Thursday, December 12, 2013

Reconciling MMT and the Current Legal Finance System

Modern Money Theory (MMT) explains the way finance works in a country with its own currency, when many self imposed legal constraints are removed. Currently existing legal constraints in the United States include the following:

1) a national debt limit

2) the Treasury can only mint coin

3) the Federal Reserve bank (Fed) can issue paper money and credit Treasury and private reserve accounts in payment for notes, bills and other Treasury and privately issued financial assets it buys in the open market. The Fed cannot buy Treasury securities directly from the Treasury.

3) the income earned on assets the Fed purchases is paid to the Treasury

4) the members of the Fed Board of Governors are appointed by the President and approved by the Senate.

In these legal constraints we see and attempt to make the Treasury and Fed somewhat independent, but also subject to government action in the final analysis. This is probably due to the time period when these laws were enacted, when the country was on the gold standard. We are no longer on the gold standard now,  so some no longer apply, as we are now a country with a fiat currency. If held strictly to the current legal constraints, the country is treated like an individual or state which must use tax collections or borrow in it’s own currency to finance its operations.

The contention between MMT advocates and its critics largely revolves around the independence of the Fed from the Treasury. In practice, over the years the Fed and Treasury have acted jointly on the vast majority of matters, for example, in Fed provided loans to bring reserve accounts up to the required level and in purchasing Treasury notes and bills from member banks to lower the interest rate the Treasury needs to pay on them. MMT economists tend to treat the Treasury and Fed as a consolidated unit. Critics sometimes do not. Both have a point and the difference is not likely to be resolved any time soon.

The downside of the current stalemate serves to reinforce the commonly held premise that the federal government needs to be treated like and individual or state that is a user of the currency and not like the issuer to the currency that it is, which leads to policies that are the exact opposite of what is needed when the country is in a recession or near depression and unemployment is high. The current emphasis on cutting spending and limiting debt, when fiscal stimulus or reduced taxes are needed to increase demand is an example of this case. When the country is prospering and at full employment taxes need to be increased or federal debt repaid to avoid inflation. These necessities, and the need for changes in the law to accommodate them, are obscured by the lack of understanding of the underlying principles that MMT  seeks to reveal .

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