By Dan Kervick
In Part One of this essay I defended the MMT view that the national government is the monopoly issuer of the currency in the US, and I attempted to clarify the actual economic status of that government currency with respect to the Fed’s conventional balance sheet accounting. In this concluding part of the essay I will further develop the contrast between the government’s role as currency issuer and the role of private sector households and firms – including commercial banks – as currency users. I will then make a few points about how the government supplies currency to the non-governmental sectors of the economy before concluding with a discussion of several topics that tend to engender resistance to the very idea that such a currency monopoly exists.
The Role of Banks
The national government in the United States is a producer of fiat money. It creates money by spending it into existence, and the money it creates is not really a liability or debt for anything else. But the claim that the government is the monopoly producer of the currency says more than this. If the government is the monopoly producer of the currency, then that means that the government is the only agent in the economy that produces additional units of the currency.
This claim seems implausible to many people. Don’t banks also produce money when they issue loans and create demand deposit balances in the process? Isn’t this kind of money usually included in various measures of the money supply?
When MMT writers argue that the government is the monopoly producer of the currency and the monopoly producer of net financial assets, I take it that they mean to assert two things: (i) the government is unquestionably the sole producer of the monetary base or “high powered money”, which includes both physical currency and bank reserve balances at the Fed, and (ii) the government is ultimately responsible for any net addition to the total financial assets of the non-governmental sector, since that quantity can only increase if the government makes a net addition to the monetary base.
But here is one thing that MMTers do not mean when they say the government is the monopoly supplier of net financial assets to the economy: They do not mean that quantitative additions to the monetary base cause additions to the quantity of bank credit in existence. The idea that such quantitative additions cause expansions of bank credit is based on the money multiplier and loanable funds model of the banking sector. MMT writers have been unanimous in their insistence that the causation goes the other way: banks expand their balance sheets and extend more credit primarily in response to the demand for more consumption and more production in the non-financial sectors of the economy. These forces generate additional demand for credit, and banks will supply that credit, without regard to their current reserve balances, so long as the borrower is willing to take the loan at an interest rate that is profitable for the bank, and with the bank taking due account of the borrower’s credit-worthiness and the risks involved in the loan. The Fed influences rates of banks interest and the availability of credit at a particular price, because it can effectively target the interest rates for borrowing additional reserves from either other banks or the Fed directly. But it has little influence over the volume of bank lending as a result of its control over the quantity of bank reserves. The Fed can target price, but not quantity.
So how can these two MMT claims be true concurrently? If the Fed does not determine the total quantity of bank credit, and if bank credit creates financial assets, how can the government be said to be the monopoly supplier of net financial assets? The key term here is “net”. In our system, private sector banks can’t conduct their business of credit creation without a great deal of government participation. Bank deposit balances are essentially IOU’s: they represent liabilities of the bank. What does the bank owe in virtue of these IOUs? Basically, they owe the state’s money, in the form of either physical currency or reserve balances. Here’s why:
People make payment orders on their deposit balances when they write checks or pay with an ATM card, and therefore any ongoing expansion in the volume of bank deposits requires an ongoing expansion in the volume of payments, unless banks are already carrying excess reserves. How are those payments made? Well in the simplest instance, the payment might be to another customer of the same bank, and then it is easy. Suppose I write a check to you on my bank deposit, and you are a customer of the same bank. You deposit the check with the bank. That deposit amounts to an order by me to the bank to deduct a certain quantity from my own deposit balance and to credit that same amount to your deposit balance. In effect, my bank cancels at my direction an IOU for money it owes me, and creates a new IOU for the same amount issued to you. It has just shuffled creditors but not altered the total amount it owes.
But most payment orders in our system initiate a sequence that concludes with a payment from one bank to another, and these payments are settled and cleared through the banks’ reserve accounts at the Fed. If I give you a payment order on my demand deposit in exchange for some good or service you give to me, then my bank has become your debtor. When you deposit my payment order with your bank, your bank either gives you some vault cash or exchanges its own IOU with you for the payment order by creating an additional demand deposit for you. The payment order is signed over by you to your bank. My bank has then become the debtor of your bank. Your bank and my bank then settle and clear the payment through the Fed. My bank has not made good on its legal obligation and discharged its IOU until my bank’s reserve account has been debited and your bank’s reserve account has been credited.
So the IOUs that comprise bank deposit balances have not been paid until someone either receives physical currency from that bank or a transfer of funds from the bank’s reserve account at the Fed. But physical currency and reserve balances can only come from the government. Thus demand deposit balances consist of IOUs for things of which the government is the monopoly supplier. These IOUs are very liquid and generally accepted as payment in exchange for goods and services. Thus they are conventionally classified as one form of money – “broad” money.
When the bank awards a loan, the bank will create a demand deposit for the borrower. That is a debt of the bank. In return, the borrower assumes the obligation to pay the bank an even greater amount of money at some point in the future. That is another debt and so the process involves exchanging debt for debt. The obligations differ in their quantities and time parameters: the demand deposit balance represents a standing obligation to pay the depositor immediately. The borrower’s debt is an obligation to pay some greater quantity of money in the future and over some longer period of time.
Whenever a financial debt comes into existence, there is a creditor and a debtor, an asset and a liability. If I give you an IOU for $1000, then that IOU is an asset for you worth $1000 and a liability for me worth – $1000. That’s positive value for you and negative value for me, but the private sector as a whole has not gotten richer as a result. Your wealth has increased by the same amount that my wealth has decreased. It nets to zero.
So this is what MMT means when it says that the government is the monopoly supplier of net financial assets to the non-governmental sector. Although banks and other can create IOUs on their own, without those IOUs being either produced or brought into existence by the government, the IOU does not add to the net financial asset value in the economy, because the creation of the debt brings an asset and offsetting liability into existence at the very same time. The issuance of bank credit, no matter how voluminous and liberal, does not add once cent to the net quantity of financial assets in the economy.
But the government’s fiat currency is not like this. When the government issues base money, unlike when a bank issues IOUs for base money, the government does not incur an obligation by virtue of the issuance which offsets the asset received by the recipient. So the economy receives as a result a net injection of financial assets.
How the Government Supplies Money
So, if the non-governmental sector’s net stock of financial assets is to grow, the government must augment that stock. But there are two substantially different ways it can augment this stock. We can refer to these different ways of supplying money to the economy as the Fed channel and the Treasury channel. It wouldn’t be far wrong to describe these in conventional terms as the channels controlled respectively by monetary policy and by fiscal policy. But MMT emphasizes that there is no sharp distinction between fiscal policy and monetary policy, since fiscal operations in modern monetary systems often involve central bank participation and are thus an exercise of monetary policy at the same time.
MMT tends to differ from some dominant tendencies in mainstream economics in the relative importance they ascribe to these two channels. As described in the previous section, MMT’s leading thinkers tend to view government operations through the Fed channel as primarily passive and accommodative responses to private sector initiatives. Also, the primary way the Fed injects additional reserves into the banking system is to purchase Treasury securities via open market operations. So while dollars are being injected in the immediate term due to one of these purchases, the purchase of the security means that interest income associated with that security is lost to the private sector and redirected to the Fed. Thus, we have only an “asset swap”. Although government injections of money through the Fed channel are a routine and essential concomitant of a smoothly performing banking system, the Fed can’t do much to jolt a flagging economy to life by targeting changes in the overall volume of reserves. This MMT perspective is at at odds with that of several prominent economists and pundits who have frequently called for additional rounds of Fed quantitative “stimulus” over the past few years, and who argue that the Fed exerts substantial potential control over everything from aggregate demand to the total level of nominal spending.
In contrast to this MMT picture of Fed powers as more limited and reactive than is widely believed, MMT argues that monetary operations through the Treasury channel, on the other hand, can lead directly to surges in demand for consumer goods and to the private sector production that is spurred by that additional demand. And Treasury injections of this kind can be essential to offsetting demand drains caused by high private sector saving desires.
The central bank can’t make banks lend more by flooding the system with additional reserve balances, because all of those private sector banks will only wish to expand credit if there are businesses that have a need to finance expanded production with added debt. And businesses only have such a need when they have actual or potential customers with the income to turn their purchasing desires into market demand. But Treasury injections of money can directly increase consumer purchasing power and demand for goods and services – and thus spur both the desire of firms to expand production and the demand for credit to finance that expansion.
Another way of looking at it is this: Government monetary policies designed to increase the quantity of bank reserve balances will not automatically increase the quantity of demand deposit balances, since there is no causal mechanism that transmits increases in reserves into increases in demand deposits. Instead the causation goes the other way. The demand for credit causes an increase in demand deposits as banks advance loans and create demand deposit balances in the process. This expansion in turn causes banks to seek more reserves to meet their reserve requirements and make the expanded volume of payments that are likely to be prompted by the expansion of deposits.
However when the government spends money directly into the private sector, either by making a transfer payment or by buying goods and services, that payment shows up immediately as an additional demand deposit balance in the recipient’s bank account. As a result, a payment is settled and cleared between the Treasury and the bank that holds the deposit, and that leads to an increase in the non-government sector’s total stock of reserves, and hence its net financial assets. But there is no element of mere hope here. You don’t get a boost to reserve balances first coupled with a mere hope that the boost will lead to an increase in demand deposit balances through the magic of the money multiplier. Instead, you get a direct government payment into a demand deposit account, with the added reserves appearing only as a consequence. If the government’s aim is to boost spending and economic activity in the real economy, the latter approach is clearly more direct and effective.
Finally, it is vital to recognize that because the government runs a currency monopoly, and because the government can run a pure deficit not offset by additional taxes or borrowing from the private sector, currency injections done correctly through the Treasury channel need not cause any crowding out of private sector spending. They can represent a straightforward addition of financial assets and purchasing power, not a mere transfer of purchasing power from one location to another.
What the Currency Monopoly is Not
Let me conclude by briefly touching on a few topics that come up frequently in discussions of the government’s currency monopoly, and that engender confusion and resistance to MMT positions on the role of government in our economy.
Some argue that it just can’t be true that the government has a currency monopoly, because if it did, then the government would be in control of the price of everything. Almost every transaction in our economy involves an exchange of goods or services for money, and so the price of money is a factor in almost all transactions. But monopolists set the market price of the product they produce. So if the government were the monopoly producer of our currency, the government would control virtually every price. But it is implausible to think the government has that much control.
There are two points to make in response here. First, while it is true that monopoly producers can set the price of their product in the primary markets in which they sell them, there is no reason to think that monopolists fully control the price of that good in secondary markets where it is re-sold. And they certainly don’t fully control the price of mere IOU’s for their product sold in secondary markets. The government is the monopoly issuer of bank reserves and currency – the monetary base – and therefore can exert whatever control it desires over the price at which reserves and currency are sold to banks, and the price the government itself pays for the goods and services it purchases. But it does not control all rates of interest charged for bank IOUs or currency. Nor is it in direct control of the rates at which people exchange the government currency in private markets for whatever it is they want to buy. These ordinary market transactions take place in what are in effect secondary markets for the government’s money.
Also, it is important to recognize that when one says the government can “control” the price in pays for whatever goods and services it purchases, that does not mean that the government can automatically obtain whatever goods and services it wants at whatever prices it wants. Monopolists control supply, but not demand. They determine the shape and position of the supply curve, but not the demand curve. If a monopolist is bound and determined to sell its monopolized good at some very high targeted average price, it might be able to do so – but only if it is willing to limit its sales only to those relatively few buyers who are willing to pay that very high price. So the value of the goods and services a monopoly currency producer is able to receive for its currency depends on the market demand for that currency.
However, MMT asserts that the government does have substantial influence over the demand for its currency, not just supply. MMT writers defend a version of chartalism – the claim that the government creates an ongoing demand for its currency by creating tax obligations that can only be discharged with the government’s money. This view has been criticized on the grounds that the form of money that the government actually controls – physical currency and reserve balances – is not actually required by taxpayers to pay taxes. If the taxpayer possesses broad money in the form of a commercial bank demand deposit balance, the taxpayer can write a check to the government on that account and the check will be accepted. No state monopoly money required!
But note what happens when the government cashed the check: The check is a payment order that directs the taxpayer’s bank to pay the Treasury. As a result, the bank debits the taxpayer’s deposit account, and then settles and clears a payment with the Treasury. That payment is a transfer of funds from the bank’s reserve account at the Fed to one of Treasury’s accounts at the Fed. Thus, even though the taxpayer might not exhibit any direct demand for the government’s base money, the bank requires that base money to make a payment to the Treasury on the taxpayer’s behalf. So the tax obligation does generate a demand for reserve balances, but the causal path from obligation to demand involves two steps rather than just one.
MMT is sometimes criticized as presenting a statist view of a centralized or command economy whose productive processes are all driven and determined by government bureaucrats. That is clearly inapplicable to the innovative, free and largely private economy in which we live.
But this stereotype of MMT is simply erroneous. The fact that the government operates a monopoly over the currency does not mean that the government is somehow running the whole economy or drives all of the processes of growth and production. The currency system should be viewed as a public utility. It plays a vital role in the smooth and effective functioning of the payment and financial systems, but it by no means determines everything that happens economically.
It is certainly true that one theme of MMT thought is that there is much public incomprehension of the monetary system, and that if people did better understand the currency monopoly that their own government operates, they would be better positioned to take greater democratic charge of that monetary system, and use it more effectively for public purposes and the common good. But ultimately, the scope and size of government, and the degree of control it does or does not exercise over the economy, is a matter for political decisions that reflect a host of social and moral values. The fact that US citizens already posses a currency monopoly means that they possess tremendous latent and unrealized powers to take a more activist and democratic hand in their economic future and destiny if they choose to do so. But whether these citizens choose to become more active, become more passive or stay about the same in using the currency monopoly for public purpose is up to them. The fact that the monopoly already exists does not mean that the government is actively directing economic affairs.
Most MMTers regard themselves as part of the post-Keynesian tradition in economic thought. A central feature of that tradition is the endogenous money approach that emphasizes something we have already touched on: banks don’t lend their reserves, and their lending is not significantly constrained by their central bank reserve balances. Rather reserves are acquired only to make payments and to meet reserve requirements. Banks make loans first, on the basis primarily of the market demand for credit, and then acquire the additional reserves they might need after the fact. The central bank’s influence over this process is primarily related to its determination of the price of reserves, not the quantity of reserves.
This view is sometimes held to be inconsistent with MMT’s insistence on the existence of a government currency monopoly, and its claim that the government is the sole supplier of net financial assets to the economy, since these latter doctrines seem to suggest that the government is somehow driving bank lending after all.
We have already seen what is wrong with this interpretation. MMT holds that the non-governmental sector’s supply of net financial assets cannot increase unless the government supplies additional money to that sector. But MMT also recognizes that the provision of those reserves through the Fed channel is primarily reactive: the central bank either sells additional currency and reserve balances to banks when banks come seeking them, or makes sure that the Fed Funds rate – the interest rate for interbank lending of reserves – is such as to assure that banks needing additional reserves can acquire them from one another. The primary goals here are the smooth functioning of the payments system and modulation of interest rates.
Of course, this generally accommodative stance of the Fed is a policy choice, and could be altered in principle. If for some reason the Fed stopped purchasing Treasury securities, stopped discount lending, dramatically increased penalties for overdrafts, stopped paying interest on reserves and jacked up the target Fed Funds rate to astronomical levels, then payments would probably grind to a halt in relatively short order. Banks would not be able to acquire the additional reserves they need to meet their larger reserve requirements and make the expanded volume of payments that would follow from expansions in their demand deposits. So they would slow down or stop making additional loans.
The endogenous money model essentially tells us that boosts in reserve balances don’t “push” new loans and demand deposits out into the real economy; rather the demand for credit and deposit balances generally “pulls” more reserve balances out of the Fed, to accommodate the desires of the market. The causal mechanisms in place here mean that the central banks can – in principle – choke off expanded lending by declining to supply the additional reserve balances that are demanded. But it cannot do much to stimulate expanded lending by flooding the banking system with more reserve balances. The way the government can boost demand for credit is by boosting demand for consumption and production. And it does that by using the more active Treasury channel to spend money directly into people’s deposit accounts, not by relying on the Fed channel. This picture is fully consistent with both the endogenous money view and the currency monopoly view.
It could be held that MMT exaggerates the role of government and errs in its currency monopoly view by attributing exclusive powers to the government that are actually possessed by banks as well. One of these powers is seigniorage, a power that is possessed by any currency issuer. If the banks do possess seigniorage power, then they possess a power that only pertains to currency issuers – and that would mean that the government is not a monopoly issuer of the currency after all.
Seigniorage is a phenomenon that has always existed so long as there has been money and so long as there have been money issuers, but that has come to be especially obvious in the modern world of fiat money, as governments have moved away from metal or metal-backed monies. Seigniorage consists in the fact that the value that can be obtained from the exchange of units of currency in the marketplace is generally significantly less than the cost of producing that money. Thus the issuer or producer of the money has the option of producing additional units of the money and using it to buy things, thus earning a profit. In the contemporary world, where the cost of producing billions of dollars of government money is just the cost of punching out a few keystrokes on a computer keyboard, seigniorage profits are potentially vast.
But some would say that commercial banks can make these kinds of profits as well. Consider this possibility: a bank wishes to outfit several branch offices with new office furniture. It negotiates a price with an office furniture company, creates a new deposit account for the company and credits that account to the tune of $20,000. The furniture company delivers $20,000 worth of office furniture. Has not the bank here reaped seigniorage profits, the same way the national government would if it expanded its pure deficit and purchased a fleet of jet fighters without raising taxes?
No, I believe the two cases are not at all comparable. Remember that demand deposit balances at a bank are genuine liabilities of the bank. Once that $20,000 balance has been created for the furniture company, the company can write a check on the balance at any time. And if it does so the bank has to pay up! If the furniture company goes out and buys a new company car for $20,000 and writes a check on its demand deposit to make the payment to the car dealer, then the bank owes the car dealer $20,000. So much for the dream of ultra-cheap office furniture.
As I have argued, there is no economically meaningful sense in which a national government that issues new money to pay for some good or service has incurred a genuine liability of the kind the commercial bank has incurred. If the government prints $150 billion in new paper currency to pay for its jet fighters, and the aircraft firm takes some of that money to an architectural firm to purchase a new office complex, the government does not then owe money to the architectural firm. The government’s fiat money, the monetary base, is not a credit instrument. It is not an IOU for something else. It is the final means of payment itself. Once it has paid its fiat money to the aircraft firm, business between the government and that firm has been concluded. The firm does not possess a further claim on the government.
US citizens are in possession of a very valuable public enterprise: a monopoly on the production of the nation’s currency supply. MMT helps us see and understand this monopoly. Now it’s up to us to figure out what to do with it. And perhaps our friends in the Eurozone will begin work on re-constituting their own democratically run, public currency monopolies, so they can put such monopolies to work on behalf of public purpose, and save their continent from the mad austerity mongers in the Euro-plutocracy.