Modern Monetary Theory – An Overview

I’ll try to provide brief, working definitions to everything below. Before I dig in, I just want everyone reading to know that I’m not an economist, I am not an expert on anything pertaining to economics, and for all I know everything I’m about to tell you is dead wrong and I’m an idiot. Now, with that out of the way:

In my recent travels around the internet, I happened across the blogs of Bill Mitchell and Warren Mosler, which discuss Modern Monetary Theory (MMT). MMT is a macroeconomic theory which tries to explain the operation, structure, and behavior of national economies (as all macroeconomic theories do). This puts it in the same league as Keynesianism and Monetarism. Keynesianism is an economic theory that states that private sector organizations will often make decisions that are good for themselves but that may lead to a net bad for the economy/society as a whole. The public sector (government) must step in and, through either direct spending/stimulus or fiscal manipulations, correct these problems and restore balance to the up-and-down business cycle. Essentially, when the economy starts tanking, the government should step in and spend money to stop the decline and prevent or lighten a recession. Monetarism also believes in public sector intervention, though it places a much higher emphasis on regulating the supply of money and managing interest rates via central banks. Monetarists tend to look down on excessive government spending and direct interventions and instead manipulate the money supply. Roughly speaking, US economic policy from the New Deal until the early 1980s was mostly Keynesian, while policy from the early 1980s until today has been roughly Monetarist.

But MMT has fascinated me, because it claims both of these schools of thought are fundamentally in error. If its proponents are correct, then the way that we currently think about the national economy is very wrong, often backwards, and extremely harmful to our own well-being. We have been systematically under-investing in the economy and in our human capital since at least the 1970s. Why do I say the 1970s? Because that’s when we switched from the gold standard to a fiat currency, and that switch subtly changed the nature of our government’s relationship to the economy.

More definitions. A country on the gold standard holds a certain amount of gold in reserve and bases the value of its currency on the weight of this gold. A dollar under the gold standard is directly convertible into some amount of gold. When you acquire more gold, you can print more dollars. If you have printed as many dollars as your gold supply allows you to and then print some more, the worth of an individual dollar decreases (inflation). So basically, the total amount of money that can circulate through the economy and be spent by either the public or private sectors without having inflation is restricted by the amount of gold at hand and the conversion rate of dollars to gold. A similar dynamic is at work for other money systems based on commodities such as silver, salt, etc.

Fiat currency is more interesting. It is not based on any commodity and individual notes (dollars) are actually worthless in and of themselves””you cannot convert them into gold, silver, or anything else. So why does anyone use this worthless money? Because the government exercises its sovereign power to mandate that taxes be collected in its currency. The private sector (companies and individuals) needs this currency to meet its tax obligations to the state. This enforces the use of the fiat currency. I’ve stated above that I find this an interesting currency system””in my mind, its basic operating principle is much more about power dynamics and the state’s monopoly on violence then it is about inherent values of commodities and exchanges. It’s more honest, in a way. A longer and more interesting definition of both of these standards can be found here.

So, I’ve briefly defined Keynesian and Monetarist economics and have also defined gold and fiat currency standards. Where does MMT come in? Proponents of MMT claim that Keynesians and Monetarists and most people who take any interest in the national economy today still reason as though we’re on the gold standard. To understand why, I’m going to move on from the definitions of the gold and fiat standards and discuss their dynamics””how they function and “move.”

On the gold standard, the total amount of money in circulation is constrained by the amount of gold the nation possesses and the value of that money in relation to the gold””X dollars is worth Y ounces of gold, and we only have so much gold to go around. Now imagine that the national economy is running at the maximum amount of dollars allowed by this standard. If the government wants to spend money on a new program then it has to either raise taxes to bring in more money from the private sector or it has to issue debt and sell it. The first part of that (taxes) is pretty straightforward, but the second is a little unintuitive to me. Here’s what it means: the government “sells” its debt to private sector or foreign national buyers and these buyers basically provide the money to the government, to be repaid over time and with interest. So under taxation, money is sent from the private sector to the public sector to then be spent by the public sector. With debt issuance, money is provided to the public sector by the private sector and is expected to be repaid. Either way, the government is taking in money from the private sector (or foreign governments) to provide for its expenditures.

This is the “household” model of government spending, which functions in a somewhat similar manner to how you and I balance our checkbooks or take out and repay loans. All the government officials, economists, and people-in-the-street that are worried about the federal deficit and about the crushing burden we’re placing on our kids are worried about repaying the debt-generated loans outlined above. They worry that if the government’s repayment fees are too high it won’t be able to pay for things like Social Security, Medicare, infrastructure, education, etc. And under a gold standard they would be correct to worry.

Proponents of MMT claim that under a fiat currency regime it’s wrong (and damaging) to worry about federal debt. Under a fiat regime:

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 ”œwhat 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 funds.

There are other implications of a fiat currency regime, but these are the most interesting and unconventional in my mind. This is what Modern Monetary Theory is all about””the actual implications of a sovereign government issuing its own fiat currency. Note that I’ve been trying to explicitly reference the federal government here, since it issues currency. State, city, and other local governments do not issue currency and must therefore balance their budgets””they rely on tax income for their expenditures.

Some of you may be thinking that what I just outlined has little to do with economic reality in the US at this time. If we’re on a fiat currency system, why are we so worried about federal debt? Why is Obama calling for a freeze in (some) government spending? Why are we talking about entitlement reform? Well, we are on a fiat currency system. The reason that we’re so worried about these things is that we think we’re still on a gold currency system and have been behaving accordingly. The US government still issues debt commensurate with its expenditures, but it doesn’t have to. What is outlined above is the potential of a fiat system. We and every other fiat nation on Earth are operating under voluntary restrictions that keep us acting like we’re on the gold standard when it comes to government debt and money supply.

These voluntary restrictions are only voluntary in that we’re not fully aware of them and do not have to operate with them. And they have led to prolonged, systematic underinvestment in our economies””both their physical capital and human labor. I’ll have more on this and other topics in a later post (for example, running the economy at full steam will bid up the price for oil, so some of the assumptions above have big caveats). For now, I’ll leave you with this thought: Under a fiat regime, running a federal budget surplus is usually a bad thing and will often lead to recession.

Further reading:

A Simple Business Card Economy
Some Neighbors Arrive (a model of MMT)
A MMT Lullaby
What is a Government Sovereign in Its Own Currency?
Fiscal Sustainability 101 – Part 1
Fiscal Sustainability 101 – Part 2
Fiscal Sustainability 101 – Part 3
MMT Q&A Part 1
Who is in Charge?

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  • I used to post frequently at Agonist until I, like Bolo, happened upon MMT through a comment on a blog. After discovering it, I jumped in with both feet, which is why I haven’t been around here lately.

    At first, I was tempted to dismiss MMT as far-fetched but the author of the comment provided references, as Bolo, as done. I decided to check it out and what I read blew my sock off. It was as if the scales fell from my eyes and I could see the operational reality of economics and finance clearly for the first time.

    Since discovering MMT, I have been spending most of time since on the MMT blogs and reading as much as I can about and its policy applications. I am convinced that t MMT is the holy grail not only of economics and finance but also their progressive application to policy-making. MMT is purely descriptive of the currency monetary system, but it’s implications for progressives are enormous in that it shows how all the fiscal responsibility stuff is just nonsense. Yes, progressive goals are fully fundable when one understands how the present monetary system works.

    The chief argument that progressivism faces is, “We can’t afford it.” Even the president is announcing from the bully pulpit, “The country is going bankrupt.” No only is no such thing happening, but also it can’t happen under the currency monetary system.

    Bolo’s links are great. However, for those who don’t have some economic chops already, Bill MItchell’s blog can be a bit intimidating at first. In my opinion, if your Econ 101 is rusty the best place to start in understanding the basics of MMT is Warren Mosler’s 7 Innocent Deadly Frauds. While at Warren’t site, check out the required readings as well. Randy Wray’s Understanding Modern Money: The Key to Full Employment and Price Stability (1998) is an excellent book, written for non-economists. Also check out the Financial Stability Teach-In taking place in D.C. on April 28th. Some of the MMT heavy hitters will be presenting.

    Here are some MMT bloggers for those interested in pursuing this:

    Marshal Auerback

    Scott Fulwiller

    Bill Mitchell

    Warren Mosler


    L. Randall Wray

    There are also a number of working papers by these and others writing in the field that are available (free) at

    The Levy Institute

    and the

    Center for Full Employment and Price Stability

  • A government that is the monopoly provider of a nonconvertible currency of issue with a flexible exchange rate does not tax to fund disbursements. Taxes just withdraw funds from nongovernment to prevent inflationary pressure. Similarly, the government does not finance itself with debt, and it extinguishes its debts are extinguished with currency it issues. In fact, there is no financial reason that such a government needs to use debt at all. Excess reserves can be neutralized in other ways. Monetarily sovereign governments with fiat currencies are not financially constrained.

    The only constraint on such governments is real resources. if the government issues too much currency relative to real output capacity, then inflation will result and if not enough, then an output gap will open and there will be recession and rising unemployment. The accounting is simple. If spending power (nominal aggregate demand) not equal the goods and services available for sale, (real output capacity), then some goods and services will not be purchased, inventories will increase, business will cut back, unemployment will increase, and contraction will set it. Thus, to maintain full capacity utilization, government must make up the shortfall in demand (unless the shortfall is offset by increasing exports, unrealistic for the US). Otherwise, there will be a recession and unemployment.

    The government as currency provider has the prerogative and corresponding responsibility to provide the correct amount of currency to balance spending power (nominal aggregate demand) and goods for sale (real output capacity). If the government issues in excess, then demand will rise relative to the goods and services available at full output, and inflation will occur due to a glut of money. If the government falls, short in maintaining this balanced, then recession will set in and unemployment will rise, due to a glut of goods and services offered for sale.

    Right now, the US government needs to run a larger deficit to close an output gap and reduce unemployment that cost the country a huge amount in terms of foregone opportunity. The risk of creating inflation now is zero, and the rise of national debt reflects the increased desire to save, along with a current account deficit. The “national debt” is really the nation’s net financial savings. Treasury securities are someone’s savings that will eventually be either spent or invested.

  • 1. In the US the federal government is the currency issuer and firms, households and states are currency users. Any analogy comparing federal government finance to non-federal government finance is therefore invalid. There is just no parallel. In fact, issuer and users are opposites.

    2. Being the sovereign provider of a non-convertible floating rate (fx) currency of issue, the US government is not financially constrained. This means that the federal government does not need to tax or borrow to finance its deficit spending. To say that the government will go bankrupt, become insolvent, run out of money or default on its debt is like saying that a scoreboard will run out of points. It is more than erroneous, it is simply ridiculous.

    2a. While the federal government is not financially constrained since it issues its own non-convertible floating rate currency, there is the real constraint of inflation occurring if nominal demand exceeds real output potential. At this point the government must either cut discretionary spending to decrease its input into the economy, or else raise taxes to withdraw currency from the economy. Both reduce nominal aggregate demand. Conversely, when the public desires to save instead of spend, especially coupled with a trade deficit, if business does not fill the gap with investment, then the government must spend in order to fill the gap in nominal aggregate demand or there will be a real output gap and rising unemployment.

    3. The government’s prerogative as currency issuer entails a corresponding obligation to provide sufficient currency to the economy for public purpose, which includes facilitating commerce and providing for the general welfare. In this sense, the money that the government provides is a public utility. The government is the monopoly provider of its currency of issue by law, and the government only accepts own currency in payment of taxes, fines and fees, establishing an ongoing need for the currency. Currency issuance provides the funds to pay taxes, not the other way around, as many erroneously believe. Note well: The federal government does not need to go to the public and business to get money to spend. It just issues its own currency. This is done mostly through simple accounting entries instead of printing Federal Reserve notes or minting coin, as many erroneously imagine.

    3. Government deficits result in non-government surpluses (increase in net financial assets). Government surpluses result in non-government deficits (decrease in net financial assets). Non-government net financial assets are employed in the economy to create real assets. The government uses the money it issues to fund its operations and other expenditures. Through its expenditures (deficits) the government adds to the net financial assets of non-government. Commercial banking cannot increase or decrease net financial assets because all its transactions are essentially credit or transfer transactions that net to zero on the books. On balance, government deficits are therefore “good” instead “bad.” They only become “bad” if they lead to nominal aggregate demand exceeding the real output capacity of goods and services and the government doesn’t act by cutting discretionary spending AKA pork, or raising taxes in order to prevent inflation.

    4. As long as there are goods and services for purchase, the government can purchase them. The things that government purchases are to further the public purpose, such as defense, education, social insurance programs like SS and unemployment insurance, social welfare such as food stamps, and health care (VA, Medicare, Medicaid at present). There is no reason that the government cannot extend this purchasing power to include universal health care and meet its future obligations to Medicare and SS, as well as defense, and other necessary spending. This doesn’t have to be paid for by taxes, or by borrowing, and the government can negotiate the prices it is willing to pay for the services it wants to purchase in private markets. The government can also contract for services to administer the system in the private market, as it does in other areas. Incidentally, the government can also make unemployment a thing of the past by instituting a job guarantee as employer of last resort. (It’s had no problem shoveling funds to Wall Street as lender of last resort.) There is no obstacle to getting this done other than removing the ignorance that stands in the way of it.

    Virtually all the counter-arguments are based on mistaken premises that fail to take into account that when Nixon closed the gold window on August 15, 1971, the US monetary system shifted from a convertible fixed fate currency to a non-convertible floating rate one. This involves an entirely different financial and economic dynamic that renders obsolete the current conservative shibboleths, which liberals and progressive often unwittingly embrace at their peril. Progressives really need to study up on this, or they will continue to sabotage themselves by falling for a conservative established narrative that is based on erroneous assumptions and misleading memes like “fiscal responsibility,” which falsely assert that social programs are unaffordable, or that they steal from the real economy and undermine national prosperity. It’s just nonsense.

  • And for the additional comments below, which expand on my tiny introduction to the topic. I made this post mostly because it was very hard to find a single, short introduction that placed MMT in context and quickly spelled out its principles. Granted, I didn’t hit all (or even most) of its principles here, but I think its a start.

    For those reading this who are not familiar with econo-speak at all, the first 2 or 3 links at the bottom of my own post are pretty intuitive to follow.

    Also, I’m a little wary of some of Mosler’s statements about imports/exports, but I haven’t read him as much as Mitchell–so I could just be mistaken.

    I’m still digging into this stuff as well. If MMT and its associated thinkers are correct, then what they’ve discovered (hypothesized, created, etc.) is extremely important. It has a bearing on virtually every discussion we have here at the Agonist and on most blogs I read that are at all concerned with the economy and politics. I also agree that its an inherently progressive (maybe event Left) paradigm for approaching economics, the state, and public welfare.

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