What is modern monetary theory

What is Modern Monetary Theory? You cannot take part in a discussion about economics these days without hearing the term Modern Monetary Theory come up. It's important to understand what it is, because a great deal that is said about MMT, as I will refer to it throughout this video, is complete nonsense. Some of its supporters don't help MMT by making claims about it that are frankly entirely unfounded and even untrue. Almost everything said about it by its opponents is, let's be honest, largely a work of fiction, because they want to, for reasons that are not apparent to me, deny the truth implicit within it. There is, in fact, very little about MMT that is either very radical, new, or unusual.

It is simply a description of the way in which money is created and used by central governments. In a modern fiat currency, I am aware that I have already used a number of terms that are quite complicated. For example, how money is used. We must remember that money is debt, and debt is created by bank lending. We must also remember that fiat currency is not backed by any form of asset.

It is not linked to gold, silver, or anything else; it is simply a government promise to pay that gives currency its value. What we're talking about is how money of that type is created by the government and how the money created by the government functions within the economy of which we're all a part. Most of the time, most economists try to ignore this issue. They often pretend that money hardly exists, which is quite absurd. Because, of course, money not only exists, but the existence of money and its management are a major part of managing the economy.

Understanding how money works is crucial, and that is what Modern Monetary Theory (MMT) accomplishes. This is why I believe it is central to the understanding of macroeconomics. With that said, let's discuss how this concept operates. MMT posits that a government with its own central bank and currency—like the United Kingdom, which utilizes the Bank of England and the pound sterling—does not need to tax or borrow before spending. Instead, the government can fund its expenditures entirely through the creation of new money by its central bank acting on its behalf. As a result, the government becomes indebted to its central bank for the amount expended. To put it another way, the government can simply instruct its central bank to make a payment to whomever it wishes. The central bank is obligated to increase the government's overdraft to facilitate this payment. Importantly, there does not need to be pre-existing money to complete the transaction, because the act of increasing the overdraft itself generates the money the government intends to inject into the economy. This is the core idea at the heart of MMT.

Now, a government that borrows in this way from its own central bank need never repay the debt it owes to that central bank for one very good reason: it owns the bank in question, and therefore the bank has no effective claim against the government. However, there is an even better reason why it need not make the repayment of at least some of the money that has been created. The money created in that way then becomes the money supply of the jurisdiction for which the government is responsible. One of the ways we can identify that a jurisdiction or state exists is that a government is able to implement the currency it declares to be legal tender in that geographic location. Therefore, it must ensure that if it declares a currency to be legal tender, there is enough of it available.

And by the process of spending into existence to support its programs, hopefully mandated by a democratic election, a government can create the money supply that allows the economy to undertake the transactions that will sustain it. So, it does not have to repay all that debt. This is a critical point to understand. That said, it cannot obviously avoid clearing some of that debt. This is an important point to grasp.

That said, it cannot obviously clear some of that debt. The reason why is that if you kept on creating new currency forever, you would end up with hyperinflation. That obviously is totally unwise, and Modern Monetary Theory (MMT) clearly understands this fact. It states that there is one fundamental tool that exists to ensure that the government can control inflation. Anyone who says that MMT is not concerned about inflation has clearly missed the point of the theory, because, in fact, it is obsessed with inflation and how to control it.

What it says is that the major control instrument we have to stop inflation is taxation. Tax takes the money that the government has created as a result of its spending and brings it back into the central treasury, where it is canceled. If you look at a banknote, it states, "Promise to pay the bearer on demand the sum of £5" or whatever the amount is. That promise is fulfilled by accepting that note in settlement of your tax liability. Once the tax liability is paid, it is finished, complete, and canceled.

You haven't got another liability. The fact is that paying tax cancels your liability to the government, just as the repayment of a bank loan cancels the money that was created when the loan was advanced. Thus, paying tax cancels the money that the government has put into existence through its spending. This is fundamental to the understanding of Modern Monetary Theory (MMT). The primary tool for controlling inflation is not the interest rate, which you would believe if you listened to neoclassical economics and neoliberal economics, which advocate the use of interest rates through independent central banks to achieve this role.

Instead, taxation is the fundamental tool to control inflation; therefore, fiscal policy is primary in modern monetary theory. The secondary role of tax in the government's funding cycle is to provide government-created money of a jurisdiction with value in exchange. Now, this is a little more complicated to understand. But let's be honest: if you were given a £5 note and had no idea what it was, or you were in Fiji at the time with no opportunity to exchange it for local currency, then that £5 note would, for all practical purposes, be entirely worthless to you. However, if you're in the UK, that £5 note, which would be worthless somewhere else, does have value, and the value is created by the fact that the government will accept your money in exchange for tax liabilities owed.

Now in the UK, at present, well over a third of most people's income is in some way or another going to eventually be paid in tax. It won't all be paid in income tax; some will be paid in National Insurance, some will be paid in VAT, and some in alcohol duties, tobacco duties, car duties, road fund licenses, or whatever else it might be. But ultimately, significant amounts of money are going to be paid in tax. Because trade gives rise to tax liabilities, those undertaking trade in the UK will always use the pound as their chosen instrument for trading. They do this because they don't want to take the exchange risk of holding dollars or any other currency, not knowing what those dollars or other currencies might be worth on the day they have to pay their tax. Therefore, they will trade using pounds, as this way they minimize their exchange risk. However, this means that by requiring tax to be paid, the government forces its currency into use within the economy, so that people use it. There's a corollary to this.

The government gains control of the economy by managing the currency. This is fundamental to the macroeconomic control of an economy by a government, and Modern Monetary Theory (MMT) is the only economic theory that truly explains how that value is created. Once the roles of tax have been fulfilled, tax can serve other purposes. For example, it can help deliver economic, social, regulatory, and inequality agendas on behalf of the government. This is something that every government around the world typically aims to accomplish. They wish to promote certain activities and discourage others, and tax is incredibly useful for that.

But what I stress is that this is a further role of tax that has nothing to do with revenue raising. It has everything to do with supporting other government agendas, which is a quite different objective, and this has to be fully understood. However, it does make tax one of the most powerful instruments for delivering policy by any government anywhere. In my opinion, MMT explains this. So, what else does MMT say?

Most importantly, what it says is that if the situation I have described exists, then the government does not need to balance its income and expenditure. In fact, what it also says is that in most situations, that balance would be thoroughly undesirable. For example, if the government has a growing economy and modest but controlled inflation, then the expansion of its money supply is essential. That expansion of the money supply is best delivered by running government deficits. It follows, like night follows day, that this is what a government should do to ensure there is sufficient money in existence to let the economy grow. However, that shortfall is not something that creates a risk to the economy as a whole.

In fact, it is essential to ensure that there is cash in existence. Moreover, there is no reason why the government has to borrow any money back. It could simply run an overdraft at the Bank of England, or whatever its central bank might be if we're discussing another country, and that would serve the purpose just as well. In other words, a government in this situation never needs to borrow from financial markets. That is because a government of this sort can always borrow instead from its central bank.

It has no dependency on financial markets as a consequence. For anyone to pretend that there is such a dependency is to claim a falsehood. It does not exist, and we know it doesn't. When we faced crises in 2008-2009 and in 2020-2021, the government created hundreds of billions of pounds of new cash to meet its own needs. It did this by effectively borrowing from its own central bank using the quantitative easing process, which ultimately leads to this situation arising.

And it did not need to go to the financial markets to say, "Please fund furlough," or whatever else it might have been. That didn't happen. The government does not need to borrow from financial markets. However, the government might well wish to offer a savings facility to banks and other financial institutions within the jurisdiction that wish to save with the safest institution available within the country as a whole, and that is the government. The government is always the safest place to save money in a country like the UK. And that's for one very simple, straightforward reason.

The government always repays its debts. It is the one and only organization that can do that. As a consequence, large companies, banks, pension funds, and others are very keen to save using government bonds, as that is the one asset they can rely upon to always be repaid. Nothing else is guaranteed in that way, including any deposits they might hold at the bank, since only the first £85,000 of the sums they hold on deposit are guaranteed. For many of these organizations, that amount can be totally insignificant. Therefore, the government can and very often does provide this facility, but it must be understood for what it is.

It's a savings facility. It is not in any shape or form a borrowing facility because it doesn't need to borrow from these organizations. It is providing them with a safe place to save. So, where are we? We have a government that is in a position to control inflation without the use of interest rates.

We can instead use tax rates to control inflation, or we can vary the scale of the deficit because that stimulates or reduces the scale of economic activity. The term has a consequence for the level of inflation within it, and the government could also, if it wishes, use credit controls on commercial bank lending to manage inflation. However, Modern Monetary Theory (MMT) describes a situation where, if inflation is a priority and inflation management is always a concern in macroeconomic thinking, this can be achieved without the use of interest rates. MMT suggests that it would be wise to implement a low interest rate policy within any economy. There are several reasons for doing so. Firstly, this approach minimizes the interest rate obligations that the government will incur by providing a savings facility to those who use its banking services. In other words, the interest paid on government bonds or on national savings and investments accounts would be reduced to the minimum possible, which the government would appreciate.

Secondly, providing a low interest rate creates the best possible environment for investment. Investment is not funded by savings; it is funded by borrowing. If borrowing is inexpensive, the amount of money invested in productive capital within an economy will increase, resulting in growth, should that be the government's objective. Thus, whether growth is the primary goal or not, low interest rate policies remain beneficial. Thirdly, having a policy that minimizes the interest rate paid within an economy reduces the amount of money reallocated upwards through interest payments on items like mortgages. This, in turn, helps reduce inequality, which should be a goal for any sensible government aiming for economic balance as an outcome from macroeconomic policy. All of this means that a government can pursue another objective: full employment. This is feasible within a Modern Monetary Theory (MMT) framework because a government planning for inflation can utilize underused resources in its economy without the risk of triggering inflation.

So, if, for example, there are people who are underemployed or unemployed in the country, a government can pursue full employment, which would put those individuals to work in a way that would not create inflation because they are currently out of work. Employing them cannot create inflation. However, this policy, if properly understood within the context of Modern Monetary Theory (MMT), is limited. This means that if there is no capacity to put extra resources to work and the government still tries to spend, it cannot achieve that objective unless one of two things happens: one would be inflation, as it would bid up the price of labor or other assets. Alternatively, it must increase taxation.

Now, it doesn't increase taxation in that situation to actually raise revenue, and that is an incredibly important point to make. What it does do is increase taxation to ensure that these resources are not going to be bid for in the private sector because the state wants to use them in the public sector. This, as a matter of fact, is another use of taxation. It effectively removes resources from use within the private sector so that the state may acquire them at a reasonable price. This is part of macroeconomic management because we know that the state and the private sector must work together to achieve all economic outputs, and therefore, this balancing is essential. However, it is a balancing act that has to be carefully planned to ensure that inflation does not result.

There could be a guarantee of full employment within an MMT (Modern Monetary Theory) economy. I am not wholly convinced that it is necessary, nor do I see it as a required balancing act to say that everybody must have work if they want it. I think that is a desirable outcome, but I don't see it as an essential outcome. I will differ with some MMT economists on that point.

They call this a job guarantee. I think it is something that the government may wish to pursue as a policy objective. I do not see it as a call to Modern Monetary Theory (MMT). Every single other thing that I have described within this video is, however, I think core to MMT. Now, I am well aware that this has been quite a long and complicated video.

There is a comprehensive written version of this available as well, and we will provide the link below this video so you can download it from the Funding the Future website. I have addressed this issue in several ways over a substantial period of time. Understanding Modern Monetary Theory (MMT) is crucial if you want to grasp how the macroeconomy truly operates. There is nothing I have said that is particularly radical, unusual, or even challengeable. In other words, this is the consensus among central banks regarding how money functions within the economy. This is the way that every reputable economist now agrees money is created.

This is a way in which everybody knows, in fact, it can be managed. It does challenge the idea of independent central banks and their control of inflation using interest rates, but that's a part MMT does very little with that is radical, different, or unusual. It is simply a form of post-Keynesian economics that asserts that with careful management of money, we can achieve the goal that any economy should strive to fulfill, which is full employment. If there is no management of money, we cannot achieve this essential goal.

That is full employment. If ensuring the well-being of people is achieved by guaranteeing them work to the greatest possible degree that a government can, then that becomes the aim of any government. In that context, Modern Monetary Theory (MMT) makes sense to follow. If you want to run an economy without guaranteeing full employment, by all means, manage the central bank using interest rates to control inflation. However, be prepared to take the risk of ongoing unemployment as a buffer while the economy overheats or underheats due to interest rate policies. But if people are not going to be able to do that, then full employment comes first, and so does the necessity for MMT. That is why it is so important.