What is Modern Money Theory?

By L. Randall Wray

Happy New Year to All. We are (I think) a bit over half-way through the Modern Money Primer. We should be able to finish it by sometime next summer.

OK, you might be wondering: Isn’t this a strange point at which to raise the question, “what is modern money theory?” Yes, in some important ways, it is. However in the past week there have been some really pretty extraordinary pieces in the popular media trumpeting MMT.

The Economist magazine featured a major story, Heterodox economics, Marginal revolutionaries: The crisis and the blogosphere have opened mainstream economics up to new attack. Of the three heterodox approaches it discussed, one was the “neo-chartalist” or “modern money theory”. Warren Mosler as well as UMKC appeared in the story; indeed, there are two cartoon caricatures featuring Warren adorning the story.

In addition, John Carney at CNBC has been running a series of pieces that discusses MMT. This one is particularly good: MMT, NGDP, And Austrian Economics: Alphabet Noodling!. And here is a link to his previous one:

Further, the debates about MMT continue in the blogosphere, including over at Cullen Roche’s blog: The Fundamental Difference between Austrians AND MMT’ers. And a truly excellent piece on Bill Mitchell’s Billy blog. Bill’s post led to a bit of a scuffle over what is actually in MMT—with Cullen arguing that the Job Guarantee cannot be a component, while Bill insisted that it must be. Warren has sided with Bill and written very persuasive comments arguing that we need the price anchor.

In this Primer we will eventually get to the Job Guarantee, so I do not want to discuss that today. But the arguments made by Cullen have led to two questions: what is within the realm of MMT? And just where did the name “Modern Money Theory” come from? Indeed, Stephanie Kelton was asked the second question and did a bit of investigation. To be sure, we are not sure.

My 1998 book was entitled “Understanding Modern Money”. When I was writing the book, it had a much more boring working title, and I asked Mat Forstater and Warren to help think of something catchier. We threw around a lot of ideas and rejected all of them. I had in the manuscript the quote I love from Keynes that argues that the State names the money of account and chooses what can answer to that name, and has done so “for some four thousand years at least”. And so I chose to use the term “modern money” to apply only to monetary systems that have existed for the past “four thousand years at least”. Whatever type of money that might have existed before that, we cannot be sure. But for the past 4000 years, at least, we have had State Money—that is, Modern Money. From whence came the book title.

I tended to call our approach the State Money approach in the early years; perhaps I also used the term Chartalist. That derived from the work of Knapp, who was followed by Keynes in his Treatise on Money (1930). This has usually been misinterpreted, following Schumpeter, as a “legal tender law” approach—a position clearly rejected by Knapp and Keynes. Both Keynes and Schumpeter knew that it had to be more than legal tender laws. But that is a matter for another time.

Later, our approach was given the name “neo-Chartalist”—which I think was supposed to be somehow derogatory. After several of us moved to UMKC, it began to be called “the Kansas City approach”. That of course was misleading because our sister center was in Newcastle under Bill Mitchell’s direction, and it also ignored the work of Charles Goodhart in the UK; by that time there were already many other people working on the approach, spread around the country and even around the world.

In any event, somehow it got the name Modern Money Theory. We think the first time those exact words were used might have been in a comment to Bill’s blog in 2007; if anyone can find that comment or a previous use, please send it along. It also looks like Bill used the term “modern monetary theory” in an academic paper in 2008.

I decided to look back over my own PowerPoints to see how my presentations of the approach evolved. I’ll provide three. Please be kind—looking at those early ones is a bit painful. But remember that PowerPoint was a new technology back in 2005! And I am still no match for Steve Keen.

The first one is titled THE CREDIT MONEY, STATE MONEY, AND ENDOGENOUS MONEY APPROACHES, from a series of lectures I gave for a short course at UNAM in Mexico City in May 2005.

As noted on the first slide, the lecture’s primary purpose was “to draw out the links among the state, credit, and endogenous money approaches, after first discussing the nature of money via historical and sociological analysis”.  “The credit approach locates the origin of money in credit and debt relations…” On the other hand, the state money approach “Highlights the role played by “authorities” in the origins and evolution of money. The state imposes a liability in the form of a generalized, social, unit of account–a money–used for measuring the obligation. Once the authorities can levy such obligations, they can name what fulfills this obligation by denominating those things that can be delivered, in other words, by pricing them.” And, finally, the endogenous money approach consists of four main components. “1. Money is “endogenous”: loans create deposits, which are credit money. 2. Reserves are “horizontal”, nondiscretionary. 3. Overnight inter-bank lending rates are “exogenously” set by policy. 4. Banking School reflux principle: deposits return to banks to retire loans, destroying money. Similar to the “fundamental law of credit” of Innes: the creditor/issuer must accept its own liabilities to retire debt of the debtor. “Excess Money” is not possible.”

The slideshow concludes with the attempted integration (sorry, a bit long):

“The state chooses the unit of account in which the various money things will be denominated. In all modern economies, it does this when it chooses the unit in which taxes will be denominated and names what is accepted in tax payments. Imposition of the tax liability is what makes these money things desirable in the first place. And those things will then become the (HPM) money-thing at the top of the “money pyramid” used for ultimate clearing.

The state then issues HPM in its own payments—in the modern economy by crediting bank reserves, and banks, in turn, credit accounts of their depositors. Most transactions that do not involve the government take place on the basis of credits and debits, that is, privately-issued credit money. This can be thought of as a leveraging of HPM used for ultimate clearing. In all modern monetary systems the central bank targets an overnight interest rate, supplying HPM on demand (“horizontally”) to the banking sector (or withdrawing it from the banking sector when excess reserves exist) to hit its target.

There is an important hierarchical relation in the debt/credit system, with power—especially in the form of command over society’s resources—underlying and deriving from the hierarchy. The ability to impose liabilities, name the unit of account, and issue the money used to pay down these liabilities gives power to the authority that can be used to further the social good.

“Sovereignty”: However, misunderstanding or mystification of the nature of money constrains government by the principles of “sound finance”. While it is commonly believed that taxes “pay for” government activity, actually obligations denominated in a unit of account create a demand for money that, in turn, allows society to organize social production, through a monetary system of nominal prices. Much of the public production is undertaken by emitting state money through government purchase. Much private sector activity, in turn, takes the form of  “monetary production”, or M-C-M’ as Marx put it, that is, to realize “more money”. This is mostly financed by credits and debits—that is, “private” money creation. Because money is fundamental to these production processes, it cannot be neutral. Indeed, it contributes to the creation and evolution of a “logic” to the operation of a capitalist system, largely “disembedding” the economy. At the same time, many of the social relations can be, and are, hidden behind a veil of money. This becomes most problematic with respect to misunderstanding about government budgets, where the monetary veil conceals the potential to use the monetary system in the public interest.”

Well, I think readers of this Primer will recognize many themes we have already covered, and we will be going through those that are unfamiliar in coming weeks. Not much of anything in this passage that I’d change.

The second PowerPoint to be examined is titled MODERN MONEY AND FUNCTIONAL FINANCE, from a lecture (again) at UNAM in May 2007.

It has some snazzy pictures I downloaded from the internet, and repeats much of the theme from above. What I want to point to is the introductory slide:

“The state money approach is associated with Knapp, Keynes, and Lerner, while credit money is associated with Innes and Schumpeter, and more loosely with the Circuit and endogenous money approaches. The functional finance approach is associated with Lerner.

Modern Money = endogenous money + state money + credit money + functional finance”

This was the first slide I could find in which I wrote out an “equation” listing what I took to be the fundamental components of my “modern money” approach. There is a later slide that lists the various “heterodox” schools of thought from which my approach derives:

• Marx, Keynes, Veblen: M-C-M’; MTP; Theory of business enterprise
• Institutionalists: M is all bound up with power: to do good and bad; perhaps the most important institution in CapEcon
• Post Keynesians: M and uncertainty; M and contracts; holding M
• Chartalists: State M, bound up with sovereignty
• Functional Finance: State M and Govt spending

Sorry for the abbreviations—I was learning to reduce the amount of writing put on each slide—but I think you can figure out what they stand for. (MTP refers to Keynes’s “monetary theory of production”, which is very similar to Marx’s M-C-M’ formulation and to Veblen’s “theory of business enterprise”. M, of course, stands for money. And CapEcon is a capitalist economy.)

The final presentation comes from a panel at the Association for Institutionalist Thought, April 2008, on “how to teach economics”. My presentation was: How to Teach Money

And what I want to point to is the addition I had made to the slide just presented:

• Marx, Keynes, Veblen: M-C-M’; MTP; Theory of business enterprise
• Institutionalists: M is all bound up with power: to do good and bad; perhaps the most important institution in CapEcon
• Post Keynesians: M and uncertainty; M and contracts; holding M
• Chartalists: State M, bound up with sovereignty
• Functional Finance: State M and Govt spending
• TOGETHER: MODERN MONEY

In other words, my argument then—and now—is that the modern money approach integrates all of these approaches into a coherent theory of the way money “works” in the modern economy.

Much of the new ground explored by MMT has been focused on providing an accurate description of what we call “monetary operations”—including the coordination between the central bank and treasury, with special focus on describing how “government really spends”. We have spent so much of our time on this for two reasons: first, almost no one understood this as recently as 2 or 3 years ago. Second, it is important, critically important, to formulating sensible policy.

And as an accurate description, this part of MMT should be accepted by anyone, no matter what their theoretical, political, or ideological persuasion. Ironically, it is the description that has been viciously attacked, even though no one, and I mean no one, has found any holes in the argument.

But MMT is much more, at least in my view.