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ModernMoneyTheory:APrimeronMacroeconomicsforSovereign

MonetarySystems
PostedonJune6,2011byadmin|53Comments

ByL.RandallWray

ThisweekwebeginanewfeatureatNewEconomicPerspectivesaPrimeronModernMoneyTheory.EachMonday
wewillpostarelativelyshortpiece,graduallybuildingtowardacomprehensivetheoryofthewaythatmoneyworks
insovereigncountries.WewillthencollectcommentsthroughWednesdaynight,andwillpostaresponsetothe
commentsonThursday.Thecommentsshouldbedirectlyrelatedtothatweeksblog.Sincewearetryingtodevelop
anunderstandingofMMT,weespeciallyencouragecommentatorstoletusknowwherewehavebeenunclear.Since
wewillbepresentingthePrimeroverthecourseofthecomingyear,wewillsometimeshavetobegforpatience
obviouslywecannotpresenttheentiretheoryallatonce.

TheseblogsbeginwiththebasicsnopreviousknowledgeofMMTorevenofeconomicsisrequired.Theblogsare
sequentialeachsubsequentblogbuildsonpreviousblogs.Theblogswillbeattheleveloftheory,withonlylimited
referencetospecificcases,histories,andpolicies.Thatisintentional.APrimershouldprovideageneraloverview
thatcanbeadaptedtospecificnationalsituations.TheregularpagesofNEPwillcontinuetodiscusscurrentreal
worldpolicyissues.ThePrimerwillremainonadifferentplane.

WhatfollowsisaquickintroductiontothebackgroundandpurposeofthePrimer.

MMTPrimerBlog#1

Inrecentyearsanapproachtomacroeconomicshasbeendevelopedthatiscalledmodernmoneytheory.The
componentsofthetheoryarenotnew,buttheintegrationtowardacoherentanalysisis.Myfirstattemptata
synthesiswasinmy1998book,UnderstandingModernMoney.Thatbooktracedthehistoryofmoneyaswellasthe
historyofthoughtundergirdingtheapproach.Italsopresentedthetheoryandexaminedbothfiscalandmonetary
policyfromthemodernmoneypointofview.Sincethattime,greatstrideshavebeenmadeinapplicationsofthe
theorytodevelopinganunderstandingoftheoperationaldetailsinvolved.Toputitsimply,wehaveuncoveredhow
moneyworksinthemoderneconomy.Thefindingshavebeenreportedinalargenumberofacademicpublications.
Inaddition,thegrowthoftheblogospherehasspreadtheideasaroundtheworld.Modernmoneytheoryisnow
widelyrecognizedasamoreorlesscoherentalternativetoconventionalviews.However,academicarticlesandshort
blogsdonotprovidethepropervenueforacomprehensiveintroductiontotheapproach.

Thisprimerseekstofillthegapbetweenformalpresentationsintheacademicjournalsandtheinformalblogs.Itwill
beginwiththebasicstobuildtoareasonablysophisticatedunderstanding.

Inaddition,itwillexplicitlyaddressanothergap:thecaseofdevelopingnations.TheMMTapproachhasoftenbeen
criticizedforfocusingtoomuchonthecaseoftheUS,withmanycriticsassertingthatithaslittleornoapplicationto
therestoftheworldsnationsthatdonotissuetheinternationalreservecurrency.Tobesure,thatcriticismis
overdonebecausemodernmoneytheoristshaveappliedtheapproachtoanumberofothercountries,including
Australia,Canada,Mexico,Brazil,andChina.Still,muchoftheliteratureexplicitlyaddressesthecaseofdeveloped
nationsthatoperatewithfloatingexchangerates.SomesupportershaveevenarguedthatMMTcannotbeappliedto
fixedexchangerateregimes.AndtherehasbeenverylittleapplicationofMMTtodevelopingnations(manyofwhich
doadoptexchangeratepegs).

Sothisprimeralsofillsthatgapitexplicitlyaddressesalternativeexchangerateregimesaswellasthesituationin
developingnations.Inthatsense,itisageneralizationofmodernmoneytheory.

Unlikemy1998book,thisprimerwillnotrevisitthehistoryofmoneyorthehistoryofthought.Theexpositionwill
remainlargelytheoretical.Iwillprovideafewexamples,alittlebitofdata,andsomediscussionofactualrealworld
operations.Butforthemostpart,thediscussionwillremainatthetheoreticallevel.Thetheory,however,isnot
difficult.Itbuildsfromsimplemacroidentitiestobasicmacroeconomics.Itisdesignedtobeaccessibletothosewith
littlebackgroundineconomics.Further,theprimermostlyavoidscriticismoftheconventionalapproachto
economicstherearemanycritiquesalready,sothisprimeraimsinsteadtomakeapositivecontribution.Thathelps
tokeeptheexpositionrelativelyshort.

Inthisprimerwewillexaminethemacroeconomictheorythatisthebasisforanalysingtheeconomyasitactually
exists.Webeginwithsimplemacroaccounting,startingfromtherecognitionthatattheaggregatelevelspending
equalsincome.Wethenmovetoasectoralbalanceapproachshowingthatthedeficitsofonesectormustbeoffsetby
surplusesofanother.Weconcludebyarguingthatitisnecessarytoensurestockflowconsistency:deficits
accumulatetofinancialdebt,surplusesaccumulatetofinancialassets.Weemphasizethatalloftheseresultsapplyto
allnationsastheyfollowfrommacroeconomicidentities.

Wenextmovetoadiscussionofcurrencyregimesrangingfromfixedexchangeratesystems(currencyboard
arrangementsandpegs),tomanagedfloatregimes,andfinallytofloatingexchangerates.Wecanthinkofthe
possibilitiesasacontinuum,withmanydevelopednationstowardthefloatingrateendofthespectrumandmany
developingnationstowardthefixedexchangerateend.

Wewillexaminehowagovernmentthatissuesitsowncurrencyspends.Wefirstprovideageneralanalysisthat
appliestoallcurrencyregimeswethendiscussthelimitationsplacedondomesticpolicyaswemovealongthe
exchangerateregimecontinuum.Itwillbearguedthatthefloatingexchangerateregimeprovidesmoredomestic
policyspace.Theargumentisrelatedtothefamousopeneconomytrilemmaacountrycanchooseonlytwoof
threepolicies:maintainanexchangeratepeg,maintainaninterestratepeg,andallowcapitalmobility.Here,
however,itwillbearguedthatacountrythatchoosesanexchangeratetargetmaynotbeabletopursuedomestic
policydevotedtoachievingfullemploymentwithrobusteconomicgrowth.

LatermuchlaterwewillshowhowthefunctionalfinanceapproachofAbbaLernerfollowsdirectlyfromMMT.
Thisleadstoadiscussionofmonetaryandfiscalpolicynotonlywhatpolicycando,butalsowhatpolicyshoulddo.
Again,thediscussionwillbegeneralbecausethemostimportantgoalofthisPrimeristosetouttheorythatcanserve
asthebasisofpolicyformation.ThisPrimerspurposeisnottopushanyparticularpolicyagenda.Itcanbeusedby
advocatesofbiggovernmentaswellasbythosewhofavoursmallgovernment.Myownbiasesarewellknown,
butMMTitselfisneutral.

Asmentionedabove,onemajorpurposeofthisprimeristoapplytheprinciplesdevelopedbyrecentresearchinto
sectoralbalancesandthemodernmoneyapproachtothestudyofdevelopingnations.TheLevyEconomicsInstitute
hasbeenattheforefrontofsuchresearch,followingtheworkofWynneGodleyandHymanMinsky,butmostofthat
workhasfocusedonthesituationofdevelopednations.JanKregel,inhisworkatUNCTAD,hasusedthisapproach
inanalysisoftheeconomiesofdevelopingnations.OthersatLevyhaveusedtheapproachtopushfor
implementationofjobcreationprogramsindevelopedanddevelopingnations.Thisprimerwillextendthese
analyses,explicitlyrecognizingthedifferentpolicychoicesavailabletonationswithalternativeexchangerate
regimes.

Finally,wewillexplorethenatureofmoney.Wewillseethatmoneycannotbeacommodity,rather,itmustbean
IOU.EvenacountrythatoperateswithagoldstandardisreallyoperatingwithmonetaryIOUs,albeitwithsomeof
thoseIOUsconvertibleondemandtoapreciousmetal.Wewillshowwhymonetaryeconomiestypicallyoperate
belowcapacity,withunemployedresourcesincludinglabor.Wewillalsoexaminethenatureofcreditworthiness,
thatis,thereasonwhysomemonetaryliabilitiesaremoreacceptablethanothers.Asmyprofessor,thelateandgreat
HymanMinskyusedtosay,anyonecancreatemoneytheproblemliesingettingitaccepted.

Thisseriesofblogsactuallybeganasanefforttoprovideabasicprimeronmacroeconomicsthatcanbeusedbyhome
countryanalystsindevelopingnations,asanalternativetothemacroeconomictextbooksthatsufferfromavarietyof
flaws.Thepurposewasnottocritiqueorthodoxtheorybutrathertomakeapositivecontributionthatmaintains
stockflowconsistencywhilealsorecognizingdifferencesamongalternativeexchangerateregimes.JesusFelipeatthe
AsianDevelopmentBankurgedmetoputtogetheraversionthatcouldbemorewidelycirculated.Atthesametime,
manybloggershaveaskedthosewhohavewrittenonMMTtoprovideaconciseexplicationoftheapproach.Many
professorshavealsoaskedforatextbooktouseintheclassroom.

Thisprimerisdesignedtofulfilatleastsomeofthoserequests,althoughatextbookforclassroomusewillhaveto
wait.Tokeeptheprojectmanageable,Iwillnotgodeeplyintooperationaldetails.Thatwouldrequirecloseanalysis
ofspecificproceduresadoptedineachcountry.Thishasalreadybeendoneinacademicpapersforafewnations(as
mentionedabove,fortheUS,Australia,Canada,andBrazil,withsometreatmentofthecasesofMexicoandChina).
AsIamaimingforanonspecialistaudience,Iamleavingthosedetailsoutoftheprimer.WhatIdoprovideisabasic
introductiontoMMTthatdoesnotrequireagreatdealofpreviousstudyofeconomics.Iwillstayfreefrom
unnecessarymathorjargon.Ibuildfromwhatwemightcallfirstprinciplestoatheoryofthewaymoneyreally
works.Andwhileitwastemptingtoaddressawiderangeofpolicyissuesandcurrenteventsespeciallygiventhe
globalfinancialmesstodayIwilltrytostayclosetothismission.

IthanktheMMTgroupthatIhaveworkedwithoverthepasttwentyyearsaswedevelopedtheapproachtogether:
WarrenMosler,BillMitchell,JanKregel,StephanieKelton,PavlinaTcherneva,MatForstater,ScottFullwiler,and
EricTymoigne,aswellasmanycurrentandformerstudentsamongwhomIwanttorecognizeJoelleLeClaire,
HeatherStarzinsky,DanielConceicao,FelipeRezende,FlaviaDantas,YanLiang,FadhelKaboub,ZdravkaTodorova,
ShakuntalaDas,CorinnePastoret,MikeMurray,AllaSemenovaandYevaNersisyan.Otherssomeofwhomwere
initiallycriticalofcertainaspectsoftheapproachhavealsocontributedtodevelopmentofthetheory:Charles
Goodhart,MarcLavoie,MarioSeccareccia,MichaelHudson,AlainParguez,RobParenteau,MarshallAuerback,and
JamieGalbraith.Otherinternationalcolleagues,includingPeterKreisler,ArturoHuerta,ClaudioSardoni,Bernard
Vallegeas,andXinhuaLiuletmetryouttheideasbeforeaudiencesabroad.Manybloggershavehelpedtospreadthe
word,includingEdwardHarrison,LambertStrether,DennisKelleher,RebeccaWilder,YvesSmith,JoeFirestone,
MikeNorman,TomHickey,andthefolksatNewEconomicPerspectivesfromKansasCity,LynnParramoreatNew
Deal2.0,HuffingtonPost,andBenzingawhopostedmyblogs(andaboveall,wearingtwohats,BillMitchellat
billyblog!).AllthoseatCFEPsintheUSandCoffeeinAustraliaandEuropehavehelpedtopromotetheideasover
thepastdecade.AbigThankstoall.