Lavoie’s Critical Look at Modern Money Theory: A Reply

In October 2011 Marc Lavoie, a post-keynesian economist, very friendly to Modern Money Theory (MMT) wrote a paper presenting a friendly critical look at MMT. In his conclusion, Lavoie states that “. . . the neo-chartalist analysis is essentially correct . . . “ affirming his substantial agreement with MMT’s analysis of banking operations and fiscal realities in nations with non-convertible fiat currencies, with floating exchange rates and no debts in currencies they do not issue, as well as MMT’s analysis of Eurozone viability. But he goes on to say (p. 25):

“There is nothing or very little to be gained in arguing that government can spend by simply crediting a bank account; That government expenditures must precede tax collection; that the creation of high powered money requires government deficits in the long run; that central bank advances can be assimilated to a government expenditure; or that taxes and issues of securities do not finance government expenditures.”

So, Lavoie questions the wisdom of MMT economists and writers making certain counter-intuitive statements he perceives as certainly questionable, perhaps untrue, and also confusing to people, economists and decision makers trying to understand MMT writings. He considers these statements an important barrier to understanding, and he wants this ‘baggage’ to be discarded because he thinks it hurts MMT and post-keynesian efforts to get important new approaches to economics accepted.

Recently, Lavoie’s work was used in a very vigorous and important discussion at Rodger Malcolm Mitchell’s Monetary Sovereignty web site by a commenter named “Tom,” questioning some of Rodger’s formulations and the statements of other commenters who defended the MMT and MS positions. I participated in the discussion, but also concluded that it would be more useful to write a more formal reply to answer Lavoie’s question of what is gained by taking some of the positions MMT and MS writers often take. This is my reply.

The Consolidated Government Assumption

Well, let’s set the parameters of this discussion. When MMT writers refer to the Government, they don’t mean just the Executive Branch or the Treasury. They include in “the Government,” the whole central government including the Congress, the Supreme Court, and the so-called “independent agencies” including the Federal Reserve — the Central Bank of the United States. Now, there is wide disagreement about whether the Fed, comprised of its Board of Governors, the Federal Open Market Committee (FOMC), and the Regional Fed Banks are a Government agency. I won’t try to resolve those disagreements in this post. I’ll just assume for purposes of this discussion that the system comprised of these institutions and their interaction as created by the Congress, is part of the Federal Government under the full authority of the Congress to regulate.

Whether this is right or not is disputable, and I’m sure some of my friends among the commenters will dispute it. But, what is not open to dispute is that when MMT writers make the claims attributed to them by Lavoie, this is what they are assuming. So, if one wants to refute these claims he or she must argue against the basic assumption, or failing that one must critique the MMT claims by first stipulating to that key MMT assumption, for the sake of argument.

Lavoie disagrees with the MMT assumption that it is useful to see the Government, especially the Treasury and the central bank, from a consolidated point of view for purposes viewing the reality of fiscal operations. He does not dispute this by claiming that the central bank isn’t part of the Government, and in my view he presents no compelling argument why the MMT conceptual consolidation of the Government and the central bank is incorrect; but, in spite of this he opts to view the Government and the central bank as separate entities because he finds that view more illuminating for his own analytical purposes.

He’s entitled to do this, of course. But, in evaluating his view that MMT gains little or nothing from various statements it makes, I think one needs to keep in mind that what is gained may look different if one accepts the consolidated Government point of view than if one doesn’t. Now, let’s get to each of the MMT claims Lavoie questions and try to answer his question about what is gained by asserting them.

“Government can spend by simply crediting a bank account;. . . ”


I think MMT economists and writers point this out because it is true, provided that all parts of the Governmental spending system are aligned. That is, if spending is appropriated by the Congress and the Federal Reserve banking agent of the Treasury places the reserves in the Treasury General Account, then the Government can, and most often currently does, spend by crediting private sector bank accounts. So, the question now becomes what is gained by simplifying the above explanation into the short claim above?

And the answer is that MMT wants people to know that their Government, as a whole, can spend freely if it wants to, because if MMT can convey that message to people, then they will be in a position to deny the claims of the austerity-mongers that the Government just doesn’t have the money and cannot get it, because it must either tax or borrow, and then face inescapable “funding” constraints on both options. If we could get to the point of public recognition that such a claim is false, then that would be a great, enabling, political gain in the fight for MMT-based policies.

Looked at in other words, MMT writers see the power of the austerity position on fical policy in its claim that “There Is No Alternative” (TINA). The idea that the Consolidated Government spends by simply marking up accounts creating its fiat money in the private sector is a powerful one in beginning to make the case that “There Are Good Alternatives” (TAGA) to austerian fiscal policy.

“. . . government expenditures must precede tax collection; . . . “


MMT doesn’t exactly say that. What it says, as Lavoie recognizes in his detailed analysis in the paper, is that from a logical point of view there has to have been government spending of the currency unit of choice allowing people to accumulate that currency, before it can be used to pay government tax obligations. That doesn’t mean that MMT is saying that government spending must precede tax collections on any given month, or given day, or given year. As Stephanie Kelton puts it in her account of the way in which deficit spending creates net financial assets:

“As we in the MMT tradition consistently insist, spending must, as a matter of logic, precede taxation in the first instance (for it would be impossible to collect dollars from the private sector unless they had first been spent into existence by the public sector). But in the real world, the Treasury receives tax payments on a daily basis, and government checks are clearing bank accounts on a daily basis as well. So there is really no objective beginning point or ending point. You can begin with spending if you prefer. But it will not alter the result.”

So, I think Lavoie has overstated this MMT claim. If he doubts the validity of the claim made as a point of logic then I think it’s up to him to explain how people can have the currency needed to pay taxes without the Government, in the MMT meaning of that term, spending in the first place to originate the process of establishing the legitimacy and value of the currency.

“. . . the creation of high powered money requires government deficits in the long run; . . . “

High-powered money includes cash money and reserves emanating from the Government, including the Federal Reserve. If there’s no deficit spending the Government is destroying as much money through taxation as it is spending/creating. And so, it is not doing any net high powered money creation. MMT writers simplify a bit when they they say “the creation of high powered money” rather than “the net creation of high powered money” but I think it’s easy to excuse the simplification since the word “net” tends to make people’s eyes glaze over, and much MMT writing is an attempt to communicate with the broader public, rather than just other economists.

Lavoie seems to think that net high powered money creation isn’t necessary for an economy, even if it is good to have. He says:

“While I would certainly agree that government deficits in a growing environment are appropriate, as it provides the private sector with safe assets, which can grow in line with private, presumably less safe, assets, it is an entirely different matter that government deficits are needed because there is a need for cash. Even if the government keeps running balanced budgets, central bank money can be provided whenever the central bank makes advances to the private sector.”

Of course, it’s true that the central bank can provide money to the private sector through lending and asset swaps; but this kind of money creation is not net money asset creation unmatched by a corresponding liability. So, all it can do in the long run is to produce unsustainable credit bubbles that will periodically crash the economy, rather than net money asset creation, which can support the continuous creation of real wealth.

The gain in using formulations like the one Lavoie critiques is that these and related expressions provide a counter to the conditioning of people to the idea that deficits are somehow a negative state that ought to be avoided as much as possible. Lavoie is certainly no opponent of deficit spending, but I think perhaps, he’s not giving deserved recognition to the difficulties MMT economists have been having in fighting the world view of austerity that looks at deficits as overwhelmingly negative states that ought to be minimized and eventually avoided. A negative view of deficits as immoral is fundamental to the austerity posture in fiscal politics. If we can get people to agree that deficits are necessary for nominal wealth accumulation in the longer run, then we will greatly weaken the negative view of deficits that is so important to austerians.

“. . . . central bank advances can be assimilated to a government expenditure; . . .


I’m not sure what Lavoie has in mind here. It’s not clear to me what he means from the analysis in his paper, and I’ve never seen an MMT writer say anything like the above statement.

“. . . taxes and issues of securities do not finance government expenditures. . . . ”


Lavoie wonders what is gained by a statement like this after he has shown through an analysis using T-accounts that the Treasury borrows from the private sector when it needs to deficit spend. Then he says (p. 18):

“The purpose of this whole exercise is to show that there is no point in making the counter-intuitive claim that securities and taxes do not finance the expenditures of central governments with a sovereign currency. Even in the case of the US federal government, securities need to be issued when the government deficit-spends, and these securities initially need to be purchased by the private financial sector. It seems to me that the consolidation argument – the consolidation of the central bank with the government – cannot counter the fact that the US government needs to borrow from the private sector under existing rules.”

However, it’s just not true that the Consolidated Government needs to borrow from the private sector to deficit spend under existing rules. Here are four reasons why this is not so.

First, “existing rules” include the Constitution of the United States which states the most fundamental rules of all for the Consolidated Government. Article One of the Constitution provides Congress with the authority to create money without limit and to appropriate spending with or without borrowing. That authority is a fact. And it is important for people to recognize that any constraints on the authority to create money without issuing debt instruments that may exist in current practices are, as MMT says, self-imposed constraints.

Second, apart from existing constitutional authority to delegate authority to the Treasury to spend without borrowing, there is also the fact that in addition to those rules that appear to constrain the Treasury component of the consolidated Government to only taxing and borrowing to deficit spend, there is also legislation that allows the Treasury to coin money, deposit it at the Fed, force the Fed to provide reserves in return for that deposit, and proceed to have the seigniorage revenue resulting from this process “swept” into the Treasury General Account (TGA), the spending vehicle of the Federal Government.

Seigniorage has always been a relatively minor source of reserves for Treasury. However, an act passed in 1996 provides the authority to mint platinum coins of arbitrary face value to use in the process of gaining seigniorage. Face values on these coins can be in the many trillions of dollars and can fill the public purse to arbitrarily high levels. These reserves can only be spent on Congressional appropriations and repaying Federal debts and interest due, so this capability doesn’t take away the purse strings from the Congress. But it does make Lavoie’s claim that the consolidated Government needs to borrow from the private sector to deficit spend under existing rules untrue; even overlooking the constitutional authority of Congress to amend current constraints on the Treasury’s ability to generate reserves “out of thin air.”

Third, there is the issue of whether the Treasury is really borrowing money, when it issues debt instruments in return for the Consolidated Government’s own fiat. MMT economists often point out that when the Government “borrows” money it is not like you or I borrowing money. Yes, the Government must repay in both cases, and in both cases the term ‘debt’ is used. But, a) the Government’s debt is more like the liability of a bank to its depositors, than it is like the liability you or I might have to the bank.

The Government, in selling its debt, is functionally providing the equivalent of a time deposit opportunity to depositors, rather than borrowing money from people who are incurring a risk that they won’t be repaid. In fact, the Government’s “time deposit” carries the same risk with it that a “time deposit” placed in a bank does, since it is the Government that insures such deposits.

And b) what sort of ‘debt’ is it that provides no burden at all on the borrower and pays a return to the lender without exposing that lender to risk? It certainly isn’t like a ‘debt’ that you and I or any user of a currency incurs. The reason is that the power and authority of the consolidated Government to create reserves is unlimited, so no matter how circuitous the process of generating those reserves may be, the issue is never in doubt. The Government can always create the reserves it needs to repay its debts. And under the 14th Amendment, to the US Constitution, section four, the US cannot default on its ‘debts.’

Fourth, “the counter-intuitive claim that securities and taxes do not finance the expenditures of central governments with a sovereign currency” is true if one considers carefully the term “finance.” When you or I have to “finance” our spending we must do it from money we acquire from others through our economic activity including our lending. But, the Consolidated Federal Government in the end creates money from the Fed’s power to generate reserves, and the Treasury’s (US Mint’s) power to generate currency (ordered by the Fed) and coins.

The Treasury may tax and borrow as an important part of its spending operations, but that doesn’t mean that it is the Consolidated Government that ultimately “finances” these spending operations through these measures. The Treasury may use these measures plus seigniorage to generate the reserves that end up in the TGA; but the Consolidated Government, viewed as whole, ultimately enables and facilitates the Treasury’s spending through exercising its collective authority to create reserves by fiat in the TGA in response to Treasury’s tax, debt instrument sales, and seigniorage-producing activities. It does not “finance” its spending in the manner we normally associate with the term “finance.”

So, what do MMT writers gain by claiming that the Consolidated Government doesn’t ”finance” deficit spending by “taxing” or “borrowing?” I think the answer is that we continue to underline the central point that governments sovereign in their own currency have no solvency concerns, because they have an unlimited capability to generate nominal wealth. This point is very central to both MMT and MS, because it implies that austerity is an untenable position in fiscal policy, and that the whole litany of neoliberal concerns about the sky falling someday because the Government is running out of money is just a fairy tale.

This point is where the action is politically, and much of the effort of MMT and MS writers is devoted to demonstrating it in various ways, and underlining it again and again in order to overthrow the neoliberal paradigm of economic thought. I think that overthrow is our main messaging objective, and that objective is served by the various counter-intuitive statements that Lavoie views as “baggage” MMT ought to get rid of.

For my part, I think these statements are both true and also important in creating our alternative paradigm. Paradigms advance by creating cognitive dissonance in those who accept the old paradigm or who are neutral in relation to that paradigm. That is, I think, exactly what we are doing.

And out of that dissonance we are beginning to see change. Let us hope that we will see that change accelerate over the next few years so that the world and its various nations will be able to end the global move toward plutocracy, and a new feudalism that is gradually impoverishing the middle class and ending the hope brought by freedom and democracy everywhere this new feudalism advances.

(Cross-posted from New Economic Perspectives.)

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