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

by L. Randall Wray

“modern money theory” (MMT).

there are many critiques already, so this Primer aims instead to make a positive contribution. That helps to keep the exposition relatively short.

My own progressive biases are well-known, but MMT itself is neutral.

We will see that logically money cannot be a commodity – like gold; 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.

The word “money” will refer to a general, representative unit of account.

Net financial assets

net wealth (or net worth)

(Government Y – E) + (Private Y – E) + (Foreign Y – E) = 0.

Either way the balance is measured, it sums to zero in the aggregate.

“state money system”.

money of account,

The sovereign government cannot become insolvent in its own currency; it can always make all payments as they come due in its own currency.

Indeed, if government spends and lends currency into existence, it clearly does not need tax revenue before it can spend.

Again, all of this was obvious 200 years ago when kings literally stamped coins in order to spend and then received their own coins in tax payment.

It is harder to see that now because modern governments have their own banks – central banks – that make and receive payments for them. These payments are mostly electronic. Hence, modern governments do not normally make payments using coins or paper notes and do not collect taxes paid using coins or notes. Instead, they instruct their central banks to make payments for them by crediting bank accounts; tax payments lead central banks to debit bank accounts.

It seems to make sense to argue that governments need “revenue” from household tax payments before they can spend. In fact, the reality is precisely the opposite: households need the government to spend before they can pay taxes!

Another shocking realization is that a sovereign government does not need to “borrow” its 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 as something quite different from borrowing.

reserve deposits (bank “checking accounts”) at the central bank.

MMT recognizes that sovereign government bond sales are functionally equivalent to monetary policy operations.

You don’t need to understand all of that to get the main point: sovereign governments don’t need to borrow their own currency in order to spend! They offer interest-paying treasury securities as an instrument on which banks, firms, households, and foreigners can earn interest. This is a policy choice, not a necessity.

It provides currency and reserves either by spending them (fiscal policy) or lending them (monetary policy).

Banks had to create the notes before debtors could pay down debts using banknotes. Today banks create deposits when they lend, and loans are repaid using those bank deposits.

MMT says that the main purpose of the tax system is to “drive” the currency.

From this perspective, the true purpose of taxes is not to provide “money revenue” that government can spend. Rather, taxes create a demand for the government’s own currency so that the government can spend (or lend) the currency.

While there is a symmetry between government currency issue and private bank issue of notes or deposit, there are also differences.

Government imposes a tax obligation, while private banks rely on customers voluntarily deciding to become borrowers.

Sovereign power is (mostly) reserved to the state. This makes its own obligations – currency and reserves – almost universally acceptable within its jurisdiction.

Indeed, banks and others normally make their own obligations convertible into the state’s obligations.

A lot of people have great difficulty in getting their heads around this “money creation” business. It sounds like alchemy or even fraud. Banks simply create deposits when they make loans? Government simply creates currency or central bank reserves when it spends (or lends)? What is this, creation of money out of thin air?

Hyman Minsky said “Anyone can create money”, but “the problem lies in getting it accepted”.

Still, both Uncle Sam and Citibank are constrained in their “money creation”. Uncle Sam is subject to the budget authority that is provided by Congress and the President.

Citibank is subjected to capital constraints and limits on the types of loans it can make (and types of other assets it can hold). Yes, we freed the banks from most regulations and supervision over the past couple of decades – to our regret.

Government spending for the public purpose is beneficial, at least up to the point of full employment of the nation’s resources.

We’ve had far too much private “money creation” fueling run-away financial markets and far too little government “money creation” to serve the public purpose.

We do need fundamental reform – including downsizing of the behemoth banks, greater oversight, more transparency, prosecution of financial fraud, and putting more of the “public” in our “public-private partnership” banking institutions.

The most “unsound” budgetary policy is mindless pursuit of something called a “balanced budget” – meaning one in which tax “revenues” exactly match government spending over a stated period (usually a year).

As MMT teaches, the government’s debt (including currency, bank reserves, and treasury bonds) is the nongovernment’s financial wealth.

Government deficits

A government or corporate bond is a household asset but represents a liability of the issuer (either the government or the corporation).

The household has some liabilities, too, including student loans, a home mortgage, or a car loan. These are held as assets by the creditor,

net financial wealth.

In order for the private sector to accumulate net financial wealth, it must be in the form of “outside wealth”, that is, financial claims on another sector.

Once we subtract all financial liabilities from total assets (real and financial) we are left with nonfinancial (real) assets, or aggregate net worth.

these financial assets are government liabilities – government currency and government bonds.

This deficit accumulates to a stock of government debt – equal to the private sector’s accumulation of financial wealth over the same period.

We can formulate a resulting “dilemma”: in our two-sector model it is impossible for both the public sector and the private sector to run surpluses.

Another useful division is to form three sectors: a domestic private sector, a domestic public sector, and a “rest of the world” (ROW) sector that consists of foreign governments, firms, and households.

Finally, and more realistically, the domestic private sector can accumulate net financial wealth consisting of both domestic government liabilities as well as ROW liabilities.

net financial assets – or outside wealth