...against fictions and other tall tales

Tuesday, 3 January 2012

Modern money: theory or approach?

A quick post. I've noticed a lot of discussion recently on other sites regarding the nature of modern monetary theory (MMT) and, more specifically, on whether its analytical and descriptive elements can be separated from the prescriptive policy proposals advanced by the originators of MMT.

In my view, it's clear that MMT as a theoretical framework encapsulates both descriptive and prescriptive elements. The descriptive part of MMT aims to describe the functioning of a modern monetary system and shed light on the nature of government finance. The main emphasis here is to explain that modern currencies cannot be understood without considering the legal and institutional context within which a modern, sovereign government (i.e., that has control over its own currency) exercises its authority. Specifically, the government's power to levy taxes and declare what it will accept in payment of taxes are the two important components for understanding modern currencies and identifying the options available to the government for financing expenditures and setting prices (e.g., of interest, manpower, commodities, etc). Flowing from this understanding of government finance is the fact that modern governments do not face operational financial constraints, but rather face self-imposed, legal ones that result from past political decisions, as well as constraints imposed through convention. Balancing the government budget on a yearly basis is one example of a self-imposed constraint.

As for the prescriptive part of MMT, my understanding is that it focuses mainly on (1) the implementation of a job guarantee (aka, buffer stock employment model) or an employer of last resort scheme as a way to achieve full employment and price stability, and (2) the application of a monetary policy where the central bank sets the nominal rate to zero, thereby letting the real rate adjust endogenously (resulting, in most cases, to a negative rate due to inflation). From a policy standpoint, I don't have any problem with the former, as I believe that such a proposal could gain considerable traction once the public understands how the policy would function. However, I can understand why some people have reservations regarding the viability of the proposal to put forth a zero nominal interest rate, as it would most likely lead to a negative real rate of interest. A good alternative, in my view, would be for the monetary authorities to set, as much as possible, the real interest rate equal to the rate of growth of labour productivity. In this way, the real rate of interest should remain mostly positive and an amount of money equivalent to one hour of labour time, if lent at that rate of interest, would continue to be worth one hour of labour time when paid back with interest.

But, setting aside this very minor point of divergence, it should be pointed out that MMT falls under the larger body of thought known as 'chartalism' or 'modern money approach', which is not tied to any specific policy prescription. This means that it isn't really a problem if people have different views about the prescriptive part of MMT: the chartalist or modern money approach allows for a wider range of points of view and policy recommendations. In a good article on chartalism, modern money economist, Pavlina Tcherneva, explained this point as follows:
...it is important to point out that Chartalist propositions are not necessarily tied to any particular policy prescription; they are simply a way of understanding the state’s powers and liabilities and its financing and pricing options. (2006:81)
So, to conclude, if you find MMT's framework for understanding the implications of modern money useful for analyzing the economy and government policy but aren't sure about the policy proposals associated with the framework, there's no big problem: you're still applying the modern money approach.


Rochon, L-P, and M. Setterfield (2008), "The political economy of interest rate setting, inflation and income distribution", International Economic Policy Institute, Working paper series, 2008-01

Tcherneva, P. (2006), "Chartalism and the tax-driven approach to money", in P. Arestis and M. Sawyer (eds), Handbook of Alternative Monetary Economics, (Northampton, MA: Edward Elgar), pp. 69-86.


  1. Pasinetti's idea of setting interest rates at the fair level is a good idea.

    I think it is a bit theoretical as nations keep running into balance of payments problems.

    About MMT, I think it is a bit weird to club good ideas as "MMT". Most of what MMTers say already exists in Post Keynesian Theory and in the sense the latter is the rich cousin. MMT's contribution is trying to argue that the government cannot be said to be borrowing or does not borrow or that bond issuance does not finance spending and all that. It is misleading and a huge waste of time.

    Plus of course JG. The Neochartalists will always push JG because that will presumably provide a stamp.

  2. Ramanan,
    "Most of what MMTers say already exists in Post Keynesian Theory and in the sense the latter is the rich cousin".

    Would you say that the knowledge/information embodied in the following paper from Fullwiler is mostly old stuff recycled from the "traditionnal" Post Keynesians? http://www.nakedcapitalism.com/2010/08/guest-post-modern-monetary-theory-%e2%80%94-a-primer-on-the-operational-realities-of-the-monetary-system.html

    With respect to MMT saying that Government "cannot be said to be borrowing", I do not necessarily disagree that it is a waste of time. This being said, since the Central bank is the monoply supplier of reserves to the banking system, "borrowing" or creating reserves (with reserves rewarded at the overnight rate) are two equally valid options from an operationnal standpoint for the Government to which this Central bank reports. Unless I am misleading, this is another important contribution from MMT to Post Keynesian.

  3. Joseph,

    "is mostly old stuff recycled from the "traditionnal" Post Keynesians? "

    Definitely YES.

    Plus it still tries to sneak in bizarre interpretations I mentioned in my first comment.

  4. Ramanan,
    If you have time, I would appreciate that you share with me these "old" Post Keynesian papers/knowledge that were somewhat recycled by Mr Fullwiler, and more generally, by MMT authors.

    Also, if you could be more specific on the "bizarre intepretations" included in the aforementioned paper, it would be greatly appreciated.

  5. Joseph,

    "Completely contrary to the loanable funds model, in fact, the vast majority of bank liabilities have been created by banks simply growing their balance sheets through loans and asset purchases."

    There is a vast literature on endogenous money - from Nicholas Kaldor, Basil Moore, Marc Lavoie, from the 70s and the 80s and Circuit Theorists etc from the 1960s.

    "the domestic private sector’s net saving of financial assets is by definition equal to the government sector’s deficit and the current account balance"

    That is the work of Kaldor, Godley and Cripps from their Cambridge days in the 60s and the 70s.

    "a central bank under a gold standard has different operational realities than a central bank under flexible exchange rates."

    That was shown to be true under certain set of assumptions that the government can set a higher output in floating exchange rates - by Godley in the mid 1990s.

    "Even in this case, though, the operational logic of interbank markets means that for the central bank to achieve its target rate in the absence of interest on reserves at the target rate, it must offset any changes occurring to its own balance sheet"

    Kaldor, Moore, Lavoie, Eichner ... from the 1980s.

    "Instead of the money multiplier, a proper understanding of the operational realities of the monetary system demonstrates that central banks—as monopoly suppliers of reserve balances to the banking system—must set an interest rate target"

    Moore, Lavoie, Kaldor etc.

    "Given the tactical logic of the Fed’s operations to achieve an interest rate target, flows to/from the Treasury’s account must be offset"

    Eichner in the 1980s.

    "Bond sales are much like calls from the tax and loan accounts—monetary operations—since if the Treasury doesn’t sell bonds, the Fed must to be able to hit its fed funds rate target"

    This is where the bizzare interpretations begin. As long as the Treasury does not have an overdraft at the Fed and/or cannot borrow from the Fed, it necessarily has to issue bonds and collect taxes.

    If someone wants to propose a case where the Treasury has an open line of credit, make it a proposal instead of saying that it is operational reality.

    Coming back ...

    Expectations of interest rate on discussion of long term rates - Kaldor and Moore.

    "Fed always has the ability to set the market rate on Treasuries as long as it is willing to buy all quantities offered at its bid price"

    Yes, Godley and Cripps mention this clearly in their 1983 text.

    This is just a small list. I suggest you read through the papers and books of authors I mentioned. Didn't even mention Davidson, Graziani and big names such as that.

    I believe MMT has sold you the case that it is the only game in town :-)

  6. C'est un post formidable. L'echange entre Circuit, JL et Ram est exceptionnel pour ce debut d'annee-qui etant donne l'elan promet d'etre extraordinaire.


  7. Ramanan,
    Thank you for all of that. I will for sure read more on these authors (I am already quite familiar with the work of Godley and Lavoie, less so of the work of the others).

    No, MMT did not sell me anything. I did not arrive to MMT through the academic route, but rather through my interest in banking, monetary and fiscal operations. It just happened that a friend sent me few blogs and a paper authored by Scott Fullwiler ("Interest Rate and Fiscal Sustainability", http://www.cfeps.org/pubs/wp-pdf/WP53-Fullwiler.pdf) and I then realised that a small group of academic guys had the same interest. I have never believed that MMT is the only game in town, although I came to PK through the "MMT door" like a bunch of us in the blogoshepre. Clearly, a lot of things in MMT came directly from PK, I have never disputed that, nor did I see any MMT authors trying to dispute that (there is a reason why people situate MMT or "new chartalism" within the wider PK school).

    You should at least credit MMT as to why the wider PK school now have such a wide distribution/recognition on the net, which Lavoie clearly recognised in his paper (http://www.boeckler.de/pdf/v_2011_10_27_lavoie.pdf). I, for one, would have never became familiar with the work of Godley and Lavoie without the "MMT.net" phenomenon.

    Perhaps because I have no vested "academic" interest in the whole thing, I could not care less whether my knowledge of monetary and banking operations comes from the PK, MMT, Chartlist, or whatever schools. In fact, in the case of Canada, my knwoledge came mostly from the Department of Finance and the Bank of Canada papers (are these MMT or PK papers? ;-)

  8. Ramanan,
    But isn't that the whole point - bringing in ideas from different schools into a coherent whole for applied/practical purposes. Arguably, much of post-Keynesian monetary theory is based on the efforts of others, including the circuitistes, French endogenous school (eg, Dezinet) and even US institutionals (the Fed and so on). MMT's doing a good job of assembling these into one, and adding the fiscal implications via functional finance. I consider 'Soft Currency' by Mosler important in that regard.

    Moore and Eichner are good citations.

  9. On the comments to this post:

    Indeed Joe and Circuit. There is nothing new per se in the work of MMT/Neochartalists and they acknowledge their Circuit Theory predecessors.

    On the post itself:

    Circuit, with reference to Pavlina you seem to be separating MMT away from Neochartalism. I've been using the terms synonymously.

    Or do you think the "not necessarily" is enough of a caveat to tie MMT/Neochartalism together with a JG and that the "not necessarily" more likely applies to other policy prescriptions?

  10. My understanding of the expression 'neochartalism' is informed by my reading of Randy Wray's Levy paper 'The Neochartalist approach to money' (2000). In that paper, Wray equates neo-chartalism (NC) with a 'state money approach' but stays clear from suggesting that the approach *requires* the implementation of a buffer stock program (although he does discuss its attributes and merits). In fact, in the paper Wray writes: "...*some* working within the neo-chartalist approach have recognized" the possibility of achieving both full employment and price stability. I always interpreted that passage to mean that there are various points of view within NC, and that the buffer stock program is one policy option among many. From what I always understood from the specific term 'MMT' (and this seems to be confirmed in recent posts/articles), buffer stock or ELR was always a component. That said, I like Mosler's take on all this, as he seems open to divergence of opinions:


  11. So to refine the point, the JG is an option within the Neochartalist approach but a buffer stock is mandatory?

  12. Senexx: sorry for delay - I've been away for a few days. My understanding is that either programs are associated with NC or MMT. But my point is that there are analyses that use NC's understanding of money which don't necessarily require a JG or ELR, but rather more conventional expenditures, such as public investment.

    That said, I've been reading some of Randy's latest articles/posts in which he equates NC with MMT (as you do). This tends to support your view. I must admit being a bit confused by Wray including Goodhart as an MMTer. I have no problem considering him as a chartalist (his 1998 paper 'Two concepts of money is a key reference), but I have never read anything by Goodhart where he endorses an ELR or JG. If, by any chance, you have, I would greatly appreciate a reference.

  13. Your post is timely, but moreso well-structured!!! The novelty that Bank OPs (descriptive facet) don't make a difference to the markets or CB practice is correct. I'm amazed that some pundits actually believe that CB operations are unknown to CB operatives, and that the latter need to be enlightened. A stunning revelation edging on the ludicrous. Wherefrom money originates is irrelevant; the monetary system does not methodologically require a causation framework from a phenomenological network perspective in order to prescribe. Maybe Graziani and Pasinetti,(as with Parquez, Minsky, Godley, the CANbridgeans and other post-keynesians) too engrained in the theoretical prerequisites of circuit theory, suggest 'origination' postulates. However, ontologies lead more to unproductive discussions than constructive prescriptions. The best from these two 'greats' is not in their philosophy but their systemic insights that clarify and justify fiscal complements to monetary policy.

    @readers, Ram, JL and SEN nods...because as you all suggest, to some extent-it is a waste of time! I would add that the most detailed and penetrating work by operatives was done in the mid-70's by a pair of youngsters from FRBR and FRBKC. Both signatories should be a household name for 'MMT-ers'; unfortunately, Fed work is lost in the archives of ideologues as being 'monetarist'-quite to the contrary. MMT-relevant foundational work has been around for years. Seems like the whole world discovered something that's been around for years, and the so-called novelty is generating a blog industry. Even Tcherneva is supposedly anchoring as the fad's moderator, and unfortunately so.

    The Fed, and daresay only the Fed, in a global multiple currency system can set the market rate! Some people think that the fractional and shadow bank system combined contrives the money supply, and because the latter is beyond constraints and controls, there is no possible regulation of the MS. Partially true; if you assume SBs lurking in 'absolute' autonomy to the rest of the system, although in the system. They can do damage, as seen. However, SBs are not 'absolute' entities, they cannot backstop their own risks. Only the FED is its own backstop-a deus ex machina in the system. (As anecdote, it is also the ECB's backstop at the moment by 'activating' tactical actions that 'enable' ECB tactical measures, and has been acting likewise for a recent time. The Fed has long transcended Bagehot's realm.)

    In fact, and with no disrespect to other CB, in the worst case thought experiment, which entails a monetary and financial armageddon , a Fed intervention in the marketplace can 'wipe-out' the SB system ; the reverse is not possible, and never was. The so-called 'Fed paralysis' of 2007-2009, is a misnomer. The constitutional and political constraints that parameter Fed actions are limitative in a global system that overwhelmingly operates beyond sovereign authorities and jurisdictions.

    The JG concept, a noble issue, but requires, to be effective, private sector support. To preclude the latter is, in principle, to dismember private capital from public partnerships, unleash private sector reward expectations, enhance the inequality gap and entrench a New Normal for Structural Unemployment. If one wishes to retain a free market economy, the real challenge is to promote risk/reward tradeoffs that normalize expectations around dividends rather than capital appreciation. (We should avoid discussions about dividend policy being affected by standard financial considerations etc. and focus on principles.) Lobbies and pundits will finetune the raucus.)

    Although Policy may be grounded in theory, legislators address real world configurations and permutations, influences, interests and powers. I commend your commentators; the conversations are very serious, your initiatives-as always serious and significant. Best wishes for the New Year to FRB and its readers.

    1. Goffredo: You are spot on with regard to the pair of 'youngsters' from the FRS. I call them pillars! Ray Lombra and Ray Torto brought the discussion on the interaction between the money supply and reserves to a new level. Much of post-Keynesian monetarist economics trickles from their work, as I hinted in one of the comments above.

      As for your unrelenting focus on the policy-relevance of model, I think more economists are starting to think like you. I know I'm sold to it. Very interesting take on circuit theory's effectiveness in clarifying and justifying fiscal compliments to monetary action. Well said.

    2. I really appreciate your comments, GC. There's lots of valuable insight. I'm especially grateful for your views on JG and the Fed. I like your characterization of the Fed as a deus ex machina in the system. Also, I'm starting to think I should author a book entitled "Transcending Bagehot's Realm". Can't think of a better title for a handbook on Fed policy in the modern era! Always great to have you onboard here at FRB.

  14. For me the main interest in MMT is that it brings together various ideas that focus on the use of real resources and explains monetary operations. It counters the widespread belief that governments that incur liabilities in their own free-floating currencies are subject to solvency constraints, that deficits will cause catastrophic rises in interest rates, and that issues stemming from an aging population in the future require fiscal austerity in the present. These insights are of practical use today since fiscal austerity is the current policy of choice by almost all governments despite its appalling consequences for so many people.

    The identity of those who originated various parts of what has become known as MMT is of interest, of course, but the fact, for example, that Joan Robinson of 75 years ago is one of them is not especially relevant in dealing with the current economic situation.

    For those interested in a recent article on MMT by Marc Lavoie who positions it in economic currents, (including a Joan Robinson quote from 1937!) I recommend: http://www.boeckler.de/pdf/v_2011_10_27_lavoie.pdf

    A quote:

    ‘’...as Mosler (1994, p. 12) puts it, “deficit spending would cause the fed funds rate to fall”. I must admit that when I first read this back in 1995, … I thought that Mosler, despite his use of T-accounts, was another one of these monetary cranks that Keynes talked about in the General Theory. We are so much accustomed to the loanable funds approach and to the IS/LM framework, where an increase in government expenditures tends to drive up interest rates, that it is difficult to get away from this. However, a proper understanding of the payment system reveals that it cannot be otherwise.’’

    1. Keith, the passage you extracted from Lavoie's paper (and Mosler's 1994 work) is one that I also focused on. Mosler's Soft Currency economics contains some great insight. Finally, I tend to view the contribution of MMT in a similar fashion as you: it provides an excellent counter-theory to the unrealistic (and limiting) mainstream view of fiscal policy. Also, the fact that the main MMT authors make it a point of simplifying the main tenets is much to their credit. I still can't believe a reporter of CNBC is covering this stuff! Good news indeed.

  15. @gc. I enjoyed your Jan 11 comment. Why is the notion of a Fed paralysis a misnomer. If the Fed is independent, shouldn't it have acted promptly and with due diligence in 2007?

    1. @kp

      Fed Paralysis? Let Chair Volcker have the last word. His Speech to the Economic Club of New York… April 8, 2008. “There was no pressure for change, not in Washington which was spending money and keeping taxes low, not on Wall Street which was wallowing in money, not on Main Street with individuals enjoying easy credit and rising house prices,…”
      So who was left? The shackled FED.

      Chair Volcker concludes: “The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles and practices,”

      My judgment suggests that the Fed and Chair Bernanke demonstrated a determination to act appropriately in times of turmoil. This credential can only be exercised when there is independence. Is this Fed Paralysis?

      As to the coda let me begin with this preamble: Sometimes people confuse independence and accountability/transparency especially when deliberating regulatory and supervisory issues with Central Banks. (see next)

    2. Part 2) Wilson and Congress conceived the Federal Reserve within a system of checks and balances: it permits policymakers sufficient independence with respect to monetary policy while recognizing a need for transparency and accountability towards the electorate. Being independent does not imply the Fed is non-accountable.
      The dilemma generated in a democratic society is that one hands over the management of monetary policy to nonelected policymakers. Central bank independence implies that the CB can make monetary policy decisions without fearing direct political intervention. It is important to remember that the Fed does not select its own goals; Congress establishes the targets in consultation generally. Since moderate long-term rate objectives generally result when prices are stable and the economy operates at full employment, the truism surfaces that Congress has given the Fed a dual mandate.
      Why independence? Two reasons:
      Firstly, monetary policy affects the economy with long and variable lags, but elected officials, have shorter office time horizons. Monetary policy actions will not have their full effect on the economy until much later. Monetary policy choices accommodate intermediate to long term horizons. AS such conflicts and anomalies may surface between monetary policy results over the short term versus its longer term consequences. Hence the political predicaments to be surmounted.
      The second reason is to separate the authority of those in government responsible for making the fiscal decisions to spend and tax from those responsible for printing money. This reduces the temptation for fiscal authorities to use the printing press to finance its public spending. Efforts to politicize CBs can be perceived as an effort for fiscal authorities to strengthen their influence on the printing press to avoid difficult fiscal choices.
      It is only in view of its independence and to its own risk, that the Fed edged the parameters of legality during the 2007-crisis: Bear Deal, AIG, extension of its balance sheet with Non-Treasuries, Interest on Reserves and TAF (Term Auction Facility) are a few of the “extensions” it exercised when the country and the global system were at risk, as Washington, Wall Street and Main Street fiddled! The extension and the flirtations with fiscal aspects of monetary and credit policy were audacious measures, but necessary. The Fed lent to some firms and established unprecedented lending programs, many of which were justified under a13(3) authority during "unusual and exigent circumstances."

      This determination to act reasonably and appropriately was in large part possible as a result of its independence something a quasi-independent CB could never have initiated.

  16. @kp An old indexed reference (just heard the call)before the swell comes in:

    for the sceptics also.