When two original MMT developers get together to discuss their work - The Gower Initiative for Modern Money Studies

In this post, Professor Bill Mitchell provides a reference guide to the basic principles of MMT as seen by himself and another of the original MMT developers, Warren Mosler. This post was originally published on Professor Mitchell’s blog.

Last week, Warren Mosler and I had one of our regular catchups and we discussed at length the state of play in Modern Monetary Theory (MMT). We are quite protective of it. We mused about how we started out on this Project and where it has gone. As old stagers do when they get together. We also reflected and compared notes on what the state of MMT is now, given the increasing visibility of the ideas in the mainstream media all around the world and the proliferation of social media activists who have chosen to identify and promote our ideas. There were aspects of that development that we identified as being of concern for us and other aspects which we considered to be a cause for optimism (celebration is too strong a word). We thought it would be a good idea to take a breath and document what we considered to be the essence of MMT – as a sort of checklist for people who want a fairly precise account of the body of work. I agreed to write this document after input from Warren. So, this is what we mean by MMT. What follows is my account of our conversation expanded to add meaning where required.

Obviously, I have previously considered some of the things we discussed in these blog posts (among others):

1. Reflections on the 2nd International MMT Conference – Part 1 (October 3, 2018).

2. Reflections on the 2nd International MMT Conference – Part 2 (October 4, 2018).

And earlier:

3. The divide between mainstream macro and MMT is irreconcilable – Part 1 (September 10, 2018).

4. The divide between mainstream macro and MMT is irreconcilable – Part 2 (September 11, 2018).

5. The divide between mainstream macro and MMT is irreconcilable – Part 3 (September 12, 2018).

And even earlier:

6. Modern Monetary Theory – what is new about it? (August 22, 2016).

7. Modern Monetary Theory – what is new about it? – Part 2 (long) (August 23, 2016).

8. Modern Monetary Theory – what is new about it? – Part 3 (long) (August 253, 2016).

The concerns we discussed, initially, relate to matters I raised in the blog posts (1) and (2) above.

There is a tendency in the social media to use the term MMT as a slogan rather than relating to it as a coherent and body of academic work in economic theory and practice that has been meticulously developed over more than 25 years.

This tendency manifests in claims that the essence of MMT is that the capacity of the government to fund programs is unlimited and so there is massive scope for all sorts of progressive policies to be introduced.

Basic Principle 1: The beginning of the MMT ‘money story’

Societies that use state money are very different to barter-type system.

In a monetary society, the state is at the top of the monetary hierarchy. We cannot understand how such a system works unless we understand the functions of the state in this respect.

The MMT ‘money story’ begins with a state desiring to provision itself in order to fulfill the political charter for which it was elected by the people.

That meaning applies to democratic systems where the politicians go to the people with a stated mission and the winner forms government.

However, the ‘money story’ is not exclusive to democracies.

Any system, short of slavery, requires productive resources to be transferred, through free-will, from the non-government sector to the government sector in order to do the work of the latter.

That insight is the beginning of our journey.

Further, the state (generally through its designated agent, the central bank) is the sole supplier of that which it demands for payment of taxes.

The taxpayers do not have the capacity to meet their legal tax obligations defined by the state without the state acting first.

But the imposition of the tax liability is an important step in the ‘money story’ to understand.

What it means is that the tax liabilities (not tax payments) function to create sellers of goods and services in exchange for the required state tax credits, the latter which we refer to in common parlance as the state’s currency.

So we can think of a currency as being a tax credit with the state.

This provides a further insight that is intrinsic to MMT.

The tax liabilities function to create what we define as unemployment – where people seek work in exchange for the state’s currency.

Thus taxation is a way that the government can elicit productive resources and final goods and services from the non-government sector that it needs to advance its political agenda.

It is clear that the non-government sector has to get the currency before it can use it to pay its tax bills.

Where else could the non-government sector get the currency from to meet its legal liabilities to the government, if the latter did not purchase goods and services provided by the non-government sector or make transfers to that sector?

So the state can then provision itself by buying what is being offered for sale with its otherwise useless currency.

And thus we understand the basic operations involved.

The state, from inception, as the sole supplier of the funds needed to pay taxes or buy the debt issued by the state, must necessarily impose tax liabilities on the non-government sector before it can spend.

Given that the non-government sector requires fiat currency to pay its taxation liabilities, in the first instance, the imposition of taxes, without a concomitant injection of public spending, by design, creates unemployment (people seeking paid work) in the non-government sector.

The unemployed or idle non-government resources can then be utilised through government spending, which amounts to a transfer of real goods and services from the non-government sector to the government sector.

While real resources are transferred from the non-government sector in the form of goods and services that are purchased by government, the motivation to supply these resources is sourced back to the need to acquire fiat currency to extinguish the tax liabilities.

Further, while real resources are transferred, the taxation provides no additional financial capacity to the government of issue.

Conceptualising the relationship between the government and non-government sectors in this way makes it clear that it is government spending that provides the paid work which eliminates the unemployment created by the taxes.

This understanding provides a further insight.

State spending therefore, is constrained by what is offered for sale in response to tax liabilities.

But, importantly, spending by such a government is not operationally constrained by revenues.

Note here that this conclusion does not apply to the 19 Member States of the Eurozone because they surrendered their currency sovereignty and use a foreign currency instead.

Principle 2: The unemployment and Job Guarantee story

In a normal function economy, there will always be some unemployment as people move between jobs. Typically this state should be transitory and a low percentage of those willing and available for work. We call this an irreducible level of unemployment and it might be around 1 to 2 per cent, depending on the nation.

Anyway, unemployment in excess of that irreducible minimum is called mass unemployment.

And, bringing together the initial insights above we can conclude that unemployment is the evidence that state spending is insufficient to have hired all people that the state’s taxation has caused to become unemployed.

In the Post-World War 2 period where the so-called ‘Keynesian’ consensus operated mass unemployment was referred to as ‘demand-deficient’ unemployment, which described a situation where there is a shortage of jobs overall relative to the willing supply of labour resources (persons and hours) at the current wage levels.

The tag went beyond description though because it indicated that such unemployment arose because of a deficiency in aggregate spending.

Mass unemployment thus varies over the economic cycle – rising when aggregate spending falls below the level needed to fully employ the available workforce and falling when aggregate spending moves closer to the level needed to full employ the available supply of labour.

This conception is fully consistent with the way MMT characterises mass unemployment. The difference is the emphasis MMT places on the role of government and the operations of the tax liabilities.

Thus, mass unemployment arises because, after the non-government sector has implemented its spending and saving decisions, the level of spending in insufficient to create sales and output commensurate with the provision of jobs necessary to absorb the willing and available supply of labour.

The MMT emphasis is that this shortage arises because for a given state of tax liabilities, government spending is insufficient.

We thus understand that the remedy is to either to spend more into the non-government (which may involve hiring the unemployed directly) and/or reducing the tax liabilities.

Warren would say that the government should do this until the unemployed transition back to the non-government sector.

His view is that, initially, the government should provision itself as desired to the ‘right size’ as explained. And once the government is at it’s desired ‘right size’ the remaining unemployed can be transitioned back to the private sector.

I would express this a little differently by allowing the possibility that the Job Guarantee pool could be a permanent employment location for some workers if they so choose. Having a small fairly rigid buffer doesn’t reduce its price stability features.

I also understand that one could make a case to render these jobs permanent within the non-Job Guarantee part of the public sector, which then relates directly to Warren’s reference to the ‘right size’.

But the point is that the currency-issuing government always chooses the prevailing unemployment once the spending and saving decisions of the non-government sector are implemented.

In the current era, governments use the unemployed as a buffer stock to provide a price anchor for wages in the general economy.

In the ‘Keynesian’ full employment period, governments saw mass unemployment as a policy target – to be kept as low as possible within inflation limits they believed existed.

But in the neoliberal era, governments use unemployment as a policy tool to discipline wage demands and soften sales (thus putting a discipline on firms who might concede wage demands).

The unemployed buffer stock approach (sometimes called the NAIRU approach) is the way in which inflation control is managed.

However, the longer people stay unemployed the higher is the skill loss and non-government employers tend to prefer to hire from those already working or who have been unemployed for only short periods of time.

In other words, the disciplining power of unemployment requires that the unemployed constitute a threat to those still in work so that they will moderate their wage demands.

However, over time, the threat from this unemployment pool starts to wane as the unemployed endure skill losses and firms introduce new technologies and processes.

In this case, the so-called NAIRU has to be pushed higher and higher by contractionary fiscal and monetary policy for the same degree of threat to be maintained.

There are also massive costs involved in both income loss and personal pathologies (social exclusion, psychological harm, etc) that further compound the overall disadvantages of the unemployment buffer stock price anchor.

On any reasonable grounds, this approach to price stability is very costly and ultimately, unworkable in a modern economy.

High and sustained levels of unemployment, ultimately, undermine the social and political stability of a nation, which creates unintended costs that go far beyond those noted above.

These blog posts provide much deeper discussion of these points:

1. Buffer stocks and price stability – Part 1 (April 26, 2013).

2. Buffer stocks and price stability – Part 2 (May 13, 2013).

3. Buffer stocks and price stability – Part 3 (May 17, 2013).

4. Buffer stocks and price stability – Part 4 (May 24, 2013).

5. Buffer stocks and price stability – Part 5 (May 31, 2013).

The MMT alternative is that the government introduces a Job Guarantee policy to establish an employed buffer stock which provides a superior price anchor than the current policy that used unemployment as a buffer stock.

Warren sees the employed buffer stock as a means to promote the transition from unemployment to private sector employment.

I see that it can do that but may also be a permanent pool of workers who will never be able to gain private sector employment at current wages. My bias is not to privilege non-government employment over public employment.

But that doesn’t alter the fact that the Job Guarantee is an anti inflation policy that further renders the positive externalities of higher paying jobs for anyone willing and able to work.

These blog posts are also relevant:

1. Whatever – its either employment or unemployment buffer stocks (December 30, 2011).

2. MMT is biased towards anti-crony (December 28, 2011).

The Job Guarantee is a macroeconomic stability approach, which means it is much more than a simple public sector job creation policy.

As MMT has gained in popularity, there have been a number of different job guarantee proposals coming out of the woodwork, many of which claim to be derived from MMT.

Note the use of the lower case j and g in the previous paragraph.

However, there is only one Job Guarantee in MMT.

The Job Guarantee within MMT is a technical construct designed to replace the mainstream Phillips curve (the trade-off between unemployment and inflation).

The Job Guarantee is a superior buffer stock mechanism to mass unemployment for maintaining price stability.

And this means, that even if one didn’t hold the philosophical or moral commitment to the ‘right to work’ they would still advocate a Job Guarantee (MMT style) in contradistinction to the NAIRU-approach which uses unemployment as the buffer stock price anchor.

They would have to agree that in efficiency terms – which relates to resource wastage etc – the employment buffer stock approach is superior to the current dominant alternative.

The Job Guarantee disciplines inflation because the government offers anyone a job at a fixed wage that is at the bottom of the wage structure.

In times of inflation pressures, the government can use fiscal policy to redistribute workers from the inflating sector to the fixed price Job Guarantee sector.

Clearly, it is desirable to keep the Job Guarantee buffer stock at a minimum.

And so fiscal policy adjustments can be implemented to keep the Job Guarantee pool at minimum required levels to achieve desired price stability.

Principle 3: The Public Debt story

In trying to understand, the issuance of public debt, we note that funds spent by the State into the non-government sector (for goods and services) is either lost to the economy when taxes are paid, or remains in the economy as savings until used to pay taxes.

That is just a matter of accounting.

The ‘savings’ are stored as financial assets in various forms.

As a matter of accounting between the sectors, a government fiscal deficit (spending that isn’t matched by taxes) adds net financial assets (adding to non government savings) available to the non-government sector and a fiscal surplus has the opposite effect.

The last point requires further explanation as it is crucial to understanding the basis of MMT.

Given the current bias toward (unnecessarily) matching fiscal deficits (spending greater than tax withdrawals) we say that what is commonly termed the ‘public debt’ is really just the accounting record of the savings – the funds spent by the state that have not yet been used to pay taxes.

In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending.

The government, as the currency monopolist, is the only entity that can provide the non-government sector with net financial assets (net savings) and thereby simultaneously accommodate any net desire to save (financial assets) and eliminate mass unemployment.

In accounting terms, the government’s deficit (surplus) is exactly equal at all times the non-government sector’s surplus (deficit).

All this ties in with our previous discussion by allowing us to see the limits on government spending.

It is clear that government spending has to be sufficient to allow taxes to be paid.

In addition, net government spending is required to meet the private desire to save (accumulate net financial assets).

It is also clear that if the Government doesn’t spend enough to cover the taxes to be paid and the non-government sector’s desire to save overall, then the manifestation of this deficiency will be unemployment.

In MMT, the basis of this deficiency is at all times inadequate net government spending, given the private spending (saving) decisions in force at any particular time.

Further, fiscal deficits manifest in the non-government sector as actual cash balances in banks and credit balances in reserve accounts and securities (debt) accounts that are maintained by the central bank in the nation.

All commercial banks hold reserves at the central bank as part of the ‘clearing system’, so that all the transactions that occur on a daily basis can be validated and resolved.

The debt accounts record the outstanding government debt in various forms (short-term and long-term) that has been issued to match the fiscal deficits.

If you think about the process through which net government spending initially create an increase in net financial assets in the non-government sector you will appreciate that spending effectively involves the government crediting bank accounts in the non-government sector and taxing involves the government marking down bank account balances.

A fiscal deficit means there is a net accretion in these accounts. Initially, after all the transactions are made between government and non-government and within the non-government sector, that net accretion shows up as increases in the banks’ reserve accounts at the central bank.

Interest may or may not be paid on those balances.

If the deficit is matched dollar-for-dollar with debt issuance then the government would debit (mark down) the balances in the reserve accounts (of the banks that were party to the debt purchases directly or through their clients) and credit (mark up) another ‘account’ which we can call ‘outstanding public debt’.

In other words, the debt issuance effectively just results in funds in reserve accounts being transferred to funds in the ‘outstanding public debt’ account.

When specific debt items (bonds) mature (that is, reaches the time that the government has to pay back the principal), a reverse operation would occur.

The ‘outstanding public debt’ account would be debited (marked down) and bank reserves would be credited (marked up).

And if the central bank was to pay market rate of interest on reserve balances (as many are currently doing) then there is functionally no difference between the impact of leaving funds in the reserve accounts as opposed to issuing debt and transferring the funds to the ‘outstanding debt account’.

This also means that traditional open market operations, where the central bank buys and sells public debt to the non-government sector in order to drain or add reserves such that there is an appropriate balance that allows it to maintain its current interest rate target is unnecessary.

Some further points.

First, the debt issuance does not fund the net public spending. It just gives the non-government sector an alternative financial asset in which to store its overall saving.

The net spending would occur without the debt being issued.

Second, the funds used by the non-government second to purchase the debt came from past fiscal deficits that had not been taxed away.

Third, if the government was concerned about the interest rate (yield) it was paying on the debt it issues, then the central bank can always control that yield through appropriate purchases of that debt itself, which influence the price of the assets in the market and thus the yields.

This changes the interest paid by government from the market yield of the debt purchased to the rate paid by the central bank on reserve balances.

Fourth, the central bank can always purchase any debt that the private sector chooses not to purchase via the primary auctions. There may be legislative or regulative rules that apply here but they are creatures of the government anyway.

The last two observations mean that there is never a reason for government bond yields to rise above a level that the government considers to be acceptable.

Which means that a currency issuing government (which is the consolidation of the Treasury and central bank) can always assume the role of its own largest lender and borrow as much as it likes from itself (subject to laws it itself makes etc).

Fifth, governments always have the option of issuing only short-term debt anyway.

There is a distinction between the interest the government pays and the yields on longer term government bonds, as the government can elect to not sell long-term bonds if it doesn’t want to pay those rates. But it might want long-term bond yields to be lower for other reasons, such as the cost to private borrowers for home mortgages.

But even in that instance, the government can use the banking system to fund those at any rate it elects.

Principle 4: The Price Level story

We define ‘inflation’ as a continuous increase in the price level. A once-off rise in prices in not considered to be an inflationary episode.

In MMT, given the currency is a state monopoly, the state becomes the ‘price setter’ because the price level is necessarily a function of the prices paid by government when it spends or the collateral demanded when it lends.

This ties in with the Job Guarantee as a macroeconomic stabilisation framework within MMT. As the government is offering jobs at a fixed price to anyone with a zero bid for their services in the ‘market’, that spending becomes a price anchor.

A continuous increase in the price level will not be the case unless the state keeps bidding for goods and services in the market at the continuously higher prices.

All spending in the economy carries an inflation risk if it tries to compete on a continuous basis for real resources that are currently fully utilised.

We need to understand that a once-off increase in government (or non-government) spending will typically not generate an inflationary episode.

The price level might rise as mark-ups are applied to the higher costs but such an impact is finite.

Typically, there are spare resources available for purchase, and, as such, the inflation risk is low.

But history tells us that this is not necessarily the case. There are well-documented examples where unemployment has been high and there is a concomitantly high inflation rate. Venezuela and Turkey are current examples. The stagflation that beset the West after the OPEC oil price rises in the 1970s is another example.

We understand those examples, within MMT, by realising that, ultimately, the inflation continues because the government paying more for the same ‘basket’ of goods and services, through various means such as indexation policies.

But it should be understood that the ultimate constraint on government spending is not financial but real – the actual resources that are available for sale.

Principle 5: The fiscal sustainability and fiscal space story

In the mainstream macroeconomics, the concept of fiscal sustainability and fiscal space is defined in financial terms.

For example, the IMF defines fiscal space in this way:

… (the room in a government’s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy. The idea is that fiscal space must exist or be created if extra resources are to be made available for worthwhile government spending. A government can create fiscal space by raising taxes, securing outside grants, cutting lower priority expenditure, borrowing resources (from citizens or foreign lenders), or borrowing from the banking system (and thereby expanding the money supply). But it must do this without compromising macroeconomic stability and fiscal sustainability – making sure that it has the capacity in the short term and the longer term to finance its desired expenditure programs as well as to service its debt.

MMT rejects these notions outright.

You cannot fiscal space or sustainability by some given deficit size relative to GDP or some threshold level of public debt to GDP or any other self-referencing ‘financial’ ratio.

The concept of fiscal sustainability cannot be meaningfully defined in terms of any notion of public solvency. A sovereign government is always solvent (unless it chooses for political reasons not to be!).

The concept of fiscal sustainability will not include any notion of financing imperatives that a sovereign government faces nor invoke the fallacious analogy between a household and the government.

The concept of fiscal sustainability will not include any notion of foreign ‘financing’ limits or worries about foreign ownership of a sovereign government’s debt.

We have learned that:

a sovereign government is not revenue-constrained which means that fiscal space cannot be defined in financial terms.
the capacity of the sovereign government to mobilise resources depends only on the real resources available to the nation.

But, saying a government can always credit bank accounts and add to bank reserves whenever it sees fit doesn’t mean it should be spending without regard to what the spending is aimed at achieving.

The concept of fiscal sustainability is more appropriately defined in terms of societal goals such as well-being.

For example, fiscal sustainability is directly related to the extent to which labour resources are utilised in the economy.

The goal is to sustain full employment, which is the base case in an efficient economy that seeks to avoid resource wastage.

Once the government assumes its responsibility to achieve and sustain full employment there are specific requirements imposed on its spending.

In this blog post – The full employment fiscal deficit condition (April 13, 2011) – we learned that:

The lessons, in summary, are:

1. A macroeconomy is in a steady-state (that is, at rest or in equilibrium) when the sum of the spending injections equal the sum of the spending leakages. Whenever this relationship is disturbed (for example, by a change in the level of injections, however sourced), national income adjusts and brings the income-sensitive spending leakages into line with the new level of injections. At that point the system is at rest again.

It should be understood though that the system is in constant flux and equilibrium defined in this way is being continually disturbed. The resulting income changes work to bring the injections and leakages back into balance.

2. The injections come from export spending, investment spending (capital formation) and government spending.

3. The leakages are household saving, taxation and import spending.

4. For every ‘agent’ that spends more than their income, another ‘agent’ necessarily spends less than their income.

Any government, corporation, resident or non-resident can run deficits (spending more than they earn). For example, those who spend more than their incomes include households borrowing to purchase houses, businesses borrowing to invest in new capital equipment, and governments that spend more than they extract in taxes. On the other side, households and businesses that save are running surpluses.

5. An economy at rest is not necessarily one that coincides with full employment or has all desired savings realised.

6. When an economy is ‘at rest’ and there is high unemployment – there must be a spending gap and unmet saving desires – given that mass unemployment is the result of deficient demand (in relation to the spending required to provide enough jobs overall).

7. If there is no dynamic which would lead to an increase in private (or non-government) spending then the only way the economy will increase its level of activity is if there is increased net government spending – this means that the injection via increasing government spending has to more than offset the increased drain (leakage) coming from taxation revenue.

8. To sustain full employment, the fiscal deficit has exactly offset the gap left by non-government leakages being greater than the injections.

If the fiscal deficit is not sufficient, then national income will fall and full employment will be lost. If the government tries to expand the fiscal deficit beyond the full employment limit, then nominal spending will outstrip the capacity of the economy to respond by increasing real output and while income will rise it will be all due to price effects (that is, inflation would occur).

In some cases, a fiscal surplus will be required to sustain full employment without inflation should the non-government injections outstrip the leakages (say if the export sector is particularly strong).

A government operating according to those rules is conducting a sustainable fiscal policy.

The fiscal balance that arises under those conditions is whatever it is.

There is nothing intrinsically good or bad about a fiscal deficit of 2 per cent of GDP, compared to a deficit of 10 per cent of GDP or a fiscal surplus of 3 per cent of GDP.

Assessing fiscal sustainability requires us to understand the context which means we have to understand the saving and spending decisions of the non-government sector.

This also ties in with the MMT concept of fiscal space, which is about unmet savings desires as evidenced by the existence of mass unemployment.

In a modern monetary economy, fiscal space has nothing to do with what the current fiscal balance is or has been and what the current public debt ratio is or has been.

A sovereign government can purchase any idle resources that are for sale in its own currency, including all idle labour.

The available resources (good and services) that are for sale in the currency of issue defines how much fiscal space the government has.

Such a government can never run out of funds in pursuing its goal to ensure all available resources are being productively deployed.

So a past deficit poses no particular constraints on what the government can do in the future, except to say that if the deficit has been properly calibrated to sustain full-employment fiscal then there will be less to do should the private sector contract.

To better understand the concept of fiscal sustainability and disabuse yourself of the false claim that it is somehow related to deficit history or public debt ratios, the following introductory suite of blog posts will help:

1. Fiscal sustainability 101 – Part 1 (June 15, 2009).

2. Fiscal sustainability 101 – Part 2 (June 16, 2009).

3. Fiscal sustainability 101 – Part 3 (June 17, 2009).

4. The full employment fiscal deficit condition (April 13, 2011).

5. Fiscal space has nothing to do with public debt ratios or the size of deficits (August 30, 2018).

Principle 6: The currency sovereignty story

To finish the discussion we can now clarify the MMT meaning of currency sovereignty.

Some people seem to think that monetary sovereignty is about being able to buy everything a nation might need to be prosperous.

I note that Warren prefers not to use the term ‘sovereignty’ because in his view it leads to confusions such as the statement in the preceding sentence.

I prefer to use the designation however.

In common parlance, the term relates to the power of the government. But what I think MMT shows is that there is a sharp difference in the capacity of a government that I has ‘monetary sovereignty’ (defined below) and one that does not.

The Eurozone governments are ‘sovereign’ in the common parlance but not in the MMT parlance because they use a foreign currency.

That is why I prefer to use the term.

However, Warren and I agree on the substance that follows.

In MMT, currency-issuing countries that do not borrow in foreign currencies or peg their currencies by any arrangement are sovereign in that currency.

Such a government, which in MMT represents the base case for conduction monetary and fiscal policy:

1. Spends and taxes in its own currency exclusively.

2. Its central bank sets policy interest rate. The preferred setting is at zero per cent.

4. The currency floats.

5. The Government does not borrow in any foreign currency.

Accordingly, that government can purchase anything that is available for sale in that currency including all idle labour.

As a result no productive resources ever need to be idle if they are looking to be used.

Of course, it does not mean that a country devoid of natural resources or dependent on imports for food and energy will generate prosperity just because its government can ensure all productive resources are working.

If no other nation desires the exports of that sort of country then it remains materially poor regardless of how ‘sustainable’ the government’s fiscal policy is.

This blog post goes into much more detail – Ultimately, real resource availability constrains prosperity (February 11, 2016).