Continuing our discussion on squid: introducing mmt
I’ve tried about three times to do this post, at the tired end of the day, and failed. I’m trying to put a coherent point together; it’s in my head, but getting it out is proving to be hard.
#MMT: Modern Monetary Theory
Modern Monetary Theory is over a century old. It’s the theory underlying Keynesianism, and stems from an understanding that money need no longer just be gold. Instead, money became what we now call a fiat currency, that is, something controlled and issued by sovereigns. When sovereign (states) control the issue of money, they practise what is known as seigneurage, which originally means being a sovereign and in economics means minting the currency. Sovereigns cannot default on debts denominated in their fiat currency, because they can always print more. Sovereigns control the money because they (and only they) have the power to collect taxes, and they can insist that taxes be paid in the currency they control. Thus, in order to pay taxes, citizens have to obtain the currency from the sovereign, by borrowing it from the central bank (also controlled by the sovereign) or by providing goods and services to the state in return for the state’s fiat currency.
But banks can also create money, unless they are strictly controlled (which they aren’t). Under a gold standard, a bank can only lend money it already has. With paper or electronic money, all it has to do is to create a loan in its books. This creates an asset, in the form of money owed to it by the borrower, and a liability, in the form of a balance on the borrower’s current account, from which the customer spends it on whatever he chooses. When the loan is fully drawn down, the bank has an asset – money it is owed – and no corresponding liability. Under accounting rules, the balance becomes part of the bank’s capital, and it can take in deposits against the apparent security of a strong balance sheet. The creation of electronic money by private-sector banks has fuelled the global economy since the 1980s, and it closely parallels the creation of paper money by regional banks in the UK in the period during and after the Napoleonic wars. The problem comes when borrowers default on their loans. Assets are written off, depositors get worried and withdraw their funds and – if they aren’t rescued – banks collapse. This has happened rather a lot recently. Since 2008, banks in many countries have either collapsed or had to be rescued by their governments, in most cases because they had made too many loans secured against over-valued properties.
The challenge we all face is preventing this from happening again. However, the necessary changes to the banking system just haven’t been made – and there is little agreement on what they should be. There’s also very little agreement about what the effect of the various bailout and rescue packages is; perhaps the most misleading, according to MMT, is the idea that bailouts are funded by the taxpayer. They’re not: they’re funded by sovereign states “printing” more money. The situation in Europe is particularly complicated, because Eurozone member states can’t bail out their own banks, and there is no over-arching European sovereign state to do it either. Most commentators now recognise that this is a fatal design flaw of the Euro, one that must be remedied if the currency is to survive.
But I am thrashing over familiar ground. We can complain all we like about the problems; what we need are solutions.
As far as I can tell, there are broadly two schools of thought, besides the discredited conventional wisdom:
– On the one hand, the libertarian right, at its most extreme, advocates a return to the Gold Standard. This takes control of money away from the state, which libertarians broadly distrust, and from banks, who have generally messed it up. Almost all economists agree that this would be disastrous; it was disastrous for the UK the last time it was tried in 1925-33 and hurt America badly during the Great Depression.
– On the other hand, the left advocates a return to strict controls on money formation, so that it can only be created by sovereigns. To lend money, banks would have to borrow it from the central bank, which could then control how much it lent and on what terms. The state, however, doesn’t have a particularly good record at controlling money, because it is subject to democratic pressures. Until 1997, the Bank of England was controlled by the Chancellor of the Exchequer, who decided interest rates politically. The first act of the incoming Labour government in May 1997 was to make the Bank independent of political control. Before then, monetary policy had been intensely political, with Chancellors routinely loosening policy in the run up to an election, to stimulate expansion, and then facing the consequences of higher inflation afterwards. Of Conservative Chancellors between 1989 and 1997, only the last, Ken Clark, did not mess with the money in the run up to the election, because he hoped that Britain would swiftly join the Euro after it. It was this single decision, to grant independence to the Bank of England, that most of all justified Gordon Brown’s claim to have ended “boom and bust”. We now know that he hadn’t; by decoupling it from the political cycle, he managed to make both the booms bigger and the bust worse.
I am not persuaded by either the libertarian right or by the modern-monetarists on the left; and in my next post in this series I will explain why.