Book Summary - Modern Monetary Theory by L. Randall Wray

Introduction: The Basics of Modern Money Theory (MMT)

MMT derives its theoretical foundations from the works of John Maynard Keynes, Karl Marx, A. Mitchell Innes, Georg F. Knapp, Abba Lerner, Hyman Minsky, Wynne Godley, and many others. 

As per the author, the most important original contribution of MMT has been the detailed study of the coordination of operations between the treasury and the central bank. It helps to answers the questions about how does the government "really spends".

MMT assumes the existence of the State Money System, in which the state chooses the money of account. This is then used to impose obligations eg. taxes, denominated in that money unit. The state also issues currency which can then be accepted to discharge the obligations.  

The government brings currency into existence by spending, which becomes an income for the households. The households then use this currency to make the payment of their obligations to the state. Thus, the government does not need revenues/taxes in the first place to spend. It can spend first which brings new money into existence, which then can we used to make tax payments. Additionally, a government which issues its own currency can never default in the payment of its obligations, as it can always issue new currency to repay the debts which had been contracted before.

Hyman Minsky said “Anyone can create money”, but “the problem lies in getting it accepted”.  Thus, as per MMT the main purpose of the tax system is to "drive" the currency. The utility of the state money is that it can be used by citizens to discharge or pay taxes. Hence, it is one of the reason why the citizens will use state money in transactions. Taxes and other obligations create the demand for state money. So the primary purpose of tax is not to provide revenue but to create demand for state money so that the government can spend or lend the currency.

Government budgets are not the same as household budgets because the government can create money to finance the spending where as the households first need to earn money in order to spend it. While households need to produce valuable goods or services which they can exchange to acquire money in the first place, there is no such obligation on the government. It can create money out of thin air and  spend it first to earn/tax it later. 

According to the author, the problem is not the "thin air" nature of money creation by government, but how much quantity of money is created and the purpose for which it is spent. Government spending is beneficial at least up to the point the economy reaches full employment. 

 Money can created both by governments and private entities like banks and financial institutions. Author thinks that, the solution to current economic and financial problems is not austerity but public spending. There is far too much private "money creation" which is fueling run-away financial markets and far too little government "money creation" to serve the public purpose.

Pursuing a policy of balanced budget is unsound because whatever currency the government supplies through spending will have been "returned" in tax payments, so the household sector has nothing left. If a government runs a balance budget then there would be no net contribution to the financial wealth of the nation. According to the author it is hard to see why anyone would advocate such a crazy goal. 

MMT teaches that the government's debt is non-government's financial wealth. Government deficits equal non government's surplus, generating income that can be saved. These savings is in safest form - claims of sovereign government which cannot default on debts denominated in its own currency.

MMT concludes that budget deficits, monetary policy, inflation-unemployment trade off, fixed exchange rates, monetary unions and current account deficits which traditionally put limits on government spending do not actually matter. 

My thoughts after reading the chapter.

If I were a politician reading this chapter, it would seem to me that MMT does look like a Panacea to all the problems that any government in the world is currently facing. 

The assumption of the state money system is acceptable as currently this is how most countries work. The government decides by passing a law as to what is a legal tender.

I find the argument that governments do not need to tax first to spend but it is actually the other way round, difficult to digest. I think it is only half true and it actually works both ways. Government spending is revenue for household and household tax payment is revenue for government, which can again be spent by governments on households. It’s a zero-sum game.

Also, I find it highly unfair and immoral that while individual citizens have to make valuable contribution to society in order to gain purchasing power, the government is allowed to get a free lunch. That it can spend in first place without contributing anything valuable to the society. That it can gain purchasing power by debasing and printing new money out of thin air at the expense of ordinary citizens. Citizens are vexed twice, first in form of taxation of their income and then again by erosion of their purchasing power.  

It is also not very difficult to accept the argument that the government cannot default on the debt which is denominated in it own currency. While this debt is safe from default risk that does not automatically make is free from inflation risk, which would be the biggest concern for any creditor in a world where there are no limits on government deficits and thus government spending. 

It would be interesting to see how full employment is defined and calculated later in the book. Based on my current understanding full employment is largely a theoretical concept and actually very difficult calculate in practice. From the current reading it seems that the level of full employment is like a fixed target where as to my understating it is more like a moving goal post which may be difficult to hit precisely.

 

I really do not understand the argument about how government "money creation" will serve public purpose. Yes, private "money creation" did fuel run-away financial markets. Is the plan then to use government "money creation" to fuel run-away inflation to serve the public purpose?

My head hurts after reading the argument that balanced budget is a crazy idea and why would anyone advocate it. Currently, I feel the same about MMT. Nevertheless, I hope to learn more about why balanced budget is such a crazy idea in the subsequent chapters.

I also look forward to understanding why budget deficits, monetary policy, inflation-unemployment trade off, fixed exchange rates, monetary unions and current account deficits do not actually matter. 

Stay tuned for subsequent chapters. Please let me know in the comments section about your thoughts on this chapter. Please subscribe to my blog to get notified when I finish writing the summary of next chapter. 

Until next time,

Nirav Gala.