An Introduction to Modern Money Theory

Modern Money Theory (MMT) provides a description of the way money actually works in our modern world. Money is a scary topic. It is also rather complex. So bear with me.

We will begin with a discussion of what we might call the "nature" of money - what is this thing we call money? When we use the term, most people will think of a shiny coin or a paper "note" or "bill" - something they can get their hands on to buy something they want. But today the vast majority of payments do not involve use of coins or notes.

Some will also think of an idealized past, when money was "backed up" by "hard" gold or silver, giving it a "real" value. They bemoan our modern money that appears to have no real or permanent value - what many call a "fiat currency." Some even heed the call of the Ron Pauls of the world to bring back the gold standard.

And since the global economy nearly collapsed in the late "aughts" of the beginning of the twenty-first century, many - rightly - think there is something wrong with money. They want to reform our monetary system.

But if we are going to reform it, we really need to understand it.

This book will help you to understand both our private money and our government money: what money really is, where it comes from, and how it works. Along the way, we'll see how this alternative perspective sheds light on reform - how we could change the monetary system to make it work better for us. This requires sweeping away mountains of misunderstanding about money.

A. MMT's Shocking Conclusions

MMT reaches conclusions that are shocking to many who've been taught the conventional wisdom. Most importantly, it challenges the orthodox views about government finance, monetary policy, the so-called inflation-unemployment trade-off, the wisdom of fixed exchange rates, and the folly of striving for current account surpluses. (If you don't know about any of those things, don't worry - indeed that might make it easier to follow what comes!)

For most people, the greatest challenge is MMT's claim that a sovereign government's finances are nothing like those of households and firms. While we hear all the time the statement that "if I ran my household budget the way that the federal government runs its budget, I'd go broke," followed by the claim "therefore, we need to get the government deficit under control," MMT argues this is a false analogy.

Of course, households and firms can and do become insolvent when they issue too much debt. But a sovereign, currency-issuing government is nothing like a currency-using household or firm. The sovereign government cannot become insolvent in its own currency; it can always make all payments as they come due in its own currency.

Governments spend first, then tax. That means tax revenue is not needed for spending. That does not mean taxes are unimportant - they serve other useful purposes. But the national government does not need to receive its own currency before it can spend - indeed, it cannot receive currency until after it spends.

Another conclusion is that a sovereign government does not need to "borrow" its own currency in order to spend. Indeed, it cannot borrow currency that it has not already spent!

This is why MMT sees the sale of government bonds by the sovereign as something quite different from borrowing: bond sales are part of monetary policy and help the central bank to manage interest rates. Governments don't need to borrow their own currency! As we will explain, governments spend their currency first and then receive it back in tax payment.

We'll revisit this argument later. What is important for now is MMT's recognition that government's spending is never constrained by taxes or by "bond market vigilantes" who might refuse to lend. To put it as simply as possible, governments today spend by "keystrokes" that they cannot ever run out of.

It surprises most people to hear that banks operate in a similar manner. They lend their own deposits into existence and accept them in payments on loans they hold. Strange, but true!

A century ago, a bank would issue its own bank notes when it made a loan. The debtor would repay loans by redeeming bank notes. Obviously, banks had to create the notes before debtors could pay down debts using the bank notes.

However, banks gradually got out of the business of issuing notes and instead turned to deposit banking. In the US today, only the Federal Reserve Bank (the government's bank) issues notes - our green paper currency. Private banks only issue deposits.

Banks now create deposits (not notes) when they make loans; debtors repay those loans using bank deposits (and the deposits of any US bank can be used to pay down loans at any other US bank). Almost all bank loans are repaid this way - by debiting bank deposits. And what this means is that banks need to create the deposits first before borrowers can repay their loans.

Hence, there is a symmetry: the sovereign spends currency (or central bank reserves - explained later) into existence first, and then taxpayers use the currency (or central bank reserves) to pay taxes; and banks lend their deposits into existence, then the bank's debtors use bank deposits to pay down loans.

The money is always created "out of thin air" - when the government spends or the banks lend. There's no theoretical limit to the government's ability to create its money (currency and reserves) and no limit to banks' ability to create bank money (deposits). You may find that shocking, and maybe even scary. This book will explain how money creation works and how we can use that knowledge to improve the functioning of our economy.

We will argue that the true constraints we face are real resource constraints and the limits of our knowledge. If we know how to do something, and we have the real resources (labor, natural resources, and productive capacity) required, we can find a way to afford to do it. If we have unemployed resources (most importantly labor), we can find a way to pay that labor to work. If we have idle plant and equipment, we can find the finances to put it to work, too. Importantly, if we have the resources and technology required to save the planet from climate catastrophe, we can financially afford to do it.

This does not mean government faces no constraints - it faces political constraints as well as real resource constraints. Even if politicians did not worry about "where will the money come from," they do care what money is spent on - that is, they have preferences regarding what the government should do. Further, policy often would lead to competition between the government and the private sector over use of resources. Even if there are a lot of unemployed workers and machines, it can be difficult to ensure that a new policy would not also demand resources that are already in use. In that case, the government would bid against private use of those resources. In other words, there could be a real trade-off: less private use and more public use. Since government doesn't face a financial constraint similar to that faced by the private sector (and the private sector needs to make a profit, the government doesn't), the government can win a bidding war. Not only does the government end up with the resources, the bidding war causes prices to rise. The result could be inflation.

Still, the usual situation (outside major wars) is that there are unemployed resources that could be mobilized for public programs. And if the government can surmount the political constraints, it can always afford to mobilize the unemployed resources in the public interest. Money is not the problem.

Ultimately, this should be comforting, not scary. Understanding how money really works lets us focus on the real barriers - politics, real resources, technical know-how, and inflation. In coming years we face a number of challenges - one might even claim we face existential threats perhaps greater than humans have had to deal with since they first came out of Africa. Survival of anything like organized human civilization may be in question. But the scientists claim that we have most of the know-how to tackle the challenges. MMT claims that we have the financial ability - we can finance what it takes to rise to the challenge. If we can clear away the misunderstandings, align the politics, and mobilize the resources, we can win.

We hope that this book will motivate you to pressure those with the power to take action to do what is necessary to make the world a safer and better place for humanity.

B. Themes to Be Covered

This book will provide an overview of several themes that are important to Modern Money Theory:

• What is the nature of money?
• How does private money get into the economy?
• How does the government's own money get into the economy?
• How does the government really spend?
• Can a government be forced into bankruptcy by the weight of its own debt?
• What are the true constraints we face?
• What are the trade-offs?
• Is it true that economics is a zero-sum game?
• What role does money creation play in creating financial...