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January 20, 2022

What is modern monetary theory?

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Modern Monetary Theory (MMT) is an approach to economics that views money as a human relationship, rather than a thing in our wallets.

Any theory of money must at least explain how it gets its value and why people use it: anyone can create an IOU and issue it as money, so why do people use the government’s money?

The MMT answer is: to pay taxes. To understand this it is first necessary to understand what is meant by ‘sovereign money’.

Legal monopoly

A sovereign government is one who has supreme authority within the jurisdiction of its internationally recognised borders with other sovereign governments. A sovereign government that issues its own currency and has a floating exchange rate (i.e. its currency is not pegged to another government’s currency, nor gold, nor anything else), has what is called a sovereign currency. That government has a legal monopoly on the issuance of its currency (counterfeiting is a serious crime) and can issue as much as it wants – that is, it has no nominal limits to the amount it can spend.

This is only the case for the federal or national government – it is not true for local or state governments, who, like any individual or business, are a user of the currency, rather than the issuer.

Most governments today meet the sovereign currency criteria, including Australia’s. The flipside of a sovereign currency is a legal monopoly on the use of force – a key part of the MMT money story, which I tell now.

Use of force

Part one of the MMT money story is that a sovereign government wants to provision itself: it wants an army, a police force, doctors, teachers etc. To achieve this, it first imposes a tax liability, which must be paid in the sovereign currency. If the tax is not paid, the government can dispossess someone of their land or property, put them in jail etc.

In this way the flipside of a sovereign currency is a legal monopoly on the use of force, and according to Jason Hickel, Europeans commonly used this method of imposing tax liabilities in their colonisation of Africa. With a tax liability having been imposed, the government creates unemployment, which by definition is people looking for paid work: since people do not want their land or property to be taken from them, nor to go to jail etc., people are now looking for ways to pay the tax.

It’s important to emphasise here is that it is not so much our taxes that the government wants, but our labour, and this opens up the big question of what sort of work we value and want done in our society.

Creating unemployment

Now that there are people looking for paid work (i.e. unemployment), the next step is for the government to use its power to spend money into the economy, offering the sovereign currency for jobs it wants done: army personnel, police officers, teachers etc. While a sovereign government has no nominal limits to spending, there are real limits to the size of the economy relative to the containing biosphere.

A few other corollaries follow from the nature of a sovereign currency. First, the government’s debt is the public’s credit; as such, government debt is both bad, but also necessary, and potentially beneficial, depending on what it is spent on – eg is the government spending to invest in schools and hospitals, or to finance wars?

The second is what is called the ‘household fallacy’: the government should not operate its accounts by trying to ‘balance the budget’. Users of the currency must do this (including state and local governments), but a sovereign government is the sole issuer of the sovereign currency and can always afford to buy anything for sale denominated in its own currency, whether material or labour, and it can never go bankrupt in its own currency. Finally, government must spend at least as much as it demands in taxes, otherwise unemployment results.

The final step is for government to redeem the currency it spent by collecting taxes and extinguishing its debt.

In summary, while the conventional wisdom is that government must first raise taxes in order to spend, MMT argues that the opposite is true: government must first spend before we can pay taxes. For instance, the Australian Government spent hundreds of billions of dollars in response to COVID-19 without any need to raise taxes first. We all know this, but MMT draws out many important social and political conclusions, some of which I will explore in a follow up article. In the meantime MMT literature and YouTube videos are aplenty; some of its pioneers are Warren Mosler, Bill Mitchell, and Randall Wray. Interested and respectful readers are invited to participate in a discussion of these and related matters. Please email [email protected] for time and venue.


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