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Modern Monetary Theory (MMT): How Fiat Money Works

David_N

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This is something everyone should read to understand how things actually work.
Modern Monetary Theory (MMT): How Fiat Money Works - The Daily Reckoning
Warren Mosler tells a good story that shows how our economy works at its most basic level.

Imagine parents create coupons they use to pay their kids for doing chores around the house. They “tax” the kids 10 coupons per week. If the kids don’t have 10 coupons, the parents punish them. “This closely replicates taxation in the real economy, where we have to pay our taxes or face penalties,” Mosler writes.

So now our household has its own currency. This is much like the U.S. government, which issues dollars, a fiat currency. (Meaning Uncle Sam doesn’t have to give you something else for it. Say, like a certain weight in gold.) If you think through this simple analogy, all kinds of interesting insights emerge.

For example, do the parents have to get coupons from their kids before they can pay them to do any chores? Obviously not. In fact, the parents have to spend their coupons first by paying their children to do chores before they can collect the tax. “How else can the children get the coupons they owe to the parents?” Mosler writes.

“Likewise,” he continues, “in the real economy, the federal government, just like this household with its own coupons, doesn’t have to get the dollars it spends from taxing or borrowing or anywhere else to be able to spend them.”

The government creates dollars. It doesn’t even have to print them. The vast majority of spending is simply done by adding electronic dollars to bank accounts. Therefore, the U.S. government can’t go bankrupt. It pays all its bills in U.S. dollars, of which it is the sole issuer.

This sounds really obvious, but it is amazing how many people — even very smart people — forget this simple fact. They get hysterical about the fiscal deficit or the national debt. (This is not to say there aren’t bad consequences from issuing too many coupons, or from government spending in general.) The only way the U.S. government can default is if it chooses to do so.

How can the kids “save” coupons in excess of the weekly tax? Well, they can only do that if the parents spend more than they tax. There is no other way to hoard coupons. In the real economy, the same is true. The private sector can save dollars only if the government spends more than it taxes. Spending pours fiat money into an economy; tax payments drain it away.

Another question: Do the parents have fewer coupons if they spend more than they tax? No. The parents make the coupons. They don’t even need physical coupons. They can simply track them on a piece of paper or in a spreadsheet. Likewise, the U.S. government doesn’t have any fewer dollars after running deficits. It can’t run out. (There are real-world restraints on how much government spends.) To borrow from another Mosler analogy, the U.S. government can no more run out of dollars than a scorekeeper can run out of points.

Here is what needs to be understood:
On one level, MMT is simply a description of how a fiat currency system works. On another level, there are policy prescriptions that flow from this understanding. My only advice on the latter is this: Don’t let your politics deter you from making sense of MMT. (MMT itself is politically agnostic.)

I’d recommend both of Mosler’s books. Start with The 7 Deadly Innocent Frauds of Economic Policy. It’s a short book, just over 100 pages and written in plain English. Mosler has a gift for making complex things simpler. If you try to think through the issues in an honest way, you’ll come away with some “Ah-a!” moments.

Then you can move on to Soft Currency Economics. Believe me, these books will challenge your long-held views on money. (Always a good thing, in my mind. What’s the point of only reading things you know you’ll agree with? Challenge yourself… or ossify.) If you want more, pick up Randall Wray’s primer Modern Money Theory.

One great story Mosler tells in both books is how he cleaned up on another free lunch in lira-denominated bonds in the early ’90s. This was before the euro and back when there was worry over a default by Italy’s government. Italy’s national debt was 110% of GDP and interest rates were high on its bonds.

But Mosler knew that it was the sole issuer of lira. Italy could not default unless it wanted to. Mosler actually met with senior officials in Rome to let them in on the “secret.” Long story short, Italy didn’t default. Mosler’s fund made over $100 million.
 

David_N

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Here's another great read by the same author: Why a Central Bank Can Never Run Out of Money - The Daily Reckoning
“We can’t run out of money,” economist L. Randall Wray said. The U.S. government spends through keystrokes that credit bank accounts, he continued. The money comes from nowhere. The government doesn’t need to finance itself with taxes. And it doesn’t borrow its own currency. It can afford all that is for sale in dollars.

Despite laying out an incontrovertible set of facts, Wray’s audience often is aghast. He says he gets four reactions when he tells people about how the government spends:

Incredulity: “That’s crazy!”
Fear: “Zimbabwe! Weimar!”
Moral indignation: “You’d destroy our economy!”
Anger: “You’re a dirty pinko commie fascist!”
 

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celticwar17

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:roll: Alright so we should just then have the government give everyone 1 million dollars!!!!! And we'll all be Millionaires!!! We should also buy a death star, free college tuition for life, and instead of paying to go to college WE ACTUALLY get PAID to attend college! The government should also pay for everyone to have a mansion !!! Because it can just print money! We can have money coming from nowhere with no consequences!!!:roll:
 

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I read up on the newer stuff on MMT and it is unconvincing. But maybe you can tell me the assumptions in the models that allow infinite money to do no harm.

Which stuff are you talking about? Links please.
What models?
 

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I'm sorry, I do not buy it.

MMT still has too much warranted criticism to be accepted as "policy prescriptions" from a "description of how a fiat currency system works." There is still a function of investment in a nation's currency that subscribers of MMT tend to diminish and assume it has no consequence.
 

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:roll: Alright so we should just then have the government give everyone 1 million dollars!!!!! And we'll all be Millionaires!!! We should also buy a death star, free college tuition for life, and instead of paying to go to college WE ACTUALLY get PAID to attend college! The government should also pay for everyone to have a mansion !!! Because it can just print money! We can have money coming from nowhere with no consequences!!!:roll:

Who is saying we should give everyone a million dollars?
 

David_N

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I'm sorry, I do not buy it.

MMT still has too much warranted criticism to be accepted as "policy prescriptions" from a "description of how a fiat currency system works." There is still a function of investment in a nation's currency that subscribers of MMT tend to diminish and assume it has no consequence.


What criticism do you refer to? There are criticisms of policy implications, sure, but the descriptions put forth by MMT are the way things actually work. What do we diminish?
 

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What criticism do you refer to? There are criticisms of policy implications, sure, but the descriptions put forth by MMT are the way things actually work. What do we diminish?

I said clearly what MMT diminishes.

MMT reduces the role of investment in a nation's currency, perhaps said a better way MMT does not place any weight on investment (via bonds) to a nation's monetary policy.

While there may be a literal truth that a government with its own currency and in total control over their own monetary policy cannot go bankrupt, what a government can do is destroy the valuation of that currency if fiscal credibility is lost from poor decisions. MMT cannot get around this, no matter how much MMT tries to reduce the impact of fiscal credibility by a government in charge of their own currency.
 

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I said clearly what MMT diminishes.

MMT reduces the role of investment in a nation's currency, perhaps said a better way MMT does not place any weight on investment (via bonds) to a nation's monetary policy.

While there may be a literal truth that a government with its own currency and in total control over their own monetary policy cannot go bankrupt, what a government can do is destroy the valuation of that currency if fiscal credibility is lost. MMT cannot get around this, no matter how much MMT tries to reduce the impact of fiscal credibility by a government in charge of their own currency.

Huh? I'm not following you here. MMT advocates talk about bonds and their role in relation to draining reserves/as a way for the private sector to save all of the time. MMT also talks about how a government should never allow demand pull inflation to occur. (Caused by demand exceeding supply.)
 

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Who said money creation was without consequence? If we cause demand to exceed supply, we will get inflation.
Is your plan to spend until you get inflation?
 

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Huh? I'm not following you here. MMT advocates talk about bonds and their role in relation to draining reserves/as a way for the private sector to save all of the time. MMT also talks about how a government should never allow demand pull inflation to occur. (Caused by demand exceeding supply.)

That does not address how investment in a nation's currency can be influenced by economic and monetary policy. What it really does is undervalue the risk of policy recommendations on the false assumption that the markets will tolerate anything MMT suggests is monetarily sound irregardless of deficits or Total debt as it relates to GDP. Demand exceeding supply is another oversimplification.
 

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Is your plan to spend until you get inflation?

We already have inflation today, the question is where we are in relation to the target. Something else MMT tends to oversimplify.
 

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That does not address how investment in a nation's currency can be influenced by economic and monetary policy. What it really does is undervalue the risk of policy recommendations on the false assumption that the markets will tolerate anything MMT suggests is monetarily sound irregardless of deficits or Total debt as it relates to GDP. Demand exceeding supply is another oversimplification.

What makes you think MMT ignores any of that?
 

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What makes you think MMT ignores any of that?

Just what I can find on the subject, tells me that Krugman's initial criticism of MMT was probably worthy of note even if he has somewhat backed off of that criticism recently.

There is too much discussion we need to have on this as it relates to macro economic behavior to simply turn everything over exclusively to the boundaries of MMT principles on some arrogant assumption that all MMT criticism is completely wrong and all MMT "policy prescriptions" are spot on. That is only made worse by the reality of economics once it becomes politicized.

Taking that attitude will end up alienating too much of the field of academia that you are going to have to sell MMT to, no matter if you like that fact or not.
 

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Just what I can find on the subject, tells me that Krugman's initial criticism of MMT was probably worthy of note even if he has somewhat backed off of that criticism recently.

There is too much discussion we need to have on this as it relates to macro economic behavior to simply turn everything over exclusively to the boundaries of MMT principles on some arrogant assumption that all MMT criticism is completely wrong and all MMT "policy prescriptions" are spot on. That is only made worse by the reality of economics once it becomes politicized.

Taking that attitude will end up alienating too much of the field of academia that you are going to have to sell MMT to, no matter if you like that fact or not.
Krugmans criticism has been viciously commented on, and even he has backed off. There are a lot of misconceptions about what MMT advocates believe and want, which leads to the "ZIMBABWE, WEIMAR!" Nonsense that is spread like wildfire whenever a discussion appears. Well, the way the system works tends to be ignored when it comes to macroeconomics, we have textbooks that teach gold standard concepts, etc.. And do economists understand fed operations? Not many, I'd venture to say. Who says all criticism is wrong? The criticism is aimed at exaggerations. You can disagree with the policy prescriptions, that's expected.
 

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Krugmans criticism has been viciously commented on, and even he has backed off. There are a lot of misconceptions about what MMT advocates believe and want, which leads to the "ZIMBABWE, WEIMAR!" Nonsense that is spread like wildfire whenever a discussion appears. Well, the way the system works tends to be ignored when it comes to macroeconomics, we have textbooks that teach gold standard concepts, etc.. And do economists understand fed operations? Not many, I'd venture to say. Who says all criticism is wrong? The criticism is aimed at exaggerations. You can disagree with the policy prescriptions, that's expected.

Don't lump me in with the "ZIMBABWE, WEIMAR" because you do not like my criticism of MMT. Then you would be making the same everyone vs. us mentality mistake as those that run around saying "99% of economist debunk MMT."

I made no exaggerations of MMT, I made specific points of concern that have been made by others. Krugman backing off comments has *not* been followed up with "MMT is complete right, and I was completely wrong about MMT." He says that and I'll reconsider.
 

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Don't lump me in with the "ZIMBABWE, WEIMAR" because you do not like my criticism of MMT. Then you would be making the same everyone vs. us mentality mistake as those that run around saying "99% of economist debunk MMT."

I made no exaggerations of MMT, I made specific points of concern that have been made by others. Krugman backing off comments has *not* been followed up with "MMT is complete right, and I was completely wrong about MMT." He says that and I'll reconsider.

I wasn't lumping you in with them, I apologize if that's what you got from my post. No one says MMT advocates policy ideas are correct, that's where the debate lies. But we shouldn't even be debating the fact that a deficit adds dollars to the private sector, a surplus drains them, etc, etc...Of course krugman won't say that, that's essentially suicide.
 

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We already have inflation today, the question is where we are in relation to the target. Something else MMT tends to oversimplify.

More of the problem I'm wondering is that when rapid inflation actually starts, it's very hard to stop. Whether or not there is currently inflation is not a good way to measure how much you should be spending.
 

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More of the problem I'm wondering is that when rapid inflation actually starts, it's very hard to stop. Whether or not there is currently inflation is not a good way to measure how much you should be spending.

For rapid inflation, or hyperinflation, to occur we would have to see some massive underline economic fault probably causing a real depression.

But to trigger it would probably be a matter of fiscal policy and economic policy where there is quick caused massive imbalance between the money supply and GDP direction on a trend line. The model of inflation caused by financing deficits with created money absent necessary taxation and bond investment. Say, when government spending (G) is sharply upward with no end in sight but entirely with printed money... but consumer spending (C) and investment (I) and perhaps even Net Imports (Ex - Im) as well is all headed sharply downward. Confidence in the reasons and the methods for (G) going up so sharply become the issue.

Usually we are talking about things like the after effects of a nation losing a long term war or some massive social unrest causing economic turmoil, something that is outside of the normal economic cycle where the nation's overall growth trend line heads downward and continues on that path for a noticeable time frame. Something that renders monetary policy and economic policy as completely ineffective, as once confidence is lost bad results are soon to follow.

MMT is not suggesting anything contradictory to that really, it is just take on the function of modern Fiat Money systems and policy suggestions because of those theories.

But inflation in a normal economic context including MMT (that 1.5% to 2.5% range or a steady rate of inflation) shows economic activity and growth that is responding to well to ongoing economic and monetary policy from our mixed economic model. This is mainly observed by low inflation tends to actually encourage the purchase of goods and services on a sustained path, ideally relative to a steady rate of overall payroll increases across the income quintiles. This is also observed by low but steady inflation tends to make borrowing money for both consumer debt markets (homes and cars) and business risk markets (entrepreneurship and business expansion) more appealing. Steady low inflation can support reasonable rates on borrowing. The benefits of a controlled low inflation rate are numerous for a growing economy.

Our problem, for the purpose of MMT, is the understatement of the risk of monetary policy decisions. MMT suggests inflation is mostly tied to resources conditions, and not as much about monetary policy. We know, since even our Fiat Money system has investment, that is not quite accurate. MMT does stipulate that confidence does matter on acceptance of monetary policy, but I contend so does *investment confidence* in a nation's monetary and economic policy.
 
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