Steven Hail with another Explainer!

Adapted from Steven Hail’s tweet thread where he goes into some misconceptions and misperceptions.

If you are a currency issuer, levying taxes in that currency, with a floating exchange rate and no significant foreign currency debt, then you are in a privileged position, which you should use wisely and responsibly. You are a monetary sovereign.

This means you face no purely financial constraints. This is a pure fact. It is not based on any theoretical assumptions. In your economy, there are real constraints, so if there is too much spending overall there will be inflationary pressure. But no purely financial constraints.

So when it is responsible to do so and not forecast to be inflationary, you can spend in support of people and the economy, as is appropriate, and you should have no simple and childish specific target for the fiscal balance. It is not an appropriate target, in itself.

The macroeconomic role of taxes is to sustain the demand for your currency and to limit inflationary pressures. This very much does not mean changing taxes has to be or should be the only or even the primary tool for inflation management.

It does mean the appropriate fiscal balance should be largely given endogenously, by the behaviour of the private and foreign sectors, and the state of the economy and by what is necessary to achieve and support the economy, and in normal times sustain full employment.

Given that the private sector will normally aim collectively to run financial surpluses over time, then in the absence of persistently large trade surpluses, the government will normally run fiscal deficits, whether it sets out to do so or not.

A fiscal surplus, absent a trade surplus, requires a private deficit, as a matter of accounting. Not theoretical – pure accounting. This is normally associated with a build-up of private debt, which leads to a more fragile monetary system.

Fiscal surpluses, absent trade surpluses, lead to rising private debt, a recession, or both. Fiscal surpluses, absent trade surpluses, are unsustainable. It is fiscal deficits which are sustainable, whenever they are not inflationary. They are normal.

A fiscal deficit is a deposit the monetary sovereign government has placed in the banking system. A government deficit is a non-government surplus. Essential if nominal GDP is to grow with healthy private balance sheets, in a way which is financially sustainable.

Governments, when they issue bonds, are simply offering investors transferable term deposits at the central bank, in exchange for transaction accounts. Pros and cons of issuance are complicated. But bond issuance is not compulsory. During QE, it is not really happening at all.

Not in net terms, in any case. Taxes do not literally ‘fund’ government spending. They limit inflation risk and maintain a demand for the currency. Bonds do not ‘fund’ government spending. They drain reserves from the banking system. 

Spending by a monetary sovereign is not bound by a purely financial constraint. Every $1 spent is a new dollar. Taxes vacuum away some of those $s. Bond issuance changes their form. $s paid in interest are new dollars too.

Interest paid = policy variable. Bond issuance = a choice. 

All the above is based on intrinsic truths about the monetary system; Based on balance sheets and flows of funds;. Based on fact; You can obscure it with formal or informal practices and self-imposed constraints. But you can’t change the facts.

Modern monetary theory is not something you need to introduce. It already exists. The only assumptions made above were that you are a monetary sovereign currency issuer. If you are not, MMT will provide a different analysis, and you will have less freedom of action.

Nothing to do with ‘printing money’. Not a recipe for spending without limit. Simply a technically correct description of how the monetary system functions. The above is as simple as I can make it. There is much more to learn, of course. But the above is correct.

So you either understand it, or you don’t. MMT is something you either understand, or you do not understand. It does not require you to believe in anything. It does not have to conform to your preconceptions, or your common sense, any more than gravity. Just a set of useful facts.


Australian Economists and Modern Money Theory

Australian economists and others are finally entering the public discussion on Modern Money(tary) theory.  It is welcome.  Below are the tweets that inspired this post (re-post).  The post itself comes from Andrea Terzi whom you can follow on twitter @ndrea_terzi.

Australian Real Progressives has previously dealt with many misconceptions about Modern Money(tary) theory.  Australian audiences should have discussions with Bill Mitchell, Martin Watts, James Juniper, Phil Lawn, Rohan Grey and Steven Hail to discover the nuance and complexities of Modern Monetary Theorists and how it differs from ‘smart traditionalists‘.  Hopefully, the post below goes some way to addressing the differences.

The Civilized Money View (aka MMT, or Modern Monetary Theory) has historical precedents:

First, the notion—developed by Adam Smith—that the wealth of a nation is measured not by monetary values, but by its capacity to produce goods and services.

Second, the notion of money—developed by John Maynard Keynes—that any modern state claims the right to declare what money is.

While Smith’s concept hints to full employment as the primary policy objective, Keynes’s concept hints to the management of money as instrumental to reach such objective. Furthermore, MMT explicitly recognizes that the currency itself is a public monopoly.

This leads to an appreciation of the monetary system fundamentally different from the traditional Monetarist-Keynesian paradigm.

What follows is a summary of eight key differences between these two models: the Monetarist-Keynesian paradigm (MK) and the Civilized Money View (or MMT)

MK – The central bank controls the money supply indirectly through its power to control the monetary base.

MMT – The private sector uses bank deposits as money, and bank deposits are not directly controlled by the central bank: they get created by government spending and bank loans.

MK – Because the central bank controls the money supply, it also controls the nominal interest rate in the money market.

MMT – Because it is the monopolist of money, the central bank controls the interest rate.

MK – The long-term nominal interest rate is determined by private preferences about real saving and investment, as well as by inflation expectations.

MMT – The central bank has the power to control the interest rate at any maturity: the interest rate is a purely monetary phenomenon.

MK – A monetary expansion can expand output and employment temporarily and yet, at some point, it generates inflation.

MMT – Any operation by which the central bank buys or sells financial assets does not make the private sector any richer and has little or no consequence on private spending decisions.

MK – Government decisions are largely driven by short-term personal goals of politicians, and thus the management of money should be the responsibility of an independent institution with a long-run horizon.

MMT – While monetary policy can only set interest rates, fiscal policy is much more powerful, since any deficit of the public sector generates an equivalent financial surplus of the private sector, and thus affects spending decisions.

MK – Taxes serve the purpose of financing government spending.

MMT – Because government spending takes resources off the private sector and simultaneously generates income and wealth in the private sector, it will cause inflation from excess demand unless a sufficient amount of taxes is levied on the private sector.

MK – If the government spends more than its tax revenue, it must borrow funds from the private sector, and this reduces funding to the private sector.

MMT – Unless it loses its power to define what money is, the government is the currency issuer: It faces no funding constraint, and it must spend or lend first, before the economy has the funds needed to pay taxes and buy government debt.

MK – Price stability is a precondition for economic growth and job creation.

MMT – A government deficit of a size that matches the private sector’s desire to accumulate financial savings is a precondition for full employment.

This post is Creative Commons Attribution-Noncommercial-Share Alike 2.5 Switzerland License and I dare say any other country as well. It first appeared here via Franklin College’s Andrea Terzi.

I felt it was that important it had to be shared with a larger audience.  Of note is that the MK paradigm mentioned throughout is the traditional current orthodox neoclassical approach used in mainstream economics today.