The Flow of Funds in Theory and Practice: A Flow-Constrained Approach to Monetary Theory and Policy

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Moreover, MMT emphasizes that government deficits increase the net financial assets of the private sector. Without deficits providing the public with Treasury securities, the only government liability held by the private sector would be fiat money. This is how MMT arrives at its counterintuitive conclusion that deficits can actually lower interest rates, a conclusion that has baffled critics like Sumner and Krugman.

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Therefore expanding either of them can have roughly similar impacts on the economy. Because exponents of MMT consider increased money and increased debt as complementary ways to increase aggregate demand, they see little need to worry about the size of the government debt.


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Given their insistence that the government has no budget constraint, they are oblivious to the possibility that expectations about increased future taxes can affect perceptions of wealth, either as proposed in the FTPL or through even a partial working of Ricardian Equivalence. MMT even challenges the empirical significance of the Fisher effect, in which expectations about future inflation cause a divergence between nominal and real interest rates. Government policy, in their view, should therefore focus exclusively on nominal interest rates.

How do all these assumptions lead to an endogenous money supply? Well, if private investment is a slave to animal spirits, so is bank lending. Advocates of MMT argue that deposits are not the source of bank lending but the other way around: bank lending creates deposits.

Thus, the supply of bank loans is entirely demand driven, and that demand determines the amount of money banks create in the form of deposits. The defenders of this view realize that banks do wish to hold some desired level of reserves for clearing purposes and to satisfy customer demand for cash. And this desired level can change. But reserves, they claim, place no limit on bank landing.

Modern Banking in Theory and Practice

Nor do increases in total reserves create any impetus for bank lending. Changes in total reserves will, therefore, not affect how much money banks create through deposits. If the central bank should create more reserves than banks wish to hold, the banks will attempt to lend the excess reserves to other banks in the overnight lending market, which, for the United States, is the Federal funds market. To keep that rate on target, the Fed will have to reduce reserves with open market sales of Treasury securities, which automatically reduces the monetary base.

Similarly, if banks wish to hold more reserves, they will try to borrow them from other banks, raising the Federal funds rate and forcing the Fed to increase the monetary base. This assumed endogeneity of bank lending thus makes both the total money supply and the monetary base endogenous.

Every step in this reasoning relies on a belief that the underlying risk-free nominal interest rate is not a market phenomenon but is ultimately arbitrary. Although longer-term and less-liquid financial assets and also real assets will still enjoy positive returns, profits, expectations of future profits, and liquidity will solely determine the spreads between various financial and real assets.

To be sure, MMT concedes that the ability of an endogenous money supply to constrain inflation has limits. Government spending can still run up against the scarcity of real resources. There you have the topsy-turvy world of MMT. With accounting games, advocates of MMT attempt to reverse the roles of the government treasury and the central bank. They believe that the Treasury should control inflation and the Fed should finance government expenses.

And because both the treasury and central bank are government institutions, there is some truth to the idea that both institutions have dual roles. But as many others have pointed out, MMT theorists have yet to address or even consider the enormous public-choice problems that could hinder how their desired role reversal might function in practice. We have tried to extend that tradition. This adds only a rest stop, creating a short lag as tax revenues flow toward expenditures.

Basingstoke, UK: Palgrave Macmillan, , p. For more articles by Jeffrey Rogers Hummel, see the Archive. Interpreting Modern Monetary Theory 0. Using Taxation to Limit Inflation The most unusual feature of MMT is the second possible constraint: the claim that government taxation can control inflation. For background definitions, see Keynesian Economics , by Alan S.

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Modern money and the escape from austerity

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Modern Monetary Nonsense by Kenneth Rogoff - Project Syndicate

See also: supply side aggregate economy. See also: supply side. See also: accountability , political accountability. See also: collateralized debt obligation.

Introduction to Monetary Theory - Lecture 1.2

See also: diffusion. See also: diffusion gap. Also known as: diminishing marginal utility. Also known as: diminishing marginal returns to consumption. Also known as: subjective discount rate. Also known as: decreasing returns to scale. See also: economies of scale. The latter process applies when the economy moves towards a stable equilibrium or away from a tipping point an unstable equilibrium. In contrast, rents that arise in equilibrium are called equilibrium rents. See also: inflation , deflation. See also: progressive policy , regressive policy.

Also known as: specialization. It is capable of producing the same amount of output as the alternative technology with less of at least one input, and not more of any input. In short: an outcome is dominated if there is a win-win alternative. See also: reservation option. Also known as: increasing returns to scale.

See also: diseconomies of scale. This fraction is usually multiplied by and reported as a percentage. See also: labour discipline model , employment rent.

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