Basic MMT and Economic Justice

Published on 2014-10-15

Contents

For most of this whole course on MMT I am going to use the example of New Zealand, since many people claim MMT only applies to a country like the USA which enjoys a global reserve currency status. This would be false. MMT applies perfectly well to a small open economy like New Zealand. The currency is the NZD.

The Bare Minimum

If you have a very sharp mind and keen intelligence you can almost derive answers to most of the basic questions concerning state currency monopoly systems (which would describe most monetary systems in all major countries today) using the principles in the following four subsections:

The System

MMT is based on one axiom, one legal reality, and one identity:

All economies face real resource constraints.
Currency issuers (usually these are governments or their licenced agents) face no purely financial constraints. To learn why this is a legal reality see What is Money.
Sectoral balances sum to zero.

A few supporting definitions and operational realities:

Real resources: material goods, workers, capital machinery, natural re-sources, water, sunlight, land,…
Fiat currency: a unit of account for issuing or settling debts. Normally a single economic region issues only one fiat currency and it is defined as “that which is accepted for redemption of tax liabilities, fees or fines of the state.” The most efficient modern forms of fiat currency are electronic digits in a bank account, which is indeed the most common form of NZD currency.
Bank reserves: banks use reserve accounts (held at the central bank) to facilitate payments clearing. Bank reserves are not used to make loans, nor are deposits. In fact, deposits are liabilities of a bank, and debts owed by customers are the bank’s assets. Reserve accounts are just spreadsheets at the central bank and are for payments clearing operations.
Bank credit: banks are licenced to issue money when they extend credit. Operationally this is not a loan or a borrowing by the customer, because banks do not lend out their reserves and deposits. Bank credit (what we tend to think of as bank loans) are nothing but electronic entries in a spreadsheet, the bank marks-up the customers account and records a corresponding debt that the customer must repay with interest at a due date or dates.
Currency issuer (or ‘money sovereign’): monopoly issuer of a non-convertible fiat currency with floating exchange rate, and no foreign denominated debt.
Sectoral balances: one sector’s deficit is another’s surplus. MMT in the macro normally recognizes four sectors: government, banks, house- holds+firms, foreign. The domestic private sector comprises the private banks, households and firms. But one can split an economy into as many sectors as one likes, the sectoral balances still sum to zero.
Private sector means ’non-government’ including all foreigners.

Comment: Some folks call a currency issuing government the “monetary sovereign,” but that can be a misleading term, since full sovereignty is widely recognized in MMT circles as connoting a whole raft of powers, such as food self-sufficiency, energy self-sufficiency and legislative sovereignty, and perhaps more. All forms of ‘sovereignty’ are desirable, but currency issuing authority is the minimum necessary and sufficient for an economic region to be considered well-described by MMT.

Comment: When people first encounter fiat money they usually ask, since it is not gold mined out of the Earth, “where does the government get this money from?” The answer is the government does not get money from anywhere, the NZ dollar is a unit of account, the government neither has this stuff nor doesn’t have the stuff, when they want to spend they mark-up someone’s bank account with a computer, and when they tax they mark-down the person’s account, and that’s all that happens. No gold is lost, no one’s grandchild is put at risk, no “borrowing from China,” occurs at all.

Another way of putting this is that the NZD is the State’s unit of account. Like a kilogram is a unit of measure for mass.

You never own or emit or collect kilograms. You can own or collect masses, like sheep, pancakes, potato chips, paua, kiwifruit, apples and whatnot. You collect certain masses, you measure them in the kilogram unit. The authority defining the measurement unit cannot ever run out of units — it’s just not an applicable concept, it’s like saying you could run out of names for babies. They can however run out of real types of mass that the measurement unit denominates.

For macroeconomics, the critical resource a government can “run out of” is human labour. But in a sense that’s a good thing, if or when government has run out of labour it can hire at existing wages, then it knows it has reached full employment. Further public sector hiring will then just push up wages in certain sectors, by competing with the private sector for already employed workers.

Under some conditions this could even be good policy. Public sector jobs might be more critical than many bullsh*t workers in the bloated private sector. But these are political matters requiring political choices. (Who is to say what counts as a bullsh*t job ?)

The Money Sequence

The state desires to provision itself.
The state imposes tax liabilities payable in its currency as the tax credit.
This results in sellers of goods and services (and hence also unemployed people) seeking state currency.
The state then makes its desired purchases, and thus from inception is the price-setter, not price-taker. (The government sets the price level.)
Taxes are paid and bonds purchased.

What Happens to State Spending?
After the state spends, the private sector has only two choices:
(a) use the money to pay taxes, in which case it’s removed from the economy,
(b) don’t use the money to pay taxes, in which case it remains in the economy until it is used to pay taxes.

The Public Debt
The national debt (=private savings) is the funds spent by the state that have not yet been used to pay taxes, it is dollar-for-dollar our private savings. (government deficit = private surplus.)
The ‘national debt’ constitutes what is best thought of as the net money supply of the economy.
A growing economy is expected to include a growing net money supply.

Unemployment
Taxation, by design, causes unemployment.
Residual unemployment — after state hiring and spending — is the evidence the state has not spent enough to cover the need to pay taxes and the private sector’s desire to save out of income.
If the state doesn’t spend enough to cover the need to pay taxes and desire to save, the evidence is unemployment.

Reversing Unemployment
Unemployment is the evidence that the state’s tax policy caused more unemployed than the state + private sector has hired.
The state has the option to reduce the tax liabilities or get the unemployed hired through increased public spending (preferably on direct job creation for public purpose).

The Job Guarantee
Tax liabilities created more unemployed workers than the state wanted to hire.
Business resists hiring the unemployed and prefers hiring people already working, and in any case, firms cannot hire if they cannot make sales.
The JG facilitates the transition from unemployment to private sector employment, providing the non-government sector with a net injected supply of money, boosting sales.
The JG is a superior price anchor vs unemployment (unemployment$\leftrightarrow$basic income).

The JG program is the superior automatic stabilizer for an otherwise unstable economy.

Summary:

All state currencies are IOU’s of the state. Q. What does the state owe you? Answer: the state says it owes you redemption for payment of tax liabilities. The State always honours this obligation. Why would they not? The State creates the need to pay tax liabilities, it issues the only records of account that are accepted for such payments, and it can always accept them back, it’s just book entries.

The Bond Story

Treasury Bond Operations Prelude

A crucial insight was made (around 1990) by Warren Mosler which (together with Bill Mitchell’s insights on buffer stocks for employment) kick-started MMT before it was known as MMT, and this was the realization that when the Central Bank (Federal Reserve in the USA, RBNZ in New Zealand) sold or purchased bonds this was functionally equivalent to the Treasury selling and buying bonds. The issuance of Treasury bonds could thus not be considered a borrowing operation, an issuer of a currency can no more borrow from itself than you or I can borrow our own IOU’s. To be sure, when you or I issue an IOU we can certainly borrow it back, but the point is that this serves no purpose other than to drain IOUs from everyone else.

However, if we regard it as borrowing, the IOU is owed back to the person we borrowed it from, so we have not altered the net money supply of IOUs. Now, given that we can write as many IOUs as we like, we are not revenue constrained in our own IOUs, so we have no need for the borrowing. Why would we offer to borrow our own IOUs then? The answer, Mosler explained, was that we might do so to generate a positive interest rate for our IOUs, by offering some interest on those IOUs that we have “borrowed.”

Only now, we recognize this is not a borrowing operation at all. It is functionally the equivalent of offering a savings account, a term deposit. The further purpose of offering term deposits backed by government guaranteed interest returns, is to define the term structure of interest rates, and that serves a controlled pro-inflationary purpose, a stable form of economic stimulus, but which MMT recognizes as highly regressive, because it amounts to little more than welfare for those who already have money.

However it is far worse than this, far more regressive, because this issuance of bonds is not only basic income, it is basic income but only for people who already have money and in proportion to how much money they already have. It is an obscene policy. There is simply no good reason for our government to be issuing bonds. If we had a fixed exchange rate policy (so similar to a gold standard, our government would be promising to redeem the tax credits (NZD) for either gold or for a foreign currency) then it would be necessary to issue bonds, in order to prevent mild inflationary pressures. But why? There is no need for enriching people who are already rich with such policy, our governemtn should instead float the NZD, and offer zero interest.

The greater body of work on MMT recognizes that a far more effective way to stimulate an economy is to supply new money at the bottom, in the form of either a Basic Income Guarantee or even better a Job Guarantee, or combination of both. But an even more effective way to fuel an economy is for the state to directly hire workers who are willing to take jobs in the public sector proper, because such jobs (teachers, nurses, public attorneys, public banking, road works, police, fire-fighters, parks wardens, sanitation workers, electricity utility supply workers, conservation workers, government R&D scientists, &c.) all help provide free non-profit public services which lower the nominal costs to the private sector of conducting business.

The cost to the private sector of all this state sector hiring is a real cost, not a monetary cost. The cost being those workers (and any electricity, computers, paper, fuel, food) resources they consume during their work are now no longer available for hire in the private sector.

Only MMT has recognized this fact. All other schools of economics to date claim taxes are paying for these public utilities, and thus in the long run are not lowering costs to private sector businesses. Well, they’re all wrong. MMT is correct. Money can only come from government net spending (or unstably from bank credit extension) and so when the state provides public services not only are they lowering private business costs, they actually fund the private sector withcapacity to pay their tax liabilities. Everyone else has the money story backwards, including most post-Keynesians and Marxists.

The Treasury Bond Story

Whether the Central Bank or the Treasury sell bonds, the function is exactly the same — to offer interest on savings. The purpose is not to fund the government. The purpose is to set the desired inter-bank interest rate.
Treasury and Reserve Bank bond operations are thus pure asset swaps: cash (reserves) are swapped for a savings account (Treasuries).
In countries like the USA where the Central Bank is forbidden from directly purchasing Treasury securities, a six-step process of bond auctions, repo agreements, and reverse repos is used to by-pass the law, and the net effect is exactly the same as the Federal Reserve purchasing Treasuries! We call this deficit spending, but you can also think of it as the government funding itself because functionally it amounts to exactly the same, the government issuing Its own IOU’s and booking it as Treasury debt — this is the left pocket of government (Treasury) owing the right-pocket of government (Central Bank), but why this “charade”? It’s to make sure no accounting mistakes are made! But that’s all. It serves a purpose.
When the Central Bank has an interest rate target mandate, if they do not sell bonds when the government spends, the result will be excess reserves in the banking system, which will send the overnight cash rate (OCR) to zero.
To maintain the desired OCR target the Central Bank must therefore either sell bonds to drain reserves, or pay interest on reserves (either method will work).
However, there is little need to inflate the economy this way, through welfare for those who already have money, and an alternative policy is to set a permanent zero interest rate (ZIRP).
With ZIRP no bonds are offered. All existing Treasuries could be retired at maturity, and no more issued. If the central bank does not allow commercial banks to have overdraft facilities they could continue issuing three month Treasury bills for purposes of ensuring the payments clearing system operates smoothly. (This is a bank system software problem, not an economic problem.)
Existing savings schemes (like pension plans) which rely on interest from Treasury bonds, could instead be scrapped and all pension payments could be made directly each month as the promised payments come due. There is no need for a superannuation trust fund. Moreover, pension payments can be arbitrarily increased to a dignified living wage, since the governments cannot run out of money, they can choose the pension wage (which means choosing what proportion of real output retirees can claim).
A superior way to stabilize the economy is with direct fiscal policy: money injected at the bottom, via either a Job Guarantee or Basic Income Guarantee (or combination of both); coupled with a progressive tax structure as a further automatic stabilizer (as inflation rises, tax receipts automatically rise, cooling off the inflation).

Comment 1. A fascinating aspect of point 1., of the Treasury Bond Story is that even if people think and act as if bonds are funding the government then they are still wrong. In other words, there is no logical way that selling government bonds is a financing operation. This follows logically from the facts, (a) the NZ dollar is a fiat currency, an IOU of the government, and (b) only the government can net issue these IOUs. Thus, not only are Treasury bond operations purely for purposes of interest rate control, they cannot logically be used for any other public purpose other than basic income for wealthy people.

Comment 8 (a). The remark about pension payments is subtle. While the government can always afford to mark-up the bank accounts to make pension payments, if the pensioners spend their income wildly this can put pressure on the supply of goods, which can cause price inflation, which once it propagates into higher private sector wages just reduces the purchasing power of the pension. The government policy thus needs to be informed by stability analysis, so that pension payments can be increased above the subsistence level they are today, but consistent with the claims on real resources (electricity, rent, groceries, &c.) that the average pensioner needs and that the workers can supply.

The main implication is that if we want to raise the retirement pension, it is best to guarantee full employment, because then we maximize our production of real goods the pensioners have a claim on consuming. The idiotic policy would be to force people to save for retirement, because that is a demand leakage which contributes to unemployment (if government does not raise spending or cut taxes) and lowers our economic output that pensioners are claiming upon.

If today’s workers wish to save for their retirement more than the government guaranteed pension, they can always use a bank term deposit, or gamble on the share market. (But not real estate gambling, which should be banned, since it serves no public purpose. Or rather than banning ownership of second homes for speculation, there could be a heavy tax on non-owner occupied real estate, which lowers the necessary tax on owner-occupied housing.)

The point of a decent society that MMT shows us is possible, is that there should be no need for such gambling. The government pension can always be made to afford a decent dignified retirement, provided the government ensures full non-bullsh-t job employment of Kiwis — and this can always be roughly ensured (up to definitions of what counts as a bullsh*t job).

Comment 8 (b). A pension trust fund is a great idea if you have a finite money supply to defend, but under New Zealand’s monetary system it is highly regressive. I do realize currently scrapping superannuation and simply guaranteeing all pension payments is politically untenable (but reading this you have to wonder why!), even if the pension payments would be guaranteed forever, there is currently just too strong a social psychological blockage in understanding.

The Price Story

We begin with one more axiom:

Monopoly actions: A monopolist always has two options: (a) set the price and let quantity float, or (b) fix the quantity they supply and let the price float.

Most monopolists find it convenient (for their customers) to use option (a): to fix the price, and only later adjust the price to control quantity emitted as needed.

A good example is electricity supply. Why would a hydro-power station choose to fix the quantity of electrons they emit each day, forcing customers to bid for these electricity units? It’d probably result in a hyper-darwinian raw competition nightmare — only the wealthy would get all the electricity they need, unless the power station knew what the demand was. It would be far more efficient and socially equitable to fix the price of electric power and allow the supply to vary, by controlling the dam gates. This is what all our electric power utility companies do. If they are at full dam release and there is still more demand the electric utility will raise the price to suppress demand.

This sounds like at the demand limit we will get a squeeze on poor people. But this is only if the electric utility company is entirely dependent upon sales and is greedy. A clear alternative is to treat electric power as a public good, so the government can always regulate the price level. There is no need for a competitive market for something like education, housing, energy or food.

The idea of markets is to allow consumers with adequate purchasing power to determine relative prices. But when we are talking about basic human necessities like water, air, energy, food, housing, the need for a free market needs to be seriously questioned. MMT proper might be agnostic on such political preferences, but at least MMT reveals what is possible and distinguishing what is necessary. Markets are not always necessary for price stability. Moreover, markets tend to settle at a Pareto distribution — the rich take all effect, so even when equilibrated they produce injustice. Spiritual economics, which Ōhanga Pai is trying to promote, is about an equilibrium of an entirely different kind, one of shared optimal prosperity and fairness, hard work is fairly compensated, rentiers are eliminated, and not just about mere market clearing equilibria.

The currency-issuing government (like NZ) is a currency monopolist.
The government can fix prices through:
- wages it pays to public sector employees — which establish a wage standard for the rest of the economy through competition for hiring,
- transfer payments made to social welfare recipients and pensioners — which is effectively adding to the non-government sector wage rate via addition to aggregate demand,
- collateral demanded for bank credit (aka. bank loans) — this includes not only RBNZ credit, but also private bank credit, since private banks permitted to issue NZD credit have to obtain their licence and regulations from the State. This effectively fixes the interest rate ceiling provided there is no commercial banking monopolist, via competitive pressure on banks competing for customer debtors.
- Regulating reserve balances, or IRMA, through Treasury bond operations to fix the interest rate floor.
In New Zealand the practice is typically for the NZ government to fix prices and let quantity of NZD float.
The state-currency is unique in that the ‘own-price’ (the amount the commodity trades for units of itself) has a meaningful consequence, which is realized as the bank interest rate spread.
The government sets the currency ‘own price’ (aka. the interest rate) through central bank reserve policy (by paying interest on bank reserves and/or by issuing Treasury securities). The RBNZ rates so determined (by political decisions) set the corridors for all private bank credit lending rates. It cannot be otherwise because private banks are in competition for funds, and so cannot for long offer savers an interest-income rate too much lower than the RBNZ rate, and cannot demand for long a rate of interest repayment too much higher than the RBNZ ceiling rate because then competing banks will undercut them.
Private markets offer goods for sale in NZD because they need NZ dollars to pay their taxes.
The amount of NZ dollars available to make purchases in the private market, for goods priced in NZD, is determined by the prices paid by government and the regulations on bank credit, also determined by government.
NZ dollars cannot come from anywhere else, they either come from government spending at prices the government sets, or from bank credit which government regulates. We do not get NZD from China: before Chinese consumers can get NZD to buy goods from us, or purchase NZ Treasury securities, we must first supply them, either with NZ bank credit or NZ government spending.
No other agency has the legal authority to issue NZ dollars. Therefore, the NZ government, and only the NZ government, can and does determine the general level for prices for all goods for sale in NZ dollars — whether the government politicians know it or not.
The NZ government sets the price level in NZ dollars, and thus sets the inflation rate of the NZ dollar — again, this is true whether government representatives know it or not! If tomorrow the NZ government chose to increase public sector wages and social welfare benefits to ten times the current amounts, general prices for all goods in the whole economy would the next week or so adjust upwards by about ten times. The government chooses the price level.
If the government refuses to pay higher prices there will be no inflation (other than for certain single commodities through import prices, which are not under our government’s control). This may or may not be good policy depending upon circumstances, such as import needs.
The result of government refusing to pay higher prices will be no contracts for the non-government sector if higher prices are demanded, and so no government spending, and this collapses aggregate demand in NZD. If the government is still issuing tax liabilities, and collecting on them, then prices will rapidly lower until the government is now willing to spend again. (This is just monopoly pricing effect, not good policy. No government should want to deflate the currency this way! (Because it only benefits the wealthy.))
In all cases then, the government chooses the price level, and thus chooses the inflation rate. Inflation is a policy variable, not a market determined quantity. (This does not mean inflation rate is an easy policy variable to manage.)
It might be very good policy for government to use fiscal policy (through a job guarantee wage + benefit floor) to deliberately raise the price level periodically, perhaps every five years. This is not technically inflation, but has the same effect: it lowers the purchasing power of hoarded wealth, and lowers the burden on the poor of their past debt (since now their wage rate floor is higher than their past debt servicing rate).
In a recession, in particular, designed controlled one-off inflation (a deliberate re-gauging of the currency unit) can be highly progressive egalitarian fiscal policy, but it depends upon how the currency is re-gauged, if it is done by providing currency injections at the base of the economy then it’s egalitarian. (The poorest should never be the ones carrying the burden of a recession that was not their fault.)
In an economic boom when natural resources might be under threat of being depleted, a designed deliberate currency re-gauging policy might be desirable though either taxes, or fines, on goods for sale that are depleting natural resources, or through rationing and various other fiscal policies.
The NZ government is not beholden (in principle) to any private market forces for implementing any of these policies, it is beholden (in principle) only to the market for election votes, aka. democracy.

Comment on 10. Another way the government can be seen to be the monopoly price setter would be through the “own price” of the currency, otherwise known as the interest rate. If the government sets a very high interest rate, high enough that the debt servicing pretty much became an operating cost for all economic sectors, then the interest rate would be the inflation rate — this is by academic definition, both would then become the “price” for holding on to cash.

* * *

This completes the basic outline of MMT. However, there are thousands of papers expanding on these basics, full of subtlety, nuance and with additional extra policy prescriptions, that are not considered part of MMT proper, but which can be considered as closely affiliated (such as green energy transition economics, social welfare economics, trade economics, poverty elimination, housing economics, anti-fragile banking, and the like).

Some of these topics will be addressed in later questions.

Caveats

Please just take careful note of the postulates under The System. If any economy does not satisfy these conditions then it is not necessarily well described by proper MMT, but MMT might still be useful with a few tweaks. An example would be when a nation runs a fixed exchange rate policy. They can always choose to move to floating exchange rate, but if they choose not to, then their fiscal policy space is severely reduced compared to a proper MMT economy.

Almost all post-Keynesian, Neoclassical and New Keynesian analysis implicitly adopts fixed exchange rate thinking, and so will not be correct according to MMT if a country runs a floating exchange rate, but will agree with MMT policy constraints if the country does run a rigid fixed exchange rate or currency peg. (The MMT analysis updates in this case, basically becoming a post-Keynesian framework.)

Post-Keynesian analysis is thus roughly a proper subset of MMT.

For example, under fixed exchange rates a government will have a deficit constraint (aka. fiscal injection limit), but what the constraint is exactly will be impossible to compute (although it might be estimated to some fair uncertainty), because it depends upon microeconomics and resource capacity. The point is that full resource capacity cannot be used when a nation fixes their exchange rate, they may be forced (by their own needless self-imposed constraints) to tolerate involuntary unemployment, while a proper MMT system never has to tolerate any unemployment. There is no inflation constraint in an MMT system when a floating exchange rate is adopted. Later questions will explain why. There is however, always a real resource constraint — that’s just physics.

In MMT frameworks, the “price paid” for maintaining full employment can be an exchange rate depreciation. But this benefits exporters. The opposite benefits importers. So exchange rate movements are internal domestic redistributions. There is always sufficient flexibility in an open economy for such movements. They determine who gets to play more golf and who gets to go to work in the factory. The government role is to not intervene in the exchange rate, but to;

ensure there is no exchange rate speculation (which serves no public purpose), and
the internal redistributions are fair and equitable (so that the export oligarchs are not the only ones getting to knock off early for golf).

Post-Keynesians think there is an inflation constraint. They are wrong. (At least wrong in the case of New Zealand.) They would be correct if a fixed exchange rate was applied.

But New Zealand dropped fixed exchange rates in 1985, since that date the NZ government has been operating with no constraint on full employment, yet disgustingly acting to create unemployment nonetheless, a terrible policy mistake persisting for over 35 years — wiping out the otherwise decent livelihood of an entire generation, now nearing two entire generations of Kiwis.

For roughly the same reason, post-Keynesians think a large government debt is a problem, since “debt servicing” has to be “funded” by raising taxes. (What they mean by “funded” is that there is a need to keep the exchange rate fixed — so it is bad language framing.) This is of course incorrect in a proper MMT system. The government operating a floating exchange rate has no debt constraint, they have only real resource constraints.

MMT tells us that “debt servicing” for a government sovereign is nothing but typing numbers into bank accounts of Treasury bond holders. There is no constraint here other than psychological, or political. Governments can refuse to type in those numbers. Then the bond holders are defrauded, the governments defaults. Why would a government choose to voluntarily default on such debt obligations? There is no good reason other than to either, (i) defend a gold supply (inapplicable today post Breton-Woods), or (ii) defend a desired exchange rate (inapplicable to NZ since 1985).

But otherwise post-Keynesians are very close to MMT in all other respects on macroeconomics.

Neoclassicals and New Keynesians have far more diverging views other than just obsessing on fixed exchange rates, they for instance still have completely idiotic thinking about money supply, marginal product of labour, marginal cost of production, and the champion of all bone-headed macroeconomic thinking — the NAIRU (a total and utter myth). There is a NAIRU only if governments refuse to hire the unemployed. But most governments are prepared to hire plenty of people who cannot find employment in the private sector, so the NAIRU is at best just an artefact of stupid government policy (governments who think (or act as if) the private sector is supposed to be responsible for full employment).

Today Australia, New Zealand, Japan, and the USA are all examples of MMT systems. This does not mean their politicians understand MMT, and typically they will not, so bad policy choices that MMT would tell you are harmful to workers can often result — this is no fault of the MMT system that exists in these countries.

It is a fault of political misunderstandings and power plays by oligarchs who desire to see workers in debt (desperation for a job means the wage bargain can be undermined). The labour market is not a fair game (employers do not always forego income when a worker is fired).

The analogy would be like playing Football in a system that is governed by Rugby, or even worse, it could be in the USA a lot like trying to play NFL with the rules of baseball, completely messed up government policy results, for no good reason other than ignorance of the monetary system. Under such political conditions one cannot blame MMT for any economic crises, the blame has to fall upon the decision makers who utterly fail to understand their own nation’s monetary operations.

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