What is Modern Monetary Theory and will it help?

Modern Monetary Theory (MMT) is a macroeconomic theory for the current age in which governments have abandoned the gold standard and also floated their currencies. It is ‘macroeconomic’ and ‘monetary’ because many of its conclusions relate to the money supply in an economy. Does it offer scope for a new economic approach recognising people? Can it better assist responses to robotics and computerisation than current economic approaches?

Historically, gold was important because coins were minted from it (and silver). Even when coins were no longer minted in gold, the currency issued by governments was convertible to gold and governments needed to hold sufficient gold reserves to satisfy a potential demand from all holders of their currency — that was the gold standard. In that situation governments could not spend without first taking money from the economy (taxation) because the money supply was limited to match the quantity of gold. Following WW2, fixed exchange rates also meant that governments, through their central banks, had to defend the rate they had fixed by buying or selling their own currency in international money markets: that also affected the money supply in their home economy and also placed limitations on government spending. Floating currencies now allow central banks and governments to target domestic economic policy goals knowing that the floating exchange rate will resolve the currency imbalances arising from trade deficits or surpluses.

MMT points out that much economic thinking since the 1980s operates as though the gold standard is still in place — namely, that governments can only fund their spending by taxation and therefore deficits are bad — but some MMT proponents and supporters argue that this has ideological (neoliberal) rather than genuine economic underpinnings.

Since the abandonment of the gold standard, most countries, including Australia, now have a fiat currency — that is, it is created by government fiat (decree) — and it has no intrinsic value. My $50 note is not matched by $50 worth of gold any longer, nor is my plastic note worth $50 itself (in 2012 Australia’s polymer notes cost 34c each on average to produce irrespective of their face value). My note has value only because the government decrees it has and the government is the monopoly provider of currency: therefore it is the currency I need to participate in the economy and to pay taxes.

MMT places this new reality at the centre of its approach. A sovereign government issuing its own currency can never run out of money, never go bankrupt or default on its ‘debt’. That in a sense was Greece’s problem: as part of the Eurozone it was no longer an issuer of its own currency. In that circumstance, as for the states within a sovereign nation, the oft-used analogy of a household budget still applies but it does not apply to the sovereign issuer of a currency.

The ‘sovereign issuer of currency’ argument leads to probably the most well-known and sometimes controversial aspect of MMT, that a government can always ‘create’ money. The critics argue such printing of money — although these days it actually requires only a few keystrokes on a computer to create deposits in the private banking system — will lead to hyperinflation as in Zimbabwe or the Weimar Republic in post-WW1 Germany. MMT accepts that inflation is one factor that imposes a limit on government spending but that limit is not reached until all the ‘real’ resources of the economy are fully utilised — all human resources (full employment) using all available physical resources. If a government continues to spend after that, then dangerous inflation may result but, prior to that point, MMT argues that government spending to assist utilisation of available resources will not lead to uncontrolled inflation. For MMT, the issue is not just money but the real human and physical resources that are available to the economy and not currently being used:
If there are slack resources available to purchase then a fiscal stimulus has the capacity to ensure they are fully employed.
As a means to help control inflation, current mainstream economic thinking accepts the Non-Accelerating Inflation Rate of Unemployment (more commonly known by its acronym, NAIRU). The Australian Treasury uses NAIRU in its modelling as the basic foundation of longer-term stable inflation — currently the NAIRU in Australia is 5% unemployment. Before NAIRU, full employment was taken to mean there would be about 2% unemployment, allowing for people moving between jobs or unemployed short term for various reasons. In practice, NAIRU provides a ‘buffer stock’ of unemployed which basically means that having those extra unemployed, above the previously accepted 2%, provides downward pressure on wages growth because the unemployed are more willing to accept lower wages simply to have a job. The argument goes that if unemployment falls below the NAIRU level the competition for workers will mean employers accept demands for higher wages thus leading to higher inflation. (Despite the whole capitalist free market system being based on competition, whenever workers appear to have a competitive advantage it is decried as a threat to the economy!)

MMT rejects the NAIRU and instead proposes a Job Guarantee for the ‘unemployed’, sometimes referred to as ‘transitional employment’ which probably describes it better. As opposed to the NAIRU ‘buffer stock of unemployed’, MMT offers a ‘buffer stock of employed’ but this is done at a ‘fixed price’ — in Australia this would be the minimum wage, inclusive of standard employment conditions. It means the government supports employment until such time as a person obtains higher paying mainstream work and it will be in productive work using under-utilised resources:
What matters … is whether there are enough real resources available to produce goods and services that are equal in value to the government’s job-guarantee spending. If these resources are available — if they are not already being used to produce something else — then the increased demand that results from the payment of job-guarantee wages will not be inflationary, regardless of what they go to produce.
On broader monetary issues, MMT says that there can only be saving in the private sector, inclusive of banks, businesses and households, if the government spends more than it collects in taxes: that is, only when the government adds money into the economy can there be private sector saving as well as investment.

A good, simplified explanation of this was provided by John Carney at CNBC in 2012:
The MMT people aren’t actually referring to you and I saving. They aren’t even talking about the entire household sector saving financial assets. They are talking about the entire private sector spending less money than it earns.

You can easily see why this would be impossible without the government spending more than it collects. Every dollar someone is paid is a dollar someone else has spent. If we all — every single person and company — spend less than we are paid, very quickly we will find we have to be paid less. The aggregate effect of savings is to reduce the total amount people are being paid for things.

So this is what MMT people are talking about when they refer to a “private sector desire to net save.” They mean that if you add up all the earning, spending and savings of every person and company in the economy outside of the government, sometimes you find that the private sector is trying — nearly impossibly — to earn more than it spends.

The only thing that can make private-sector net savings possible is government spending. If the government spends more than it takes in taxes, the private sector can earn more than it spends. Remember, if everyone pays less than they earn, some outsider must be paying more than he earns.
The MMT equation for this is:

(G – T) = (S – I)

Or in words, government spending (G) minus taxes (T) equals private saving (S) minus gross private investment (I). This is so because in macroeconomic terms the two represent the entire amount of money in the economy. And the other key of this equation is that it shows that money does not come into being in the private sector unless the government has first spent it (over many years now).

MMT points out that when governments run surpluses it leads to an increase in private sector debt because, in that circumstance, if the private sector wishes to save and invest, it has to borrow from the existing pool of money (and the government surpluses are actually reducing the money supply). This is explained by the concept that transactions between banks, businesses and households are ‘horizontal’ transactions and cannot change the amount of money in the economy (liquidity). Only a ‘vertical’ transaction between the government and the private sector can change liquidity (MMT includes both the treasury and central bank when it talks of ‘government’).

In the USA, on all occasions when the government has run surpluses, and reduced debt for a few years, it has been followed by recessions or depressions. Arising from the indebtedness forced on the private sector by the government surpluses, there comes a point when the private sector reduces spending because it cannot afford to take on more debt, thus creating an economic slow-down. In such circumstances, only government spending can relieve the situation. (It is also of interest that since 1776 the US government has been in debt in every year except for the years 1835 to 1837.)

In a globalised world, however, national economies do not operate in isolation so one more aspect needs to be added to the equation: exports (X) and imports (M).

(G – T) = (S – I) ? (X – M) or

(G – T) + (X – M) = (S – I)

If a country has a trade surplus that adds to private savings. Many countries, however, as Australia, operate a trade deficit which means that private sector saving is reduced and more reliant on government spending. And at a global level the nett outcome of all countries’ trade must sum to zero, so it is impossible for every country to run a trade surplus — a surplus in one country necessarily requires a deficit in other countries. So a trade deficit or surplus is not bad in itself but does affect private sector saving and creates more need for government to adjust its spending appropriately.

Although even MMT still talks about deficits and surpluses, my reading is that those words are less relevant in MMT. If a government can create money it can never really be in deficit (except perhaps in a point-in-time accounting sense). Even claiming that the deficit represents spending more than collected as taxes is not relevant. MMT says that the government does not need taxes in order to spend — it can always create whatever money it needs. The real purpose of taxes is to take money from the economy or, in economic terms, to reduce liquidity, meaning there is less money to spend and thereby total demand across the economy is also reduced. What taxes can achieve is to create ‘space’ for government spending. If an economy is already running at capacity and the government continues to spend, that is increases liquidity and demand without first making space for that spending, then high levels of inflation may result because there is more money in the economy to buy the same amount of goods and services, meaning people competing for those goods and services are willing and able to pay higher prices to obtain them. So taxes can be important in allowing government spending without dangerous inflation but are not necessary in themselves for that spending.

Similarly MMT argues that the sale of government bonds is not necessary to fund government ‘debt’. So-called ‘debt’ can actually be met at any time because the government can ‘create’ the money to do so. But as always the limiting factor is controlling demand in relation to the capacity of the economy so as not to allow dangerous levels of inflation.

MMT’s explanation is that the sale of government bonds is primarily a means of controlling interest rates: this relates to the overnight commercial bank reserves placed with the central bank but I won’t attempt to explain how that works. (This interview with Bill Mitchell for the Harvard International Review provides an explanation and also a good summary of MMT.) A secondary reason is that banks, financial markets and the private sector generally, desire government bonds as a safe haven to park money. Here in Australia, that became obvious during the Howard/Costello years when the government paid down its debt and saw little need to make new bond issues but the private sector complained and the government had to issue more ‘debt’ even though it had no debt: that fact alone gives credence to the MMT argument.

Although the approach is called Modern Monetary Theory, it places more emphasis on fiscal policy. Bill Mitchell writing on the current economic problems said, ‘until we stop relying on monetary policy and restore fiscal policy to the top of the macroeconomic policy hierarchy, nothing much is going to change’. Mitchell argues that governments have been using the wrong approach to overcome the current economic stagnation affecting many countries:
It is not that they have run out of ammunition. They have been using the wrong ‘ammunition’. For example, trying to drive growth with low or negative interest rates failed to work because the lack of bank lending had nothing to do with the ‘cost’ of loans.

It had all to do with the dearth of borrowers. Households, carrying record levels of debt and facing the daily prospect of losing their jobs, were not going to [start] suddenly bingeing on credit again.

Business firms, facing slack sales and a very uncertain future, could satisfy all the current (low) levels of aggregate spending in their economies with the existing capital stock they had in place and therefore had no reason to risk adding to that capital stock.
In the MMT model, the remedy to many economic problems is fiscal stimulus not austerity which only exacerbates the problems. And as a sovereign issuer of currency the government always has the capacity to provide such a stimulus when there are under-utilised resources in the economy.

Using fiscal policy, and the knowledge that governments can spend as much as they wish, limited only by available real economic resources and inflationary impacts, MMT suggests that the real issues are social policy issues. The debate should not be about ‘debt and deficit’ but what we as a society wish to achieve, wish to become, and, within the limits mentioned, governments do have the capacity to meet those goals. For me that is an important outcome from MMT, not just that it offers a new economic approach but that it offers scope for a new policy and political approach. To that extent, it does allow space for people by creating an economic approach that recognises social policy goals are of critical importance and the ability to achieve them is not so limited or proscribed as it is by existing neoliberal economic theory. For that reason alone MMT deserves more attention.

Next week, in the last of this four-part series, I will consider whether governments are ready for the coming economic and social changes.

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21/09/2016Ken You have gifted us yet another erudite piece, this time on the complex subject of Modern Monetary Theory. I now have an understanding of how it works, and how it contrasts with neoliberal thinking, on which our contemporary federal government seems to base its actions. Presumably there are those in Treasury who do understand MMT, who have enlightened the Treasurer and Finance Minister about its features. If that is so, these ministers seem unprepared to endorse its precepts and adopt it practically. They still rabbit on about the evils of 'debt and deficit', and 'the need to reduce spending' in order to carry out 'budget repair'. Is this because they believe the neoliberal approach is the only way to go, emphasising as it does reduction of expenditure, fiscal austerity, lowering taxes, debt reduction, running surpluses, and balancing the Budget. Yet, as you point out, such an approach has lead to recessions: "In the USA, on all occasions when the government has run surpluses, and reduced debt for a few years, it has been followed by recessions or depressions." So my question is: Why do they use this approach, when a potentially more effective approach is available? Is it because the neoliberal approach is so entrenched in their thinking that no other can gain traction? Are they fearful of trying MMT? Do they see it as too closely resembling Keynesian economics, which they appear to despise? Or is it because the neoliberal approach gives them an opportunity to castigate Labor repeatedly for its 'profligacy'? As monetary policy seems to have temporarily exhausted its potential to stimulate the economy, why do they not try another approach? I would be interested to read your views about why the Coalition eschews MMT. Thank you for another valuable contribution to TPS.


21/09/2016MMTers have their hearts in the right place, but for mine MMT is a mixture of the correct and trivial and the grandiose and wrong. Basically everything you've described here (a very thorough summary) would not come as alien to a mainstream economist (e.g. Ken Henry, Krugman, etc.). MMT devotes a lot of time and ink to "explaining" what is conveyed simply in the standard government budget constraint: G = T + B + M. That is, government spending must equal the sum of taxes, new borrowings and new money. The question is whether MMT reaches conclusions that differ from orthodoxy. I don't see how it does. Ponder your statement (emphasis mine): "So taxes can be important in ALLOWING GOVERNMENT SPENDING without dangerous inflation but are NOT NECESSARY in themselves for that spending." If taxes (and bonds) are necessary to make government spending economically sustainable, then functionally it matters very little whether it is described as "financing" that spending or as something else. Now when the economy is depressed, that's a totally different matter. Yes the government can run money-financed deficits during a depression to stimulate the economy - but those are special circumstances. Prioritising fiscal policy over monetary policy at or near the zero lower bound - also not innovative, as signified by the many mainstream economists making this exact argument. MMT is a corrective to media-pushed austerity arguments, but is not very innovative.


21/09/2016"The question is whether MMT reaches conclusions that differ from orthodoxy. I don't see how it does... If taxes (and bonds) are necessary to make government spending economically sustainable, then functionally it matters very little whether it is described as "financing" that spending or as something else." Bonds are not necessary, though. Bonds are a holdover from the gold standard days, when governments wanted to spend, but had insufficient reserves. The purpose of taxes is misrepresented if they are said to "finance spending". They plainly don't. The conclusions MMT reaches make it next to impossible to promote austerity, and put into question a range of policies pursued by Western governments over the past 30 years. How can that not differ from orthodoxy?


21/09/2016Ken: A masterful exposition! Kudos!


21/09/2016Good article - thanks. But I think this: "The ‘sovereign issuer of currency’ argument leads to probably the most well-known and sometimes controversial aspect of MMT, that a government can always ‘create’ money." needs to have added that such is not unique to MMT. Indeed orthodox, albeit 'liberal', prominent economist James Galbraith has stated that the US government [Treasury] can 'always print money' if it needs to combat a monetary crisis and that the only hurdle to such would be if they ran out of electricity and thus could not operate their computers to send pixel money around the country. Just in case someone reckons that view is unique to MMT, and a 'lefty' like Galbraith, there is also the famous example of Alan Greenspan, arch-conservative and head of US Treasury at the time of this comment : "We can always print more money" https://www.youtube.com/watch?v=q6vi528gseA PS next the video on that link is also worth a look.


21/09/2016Hugh: "So taxes can be important in ALLOWING GOVERNMENT SPENDING without dangerous inflation but are NOT NECESSARY in themselves for that spending." If taxes (and bonds) are necessary to make government spending economically sustainable, then functionally it matters very little whether it is described as "financing" that spending or as something else." Do you see how words matter? Taxes are "useful" on occasion, to make govt. spending economically sustainable. They are not necessary. This makes all the difference between people who scream about budget deficits and those who are relaxed about them. Fred: You are absolutely right. Various people have said that govt. can just print money. But then they have gone back to bemoaning "the deficit and debt". That is the problem with the neoliberal mind-set. They don't still want to admit that the "real economy" is important while the "budget" is just financial accounting, and that too of something that can be adjusted given the right circumstances. The entire neoliberal "mantra" of govt debt being "intergenerational theft", and "maxing out the credit card" and causing higher taxes in the years to come is all just lies. As for the "mantra" that "printing money causes inflation", the US, the UK, and the ECB have just disproved it by their QE exercises. But they still talk about "balanced budgets", "budget repair" and all that nonsense. It is basically "framing" to dupe the voters into voting against their own interests.


21/09/2016When I suggested that the "next video was worth a look" [see PS in my comment above] I thought that video was of Greenspan admitting to Congress how his neo-lib ideology had been shown to be wrong. But its a different video. This a link to the Greenspan epiphany: https://www.theguardian.com/business/2008/oct/24/economics-creditcrunch-federal-reserve-greenspan "The former Federal Reserve chairman, Alan Greenspan, has conceded that the global financial crisis has exposed a "mistake" in the free market ideology which guided his 18-year stewardship of US monetary policy. A long-time cheerleader for deregulation, Greenspan admitted to a congressional committee yesterday that he had been "partially wrong" in his hands-off approach towards the banking industry and that the credit crunch had left him in a state of shocked disbelief. "I have found a flaw," said Greenspan, referring to his economic philosophy. "I don't know how significant or permanent it is. But I have been very distressed by that fact." There's more. What I find amazing, tho' unfortunately understandable, is how the neo-lib propaganda rolls on unimpeded despite having its finery stripped bare. We are still subjected to arrant economic nonsense on a daily basis. PS If anyone has a direct link to Greenspan's embarrassing admission to Congress I'd appreciate getting it - I know its out there somewhere but I can't find it.


21/09/2016good evening people Sorry I'm late to this and your comments have gotten a little ahead of me but I've had a busy day and evening. I might say that I am not an economist and, in a sense, researched and wrote this as much for myself as for the readers so that I too had a somewhat better understanding of MMT. Your various comments have been quite insightful. I won't try to respond to each individual comment but make the following observations. I have since writing this article also been reading about 'sectoral balances' which, apparently, in economic terms is what the MMT equation is pointing to. And sectoral balances are relevant to Hugh's comment. totaram you are right to point out that QE has not led to runaway inflation in Japan, the US or some European countries. Part of the point of QE was to lift inflation at least a little because it had fallen below levels necessary for a healthy economy (and Australia is still having that problem but our government is leaving it to the Reserve Bank to resolve but its only weapon at the moment is interest rates and they are not helping at any speed). As for Greenspan adopting a more flexible monetary policy, I read that he was derided by a number of economic conservatives and neoliberals for that approach.


22/09/2016Thanks for the excellent piece and the comments. MMT depends on an assumed rationality. As for much of economic theory it is this assumption that distorts. The last few years suggest neo-liberal thinking is hardly changing and any desire to change the thinking in treasury is swiftly countered by leadership changes within treasury Instigated by politicians with an often less than rational pattern of decision making. Change is most likely to come from worldwide economic factors and how this causes a need for change within the Australian economy and the reaction of dominant interests. Recents Australian governments and the quality of their economic decision making have not been rational nor economic. We can only hope. I would be reluctant to promote the idea of printing money amongst some of our elected representatives!!

Richard Tye

22/09/2016Great article. Thank you. Just want to ask about the accuracy of the following statement: MMT points out that when governments run surpluses it leads to an increase in private sector debt because, in that circumstance, if the private sector wishes to save and invest, it has to borrow from the existing pool of money (and the government surpluses are actually reducing the money supply). Does the private sector have to borrow from the existing pool of money? This suggests that commercial banks operate as financial intermediaries. That's to say they take in deposits and then lend them out. MMT shows that commercial banks do not operate as intermediaries; they create commercial bank IOUs via the lending process when a borrower in effect signs a promise to pay. They purchase the promise to pay with newly created deposits. The balance sheets of both parties to the deal increase simultaneously, but the overall effect nets to zero: assets are balanced by liabilities. Therefore, my point is that there is no borrowing from an existing pool of money. Am I correct in my thinking? Kind regards, Richard Tye


22/09/2016Richard Thank you and welcome to TPS. You may well be right. I did have trouble with that part of the article and changed it a number of times. But when I say borrowing from the existing pool of money that is on an aggregate level, all money that exists across the entire private sector. As you say, banks can lend simply by creating an IOU but that still has to be repaid from the existing pool of money, it does not change the aggregate of funds that exist in banks, companies, households. So, yes, I may need to explain that better (even understand it a little better myself - because as I said in my earlier comment I, like many of you, am still coming to a proper understanding of all the details of MMT.)


22/09/2016Golly: Unfortunately for your comment, with a fiat currency, ALL money in circulation is indeed "printed" and enters the economy through govt. spending. So whether you wish to encourage them or not, that is the truth of it. Ken: the sectoral balances are actually nothing to do with fiat currency. They are simply a financial accounting identity, that neoliberals do not like to talk about. They are fundamental to showing that, unless a country has trade surpluses, a govt. budget surplus leads to increasing debt for the private sector. Peter Costello's surplus budgets were delivered on the back of private sector debt going from around 50% of GDP to around 150%. And unless govt. continues to run deficits, the private sector finds it hard to try and pay down its debt. This runs completely counter to the "budget repair" mantra. This is the fact about debt no one in the general discourse mentions. It is not govt. debt that is the problem, because the govt. cannot default. It is the private sector debt which can have defaults and then cause financial meltdowns (remember the GFC?)


22/09/2016totaram Thank you for the explanation about 'sectoral balances' and reminding us that the GFC (or the Great Recession, as the Yanks call it) was contingent upon private sector debt.

Iain Dooley

23/09/2016Thanks Ken for a brilliant summary of all things MMT. In answer to your question at the end YES! I think that MMT can change government but only if we force it just to the mainstream political conversation. I am trying to do that through the Australian Employmeny Party: http://www.australianemploymentparty.org/
How many oranges do I have if I have 3 oranges and take ONE away?