I suppose it is in the title but everything you read about Modern Monetary Theory (MMT) focuses on the importance of money and the positive effects it can have in and on the economy if it is used wisely under MMT guidance. In this second article I am going to look at their misinterpretation of the role and quantity of money and in the next blog I am going to look at a third mistake regarding their understanding of the price of money (rate of interest).
What MMT fail to realise is that money is only important in a negative and damaging way. It cannot create jobs, grow the economy, be a source of investment, deal with wealth and income inequalities etc. Money is benign. If it is managed well things will not go wrong, but if it is managed badly then it damages the economy.
I am sure that this is not the case, but it does seem that MMT fail to recognise that money existed long before government management of money took over. The earliest forms of mass money were the monetary metals, gold and silver and in the UK before the 1844 Bank Charter Act the economy ran reasonably efficiently in monetary terms with consumers buying products, people paying taxes, government spending, people saving, people borrowing, which are all things MMT want us to believe will only happen effectively if government manages money.
MMT makes statements such as government spending creates money whereas government taxation destroys money. These are statements that misunderstand the circular flow of income (thank you Keynes) and how withdrawals from it result from taxation and injections into it occur when government spends. These things are continuously and, for the most part, simultaneously going on so there is zero net effect. It is therefore misleading to suggest in any way that they are separate, unrelated, events. Even worse to suggest they are money flows when they are income and spending flows. Of course it is possible for government to tax people and refuse to spend the money or even destroy the money as they did after the First World War in a misguided attempt to return to the pre-war gold standard. Alternatively they could spend money and refuse to finance it through taxation. For the most part this is just mismanaging flows of income and nothing to do with changing monetary aggregates.
MMT say that government must overspend their budget to create private sector savings. Again this is an incorrect statement as government can balance its budget or even have a budget surplus and the private sector could be saving more or less and will do so relative to changes in their income, expectations or confidence about the future and this can be totally unrelated to changes in government spending and taxation or the balance between the two.
Warren Mosler makes an important distinction between vertical and horizontal money and rather obscures the point that all fiat money has changed from something that had value in use and exchange to something that only has a value in exchange. All fiat currencies have just two components which are currency that was created by the Central Bank and bank credit that was created by private sector bank loans. About 5% of fiat money in the UK is currency and is sometimes referred to as base money. However 95% of money was created by bank lending and it is this component of money that produces another error when MMT say that money is debt. 95% of fiat money was created by issuing debt, but once it has been issued it is no longer debt just money that is used again and again as a unit of account that measures income, saving, consumer spending, government spending, investment, acts as a store of value and a standard for deferred payment.
Mosler also argues that when government spend this is vertical (exogenous) money creation and when banks issue loans this is horizontal (endogenous) money creation. Private banks issuing net new loans (that is more new loans than were cancelled in the same time period) does increase the stock of money. However government spending has no effect on money creation unless it is financed by money printing. This occurs if some of the fiscal deficit for one year is left unsold at the Central Bank.
A last point, although there are many more that could be considered, is the mistake in terminology that Wynne Godley made and MMT have picked up when they identify financial sectoral flows and balances as money when they are in fact flows of income and spending that sum to zero.
Throughout their work MMT fail to distinguish between monetary and fiscal policy. In reality it is very simple to totally separate fiscal policy and monetary policy and once the clear differences between them have been understood then it is easy to see how they can act together or in opposition to each other. The money supply and monetary demand can be expanded or contracted irrespective of whether the government is running a fiscal balance that is zero, in deficit or in surplus (the surplus is more difficult to grasp). Once this clear separation has been understood then the analysis of each of their roles can be seen when they are acting apart or acting together in pursuit of the same economic outcome. When this is understood it is easier to grasp how a large budget deficit can have no effect on the money supply while a small budget deficit can have a large impact on the money supply. It all depends on how the debt is financed not on how large it is.
To read about what money is, what money supply means, how money creation takes place and how all of that is turned into monetary demand go to my blog article ” Money, money supply, money creation and monetary demand”
John Hearn 11/7/2019
jbhearn 
“The monetary and financial system of an economy are part of the socio-politico-economic control mechanism used by every state to connect the economy with the polity and society. This neural network provides the administrative means to collect taxes, direct investment, provide public goods, trade. The money measures provide a crude but serviceable basis for the accounting system which in turn, along with the codification of commercial law and financial regulation are the basis for economic evaluation and the measurement of trust and fiduciary responsibility among the economic agents. A central feature of a control mechanism is that it is designed to influence process. Dynamics is its natural domain. Equilibrium is not the prime concern, the ability to control the direction of motion is what counts. Money and financial institutions provide the command and control system of a modern society. The study of the mechanism, how they are formed, how they are controlled and manipulated and how their influence is measured in terms of social, political, and economic purpose pose questions not in pure economics, not even in a narrow political economy, but in the broad compass of a political economy set in the context of society. ” Martin Shubik
https://ideas.repec.org/h/eee/monchp/1-05.html
LikeLiked by 1 person
I got lost at the part where you dispute that “government spending creates money whereas government taxation destroys money” and instead that (if I have you right) the perpetual government budget deficit has “zero net effect“ on money supply and has “nothing to do with changing monetary aggregates”. Is that what you mean? I recall being told in macroeconomics class that Keynes claimed temporary deficits were a tool to be used temporarily to cure a slump by boosting aggregate demand; while Milton Friedman, from another perspective, essentially out and out said clearly that deficits add to the money supply. What you wrote seems like a wholly new interpretation. If deficits are one source of money creation, since in practice since the 30’s governments have used them at all times, with no budgetary discipline whatsoever, in my opinion the MMT adherents are quite justified to regard these as de facto detached activities. I think the far more critical question is what sort of damage is orders of magnitude of excess spending going to do to money and the economy. Just curtly dismissing the Weimar hyperinflation after it created Hitler (something they do constantly) seems mad.
LikeLike
You were taught reasonably well. The point about a budget deficit is that it can be financed in two ways. One is non inflationary when all debt is sold to real people. The other is inflationary if unsold debt is left at the CB and money is printed. It is therefore possible for large deficits not to be inflationary and small deficits to be inflationary.
LikeLike
I see. I think you are saying that since bond buyers can’t print money they have to buy them using something, hence the overall process has no effect on total money supply.
It sounds then like MMT exponents propose to keep the central banks like the Fed around, but are happy to monetize the debt— that is, what’s being done now— except they think it could be done at arbitrary times and not just limited to moments of “financial crisis”. Have I got this part right?
LikeLike
Yes MMT do not separate monetary and fiscal policy and make the mistake of thinking that government spending and taxation increases and decreases the money supply.
LikeLike
Stephanie Kelton tweeted this:
“ I wish people would stop calling for “stimulus” right now. We don’t need stimulus. We need need stay-mulus. We’re talking about holding it all together to prevent a devastating collapse, not boosting aggregate demand.”
So MMT denies the relevance of Keynes’ notion of aggregate demand? I am now completely baffled as to what they believe. But then I’m also not particularly eager to buy her new book to find out what she’s talking about (!).
LikeLike
There are no practical difference between central bank reserves and Tbills! Therefore MMTers are correct on the operational realities of the monetary system! The deposits used to buy the Tbills are exactly the sum of the deficit and that is the surplus of the private sector!
Check Perry Mehrlings Money view! It makes this clear!
The MMTers are wrong on believing politicians are good decision makers but that is another story…
LikeLike
Thanks for your comment. Small difference in as much as TBills are assets while CB reserves are currency. Also the flows are a little more complicated than MMT suggest. If the private sector buy all the TBills then they have used their surplus to buy the government deficit. However other private sector surpluses can also finance private sector deficits and public sector deficits can be financed by currency printing. All these have different effects on the economy.
LikeLike
the importance of separating monetary policy from fiscal policy is underscored, emphasizing that deficits and debt financing which do not directly alter the money supply.
how can policymakers better distinguish between the roles of monetary and fiscal policy to effectively manage the economy without misconceptions about money creation and its impacts?
LikeLike
Policy makers need to understand basic economics and not be taken in by populist theories that are wrong but tell them what they would like to tell voters at election time.
LikeLike