issued to cover deficits. It was one thing to say through the lens of MMT that they needn’t, but it is another thing entirely to actually dispense with all of that.

For sure, which it’s why we need to move the discussion on from tax to spend, to something a bit more accurate, to which perhaps politics will move too. We can’t leave everything to AOC and John Yarmuth. Hence the motivation for starting this discussion - to help a few people to see the light :smiley:.

To be sure, nobody benefits from having a debt ceiling. Getting rid of that would allow for optimization of how money is used, rather than where it comes from. Then again, the government (in the US at least) probably also could get by just with revenues if they stopped outright giving money to corporations and started buying goods and services from corporations at fair market prices instead.

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They couldn’t, for the reasons explained through a sectoral balances view of the economy.