What is modern monetary theory

what is modern monetary Theory you cannot take part in discussion about economics these days without hearing the term modern monetary Theory come up and 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 which are frankly entirely unfounded and even untrue almost everything that is 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 government in a modern fiat currency the economy now I am aware that I've 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 or silver or anything else it is simply a government promise to pay that gives a fat currency its value and what we're talking about is how money of that type is created by the government and how that money created by the government functions within the economy of which we're all a part most of the time most of Economics tries to ignore this issue it pretends in many cases that money hardly exists which is quite absurd because of course money does not only exist but the existence of money

and the management of money is major part of the management of the economy so to have a theory which explains how money works is really important and that's what mmt does and that is why I think it is core to the understanding of macroeconomics so having said all that as a preamble let's talk about how this thing works mmt says that a government that has its own Central Bank and its own currency which in a country like the United Kingdom would be the bank of England and the pound sterling and with that currency being internationally

acceptable which we know the pound sterling is then that government need neither tax nor borrow before spending because its entire government expenditure can be funded by new money creation by its Central Bank acting on its behalf with the government then being indebted to its Central Bank for the sum that it's expended let me put that another way the government can simply tell its Central Bank please make a payment to whoever the government wishes and the central bank is required to mark up the government's overdraft to make the payment and there does not need to be

any money there to allow the payment to take place because the mere process of increasing the overdraft does in itself create the money that the government wants to spend into the economy and that is the core idea at the h part 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 and that is because it owns the bank in question and therefore the bank in question has no effective claim against the government but there's a

much better reason why it need not make the repayment of at least some of that money which has been created because the money made in that way then becomes the money supply at the jurisdiction for which the government is responsible and one of the ways in which we can even identify that a jurisdiction or state exists is that a government is able to put into place in that geographic location the currency that it declares to be legal tender so of course it has to make sure that if it's declared a currency to be legal tender

there must be enough of it available and by the process of spending in money into existence to support its programs hopefully mandated by a democratic election then a government can create the money supply that allows that economy to undertake the transactions which will sustain it so it does not have to repay all that debt and this is a critical point to understand that said it cannot obviously not clear some of that debt the reason why is that if you kept on making new currency forever you would end up with hyperinflation that obviously is totally unwise

and modern monetary Theory mmt clearly understands that fact and so it says there is one fundamental tool that exists to make sure that the government can control inflation anybody who says that mmt is not interested in inflation has clearly missed the point about the theory because in fact mmt is obsessed by inflation and how to control it but what it says is that the major control instrument that we have to stop inflation occurring is taxation because tax takes the money that the government has created as a result of it spending into existence and brings it

back into the central treasury where it is cancelled if you look at a bank note it says on it I promise to pay the bearer on demand the sum of £5 or whatever that promise is fulfilled by accepting that note in settlement of your tax liability when the tax liability is paid it is finished it is complete it is cancelled you haven't got another liability so the fact is that paying tax cancels your liability to the government and in exactly the same way as repayment of a bank loan cancels the money that was created when

a bank loan was Advanced so paying cancels the money that the government has put into existence by reason of its spending this is fundamental to the understanding of mmt the primary tool for the control of inflation is not the interest rate which you would believe if you listened to neoclassical economics and neoliberal economics and its belief in the use of interest rates through independent central banks to achieve this role instead taxation is the fundamental tool to control inflation and therefore fiscal policy is primary in modern monetary Theory the secondary role of tax in the government's

funding cycle is to provide the 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 pound note and you had no idea what what it was or you were in Fiji at the time with no opportunity to exchange it into local currency then that5 note would for all practical purposes be entirely worthless to you but if you're in the UK that5 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 owing now in the UK at present well over a third of most people's income is in some way or other 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 some in alcohol duties or tobacco duties or car duties or rof fund licenses or whatever else it might be but ultimately significant amounts of money are going to be paid in tax and because trade gives rise

to tax liabilities those undertaking trade in the UK will always use the pound as their chosen instrument for trading because they don't want to take the exchange risk of waiting with dollars or whatever it might be to not know what those dollars or whatever else they might be will be worth on the day when they have to pay their tax and therefore they will trade using pounds because that way they minimize their exchange risk but that means that by requiring that tax be paid the government forces its currency into use in the economy so that

people use it as a coroller the government gets control of the economy by having management of the currency this is fundamental to macroeconomic control of an economy by government and mmt is the only economic theory that really has an explanation of how that value is created once those roles of tax have been fulfilled then tax can have other roles it can for example deliver economic social Regulatory and inequality agendas on behalf of the government and that is something that every government around the world usually wants to undertake they wish to promote s activities they wish

to discourage others and tax is incredibly useful for that but what I stress is that that is a further role of tax which has nothing to do with Revenue raising it has everything to do with supporting other government venders which is a quite different objective and this has to be fully understood but it does make tax one of the most powerful instruments for delivering policy by any government anywhere and in my opinion mmt explains this so what else does mmt say most importantly what it says is that if the situation that I have described exists

then the government does not need to balance its income and expenditure in fact what it also says that in most situations that balance would be thoroughly undesirable for example if the government has a growing economy a modest but controlled inflation then the expansion of its money supply is essential and that expansion of the money supply is best delivered by running government deficits it follows like night does day that this is what a government should do to make sure there is sufficient money in existence to let the economy grow but 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 what is more there is no reason why the government then has to borrow any money back it could just run an overdraft at the bank of England or whatever its Central Bank might be if we're talking about another country and that would meet 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 claiming a falsehood it does not exist and we know it doesn't in the case of the UK when we fac crisis in 20089 and in 20221 the government created hundreds of billions of pounds of new cash to meet its own needs it did it by effectively borrowing from its own Central Bank using the quantitative easing process which does end up with this situation arising and it did not need to go to the

financial markets to say please fund Furlow or whatever else it might have been that didn't happen the government does not need to borrow from financial markets but having said that the government might well wish to offer a savings facility to Banks and to other financial institutions within the jurisdiction who wish to save with the safest institution that is 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

repay its debts it is the one and only organization that can do that and as a consequence large companies Banks Pension funds and others are very keen to save using government bonds because that is the one asset that they can rely upon to always be repaid when nothing else is guaranteed in that way including in their case any deposits that they might hold at a bank because only the first £85,000 of the sums that they hold on deposit are guaranteed which in the case of many of these organizations will be a totally insignificant amount therefore

the government can and very often does provide this facility but it has to 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 which is in the 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 activ ity which in turn has a consequence for the level of inflation within it and the government could also if it wish use credit controls to Commercial Bank lending to control inflation but mmt does describe a situation where if inflation is a priority and inflation management is always a matter of concern in macroeconomic thinking then this can be delivered without the use of interest rates because mmt suggests that it would be wise to run a low effective interest rate policy within any economy there are a number of reasons for doing so firstly

that of course minimizes the interest rate obligations that the government will incur by providing a savings facility to whoever uses its banking facilities in other words the interest paid on government bonds or on National savings and Investments accounts will be reduced to the minimum possible which the government would appreciate secondly of course to provide low interest interest policy provides the best possible environment for investment because investment is not funded by savings it is funded by borrowing and if borrowing is cheap the amount of money that will be invested in productive Capital within an economy will

rise and the result is that we will get growth if that is the government's objective so whether growth is the objective or not low interest rate policy still pay and third having a policy which minimizes the interest rate paid with in an economy reduces the amount of money that is reallocated upwards by the payment of interest on things like mortgages and that reduces inequality which must be a government goal in any sensible environment where an economic balance is sought as an outcome from macroeconomic policy all of this then means that the government can have one

other objective and that is full employment this is possible inside an mmt environment because what a government that is planning for inflation can do which any government that is subscribing to mmt will be doing will be to say that if there are underused resources within its economy it can seek to put those resources to use without the risk of inflation arising 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 people to work in a way that could not create inflation

because they are at present sitting out of work putting them to work canot create inflation but this policy if properly understood within the context of mmt is limited 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 because it would bid up the price of Labor or other assets or 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 make sure 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 and this as a matter of fact is another use for taxation it effectively removes resources from use within the private sector so that the state may buy them at a reasonable price and that 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 but it is a balancing act that has to be carefully planned to make sure that inflation does not result there could be a guarantee of Full Employment within an mmt economy I am not wholly convinced that is necessary nor do I see it is a necessary Balancing Act to say everybody must have work if they want it I think that that is a desirable outcome 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 do as a policy objective I do not see it as core to 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 quite complicated video there is a whole 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 because I have addressed this issue in several ways over quite a long period of time

but understanding mmt is really important if you are to get your head around the way in which the macroeconomy really works there is nothing that I have said that is either particularly radical or unusual or even challengeable in other words this is the way that central banks agree that money Works within the economy this is the way that every Economist of any repute now agrees that money is created this is a way in which everybody knows inflation can be managed it does challenge the idea of independent central banks and their control of inflation using interest

rates but that apart mmt does very little which is radical or different or unusual it is simply a form of post canian economics that says that with careful management of money we can achieve the goal that any economy should try to fulfill that is full employment if ensuring that the well-being of people is delivered by guaranteeing them work to the greatest possible degree that a government can and that becomes the aim of any government then mmt makes sense for it to follow if you want to run an economy without guaranteeing full employment by all means

run the Central Bank using interest rates to control inflation and take the risk that there will always be unemployment as a buffer whilst it overheats or under heats the economy through the use of interest rate policy but if people come first so does nmt and that is why it is so important [Music] [Music]