6 MINUTE READ - A Modern Monetary Theory/MMT update and exchange from the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff.
Now that Modern Monetary Theory (MMT) has been discredited by the 2021-2023 inflation that many of its proponents said wouldn’t happen for a very long time if the central bank printed vast amounts of money to pay for:
-the Green New Deal
-free college for all
-government jobs guarantee program
-universal basic income
-free child care and day care
-complete rebuild of public infrastructure
…it seems like a good time to combine several online exchanges the Cautious Optimism Economics Correspondent has had with MMT’s enthusiasts, most of whom are very sure of themselves after reading a few blog entries by Stephanie Kelton or Warren Mosler.
Note: The Correspondent has actually had these conversations with MMT’ers and takes pain to present their arguments accurately. There are no straw men here. They routinely say these things, so you'll get a partial picture of what MMT promises its followers.
1) MMT disciple: MMT is not a “theory.” It’s a description of how our monetary economy actually works. None of the other economic schools understand the monetary system. Government deficits are a good thing. Every time the government spends a dollar more than it collects in taxes, the Federal Reserve makes a keystroke entry that creates a new dollar of money into existence which the economy cannot survive without. MMT opponents don’t understand our economy cannot exist without government deficits to create money.
Economics Correspondent: Deficit spending does not “create” money. The central bank creates base money (reserves) when it buys securities in open market operations, and the private banking system multiplies reserves into greater demand deposit balances through lending—all longstanding standard textbook stuff.
2) MMT disciple: No, those textbooks and academics don’t understand the monetary system. I’m telling you when the government spends money that it hasn’t first collected in taxes, it mails an overdraft check to a recipient who deposits it at his bank. The Fed then uses a computer keystroke to credit his private bank with dollars and new money is created into existence. Under our current system there is no limit to how much Congress can spend and deficit spending is literally what creates the money we rely on to run our modern economy. It's simple accounting.
Economics Correspondent: You left out the other half of the transaction accounting. Namely… when the Fed credits the recipient of the government’s check at his bank’s reserve account, the central bank must also necessarily debit the Treasury’s account at the Fed—named the Treasury General Account or TGA—by the same amount. The dollar credited at the private bank is offset by the dollar debited from the Treasury. One dollar in reserves is simply transferred from the Treasury’s account to the private bank’s account. No new money is created, and when the TGA balance reaches zero the government can no longer spend without either taxing or borrowing first. The Treasury has also been forbidden by law from running an overdraft at all since 1981.
3) MMT disciple: That’s not true.
Economics Correspondent: No, it absolutely is true, but to make this simple why don’t you just show me the government accounting that proves your case? Find me anywhere in the U.S. Treasury’s daily, weekly, or monthly statements of operations the deficit spending offset accounting item for “new money created for the Treasury by Federal Reserve.”
4) MMT disciple: I don’t care what you say, it’s still not true.
Economics Correspondent: Does that mean you haven’t found any Treasury financial statements to prove it?
5) MMT disciple: I don’t need accounting. The Fed’s creation of new money from deficit spending is a tautology that needs no proving.
Economics Correspondent: OK don’t just take my word for it then. How about monetary economist George Selgin who writes:
“[MMT economist Stephanie Kelton] unaccountably forgets to mention that, to complete the clearing transaction in question, the Fed must also debit the Treasury’s own account, known as the Treasury General Account, or TGA, for short. What difference does this make? …it means that there is, after all, a practical limit to how much Congress can spend, and that limit really isn’t all that different from those faced by ordinary households or businesses: when the rest of us write checks, our banks also end up debiting our checking accounts by corresponding amounts as the checks are returned to them for payment. That matters because at some point, if we spend too much, our bank balances will be depleted, and our checks will start bouncing...."
"...although most bank depositors enjoy certain overdraft privileges, and the Fed once granted similar privileges to the Treasury, in 1981 Congress itself permanently eliminated the Treasury’s overdraft privileges. Consequently, if Congress is to avoid running out of money, it can’t write checks in amounts exceeding the balances in its TGA account."
6) MMT disciple: Whoever George Selgin is, if he’s not an MMT economist then he doesn’t understand how the monetary system really works. Regardless of what you say, the reality is whenever Congress deficit spends it creates new money through the Fed system. When Congress runs a surplus it destroys money that the economy needs. Critics of deficits are unsophisticated and don’t realize the government’s deficit is the private sector’s savings.
Economics Correspondent: OK then, let’s check that “money from deficits” claim against real world observation.
The last year and a half Congress spent far more than it collected in taxes, running a deficit of $2.2 trillion. According to MMT the money supply should have expanded by $2.2 trillion, but it has actually fallen by over a trillion dollars (link at https://fred.stlouisfed.org/graph/?g=19RcK). So, where do I find all the new money that these huge deficits are supposed to be creating?
7) MMT disciple: You’re measuring the money supply by M2. I’m referring to the monetary base (currency plus reserves) which is what the Fed really controls.
Economics Correspondent: OK, the monetary base has fallen too: by over half a trillion dollars (link at https://fred.stlouisfed.org/graph/?g=19Rcx). That’s a big difference from rising by $2.2 trillion. So again, where is all the new base money and reserves these government deficits have created?
8.) MMT disciple: Well the U.S. runs a trade deficit which drains money out of the system. That’s where it’s going.
Economics Correspondent: In late 2023 the trade deficit is at a three year low.
Furthermore, if we go back to the late 1990’s the government was running a small surplus and the U.S. was also running a trade deficit. Since MMT alleges both “drain money from the economy” the money supply should have unquestionably contracted. But the money supply and monetary base did the opposite—M2 expanded by +20.1% and the monetary base by +22.9% from 1998 through 2000 (links below).
Once again as conventional monetary economics states, Federal Reserve monetary policy and open market operations grow and contract the money supply, not government deficits.
9) MMT disciple: Well the money supply is contracting today because private banks are cutting back on lending and reducing demand deposit balances.
Economics Correspondent: That’s not a new insight. All economic schools, not just MMT, understand that when banks cut back on lending M1 and M2 are more likely to fall.
Remember you also just said the broad M2 money supply doesn’t matter, only the monetary base which bank lending doesn't impact, only Fed operations. Well the monetary base has fallen by over half a trillion dollars at a time when MMT argues deficits are supposed to have printed 2.2 trillion new dollars in reserves. That hasn’t happened.
10) MMT disciple: You don’t understand how the economy works. Sovereign money doesn’t behave like a household. The government never has to worry about running out of money. We can deficit spend to finance a Green New Deal, universal basic income, a jobs guarantee program, universal healthcare, free college tuition, free daycare for working parents, and racial reparations. The government doesn’t have to worry about how to pay its bills because it is the monopoly issuer of its own currency.
Economics Correspondent: The government has barely even started spending on any of those massive programs and we’ve already suffered from runaway inflation. So no, Congress can’t pay for some socialist utopia using the printing press. And the fact remains unchanged that the government has run huge deficits the last 18 months yet every measure of money, including those you accept one moment and don’t accept the next, have all fallen. Those trillions of deficits have not inflated the monetary base, reserves, M1, or M2, all of which have fallen due to the Fed’s well-established monetary policy decisions.
<end of combined discussions>
Conclusion? MMT is just the latest in a long history of something for nothing fads, like another promise of the perpetual motion machine—with an electric cord under the tablecloth.
”There’s nothing new that’s true and nothing true that’s new in Modern Monetary Theory.”