Modern Monetary Theory - How the US Government really pays for things

Discussion in 'Economics' started by Misthos, Dec 17, 2010.

  1. Has anyone heard of this? It is actually a description of how the US fiat monetary system works. I believe there are a lot of misconceptions out there, and they are reinforced by the media, politicians, and economists.

    From my blog:

    Basically, these are the facts:

    China does not fund the US deficit.

    Income Taxes do not fund US government spending.

    There is a reason that the US Federal Reserve was created around the same time that the US Federal Income Tax was created. The two work together to control aggregate demand, and combined with debt issuance, to hit the target rate.

    The government is not operationally constrained - it buys whatever it wants, whenever it wants, without reliance on tax revenues or debt markets.

    Sounds crazy, right? But that's actually how the system works. I'm not saying I support the current system, and I'm not saying that the current system is sustainable either. I'm just making an objective statement.

    Does that mean we can run deficits forever? No. Because at the end of the day, a free-floating currency is judged by the market and is also subject to geopolitical factors.
  2. jinxu


  3. LeeD


  4. I have seen that video - but its focus is more on the role of credit in the banking system. Yes, due to double entry book-keeping, money is created as loans are created, and the interest continues to accumulate.

    What I wrote above is fact. Whereas you and I have to work or borrow to get money, the US Government does not. The US Government does not technically rely on the bond market to pay its bills. Taxes control behavior - aggregate demand - more than fund the government.

    Much of what we have been told about our current monetary system is wrong.
  5. Modern monetary theory makes some very interesting predictions based on their description of monetary systems. One of those predictions is that government budget deficits are necessary for the functioning of a monetary system. The idea is that governments create currency as they spend and destroy it as they take it back in through taxes. Running consecutive years of surpluses would then take too much currency out of private circulation and is actually harmful. According to MMT every dollar in private circulation is there as a result of the government running a deficit in previous years.

    Governments are operationally constrained in only one way: their ability to create private sector demand for their currency through taxation. The idea here is that the value of a currency does not derive from habit or intrinsic value, but from the government’s monopoly on the use of force. Dollar notes have value because the government can force its citizens to pay taxes denoted in dollars.

    What this amounts to is that the government never has or doesn’t have any money. They create money as they spend, but in order to do so governments must create room for their spending by reducing private demand through taxation.

    See: A website run by Warren Mosler, a bond trader who is running for Senate in Connecticut

  6. Many governments like Canada and Australia had surpluses for many years in a raw. Nothing bad has happened. Money still were created by banks and economic growth was strong
  7. Canada and Australia manage to grow due to their large trade surplus. They sell natural resources to the rest of the world and this provides the private sector surplus that's required to sustain economic growth.

    Just because an economy manages to grow under a government surplus that doesn't mean it's actually good policy to implement elsewhere. It can work in a resource based economy during temporary resource booms as a way to take money out of the economy to dampen inflation. It can never work on an infinite time line though as the private sector eventually runs out of currency to pay their taxes with.

    The bottom line is that a government surplus means that the private sector is over taxed.
  8. Erm, you ever heard of chartalism, Misthos?
  9. The US government does not control money creation. The FED does it and it is by law independent. The FED's mandate is ""to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." "

    I don't see where you got that the government is not operationally constrained in general. What you say is correct only during periods of price stability or danger of deflation when the objective of the FED happen to match the needs of the government but it is not a general rule and I do not know where you got that. During periods of inflation for example, the governemnt may be operational constrained by tax revenue alone because the FED will refuse to print money and resort to a restrictive policy. High interest rates may make the issuance of government bonds prohibitive and tax revenue may end up being the only source of funds.

    Price stability and danger of deflation are two main reasons of the tax cuts now for the next two years. The FED is accomodating this policy. Surely they expect increased inflation after two years and taxes will go up.
  10. intradaybill,

    why do you think that the bailout funds in '08 and '09 were provided by the Federal government and not by the Federal Reserve?

    The Fed can create bank reserves by buying up government bonds and distressed assets in the financial system. They're like the government in that they can operate on negative net capital and can create 'something out of nothing'. The scope of what they can do is more limited than the federal government's though.

    To think the federal government would have to wait for a bond auction or tax collection in order to spend is ridiculous. The federal government has a monopoly on the issuance of currency and they do not have to compete for their own currency with the private sector.
    #10     Dec 17, 2010