Yves here. Please welcome István Tóth, who was so gracious as to submit this article. It describes the way that Milton Friedman adopted some ideas that the precursor to Modern Monetary Theory, “functional finance” embraced, at a time when the latter was a hot topic. Tóth then describes how Friedman’s ideas evolved into something very different, his famed monetarism.
Some observations, since not all readers will know the fine points. One is the reliance of Friedman and his allies on “fractional reserve banking” as how the banking system works. That has been disproven although far too many business schools and economic departments remain anchored to discredited ideas. Banks do not intermediate existing savings (that is another fallacy, the “loanable funds theory” which plagues modern macroeconomics). They create money out of thin air. New loans create deposits. Paying back loans destroys money. The constraint on this process is reserves, which the central bank will create subject to its interest rate target.
In addition, Friedman’s monetarist were disproven in central bank experiments under Reagan and Thatcher. They found that changes in money supply did not correlate with any macroeconomic variable, which is the opposite of what Friedman posited.
By István Tóth, Economist, Managing director of Port of Gönyű, Hungary
In his 2012 book Modern Money Theory—a particularly elaborate exposition of the school that goes by that name—L. Randall Wray makes a rather surprising observation: in his 1948 essay A Monetary and Fiscal Framework for Economic Stability, Milton Friedman outlined a fiscal–monetary framework that bears a striking resemblance to Abba Lerner’s concept of functional finance, which in turn stands as a cornerstone of modern monetary theory.
Modern monetary theory (MMT) rests on a single central insight: unlike other actors in the economy, the state is not merely a user of money but also its issuer. Since, in technical terms, the state can create money without limit, its spending is not constrained by revenues; it is constrained only by the scarcity of real resources. In other words, the state can finance any expenditure by creating money, independently of taxation. Proponents of MMT—following the ideas of Beardsley Ruml, a former president of the New York Fed—argue that the primary role of taxation is not to fund public expenditures, but to serve socially desirable purposes (by discouraging or encouraging certain activities), as well as to regulate the amount of money in circulation. For this reason, the budget balance itself has little economic policy significance: it is a mere residual, the arithmetic difference between revenues and expenditures, a figure in an accounting statement. It is precisely here that MMT meets Lerner’s doctrine of functional finance.
As Lerner explained in his 1943 essay Functional Finance and the Federal Debt, the true measure of economic policy success is not the balance of the budget but—very much in line with Keynesian thinking—the achievement of full employment and high utilization of productive capacity, paired with stable prices. In other words, the equilibrium of the economy as a whole. Fiscal policy should be judged solely by its impact on the economy, not by the conservative requirements of orthodox budgetary thinking. The evidence of excessive government spending is not a budget deficit, but inflation; likewise, the evidence of insufficient government spending is not a budget surplus, but unemployment. For this reason, government should regulate the volume of its expenditures so as to avoid both unemployment and inflation, while the budget balance remains of secondary importance. Ensuring full employment may well involve persistent deficit financing—as long as the price level remains stable, this poses no real economic problem. According to Lerner, government could even sustain full employment without debt growth, relying purely on money creation. In this case too, avoiding inflation is the sole limiting factor. To curb inflation, government may raise taxes or issue bonds to withdraw money from circulation, emphasizing that in this context government bonds play no financing role, serving only to regulate the money supply.
In his 1948 essay, Friedman proposed that the Federal Reserve refrain from open market operations and other discretionary interventions, while requiring commercial banks to hold 100 percent reserves against all demand deposits. As a result, changes in the money supply would depend exclusively on the government’s fiscal balance. Friedman also advocated a fixed structure of government expenditures and revenues. Taken together, these measures would make the volume of money in circulation fluctuate with the level of economic activity: in recession, deficits financed by money creation would expand the money supply, while in booms, surpluses would contract it. In this way, the budget’s position would exert an automatic countercyclical effect on purchasing power and aggregate demand. The abolition of open market operations, the requirement of 100 percent reserves, and the fixed fiscal structure were all meant to ensure the smooth functioning of this mechanism.
Wray’s suggestion, then, is not without merit: Friedman’s 1948 fiscal–monetary framework indeed departed from fiscal orthodoxy, and the regulation of the money supply through the budget balance, in the service of economic stability, did resemble Lerner’s functional finance. Yet there was an important difference: Friedman’s ultimate aim was to insulate policy from the uncertainties of discretionary decision-making by means of an automatic rule-based framework—a quasi-autopilot mechanism—whereas Lerner’s functional finance sought to provide theoretical foundations for discretionary fiscal policy.
Where, then, did the theoretical similarity come from? Wray argues in his 2012 book that in the 1940s the idea of functional finance was “in the air,” widely shared across the political spectrum and far from marginal. This claim, however, is only partly accurate. By the mid-1930s many economists had indeed accepted that in times of recession government could stimulate demand through active spending—even deficit spending. Yet Lerner himself complained that most of his contemporaries approached the principles of functional finance timidly, with compromises and only partial understanding. The prevailing interpretation of deficit financing remained half-orthodox, as most economists refused to embrace its full logical implications. What can be said with certainty is this: Friedman did not draw his 1948 framework from the Keynesian air of the times.
Friedman did spend two years at the University of Chicago in the 1930s—first as a graduate student (1932–33), then as a research assistant (1934–35)—but he did not return there as a faculty member until 1946. In the early stage of his career Friedman was mainly occupied with price theory, and it was only with the 1948 essay that he gave his first indication of turning to monetary economics. In fact, the essay can be seen as his debut as a monetary economist. Yet it was not particularly original: Friedman’s fiscal–monetary framework was a direct continuation of what the Keynesian Alvin Hansen had labeled the “Mints–Simons program,” developed by a handful of University of Chicago economists during the 1930s and early 1940s.
In those years a small circle of Chicago economists—notably Paul Douglas, Frank Knight, Lloyd Mints, and Henry Simons—constructed a policy-oriented framework for economic stability, built on Irving Fisher’s equation of exchange and spurred by the turmoil of the Great Depression. While they differed on details, they shared the conviction that business cycles were caused by instability in the velocity of money—that is, in money demand—which was further amplified by the fractional reserve banking system. In other words, economic fluctuations had fundamentally monetary roots, and fractional reserve banking was eo ipso unstable. They also attributed the Great Depression to an autonomous fall in velocity. On this point, their views closely paralleled those of Keynes with respect to the downturn phase of the cycle. They also agreed that fluctuations in velocity could be offset by appropriate changes in the money supply. Yet they maintained that in times of crisis Federal Reserve open market operations were ineffective, as banks were unwilling to lend and firms unwilling to borrow. Put differently, in crisis, policy instruments operating through the banking system were useless, and monetary expansion had to be carried out through the government’s fiscal position—i.e., by financing increased budgetary expenditures with money creation, which directly injected additional money into the economy. Consequently, the Chicago economists called for abandoning the gold standard, introducing flexible exchange rates, mandating 100 percent reserves, and—most importantly—using deficit-financed spending in times of crisis. At the same time, they also viewed discretionary fiscal policy as a source of instability. Thus, to prevent crises, they advocated introducing a monetary rule that would render the velocity of money more predictable and stable. These ideas were essentially formulated as early as 1933, and Friedman’s 1948 essay was directly rooted in them. Far from being “in the air,” they laid the foundations of a specifically Chicagoan monetary tradition.
Yet the Mints–Simons tradition of the 1930s and 1940s—what is now often referred to as “old Chicago”—was not identical with the monetarism later associated with Milton Friedman. Through his correspondence with Clark Warburton, the first genuine monetarist economist, and through his joint empirical and historical research with Anna Schwartz, Friedman in the early 1950s began to distance himself from the Mints–Simons framework, and over the course of that decade eventually turned it upside down. As we have seen, the old Chicago economists believed that economic instability stemmed from autonomous shifts in money demand and the inherent fragility of the banking system, which had to be offset by adjusting the money supply. Friedman, by contrast, came to the conclusion that money demand and the banking system were essentially stable, while the true source of instability was the fluctuation of the money supply itself, resulting from the discretionary policies of the Fed. This realization also implied that monetary policy could be highly effective—though not always to the economy’s benefit. In other words, whereas old Chicago sought a framework to counteract instability arising from the private economy, the monetarist Friedman’s aim was to establish a rule-based system that would shield the private economy’s inherent stability from disruptions caused by discretionary policy. In this last respect, he remained faithful to the old Chicago tradition. Just over a decade after the 1948 essay, his 1960 book A Program for Monetary Stability presented the fully armed Friedman of monetarism.
In his 2012 book, Wray refers to Friedman partly in order to enlist a prestigious name in support of functional finance, and partly to suggest that Lerner’s ideas in the 1940s were “in the air” and anything but marginal. The history of ideas, however, paints a somewhat different picture. Friedman only approached functional finance in 1948, as a temporary adherent of the Mints–Simons program—a program that was far from widely accepted at the time. Moreover, Wray overlooks the fact that invoking Friedman is somewhat double-edged: for while it may be true that Friedman began as a sort of “proto-MMTer,” he ultimately became the leading monetarist. Which may also be taken to mean that today’s MMT enthusiasts, too, might yet find their way toward monetarism.
References
Friedman, M. (1948). A Monetary and Fiscal Framework for Economic Stability. American Economic Review, 38(3), 245–264.
Friedman, M. (1960). A Program for Monetary Stability. New York: Fordham University Press.
Lerner, A. (1943). Functional Finance and the Federal Debt. Social Research, 10(1), 38–51.
Tavlas, G. (2023). The Monetarists: The Making of the Chicago Monetary Tradition, 1927–1960. Chicago: University of Chicago Press.
Wray, L. R. (2012). Modern Money Theory. London: Palgrave Macmillan.
America needs to be re-balanced. Kindness, decency, and moderation. Go, Zohran, go!
The history outlined here shows just how close mainstream economics has occasionally come to embracing radical ideas like functional finance — only to retreat back to orthodoxy when the implications threatened established interests. That is why the financial status quo is unlikely to sanction anything resembling Modern Monetary Theory (MMT) on a practical level. It undermines the hegemony of existing financial actors by challenging the myth of money scarcity, and with it, their power to control access to credit, liquidity, and legitimacy.
If we accept that resistance is inevitable, then the task is not to wait for permission, but to act more wiley — to think like a hacker of the system. Rather than challenging the citadel head-on, we can prototype parallel operating systems that demonstrate better outcomes and quietly spread by proof of use.
This is precisely where Community Benefit Tokens (CBTs) come in. Unlike MMT, which relies on a sovereign government to exercise its money-creation powers responsibly, CBTs allow communities themselves to issue and circulate tokens backed by real, measurable value: the elimination of waste and the growth of health, wealth, and happiness.
CBTs function as a bottom-up functional finance:
They mobilise underused resources without waiting for state reform.
They re-frame money as a tool for regeneration, not extraction.
They create new information assets (proof of impact) that can be licensed and scaled across places.
In short: if MMT remains trapped by the politics of nation-states and the guardianship of orthodox finance, CBTs offer a way to sidestep the gatekeepers and start building an alternative now — a hacker’s route to monetary reform.
This also serves as a solution to local liquidity stumbling blocks. Not to mention mental blocks. And mobility roadblocks. Literally. Because we are becoming less mobile by the minute. Not only for lack of gasoline and charging stations, but lack of opportunity. And the more we become internet-connected and fluent, the less we need to run around. So here we all sit twiddling our thumbs and suffering vague apprehension about the future. We might as well pick up the shovel and join a work crew and a local council, and create sustainable local wealth. CBTs are already allowed, IIRC, because any taxing authority can issue a currency. Or establish a “time bank”.
According to MMT, taxation is usesful for discouraging and encourage certain activities, and taxation is furthermore necessary to regulate the amount of money in circulation, as the article correctly states.
But these are not the primary purposes of taxation, according to MMT. The primary purpose of taxation is to create a demand for money, to give it value. As MMT economist Matthew Forstater explains in the below linked article, the state does not need the money it alone creates; it needs the people it taxes to need its money. It does that by requiring them to pay taxes (and also by requiring fines, etc.) in its currency.
This purpose of taxation is logically prior and more fundamental than its use in regulating economic activity and managing the money supply.
Forstater illustrates this via the example of colonial curriencies created by the British in Africa, in this gem of a paper: https://tools.bard.edu/wwwmedia/resources/files/941/WP%2025%20-%20Taxation%20-%20A%20Secret%20of%20Colonial%20Capitalist%20(So-Called)%20Primitive%20Accumulation%20-%20Forstater.pdf
The same principle is illustrated by Warren Mosler’s well known anecdote about how he got his children to do household chores in exchange for his own business cards by requiring them to pay “taxes” to him in this token currency.
A Forstater’s paper fascinatingly demonstates that Marx himself understood how fiat currencies were created in this manner in colonial contexts, though he completely failed to apply the insight when he endorsed the false commodity theory of money in the first chapter of Capital, vol. 1, to the eternal detriment of the Marxist tradition.
Great comment.
It’s the Glibertarian/Conservative utopia of money as a natural occurrence (which they naturally have while others, for whatever naturalistic reason is currently fashionable, don’t) that drives this persistent misconception of the obvious.
The incentive structure endemic to the very idea of money tugs heart(lessness) strings of sociopaths and authoritarians
While I enjoyed reading about this historical evolution in economics, the section at the end that is quoted above strikes me as quite a leap of logic. I don’t want to be completely dismissive of the author’s conclusion. Surely, someone from MMT economics could provide some sort of agreement or disagreement to this conclusion.
I agree the last paragraph seems to be a lot of hurried thought which may or may not include real logic. A key give away is no reference to the possibility that Friedman changed his beliefs to forward his career. The economics profession is full of people who push forward all sorts of so-called research because it gets funding, not necessarily because it’s valid economic research. I mean it’s not like monetarist ideas are the only false economic assumptions that don’t ever seem to die.
Guilt of association. Friedman is pretty unpopular across the political spectrum. Do we want to be like Friedman? Probably not. His ideas got into academic journals for there ‘establishment’ aesthetics. Whereas Hayek got all the cool kids talking about Austrian economics.
L. Randall Wray said pretty much the same in a lecture I saw on YouTube. The origin story of money. I wonder if I can find that again.
RE: “To curb inflation, government may raise taxes or issue bonds to withdraw money from circulation…”
I understand the tax part, but how does issuing bonds withdraw money from circulation? Since bonds pay interest, the overall net effect would seem to be to increase the money supply, which increases inflation. Is the thought that investing in bonds takes the money invested out of circulation until the bond matures? And if so, then taxing takes money our of circulation permanently, while bonds take it out temporarily, correct?
If the bonds are used to get people to refrain from spending on goods that are not being produced in sufficient quantity, this fights inflation.
For example, during WW2 the US economy was paying lots of workers to produce things for the war effort, and not enough houses, cars, and other civilian goods were not being produced. If these workers had spent their earnings on scarce consumer goods, it would have caused inflation. The government’s solution was to get people to invest their earnings instead in “war bonds,” which were sold to the public as financing the war effort, though the real purpose (as archival records reveal) was to prevent inflationary spending. When the war ended, and the economy returned to civilian production, the government managed this process very carefully to ensure that there would be new housing and cars and other expensive things being produced in sufficient quantities to absorb the money that was being returned to investors as the bonds gradually came due.
Episodes 32 & 33 of the MMT podcast, are a two-part interview with Sam Levy, who describes his fascinating paper on this history. It reveals that the economists who dreamed up the plan knew very well that the bonds did not literally finance the war effort, and that their explicit purpose was to prevent inflation. In other words, they understood MMT long avant la lettre.
Episode 32: https://pileusmmt.libsyn.com/32-sam-levey-how-uncle-sam-paid-for-world-war-ii-part-1
Episode 33: https://pileusmmt.libsyn.com/33-sam-levey-how-uncle-sam-paid-for-world-war-ii-part-2
It’s actually pretty amazing to think about how advanced the generation in charge during the 1940s really were: nuclear engineering, jet engines, chartalism, progressive income taxes, social insurance, world peace through trade and quasilegal institutions…
My understanding is that Treasury bond sales move reserves (account balances of banks at the Federal Reserve) from non-government bank accounts to the Treasury account (at the Federal Reserve). This does decrease the “money supply” because (as I understand it), non-government bank account balances at the Fed are included in the monetary aggregates while Treasury account balances at the Fed are not included.
(Aside — and this is why “spending creates money”, because when the Treasury pays for something that the government has purchased from the non-government sector, reserves are transferred from the Treasury account (at the Fed; this is not included in the monetary aggregates) to the account of the non-government bank at which the payment recipient banks; this is included in the monetary aggregates).
Control of the level of reserves in the banking system is needed for Federal Reserve monetary policy. If the level is too high, the overnight interbank interest rate will fall toward zero and the Fed will lose control over short-term interest rates (alternatively, the Fed could pay interest on reserve balances, in which case it could maintain control over short-term rates without the need for Open Market Operations to manage the level of reserves in the banking system).
Thank you both above!
I thought I’d provide some added info on Yves comment on how monetarism was operationally disproved during the Reagan years. As has already been pointed out, these experiences should have put a nail in the coffin of monetarism, but since economics is too often driven and supported by those with ideological goals it just doesn’t seem to die even when faced with reality.
As anyone who is well schooled in MMT or the workings of banking can (or should be able to) tell you, the creating/making of a loan will net yield a new deposit in the banking system. New loans invariably create demand for more central bank funds for a couple of reasons… 1) the new loans create more interbank transactions which require more funds to successfully clear and settle those payments 2) if the banking system has a reserve requirement more central bank funds are needed to meet those requirements given the new deposits.
In August of 1979, Paul Volker, was appointed the Chairman to the FED. I do not recall the date of the decision, but a college professor of mine said it was a decision the financial world would never overlook should it happen again. Anyhow at some point Mr Volker and his team decided they would rain in the growth of the money supply by restricting Fed reserve balances – it’s new target would be the “monetary base”.
Historically the FED has managed the supply of FED reserve balances by targeting an interest rate and then adding or subtracting balances via buying and selling US Treasuries in the US treasury bond market. Volker’s new policy would be to limit the amount of additional new balances the FED would add to the treasury market regardless of what happened to interest rates.
The monetarist idea was that if FED reserve balances were more fundamentally controlled, money creation and inflation would be controlled.
While history does indirectly show that Volker’s policies helped with inflation, the reality is that the near collapse of the financial sector (caused by Volker’s policy) and the worst recession since the great depression is what brought inflation down. It should be noted, the Volker’s policies likely set the seed for what becomes the Greenspan Put assumption in finance.
The only thing that prevented the collapse of the payments (i.e financial) system was the Volker agreed to not close the FED discount window. When a bank can’t meet its EOD reserve requirements (indirectly meaning it can’t or might not be able to meet its payment needs for the days settlements) it can borrow reserve balances from the FED.
Once the FED limited what it was adding to the Treasury markets interest rates went through the roof as FIs scrambled for funds to clear and settle payments and meet reserve requirements. It also meant dozens of FIs crashed into the FED Discount window everyday to borrow funds. This looked bad given the FEDs policy desires, so Volker’s FED decided they’d send bank inspectors to every FI who needed to borrow at the discount window.
Eventually lending dried up as rates and unemployment were onerously high, and the side policy of frightening banks with regulatory reviews if they needed MORE required reserves, but eventually and quietly the FED also abandoned its monetary base target because it was a proven failure. The knock-on consequence of the policy and its supporting policy of sending bank examiners to FIs who dared use the discount window would trigger the Greenspan Put.
When the “great crash of 1987” happened, the least known detail is that on the next day the markets opened… there was no market. Markets happen because of businesses called market makers. No one was willing to lend to these market makers the following day so there were no resources to complete any trades. It required Alan Greenspan and team to call all of the major lending institutions and promise them that if they needed the FED discount window that there would be no questions asked. Trading started shortly after there was credit available (and the FED balances to support the loans and the down stream deposits and transactions).
And to your last point, not just in the US. The Fed called the Bank of Japan and told it to buy Treasuries. The BoJ called all the biggest financials institutions and ordered them to do so.
I’m starting to get it. In the discussion on bonds here day before yesterday I asserted that banks create money by making loans and was corrected that the Fed creates the money and the banks just handle it.
I think a clearer picture is the Fed makes reserves available to banks but that money is not in the public sector. Banks originate the money in the public sector by making loans. The banks borrow money from the reserve and deposit it back as the loan is repaid. The bank keeps the interest.
That reserves are only potential money is evident by periods when the reserves are available but banks are not making loans necessitating the Fed to find other mechanisms to introduce liquidity into the system.
That sounds right to me, and whomever corrected you was wrong. Banks create the money and the Fed regulates and provides reserves as necessary so that the banking system doesn’t collapse.
> That reserves are only potential money is evident by periods when the reserves are available but banks are not making loans necessitating the Fed to find other mechanisms to introduce liquidity into the system.
This appears to me to imply the concept that “banks lend out of their reserve balances”. I think this is mistaken (though I also think it’s a common concept).
Reserves are bank balances at the Federal Reserve Bank. They are transferred between banks as payments are settled (a payee deposits a check at the payee’s bank; that many reserves are transferred from the payor’s bank’s Fed reserve account to the payee’s bank’s Fed reserve account). When banks lend, they simply create an electronic entry to document the loan amount credited to the borrower, and receive a loan note in return. No reserves required. If all the checks written by the borrower are deposited into the borrower’s bank (ie, if the borrower’s payees all bank at the same bank), no reserves need to move.
If the banks do not deposit the loan principle to the Fed then how does repaying a loan destroy the money (take it out of circulation? It is confusing. Banks are required to deposit money to fulfill their reserve requirement but banks do not originate the reserve.
Reserves get injected into the banking system when the Treasury makes payments (for things purchased by the government) or when bonds (previously issued by the Treasury) mature.
The idea that “repayment of a loan destroys the money the bank created when it made the loan” is accurate, but this has nothing to do with reserves. Bank lending does not create reserves (“vertical money”). When the bank makes a loan, it creates a deposit account balance in the name of the borrower (money creation — but note, this is “horizontal” money. It vanishes when the loan is repaid).
Banks can originate loans irrespective of the size of their reserve balances with the Fed. They will need reserves to settle payments when checks drawn against accounts of their depositors are deposited to other banks (and if they have insufficient reserves to settle such payments, they can borrow them from other banks on the interbank overnight market, or they can borrow directly from the Fed).
As I understand it, there are two parallel things happening — account holders’ deposit accounts are being debited and credited as checks are deposited. And correspondingly, the Fed reserve accounts of these banks are debited and credited as payments are settled (a check written on bank A was deposited to a different bank B — if A and B are the same bank, there is no movement of reserves).
Why is it done this way? I’m not sure, but I think it might be (in part) a mechanism to prevent banks from limitlessly making loans. The necessity to settle payments within the Federal Reserve System constrains lenders to make loans only to creditworthy borrowers.
“…and was corrected that the Fed creates the money and the banks just handle it.”
No that is incorrect at the macro level and even at an individual bank level if one look close enough. At the FI I work for it is sometime mentioned in amusement that we offer a small dollar short term loan and a secured credit card for people who are credit score challenged. Some people have figured out that they can obtain a small dollar loan and deposit that money into their savings and then use that deposit to obtain a secured credit card. The loan created the deposit.
To the extent that the institution needed more reserves, it would have just sought more reserves via any normal business operation… like acquiring deposits, issuing bonds or borrowing on the FED funds market. In aggregate if there are a lack of reserves available the FED adds those funds; that’s why it has a target interest rate. When the market pressures pushing up or down on that rate the NY FED adds or withdraws funds from the overnight market to keep the rate in the desired range. Note these day to day actions are REACTIVE, not proactive.
Also note that if the FED moves the target rate up or down it is in aggregate only changing the cost of reserves; it is not depriving or taking away any necessary money for the system to operate – at any given rate point the FED will provide any level of funds to hold that rate (or range of rates). But again, the level of reserves provided is of no limit and it is reactive relative to demand and the policy change.
This seems to be a mostly historical discussion. I would think much recent empirical data could help resolve the argument between Lerner and Friedman as to the root cause of monetary instability.
There is a big difference of (mostly?) “opinion” here with major policy implications. To summarize (as I understand it) Lerner thought the root cause of the monetary instability was in the private sector (e.g. “shifts in the autonomous demand for money” and “the inherent fragility of the banking system”), “which had to be offset by Fed actions to adjust the money supply”. Whereas Friedman thought that private “money demand and the banking system were essentially stable, while the true source of instability was the fluctuation of the money supply itself, resulting from the discretionary policies of the Fed.”
Sheesh, fifty years later, are we any closer to resolving this? This is a really big deal, because the policy implications for justifying Fed interventionism are profound. Is the instability coming from the private sector or from the Fed? Is government intervention necessary or a root cause of the problem?
I thought that one basic assumption of Friedman — that Velocity is pretty stable — has been disproved empirically, but I’m not sure whether the instability in velocity is due to Fed actions (as happened during QE) or the fragilities of the banking system or Fed intervention. Or is the root cause sometimes one or the other, depending on business conditions?
I think the Great Financial Crisis had as root cause private sector fluctuations due to shifts in demand for CDS’s, CDO’s and declines in the housing market, all within the private sector.
We do know that the Fed does not operate robotically according to rules, as Friedman wanted. It still has all the discretion it has ever had. Would a predictable, rule-based Fed be better?
Can someone in the NC commentariat shed light on how MMT and/or mainstream monetary theorists see the empirical evidence on this issue?
MMT theorists, I think, would argue that monetary policy is not the right tool to use for steering the macroeconomy. I think that they tend to prefer that short-term rates be kept low and that the twin policy goals of stable prices and full employment be fulfilled through fiscal (spending/taxation) policy. They think that the Fed is the wrong body to have responsibility for achieving the “dual mandate” policy goals of full employment with price stability.
If you have the time, you may find Randall Wray’s MMT Primer to be helpful. In the last dozen chapters there is a heavy emphasis on a MMT-informed positive proposal for “full employment with price stability”, the “employer of last resort” concept, aka the “Job Guarantee.”
I would agree with the theorists but fiscal policy is generated by congress, a thoroughly fickle body. The Fed is necessary as an independent semi-rule based counter. We have seen congress (GOP) not pass infrastructure spending when interest rates were zero because they didn’t want Dem’s to have a win. At that time the Fed said their policy was driven by lack of fiscal solutions from congress.
There’s a lot to be said for “automatic” policy processes that don’t require discretionary action by Congress. It sounds from the main post like Friedman was thinking along these lines at one time. The MMT “Job Guarantee” concept, if it were implemented in long-term legislation and given funding that Congress could not interfere with, is an example of an automatic stabilizer mechanism that would work countercyclically, without need for Congress to react to developments in the macroeconomy.
Perhaps it will be attempted at scale somewhere, somewhen.
Put it this way … Raygun back in the day was fully aware about all the hot money associated with cocaine moving through Florida. It was a good thing because the flows were pulling Florida out of a economic dump and pumped money into everything being built at the time. Cough … Florida at the time was a huge issue for the GOP and wanted to cement it as a conservative state. Heck even the whole social use of the drug was seen as a good thing, driving business people to be more Hayek like – making money is the most rational thing eva … screw altruism.
It was only after a very public shoot out between LatAm gangs in a shopping mall parking lot, total paramilitary level stuff, did Raygun sic the security apparatus on the non white sorts to be seen as dealing with it.
I was never sold on monetarism. They mostly relied on some form of MV = PQ where M – money supply is the variable, while V – velocity is assumed to be constant and then equal price times quantity. This theoretically, allows the money supply to be the big lever in managing the economy. The problem is that velocity can’t just be assumed to be constant. New markets open, new opportunities, competitive position changes, offshoring production happens – the factors that affect velocity are infinite and affect the economy in different ways and to different levels. Holding velocity constant is an example of what I call assuming your conclusion – because when I don’t allow it to change then my equation works every time – but it is totally unrealistic. Yes it works on paper but for the study of economics to have any use value it needs to also work in real life.
I find the Monetarists and the Marginalists (Neo Classical) economists make this mistake all too often. I also find the MMT people making similar errors. The start with this assumption of being a state being a monetary sovereign – a creator of money. When a case like Argentina or Britain comes up where they government can create money but nobody wants to hold it – well I guess they aren’t really sovereign, so the model still works. How can a state be a monetary sovereign if it can’t levy taxes as it sees fit?
Fiat money is a invention of the state and the particulars can vary by state. When the political process takes over the printing press inflation ensues and the money becomes less functional, something Trump wants to experiment with. Otherwise most anything can serve as money but nothing is as efficient as fiat. It seems to have the most moneyness of any money.
Now we have bitcoin and stable coin
“Anything can serve as money.” Exactly, if I want to buy something but don’t have money I issue an IOU, which has the same effect as money. The only trick is that the seller has to accept the IOU. Same thing when a monetary sovereign creates money, it creates an IOU and it works fine as long as holders are willing to accept it.
The bit about being a monetary sovereign wrt MMT is only applicable to 7 nations with developed economies e.g. Argentina never was or has been a autonomous monetary sovereign. Britain has whiteanted its economy since TINA/FIRE Sector econ along with making the City of London its cornerstone e.g. over financialized.
This is why its interesting to see Russia/China play by different book[s. Russia sorted out a bunch of stuff like taxation, tariffs/sanctions/300B frozen became capital outflow controls, SMO paved the way for the Government to fund non profit MIC Mfg i.e. jobs for non military personnel and personnel coming out of the military service. Big deal on the latter as it assists in reintegration to social society. Yet as Yves has noted they have not strayed far from Orthodox economics.
China on the other hand has really gone on an adventure with a multivariate approach of state and private. State controls/oversees the critical economic policy decisions whilst both supporting and funding a percent of market based innovation. When the private sector, due too profit[tm] incentives, me get rich IBGYBG it clips its wings and offloads it in a SV to go poof.
Contra the whole reason this blog was started with all the hard data showing the GFC [credit risk] was coming …. years … couple of bespoke Oz firms go splat to bad maths … B&S … boom. All due to unenlightened self interest as funded by U.S. elites in shaping a utopian society …. now look at it ….
Only applicable to 7 nations? Which 7?
MMT proponents appear to argue that it can work anywhere the state is the issuer of the currency. I wondered why it wasn’t tried in Argentina. I wonder if it will be tried in England — I hope it will be. If it works, great, England will get back on its feet and show the world how things can and should be done. If it does not, then the experiment should put an end to this century long debate.
This is old hat on this blog. Seek it.
MMT is open to 7 exceptional economies and fails everywhere else. Seems like a pretty limited academic pursuit.
MMT is just a description of monetary accounting for autonomous monetary sovereigns – nothing more. Its not cookie cutter economics based on deductive rationalization/s and then projected on every nation, some are told to obey BTW.
As far as academic pursuits go wellie see Monetarists/Marginalists clinging to their opinions. Worse some will cling to their so called laws when demonstratively shown its wrong, some like Tom Sargent [if memory serves] said that is what – he – chooses too ***believe***. Then Milton Friedman before becoming a poster boy for economic right think was found guilty of writing propaganda for the real-estate developer lobby by a congressional hearing. Using his academic credentials for burnishing a payed for outcome for his clients.
Good luck with that one size fits all economic theory stuff ….
What is the test for a monetary sovereign? My understanding is that a monetary sovereign can run its monetary and fiscal policy as it sees fit. So when Trump had his Liberation Day, where he increased tariffs willy-nilly on various countries. The market response was that the prices on treasuries dropped and Trump had to pause the changes and figure out a different way to implement them. Trump was not as sovereign as he thought he was.
It is not about fitting a theory to a country, it is about understanding what is similar to each economy, how it changes through time, and how those changes affect the people in that economy and testing your theories for validity against that reality. If your theory only works in one spot at one time and relies on a series of assumptions that actually lead to the conclusion you want – it doesn’t have much use value.
I think that “monetary sovereignty” should not be thought of as a binary condition, but rather as a continuum of “degree of fiscal space”, depending on the currency arrangements, the size and composition of the national economy, the trade balance, whether the currency floats or is pegged to an external currency, etc. Some governments have a lot of fiscal policy freedom; others have very little.
US has significant fiscal space (in part due to its currency being the primary international reserve currency). Arguably, Russian Federation has even more due to the autarkic character of its economy. Eurozone governments have much less, since they are currency users rather than issuers (and there are other problems, such as dependence on external sources of natural resources).
Some of these considerations are discussed in chapters 25-29 of Randall Wray’s MMT Primer (I keep linking to this, perhaps to reader annoyance. I think very highly of Wray’s presentation).
MMT calls itself a “theory” (which in conventional parlance might imply uncertainty about its validity), but it’s simply a “description” (an accurate one, as far as I can tell). It applies even to governments that have much less fiscal space than US has, and it recognizes the limitations on fiscal policy that such governments face.
Agree with the black and white thinking wrt MMT. Per se developing nations don’t have the economic depth or currency flows to utilize MMT.
NEP has it all laid out for anyone that is curious. Problem is there are no simple answers as things have moved from a hard floating currency, a Gov set price/convertibility, too a fiat currency with hard currency hangovers – based on ideological preferences. Some economic sorts still think the government borrows money from people buying treasuries, ugh, at that level its in house only ….
I think there has been a BIG part of the picture left out here.
When Milton friedman’s name wasn’t a bad thing…. in the 1930’s….
the “chicago plan” of 1939, that was signed on by @ 157 economists… like irving fischer, simons, and many others including milton friedman… and @ what like 400 institutions.
The big point , which was very clearly stated in the paper…. was that the federal reserve was a private organization of a collaborative of private banks.
The same debate is held to this day. The fact that the banks, own, fund, supply the people to run all the twelve branches of the fed. They supply ” the story” , of how the fed is “independent”, or quasi-public private…. despite being a creature of these banks who OWN the shares and voting rights that control everything, that inform the congress, how they should act, and it has never been audited. 100 years of “believing them”. that this is the best way to go.
It seems much of MMT… would really have been what the monetary reformers would have addressed as the factual functions of fiat in practice. The real world applications of how to keep control of the monetary system. Whereas, the big point is that the private banking controlled FEDERAL RESERVE, really functions to enable wall street to control the economy for their own collective benefit. The constitution laid out that the power to create money should be with congress. Which means that the day to day controls on the money supply would be handled by the treasury .
How were all of these learned economists “fooled” in the thirties that the fed wasn’t part of the government?. Yet, the problem of MMT, in general, is just allowing all of this fiscal architecture to be owned and maintained by wall street interests who are often an interest that is preying on the population like a predator.
Even Dr. Hudson regularly points out that the chinese now have chosen not to let their central bank to be in the hands of private actors. The chinese must be applying these same MMT principles(if this is indeed how money works); yet they have the ability to control the banking system and allowing it to work for the benefit of the people of china. This is how they fund their growth that is allowing them to gain the dominant position in the world in every way.
But straight up MMT mantra, omits the private control, for private growth, at the expense of public good.
Whereas, Monetary reformers point out that there needs to be an end of control of the monetary system by those who control the banking system. Those whose business is making money. Those well meaning people who believe the MMT mantra, always seem to assume some “well meaning intention” to the federal reserve and the american banking system. As if , just letting them do things as they are doing now… they wil take care of everyone and everything.
The good things. the commons. cannot be monetized by a healthy society. We are not a healthy society.
In 2011-2012 1112th congress, Dennis Kucinich proposed a new Chicago plan. “the NEED ACT” HR 2990… everyone should read it. It is there for everyone to see.
The point is the same…. separate our monetary system from the private banking system of control.
*Sigh*
Milton Friedman was a grad student and at most co-author on some articles in the 1930s. He didn’t become an assistant prof until 1940. So he was just one rung above being a nobody then.
The regional Feds are not private. That is a myth promoted by the right. They have no owners. The preferred shares distributed to Fed system members do not confer any ownership rights. They are merely a mechanism for distributing seignorage profits to Fed members to give them an incentive to be in the system.
Well friedman was working in the us gov’t by 35, and with the board of economic research. I wasn’t saying he was a major force behind anything. I think his “getting religion” and being a finance shill proves who he actually became… but early on he at least could see where the main problem was.
And , saying that the regional fed banks aren’t “owned” because the “shares” only are a means of “getting paid”, is only an excuse for someone not wanting to see the forest through the trees.
It is the groupthink, that pervades our inherently incestuous financial system that IS ruining the world as we speak.
So I’m going to go with those guys, and all the others( even some on “the right” who have a silly idea of ownership, but hey at least they can tell when smoke is being blown in their faces), who correctly point out where propaganda comes from.
Yes, he was a junior beancounter It was the only job Friedman could get in the Depression.
I suggest you bone up on the Powell Memo. The right has systematically sold vastly more economic propaganda than the left
yes
The Powell memo is a hell of a thing. Talk about being awarded for a job well done, the future(at that point )supreme court justice. It says so much for anyone interested in what happened. It is amazing the degree people who hated FDR and the NEW deal.. holding onto a grudge for 40 years.. before they could take advantage of the decades spent preparing the american population. The movie, “heist who stole the american dream” is a great thing to watch for people to get started. And really, the never ending spigot of money that has always been available for “the right”. anti labor forces in society. whether it was gen smedley butler’s foiling the plot to overthrow the US gov’t in @ 1934, by the fascists/industrialist/banker.. to the funding of hyeck and the mount Perelin society , or even the university of chicago economics dept… or even the british roundtablers , createdin 1891 in britian , later creating the council on foreign relations in the us in 1919, and the royal institute of international affairs1919 in britian.
Big monied interests have long chosen to go the route of “pre-education” to bring about public opinion.
Too bad there no money in doing the right thing. No competitive advantage. So we never get an unending stream of money paying for the education of americans to take care of themselves first, and let big business prove why they are worth giving tax breaks to.
Private ownership of the Fed may indeed be problematic, but I think that the bigger problem is that Congress, by outsourcing macroeconomic management to the Fed, has abdicated its duty to the American people to serve their interests. The Federal Reserve has only one conventional policy tool, the overnight interbank interest rate, but has been assigned two objectives, price stability and full employment. In practice, (as Stephanie Kelton poignantly observes in her book The Deficit Myth), the unemployment level is treated as a policy tool and is adjusted to the level necessary to restrain price inflation (the NAIRU concept). The Fed controls inflation by managing the level of human suffering in the economy.
MMT theorists generally advocate Federal legislation to create a robust automatic stabilizer program, the “Employer of Last Resort” concept, aka the “Job Guarantee”, and to rely on fiscal policy, in part through the Job Guarantee program, to achieve full employment with price stability.
Chapters 42 through 50 of Randall Wray’s MMT Primer discuss the Job Guarantee concept.
Nice article, thank you!
May I suggest replacing the phrase “banks create money out of thin air” by “banks engage in contracts, thereby creating debt/credit pairs”?
Money creators go to jail, remember?
This was the crux of what 5000 years of Debt was banging on about e.g. money since before it was recognized as a circulated token … was a contract i.e. not says law with a side of barter. Small inter personal – contracts – which then evolved with the advent of city/nation states.
Not that elites game the dynamic for self serving reasons or anything …