Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems

By L. Randall Wray

This week we begin a new feature at New Economic Perspectives—a Primer on Modern Money Theory. Each Monday we will post a relatively short piece, gradually building toward a comprehensive theory of the way that money “works” in sovereign countries. We will then collect comments through Wednesday night, and will post a response to the comments on Thursday. The comments should be directly related to that week’s blog. Since we are trying to develop an understanding of MMT, we especially encourage commentators to let us know where we have been unclear. Since we will be presenting the Primer over the course of the coming year, we will sometimes have to beg for patience—obviously we cannot present the entire theory all at once.

These blogs begin with the basics; no previous knowledge of MMT—or even of economics—is required. The blogs are sequential; each subsequent blog builds on previous blogs. The blogs will be at the level of theory, with only limited reference to specific cases, histories, and policies. That is intentional. A Primer should provide a general overview that can be adapted to specific national situations. The regular pages of NEP will continue to discuss current real world policy issues. The Primer will remain on a different plane.

What follows is a quick introduction to the background and purpose of the Primer.

MMT Primer Blog #1

In recent years an approach to macroeconomics has been developed that is called “modern money theory”. The components of the theory are not new, but the integration toward a coherent analysis is. My first attempt at a synthesis was in my 1998 book, Understanding Modern Money. That book traced the history of money as well as the history of thought undergirding the approach. It also presented the theory and examined both fiscal and monetary policy from the “modern money” point of view. Since that time, great strides have been made in applications of the theory to developing an understanding of the operational details involved. To put it simply, we have uncovered how money “works” in the modern economy. The findings have been reported in a large number of academic publications. In addition, the growth of the “blogosphere” has spread the ideas around the world. “Modern money theory” is now widely recognized as a more-or-less coherent alternative to conventional views. However, academic articles and short blogs do not provide the proper venue for a comprehensive introduction to the approach.

This primer seeks to fill the gap between formal presentations in the academic journals and the informal blogs. It will begin with the basics to build to a reasonably sophisticated understanding.

In addition, it will explicitly address another gap: the case of developing nations. The MMT approach has often been criticized for focusing too much on the case of the US, with many critics asserting that it has little or no application to the rest of the world’s nations that do not issue the international reserve currency. To be sure, that criticism is overdone because modern money theorists have applied the approach to a number of other countries, including Australia, Canada, Mexico, Brazil, and China. Still, much of the literature explicitly addresses the case of developed nations that operate with floating exchange rates. Some supporters have even argued that MMT cannot be applied to fixed exchange rate regimes. And there has been very little application of MMT to developing nations (many of which do adopt exchange rate pegs).

So this primer also fills that gap—it explicitly addresses alternative exchange rate regimes as well as the situation in developing nations. In that sense, it is a generalization of modern money theory.

Unlike my 1998 book, this primer will not revisit the history of money or the history of thought. The exposition will remain largely theoretical. I will provide a few examples, a little bit of data, and some discussion of actual real world operations. But for the most part, the discussion will remain at the theoretical level. The theory, however, is not difficult. It builds from simple macro identities to basic macroeconomics. It is designed to be accessible to those with little background in economics. Further, the primer mostly avoids criticism of the conventional approach to economics—there are many critiques already, so this primer aims instead to make a positive contribution. That helps to keep the exposition relatively short.

In this primer we will examine the macroeconomic theory that is the basis for analysing the economy as it actually exists. We begin with simple macro accounting, starting from the recognition that at the aggregate level spending equals income. We then move to a sectoral balance approach showing that the deficits of one sector must be offset by surpluses of another. We conclude by arguing that it is necessary to ensure stock-flow consistency: deficits accumulate to financial debt, surpluses accumulate to financial assets. We emphasize that all of these results apply to all nations as they follow from macroeconomic identities.

We next move to a discussion of currency regimes—ranging from fixed exchange rate systems (currency board arrangements and pegs), to managed float regimes, and finally to floating exchange rates. We can think of the possibilities as a continuum, with many developed nations toward the floating rate end of the spectrum and many developing nations toward the fixed exchange rate end.

We will examine how a government that issues its own currency spends. We first provide a general analysis that applies to all currency regimes; we then discuss the limitations placed on domestic policy as we move along the exchange rate regime continuum. It will be argued that the floating exchange rate regime provides more domestic policy space. The argument is related to the famous open economy “trilemma”—a country can choose only two of three policies: maintain an exchange rate peg, maintain an interest rate peg, and allow capital mobility. Here, however, it will be argued that a country that chooses an exchange rate target may not be able to pursue domestic policy devoted to achieving full employment with robust economic growth.

Later—-much later–we will show how the “functional finance” approach of Abba Lerner follows directly from MMT. This leads to a discussion of monetary and fiscal policy—not only what policy can do, but also what policy should do. Again, the discussion will be general because the most important goal of this Primer is to set out theory that can serve as the basis of policy formation. This Primer’s purpose is not to push any particular policy agenda. It can be used by advocates of “big government” as well as by those who favour “small government”. My own biases are well-known, but MMT itself is neutral.

As mentioned above, one major purpose of this primer is to apply the principles developed by recent research into sectoral balances and the modern money approach to the study of developing nations. The Levy Economics Institute has been at the forefront of such research, following the work of Wynne Godley and Hyman Minsky, but most of that work has focused on the situation of developed nations. Jan Kregel, in his work at UNCTAD, has used this approach in analysis of the economies of developing nations. Others at Levy have used the approach to push for implementation of job creation programs in developed and developing nations. This primer will extend these analyses, explicitly recognizing the different policy choices available to nations with alternative exchange rate regimes.

Finally, we will explore the nature of money. We will see that money cannot be a commodity, rather, it must be an IOU. Even a country that operates with a gold standard is really operating with monetary IOUs, albeit with some of those IOUs convertible on demand to a precious metal. We will show why monetary economies typically operate below capacity, with unemployed resources including labor. We will also examine the nature of credit worthiness, that is, the reason why some monetary liabilities are more acceptable than others. As my professor, the late and great Hyman Minsky used to say, “anyone can create money; the problem lies in getting it accepted”.

This series of blogs actually began as an effort to provide a basic primer on macroeconomics that can be used by home country analysts in developing nations, as an alternative to the macroeconomic textbooks that suffer from a variety of flaws. The purpose was not to critique orthodox theory but rather to make a positive contribution that maintains stock-flow consistency while also recognizing differences among alternative exchange rate regimes. Jesus Felipe at the Asian Development Bank urged me to put together a version that could be more widely circulated. At the same time, many bloggers have asked those who have written on MMT to provide a concise explication of the approach. Many professors have also asked for a textbook to use in the classroom.

This primer is designed to fulfil at least some of those requests, although a textbook for classroom use will have to wait. To keep the project manageable, I will not go deeply into operational details. That would require close analysis of specific procedures adopted in each country. This has already been done in academic papers for a few nations (as mentioned above, for the US, Australia, Canada, and Brazil, with some treatment of the cases of Mexico and China). As I am aiming for a nonspecialist audience, I am leaving those details out of the primer. What I do provide is a basic introduction to MMT that does not require a great deal of previous study of economics. I will stay free from unnecessary math or jargon. I build from what we might call “first principles” to a theory of the way money really “works”. And while it was tempting to address a wide range of policy issues and current events—especially given the global financial mess today—I will try to stay close to this mission.

I thank the MMT group that I have worked with over the past twenty years as we developed the approach together: Warren Mosler, Bill Mitchell, Jan Kregel, Stephanie Kelton, Pavlina Tcherneva, Mat Forstater, Scott Fullwiler, and Eric Tymoigne, as well as many current and former students among whom I want to recognize Joelle LeClaire, Heather Starzinsky, Daniel Conceicao, Felipe Rezende, Flavia Dantas, Yan Liang, Fadhel Kaboub, Zdravka Todorova, Shakuntala Das, Corinne Pastoret, Mike Murray, Alla Semenova and Yeva Nersisyan. Others—some of whom were initially critical of certain aspects of the approach—have also contributed to development of the theory: Charles Goodhart, Marc Lavoie, Mario Seccareccia, Michael Hudson, Alain Parguez, Rob Parenteau, Marshall Auerback, and Jamie Galbraith. Other international colleagues, including Peter Kreisler, Arturo Huerta, Claudio Sardoni, Bernard Vallegeas, and Xinhua Liu let me try out the ideas before audiences abroad. Many bloggers have helped to spread the word, including Edward Harrison, Lambert Strether, Dennis Kelleher, Rebecca Wilder, Yves Smith, Joe Firestone, Mike Norman, Tom Hickey, and the folks at New Economic Perspectives from Kansas City, Lynn Parramore at New Deal 2.0, Huffington Post, and Benzinga who posted my blogs (and above all, wearing two hats, Bill Mitchell at billyblog!). All those at CFEPs in the US and Coffee in Australia and Europe have helped to promote the ideas over the past decade. A big Thanks to all.

Enough with the preliminaries. We get started with the theory next week.

53 responses to “Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems

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