MMT — the key insights

31 Jul, 2019 at 10:25 | Posted in Economics | 20 Comments

As has become abundantly clear during the last couple of years, it is obvious that most mainstream economists seem to think that Modern Monetary Theory is something new that some wild heterodox economic cranks have come up with. That is actually very telling about the total lack of knowledge of their own discipline’s history these modern mainstream guys like Summers, Rogoff and Krugman have.

New? Cranks? Reading one of the founders of neoclassical economics, Knut Wicksell, and what he writes in 1898 on ‘pure credit systems’ in Interest and Prices (Geldzins und Güterpreise) soon makes the delusion go away:

It is possible to go even further. There is no real need for any money at all if a payment between two customers can be accomplished by simply transferring the appropriate sum of money in the books of the bank

A pure credit system has not yet … been completely developed in this form. But here and there it is to be found in the somewhat different guise of the banknote system

We intend therefore​, as a basis for the following discussion, to imagine a state of affairs in which money does not actually circulate at all, neither in the form of coin … nor in the form of notes, but where all domestic payments are effected by means of the Giro system and bookkeeping transfers. A thorough analysis of this purely imaginary case seems to me to beworthwhile​e, for it provides a precise antithesis to the equally imaginary​ case of a pure cash system, in which credit plays no part whatever [the exact equivalent of the often used neoclassical model assumption of ‘cash in advance’ – LPS] …

For the sake of simplicity, let us then assume that the whole monetary system of a country is in the hands of a single credit institution, provided with an adequate number of branches, at which each independent economic individual keeps an account on which he can draw cheques.

What Modern Monetary Theory (MMT) basically does is exactly what Wicksell tried to do more than a hundred years ago. The difference is that today the ‘pure credit economy’ is a reality and not just a theoretical curiosity — MMT describes a fiat currency system that almost every country in the world is operating under.

In modern times legal currencies are totally based on fiat. Currencies no longer have intrinsic value (as gold and silver). What gives them value is basically the simple fact that you have to pay your taxes with them. That also enables governments to run a kind of monopoly business where it never can run out of money. A fortiori, spending becomes the prime mover and taxing and borrowing is degraded to following acts. If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not a major problem since fiat money means that governments can always make more of them.​

In the mainstream economist’s world, we don’t need fiscal policy other than when interest rates hit their lower bound (ZLB). In normal times monetary policy suffices. The central banks simply adjust the interest rate to achieve full employment without inflation. If governments in that situation take on larger budget deficits, these tend to crowd out private spending and the interest rates get higher.

What mainstream economists have in mind when they argue this way, is nothing but a version of Say’s law, basically saying that savings have to equal investments and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity, there is, of course, nothing to say about the law, but as such, it is also totally uninteresting from an economic point of view. What happens when ex-ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex-post. And this, nota bene, says nothing at all about the success or failure of fiscal policies!

For the benefit of our latter-day​ ‘New Keynesian’ mainstream economists, let’s see what a real Keynesian economist has to say about crowding out and government deficits:

Fallacy 3
Government borrowing is supposed to “crowd out” private investment.

The current reality is that on the contrary, the expenditure of the borrowed funds (unlike the expenditure of tax revenues) will generate added disposable income, enhance the demand for the products of private industry, and make private investment more profitable. As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly, (instead of trying to counter the supposedly inflationary effect of the deficit) those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “Supply creates its own demand” fails as soon as some of the income generated by the supply is saved, but investment does create its own saving, and more. Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.

William Vickrey Fifteen Fatal Fallacies of Financial Fundamentalism

It is true that MMT rejects the traditional Phillips curve inflation-unemployment trade-off and has a less positive evaluation of traditional policy measures to reach full employment. Instead of a general increase in aggregate demand, it usually prefers more ‘structural’ and directed demand measures with less risk of producing increased inflation. At full employment deficit spendings will often be inflationary, but that is not what should decide the fiscal position of the government. The size of public debt and deficits is not — as already Abba Lerner argued with his ‘functional finance’ theory in the 1940s — a policy objective. The size of public debt and deficits are what they are when we try to fulfil our basic economic objectives — full employment and price stability.

That governments can spend whatever amount of money they want is a fact. That does not mean that MMT says they ought to — that’s something our politicians have to decide. No MMTer denies that too much of government spendings can be inflationary. What is questioned is that government deficits necessarily is inflationary.


  1. The problem with MMT is its fervent belief in chartalism, despite the fact that most dollars in the world will never be taxed. MMT also, and relatedly, ignores Eurodollars which are dollars issued outside the “monopolistic” control of the US. MMT is very backwards in denying that the private sector creates net financial assets.
    One has but to look at US Treasuries outstanding compared to reserves to see that created bank money buys most government bonds. Then you can repo the bonds to government agencies for Fed reserves. Thus bank-created credit turns into new reserves …

  2. The recurring pattern we see is: After a crisis, (1929-1944 for example), we re-boot capitalism. This works well for some period of time. Private debt is low, having been defaulted or paid down with the private surplus implied by large government fiscal deficits during the crash. After WWII, our total private debt to GDP ratio was 0.5! Banks are conservative in their lending. There is virtually no bank financed speculative investment. House flipping, and debt financed stock buy backs are virtually unknown. Banks earn their keep by managing real entrepreneurial risk, judging entrepreneurs character, and assiduously studying their track record and accomplishments.
    This period of successful investment leads banks to believe they could make more money by extending more credit, ie, by loosening lending standards. Moreover, certain asset classes, housing, urban real estate, and so forth, establish a price history of uninterrupted aggregate price increases driven by this success by banks. Now banks assume certain asset classes are bullet proof forms of collateral. Banks cautiously begin to lend against this asset class even to price speculators who also have noted the perfect aggregate price gains of this asset class. This creates a positive feedback loop; banks lend evermore newly created credit money to speculators who drive up prices, justifying more bank lending and so on. In this phase, credit expands exponentially and total private debt to GDP climbs. In 2008, TPD/GDP reached a high of 1.7.
    Inevitably this process leads to another crash as real surplus grows far below private debt. Ultimately, private debt must be repaid from economic surplus which of course is not created by asset price speculators.
    This is the financial instability hypothesis of Hyman Minsky. This was effectively modeled and computer simulated by Steve Keen. It explains our experience of repeated financial crises by noting that capitalism as currently implemented is inherently unstable.
    MMT fails to frame its policy advice in this context. This is a serious failing. If we don’t identify the build up of private debt driven by ever expanding private credit by banks, as our main problem, and focus on using fiscal policy to reduce total private debt (as we did in WWII, diverting private consumption to savings while running massive deficits), MMT will not be a permanent policy fix for this inherent weakness of Capitalism.

    • “Inevitably this process leads to another crash as real surplus grows far below private debt.”
      This is where your analysis went off the rails, for me. No physical shortage caused the 2008 recession; there was a psychological panic among traders creating a run on liquidity. The collateral actually was bullet-proof; traders just stopped believing it. But they believed in Fed dollars the Fed created by keystroke to make a market in the arbitrarily devalued collateral …

      • It’s the burden of private debt service that leads to instability. Workers share of output falls, aggregate demand falls, firms struggle so unemployment climbs. Increasing share of profit flows to finance sector. In 2008 finance share of total private profits hit 40%.
        Marriner Eccles testified about the same mystery in 1933. There was ample productive capacity and no shortage of inputs, yet the economy foundered because of excessive debt.

        An out take:
        Before effective action can be taken to stop the devastating effects of the depression, it must be recognised that the breakdown of our present economic system is due to the failure of our political and financial leadership to intelligently deal with the money problem. In the real world there is no cause nor reason for the unemployment with its resultant dsestitution and suffering of fully one-third of our entire population. We have all and more of the material wealth which we had at the peak of our prosperity in the year 1929. Our people need and want everything which our abundant facilities and resources are able to provide for them. The problem of production has been solved, and we need no further capital accumulation for the present, which could only be utilised in further increasing our productive facilities or extending further foreign credits. We have a complete economic plant able to supply a superabundance of not only all the necessities of our people, but the comforts and luxuries as well. Our problem, then, becomes one purely of distribution. This can only be brought about by providing purchasing power sufficiently adequate to enable the people to obtain the consumption goods which we, as a nation, are able to produce. The economic system can serve no other purpose and expect to survive.

        We could do business on the basis of any dollar value as long as we have a reasonable balance between the value of all goods and services if it were not for the debt structure. The debt structure has obtained its present astronomical proportions due to an unbalanced distribution of wealth production as measured in buying power during our years of prosperity. Too much of the product of labor was diverted into capital goods, and as a result what seemed to be our prosperity was maintained on a basis of abnormal credit both at home and abroad. The time came when we seemed to reach a point of saturation in the credit structure where, generally speaking, additional credi was no longer available, with the result that debtors were forced to curtail their consumption in an effort to create a margin to apply on the reduction of debts. This naturally reduced the demand for goods of all kinds, bringing about what appeared to be overproduction, but what in reality was underconsumption measured in terms of the real world and not the money world. This naturally brought about a falling in prices and unemployment. Unemployment further decreased the consumption of goods, which further increased unemployment, thus bringing about a continuing decline in prices. Earnings began to disappear, requiring economies of all kinds – decreases in wages, salaries, and time of those employed.

        • “The time came when we seemed to reach a point of saturation in the credit structure where, generally speaking, additional credi was no longer available”
          That was an entirely psychological and fickle event. It was easily fixed by supplying liquidity from public sources when private liquidity dealers went into hoarding mode, for psychological fear-inspired reasons. There is no inevitability to debt causing a crisis; there is only the inevitability that traders will arbitrarily seize on some random thing to panic en masse about, sometime, for no good reason.

          • No, Robert, privately issued debt money is inherently destabilizing because asset prices tend to rise based on new money being created to buy them, and borrowers undertake those loans based on the expected asset price increases rather than the income the assets are expected to yield. Positive feedback. At some point the assets can’t generate sufficient income to pay the owners’ interest owing, and expected asset price increases alone sustain borrowing, as occurred in the years leading up to 2008. That is the bubble phase, and it is unsustainable because interest on private debt would eventually increase to absorb all of GDP. As that can’t happen, at some point speculators realize they can’t count on any more price increases, and stop borrowing to buy more. Then the accelerating money destruction required by repayments of principal takes over, the money supply shrinks, asset prices fall, and the expectation of capital gains turns into an expectation of capital losses. Owners try to sell assets rather than buy more, borrowing dries up reducing the money supply even more, and asset prices fall further. Positive feedback again. This unstable, positive-feedback-dominated situation is inherent in private banks being legally entitled to create debt money to fund asset purchases and legally required to destroy it when the loan principal is repaid. If private bank lending didn’t create money, people would only borrow for asset purchases in expectation of the assets’ income yield, and not count on any additional capital gain returns caused by the increasing money supply.

            • For a very long period last century, a rule of thumb was real property was worth 100 times the monthly rental income. Apply that to homes in California and they are worth less than half the current market price. Even in high rent markets like San Francisco, rents violate this rule to the downside by large multiples. The rule comes from a long run real yield of 3% on financial assets. Net of depreciation, real estate must follow the 100X rule to compete with this long term real yield on bonds. When real long bond yields return to 3%, the price of real estate should fall precipitously.

              • If you take the 100X monthly rent rule seriously, SFD homes in Vancouver are now overvalued by a factor of at least five, and in some neighborhoods ten. But as many of the purchases are for cash, by Chinese investors anxious to get their money out of China, the link to private banks’ debt money creation is weak. The ongoing uproar in HK will almost certainly cause a renewed flood of Chinese money into the already surreal Vancouver market.

            • “it is unsustainable because interest on private debt would eventually increase to absorb all of GDP. As that can’t happen […]”
              But world capital is close to $1 quadrillion, over ten times world GDP, so GDP is no limit on financial instruments.
              “legally required to destroy it when the loan principal is repaid”
              Source? Why can’t banks reinvest loan repayments? The Fed reinvested the repayments on its asset purchases for a decade and has announced it will start doing so again. Nothing in legal codes stops a bank from reinvesting loan repayments in other loans.

    • Peter, if you think you have to criticize MMT for ignoring Hyman Minsky maybe it would be fair to preface your comments with something like this-

      “While I know that Randall Wray studied under Hyman Minsky, and happened to write a book called “Why Minsky Matters” published in 2015 and just happens to be one of the founders of MMT who coauthored the MMT textbook, nevertheless- (add your ideas about ignoring Minsky and private debt here).

      MMT gets a lot of really ignorant criticism- don’t add to it please.

      • Great comment 🙂

        • Well,we have another disciple of Hyman Minsky here, ” The Commander in Chief” of this blog,that certainly could straight out confusions on what Minsky really meant! 🙂 ! Och MFF- Domzale 3-2 !Grattis ,å må gött ! 🙂

          • Tack Jan! Det var en spännande match 🙂
            Bästa hälsningar från The Commander!

      • I haven’t seen Stephanie Kelton stressing the need to lower total private debt nor have I seen MMT advocates pointing to the inherent instability of capitalism. To do the first one must lose the support of the finance sector, especially the banks, whose balance sheets will shrink if private debt is repayed. To do the second one must lose support of the wealthy, who support the dominant neoclassical view that market capitalist economies are stable, and always return to equilibrium after exogenous shocks perturb the market. Capitalism works great always, they say, it’s just occasional oil shocks and psychology hiccups that explain occasional bad luck followed by return to equilibrium. It’s hard to tell how much MMT policy wonks minimize the importance of private debt for these political realities but imo it’s a serious failing if they actually believe too high private debt is not the main problem.

        • The blog Stephanie Kelton started- “New Economic Perspectives” has regularly featured Professor Michael Hudson who absolutely stresses the importance of private debt- maybe you should check that out for yourself, its easy to do.

          MMT in general spends a great deal of time explaining how the banking system actually works and focuses on why finance is very important to the economy completely unlike neoclassical economics which almost ignores it completely. (Which given their obvious inability to understand it may not be the worst thing.)

          If you have ever read Bill Mitchell you will know how often he points to the sectoral balances as a tool to help understand the economy and to why the government is usually going to need to spend more than it collects in taxes in order to accommodate private sector savings desires and avoid the private sector, as a whole, going into unsustainable debt cycles.

          MMT economists have often said that MMT “stands on the shoulders of giants”. And they credit Marx, Keynes, Kalecki, Lerner, Godley, and yes- Hyman Minsky among others.

          The issue you seem to consider the absolutely most important economic issue is hardly ignored by MMT- even if they might not consider it quite as important as you do.

          • Bill Mitchell ignores how the private sector creates new net financial assets. His blindness on the issue is startling. The sectoral balances rely on heavily doctored (“imputed”) official statistics that ignore holding gains. Holding gains are an example of new net financial asset creation by the private sector, before government knows about it …

            • Yes Robert, Bill completely ignores how the private sector creates new net financial assets. Maybe you can explain how that happens without any help from the central bank or the government? Because otherwise I think Bill is right to ignore things that don’t happen. But I am very willing to learn if you can explain a bit. Please do. Thanks

              • Mortgage-backed securities were created and circulated as money without the Fed creating the money beforehand. When panic struck and the new net financial assets suffered a purely psychological devaluation, the Fed printed digital money to backstop the net financial asset creation. The assets were created privately first then after the fact the Fed bought them at face value.

                • Thank you. But they really didn’t become ‘net financial assets’ of the private sector until the Fed (central bank) backstopped them did they? The way mortgage backed securities and the institutions that owned them in 2008 were handled in 2008 was a political decision that the US government made through its agent the Federal Reserve. I think that decision sucked- but it doesn’t change the fact that it was the government rather than the private sector that ‘created’ the ‘net financial assets’.

  3. @ Jerry Brown MBS were most assuredly circulated as net financial assets for decades before the crisis, and are being circulated again now as net financial assets. The key point is that the private sector creates dollar-denominated assets as implied claims on the central bank, before the central bank knows about it.

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