Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 22 March 2016

MMT and mainstream macro

There were a lot of interesting and useful comments on my last post on MMT, plus helpful (for me) follow-up conversations. Many thanks to everyone concerned for taking the time. Before I say anything more let me make it clear where I am coming from. I’m on the same page as far as policy’s current obsession with debt is concerned. Where I seem to differ from some who comment on my blog, people who say they are following MMT, is whether you need to be concerned about debt when monetary policy is not constrained by the Zero Lower Bound. I say yes, they say no, but for reasons I could not easily understand.

This was the point of the ‘nothing new’ comment. It was not meant to be a put down. It was meant to suggest that a mainstream economist like myself could come to some of the same conclusions as MMT writers, and more to the point, just because I was a mainstream economist does not mean I misunderstood how government financing works. It was because I was getting comments from MMT followers that seemed nonsensical to me, but which should not have been nonsensical because the basics of MMT are understandable using mainstream theory.

One comment on that earlier post provided a link to a very useful Nick Rowe post, who as ever has been there before me. This suggested that MMT assumed a vertical IS curve (there is no impact of interest rates on aggregate demand). If the IS curve is vertical, then it explains the puzzle I have. In the thought experiment I outlined in my previous post, if the government started swapping debt for money the decline in interest rates that would follow [1] would have no impact on demand, so there would be no rise in inflation. Indeed what else could it be besides an assumption of a vertical IS curve, as MMT does not deny that excess demand would lead to inflation at full employment.

I now think that is putting it too strongly. The view that many MMT writers have is that interest rates have an unreliable impact on demand relative to fiscal instruments. In that case of course you would have to use fiscal policy to control demand and inflation. That would be the focus of the fiscal rule. It is a similar regime to one I suggest would be appropriate for individual Eurozone countries. Inflation would be a discipline on deficit bias. [2]

What about a world where monetary policy did successfully control demand and inflation, which is the world I’m writing about? Evidence suggests you then need a fiscal rule stopping deficit bias (a gradual rise in the debt to GDP ratio over successive cycles). In a country with its own central bank (so no concern about forced default) and where all debt is owned domestically, the standard reasons why you would be concerned about deficit bias are intergenerational equity, crowding out of capital, and having to raise distortionary taxes to pay the higher debt interest bill.

There is a lot you can say on all three, but the point I want to make is simple. Being in that world means you do not need to worry about other sector balances because of their impact on demand. By being in that world at no point am I misunderstanding how government financing works, or ignoring the role of money. It does not mean I read the government budget constraint from left to right or vice versa! Yet I still get comments like this one left on a more recent post.

“Your political yourself Simon. One thing more than anything really annoys me. Why do you never announce or go public and say that taxes do not fund government spending?”

Comments like the one above, taken without context from some MMT paper, just appear stupid. By all means criticise my view that monetary policy is effective, or that rising debt has costs, but in future comments like that will just be ignored.

Let me make the same point using another example. Alex Douglas in a post argues that MMT does make an original contribution to political economy. He looks at a Warren Mosler claim that the state creates unemployment, and this is the only reason unemployment exists. It seems to me (with some additional help from Alex) that this involves two elements. The first sounds like a combination of points that mainstream economists might make: deficient demand exists because we are in a monetary economy, and some combination of monetary and fiscal policy can always get rid of deficient demand. The second is that money exists because the state requires taxes to be paid with it. Now I’m less sure about that second argument, but the point is that I can unpick what I agree with and what I do not using perfectly standard economic ideas. Yet if he had simply sent me a comment which said “the state currency is fundamentally a device for coercing labour” I wouldn’t have had a clue what he was talking about.

Now you might ask at this point why is it so important to be able to put MMT arguments in the language of standard macro. MMT is a coherent school of thought, using a language that those who have read the important texts understand. [3] Someone like me should just take the time out to read those texts. Well I have read some MMT papers, but I can assure you I have read many more than pretty well every mainstream macroeconomist I know. So what you may say. But it is a fact, and you may think it is an unfortunate fact, that mainstream macroeconomics is pretty dominant in both academic and policy circles. And it will stay that way: heterodox economists have been predicting the downfall of mainstream economics for longer than I have been an economist. [4] So if MMT is to have any influence, it will be through changing how mainstream macroeconomists think.

You gain that influence by properly understanding the mainstream. Bill Mitchell, writing in 2013, lambasts economists like me who try to suggest that the fixation with debt since 2010 does not come from mainstream macro. He does not believe it, and writes

“Why is there mass unemployment if government officials understood all our claims? It would be the ultimate example of venal dysfunctional politics to hold that that everybody knows all this stuff but are deliberately disregarding it – for what?”

But that is the tragedy of what has happened since 2010. Politicians, either out of panic or with ulterior motives, decided in countries with their own currencies that we should start worrying about the market no longer buying government debt, and austerity was the result. In this they were supported by a media that thought the government was like a household, and economists from the financial sector who had their own reasons for promulgating this myth. True, they did find support from some mainstream academic macroeconomists, but that support was never based on mainstream theory.

What mainstream theory says is that some combination of monetary and fiscal policy can always end a recession caused by demand deficiency. Full stop: no ifs or buts. That is why we had fiscal expansion in 2009 in the US, UK, Germany, China and elsewhere. The contribution of some influential mainstream economists to this switch from fiscal stimulus to austerity in 2010 was minor at most, and to imagine otherwise does nobody any favours. The fact that policymakers went against basic macro theory tells us important things about the transmission mechanism of economic knowledge, which all economists have to address.

[1] Bill Mitchell appears to suggest that in this case the central bank could maintain its interest rate by selling its stock of government debt. However pretty soon it would run out of assets to sell. This is exactly why some central bankers are reluctant to undertake helicopter money. One solution with helicopter money is to get the government to recapitalise the central bank, but of course to do that would involve creating more government debt. The central bank could start creating its own debt, but if governments stopped creating their own debt and asked the central bank to do it for them, nothing has really changed. 

[2] It is not clear to me that in such a world debt would always be tied down. A government that used an effective (in multiplier terms) fiscal instrument in booms (e.g. government spending) but an ineffective one in depressions (tax breaks for the wealthy) might experience an upward drift in debt. But what is clear is that in such a regime, concern about the debt stock should never justify significant departures from demand and inflation stabilisation.

[3] Although, as the range of comments to my earlier posts showed, what people understand MMT to mean varies quite a lot.

[4] I personally would not welcome the disintegration of macro back into separate schools of thought. Economists should be like doctors, and I do not want to have to ask my doctor what medical school of thought they belong to. I have relied on doctors using the same language and being able to understand each other. However I also realise that the unwise fixation of the current mainstream with microfoundations methodology can act as an exclusion mechanism, which encourages the formation of alternative schools of thought. This is yet another reason to be very critical of this methodological hegemony.  


  1. Macroeconomics, whether you like it or not, currently consists of separate schools of thought.

    1. No. There is a mainstream where the large majority of economists are.

    2. The fact that only the majority of economists are mainstream suggests the minority are part of a different schools of thought, no?

  2. Thank you for this: it's becoming clearer.

    As I mentioned, MMT is much too modern for the likes of me to have studied when my brain still took in new thoughts, but the (simplified) summaries I have seen on various blogs suggest to me that it is not so much contradictory to but an alternative prism to conventional macroeconomics. I may be wrong, but what I have seen does tend to assume away the external world (trade, exchange rates etc) which has some pragmatic justification but is obviously inadequate for policy setting. On the other hand the simple slogan: government expenditure for real economy, tax for inflation control, has a certain elegance and superficial (at least) credibility.

    Returning to your post, you say:
    "The contribution of some influential mainstream economists to this switch from fiscal stimulus to austerity in 2010 was minor at most," but I'm afraid I have to disagree. There was a very concerted effort by 'freshwater' economists in 2010-2011 to 'warn' of the inflation danger and these, although possibly a minority in the academy, most certainly had the ear of policy makers especially this side of the Atlantic. The IMF, ECB (pre-Draghi), European Commission, OECD, BIS (I know but they are still listened to) were all banging the austerity drum and they were egged on by a number of influential academics.

    Given that you argue above that we should not choose our advisers by the school they belong to (I think that is what you are saying) this mattered a lot. In fact the 'anti-Austerians' such as Krugman and yourself, were largely marginalised at that time and only MMT-ers seemed ready to stand up and say that deficits and budget balances were not the issue. Again, if you say 'deficits are important, just not at the lower bound' this invites a discussion about the lower bound rather than the real economy. And I know from personal experiences that both academics and government advisers are often much happier talking about money and rates than about the real economy of people and jobs.

    1. These economists had the 'ear of policymakers' because they supported what the policymakers wanted to do anyway. I think it is extremely doubtful these policymakers were actually influenced by these economists. Look at Rogoff, for example, who has consistently argued over the last few years that we need more public investment.

  3. Thanks!

    Good post. I think you and I are pretty much on the same page with our understanding (or lack thereof?) of MMT.

    To me (except for the bit about taxes explaining why worthless paper gets used as money and has positive value, which to me makes a stock-flow mistake, because taxes create a flow demand for money and we need a stock demand for money) MMT sounds very much like 1960's British Keynesianism, with a new vocabulary. It's what I learned for A-level economics, around 1972. We've moved on.

    1. "We've moved on."

      To 'hot potatoes'?


    2. That's unfair Nick:
      1. the "modern" aspect of MMT refers to the fact that we are living in a post-Bretton Woods era
      2. MMT argues for the impotence and indeed unreliability of monetary policy, which surely represents a divergence relative to 1960s Keynesianism

    3. I think what Nick is getting at is that in the classic Monetarist vs Keynesian debates, it was the Keynesians who advocated using fiscal policy rather than monetary policy.

  4. Warren Mosler (leading MMTer) will be in the UK 13th April. He suggested an informal get together, so I'm organising that (afternoon / evening of the 13th). It'll probably be in Milton Keynes. More details when the venue is definitely booked.

  5. Simon says, “ then need a fiscal rule stopping deficit bias (a gradual rise in the debt to GDP ratio over successive cycles).” I think not.

    Reason is that government debt is a private sector asset. To be more exact, it’s one of the constituents of what MMTers call “Private Sector Net Financial Assets” – the other constituent being base money. So if the debt does rise, that means PSNFA rises, which induces the private sector to spend, which means no further debt funded deficit is needed. I.e. the debt is self limiting.

    The debt may well get too big because of a reason explained by David Hume long ago, namely that politicians are always tempted to borrow too much because that enables them to reduce taxes and hence ingratiate themselves with voters. But the further the debt rises, the higher will interest rates be. And if the country DOES find itself in a “high debt high interest rate” scenario, that isn't too difficult to deal with: just print money and buy back the debt (i.e. do some QE). That will be mildly inflationary, not disastrously inflationary: witness the muted effect of QE. That inflation can be dealt with via increased taxes – politically difficult maybe, but economically entirely harmless. That is there’s no reason for “QE plus more tax” to cut aggregate demand.

    1. I'm speaking well beyond my competence here but isn't the 'muted effect of QE' a consequence of our being at the ZLB? Both Simon and Krugman, in the unlikely event that I have understood them, have allowed that the implications of MMT do indeed hold at the ZLB, and object only that MMT is not presented as applicable only at the ZLB.

    2. Rather than seeing 'the muted effect of QE' as the consequence of being at the ZLB, I would see both QE and ZLB as policy responses to the collapse of bank lending. It is notable that while narrow money measures rose sharply during the QE period in the US and UK, broad money measures did not. Central bank money creation compensated for the lack of private money creation.

      It is true that QE has not generated inflation but we cannot conclude from this that it never would as the context was unusual. A QE programme undertaken while bank lending was also growing rapidly would almost certainly add to inflation. If money creation by the state is to be used as an alternative to debt outside ZLB circumstances, then we shall also need measures to control the rate of private money creation.

    3. Yes: the effect of QE is less at the ZLB. Re Simon and Krugman, assuming your understanding of them is correct (and I don’t claim to have a better grasp of S&K’s ideas than you), then I don’t understand what S&K are saying.

      MMTers tend to be unimpressed by QE and interest rate adjustments (certainly I’m not impressed). That is MMTers tend to agree with an idea put by Keynes in the early 1930s, namely that in a recession, the state should simply print money and spend it, and/or cut taxes. Under that policy, note that private sector net financial assets will rise: for every £ of “print and spend”, PSNFA rises by a £. In contrast, QE and interest rate adjustments cause no change in PSNFA.

      So S&K’s point about the ZLB is plain irrelevant to MMT, far as I can see – which quite possibly isn't very far.

  6. "What about a world where monetary policy did successfully control demand and inflation, which is the world I’m writing about?"

    It doesn't and hasn't. That's the problem. It has uncertain and unpleasant distribution characteristics and it relies entirely upon pushing private debt - which as Steve Keen, Hyman Minsky and every MMT economists has shown is dynamically unstable in an endogenous money system.

    An endogenous money system that exists and has been proven beyond all reasonable doubt by the empirical work of Professor Richard Werner.

    It's not independent central banks that 'gave stability'. It's the tendency of non-linear dynamic feedback systems to go quiet and appear stable right before the internal tensions rip the thing apart. In this case due to the ever increasing amount of private debt leading to a Minsky Moment.

    A system requiring private debt as a control mechanism has been tried and it failed spectacularly. Trying to put that genie back in the bottle is the height of foolishness.

    The MMT proposal is simple. You lock off the short interest rate at the central bank - probably at zero, narrow the commercial banks via asset restriction so they can only lend for the 'capital development of the economy' and then use Lerner's Functional Finance as the 'fiscal rule' to demand manage the economy, with the rapidly moving wobbly cyclical part handled by an enhanced Auto-Stabiliser system called the Job Guarantee. Which also happens to ensure that everybody always has a job at the living wage.

    It's time to stop the state peddling in debt and artificial financial velocity - which is only of advantage to bankers and financiers.

    We know fiscal policy works. We know auto-stabilisers work. And the Job Guarantee fixes the Philips curve issues by providing the price stability anchor mechanism.

    As Randy Wray puts it

    'I had never thought of it that way, but Bill’s analogy to commodities price stabilization schemes added an important component that was missing from Minsky: use full employment to stabilize prices. With that we turned the Phillips Curve on its head: unemployment and inflation do not represent a trade-off, rather, full employment and price stability go hand in hand.'

    1. I am much happier with the JG as a means of managing the “rapidly moving wobbly cyclical part” of demand management than with any suggestion that it would suffice to deal with mass unemployment.

      The analogy with commodity buffers is overstated as for labour the macro effects are substantial but negligible for just a single commodity market. These effects raise doubts over its use as a price stabilisation tool. Certainly, a living wage JG could prevent nominal wages and hence prices falling and offer a powerful defence against deflation. The question is whether it could also stabilise against inflationary pressures and here the design of the scheme will be critical and revolve around what those on the scheme will actually do.

      An inflationary risk arises because paying a living wage significantly higher than benefits (which will also have a positive impact on wages for those working outside the scheme) will increase demand for goods and services. That will increase prices unless output rises to the same degree and that cannot just be assumed. Hence those working on a JG scheme need to be productive, not just on ‘make work’ jobs.

      A price stabilisation buffer needs to work both ways, i.e. it needs to release workers into the wider economy as demand rises. In some JG writing it seems to be assumed that as employers prefer to take on people who are already working over those who are unemployed, this issue can be dismissed. The employer preference here is true but not sufficient. The labour market is not homogenous but consists of a large number of micro-markets distinguished by skill and locality. So a JG scheme needs to enhance skills through both formal training and ‘learning by doing’.

      Both of these problems can be tackled but neither is trivial, which is why I see JG in a supplementary rather than central role in bringing down mass unemployment. For that a large public investment programme with positive impacts on both employment and growth looks more promising.

      As a final thought, the JG proposal should be updated to take account of a rapidly changing labour market in which an increasing number of people are working but not in formal full-time jobs. So a Work Guarantee under which those in precarious self-employment or on zero-hour contracts could opt for a few days paid work could be welcome to help manage income week by week.

  7. "The second is that money exists because the state requires taxes to be paid with it."

    That's a common misconception.

    The actual position is that the ability to impose and enforce taxation by a deadline in a denomination is sufficient, but not necessary, to get that denomination accepted in exchange for real goods and services.

    It's in answer to the "why would anybody take your worthless paper" argument by the gold bugs.

    But it leads onto the derivative from that which is that the government spends its money into existence and that *causes* an equivalent amount of taxation to occur for any positive tax rate via the multiplier process. The only thing that stops that being an equivalence in any accounting period is if somebody decides not to spend all their income instantly. In other words they save for whatever reason.

    In an endogenous system there is no automatic mechanism to equate saving with lending, and so you end up with a government deficit. Or a paradox of thrift induced recession.

  8. This post by DeLong may be of interest - referring to views of 'Uncle Warren' and other MMTers

    1. Yes, I think that post is where I learned pretty much all I 'know' about MMT.

      A key point, raised in comments but not (yet) addressed by our blogger I think, is the distributional impact of (a) conventional debt financing, (b) QE and its parallels, and (c) taxation and expenditure cuts - the whole fiscal side. For too long economic theory and praxis has assumed away all distributional issues, whether hiding behind Pareto optimalisation or simply using the 'rising tide lifts all boats' cliché. Now we (in the West but increasingly world-wide) live in a state of near sufficiency in aggregate, distributive issues are the 'hard problem' we should be confronting.

    2. I have written about the distributional impact of QE. As I do not think debt can be replaced by money, or that governments can set interest rates in the long term, I'm not sure what there is to say about the distributional effects of debt financing.

    3. If we want to talk about the distributional impact of debt, then we need to look beyond standard OLG models, which assume a representative agent and usually no inheritance (although Piketty and Saez have used an OLG model with inheritance to try to calculate an optimal rate for inheritance tax).

      If instead of a single representative agent in each generation, we have two, one with enough income/wealth to buy bonds and one without, then it becomes possible to start looking at the distributional effect of debt rather than taxation on the next generation. (I am not considering the money creation option here.)

      For simplicity, let us assume that government wishes to make a one-off payment to all citizens which will immediately be consumed and that capacity exists to produce the additional output. It can do this either by levying a tax (which it can force all agents to pay) or by selling bonds to the wealthy. This choice impacts the next generation as, when repayment is due, all agents have to pay the required tax but only the wealthy young (who inherited the bonds from their parents) receive repayments (capital plus interest). The result is a next generation distributional transfer from poor to wealthy agents.

      This example is just intended to show how using differentiated rather than representative agents makes it possible to consider the distributional impact of debt.

    4. You are making the mistake of thinking that if the government did not issue debt, the wealthy would not receive any interest. But they would invest their wealth in something else (e.g. overseas assets), which means the intragenerational distribution does not change, but the intergenerational one does.

    5. I was comparing debt with tax as funding mechanisms and under the taxation option the wealthy would have fewer resources to invest anywhere. Perhaps this is clearest if the alternative to bond financing is presented as an inheritance tax.

  9. We need to give serious thought to the slope and position of the IS curve. In particular, we need to work through the consequences of the rise in the size and scope of the financial sector in recent decades. My own view is that this has steepened the curve and consequently made interest rates less effective than earlier.

    First, there is the growth in alternatives to investment in productive capacity, from derivatives through property and share buy-backs to foreign portfolios. Falling interest rates make these alternatives often more attractive than investing in physical capital, so muting the effect of lowered rates compared to the marginal efficiency of such investment. Recent experience seems to confirm this.

    Second, investment is driven not just by the desire of the borrower but also by that of the lender. As the gap between the rates paid by banks to savers and borrowers tends to rise with those rates, lending is less profitable when rates are low. Additionally, high rates attract savings into financial institutions so increasing their ability to lend without jeopardising short-term liquidity. This view from the lender’s side could even generate an IS curve that is upward sloping.

    Third, this lender’s view also allows us to see the financial crisis as sharply shifting the IS curve inward as the ability and willingness to lend declined, a shift sustained by banks rebuilding their capital. Austerity has of course further shifted the IS curve inwards through its effect on demand.

    Taken together, these points imply reduced efficacy of monetary policy in current circumstances. I would be very interested in your response to these points.

    1. I think they are all valid points.

  10. Also from DeLong on LERNER-MMT:

  11. The purest MMT policy position (Mosler/Mitchell) is the policy rate set permanently at 0, deficit spending with 0 government debt issuance, aggregate demand management through fiscal policy, and an employment guarantee.

    A vertical IS curve overstates it, but is not inconsistent with their purest policy version.

    1. Yes: that's my understanding of MMT. My only quibble is that the "employment guarantee" is actually a SEPARATE idea to the other elements of MMT, as indeed Warren Mosler pointed out. I.e. one can implement employment guarantee systems WITHOUT the other elements of MMT: exactly what they did for example in the US in the 1930s. That is they had very large scale "make work" / employment guarantee schemes, like the WPA, without other elements of MMT.

  12. "If the IS curve is vertical, then it explains the puzzle I have. In the thought experiment I outlined in my previous post...

    I have a lot of respect for your blog and what you are doing, but this is exactly the sort of thing that annoys MMs, heterodox economists, social scientists and others. Do you really think that the IS curve is vertical is an answer? What we need to know is what is the causal mechanism that leads to the interest rate and output effects we are talking about. That can only be found by working as a true social scientist and going and talking and gathering up primary material from banks and corporations etc. A lot of work. ISLM is not the real world. It is nothing more than speculation. There is a lot in it that and other artificial construct has nothing to do with the problem we are looking at. This also goes for constructs with money multipliers or Walrasian systems that imply Say's Law. They only obscure the problem and obstructs us from finding the real answers.

  13. I wonder what you think, then, of Robert Chote's latest prediction.

    I presume that you would think of Chote as part of the mainstream? Yet he thinks that we have a 55% chance of reaching a surplus. I would have thought the chances are more like 5%, no matter how much austerity is imposed, simply based on the size of our external balance of trade and automatic stabilisers. So does he really believe that it's achievable? And if in any doubt, why is he not more critical of austerity - the OBR is meant to be independent, no?

    1. The OBR is specifically not allowed to make comments about alternative policies.

    2. But I'm not talking about alternative policies. Chote is, I presume, part of the mainstream, and his remit is to validate the government's policy. And he is validating the likelihood of a surplus and the accompanying austerity.

    3. Then I do not understand your question. He clearly believes his forecast, based on the policy assumptions he is given. You disagree. You cannot judge mainstream economics on the basis of one forecast.

    4. Can test your patience with a few simple questions?

      1. IIUC, then you're talking about mainstream in terms of methodology, rather than any particular predictions?

      2. You'll hopefully forgive my ignorance, but are the model and policy assumptions that the OBR use publicly available? [If not I might add, why not?]

      3. Do you believe his forecast?

      4. Do you believe the forecast is attainable with any policy assumptions that are realistic? (I mean economically, not politically)

      By forecast, I mean any form of semi-permanent surplus.

  14. a vertical IS curve would imply a constant output no matter what the interest would assume that as investment increases that the vertical IS curve would shift to the right increasing output, I assume, until you reach full employment........this would mean that if you are increasing investment via fiscal policy, that fiscal policy has no effect on monetary policy and vice versa......... in effect there is no monetary policy................... I seriously doubt MMT's believe that and certainly Lerner was way to smart to believe that............. it is however clear that lerner believed that fiscal policy could be utilized to reach full employment in any situation.......

  15. .
    Thank you for the very interesting thought provoking column.

    Two possible unidentified inefficiencies:

    1) Why do we limit the discussion of economy modulating tools to central bank monetary policy and government fiscal tax and spend policy?

    2) Adequate demand is a persistent problem, are we considering all the possible ways to increase it?

    Those two possible inefficiencies suggest to me that a systemic economic reorganisation is needed:

    1) Drop all income taxes. A penny earned is potential demand no reason to confiscate it.

    2) Raise currency issuing government funds primarily through bonds.

    3) Control inflation through a number of tools all controlled by the central bank and all dynamically modulated based on invlation. Those tools include transaction taxes, asset taxes ( houses ), bank reserve requirements, loan to value ratios at a very minimum.

    I do not think there is any doubt that those tools could control inflation. Thus there is no justification for the demand sapping income tax or really any tax applied to gross income by a currency issuing entity.

    The net effect is an economic system with an inherently higher natural rate of economic activity. Such a system would be far less likely to suffer from secular stagnation or zero lower bounds.

    As the automation of everything proceeds and persistent demand shortfalls become routine, I suspect the logic of a Bond Funded a Government will become more compelling.

    1. "confiscate it."

      I like the recent article where tax money was looked at a public funds we all need to pay to keep society running

      "confiscating your tax dollar" or whatever is completely selfish and antisocial

  16. The idea that a quantity of government taxation and spending is made by taxing and spending a quantity of central bank reserves is not correct.

    For example.
    Person A with a commercial bank, Creates £50K in commercial bank deposits, and pays that 50K to person B in a salary.
    The Government declares the tax is £20K and The government Spends £20K with person C.

    At the end of the process, the £20K of commercial bank deposits with person C are commercial bank deposits created by person A.

  17. Hi Simon. I think Nick is incorrect on this one. Sure there could be a steep IS, but the idea is based to some extent on the fact that there is little evidence that investment is sensitive to interest rate changes. The accelerator does the bulk of the work in explaining investment behavior. But that does not mean that the interest rate cannot affect other demand components. Like consumption. Or, by the way, by making government borrowing cheap, allow for more fiscal expansion. Not sure what MMTers would say, but in general heterodox authors would accept that the interest rate does have an impact on output, but not through investment. My two cents.

    1. My account is more subtle than a vertical IS curve. It is that MMT think that the IS curve is unreliable, so we need to use fiscal policy for demand management.

  18. I agree with you prety much all of it and i am in awe that you took your time to properly understand MMT, but some insights are still escaping you.

    I can see that most of your concern is inflation (in future) and how to control it. It would be easiest to use Keynes's words on economist predictions with storm.
    Your defense of fiscal rule points to problem of controling inflation. But would not much debt be an automatic stabilizer for inflation, servicing large debt could eat into primary deficit once economy improves.
    On the other hand, deficits are necessary to cover for savings. That is why MMT says that deficits are determined by wish to save of private economy. Capital accumulation demands deficits to prevent stagnation.

    Savings can go only into bank reserves and can be pulled out at any time so savings can not be lent out by banks. Deficits replace them into economy to prevent stagnation from iliquidity. That is done by state not by banks. Only state can borrow savings and put it back into economy.
    By using fiscal rule to prevent deficits in good times it would cut into savings in the future.

    But we all agree that government debts are not an issue. Why are you saying now that it might be in good times/ non ZLB times?
    It is not, because it increases the savings that are the source for the state debt. It increases the numbers on both sides, thats it. Savings are not going to be spent anyway cause that is saving.

    State accounting shows why there is no concern for debt in non ZLB times. It is just numbers that are shifting around.
    Helicopter money is mainstream economist's idea, not MMT. MMT says that it doesn't matter, what matters is state budget decisions.

  19. You do not need a MMT paper to show taxes do not fund government spending.

    Just try doing a reserve drain before doing a reserve add.

    Taxes and issuing government bonds are just reserve drains that allow the central bank to meet its overnight interest rate.

    You have never once said taxes fund government spending all you will say is that they are a budget constraint.

    Please expand on what you mean by a budget constraint ?

    Please also explain to your readers why the monopoly issuer of £'s needs mine or your £'s before it can give out more £'s.

    1. Because giving out more £'s without withdrawing £'s that are already in circulation risks creating dangerous levels of inflation?

    2. Thanks Patrick you must agree then taxes control inflation. which are then destroyed in the reserve drain when the BOE meets its over night interest rate target every night of the week.

      On top of that when the government borrows it is only borrowing back what it originally spent via deficit spending.

      It shouts roll up roll up save your money with us in our savings account at the BOE.

      In essence it takes currency out of circulation this way also. It is this saving that causes the deficit in the first place.

      It is ironic to think on the one hand the fiscal conservatives want us all to Save. Yet at the same time they want to destroy those savings by reducing the deficit.

      Then Osborne wonders why he can't reach his targets.

    3. Nope. Thats not it. Just controls the volume of base money. Its just a choice between reserves or Treasuries, which are functionally almost the same thing... My question is, in the current world of IOER being the primary rate tool, is the Fed still targeting a certain volume of reserves? If so, why?

    4. Patrick, we all acknowledge that injecting £s may need some £s to be withdrawn to avoid excessive AD and therefore inflation. Footsoldier's point is that the withdrawing can (and should) logically happen after the injecting.

    5. Then you'll be for banning bank lending as well I presume.

      The state is just a special kind of bank.

    6. If a central bank creates money for government spending without that increased demand being balanced by borrowing or taxation, then to restrain inflation we shall have to control money creation by private banks as we approach capacity. We should acknowledge that.

  20. If you really need a MMT paper on why taxes do not fund government spending.

    Then read Stephanie Keltons paper 224 from the Levy institute.

    Called can taxes and bonds fund government spending.

    Feel free to write a post on it.

    1. "can taxes and bonds fund government spending"

      yes they can

    2. " . . . why taxes do not fund government spending."?

      “Here is a graph of the difference between cumulative tax revenue and cumulative federal spending in the US since 1789. The US started to run fiscal deficits systematically in 1931 and since then has run deficits 85 per cent of the time. Every time they had tried to run surpluses a recession has followed.
      Note the gap widens after the early 1970s, which of course is when the Bretton Woods system of convertible currencies and fixed exchange rates was abandoned and the US government adopted a fiat currency system.
      It seems that public spending is not paid for by taxes over a long period of time. Funny about that!”

    3. By "taxes do not fund government spending" do you mean
      "taxes do not fund ALL government spending"? I do not think anyone has every claimed the second.

  21. "But that is the tragedy of what has happened since 2010. Politicians, either out of panic or with ulterior motives, decided in countries with their own currencies that we should start worrying about the market no longer buying government debt, and austerity was the result. In this they were supported by a media that thought the government was like a household, and economists from the financial sector who had their own reasons for promulgating this myth. True, they did find support from some mainstream academic macroeconomists, but that support was never based on mainstream theory."

    My question remains the same. If only a few mainstream academic macroeconomists supported austerity, based upon something other than mainstream theory, where the hell were the rest of the mainstream macroeconomists?

    1. I know in the UK they were signing letters opposing the Conservative's austerity plans (before they even got elected). Many more signed those than signed the famous one supporting austerity.
      The fact that you only hear about the 20 that wrote the 'austerity letter' tells you what you need to know.

  22. MMT does not assume vertical IS curve, but it is more like indetermined vertical squigly curve. It can not be determined when is backward sloping and when it is forward sloping.

    MMT assumes that only the rise of IR can affect demand, not the fall in rates.
    IS curve in MMT is called Willingness to borrow (at given rate) and since it can not be determined it is not given in mathematical formula. And banks do not follow official rate imediately so there is a lag, a double lag on the effect of IR change.
    Animal spirits can persist in borrowing no matter the IR levels. By Minsky, these animal spirits can turn borrowing into ponzy debt; not based on profitability but on expectations of capital gaines caused by more borrowing.

    This can become visible if you keep watch on private debt behaviour, not on public debt.

    On Alex Douglas's claim about "state creates unemployment" i understood this claim by W.Mosler is that only state can measure unemployment, without a state organization no record of unemployment will exist, not that there will be no unemployment.

    On influence of MMT on mainstream. It is true that many proponents did not previously educate themselves in mainstream economics, they went straight to MMT so that they can talk past each other without noticing it. There is terminology barier.

    "What mainstream theory says is that some combination of monetary and fiscal policy can always end a recession caused by demand deficiency."
    Then many mainstreamers pretend (or believe) that it is supply side problem, not demand deficiency to avoid using correct model so they prescribe austerity to solve supply side problem.

    1. My point is that austerity is not a policy recommended by most mainstream economists, but one opposed by most mainstream economists. See my reply to Bill above.

  23. "A Critique of Modern Monetary Theory (MMT)
    Cullen O. Roche
    November, 2013
    This paper provides a broad critique of the economic theory known as “Neochartalism” or Modern
    Monetary Theory (MMT). The critique is taken from the perspective and understandings of Monetary Realism."

  24. Hello,

    I am in the MMT camp, but agree with many of the sentiments you express here.

    The only thing I would comment about is the mainstream approach to fiscal policy to battle a downturn that you refer to.

    How is fiscal policy supposed to deal with persistent underemployment (such as see in youth unemployment, or the drop in the participation rate in the United States)? How do you avoid classical "Keynesian" aggregate demand management, which risks persistent (under-) unemployment and elevated inflation?

    (MMT inherits Minsky's critique of 1960s Keynesianism; Minsky based his critique on theory by Baumol, who I am not familiar with, but you presumably would be. The MMT Job Guarantee is aimed at dealing with bluntness of aggregate demand management, based on Minsky's similar proposal.)

  25. Macro of and for the scientifically blind and deaf
    Comment on Simon Wren-Lewis on ‘MMT and mainstream macro’

    The summary argument against MMT from the standpoint of old/post-Keynesian/mainstream macro is ‘the old is correct and well understood, while the new is substantially wrong.’ (Palley)

    The old may be subjectively well understood but it is objectively false nonetheless since Keynes. In order to see where things went wrong one has to return to the very beginnings of macro: “For it can fairly be insisted that no advance in the elegance and comprehensiveness of the theoretical superstructure can make up for the vague and uncritical formulation of the basic concepts and postulates, and sooner or later ... attention will have to return to the foundations.” (Hutchison, 1960, p. 5)

    Keynes defined the formal foundations of the General Theory as follows: “Income = value of output = consumption + investment. Saving = income - consumption. Therefore saving = investment.” (1973, p. 63)

    This elementary two-liner is conceptually and logically defective because Keynes never came to grips with profit and therefore “discarded the draft chapter dealing with it.” (Tómasson et al., 2010, p. 12). As a result, all I=S models including the Keynesian multiplier are false (2011; 2014b; 2014a; 2012). Neither the proponents nor the opponents of mainstream macro got this point until this day. Wren-Lewis is only one among the many (for details see post

    It should be clear that when the foundational economic concept of profit is inconsistently defined then the whole theoretical superstructure is a flawed construction without any scientific value whatsoever. No policy recommendation can be drawn from such a model. This applies to both old mainstream macro and new MMT macro. Therefore any policy discussion between the two camps is vacuous.

    The three main points of the axiomatically correct approach are:
    • All I=S models are are false since Hicks (proof see post ‘Toward the true economic axioms’*
    • The correct profit equation for the investment economy reads Qm=Yd+I-Sm (2014b, p. 8, eq. (18)). Legend: Qm monetary profit, Yd distributed profit, I investment expenditures, Sm monetary saving. Sm establishes the connection to the money market.
    • The correct employment equation/Phillips curve is given here For details see the post ‘Have data, lack theory’

    Conclusion: The old macro is incorrect but nonetheless accepted by a majority, while the new MMT macro is incorrect but accepted by a minority. Neither approach can be taken seriously because the proponents do not know what macro profit is, but the stuff is good enough for another senseless economic policy debate.

    Egmont Kakarot-Handtke

    References see

  26. You simultaneously argue that microfoundations are an exclusion mechanism and present microfounded OLG as the counterpoint to MMT. I’d be interested if you’d be willing to defend the economic substance of intergenerational transfers, crowding out, and higher future taxes as serious problems against the MMT counterarguments (which you don’t provide). If I may speculate, I’d guess is that you think these (OLG) positions are difficult to seriously defend (or at least far less of a problem than reflexively assumed). Am I right?

    If so, MMT seems like a fine and realistic way of doing economics. The burden of improving mainstream economics is on the mainstream, not on a marginalized group with no power in the field. I applaud your willingness to make a good faith effort to understand this fringe school instead of just ridiculing it. I’m just not sure of what your ask is. If the boundaries of what you consider correct in MMT is whatever can be already stated via widely accepted mainstream constructs, then MMT can’t have anything to offer.

    1. Can you suggest a better way of examining intergenerational issues than an OLG model? As far as crowding out is concerned, you can put that in very non-microfounded terms. You can only argue that crowding out is a non-issue if you think investment always creates the savings it requires.

    2. The MMT position is that the only form of crowding out that can happen is crowding out of real goods and services when the economy is at full capacity. they disagree with loanable funds theory.As explained by Bill Mitchell in this post:

    3. I thought Warren Mosler (and others) argue that investment always creates the savings it requires (as in "savings is the accounting record of investment" ). Googling that phrase gives a bunch of hits saying just that.

    4. Simon Wren-Lewis

      You ask “Can you suggest a better way of examining intergenerational issues than an OLG model?”

      Yes. For the correct approach see the working paper ‘Settling the Theory of Saving’

      Egmont Kakarot-Handtke

    5. Regarding OLG models applied to macro, would you consider the book by Champ, Freeman and Haslag to be a good account of the mainstream view?

  27. You simultaneously argue that microfoundations are an exclusion mechanism and present microfounded OLG as the counterpoint to MMT. I’d be interested if you’d be willing to defend the economic substance of intergenerational transfers, crowding out, and higher future taxes as serious problems against the MMT counterarguments (which you don’t provide). If I may speculate, I’d guess is that you think these (OLG) positions are difficult to seriously defend (or at least far less of a problem than reflexively assumed). Am I right?

    If so, MMT seems like a fine and realistic way of doing economics. The burden of improving mainstream economics is on the mainstream, not on a marginalized group with no power in the field. I applaud your willingness to make a good faith effort to understand this fringe school instead of just ridiculing it. I’m just not sure of what your ask is. If the boundaries of what you consider correct in MMT is whatever can be already stated via widely accepted mainstream constructs, then MMT can’t have anything to offer.

  28. I am not economist, but I see it as something rather simple:
    The State can always optimize economic output to fully utilize productive capacity (i.e. full employment), and to do so without overheating, which would otherwise be expressed as higher inflation. In other words, the State can always create work to get to full employment, and stop at the first signs of accelerating inflation.

    To do so, the State through its central bank must set interest rates at below the rate of economic growth, so that the debt/GDP ratio is more or less stable. This can be effectively done by monetizing government debt issuance.

    Why can the State get away with it? Is that a form of financial suppression? The answer, as far as I understand is that there is an inherent systemic attraction of savers towards safe assets, where the definition of a "safe asset" is the one that keeps par value (or as we are now increasingly finding out something like 99.5% of par value). The sovereign, through its money-creating prerogative, can generate endless supply of such safe assets...

    So yes, in effect, it is a form of financial suppression, since by keeping the interest on debt below the rate of GDP growth the relative asset value for the savers (owners of State debt) declines with time. However, this is a voluntary financial suppression, exploiting the risk-aversion bias of savers to their detriment. And it is to a large degree an irrational bias. You would think that a rational approach would be to invest in the productive capacity of the economy, so that the relative value of your capital grows with time, as per the basic tenets of capitalism...

    As a parallel, this principle reminds me of the State lotteries, except that it is the exact opposite of them. A State lottery is a voluntary tax, that is based on an irrational bias towards windfall profits. The expected probability-adjusted return on lottery tickets is extremely small, yet nevertheless people buy them.

    The MMT theory is based on the principle that savers will buy State debt even though it produces unsatisfactory returns, simply because its par value is guaranteed.

    The end result as far as I see it is redistribution of wealth from savers to labor and to social spending, that is voluntary in nature. Interesting and not very complicated.

  29. I appreciate the article. I think a lot of MMT proponents would agree that they haven't come up with anything entirely novel, but it seems like there is a unique perspective/ focus. MMT more than other schools does seem to focus on the "operations" or actual nuts and bolts of the monetary/ banking system, whereas other lines of thought seem more theoretical. An analogy can be made to a group of people debating on how best to drive on a road trip from Maine to Alaska. One group is saying we should drive fast to get there quickly while another says we should drive slow to get there safely and preserve gas mileage. Both could be valid. MMT is the guy saying "Hey guys. That car doesnt have any tires, or gas, and the carborator is shot"... just my perspective

    1. Actually I find the 'nuts and bolts' aspect of MMT the most irritating. You just need the government's budget constraint.

  30. Thanks for your replies to my comments and my blog post. Nick Rowe also replied to me, and we had an (I think) quite interesting and useful (for me) exchange. It's here, in case you're interested:

    There is some significance in the point you're sceptical about - that fiat money exists because the state requires it for tax payments. If that is so, it makes the state *directly* responsible for most, if not all, unemployment.

    This gives a different sort of significance to the mainstream point that the state can always eliminate unemployment through a combination of fiscal and monetary policy. On the neochartalist understanding (which I share with MMT), the state only creates unemployment (by imposing tax) *for the purpose* of eliminating it, usually by hiring the labour it needs to provision the public sector.

    The neochartalist model of currency is the Hut Tax of certain colonial outposts. Colonists found they couldn't barter for labour from local villages; there was nothing they had that the villagers wanted. So they imposed a Hut Tax on heads of households in the villages, payable only in British Pounds. The villages went from full employment to mass unemployment overnight. Suddenly they were full of people wanting to sell labour for pounds, which they either needed to pay Hut Tax or needed to buy provisions from other villagers, who would now, because of Hut Tax liabilities, only sell them for pounds.

    The tax, in other words, takes people out of private employment and into unemployment, so that the state can then move them from unemployment into *public* employment. That is the purpose of a fiat currency.

    When people hold fiat currency rather than spending it, they create additional unemployment besides that created by the state through taxation. On the neochartalist understanding, the state should respond by either cutting taxes or hiring more labour, since its aim is to move only as many people out of private employment and into unemployment as it needs to hire out of unemployment and into public employment. To have more people in unemployment than the state needs to hire just wasteful. It might as well reduce the tax burden and not force the excess unemployment in the first place. Otherwise it is doing something similar to confiscating half the food from the private sector and then letting a portion of it rot in a warehouse.

  31. Prof. Wren-Lewis,

    You said:

    "What mainstream theory says is that some combination of monetary and fiscal policy can always end a recession caused by demand deficiency. Full stop: no ifs or buts."

    With respect, there is nothing in mainstream macro that protects you against market expectations of government stupidity.

  32. Here's Varoufakis in Italy smashing macroeconomic models that don't consider money and banking (money creation):

  33. Did not read every post so apologies if this was covered. If you drop helicopter money, the Fed could issue special helicopter bonds at the same time, which can be sold back as a reserve drain in the future.

  34. It should have occurred to people by now that the Banking system is obsolete, looking to the future of ever diminishing raw materials and the impact on the west, past norms are no longer relevant.

    We need to of course nationalise the banking system so that people can store money and carry out transactions, but fundamentally the financial sector has no relevance to peoples everyday needs.

    or are we just born on this planet to serve the needs of the casino economy?

    In short we need to create money and spend it directly into the economy as and where it is needed.

    Efficiency really does not matter as our economy is in decline and the feral elite see things only from their own personal perspective, we the majority must start thinking about meeting our needs and not following like sheep; becoming the serfs to a corrupt and self serving minority.

  35. For those who don't read to the end:
    The most useful idea I take from MMT is that the discussion about government debt should be re-framed to be one about the quantity and composition of "private sector net finanical assets".

    As a natural consequence, government deficits should be funded completely by "printing money", and the function of issuing bonds should be entirely the domain of the central bank.

    You're quite right to suggest that the real value (if any) of MMT would come from translating some of its insights into mainstream macroeconomics, and political economy in particular. Although I think that there is room for a healthy dose of skepticism about monetary policy, I agree with you that the suggestion of many MMTers to do away with it altogether appears to be mistaken.

    Most importantly, though, I think you're completely wrong to absolve "mainstream economics" of the blame for austerity and chalk it down to an issue in the "transmission mechanism of economic knowledge". It is mainstream economists who have drawn the lines for the modern discourse about deficits, the sutainability of government debt, and intergenerational fairness. Although it's clear that among competent economists austerity is discredited, economists are responsible for the terms of the debate that makes it seem as though it's at all possible for it to be sensible policy. The key lesson I take from MMT is a political economy lesson, and it's that the terms of mainstream economic debate on monetary policy and fiscal policy are inherently misleading.

    First of all, the whole notion of "government debt" is deeply misleading, because it draws a wholly unwarranted distinction between government bonds and money. In actual fact, government bonds and money are both different forms of government debt that differ only in that one of them pays interest and is less liquid than the other. By comparison, the use by MMTers of the much less loaded term "private sector net financial assets" to refer to the same thing is clearly preferable.

    By introducing an artificial separation between government bonds and money, mainstream economics gives a misleading picture of what the dangers of excess government spending are. The one (and only) genuine constraint on excessive government deficits is inflation. Thus, the clear lesson to learn from MMT is that the modern separation of monetary and fiscal policy is fundamentally flawed, and doesn't make sense.

    Instead, why not introduce a much more straightforward separation between fiscal policy and monetary policy, in which the government's fiscal policy sets the *quantity* of "private sector net financial assets", whereas the central bank controls the *composition* of those net financial assets, i.e. the balance between long-term bonds, short-term bonds, and money.

    For one thing, this would give the central bank much better fine-grained control over monetary policy, by contrast to most modern systems where monetary policy is perversely divided between the government and the central bank.

    Secondly, the current system, in which governments issue bonds which might subsequently be bought up by the central bank, introduces a bias towards a greater economic distortion. After all, co-existence of money and bonds is distortionary compared to a system in which only money exists, and so the default way to pay for a fiscal deficit should be to issue more money rather than more bonds.

    Once you re-frame the discussion from being about "government debt" to the quantity and composition of private sector net financial assets, concepts like the debt/GDP ratio make less and less sense.


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