This is the first in a series of blogs looking at the intellectual and practical relationship between ‘Modern Monetary Theory’ and the proposals made by Positive Money.
This is Part I: Intellectual roots and focus
Rob Macquarie is an economist at Positive Money and leads its research on climate policy and the monetary system.
Cross-posted from Positive Money
To anyone interested in macroeconomics and the role of government, the name ‘Modern Monetary Theory’ (MMT) should by now be familiar. This school of thought, which distinguishes itself from a typical Keynesian perspective as much as from orthodox economics, has won many disciples in recent years. Its leading lights – including L. Randall Wray, Stephanie Kelton, Warren Mosler and Bill Mitchell – have a large online following, and have served as Economic Advisors to presidential campaigns.
How does a theory that its advocates portray as ‘a description of how the monetary system actually works’, or ‘a lens which allows us to see the true (intrinsic) workings of the fiat monetary system’, sit with the perspective adopted at Positive Money?
A common fight
One important point should already be clear: both MMT and Positive Money constitute part of a much broader trend that began to accelerate rapidly following the global financial crisis. The capacity of the banking sector to disturb the entire economy no longer lying in doubt, many economic reformists concluded that a new perspective on money, banking and finance should be placed front and centre of the push to construct a better world.
An important fight for those who have been working for years in the heterodox economics space has been to deny the so-called ‘loanable funds’ model of how money cycles round the economy, and the attendant ‘money multiplier’. A loanable funds account claims that there is a stock of available savings in the economy that aspiring borrowers can access. As in all things according to orthodox economics, the equilibrium between the demand and supply of such funds determines the interest rate. Banks in this theoretical world act only as neutral intermediaries for this process and the central bank is able to influence the money supply by issuing reserves; loans grow in some fixed proportion to reserves – the ‘multiplier’ – as set out by reserve requirements.
According to Adair Turner, former head of the UK’s banking regulator, this model is ‘completely mythological’. This way of understanding money and banking is by now utterly discredited: the Bank of England, Bundesbank and US Federal Reserve have all released papers explaining just how far the facts of modern banking diverge from the loanable funds paradigm.
Nevertheless, the model somehow retains a hold on the academic economics establishment in the remaining bastions of orthodox practice. (For instance, papers occasionally emerge that make an attempt to salvage the theory: we know, for example, that it only works as a model ‘when there is no uncertainty and thus no bank default.’ Under what real-world conditions we can expect there to be no uncertainty is unclear from the paper in question.)
For now, suffice to say that both MMT and Positive Money are committed to a denial of the loanable funds model and a description of the much more accurate endogenous theory of money. Endogenous money creation means that the money supply expands and contracts according to decisions made within private financial entities. One major source of new money is the process of bank lending. When banks write new loans, they assign a new liability (the customer’s new deposit) and a corresponding asset (the loan) to their books. New money is created. When a loan is repaid, money (and the spending power that deposit represents) is destroyed.
What MMT and Positive Money both maintain (and here both are in line also with Post-Keynesian economists, another major heterodox school) is that because the current system works along the lines described by endogenous money theory, the orthodox approach to reforming finance and money is irremediably flawed. Money can be created, but at the moment the primary actors doing so are private banks. The next step is to urge a solution.
Taking place on different fronts
Despite unity on the importance of money creation, the crash also produced a split in the public narrative told about the reasons for the crisis. The Conservative Party in the UK, deficit hawks in the United States, ordo-liberals in the German government, and the bureaucrats of the European Commission all advanced an explanation for the crisis that castigated public debt, diverting attention from the private debt originating from banks that brought the North Atlantic financial system crashing down. The ‘austerity’ narrative became the chief adversary of the progressive community for some time, and is still harming society today.
Another current in the post-crash discourse has been the question of financial regulation. As well as the question of macroeconomic stimulus (or lack thereof), the policy response to the crisis had regulatory dimension. This debate hinges on bank lending: what sort of capital ratios are appropriate for banks’ balance sheets, whether there should be restrictions on mortgage lending, and (in the UK) how far a ‘ring-fencing’ regime will go towards protecting retail banking from financial instability. Outside the banking sector, a wider discussion about the ‘purpose’ of finance and the financial sector has drawn contributions from several corners.
With their shared roots in seeking a new paradigm on our monetary system, highlighting the importance of an endogenous money supply, and a concern for the social and economic outcomes that touch on people’s real lives and livelihoods, Positive Money and MMT have a lot in common. It is straightforward, once educated in the reality of bank lending and its importance in the economy, to take issue with where money goes in our society. Too much credit flows towards pre-existing property and financial assets. Not enough helps fund construction and maintenance of vital public services.
MMT is best known for its engagement in the fiscal policy arena. If the private sector isn’t doing its allocative job effectively, an obvious response is to turn to the simplest possible alternative: the countervailing power of the public sector. In a post-2010 context, offering warm words about public spending necessarily implies contesting austerity. In fact, the claim at the core of the MMT platform is about ‘the monetary role of the state’, as Mary Mellor puts it in Debt or Democracy – ‘governments create money through public expenditure that is credited to private/business bank accounts.’ For this reason MMT scholars are described as ‘neo-chartalists’, emphasising that money originated in the law and the state, rather than as a way to circumvent trade based on barter.
By contrast, Positive Money first cut its teeth with the idea of ‘Sovereign Money’ – a scheme bearing some resemblance to proposals for ‘full reserve banking’ (FRB). FRB was first proposed by David Ricardo in 1823 with his ‘Plan for the Establishment of a National Bank’, which required private banks to end money creation. Money was then to be backed 100% by gold. Later incarnations included Irving Fisher’s 100% Money – the Chicago Plan – and, more recently, a proposal from researchers at the IMF, helpfully titled ‘the Chicago Plan Revisited’. Clearly, what we’re dealing with here sits closer to the dialogue on financial regulation than the MMT view. From its inception, Positive Money has been rooted in the post-crisis discussion on reform to central banking and finance, seeing government spending as a significant and fundamental part of the picture but not its primary focus.
Yet Sovereign Money is not full-reserve banking. In essence, Sovereign Money is instead a proposal to end endogenous money creation by banks, and do away with reserves altogether. A Sovereign Money System would end the split between the two money circuits that currently exist: one circuit of reserves, accessed only by banks and the central bank, and one of bank deposits, used by the general public. In a Sovereign Money system, citizens and banks access the same single money circuit.
Exploring the possibility of a Sovereign Money System is one aspect of the work Positive Money does. It follows from a concern to change the structure of banks – to curtail their power to promote the bad credit allocation that was responsible for the 2007-08 crisis. MMT differs from Positive Money insofar as none of MMT’s proposals entail ending endogenous money creation by banks. Rather, MMT’s theorists emphasise a kind of counterweight to private money creation using the state’s role as originator of the money supply.
However, along with Post-Keynesians, some MMT figures recommend restrictions on the sort of trading that banks can engage in. In other words, they advance tougher financial regulations. Proposals like this that get us some of the way there certainly receive Positive Money’s support, and are therefore a point of crossover with MMT. Similarly, Positive Money doesn’t limit itself to questions of financial regulation and has participated as vociferously in the row over austerity as has the MMT group.
United over public money creation?
‘PM-type proposals & MMT are in essential agreement that the state can and should just spend state money for public purpose, with inflation the limiting factor.’
To anyone visiting the Positive Money website, material on the magic money tree and the policy option of monetary financing – or QE for People – makes the organisation’s stance on this basic tenet of the new economics as clear as day.
Another quote, this time from Michael Kumhof and Zoltan Jakab at the Bank of England, dismissing the loanable funds theory of bank lending:
‘In the real world… saving is therefore a consequence, not a cause, of such lending. Saving does not finance investment, financing does.’
Here lies the real overlap between the MMT and Positive Money viewpoints. Both movements press hardest on the final phrase from the BoE authors: it is financing that is needed to fund our societal needs, not some pre-existing stock of savings that we can draw on. Hoarding the state finances today as if a pot of gold to bestow to posterity, as the austerity advocates would have it, simply does not acknowledge the reality of incomes and growth.
Positive Money’s campaign to raise awareness of the importance of money creation, and the possibility of raising finance through public money creation, places us firmly in the same camp as the MMT theorists (notwithstanding any opposition in that quarter to a Sovereign Money System). What remains are theoretical and practical quarrels, which conceal the tight links between the two camps.
Some of those quarrels are important, as they impact on our choice of path for introducing reforms. For instance, while both groups agree that public money creation is possible, there is less consensus over which institutions would be best to make it happen. It is to such questions that the next post in this series will turn.
Part 2 will address the government debt, the notion of the equivalence between money and debt, and the power of the financial sector.