What is Modern Monetary Policy?
February 20, 2011 11:38 PM   Subscribe

Reading about the current fiscal hullaballo, the idea of "Modern Monetary Theory" keeps popping up. I get the basic gist of it but I was hoping to learn more. Will you explain Modern Monetary Theory, aka Neo-Chartalism, to me?

I was an economics major for about 15 minutes in 2007, but let's assume that I am only basically aware of what's going at the macroeconomic level. I would like for anyone who is interested to be able to look at this and understand the basic theory behind and differences between current monetary policy and modern monetary theory.
posted by daniel striped tiger to Law & Government (8 answers total) 3 users marked this as a favorite
Is the Modern Monetary Theory Wikipedia page not sufficiently enlightening?

MMT reverses the usual view that governments tax and then spend the accrued taxes, asserting that in a fiat monetary system the government creates demand for it's currency by demanding that taxes be paid in it, and then creates the fiat to spend on whatever it deems appropriate. The total amount of base money in circulation is then controlled through taxation (which eliminates money from the system) and government spending (which adds to it).
posted by pharm at 4:37 AM on February 21, 2011

Are you sure it is Modern Monetary Theory, the thing, or just monetary theory in the modern era?

If it is the specific Theory, it makes no sense because it is full of crap. It makes the mistake of trying to put a starting line and a finish line on something that did not just "start" and (we hope) does not just end. It also mistakes fiscal policy for monetary policy.

Its folly begins with this: demand for money is driven by taxes. Well, that's just ridiculous, because if you have no money you don't have to pay any taxes. At least at the federal level, there are NO taxes that I can think of that don't stem from you FIRST getting money, and then incurring taxes.

Secondly, it seems to presume that money collected in taxes is not re-spent by the government.

It is just a fancy description for a fiat currency, possibly with a little game theory thrown in. It is NOT what is happening in any economy that I know of.

Contrast with current monetary policy. Real world monetary policy means managing the number of dollars in circulation to balance against the demand for dollars. You know how fractional reserve banking works, right? I deposit $100 in the bank, and they can lend $90 of it out. I still have assets of $100, but now some other guy has $90. I have almost doubled the number of dollars that exist. And then when that guy pays back the loan, that money ceases to exist.

At the same time, productive processes are creating wealth. Factories and service industries are making profits. They are getting more money out of some economic process than they put into it. What monetary policy does is tries to balance all that stuff going on. In the latter scenario, for example, imagine if there were a fixed number of dollars "out there". As the economy tries to grow, (making those profits), it becomes harder and harder to get those profits. Not because there is no demand for the product, but because dollars are getting scarce. Customers are not spending, because their paychecks are going down, because their employers are less able to cover the bills, because nobody is spending.

So, there are different economic theories about how to control that. Your gold bug conservative types will say you shouldn't. If there isn't enough money, there are too many people. Your planned economy types will say "just raise the minimum wage and everyone will have more money". Laissez-faire does indeed work out "in the end" but in an economy that doesn't end, and has real consequences in the now, it is hard to stomach.

The truth lies in the middle. The central banks will buy and sell bonds and raise and lower interest rates to try and push and pull against the natural forces in the market place, to hopefully maintain some stability. At its most basic, they set interest rates. Not by just saying so, but by making loans and buying and selling bonds. If the rates are all too high, they will start to offer loans cheaper, until the demand for loans makes the rate drop. If rates are too low and inflation is looming, they will quit loaning out so much money.

Bonds are inverse loans. The central bank takes in dollars and hands out paper. So if there is too much money out there, they will try to vacuum up a lot of that money by offering high interest rates. It locks up cash for a while. That, of course, only works for so long. As they have to start paying those bonds back with interest, obviously more money goes out into the economy than they took in. What a central bank hopes is that it slowed down the economy enough to make it worth it.

That's the hazard of monetary policy. When they are wrong, they are REALLY wrong. When they are right, nobody notices.
posted by gjc at 7:00 AM on February 21, 2011 [2 favorites]

The reason it feels like you must not be understanding it is because it's so illogical, as gjc so well explains. There isn't any extra part you're not getting--it's an entire theory based on a completely false premise.
posted by Sidhedevil at 10:33 AM on February 21, 2011

gjc: anyone who owns property usually has to pay taxes, whether they earn income from it or not.

I don't think that MMT is entirely specious as the previous two answerers do. As gjc points out, you can't have a proper monetary theory in the modern world that doesn't take account of credit flows though.
posted by pharm at 1:19 AM on February 22, 2011

My understanding is that MMT abandons the principle that money is merely a representation of labor or scarce goods, and instead suggests that the government can directly control the real economy through fiscal policy (taxing and spending).

Many mainstream economists agree with a little bit of this line of thinking -- a very common perception is that the continuing unemployment after the recession ended is partly due to a relatively tight money supply, and since interest rates are already almost zero the government needs to spend a little more to remedy the situation.

But MMT people would say the government has unlimited control over the real economy by manipulating nominal prices, i.e. the government could declare full employment by fiat without raising taxes. The view grew out of leftist/socialist economics in the 60s, and doesn't have a lot of quantitative evidence.

MMT is not well regarded, or even well known, among mainstream economists.
posted by miyabo at 5:18 PM on February 22, 2011

GJC: demand for money is created by taxes denominated in same, yes. Of course the government has to create the money into existence.

Pharm: MMT does take credit flows into account, since if you look at the accounting identity that forms the basis for understanding, you can see that it looks at _net_ adds to the financial system. So, credit really isn't a net add of money since it is balanced out (literally) by a debt. It has to be. If I borrow $100 from a bank, yes it adds $100 the money supply, but there is now a debt of $100+ interest that I owe. Only the sovereign government currency issuer can make net increases that aren't balanced by debt, since the sovereign doesn't have to issue debt.

MMT is a description of the operational realities of a money supply. If you want to see this simulated, just look at an MMORPG like World of Warcraft. Blizzard's WoW gold isn't backed by real gold, or a currency peg to a "hard currency." Demand is driven by the game, since you have to pay NPCs for stuff to level up. That is the equivalent of a "tax" since the NPCs are controlled by Blizzard and money leaves the player side balance sheets when paid to an NPC. Blizzard doesn't have to "tax" to get WoW gold to "spend" in game by distributing to successful monster killers. That tax is just a drain for WoW gold, and the monsters are a faucet. Blizzard used to have horrible inflation problems, but over time the game managers/devs have learned how to manage the flow of currency through things like a wealth cap (effectively a top rate of 100% marginal wealth tax), very expensive ingame goods purchased from NPCs (a flat tax) and a ban on currency trading of WoW Gold >>dollars (currency controls).

Miyabo: not being well regarded by mainstream economists is a feature, not a bug. Why should I take seriously a profession that has taken the modern economy off a cliff, primarily by being shills for a few oligarchs? See Yves Smith's book, Econned for more on this.
posted by wuwei at 12:06 AM on March 2, 2011 [1 favorite]

I think any argument that every credit has a matching debt & therefore the two balance out is too simplistic when you have a fractional reserve banking system where new credit can be created without being backed by anything except the future flow of payments from another debt. Credit is money & credit money dominates base money in our financial system many times over.
posted by pharm at 1:50 AM on March 2, 2011

I only learned what MMT was because wuwei mentioned it in a previous thread, and I was curious. It's clear to me too that classical econ has been coopted to support a preexisting power structure. But that doesn't mean there isn't some underlying truth: that people make rational decisions, and that money is an easier way to arrive at these decisions but doesn't affect long run supply and demand. MMT only makes sense if you make a completely divergent case that people respond to changes in nominal prices. I'm not saying it's wrong, just that it works under a fundamentally different set of assumptions than classical econ.
posted by miyabo at 6:30 AM on March 2, 2011

« Older What suspenseful music can I find?   |   plumbing misadventurs Newer »
This thread is closed to new comments.