MODERN MONETARY THEORY: A CRITIQUE.

• Author: Coats, Warren

Modern monetary theory (MMT) claims that government can spend more freely by borrowing or printing money than is assumed by conventional monetary theory. According to Mackintosh (2019):

The most provocative claim of the theory is that government deficits don't matter in themselves for countries--such as the U.S.--that borrow in their own currencies The core tenets of MMT, and the closest it gets to a theory, are that the economy and inflation should be managed through fiscal policy, not monetary policy, and that government should put the unemployed to work. MMT has become popular with Green New Dealers because it claims to remove or at least loosen traditional constraints on government spending.

Although MMT makes much of its preferred way of looking at the process of producing money, it does not credibly reveal more scope for deficit spending without inflation. Its proposal to use taxation as a monetary policy instrument ignores decades of efforts to separate monetary policy decisions from fiscal/spending decisions in light of the differences in the political motivations of each. In fact, despite its efforts to change how we view monetary and fiscal policies, MMT abandons market-based countercyclical monetary and fiscal policies for targeted central control over the allocation of resources. It would rely on specific interventions to address "road blocks" upon the foundation of a government-guaranteed employment program.

MMT is an unsuccessful and empty attempt to convince us that we can finance the Green New Deal and a federal job guarantee program painlessly by printing money. But it remains true that shifting our limited resources from the private to the public sector should be judged by whether society is made better off by such shifts (Coats 2008). Printing money does not produce free lunches.

This article reviews MMT's approach to describing the process by which money is produced by banks (broad money) and by the central bank (base money). It analyzes whether MMT's characterization of the process reveals new, previously overlooked opportunities for the government to spend more without taxing more. It dissects MMT's claim that because it can borrow in its own currency it can spend more--by printing more money--without crowding out private sector activity. It concludes by analyzing MMT's claim that monetary policy should be shifted from the central bank to the fiscal tax authorities.

How Is Money Produced Today?

MMT motivates its case for monetary finance and the use of taxation to regulate the money supply by explaining the money supply process with a different emphasis than is usual. The traditional story for the fractional reserve banking world we live in is that a central bank issues base or high-powered money (currency held by the public plus bank reserves held at the central bank), and banks produce more money on top of that. The public deposits some of the central bank's currency in banks, which provides banks with money they can lend. When a bank lends such deposits, it deposits the loan in the borrower's deposit account with her bank, thus creating more money for the bank to lend. This famous money-multiplier story, a favorite in Money and Banking classes, reflects a money supply much larger than the base money issued by the central bank. In July 2008, base money (M0) in the United States was $847 billion dollars while the currency component of that plus the public's demand deposits in banks (M1) was almost twice that--$1,442 billion dollars. Including the public's time and savings deposits and checkable money market mutual funds (M2) the amount was $7,730 billion. I am reporting data from just before the financial crisis in 2008 because after that the Federal Reserve began to pay interest on bank reserve deposits at the Fed in order to encourage them to keep the funds at the Fed rather than lending them and thus multiplying deposits. This policy greatly decreased the ratio of total money to base money--that is, it reduced the money multiplier. In October 2015, at the peak of base money, M0 was $4,060 billion, of which only $1,322 billion was currency in circulation, and M1 was $3,018 billion!

In Where Does Money Come From? (Ryan-Collins et al. 2012), the authors argue that banks create deposits by lending rather than having to receive deposits before they can lend. However, this wellknown aspect of the bank money supply process is only part of the story. While a bank loan (an asset of the bank) is extended by crediting the borrower's deposit account with the bank (a liability of the bank), the newly created deposit will almost immediately be withdrawn to pay for whatever it was borrowed for. Thus, the willingness of banks to lend in the first place must depend on their expectations of being able to finance their loans (from existing or new deposits, by borrowing in the interbank or money markets, or by the repayment of previous loans) at an interest rate less than the rate on their loans.

The money multiplier version of this story assumes a reserve constraint--namely, that the central bank fixes the supply of base money. The MMT version highlights the fact that monetary policy these days targets interest rates at which the central bank lends leaving the supply of base money to be determined by the market. The central bank sets a policy interest rate as the instrument by which it influences the amount of credit banks wish to supply. In order to maintain its target interest rate, the central bank lends or otherwise supplies to the market whatever amount of base money is needed to cover private bank funding needs at that rate (Davies 2004). As a result of the lags in the effects of monetary policy, the rate is set and adjusted as needed in the expectation of achieving the central bank's inflation target one to two years in the future.

With the Federal Reserve's introduction of interest on bank reserves, including excess reserves (those in excess of the amount required by regulation), banks' management of their funding needs for a given policy rate now involves drawing down or increasing their excess reserves. Adherents of MMT therefore argue that "money is created 'endogenously' to finance spending" (Fullwiler, Kelton, and Wray 2012: 18). Like post-Keynesians, they contend that "loans create deposits" and "repayment of loans destroys deposits" (ibid.).

The market determination of the money supply at a given central bank interest rate is, in fact, similar to the way in which the market determines the money supply under a currency board system. When a central bank is subject to currency board rules, it passively supplies whatever amount of money the market wants to buy and hold at the official (fixed) price of...