Toward Monetary Enlightenment: An Integral Approach to Macroeconomic Policy

By Dan Kervick

One staple of economic policy debate is the running conflict between those who lean toward a reliance on fiscal policy and those who lean toward a reliance on monetary policy. Fiscal policy is concerned with the use of government spending and taxation to achieve desired changes in economic activity. Monetary policy concerns actions by monetary authorities that seek to affect the quantity of money in circulation, or its rate of increase or decrease, in order to achieve economic ends that are believed to be influenced by monetary phenomena. The debate over the relative effectiveness of the two approaches is, as I say, standard fare. But it also tends to be carried on in ways that I believe are both misconceived and outmoded.

1. The Perspective of the Consolidated Balance Sheet

In the modern era, many national governments are both the issuers of the national currency and the regulators of the national money of account. The governments of countries such as Australia, Japan, the United States and Canada are not mere users of monetary instruments produced and regulated by others. They are the monopoly issuers of these instruments. These governments combine the traditional taxing and spending role of a sovereign fiscal authority with the currency issuing role of a sovereign monetary authority. But while these facts are broadly understood, many people seem not have made the conceptual leap or shift of perspective that is needed to crystallize the consequences of these facts into a fully modern and integrated view of economic policy. We can begin the move toward a more enlightened economic policy by adopting a more integral view of government operations, one in which fiscal and monetary policy are reinterpreted as just two different aspects of the same operations.

One thing that has prevented a more rapid shift to a more enlightened and integral approach to economic policy, I believe, is that we continue to rely on outmoded institutional structures that predate the monetary system under which we now live. These antiquated structures influence the way we perceive our economic world. They foster an artificial conceptual division between fiscal and monetary affairs, and institutionalize this awkward division in the operational responsibilities assigned to different departments of the government. The resulting anachronisms harmfully limit the range of policy options that come up for public consideration. They also perpetuate the privileges of economic and political elites who are stakeholders in the old, anachronistic order. As we develop a clearer understanding of the way established institutions function, we naturally begin to think about ways in which they might be changed.

Part of the power of Modern Monetary Theory, or MMT, is that it adopts an analytic perspective on economic activity and economic policy that derives from taking a consolidated view of government operations. All payments from national government agencies, branches or departments and all receipts by these agencies, branches or departments are viewed from the perspective of a single abstract balance sheet. Similarly, all debts owed by any part of the national government and all debts owed to any part of the national government are considered with respect to the same consolidated balance sheet. Crucially, both the central bank and the various arms and accounts of the public treasury are seen as sharing the same balance sheet.

Of course, MMT recognizes along with everyone else that the national government in any country is actually divided into many interacting component parts, each acting with various degrees of dependence on or independence from the other parts, and each with its own operational responsibilities and prerogatives established by law. But the consolidated balance sheet view provides a powerful abstract framework that simplifies the analysis of the economy and economic policy, and helps lead to important realizations about the policy options that are actually available to us. Once we view government policy from this consolidated perspective, we quickly realize that what is important to the impact of government policy on the private economy, and on the lives and economic welfare of individuals, households and businesses, is not the various labyrinthine transactions or operations that take place inside and among government agencies, but the transactions that take place between branches of the government, on the one side, and economic actors in the non-governmental sectors on the other side.

Every kind of payment from a government account to a non-government account, whether for the purchase of a piece of equipment, the delivery a social welfare payment, the purchase of a debt instrument or the payment of interest or principle on a debt instrument, can be viewed as a way in which the government injects money into the private economy. Every such injection increases the net financial asset holdings of the non-governmental sectors of the economy. And every time a payment is made from a non-government account to a government account, whether for payment of a tax bill, the purchase of a postage stamp, the purchase of a debt instrument or the payment of interest or principle on a debt instrument, money has been extracted from the private economy. Every such extraction decreases the net financial asset holdings of the non-governmental sectors of the economy.

It doesn’t really matter for the purpose of analyzing monetary operations whether the branch of the government in question is the central bank or the public treasury. Ultimately we have payments to government and payments from government – they are all the same from the point of view of their effect on net financial assets. The only differences that are significant lie in (i) who outside the government is making the payment to the government or receiving a payment from the government, (ii) how much money they are surrendering or receiving, or (iii) whether the side of the transaction making the payment is receiving some real good or service in exchange or not.

So, the government cannot make a decision about how to tax and spend which is not at the same time a decision about how to extract money from or inject money into the private economy. And the policy-maker cannot make a decision about how to extract or inject money from the private economy which is not at the same time a decision about whom to give money to or to take money from. Fiscal policy is monetary policy; monetary policy is fiscal policy.

Because a monetarily sovereign government is the issuer of the nation’s fundamental monetary instruments, and not a mere user of those instruments, it is also useful to view the operations that generate payments from the private economy to the government as conceptually and operationally separate from the operations that generate payments from the government to the private sector. The national government does not need to collect its own money, whether via taxes or borrowing, in order to spend, since the government can create or destroy money, and is not limited to conveying existing money from one account to another. Under current arrangements, these distinguishable government operations might be institutionally and legally linked in various ways. A government might institute laws governing its own operations that create constraints and divisions of responsibilities applying to its own internal branches and departments. But any such linkages are themselves policy choices, subject to change by either legislation or bureaucratic initiative, and are usually not part of the deep constitutional structure of the government. We can then pertinently ask ourselves how well those laws and institutions perform, and realistically consider whether they should be reformed , or even abolished altogether and replaced by other institutions.

Because the government is always free to issue or destroy money as a policy decision, nothing important should ever depend on how much money the government itself has. All that matters is how much money is injected or extracted from the private sector; which households, individuals or firms are involved; and the terms of their transaction with the government. To get a grip on what is ultimately important in these operations, there are two different heuristic models we can apply, each of which serves just as well to bring out the really significant elements of the government’s role. One approach is to regard the government as never having any money. When the government spends, it creates new units of money on non-governmental accounts out of thin air. And when it receives a payment, it deletes monetary units from a private sector account and these units disappear into thin air. Every payment the government makes creates money. Every payment it receives destroys money.

Another way to view matters is to think of the government as always having an infinite amount of money. There is an infinite well of monetary assets into which the government can dip. When it spends it creates additional monetary assets in the private sector, but its own infinite stock of money doesn’t shrink. When it receives a tax payment, the non-governmental stock of money shrinks, but the government’s stock does not grow, since that stock is already infinite.

Of course, neither the no monetary stock model nor the infinite monetary stock model captures the way governments currently do their bookkeeping. The various branches and departments of the national government are all attributed a net balance of money according to the established accounting practices. When they spend, the money they possess is depleted. However, my contention is that these usual practices are mere conventions that could be changed without affecting the government’s real role in the real economy. We might typically think of some country’s Department of Schools, for example, as having a certain quantity of money X in its account, and being authorized to spend that sum, so that as it spends, the stock of money it has is depleted. But we could just as easily think of the Department of Schools as having no having no money at all, but being authorized to create the sum X by spending it into existence. Money attributed to government accounts, then, can be thought of as a kind of abacus for keeping track of its money injections via spending or money extractions via taxation. These operations are carried out in accordance with pre-selected policy choices, and so some way is needed of keeping track of them. But the money in those government accounts doesn’t represent a stock of wealth possessed by the government.

Governments traditionally classify the currency they issues as liabilities. But these liabilities are of a very different order from the debt liabilities private sector firms and households possess. For private sector agents, a debt liability represents negative value. It is a legally binding commitment to make a future payment out of one’s finite stock of assets, thus diminishing that stock. It is a claim against one’s finite assets. It is thus hard to see the government’s issue of currency as the creation of any kind of genuine liability at all. It is true that the holder of the government’s currency can always use it to discharge tax obligations, and so private sector firms or households who possess money possesses a credit on their tax accounts with the government. But these credits are for obligations that the government itself establishes by sheer legislative fiat, and so the fact that the government has issued credits for those obligations does not mean that the issuance of these credits represents negative value for government. Nor does the currency issued by governments in modern fiat systems represent a redeemable promise for the delivery by the government of some other objects or services of value. The only thing the possession of a US dollar entitles you to is another US dollar. When the government collects the currency it has issued, it doesn’t get richer. And when the government issues additional currency, it doesn’t get poorer. These so-called liabilities are thus something like a bookkeeping fiction. While they represent positive value to holder, they do not represent negative value to issuer.

Because of the unique role of monetarily sovereign governments in the creation and destruction of net private sector financial assets, these governments have the option of doing something that non-governmental currency users cannot do. They can run what I have called elsewhere a pure deficit. That is, they can simply spend more into the private economy that they extract from it, without negatively affecting the stock of public sector wealth. In doing so, they create money. They can also run a pure surplus that destroys private sector money, without building the stock of public sector wealth. Private sector firms and households can only run financial deficits and surpluses. If they spend more than they receive in income, they must either draw down their stock of assets by surrendering some of them to the payees, or issue debts that represent a commitment to surrender assets in the future.

MMT argues that running a pure deficit of this kind should be recognized as the normal operating condition of an intelligent national government pursuing public purposes in an effective way, at least when that government is a sovereign currency issuer that lets its currency float freely on foreign exchange markets. If the government is running a deficit in its currency, then the non-governmental sectors of the economy are running a surplus in that currency and their net stock of financial assets in that currency is growing. If the government is running a surplus, on the other hand, then the net stock of financial assets in the non-governmental sectors is decreasing. We expect a growing economy to be increasing its financial asset stocks, and so we should expect government deficits as a matter of course. Furthermore, in some circumstances the non-governmental sectors will experience a sudden surge in desire to add to their financial asset stocks, which includes the desire to pay down existing debt. If the government does not accommodate that desire by increasing its deficit, the result will be a drop in spending and an increase in unemployment.

2. Against Central Bankism

I have claimed that there is no fundamental macroeconomic difference between fiscal policy and monetary policy. The customary distinction between these two types of policy somewhat arbitrarily separates into two distinct categories the various operations by which the government injects money into the private sector and extracts money from the government sector. Nevertheless, despite the fact that the customary distinction between monetary and fiscal policy is due more hoary convention than principled theory, there is no denying that different branches of government are usually tasked with carrying out these different categories of policies: central banks carry out most of the operations customarily regarded as falling under the heading “monetary policy” and treasury departments or finance ministries carry out the most of the policies customarily regarded as falling under the heading “fiscal policy”. So instead of focusing on the distinction between monetary policy and fiscal policy, we can take an institutional perspective and distinguish treasury operations from central bank operations. Both central banks and treasuries make payments to the private sector and thereby inject money into the private sector. And both central banks and treasuries receive payments from the private sector and thereby extract money from the private sector. But the payments involved are of different kinds. The central banks operate through the banking channel or financial sector. They are permitted to do things like pay interest on reserves, provide direct loans at interest to banks, purchase financial securities from various kinds of securities dealers, and resell the securities they have previously purchased. Treasuries collect taxes that have been imposed by the legislative authorities on businesses, individuals and households, and they also dispense payments of many kinds to businesses, individuals and households. Sometimes these payments are direct gifts of money to designated recipients; sometimes they are payments for goods or services provided to the national government in exchange.

Note also that in democratic countries virtually all of these operations are carried out under authorization provided by the national legislature. In the United States, for example, the US Congress possesses the power of the purse, and the US Treasury spends only pursuant to congressional authorizations and appropriations. The Federal Reserve carries out operations with more day-to-day independence. But the Fed was created by the US Congress through a delegation of authorities specifically granted to Congress. The Fed is independent only to the extent that Congress allows it to operate independently. At any time it wishes, through further acts of legislation, Congress could assume a more direct supervisory role in central bank operations. Congress could direct the Fed to carry out the operations Congress prefers. It could even dismantle the Fed entirely and shift its operations to other agencies – either existing agencies or newly created ones. So the independence of the Fed is a relative independence only, reflecting the results of past policy choices that have not been undone.

Now it should be fairly obvious that when it comes to the potential impact of government on the economic life of the country – on its millions of ordinary people, households and businesses – conventional treasury operations are much more important than conventional central bank operations. The legislature can choose to spend money on virtually anything it wants, and direct payments to virtually anyone it wants. Similarly, it can choose to tax almost anyone it wants. Its scope of operation is vast. The central bank operates through the much more narrowly constrained channel of the banking sector. And as the present crisis should have made plain by now, monetary interventions in that sector alone cannot spur the real economic demand and productive activity that drives the economy.

A yet, in the United States at least, a very strange ideological phenomenon and theoretical bias has taken root among many pundits and professional economists. Many are deeply committed to the notion that the central bank is the institution of government charged with, and possessing the power to control, the entire macroeconomic policy of the country. They are convinced that the central bank, all by itself and acting within the scope of its established authority, can determine the aggregate demand for goods and services across the whole economy. They even think the central bank can control the level of total spending in the economy. Sometimes they are convinced that the central bank can control the level of the money supply, despite an earlier record of manifest failure by central banks to do just that, no matter how we measure this money supply. Not only do they think the central bank can do all these things, they also seem to think that it is the institution best suited to carrying out these jobs, despite the all-too-evident limitations on central bank powers in comparison with the legislative branch. Sometimes this embarrassing secular theology goes so far as to attribute to the central bank the power to determine these grand macroeconomic results through the sheer power of its mighty words. I call this tendency “central bankism”.

Note that central bankism goes well beyond the economic doctrine referred to as “monetarism”, a doctrine that claims that a variety of crucial measures of economic performance are at bottom monetary phenomena. Whatever strengths or weaknesses traditional monetarism possesses, we have already seen that monetary policy and fiscal policy are not deeply distinguishable. Central bankism is an outgrowth of monetarism, but also an elephantine extension of it. It is an irrational fixation on the powers, social importance and macroeconomic sufficiency of the central bank itself as an institution, and on the role of the banking system that the central bank superintends.

Of course, if you are convinced that your neighbor possesses magical powers, and could transform your modest home into a spectacular castle with a wave of his wand, then you will grow increasingly frustrated each day that the wand is not waved. Central bankists rail daily at the Fed for its failure to fix the economy, accelerate spending and growth and restore full employment. For some, the belief that central bank policy and monetary policy are identical seems almost a matter of definition. As a result, we have seen increasingly mysterious calls by central bankists for the Fed to engineer large-scale macroeconomic changes by engaging in operations that are only vaguely described and by working through transmission channels of dubious reality.

Even very sane and very intelligent thinkers have been afflicted by the mind-clouding fevers of central bankism. For example, in this recent essay, the economist and blogger Paul Krugman wonders what has happened to the Ben Bernanke who argued earlier in his career, when considering the economic problems facing Japan at the turn of the 21st century, for aggressive monetary policy responses to a crisis similar to the one we face now.

These arguments are contained in Bernanke’s 1999 paper, “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” In that paper, Bernanke argued that monetary policy was not powerless at the zero bound, and then went on to propose various unconventional policies that Japan might pursue. However, he prefaced these proposals with the following remarks:

… I am aware that several of the proposals to be discussed are either not purely monetary in nature, or require some cooperation by agencies other than the Bank of Japan, including perhaps the Diet itself. Regarding the concern that not all these proposals are “pure” monetary policy, I will say only that I am not here concerned with fine semantic distinctions but rather with the fundamental issue of whether there exist feasible policies to stimulate nominal aggregate demand in Japan. As to the need for inter-agency cooperation or even possible legislative changes: In my view, in recent years BOJ officials have—to a far greater degree than is justified—-hidden behind minor institutional or technical difficulties in order to avoid taking action.

So Bernanke was quite clear in recognizing that he was using “monetary policy” in a very broad sense to include policies that fall outside the permitted operations and actions of the central bank and require the participation of other branches of government. The proposals for Japan included (i) money-financed transfers (ii) depreciation of the yen, and (iii) non-standard open market operations.

Now consider the case of the United States since 2008. The non-standard open market operations have been employed. We have had two major rounds of quantitative easing as well as “Operation Twist.” How about depreciation of the dollar? The exchange rate of the dollar is regarded as the prerogative of the Treasury Department, and a dollar depreciation strategy cannot be executed by the central bank alone. Also we are in a crisis that afflicts a large share of the globe, and not everyone in the world can depreciate at the same time, especially given the acute problems in Europe and the high resulting demand for dollars. But what of the money-financed transfers? These would be the famed “helicopter drops” Bernanke is noted for having supported in theory. A government can indeed always carry out a plan of massive spending by creating the money it spends. It can either buy things with the money, or simply give the money to people. But here’s the thing: the Fed cannot do a helicopter drop! Only Congress possesses the power to authorize that kind of spending. Of course, the Fed could always try doing a helicopter, and leap one hundred giant steps beyond what most people would understand to be its established permissible exercise of authority. I take it that Congress would not stand still for the Fed overstepping boundaries in this way. Nor should they. An unelected central bank taking over responsibility for spending of that scope would be a manifest threat to democratic government. It would be the economic policy equivalent of Julius Caeser’s crossing of the Rubicon.

So what happened to Bernanke once he became Fed chairman? I would say nothing other than that once on the job, he developed a keener concern for what the job actually permits, and what aspects of “monetary policy” fall within the Fed’s ambit.

So what forces contribute to the obsession with central banks and fuel the religion of central bankism in the United States? I would point to four main drivers:

One is the strong ideological opposition to an activist and engaged government playing a large role in the economic sphere. The financial crisis of 2008 and its aftermath have created a strong fear among the Western world’s ownership elite about the potential rise of popular democratic government, and the calls for the redistributive policies and broad-based public investment that would likely result from democratic revival. Central bankism provides mainstream and establishment pundits with a vehicle for calling for “action” that nevertheless holds the great democratic masses and bay, and protects prevailing property arrangements and existing stakeholder privileges. Like the current US President, central bankists might see themselves as standing between established power and the people with the pitchforks.

A second motivator of central bankism is the sheer pathetic desire to believe that there is a simple answer to a very large social problem, an answer whose solution lies at the policy desk of a single omnipotent individual, a Wizard Banker whose inaction can be blamed as the main source of government failure, and who could heal our sicknesses and fix most of what is wrong with us all by himself. Such beliefs are comforting. If the Wizard would only wave his wand, that would save us from the challenging democratic task of getting 535 members of the US Congress to do something significant about the plague of stagnation, unemployment, rising inequality and declining living standards!

A third motivator of central bankism is that it appeals to those who are attracted by clean, elitist, technocratic approaches to governance, and repelled by the squalid disorder and messy results of democratic struggle and legislative policy-making.

A final factor motivating central bankism is political cowardice. Frankly, many people whose hearts are otherwise in the right place seem utterly terrified of the malevolent right-wing demagogues and the corrupt plutocratic tools from both parties who now run the US Congress. The seeming intention of much this gang is to protect the privileges of the very wealthy and the rent-collectors who live off the income that comes purely from ownership stakes in the productive work of others; to replace the America of democratic and egalitarian ideals with a Social Darwinist dystopia of interpersonal aggression, hierarchy and domination; to dismantle a century of achievements of progressive government; and to elevate the demented and radically individualistic narcissism of people like Ayn Rand to established public doctrine. The rise of this kind of thinking, and the brazen aggression of the Washington and Wall Street war on ordinary Americans and their democracy is so shocking, and even frightening, that good people seem determined to turn their attention elsewhere and look for saviors where they can find them rather than accept the political risks and burden of a political war on the enemies of equality and broad democratic prosperity.

3. Toward the Future

I argued earlier that we should begin the process of moving to a more integral approach to macroeconomic policy that dissolves the conventional distinction between monetary policy and fiscal policy. What would an integral macroeconomic policy look like? The answer depends on the kind of government that runs that policy. But in a democratic country, macroeconomic policy like everything else should be in hands of the people and their legislative representatives. There is no one single way of implementing an integral economic policy, but we can imagine some broad outlines. The legislature would set spending priorities for the country. It would also recognize that part of the normal functioning of government should be to run a pure deficit – a deficit that accommodates the savings desires of the public while also permitting spending compatible with full employment. It would estimate the needed size of that deficit, and attempt to hit that deficit as a target. And it would enact tax policies that were designed, given the size and types of the spending it planned, to generate revenues compatible with its deficit target. In other words, the legislature would actively seek a deficit of a specific targeted size, and enact spending and tax policies that were designed so that the excess of spending over revenues came as close as possible to the target.

It would not have to borrow from other sources to fund the budget shortfall. A monetarily sovereign government is a currency issuer, not a currency user. It can simply spend more than it taxes, inject more money into the private sector than it extracts, and thereby create additional net financial assets. It can create money by spending it into existence. Money creation is generally seen as an expression of monetary policy, and so as something that only the central bank can do. But once we understand that there is no fundamental difference between monetary policy and fiscal policy, and have turned away from the seductions of central bankism, we can see that the tasks monetarist set for monetary policy can be carried out by a democratic legislature in the course of its spending, even more effectively than by a central bank.

If the deficit grows too large, demand-pull inflation might threaten. At that point the policy makers should enact new legislation that directs the treasury either to collect more taxes more or to spend less. It could also prepare for inflation ahead of time by enacting tax-raising or spending-cutting triggers that kick in automatically if established measures of price instability reach certain thresholds.

Of course, some people are horrified by the suggestion that a legislature, responding directly to voters, might carry out monetary policy. Some people seem convinced that money is a kind of economic uranium, a substance so deadly and volatile that it is too hot for ordinary mortals to handle, and whose careful manipulations must be left to a few expert technicians. There is something to be said for this attitude, but it is overwrought. One might have heard a few centuries ago that parliaments could not control national budgets, and could not set tax policies and spending policies without creating economic disaster. But the era of legislatively controlled taxing and spending policies has been an era of unprecedented prosperity. I see no reason to think that legislatures cannot assume the same responsibilities for monetary policy. The passing of monetary policy from the secluded private conclaves of a few central bankers into the public sphere, where it will become a matter of spirited and engaged public debate and activism, will be salubrious for our democracy.

I have claimed that a government doesn’t need to borrow in order to spend more than it taxes. However, it might be held that public borrowing performs several valuable functions, even granted that the public doesn’t need to borrow to fund its expenditures. The buying and selling of treasury securities in central bank open market operations is a tool for interest rate management. Also, those securities provide their owners with a low-risk, low-yield savings vehicle for those who hold the publicly-issued currency. That in itself might be seen as an important and stabilizing public service. Finally, the existence of several varieties of securities with different maturities and coupon payments provides the government and the public with some flexibility in accomplishing these goals. While I believe the first task, interest rate management, could probably be accomplished through other means such as adjustments to the interest rate on reserves, the availability of a government-provided savings vehicle might be important. That is fine. But what the public should be in no confusion about is that the savings vehicle is not provided because the government needs to “borrow” money to fund its spending. The issue for public debate will then become, as it should have been all along, who receives the interest payments provided by these savings vehicles, and whether it best serves public purposes to continue to provide them, or would instead better fulfill those purposes to force the savers out into other markets in search of investment vehicles that might be riskier, but also more productive.

A macroeconomic policy determined by the political wrangling of a democratic legislature will frequently be messy and ungainly. Economists seem to dislike instinctively this approach to economic policy. They dream of the perfect “policy rule”, some mathematical formula that is applied with technocratic precision in a politically controlled and detoxified environment. But economic policy is always engaged in the pursuit of multiple, sometimes conflicting goals: full employment, equity, price stability, national progress and development. Perhaps it is a mistake to think all of these goals can be captured in a single rule. Might it not be better for the policy to emerge from the struggle for conflicting aims among engaged democratic citizens?

An integral macroeconomic policy approach should be organic, democratically accountable, nimble, responsive and flexible. It should be forged by broad public debate and discussion, and will no doubt require the messy contention of political factions and regions. But elitism and technocracy have not served us well. Let’s try democracy.

54 Responses to Toward Monetary Enlightenment: An Integral Approach to Macroeconomic Policy

  1. a very readable and great post Dan, I’m sharing this with everyone!

  2. Dan, could not disagree with you more on the sort of invalid distinctions of kind between government liabilities/debts & private ones in this & your earlier article. It makes things more complicated for no reason, and obscures a great deal. It’s not MMT. It’s closer to the old-Keynesian way of thinking. It’s Alvin Hansen, not Abba Lerner (or JMK).

    The only thing the possession of a US dollar entitles you to is another US dollar.
    Utterly wrong. Possession of a US dollar – a debt from the USG to the holder – entitles the holder to the cancellation of a debt measured in US dollars, most particularly to the US government, most particularly for tax payments.

    Mitchell-Innes – who certainly understood & was talking about “modern” “fiat” money: “The notion that we all have today that the government coin is the one and only dollar and that all other forms of money are promises to pay that dollar is no longer tenable in the face of the clear historical evidence to the contrary. A government dollar is a promise to “pay”, a promise to “satisfy”, a promise to “redeem” just as all other money is. All forms of money are identical in their nature. It is hard to get the public to realize this functional principle, without a true understanding of which it is impossible to grasp any of the phenomena of money..”

    Governments traditionally classify the currency they issues as liabilities. It’s not a “traditional classification”, a mere arbitrary convention, a bookkeeping fiction. It’s what it frigging, absolutely, metaphysically IS. It most certainly is “negative value” to the issuer.

    Nor does the currency issued by governments in modern fiat systems represent a redeemable promise for the delivery by the government of some other objects or services of value. Sure it does. I go to the Smithsonian Museum Gift Shoppe. I buy a stuffed animal & get a receipt. No essential difference between that & a gold standard. I can even take the stuffed animal & receipt & get my money back.

    But these credits are for obligations that the government itself establishes by sheer legislative fiat, and so the fact that the government has issued credits for those obligations does not mean that the issuance of these credits represents negative value for government. Anybody can issue currency. The problem is getting others to use it. “Sheer legislative fiat” comes perilously close to the “pious wish” “legal tender” view. It takes two to tango, the issuer & the user. Just because the US government has solved the problem of getting currency users doesn’t mean the problem is easy.

    • Dan Kervick

      Possession of a US dollar – a debt from the USG to the holder – entitles the holder to the cancellation of a debt measured in US dollars, most particularly to the US government, most particularly for tax payments.

      I mentioned that Calgacus. But I argued that those tax obligations are “obligations that the government itself establishes by sheer legislative fiat, and so the fact that the government has issued credits for those obligations does not mean that the issuance of these credits represents negative value for government. ”

      Suppose I sign and hand you an IOU for 50 chickens to be delivered by next week. That IOU, if legally binding, represents an asset for you equivalent in value to 50 chickens and a liability for me also equal to the value of 50 chickens. I am now legally bound to surrender something of substantial value to you. Neither of us makes the laws, and so to the degree we are bound to them by our debt contracts and they command the acquisition or surrender of things of positive or negative value, to the same degree these contracts represent positive or negative value.

      But suppose I hand you a signed certificate that says “Credit – 50 Danzillions”. I then say, “I hereby demand you surrender to me 50 Danzillions, or else I will put you in my specially designed penalty box.” And suppose I am the maker of whatever laws bind us, and I have the capacity to force you into the box if I am not satisfied. Then while your possession of that certificate represents positive value to you, since it is your means of escape from a very unpleasant punishment, your possession of the certificate does not represent negative value to me. It’s not like I have some desire that will only be satisfied by putting you in the box, so when I accept the certificate back and agree not to put you in the box, I have lost nothing of value. I have imposed an obligation on you. But I created that obligation by fiat, by making laws I myself create, and it was an obligation for you to perform an action that is of no intrinsic desire to me.

      Sure it does. I go to the Smithsonian Museum Gift Shoppe. I buy a stuffed animal & get a receipt. No essential difference between that & a gold standard.

      But the government has not promised you a stuffed animal in exchange for your currency. It has only created or maintained a situation in which some other people are freely willing to exchange a stuffed animal for your currency. If you go to a government office and demand a stuffed animal or any other commodity for your government-issued currency, you are out of luck. They only thing you can get for your dollars is more dollars, or equivalently credit off of government-imposed obligations to surrender …. dollars! Surrendering dollars keeps you out of tax-dodger prison. But the government obtains nothing of positive value by putting you in tax-dodger prison, and so it doesn’t surrender or lose anything of value when you successfully present your credit to stay out of it. On the other hand if the government was in possession of a large store of stuffed animals that it had acquired at substantial real cost, then any certificates it issued that were redeemable in stuffed animals would represent negative value to them: commitments to surrender something of value in their possession.

      So I continue to think that the classification of issued currency as a “liability” of the government is an outmoded booking convention that dates back to gold standard days. Giving someone a credit to cancel an obligation that I myself create by fiat out of thin air, and whose discharge is of no particular meaning to me, is not the same thing as creating a liability.

      • Robert Rice

        You’re exactly right Dan: government issued currency is not a financial liability of the government. We no longer operate within a convertible currency regime where the fiat is convertible to some commodity, which itself is regarded as money. Granted there is an attached promise to currency that the issued fiat will satisfy the non-government sector’s government tax liabilities. But this, as you noted, is not a financial liability of the government to the private sector. In this context, the government does not owe any entity any financial assets, which by definition is what a financial liability really is.

        I’ve long mused over whether some equivocate on “liability” in this context, referring to the government’s spending as a “liability” of the government to the non-government sector, an IOU of sorts. It is however worth noting the government’s “liability” resulting from money creation and subsequent spending is not of the same nature as our common usage of a financial liability. The former is a promise to receive back the issued currency as settlement of tax debt denominated in the currency (which an entity may or may not have), the latter being the vastly more common usage of any debt denominated in government fiat. These are quite conspicuously different propositions. I think some would improve clarity and accuracy within their worldview (or within their description of it) by better drawing this all important distinction between the various meanings of liability. The distinction affects how we count on the government’s balance sheet. Not drawing the dichotomy only obfuscates the description of reality while working to obstruct acceptance and understanding of some of MMT’s important insights.

      • Dan Kervick

        I’ve long mused over whether some equivocate on “liability” in this context, referring to the government’s spending as a “liability” of the government to the non-government sector, an IOU of sorts.

        There could be an ambiguity: Perhaps some use “liability” to refer to any kind of obligation. But my understanding is that “liability” in the accounting sense always refers to a debt. A’s liability to B is some legally binding claim B has on A’s assets. The liability represents negative value to A, and the corresponding claim represents positive value to B. If I make a legally binding promise to give you one of my sheep, then the existence of that promise is a liability of mine, because it represents a claim you have on my assets. But if I make a promise not to take one of your sheep, then I don’t think the existence of the promise is a liability, because you don’t as a result have a claim on my assets, and keeping the promise does not require that I lose something of value. Yet both promises are obligations: on e a promise to surrender something, the other a promise not to take something.

  3. Of course I agree with you diatribe against the novel cult of the central bank, which has infected even some otherwise good Post-K economists, and which is ascribed a fictitious venerability a la Scientology. It makes one nostalgic for the old cults of the gold standard or of rigid exchange rates, far less preposterous, far older, far more reasonable, far less inane.

    • Dan Kervick

      Yes, the obsession with the central bank, its independence and its alleged powers is a self-paralyzing pathology of our contemporary discourse.

  4. I’m familiar with the MMT consolidated view. The “Treasury Central Bank” that I referred to in my piece is my explicit institutional representation of a similar perspective. In a way, we’re not that far apart in sketching out the big picture. It’s the fine strokes that are quite different in approach. I think you/MMT tend toward a linearization of the idea of progression toward an “enlightened” consolidated view. I specify a corresponding perspective using a framework of explicit institutional optionality – one that radiates from a starting point of status quo operations – rather than a linear conceptual development starting from an original “general” case. And mine is open to policy flexibility and optionality, to be determined, rather than being inherently prescriptive just based on the institutional construction.

    • Dan Kervick

      I don’t think we disagree about the current operational realities JKH. From my perspective, the importance of taking the consolidated view is a certain degree of conceptual clarity and simplification about the net impact of different kinds of government operations on the non-governmental sector, and about the functional similarity of operations that are usually classified as very distinct.

      For example, a social security check sent to a retiree is conventionally classified as “spending”, while the payment of IOR into a bank’s reserve account is not. But they are both direct transfers of money from government to a private sector account. The CB operation directly creates a CB liability, while the treasury operation does not. But depending on the degree to which the government’s fiscal position is accommodated and assisted by the central bank, the treasury operation can be seen is indirectly creating CB liabilities.

      Another illustration: Suppose the government taxes $X from the account of A and later spends $(X+Y) into the account of B. Now suppose A and B are the same entity. In the latter case, we have borrowing followed by re-payment with interest. In the former case we have taxing followed by spending . But they are functionally identical combinations of operation. This is useful, I believe, in understanding a country like Japan, because as I understand it a good deal of Japanese social spending is officially structured as debt repayment on government bonds accumulated by citizens. In one country, a portion of worker salaries might be “taxed” and in return the government makes some kind of plan or commitment to send them money in the future, but a commitment that is not classified as a debt repayment. In another country, the “taxes” might be classified as bond purchases, and the payments classified as debt service. In the latter cases, accounting shows the country as having lower tax revenue and higher debt obligations, but from the point of view of the sustainability of government financing, the countries are not different.

      Also, suppose that a certain gradually growing % of treasury securities that are sold each year are routinely purchased in open market operations by a country’s central bank. If the debt payments on the previously sold securities are always made by issuing more debt, which is then repurchased, then the net result can be that the central bank and treasury are effectively conducting an indefinitely extended joint operation to spend money into the private sector through the treasury channel, financed by central bank money-creation. The independence of the central bank means that it has to sign off on its role in this joint operation, but it is still useful to understand that this is happening.

      So I find it useful to look at total payments in vs. total payments out (as well as looking at whatever real goods and services might be exchanged in these transactions) in evaluating the economic role of the government, and try not to place too much emphasis on the standard classifications of the kinds of payments involved. It is true that the current operation realities and laws create constraints that might not be applicable if the payments are classified differently. But these operational realities have themselves been established by government, and viewing things from the consolidated perspective along with the current operations perspective provokes clearer thinking, I believe, about the ultimate significance or lack of significance in the current operations, and about ways in which operations could be streamlined or even radically reorganized.

      I also think the independence of the central bank is something worth examining critically. Whatever operating independence the Fed has, for example, was granted to it by Congress. It’s like a spy agency that issues classifications to its operatives, and allows some of them to operate as free agents with a lot of discretion and weak reporting responsibilities – maybe even a “license to kill”. The agent is much more independent that other agents in the agency. But the agent’s status could be revoked at any time. The question is how difficult the revocation is to accomplish. In some countries, a central bank could be established as an actual “co-equal” branch of government, and its independence could then only be altered with significant constitutional change. In other countries, the change might require nothing more than a simple act of ordinary legislation.

      • Matt Franko

        good stuff here again Dan,

        “while the payment of IOR into a bank’s reserve account is not.”

        I believe the Fed has to get balances to be able to do this (ie pay interest on reserves)

        I would think that they get interest from the portfolio of Treasury and Agency securities they own and then turn around and give some of those interest receipts to banks as IOR.

        iow the Fed as I look at it can create reserves when they buy assets, but not when they pay IOR, there is no corresponding offset on the other side of the Fed balance sheet if all they do is pay IOR.

        I could be wrong. It would seem to me tho that the Fed has to receive balances back from the system (UST interest or perhaps sell something?) before they can pay IOR…


        • Dan Kervick

          Not sure about that Matt. My understanding was that if the Fed decides to pay interest on reserves, it just marks up those accounts, and books the credit to the bank’s account as a liability of the Fed – in other words, it just creates the money and provides it to the bank.

          • JKH,

            Have you read this paper by Stephanie Kelton?

            “Can Taxes and Bonds Finance Government Spending?” (1998)


          • Matt Franko


            I’ll look for an opportunity to run this out with Scott Fullwiler perhaps.

            Seems like whatever the Fed has on it’s “balance sheet”, really “Factors Affecting Reserve Balances at Depository Institutions” Fed H.4.1, would yield more than the IOR rate. iow the Fed “Balance Sheet” only has one side, the “other side” is the Reserve Balances that are with the system of Depository Institutions.

            So Fed would have a net positive “cash flow” and have more than enough interest income from Treasury via USTs and Agency Bonds to be able to pay IOR to Depository Institutions. ie the Fed portfolio would in agrregate yield more that what they owed the system as IOR…

            Anyway I’ll try to run this out… Resp,

          • From a balance sheet perspective, IOR is a debit (reduction) to CB capital and a credit (increase) to reserves, at the margin and other things equal.

            From an income statement perspective, IOR (along with other expenses) is netted against revenue (most interest earned on assets) to arrive at net income, which is a credit to CB capital, from which the annual disbursement is paid to Treasury (which itself would be a debit to CB capital and a credit to the Treasury account).

            Its helpful to try and think about the relationship between income statement accounting and balance sheet accounting as a backdrop to your general discussion in the post about “commingling” of these various types of payments. You sort of have to make a decision about whether or not you want to anchor your thinking in terms of that conventional accounting framework before you proceed into your general discussion, I think. In other words, the decision on one goes along with the approach on the other. It’s interesting, Nick Rowe sort of does monetary analysis somewhat along the lines of your approach to this (i.e. the commingling aspect, not the conclusions drawn from it necessarily).

          • y,


            (and I’m revisiting it)

            watch out


          • Dan Kervick

            JKH, I think I prefer to straddle the fence here to some extent. As I understand it, accounting is primarily a language designed for economic entities to communicate various aspects of their their overall economic condition to other people – including regulators and policy-makers – who take an interest in that condition, including people who are legally entitled to that information. The accountants use a common language with a few dialectical variations, so that there is a common basis for comparing the representations about one entity made in that language with the condition of other similar entities. And the adherence to this common language is to some degree fixed further by legal requirements. The Fed relies on this language as well, and the conventional accounting description of Fed operations is generally useful for interpreting its condition, operations and policy-decisions.

            But if we adhere to that language and the conventional descriptions expressed in it as though they describe a framework that is set in stone, we can propagate an unnecessarily limited understanding of the full range of policy options available both to the Fed as an existing institution and to the public. My own view is that the central bank of the national government – the maker of the laws and the builder or creator of much of the institutional and legal framework in which other economic entities are required to operate – is such a fundamentally different kind of beast from a commercial bank that the conventional accounting terms, while pragmatically useful, can also introduce some distortions and false analogies.

            The fact that Fed practice and some legal requirements determine that the Fed uses terms like “capital”, “income”, “earnings”, “liability” and “asset” is, to my mind, a useful but somewhat awkward attempt to jam the conceptual understanding of the unique institution of the central bank into clothes that don’t fit it perfectly.

            You are right that it always good to be clear, when recommending some policy direction, about what would be required to implement that direction – a mere bureaucratic decision? a change in a minor law? a chance in a major law? But I don’t think it is necessary to stick rigidly to one single linguistic framework . It can be useful to jump from one language to another and rely on some contextual judgement on the part of the reader.

          • Stephanie Kelton

            That’s a draft I wrote before I even started a PhD program. I think I have some old homework assignments too, if anyone’s interested.

          • Robert Rice

            I think anyone not appreciating the contribution to the conversation you made in that particular paper Stephanie would be naive. There is much to commend the paper as well as your evident talent and hard work, even if some criticisms of it prove portions mistaken.

            Anyhow, the point is you shouldn’t feel diminished should some criticisms prove correct. Your and other MMTers talent and effort is perfectly evident.

          • “before I even started a PhD program. I think I have some old homework assignments too…”

            you should communicate that to your fellow MMT travellers

            they’re the ones that treat it like some kind of bible

          • “I think I prefer to straddle the fence here to some extent…’

            I’m sympathetic to that. But the accounting I described does fit the existing institutional framework, in which Treasury is positioned somewhat like a commercial bank relative to the Fed, and the financial results are measured for both. So that’s a bit like shooting the information messenger (accounting).

            If you would like to see a less (ostensibly) constrained currency issuing framework, which I think you do, the accounting doesn’t necessarily need to get in the way of that. It just requires an enlightened explanation of what the accounting would be saying in a correspondingly less conventional institutional framework.

      • Robert Rice

        MMT reminds me a bit of the neo-Darwinian synthesis that became the accepted although evolving theory of speciation amongst biologists. It seems to me MMT synthesizes much economic theory while offering its own contributions.

  5. Two questions from an MMT newbie –

    “. . . the Fed could always try doing a helicopter [drop] . . . .”

    What would be the mechanics (and what the transmission mechanism) of that process? — all per MMT.

    “. . . money extractions via taxation.”

    Does government also extract money when it sells debt instruments to the non-governmental sector? If so, is near money differently accounted for in MMT than longer term debt?

    • Dan Kervick

      Hi Ellen,

      When I said the Fed could try doing a helicopter drop, I meant that the Fed could decide to mail a check to every American household, and clear every check when it was presented by the recipient’s bank. In other words, it could create money and give it to people. My guess is that while the actual legalities of such a business are murky, the political result would be scandalous and cataclysmic, and that a central banker who ordered such a thing would be impeached and removed from power for usurping Congressional prerogatives and exceeding the intended scope of his authority.

      On the debt instruments question, the way that I see it is that when someone in the private sector buys a government security, they hand over money in exchange for a government promise to deliver a larger sum of money later, often in stages. So, the net effect of the transaction is an initial extraction of money followed by a subsequent injection of a slightly larger sum of money. However, people who know more about these matters than me tell me that treasury securities are so liquid, that it doesn’t really add much to think of the operation as a temporary extraction followed by a latter injection. It’s just a swap of one kind of very liquid financial asset for another of virtually identical value.

      • Thanks for the response — but I don’t want to leave it there.

        The Economic Stimulus Act of 2008 was a helicopter drop but it wasn’t THE “helicopter drop” Bernanke referred to in his 2002 speech. He implied that the Fed owned a “printing press.” But that’s a metaphor. Only if money gets into the real economy (and not just into bank reserves) is the metaphor explanatory.

        So — what does Bernanke think the Fed would do to get money into the economy — that is, what are the mechanics of a “helicopter drop” sponsored by the Fed? Do MMTers agree that the Fed is capable of doing a “helicopter drop” as Bernanke implies it is?

        As an aside: I don’t think Bernanke believes the Fed could ever write checks to the general public. He must be thinking of some other mechanics.

        • Dan Kervick

          Ellen, in the 1999 paper by Bernanke referenced in my post, Bernanke referred to the helicopter drop when he recommended the Bank of Japan could carry out a “money-financed transfer” to ordinary households:

          An alternative strategy, which does not rely at all on trade diversion, is money-financed transfers to domestic households— the real-life equivalent of that hoary thought experiment, the “helicopter drop” of newly printed money.

          He then clarified that a money-financed transfer is not an option for a central bank acting alone:

          Of course, the BOJ has no unilateral authority to rain money on the population. The policy being proposed – a money-financed tax cut – is a combination of fiscal and monetary policies.

          In line with what I said in the post, I think a better way to put it is to say that a helicopter drop under current institutional arrangements would be a combination of treasury and central bank policies.

          Money monetarists seem convinced that there is always some way for a central bank to get new money out into the real economy. That’s an aspect of “Central Bankism”. But MMTers are skeptical and always point out that the mechanisms monetarists typically recommend – such as flooding the banking system with reserves – don’t work. MMTers have tended to endorse instead things like at payroll tax holiday, which is a helicopter drop of a kind, but which clearly requires the action of the legislature.

          • Dan Kervick

            “Money monetarists”

            Weird typo. I meant just to say “many monetarists”.

  6. Alex Seferian

    Thank you for your very instructive post. I’ve been following MMT for some months now and I have a general question: how effective really is monetary policy? To help me frame that question I outline below a set of MMT sourced statements that I have picked up (including from your writings) or interpreted from my readings. I always refer to sovereign countries like the US. Is anything below wrong or misleading?

    1. Central banks (CB) “can do things like pay interest on reserves, provide direct loans at interest to banks, purchase financial securities from various kinds of securities dealers, and resell the securities they have previously purchased.”
    2. To the extent the last two activities do not involve the purchase and/or resell of existing government securities, then each of the listed actions above involve the creation of new net financial assets (money).
    3. These CB activities have a relatively minor impact on the creation money when compared to those activities carried out by the Treasury (which massively injects and withdraws net financial assets via spending and taxes).
    4. As a result, CBs cannot control the money supply. At best, they control the Federal Funds Rate (FFR) (to use the US term). This rate in turn hopefully impacts interest rates across the board. However, the relationship between the FFR and other interest rates is not too direct (especially vis-à-vis long-term rates) and varies over time depending on the circumstances.
    5. Most of the financial operations within the private sector involve not physical or electronic money created by the Government, but credit money created by the private sector banks.
    6. Private sector banks in turn do not need deposits to create loans. All they need is to find credit worthy customers, and sufficiently profitable opportunities.
    7. In fact, loans are created out of thin air and in this process banks create matching deposits. These are what in part are known as the so-called “horizontal” transactions.
    8. In terms of net new financial assets, or the “vertical transactions”, banks only have to worry about retaining on their balance sheets a minimum of Reserves to meet Federal regulatory requirements.
    9. Banks also have to have on their balance sheets a minimum of equity to meet other requirements, and so as to in theory practice sound banking.
    10. It follows from above that the private sector “credit creation process” does not actually require willing lenders or savers of capital. Again, banks can create loans out of thin air so long as they have the required reserves at the Fed and equity holdings (both are relatively minute amounts compared to the loan assets).
    11. Therefore, private sector money creation does not involve a classical demand & supply dynamic. Therefore, the concept of there being a price at which demand & supply are at equilibrium is not applicable.
    12. Since the price of money is the interest rate, it follows that interest rates do not have as direct an impact on the supply & demand of credit as is generally believed.

    Conclusion: monetary policy is largely ineffective. On the one hand, the Fed cannot control the supply of money and at best they attempt to influence interest rates. On the other, the supply & demand of money in an economy is not that sensitive to interest rates. The ability for the Fed to really cool-off an economy, or give it a boost by doing what it is able to do, is very limited.

    Something above I assume is not entirely correct because the last statement seems too contradictory. However, I don’t know exactly what is off since I have tried to follow a logical train of thought. Feedback is much appreciated. Thank you in advance.

    • Dan Kervick

      On the other, the supply & demand of money in an economy is not that sensitive to interest rates.

      Alex, this part seems to go overboard, I think. The demand for loans should be sensitive to the price of those loans. However, once interest rates are near 0%, the central bank cannot boost the demand for credit by lowering its price.

      I think it is probably possible to view the market for money according to ordinary supply and demand principles. However, the special wrinkle is that the supply of bank reserves is infinitely elastic, and there is only one supplier. The central bank can produce reserves in arbitrary quantities at near zero cost, and the commercial bank can acquire as many reserves as are needed and that it is willing to acquire at the price set by the central bank. But the central bank is a monopoly supplier, so the price it charges is determined entirely by the decision of the central bank, and not by any supply constraints.

  7. Alex Seferian

    That the demand for loans should be sensitive to the price of those loans makes intuitive sense. That plus the fact that opportunities must exist to put borrowed money to good use (i.e., even if credit is cheap, the private sector will tend to borrow less if there are no worthy investments to be made). OK up to here, but what about the supply side of the equation? To answer myself in part, I guess that a similar argument can be made regarding the supply of credit: the higher the interest rate the more people will be willing to lend… but does that really matter?

    I can see Fed Monetary Policy affecting the demand for credit via interest rate targeting. The fact that the Fed is the sole supplier of reserves, and that it can produce reserves in arbitrary quantities at near zero cost, lends further support to the concept that Monetary Policy can theoretically impact the demand for money. If reserves are too expensive, less loans will be profitable given reserve ratio requirements.

    However, there is one last concept that I still have trouble getting my head around. If commercial banks can create money out of thin air, then is it not fair to say there is no need for there to be a pool of “savers and/or lenders” for commercial banks to effectively lend? At most, I can see that there has to be enough private sector savings to account for the equity in the balance sheets of commercial banks… but that is small fry compared to the asset value of loans. The reserves at the Fed that are also required are not even private sector savings. Therefore, the supply of money in the private sector credit creation process should theoretically not be that sensitive to interest rates. Supply is created out of thin air if demand arises. Hence, the Fed has a limited ability to impact the supply of money. Can holes be poked into this logic?

    • I’m not sure I understand your Hence.

      By raising or lowering the funds rate the Fed reduces or increases the number of investment opportunities which borrowers and banks agree are economically sensible. Less opportunities = less loans = less money created. And vice a versa.

      Controlling banks’ cost of funds (interest paid on interbank overnight borrowing or on savings deposits, that is, interest paid to acquire reserves) should control changes in the money supply, yes?

      • Alex Seferian

        Yes, thank you.

        1) The price of money (interest rate) affects the supply and demand for money. One can think of a set of supply and demand lines/curves on a graph and the intersection representing equilibrium. Price on one axis, quantity on the other. That is what I think people tend to imagine when discussing the market for money and it does make intuitive sense. Its what I learnt at school!

        2) Banks can create money out of thin air. To make loans commercial banks only really need to worry about: i) there being credit worthy customers, ii) there being a sufficient spread between the rates charged on loans and deposits (deposits that they themselves will create), and iii) they having a relatively minimum amount of additional money to comply with equity and reserve requirements.

        I guess I still see a disconnect between these two points. The first point implies that if the Fed lowers the price of money there will be more “willing savers”. One would move along the supply curve/line. The second point implies that the notion of “willing savers” is irrelevant. Banks can create or “supply” loans out of thin air. If this is indeed correctly put, then Fed Monetary Policy’s impact on the supply of credit should be relatively minor.

        • Dan Kervick

          Banks can create deposits out of thin air, but doing so will usually require obtaining additional reserves, for which the Fed sets the price it wants. Think of the commercial bank as a business that must obtain a certain raw material from a supplier. The commercial bank is not constrained by supply, since the raw material is available in infinite quantities, but it is constrained by price, since the monopoly supplier of the essential raw material sets the price for that material. You have to go back to what your textbook said about monopoly suppliers in the context of supply and demand analysis.

          • Alex Seferian

            That analogy does help. Thank you.

          • Alex Seferian

            Let me add one last set of questions. This all supports the notion that the Fed through Monetary Policy can and does attempt to influence the economy via the FFR/interest rates/supply and demand for credit. OK but what about the notion that for lending to take place you need people willing to save? Is one of the “raw materials” that commercial banks need (in addition to reserves) a pool of “willing savers”? I would have though that the answer is: not necessarily. The more savers, the more deposits commercial banks will have that are not matched initially by loans, and therefore the easier it will be for the commercials bank to meet reserve requirements with going to the Fed discount window. However, even if no one were to “save” in an economy (e.g., everybody just spent all their income), banks would still be able to create loans. Do you agree?

          • Dan Kervick

            I would say that you shouldn’t think of the borrowers as the businesses raw material. They are customers. So they are on the demand side of the interaction. What they buy is credit. Their is a “demand curve” that represents their current desire for credit relative to the various prices they might be charged for it. If the price of the credit determined by the supplier rises or falls, the customers’ demand for credit will fall or rise accordingly, even if their demand curve doesn’t change. Sometimes, though, the whole demand curve shifts to the right or left when the general desire for credit increases or decreases.

            The customers pay a price for the credit, and the price they pay is not exactly money, but an IOU for money. I buy a loan from my bank by offering them my IOU – to pay them back within, say, a year on a certain payment schedule with a certain quantity of interest tacked on. Different IOUs with the same official terms are worth different amounts to a bank, because in addition to the terms the bank also has to weigh in the value of the risk of default. Deadbeat Dave’s promise to pay $10,000 in one year with 5% interest is worth less to a bank then Cash Flow Cassie’s promise to pay the same amount on the same schedule with the same interest. So the bank will ask for better terms from Dave, if he qualifies at all, for the same amount of credit.

            In a recession, you might have a whole bunch of people eagerly and desperately craving credit, and willing to offer their IOUs for it. But given the general level of economic stress, misery, poverty and insecurity, their IOUs might not be worth as much as they used to be, since fewer people are in a position to make reliable promises. The bank will therefore be compelled to seek better terms from the borrowers so that the price is right for them. But by thus increasing the price of the credit it offers, it prices many of the otherwise eager buyers out of the credit market. The way I look at it is that the banks don’t have less supply; it’s just that the customers have less stuff of value to give in return, since their IOUs have all declined in value.

  8. Zachary 18

    I agree with MMT as how our economic system really works, its policy implications, and the body of your blog.

    However, as you say, “If the deficit grows too large, demand-pull inflation might threaten. At that point the policy makers should enact new legislation that directs the treasury either to collect more taxes more or to spend less. It could also prepare for inflation ahead of time by enacting tax-raising or spending-cutting triggers that kick in automatically [a bit of a perfect “policy rule"] if established measures of price instability reach certain thresholds”.

    Politically, I have serious doubts that we would be able to cut spending or increase taxes in the face of inflation. Also, our current tax system encourages lobbying for tax deals to interest groups and other tax avoidance strategies (i.e. the underground economy) that would thwart the effect of changes in tax policies in the face of inflation.

    As I said at the onset I probably am still wedded to the idea of a perfect policy rule. My question is, would a national sales tax (VAT) designed to be as progressive as possible accomplish the goal of increasing Government revenue automatically allowing it to destroy money and be hard to avoid in the face of inflation?

    I would not advocate going the whole way down the road to having only a VAT as tax policy as other forms of taxation could be adjusted when economic policy demanded. However, in the ideal, the VAT would be off the table as a tax policy tool.

  9. Detroit Dan

    Even occasional detractors like JKH and Krugman agree that MMT is fundamentally correct. Let’s face it — the MMT folks deserve the Nobel Prize. Wray, Mitchell, and Mosler have revolutionized economics.

    Debates on the theoretical margins and policy debates can productively build on the new paradigm. Keep up the good work, Dan K, JKH, and all!

  10. Stephanie Kelton,

    I came across that paper as it’s referenced in Scott Fullwiler’s “Modern Monetary Theory—A Primer on the Operational Realities of the Monetary System” which is on Warren Mosler’s list of ‘mandatory readings’. Is there anything in that paper that you no longer ‘subscribe’ to? Any more recent papers on the same subject?

    • Also, doesn’t your argument in that paper imply that Eurozone countries are also “currency issuers”?

  11. The paper was subsequently revised and published in a journal. I am sure I have not looked at it since I sent it to the Editor some 13 years ago. I don’t know what I said, but whatever it was, I stand by it. (she said, jokingly) I do not think there was any discussion of or reference to the Eurozone. My edited book — The State, The Market and the Euro — came out around the same time and foretold the crisis with the euro (clearly distinguishing currency issuers from users, so I don’t think there was any confusion about that in my Taxes & Bonds paper). I was only pointing out that the link did not go to the final, published version of the peer-reviewed piece.

    • Scott Fullwiler

      Yes, that is a ground-breaking paper given when it was written. There was nothing like it back then. And I was struggling to nail down my dissertation topic at the time; that paper was my light-bulb moment.

      We need to remember the context, though–there’s been 13+ years of debate both in academia and also on blogs that have led us to clarify the points being made in the late 1990s research such as this and Randy’s book. Many have had “difficulties” with language used back then (but some of that has to do with the groundbreaking nature of the work). In other words, our views have not changed regarding those initial insights, though we say things differently now in terms of language and metaphors (indeed, this process began rather quickly by the early 2000s given some of the critiques being published that were largely misinterpretations or written from a fixed fx perspective). As I explained in my “primer on operational realities” piece, Stephanie’s paper should be interpreted as a classic “general case” exposition (e.g., the Fed’s inability to provide Tsy with overdrafts isn’t mentioned, I think) that provides some applications to the real world (i.e., tax and loan accounts) and puts them all together in a way most had not considered before.

      • Scott Fullwiler

        In other words, a critique of the “framing” in the MMT research from the late 1990s within the context of how these are now discussed on the blogs or in academic research would not be useful and or interesting, in my view. That’s already well-tread territory.

  12. Stephanie, Scott,

    Is the US currency actually a liability of the Treasury, or not? Federal Reserve notes are described as liabilities of the Federal Reserve and obligations of the United States government. Both Treasury and Fed are part of the government, aren’t they? Aren’t ‘liabilities’ and ‘obligations’ basically the same? How are reserves/currency described on the Treasury balance sheet?

    • Dan Kervick

      y, as I understand it reserves would not appear on the Treasury balance sheet at all. Not Treasury’s department.

      • Do you know where I could get more info on this online?

        As I said above, Fed notes are liabilities of the Fed and obligations of the US govt. If ‘liability’ and ‘obligation’ are the same, then the Treasury is in effect the currency issuer, along with the Fed.

  13. This is a really important article Dan Kervick. I congratulate you for producing it. It starts to open up a new area of debate for MMT namely the importance of integrating fiscal and monetary policy and how to best integrate it as process that has built-in democratic accountability unlike the financial fat cat’s captured central banks we make do with now. Having spent a long time looking I’ve yet to find any MMT document that does what you have done. Sure there is the recommendation that to better understand MMT fiscal and monetary processes should be seen as one government operation. Plenty also of MMT writing that criticizes central banks over their performance and even ones that recommend technical changes to improve their performance but not one that raises the fundamental question of whether there are benefits to be gained in integrating Treasury and Central Bank functions to create a sort of Clearing House for Economic Policy. Excuses can be made that MMT is essentially a descriptive process of existing arrangements but not dealing with the shortcomings of the current separation of powers is in my view equivalent to the Neo-Liberal blindness that capitalism is always self-equilibrating, or self-balancing. In fact as the economist, Thomas Palley, makes clear it is self-sabotaging Global Capitalism and Financial Capitalism that have combined to undermine demand in Real Economy Capitalism to give us the Great Stagnation.

    However, having praised you I think there is a terminological weakness in your article namely stemming from the balanced sheet approach you use, which whilst correct, frames your integrative objective in the wrong language. This is the use of the word ‘deficit’ in which you talk of government ‘deficit spending’ into the economy. The comment from Zachary 18 illustrates the fear of “demand-pull inflation” in regard to governments running “deficits” and I’ve lost track of how often I’ve read comments in newspapers that MMT if implemented will produce hyper-inflation. Whilst I continue to struggle to find a better phrase than “deficit spending” I’m very much aware that a prime role of money as a technology and social relation is to act as a catalyst between labor and resources but a catalyst that good economic arrangements keeps active and bad inactive subject to inflationary pressures. Money can, therefore, be seen as an activator that can be injected into or extracted from an economy according to circumstances. Since it is now obvious that capitalism is prone to self-sabotage the injection and extraction of money in an economy cannot be left as an unplanned process. It makes sense that its use should be run through an integrative Clearing House that regards all money as one whether created or destroyed by government or private banks because it’s a balance sheet operation, a creator or destroyer of demand. And demand after all is a satisfier of human need and such a Clearing House is in the business of “demand maintenance” not deficit spending or deficit cutting.

    • Dan Kervick

      Thanks for the kind words Schofield. I understand the negative connotations that attach to the word “deficit” – since it inherently suggests a shortage of some kind. I also have tried to think of some intuitive alternative expression to describe the situation in which the government spends more that it taxes – an expression other than “spend more than it taxes.” So far, no luck. How about: “net spending outflow”

      And given that we are talking about stocks and flows, we could press the fluid dynamics analogy and use the terminology of “sources and sinks”. When more money is flowing back to the government than is flowing out, the government is a money sink; when more is flowing out than is flowing in, it is a money source. A good think about this language is that – unlike the case with the traditional terminology of surplus and deficit – the term “sink” is in this case the term with the negative connotation and the term “source” has a positive connotation.

      If we talk about “the Clinton money sink” – for example – it has a much worse connotation than “the Clinton surplus”. And instead of saying “we need to run bigger deficits”, we could say, “we need the government to engage in expanded money sourcing.”

      We could then still use “surplus” and “deficit” in the case of the private sector, to emphasize the difference between the public and private sector balance sheet.

      I don’t think we can avoid the issue of demand-pull price inflation, however. That is a real challenge to provide a more thorough MMT account of when demand-pull inflation does and doesn’t occur.

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  16. Dan I think the answer is to find a word that has a positive connotation for the activities of government including the one you mention of spending or lending into an economy more than it takes out in taxation and other charges. For example, I like a word such as “provision” so that a government “provisions” its society with the public goods and services that the private sector wouldn’t initiate but it also provisions the mediation of demand to optimize economic performance. Maybe this word is too old-fashioned but its dictionary cousins such as “services” and “resources” are even worse because of their mechanistic flavor. I think it was George Lakoff who pointed out that a great deal of our language makes reference to our bodies and its needs especially its state of well-being. So, for example, we talk about “the sickness in society” as though society was an animate being like ourselves. Indeed we even use the phrase “the body social.” The choice of the “umbrella” word then for the government activities I’ve listed above should I believe have not only a positive connotation but also a nurturing one. Hope this is of a little help.

  17. As a further comment I think the chief importance of MMT to economic understanding lies in the fact it highlights only government can “provision” the mediation or adjustment of demand in an economy through its tools of money creation and taxation.

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