"Monetary policy doesn’t work. What does work are fiscal adjustments "

An interview with Warren Mosler, a founder of the Modern Monetary Theory (MMT)

Antoni Soy, economist and professor of applied economics at the University of Barcelona

In recent years, a new economic theory has arrived at having an space between the heterodox schools of economic thought. Some people think that it may be tied to the Post Keynesian school although others put it in doubt. However, the influence of Keynes and even more of Knapp, Mitchell-Innes, Lerner, Minsky and Godley seem undeniable. For the proponents of MMT: "Sovereign governments that have the power to issue its own currency are always reliable, and therefore can afford to buy everything they want in their own currency even though sometimes they may have political constraints and also constraints linked to possible inflationary pressures."

Recently, one of its leading exponents, L. Randall Wray came to present his book "Modern Monetary Theory" which has been translated into Spanish; Randall Wray, meanwhile, writes regularly on his blog "Great Leap Forward" hosted by Euromonitor. Another of its leading representatives, the Australian WilliamMitchell, who also maintains a blog very prominent ("Bill Mitchell-billyblog") is scheduled to visit us next year to present the translation of his latest and very interesting book "Eurozone Dystopia: Groupthink and Denial on a Grand Scale". Stephanie Kelton, which is one of the leading representatives of MMT, is currently the chief economist of the Democratic minority in the Senate Budget Committee and a leading advisory of Bernie Sanders, progressive pre-candidate for the Democratic nomination to the US presidency. Many of them work at the University of Missouri-Kansas City (UMKC) and are tied to the "Center for Full Employment and Price Stability" at that university. The proponents of MMT encourage the blog "New EconomicPerspectives" and many of them work with the Levy Institute of the Bard College.

A few weeks ago Professor WarrenMosler, by many the founder of the Modern Monetary Theory, visited Spain. He came to present his book "The Seven Deadly Innocent Frauds of EconomicPolicy", published in Spanish by ATTAC Spain. So we thought that it was an excellent opportunity to interview him.

Question: Can you briefly explain your professional and academic career?

I spent my first two years at University of Connecticut as an engineering student before graduating in economics in 1971. My first real job was in banking at the Savings Bank of Manchester in my hometown in 1973. There I went from being a loan officer to being an investment officer. I grew up pioneering fixed income derivatives and arbitrage strategies on the money desk at Banker's Trust on Wall St. in the late 1970's, and then ran my own investment funds and securities dealer for 15 years. Until not too long ago I owned a small bank. During the course of my career I have regularly attended meetings at the Federal Reserve Bank and central banks around the world to discuss monetary policy and monetary operations. This has given me first-hand knowledge of how the banking system works, particularly with a non-convertible currency with floating exchange rates. It was through this understanding that in 1993 I began conceiving the academic paper that would become “Soft Currency Economics”. One of the first articles I published was 'Full Employment and Price Stability' in the Journal for Post Keynesian Economics in 1996, which is also the year when I co-Founded the Center for Full Employment and Price Stability at the University of Missouri Kansas City. For the past years I have been continuously involved in the academic community, publishing articles and giving presentations at conferences.

Question: What is essentially the Modern Monetary Theory (MMT)?

“Soft Currency Economics” which was published in 1993, can be considered the origin of the “Modern Monetary Theory” school of thought. It describes the workings of the monetary system, the currency as a public monopoly and how outdated gold standard rhetoric has been carried over to a nonconvertible currency with a floating exchange rate and is undermining national prosperity in countries across the globe. In a nutshell: MMT recognizes the currency is a public monopoly. MMT recognizes that taxation creates unemployment by design. MMT recognizes that the funds to pay taxes come only from the government of issue. MMT recognizes that unemployment is the evidence that deficit spending is too low to offset savings desires. MMT recognizes that a tax cut or spending increase reduces unemployment.

Question: How MMT is placed in the history of economic thought? Could you say that MMT is part of heterodox economic theories? Which is the MMT relationship with the other heterodox schools and specifically with the one that has been called the post Keynesianism?

It would be up to the proponents of those theories to respond to that question. My writings were independent of prior economic thought. I had never read Keynes, Knapp, Lerner, Marx or any other economic discourses at the time. After discovering the post Keynesians I suggested that my writings were a logical extension of their school of thought. So far, all but a few post Keynesians rejected that suggestion and have not moved to incorporate my suggestions into their school of thought. 

In your book, now translated into Spanish, you speak on the seven innocent (but deadly) frauds (following the terminology of the old Galbraith) in the economic policy. We would like to talk about it a little.

Question: One of the "innocent frauds" that you criticize is that, as in the case of families, government expenditures for the countries with its own currency (monetarily sovereigns) are limited by their ability to earn income. Could you explain it a little?. What conditions must be met so that a government can cope always with their expenses, i.e., it cannot have solvency problems?

The government that taxes in its own currency is not like a household subject to those taxes. A government that spends in its own currency of issue is in no case revenue constrained regarding that currency. In fact, unlike a household that is a user of the currency, from inception, the government of issue is best thought of as spending first, and then, subsequently, borrowing or collecting tax in that currency.

Question: But then, if governments with its own currency can always cope with their expenses, why the government forces people to pay taxes?

The currency is a tax credit, and it is the taxation that serves to create a notional demand for the currency. In other words, taxes are what drive the monetary system. Taxes do not finance government spending; the money to pay taxes has to necessarily come from the government as the monopoly issuer of the currency. The purpose of taxation for the government is to create sellers of real goods and services, with people looking for paid work defined as unemployed. Government spending then can hire those its tax caused to be unemployed. It can hire teachers, doctors or firefighters, for example, to provision itself. Unemployment is therefore the evidence that the difference between taxation and spending is not sufficient: either spending is too low or taxation too high.

Question: The countries of the euro zone, or at least some of them have solvency problems. Is that against your theory? Why?  The countries of the euro zone do not have their own currency neither can do their own monetary and currency policies. May also be applied to these countries the theories that you apply to the countries that have their own currency, which are monetarily sovereigns, like the USA, Japan, UK, etc.?

That is fully covered by MMT. If you examine the Euro, the Dollar, the Yen, the same understanding applies. The monopoly issuer of the currency is never revenue constrained and the government of issue has to spend first before it can collect the tax or borrow. That’s where the money to pay taxes comes from, to the penny.

The euro area has its own currency and its own central bank. Financially it works very much like any other modern currency, such as the dollar. The correct analogy would be between Euro member nations and the US states. By adopting a common currency the Euro member nations put themselves in the same position as the US states. A US state can indeed become unable to fund itself, and look to the US government and its agent, the Federal Reserve Bank for funding, much like Greece is getting assistance from the European Central Bank. But as issuers of their own currencies, the notion of a funding crisis for the US Federal Reserve Bank or the European Central Bank is entirely inapplicable. The revenue dependency adopted by the Euro member Nations is a voluntary, self-imposed constraint not itself inherent in the monetary system. For example when Greece’s government gives instructions to its central bank, the Bank of Greece, which is a member of the ECB system, to pay the IMF, the person at the ECB could say “yes, certainly” and the money would be there or he could say “no” and then Greece defaults. The ECB’s ability to pay in Euro is unlimited; the EU’s willingness to pay is a different story and a political decision.

Question: Against what it is usually explained, you defend, in the case of a country with its own currency, that high public deficit is not necessarily a bad thing: that public deficit does not reduce savings in the economy but on the contrary increases savings. Why?

What is called the public debt is nothing more than government spending of its currency of issue (euros) that has not yet been used to pay taxes and remains outstanding as the economy's net financial assets - functionally the 'savings'/financial equity that supports the macro credit structure of the economy - until used to pay taxes. Therefore, deficit spending adds to savings, by identity. If for example the government spends 100 and taxes 90, 10 remains in the economy. This is the savings of the economy, the economy’s money supply of net financial assets.

Question: Another myth that you criticize is that, in countries with their own currency, public debt is said to be an intergenerational burden, and that we are leaving our children with a debt burden they won’t be able to pay off. Why?

Again, the public debt is nothing more than all the euros spent by the government that have not yet been used to pay taxes. They remain as the net financial assets in other words the savings of the economy. The savings of the economy can be under 3 forms: Euro coins and bills, Euro balances in reserve accounts at the ECB, Euro balances in securities accounts at the ECB. When the public debt in form of government bonds is paid back, what happens on an operational level is the Central Bank shifts the Euro balances from a securities account to a reserve account. That’s called paying back the debt and it’s done continuously as securities mature for example. I’ve been at the central bank and know how they do this and there are no grandchildren involved, I guarantee! Furthermore, whoever is alive gets to consume whatever is produced. If our children built 20 million cars, 20 years from now, they’re not going to have to send them back in time to pay down some debt. Whoever is alive will get to drive the cars when they are built. Real goods and services don’t get sent back and forth in time, there is no such thing.

Question: In the dominant thought it is said that higher public deficits mean higher taxes in the future and that this is bad or negative. Contrarily, you hold that this is true but that it is not negative but rather positive. Can you tell us why?

Properly understood, taxes function to regulate aggregate demand, and not to raise revenue. The purpose of higher future taxes would therefore be to 'cool off' an economy that's deemed 'too good'. That means anything that implies higher future taxes is implying a future economy that's 'too good'- unemployment 'too low', and growth 'too high', which are generally deemed 'good things'. When the economy is in a depressed state, the debate should be about whether to increase spending or decrease taxes. Lowering taxes or increasing public spending, increases spending in the economy, which in turn increases growth and every economist paid to be right will agree with that.

Question: There are many people worried about their pensions. But instead, you tell us that it is impossible, in a country with its own currency, that Social Security could bankrupt and, therefore, we should not be worried about our pensions in the future. What explains this?

The government that issues the currency never has or doesn’t have “the money”; there isn’t any such thing. Government spending is not revenue constrained and does not require revenue. Operationally, government spends by crediting accounts at its central bank. Therefore the notion of 'running out of money' is inapplicable. If there is a real problem, it is the dependency ratio. That’s the ratio of workers to retirees. If, for an extreme example, in fifty years, we’ve got three hundred million people retired and one guy left working, that guy’s going to be really busy. The only real thing that will be useful fifty years from now is knowledge, education and technology. There’s hardly anything that we can physically build now, that is going to be of any value fifty years from now. The one thing that we do have, that people left us from fifty or a hundred years ago, is our technology, our know-how. However, ironically, because we think we need to cut back and sacrifice today and run surpluses and tax more than we spend because we are “running out of money”, the very first thing we cut is the only thing that can be useful 50 years from now, which is education.

Question: The need to export more and more and to have trade surpluses has become almost a religion. Instead, you tell us that imports are real benefits and exports are real costs, therefore, trade deficits (and not surpluses) are those that improve living standards. Could you explain a bit why you go against what it is most said and thought?

In economic terms the goods and services are your real wealth, in other words: your pile of stuff and you want your pile to be as large as possible. Everything you can produce domestically adds to your pile of stuff. Everything the rest of the world sends to you, also adds to your pile of stuff. Everything you have to export, subtracts from your pile of stuff. Exports are real costs and imports are real benefits is what it used to say not too long ago in all the mainstream economics textbooks. It used to be about trying to get the most imports for your exports, it was called 'real terms of trade' and there was no dispute. In economics, receiving is better than giving. Arguments to the contrary defy logic and can be supported only by ideological bias and propaganda that most often confuse fixed exchange rate and floating exchange rate policy options.

Today EU trade policy is based on export led growth, which is based on the implementation of austerity and so called structural reforms consisting in driving down wages and costs in a very ugly race to the bottom. It’s called increasing competitiveness: in essence it means if you can get your population to live on fewer calories than the neighboring population, you win. Policymakers don't realize that it doesn’t work, that it’s making the economy weak and that it is in fact evidence of deteriorating real terms of trade. And, of course, globally it's a zero sum game as for every export there is an equal import. Additionally, a rise in net exports from Euro zone domestic policy comes with upward pressure on the currency. That’s why export based models used to include the government building foreign exchange reserves by selling its currency versus the currency of the region targeted for exports. However the euro zone, unlike Germany under the mark, for ideological reasons does not build foreign exchange reserves. With all the upward pressure, the euro is left to appreciate to the point where there are no net exports.

Question: From some years ago the countries of the euro zone, especially peripheral ones, are in crisis. How do you explain this crisis? What prospects do you believe are necessary to be out of the crisis?

What is the crisis? If a bunch of banks lost a bunch of money no one would really care. It is because the banking crisis spilt over to the real economy and people lost their jobs, lost their homes, and lost their entire lives that we have a crisis. The real crisis is the unemployment, and it went to crisis levels when private sector deficit spending growth ended in 2008.  In 2008 the credit got shut off and the new borrowing stopped. Suddenly you did not have these people spending more than their income to make up for the people spending less than their income and sales collapsed. Capitalism is about sales. If a business has good sales, they hire people. People don’t lose their jobs until sales go bad, that is when businesses have to lay people off. It’s not more complicated than that. Sales and jobs go together. Unemployment is an unspent income story. If any agent in the economy spends less than his income, then something is not getting sold unless someone else spends more than his income and this “spending less than the income” goes on continuously: some people put money in their pension funds and savings accounts. Businesses make profits and don’t spend them all. Foreign Central Banks are accumulating reserves and not spending them. Insurance companies receive premiums and don’t spend them but hold them as reserves etc.

As a response to the crisis policymakers went from 0% interest rates to negative interest rates in the hope that they would reignite the credit boom that had occurred up until 2008. When that didn’t work they tried Quantitative Easing. That didn’t work either. The response to that seems to be even lower rates and more quantitative easing. The US has done the same thing for 7 years and it hasn’t worked yet. Japan has had 20 years of 0% rates and massive quantitative easing and it still hasn’t worked. How about this: maybe monetary policy doesn’t work. What does work are fiscal adjustments. Unemployment can be brought down immediately by tax cuts or spending increases.

Question: What role do you think the euro has played in this crisis? What role do you think the euro will have in the future

The deficit is the economy’s savings and the 3% deficit limit is a recessionary bias as it is likewise restricting savings in the economy to 3% growth. This policy of 3% public deficits and 60% public debt limits is insufficient to cover the need to pay taxes and desires to net save, as evidenced by the unemployment. The problem is the policy, not the euro per se. The euro area will prosper if it begins using deficit limits as policy tools to adjust fiscal balance as needed. A fitting analogy is a thermostat on a wall: when it’s too cold you can warm it up, and when it’s too warm you can cool it down. If unemployment was at 2% and the economy was growing too fast and causing inflation, then austerity might be the right program to cool the economy down and take some money out by raising taxes, or cutting spending. But not today, when the economy is stone-cold. At this point in time it is all about raising the deficit limit, and that’s meant for all the Euro members. That way each country can either increase public spending or reduce taxes by about 5% of GDP and every professional economist who is paid to be right will tell you that unemployment will be reduced and the economy will grow because of all the excess capacity. The economy is like a championship runner who is well trained, but the 3% deficit limit is like putting a plastic bag over his head so he can’t breathe. It’s not about adding stimulus; it’s about removing a restriction.

Question: Some tie the existence of the euro and, therefore, of the monetary integration, to the process of European economic and trade integration. However, the cases of the USA and Canada or Australia and New Zealand seem to show that a big progress is possible in the economic and trade integration without the need to have monetary integration. What do you think about that?

High levels of output and employment can always and immediately be achieved by fiscal adjustments.

Question: As you already know, Catalonia is considering becoming an independent state in relation to Spain. Do you think that the independence of Catalonia is possible from the economic point of view?

Yes, an independent Catalonia can prosper with an appropriate economic policy as long as it begins using deficit limits as policy tools to adjust the fiscal balance as needed. However I have seen no evidence of that understanding in any of their subsequent economic policy proposals.

Question: If this happens, what do you think that it would be better to Catalonia: the entry to the euro or to have its own currency and its own central bank? Why?

Prosperity requires continuous fiscal adjustment which is currently not allowed by EU policy. Catalonia could demand the EU to raise the deficit limit from 3% to 8% for example, which would immediately end the crisis. 8% might not be the right number, it might be higher or lower which is not a problem as long as it is understood as a policy tool.

What are the choices if the EU doesn’t agree to this? There are two choices: 1) Do nothing and watch civilization continue to crumble or 2) restore full employment and prosperity by reverting to a national currency with appropriate fiscal policy.

If Catalonia decides to issue its own currency it is crucial to do it right or the outcome will be worse than doing nothing. Doing it right will make things much better, but doing it wrong can make things much worse. In all the Plan B’s I have seen, including Greece’s Plan B, they were proposing doing it wrong. It doesn’t look like there is any informed decision making going on whatsoever, it’s just the blind leading the blind. In general, I’ve seen no suggestion that subsequent Catalonian fiscal policy would be any more relaxed than EU policy is right now, so I see similar macro-economic outcomes.