A Practical Assessment of Modern Monetary Theory

Stephanie Kelton’s book, The Deficit Myth:  Modern Monetary Theory and the Birth of the People’s Economy has been reviewed by several economists whose work and opinions I respect.  None found it convincing in explaining and therefore accepting the book’s thesis that Modern Monetary Theory (“MMT”) has “discovered” a wellspring of money for the United States and any other country that creates its own money. The source of this money is said to be created by “running the presses.”  MMT’s purpose in creating more money is to spend it for guaranteed income for all, the Green New Deal, write-off student loans, and sundry other undertakings. Imagine that, not paying off the existing debts!  Paul Krugman, Nobel Prize winner in economics, has labeled it “sophist” and incomprehensible. John Cochrane, The Hoover Institution and University of Chicago, finds it misleading in citing true statements, but not connecting them to her conclusions.  They have no relevance, true or not, and are the style of “sophism” cited by Krugman.  Warren Coats writes in an essay for the Cato Institute that:  “MMT is an unsuccessful and empty attempt to convince us that we can finance the Green New Deal and a federal job guarantee program painlessly by printing money.  Printing money does not produce free lunches.”

My contribution to the discussion comes from a different approach by explaining what “running the presses” means and what it does to the economy, and finally to determine how that new money can be put to use by the government.  

It is a fact that money can be created in limitless amounts; there is no shortage of power to do what Ms. Kelton advises.  Economics teaches that increasing the amount of money in the economy faster than the actual rate of growth of the economy will create excess money.  The greater the excess of money in circulation, the greater will be price-inflation of goods and services.  The opposite of too much money is too little.  Instead of encouraging consumption, as inflation does — to use the money rapidly before its purchasing power drops to worthlessness —  deflation encourages saving to gain more purchasing power by delaying consumption. The Great Depression was an ordinary Wall Street recession until the government managed it into a depression by balancing the budget and reducing the amount of money in the economy.  This caused debtors to repay debts, mortgages on their houses and farms particularly, with scarce money having more value than at the time when borrowed.  The people defaulted on their house mortgages, and banks closed as other people rushed to withdraw their savings from banks; as a monetary pandemic, so to speak.  

Today, the total amount of money in circulation is not limited to coins and currency.  The definition of money used by economists when referring to regulating its value consists of bank demand deposits, credit cards, money market funds, cash in brokerage accounts, and other accounts that can be converted to cash upon demand.  There are many more sources of money than 75 years ago, which makes its regulation a great deal different from before, but economists have advanced their understanding apace.  The phrase “running the presses” to create money is still understood as creating money, but it no longer means actually printing currency.  Since the Federal Reserve Act was passed in 1913 money is now created in commercial banks.  The “magic” stems from banks’ having two complementary businesses:  taking in money from depositors and lending money from the “pool of deposited money” to borrowers.  Usually, the loaned-money is deposited to a bank account – either directly by the borrower, or indirectly by a merchant that sold goods to the borrower.  This new deposit increases the bank’s base of deposits, thus making greater base for increasing loans.  The “magic” of this process has become known as “printing money” as a carryover from when money was tangibly printed as currency.  This process occurs numerous times in a series of transactions, often by different banks from the preceding lending bank.  When some people are borrowing, others will be repaying or saving, so that among all banks aggregated there is stability.  Every bank will not necessarily have the same loans-to-deposits ratio, but in the entire banking system there is stability of loans-to-deposits ratio, which sets the limits of a bank’s lending.  Finally, the Federal Reserve System (The “Fed”) requires banks to maintain reserves at a Fed district bank equal to a percentage of the commercial bank’s deposits, and the Fed also offers to loan money to banks or purchase assets from banks to maintain their liquidity to meet customer needs for withdrawals without delay.  Over the course of a “normally growing economy the process of printing money will maintain a slow and steady increase in loans and deposits at the rate sufficient to maintain stability.  

Ms. Kelton’s Modern Monetary Theory (Sic) maintains that somehow this new printed money is available to the government to be appropriated by Congress to pay for such things as the progressive politicians believing her magic process does not create deficits or public debt want to do.  In fact both answers are technically correct, because there is no means for the government to access this money.  I am sorry to say to my readers, this money resides in “the economy” and there is no way for the government to obtain and spend it except only by the means the Constitution provides.  The government is restricted to revenue from taxes, import duties, imposts and excises, plus the government may borrow money on the credit of the United States.  The money in the economy only reaches the government by the subjects in the preceding sentence, and by that means alone. Commercial banks used to make direct loans to governments, but not today.  If a bank chooses to invest in government debt it does so through the financial markets along with all other debt holders.  

Has Congress in calendar year 2020 appropriated some seven trillion dollars of spending that has no source of revenues, only borrowing on the credit of the United States?  I left out one source of funds used in the years before the close of the nineteenth century.  The government can sell land; there is a lot of it already owned and useable to be sold. Congress has the power.  

Publiustoo.com                                                                                    January 1, 2021