What MMT Is, and Why We Should Not Wait for the Next Crisis to Live Up to Our Means
byby Yeva Nersisyan and L. Randall Wray
As MMT has been thrust into the spotlight, misrepresentations and misunderstanding have followed. MMT supposedly calls for cranking up the printing press, engaging in helicopter drops of cash or having the Fed finance government spending by engaging in Quantitative Easing.
None of this is MMT.
Instead, MMT provides an analysis of fiscal and monetary policy applicable to national governments with sovereign, non-convertible currencies. It concludes that the sovereign currency issuer: i) does not face a “budget constraint” (as conventionally defined); ii) cannot “run out of money”; iii) meets its obligations by paying in its own currency; iv) can set the interest rate on any obligations it issues.
Current procedures adopted by the Treasury, the central bank, and private banks allow government to spend up to the budget approved by Congress and signed by the President. No change of procedures, no money printing, no helicopter drops are required.
In the old days, governments just notched tally sticks, minted coins, or printed paper money when they spent, then collected them in redemption taxes and burned or melted down all the revenue. Today all modern governments use central banks to make and receive all payments through private banks. Government spending is still financed by money creation, and taxes destroy money—but in the form of central bank reserves. Instead of wooden sticks, we use electronic keystrokes, which the government cannot run out of. Bond sales merely swap one government liability for another, while paying off bonds reverses the operation.
Critics make a big deal of the separation of the Treasury (the government’s spending arm) and the Central Bank (the issuer of currency), claiming the latter is independent and may refuse to “finance” Treasury spending. The separation of the Treasury and the Fed does not alter government’s ability to spend. The Fed is a creature of Congress and an agency of the U.S. government. Liabilities of the Fed (notes and reserves) are obligations of the United States just like Treasury securities. Yes, different arms of the government issue these, but it doesn’t change the fact that they are liabilities of the United States.
As MMT explains, since bonds can only be purchased with reserves (the government will take only its obligations in payments to itself), the reserves must be supplied first before bonds can be purchased. It demonstrates how the Fed provides the reserves needed to buy the Treasuries even as it never violates the prohibition against “lending” to the Treasury by buying the bonds directly. The Fed has to ensure that funds to buy the bonds are available to safeguard the payments system, to achieve its interest rate targets and for financial stability considerations.
None of this is optional for the Fed. It cannot refuse to clear government checks. It is the government’s bank, after all, and is focused on the stability in the payments system.
Case in point: the Fed engaged in repo operations last September to add reserves to the system when Treasury bond sales and corporate tax payments left the market without its desired level of liquidity, pushing repo rates above the Fed’s desired levels. Any disturbance in the Treasury market will have ripple effects as many financial institutions have sizable holdings of Treasuries. Indeed, the Fed’s very first intervention during the pandemic was in the form of repo operations, citing “disturbances” in the Treasury market.
Government can make all payments as they come due. Bond vigilantes cannot force default. While their portfolio preferences could affect interest rates and exchange rates, the central bank’s interest rate target is the most important determinant of interest rates on the entire structure of bond rates. Bond vigilantes cannot hold the nation hostage—the central bank can always overrule them. In truth, the only bond vigilante we face is the Fed. And in recent years it has demonstrated a firm commitment to keep rates low. In any event, the Fed is a creature of Congress, and Congress can seize control of interest rates any time it wants.
Finally, even if the Fed abandons low rates, the Treasury can “afford” to make all payments on debt as they come due, no matter how high the Fed pushes rates. Affordability is not the issue. The issue will be over the desirability of making big interest payments to bond holders. If that’s seen as undesirable, Congress can always tax away whatever it deems as excessive.
What we emphasize is that sovereign governments face resource constraints, not financial constraints. We’ve always argued that too much spending—whether by government or by the private sector—can cause inflation.
In conclusion, MMT rejects the analogy that a sovereign government’s budget is just like a household’s. The difference between households and the sovereign holds true in times of crisis and also in normal times, regardless of the level of interest rates and existing levels of outstanding government bonds (i.e. national debt). The sovereign can never run out of finance. Period.
That doesn’t mean MMT advocates policy to ramp up deficits. For MMT a budget deficit is an outcome, not a goal or even a policy tool to be used in recession. There’s no such thing as “deficit spending” to be used in a downturn or even a crisis. Government uses the same procedures when spending no matter what the budgetary outcome turns out to be. We won’t know until the end of the fiscal year as the outcome will depend on the performance of the economy. And the spending will already have occurred before we even know the end-of-the-year budget balance.
MMT recognizes that the constraint faced by government is resource availability. Below full employment government spending creates “free lunches” as it utilizes resources which would otherwise be left idle. Unemployment is evidence that the country is living below its means. A country lives beyond its means only when it goes beyond full employment, when more government spending competes for resources already in use. Full employment means that the nation is living up to its means.
The most important lesson we must learn from this crisis is that the ability of the government to run deficits is not limited to times of crisis. Indeed, it was a policy error to keep the economy below full employment before this crisis hit in the belief that government spending was limited by financial constraints. Ironically, the real limits faced by government before the pandemic hit were far less constraining than the limits faced after the virus had brought a huge part of our productive capacity to a halt!
We hope the Coronavirus will teach us that in normal times we must build up our supplies, our infrastructure and institutions to be able to deal with crises, whatever form they may take. We should not wait for the next national crisis to live up to our means.