Dr. Stephanie Kelton: Modern Money Theory Explained

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NoMoneyFlickruserBugsyhoPacifica Radio’s Guns and Butter has stayed on the drumbeat coverage of the revolutionary economic school of thought, Modern Monetary Theory (MMT), broadcasting extensive audio from the grassroots economic summit in Rimini, Italy produced by journalist Paolo Barnard:  Summit Modern Money Theory 2012.  At Media Roots, we’ve covered the entire series.  With this week’s instalment, Dr. Stephanie Kelton’s discussion includes:

“Myths about taxation and government revenues in a sovereign currency situation; debts and deficits; full social security and price stability; the use of sectoral balances to analyze the financial position of the different sectors of the macro economy; the three sectors of the macro economy; the two rules governing the three sectors; the financial balance model.”



GUNS AND BUTTER — “MMT emphasises the relationship between the state’s power over its money and its power to do things, real things, to conduct policy in an unconstrained way.  It emphasises that the state, because of its power over money, has a form of power to command resources in the economy.”  —Dr. Stephanie Kelton

“I’m Bonnie Faulkner.  Today on Guns and Butter:  Stephanie Kelton.  Today’s show:  Modern Money Theory Explained.

“Today’s presentation was given at the first Italian grassroots economic summit on Modern Money Theory in Rimini, Italy in February, 2012.

“Stephanie Kelton is associate professor of economics at the University of Missouri, Kansas City, research scholar at the Levy Economics Institute, and director of graduate student research at the Center for Full Employment and Price Stability.”  

Dr. Stephanie Kelton (c. 1:45):  “I’m going to cover some new ground.  And I’m also gonna go back and talk a little bit about a few really important concepts in MMT, that Paolo [Barnard] asked me to spend some more time talking about because I, maybe, went a little bit too quickly in one of the previous lessons.  So, let’s talk about MMT.  And why we think it’s such a revolutionary way to think about so many important economic questions.

“A day ago, two days ago, I forget, I’ve been awake a long time.  The Financial Times ran an article on MMT.  It was a big deal for us in terms of getting these ideas out there, into the mainstream and taken seriously by politicians, financial writers, and journalists, academics, and even into the hands of regular people, who pick up and read the papers.  
(c. 2:53)  “The Financial Times piece said that seeing MMT is like seeing an autostereogram, those images that look wavy and like there’s no picture.  But if you let your eyes rest long enough, the picture becomes clear.  And this is how the Financial Times described MMT.  Some people might see it right away.  And others will have to spend more time wrestling in their minds with some of the ideas because they’re so counter to everything, that we’ve been taught and that we thought we understood about money and government deficits and debt.  

(c. 3:39)  “And, so, I wanna go back and talk again about some of those important concepts.  We think, most people think, that the government collects taxes from us.  And raises money by selling bonds, so that it can finance its expenditures:  ‘The government needs our money, in order to spend.’  But MMT rejects that.  MMT says that a sovereign currency issuer doesn’t have to go out and get the currency from the users in the economy.  The sovereign currency spends its own IOUs, it spends its own money.  It creates its own currency. 

(c. 4:32) “Not only that, but the taxes they collect from us can’t actually finance anything.  And the bonds, that are sold to raise revenue for the state, in a sovereign government, also doesn’t pay for government spending.

“We think of two aspects of monetary channels.  We think of a vertical channel; this is where state money becomes important.  MMT emphasises that the state spends by issuing, what we call, high-powered moneyHigh-powered money is a fancy word for the currency of the state, the notes, the coins, and also the liabilities of the central bank, that are called bank reserves.

(c. 5:27)  “When you and I write a check to the government to pay our taxes, the check goes through a process where our bank account gets debited; and the numbers go down.  A government account gets a credit; and the numbers go up.  But the money supply, the high-powered money itself, the liabilities of the state are destroyed in the processThey are eliminated from balance sheets.  The money has gone down the drain and it can’t be used to finance anything.  

(c. 6:07)  “In addition to the vertical money—the state money—there is a horizontal aspect in any modern monetary system.  Most of the transactions in the private sector don’t involve the government, but private-issued credit money.  We can think of this as the leveraging of state money.  So, high-powered money is the liability of the government.  It sits at the top of the pyramid.  And the private sector uses the government’s money to leverage the creation of its own IOUs, its own money, its own debt.

(c. 6:58)  “In all modern systems, the central bank targets an overnight interest rate.  And then it supplies reserves, on demand, horizontally, at the interest rate, that it sets.  It also drains any excess reserves using what we call open market operations, buying and selling government bonds to hit its overnight interest rate target.  So, bonds are thought of, more appropriately, not as a financing tool, but as an instrument of monetary policy.  Bonds help the government coordinate the reserve add, that is caused by its government spending, with the reserve drain, that’s caused by the collection of taxes.

“In the US, the Treasury and the Fed have a very complex way of coordinating the government’s fiscal operations.  Many of us in the MMT school have written about this.  It is very complex.  It involves a lot of institutional detail and it isn’t something, that we need to cover here today.  If you’re interested in finding out how the very detailed operations work, you can look for something published by Scott Fullwiler on the New Economic Perspectives blog.  You can look back at an article I published in 2000, in the Journal of Economic Issues, that was called ‘Do Taxes and Bonds Finance Government Spending?

(c. 8:52)  “And, of course, Randy Wray’s book, Understanding Modern Money, also deals with some of this.  But I’m gonna skip over the operational details and just tell you that when government spends it adds new money to the banking systemWhen government collects taxes, it takes money out of the banking system.  If the government spends more than it takes out, we say that the government has run a deficit.  The deficit leaves extra reserves in the banking system.  And this triggers a response by the central bank.  The extra reserves push the interest rate down.  This is different from what conventional economics teaches us.  Conventional economics teaches that a government deficit should push interest rates up because the government is thought to compete for some limited pool of savings, and if you want to increase your deficit, you have to pay a higher price to get some of those savings.  MMT rejects that.

We understand that the state creates money, that money is not scarce, that the government doesn’t borrow household saving to finance its deficit, but rather spends first, creating the reserves, that it then drains by selling bonds.  So, the private sector loses the reserves and gains the government bonds.  This is how bonds are used to maintain interest rates in a sovereign currency setting. 

“We use a graph.  I don’t know how helpful it is.  But the vertical component, is this component, that goes straight up and down, and it shows that Treasury spending adds high-powered money (HPM), that builds up in banks until we pay taxes and then some of that money goes down the drain or banks use the state money to create their own liabilities, lending to private citizens and to private firms, leveraging the state’s money.

(c. 11:31)  “So, this is what we like to think of as the vertical and horizontal parts of the story in MMT.  It incorporates the credit theory of money, endogenous money theory, and state money.  It’s all related to Lerner’s Theory of Functional Finance.  In that piece that Lerner wrote, entitled ‘Functional Finance and the Federal Debt,’ Lerner explained that taxes don’t finance anything.  The government can’t spend the money it collects.  It’s eliminated.  And he understood that bond sales are a tool for conducting monetary policy.  Conventional economics teaches that bonds are a tool for fiscal policy, that they are financing tools.  MMT views that very differently.  The bonds are important because they allow the central bank to sell and buy bonds, adding and draining reserves from the banking system in order to hit its interest rate target.  

(c. 12:44)  “So, we should reject the orthodox theory because it’s wrong.  Conventional wisdom on government finance, taxes, and bonds is incorrect.  The conventional theory is that if the government were to finance its spending by creating new money that it would be inflationary, hyperinflationary, they usually say.  But, in fact, as MMT shows, all government spending is, by definition, financed by the creation of new money.  Sometimes, people think that we’re proposing that government do something different, that MMT says sovereign governments should finance their spending by creating new money.  We’re just describing the way they do it now.  So, this isn’t a policy proposal.  It isn’t going to lead to inflation because they already do it that way and it’s not inflationary.

(c. 13:52)  “The orthodox position again suggests that the government sells bonds and that they have to compete for some little, limited, pool of financial resource that’s out there, and if the government wants a piece of that pool and private firms want a piece and households want a piece, we have to outbid one another, and the price of those savings goes up.  The argument in the textbooks is that as the price goes up, the interest rate rises, that this crowds out other forms of spending.  The government comes in and sees that pool and says I want this piece, pushes the interest rate up for all of the other borrowers who want to borrow.  

(c. 14:43)  “And, so, it crowds out the more efficient kinds of private sector spending to make room for the inefficient big government spending.  This is the conventional story.  But, of course, this is wrong.  The bonds are sold in order to take back government money that was created by running the government deficit in the first place.  So, the deficit creates the money that is then made available for purchasing the bonds.  The pool of resources is not limited.  It grows with deficit spending.

“So, everything that the conventional story teaches, what students in any economics class, in any classroom—as we were told yesterday, in Italy they’re being exposed to an orthodox, neoclassical version of economics that doesn’t apply to governments that issue a sovereign currency.”

Bonnie Faulkner (c. 15:54):  “You’re listening to professor and research scholar, Stephanie Kelton.  Today’s show:  ‘Modern Money Theory Explained.’  I’m Bonnie Faulkner.  This is Guns and Butter.  

Dr. Stephanie Kelton: “MMT emphasises the relationship between the state’s power over its money and its power to do things, real things, to conduct policy in an unconstrained way.  It emphasises that the state, because of its power over money, has a form of power to command resources in the economy.  The state imposes the tax; that allows the state to get people to want to work and produce and provide things to the state in order to get the money that they need to settle the tax liability.  This way, the state has command over how to use society’s resources.  It’s not something that’s immediately obvious, but it’s central to MMT.  

(c. 17:06)  “And, so, at an event like this, what we want to do, as much as anything, is to lift that veil that conceals the potential that the state has to use the monetary system in the public interest. [Applause]

“We talked a little bit yesterday about how economists think about the problem of unemployment.  Essentially, there are three options when it comes to dealing with the inevitability of unemployment in any market economy.  Pure unemployment means that the unemployed sit idle, as a buffer stock of people—human beings—who get no wage and have nothing useful to do.  They are assigned no tasks and they have no income.

“Under most systems, there is some form of support for the unemployed, a safety net of some kind.  It might be unemployment compensation, a small payment made to the person who’s lost a job and can’t find one.  That payment might go on for a period of weeks, months, or even years.  All the while, the person is drawing an income, but has no tasks to perform.  

The third option, the one that MMT prefers, is a buffer stock of, not, unemployed, but of employed people.  And I talked about this yesterday and we referred to it as an Employer of Last Resort [ELR] programme or a Job Guarantee.  In a programme like this, when a person loses a job in the private sector or in the public sector, they have another job to go to.  The government does not allow them to sit idle and to pay them to do nothing.  It assigns them a useful task, something society needs done.  They get a wage.  And they get a task.

“We mentioned yesterday that Argentina implemented a form of a Job Guarantee, theirs was called the Jefes Programme.  It offered a job to the head of household.  It gave them a useful task and it paid them a basic wage.  It was highly successful.

“ELR provides people with a transition job, as the economy goes through its normal business cycle of ups and downs.  And then business lay off and then rehire workers, these people have a place to go.  They don’t sit idle in the unemployed pool.  They work in a pool of employed people.  

“The Job Guarantee programme performs the task of a genuine automatic stabiliser; no government bureaucrat has to decide whether to spend when unemployment increases.  No bureaucrat has to decide; it happens automatically.  If you become unemployed and you would like to participate in the Job Guarantee programme, you show up and you’re assigned a task and paid a wage.  You may receive training while you’re in the programme.  When the private sector recovers and begins hiring again, workers will flow out of the Job Guarantee pool and back into other forms of employment.  In this way, the Job Guarantee is a buffer stock programme.  It buffers the economy against the inevitable economic cycle.  So, society gets workers performing useful tasks; the people get to do something useful that makes them feel like they are contributing members of society.  They have wages and benefits instead of nothing or a very minimum with probably no benefit.  

“We’ve never had a Job Guarantee programme in the U.S.  But we did have an interesting programme that did many of the same kinds of things.  Someone in the audience asked yesterday about Roosevelt’s New Deal.  When Franklin Delano Roosevelt was president and the U.S. economy was in the throes of the Great Depression, Roosevelt instituted an alphabet soup of jobs programmes:  the WPA was the Works Progress Administration, my grandfather, one of them, worked in the WPA; the CCC was the Civilian Conservation Corps.  Some of you have asked about environmental problems and whether MMT has anything to say about environmental policy or energy policy.  The CCC was very much concerned with the environmental aspects.  The NYA was the National Youth Administration.  This was a programme designed, specifically, to deal with the problem of youth unemployment, which we know is a very serious problem in many parts of Europe today.

(c. 22:59)  “Roosevelt’s programmes hired the unemployed, gave them a wage, and gave them something useful to do.  They built hospitals, schools, parks, bridges, roadways, airports, stadiums, and much, much more.  They rebuilt America.  The programmes employed millions of Americans in productive and socially useful jobs.  Builders, architects, engineers, and even painters, poets, and actors were employed in these programmes.  But this is something on a huge scale.  It requires the ability to run large government deficits.  It requires sovereign money.  With sovereign currency and a commitment to functional finance, people can design a democracy that works for them. 

“When the people understand this, it eliminates for the policymaker their excuse for not acting.  They cannot say, we don’t have the money to do it.  Whatever is physically possible is financially feasible.  The only constraints that we concern ourselves with, in MMT, are real constraints.  We have already overcome in our minds, because of the monetary system and our understanding of it, the financial constraints.  They don’t exist.  The issuer of the currency can mobilise resources to achieve public purpose.  In any democracy, the people should decide what that means.  As long as the real resources are available—when I say real resources, I mean the land, the cement, the steel, the real things you need to build roads and bridges and airports and schools, whatever it is that you decide you want and need as a people—as long as those things are available, the government, through its power to tax and spend and power to control its currency, can mobilise those resources for the benefit of all.

Certain activities are simply too important to be left entirely to markets and their profit motive, as orthodox economics would have it.  Care for the environment, energy security, healthcare, income security for the elderly and the dependent, and so on, and so on, are too important to be left to market forces.  MMT shows us all that a new and better world is possible.

(c. 26:15)  “Okay, so I’m going to turn to a very important concept in MMT—the use of sectoral balances to analyse what’s happening to the financial positions of different sectors in the macroeconomy.  We’re gonna begin by recognising that deficits are normal.  Capitalist economies, many capitalist economies, run permanent deficits.  Surpluses are rare and fleeting in many large, rich countries in the world.  For some countries, the deficit emerges the ugly way.  The deficit appears because the economy is in trouble.  A recession causes rising unemployment and falling income.  When incomes fall, tax revenues drop off; deficits explode.  You’ve all seen that.  There’s an even uglier way to run a deficit and that is to implement fiscal austerity—recession by design.  And then there are the good deficits, the kind that MMT understands, doesn’t worry about, and supports.  The government can run a deficit by allowing its budget to expand and contract without any arbitrary limit to its size or to the time-frame, under which the deficit is allowed to be sustained.

(c. 28:10)  “With the kinds of policies that I’ve outlined, Job Guarantee and beyond, these may require the government to run deficits most, or even all, of the time.  So, the question is:  Is that good economics?” 

Bonnie Faulkner:  “You’re listening to professor and research scholar, Stephanie Kelton.  Today’s show:  ‘Modern Money Theory Explained.’  I’m Bonnie Faulkner.  This is Guns and Butter.  

Dr. Stephanie Kelton (c. 28:44): “A deficit hawk, we call them in the United States, is someone who is opposed to the deficit on principle.  A deficit hawk often favours what they call ‘sound money,’ a gold standard, a monetary union.  A deficit hawk would legislate rules that mandate balanced budgets at all times.  A deficit hawk believes that there’s no such thing as a good deficit.  And a deficit hawk supports immediate austerity to sharply reduce budget deficits.

“A deficit dove is a friendlier bird.  A deficit dove supports limited deficit spending in tough economic times.  But the doves want the government’s deficit balanced over the business cycle.  Deficits in bad times, surpluses in good times, balanced over the cycle.

“A dove supports rules to limit or constrain government spending.  Think of the Stability and Growth Pact, which allows small deficits, but also expects surpluses over the cycle.  A deficit dove recognises that the deficit is important when the economy turns down and they’re willing to run the deficit in difficult times.  But they want austerity after the economy recovers.  What are they worried about?

“Both the hawks and the doves are worried about the negative consequences of running a deficit.  They are convinced that, at some point, markets will refuse to lend at reasonable rates; interest rates will spike; the debt will become unsustainable; and they think that running large deficits will eventually lead to serious inflation.  Paul Krugman is a deficit dove.  MMT knows better.

“If the government takes advantage of its status as the issuer of the currency, the government could finance its deficit without borrowing at all.  It could be done with no bond sales.  This means no discipline from the bond markets.  No bond market vigilantes.  No solvency problem to deal with.  Interest rates would be lower, not higher, as [Paul] Krugman would suggest.  

“But what about inflation from running the economy too hot?  MMT doesn’t recommend that you run the economy too hot.  MMT recommends using deficits to bring the economy up to full employment, not to push it beyond.  This is a common criticism that we deal with from our critics who say we want huge deficits and beyond full employment and we never want them to stop and they’ll always be large, and, therefore, we must be insane.

“So, they mischaracterise us, so they can mock us.  Functional finance calls upon the government to maintain full employment and price stability.  We are as concerned with inflation, as anyone.  But we don’t view it as a serious problem when the economy is operating far below full employment with lots of available unused resources.  The government has plenty of space to push the economy before inflation should become a relative concern.

(c. 33:18)  “Okay, MMT emphasises that you cannot examine, weigh in on, give opinion to, make statements about the size of the government’s deficit or budget overall in isolation.  You cannot look at just one sector in the economy when we have a multisector economy.  You need to understand how the government’s budget is related to the rest of the economy.  To do this, we need a basic understanding of sectoral balances.  

(c. 34:03)  “So, what did the sectoral balances show?  In any given period, they show whether a particular part of the economy is spending more than its income—running a deficit—spending less than its income—running a surplus—or spending just equal to its income—balancing its budget.  We have to look at three sectors: two internal sectors—domestic sectors—and one external sector.  The internal sectors are your domestic private sector—the combination of all the households and firms in the country put together for analytical purposes—and the domestic public sector—local, state, provincial governments, national government.  Outside of the domestic sphere is the external sector.  This is the rest of the world.  We can call it the foreign sector, foreign governments, foreign households, foreign businesses. 

(c. 35:20)  “So, we have three sectors and two rules.  The two rules are that all three sectors cannot be in surplus at the same time.  And all three sectors cannot be in deficit at the same time.  These are not my rules.  These are the rules of accounting.  One person’s surplus is another person’s deficit.  The only way for one sector to run a positive balance is for at least one other sector to run a negative balance.  You might think of having three coins: heads is positive, tails is negative.  Hold three coins in your hand and flip all three, if they all come up heads, throw it out; it won’t work.  If they all come up tails, throw it out.  You can have two heads and a tail—two surpluses and a deficit—or two tails and a head—two deficits and one surplus.

(c. 36:38)  “Balance sheet rules apply.  Instinctively, we probably think there’s something inherently better about being in a surplus position. But, remember, we can’t all be in surplus at the same time.  It defies the laws of accounting.  At least one sector must be in deficit.

(c. 37:09)  “Here we see the government sector on the left and the non-government sector on the right.  The non-government sector includes domestic households, domestic firms, and the rest of the world, everyone who’s not government.  If there’s a surplus in the government sector than, by definition, there is a deficit in the non-government sector.  If the government is in deficit, then, by definition, the non-government sector is in surplus.

(c. 37:57)  “Two choices: two heads, one tail; two tails, one head.  Which one’s better?  The private sector needs to be in surplus almost all the time.  As a general rule, the private sector cannot survive in a deficit position.  Households and firms, as users of the currency, cannot continually spend more than their income.  At some point, even the financial wizards of Wall Street will run out of credit-worthy borrowers who are looking to borrow more.  When that happens, asset prices go sideways; sales soften; jobless claims go higher; and the economy turns down.  Government budget moves into deficit automatically, the ugly way.

“The private sector cannot create net wealth for itself.  Businesses, banks, and households together can borrow and lend, but every asset is offset by a liability from someone else in the private sector.  The assets and liabilities cancel each other out.  We can’t create net financial assets internally by ourselves, as a private sector.  Net financial wealth must come from outside the private sector.  

So, where do surpluses come from?  Remember that a surplus means that your income exceeds your expenditure.  A deficit means you’re spending more than your income.  Any one of these sectors—the private sector on the left, the public sector and the foreign sector on the right—any one of them can be in deficit or surplus, but they can’t all be in deficit or surplus together. 

“If the government sector is running a deficit, it tends to add to the private sector’s surplus. 

“If the rest of the world is running a deficit against Italy, that means Italy has the surplus.  Either, a government deficit or a trade surplus will increase the private sector’s net wealth.  This is—for those of you who might’ve wondered where the equation came from—it comes from the national income accounting.  I’m just showing you, so that you know I’m legitimate.  You just move identities around.  Trust me, okay?   

(c. 41:42) “On one side of the equation, you see where our nation’s income comes from.  I call that sources of income.  On the other side of the equation, you see how we use our income.  Sources and uses have to be equal.  We can set these equations equal, move terms to other sides, and write this equation here.  Which is the important equation for us?  

(c. 42:10) “This is the difference between what the private sector is saving and spending.  This is the difference between what the public sector—the government—is spending and collecting.  This is the difference between what the rest of the world is buying from you—your exports—and what you are buying from them—imports.”

Bonnie Faulkner:  “You’re listening to professor and research scholar, Stephanie Kelton.  Today’s show:  ‘Modern Money Theory Explained.’  I’m Bonnie Faulkner.  This is Guns and Butter.”

Dr. Stephanie Kelton:  “I mentioned that if the private sector is going to be in surplus, it requires at least one other sector to be in deficit.  This is the actual data for Italy.  The red line on the bottom shows the government’s budget balance.  You can see that in every year, since 1996, the Italian government has run a deficit.  You can also see that the bigger the deficit in the government sector, the bigger the surplus in the private sector.  Indeed, they almost look like they move exactly opposite to one another.  You could even say that as the government goes down, you go up.  That’s a different way to think about the government’s deficit.  I’m not making it up.

(c. 44:08)  “Here’s Ireland.  It looks similar.  As Ireland’s government deficit exploded, so did the accumulation of financial assets—savings—in the private sector.

“Greece: similar.

“Spain: as deficits increase—here’s Spain at more than 10% deficit to GDP and here’s the Spanish private sector in surplus.

“Germany: Germany runs surpluses on occasion.  But what happened to the private sector?  As Germany’s budget moved in to surplus, you can see here in this period where the German budget was in surplus and the private sector was driven into deficit, not some place the private sector usually spends much time because the private sector can’t survive in deficit.  

(c. 45:20)  “Here’s the United Kingdom, Japan, and the United States.  The large deficits that have been run since the downturn in the economy following the financial crisis, huge deficits that have terrified the hawks, have helped the private sector rebuild and repair their balance sheets by adding to their financial savings.  This makes for a good deficit.  The reason that the two lines were not perfect mirror images in the last set of graphs was because I didn’t include the foreign sector.  I just wanted to focus you in on the relationship between the public sector’s deficit and the private sector’s surplus. 

Here is a complete picture for the United States.  Every area in red shows you the US government’s budget position.  Anything that falls below zero indicates a public sector deficit.  You’ll notice that the U.S. government is almost always in deficit.  The blue represents the private sector’s balance.  You’ll notice that the private sector is almost always in surplus.  The green represents the foreign balance.  It’s been quite some time since the US ran a positive trade surplus.  You can see a few back in the early years.  We are now running trade deficits, sometimes, fairly substantial ones.  And that reduces the private sector’s surplus. 

So, let’s focus in on a specific period of time.  The period in the late 1990s and early 2000s when for the first time in decades the US government ran budget surpluses.  You can see those surpluses where the red goes into positive territory.  These years here represent government budget surpluses.  Many people would inherently think that would be a good thing.  It shows fiscal responsibility.  Not only did they balance the budget, but they put it in surplus.  Meanwhile, our current account deficits were huge.  The rest of the world was running large positive balances against the US.  That reduced US private- sector savings.  Surpluses fell.  It pushed the private sector into deficit on an unprecedented scale.  The private sector went from surviving above the zero line to being pushed below zero.  And the private sector remained there for a period of years, spending more than its income, borrowing to do it.  And it was all fueled by a massive bubble economy that ended in recession, which drove the public sector’s balance back into deficit where it belongs. 

(c. 49:16)  “Okay, the last part that I want to introduce this morning is the Financial Balance Model.  We are very excited in the MMT world about this model.  It was developed by a friend of ours, who is an outstanding economist.  His name is Rob Parenteau.  He writes on the New Economics Perspectives blog.  And he came up with this model.  And it is the framework that allows us to compare all three sectors’ budget positions in a graph.  Economists like graphs.  So, in fact, it’s how you gain credibility in our world.  So, one must use models and graphs.

(c. 50:15)  “The vertical axis measures the public sector’s budget position.  If the government is in surplus, we’ll be in the top half of the graph.  If the government is in deficit, we’ll be in the bottom half of the graph.  The horizontal axis measure’s the current account, the foreign balance

“If you’re on the right half of the graph, the current account is in surplus. 

“If you’re on the left half of the graph, the current account is in deficit. 

“The dashed line shows the private sector’s financial balance set at zero. 

“So, every point along the dashed line is a point where the private sector has no surplus and no deficit—spending equals income.  Above the dashed line, the private sector is in deficit.  Remember what I said:  The private sector cannot survive in that territory.  Below the dashed line, the private sector is in surplus.  Okay?

(c. 51:39)  “For a country that issues a sovereign currency, fiat money, no fixed exchange rate, the world is your oyster.  You can be anywhere in the graph.  There are no rules or reasons that you can’t be located anywhere.  But remember the diagonal line, anywhere above that is unsustainable for the private sector.  So, the only sustainable space is below that line, the green line. 

“What about here for countries that use the euro?  Where are you supposed to operate?  Well, if you’re playing by the rules, your deficit is not supposed to exceed 3% of your GDP.  So, we put in a lower bound at 3%, negative.  This is the space that’s available—in theory.  What about countries in the Eurozone that run current account deficits?  Remember that current account deficit is every where to the left of the vertical line, but you can’t go below 3%.  So, countries with a current account deficit, they get that rectangle.  Countries that run current account surpluses have a different space.  A country with a current account surplus can put its private sector in surplus with a smaller public sector deficit.  

“Here’s the situation for a country that uses the euro and also runs a current account deficit.  Can you see it?  It’s a small space.  This is the space that you are given to work with.  Anything above the dashed line means a private sector deficit.  It’s not a sustainable space for you, for any of us.  You must be below the dashed line.  But you must also be above the red line.  But because you’re running a trade deficit, you’re also to the left of the vertical line.  You get only to play in that little triangle.

(c. 54:30)  “So, lets talk about what’s happened to Italy.  Germany has crushed many members of the Eurozone through its labour policies that began in the early 2000s.  Marshall [Auerback] talked last night about the Hirsch Commission and in Agenda 2012, which was Chancellor Schröder’s economic miracle, whereby Germany ‘reformed’ its labour markets by reducing the power of their labour unions and their craft guilds making it easier for their employers to fire people at will, cut unemployment benefits, so that German benefits last about half as long as benefits in the US.  They were harsh ‘reforms.’ And as they were being implemented, unemployment, initially, increased.  It hurt the German economy, but not for long because that pain was soon transferred to others. 

(c. 55:45)  “So, I want you to look at this picture:  Italy, in 1996, was running a trade surplus of more than 3% of your GDP.  You had more fiscal space before the German policies.  And now you have that little triangle.  It doesn’t give you enough policy space without breaking the Stability and Growth Pact rules it is extremely difficult for you to keep the private sector in surplus and the economy healthy.  I would say it’s impossible. 

(c. 56:22)  “Italy makes it into the small triangle, but not often.  Most of the time, though, your deficits have been large enough to compensate for the trade deficits that you run and you’ve been able to keep your private sector in surplus.  But that’s because the rules were broken.  If you had played by the rules, for the last 14 years, you would have been successful three times.

“Ireland would never be successful.  The space is just too small.

“You see Greece.  The triangle for Greece is way up in the corner.  They can’t play by these restrictive rules, either.

(c. 57:05)  “Same problem for Spain.

“Germany, on the other hand does brilliantly, almost every point is to the right of the green line where the private sector is in surplus.  Although, Germany breaks the Stability and Growth rules, like everyone else.  It’s the large current account surpluses that Germany runs, thanks to all of you.  It’s the secret to their success.  It’s why they can run smaller deficits, stay out of trouble.  You are financing it.

Bonnie Faulkner (c. 57:57):  “You’ve been listening to professor and research scholar, Stephanie Kelton at the Summit on Modern Money Theory in Rimini, Italy.  Today’s show:  Modern Money Theory Explained.

“Stephanie Kelton is Associate Professor of Economics at the University of Missouri, Kansas City, Research Scholar at the Levy Economics Institute, and Director of Graduate Student Research at the Center for Full Employment and Price Stability.

“She is Creator and Editor of New Economic Perspectives.  Her research expertise is in Federal Reserve operations, fiscal policy, social security, healthcare, international finance, and employment policy.

“Please visit the University of Missouri, Kansas City New Economic Perspectives blog at www.NewEconomicPerspectives.org.  Visit the website for the first Italian Summit on Modern Money Theory at www.DemocraziaMMT.info.

“Guns and Butter is produced by Bonnie Faulkner and Yara Mako.  To leave comments or order copies of shows, email us at [email protected].  Visit our website at www.gunsandbutter.org.”

Transcript by Felipe Messina for Media Roots and Guns and Butter

fm: Updated 27 MAR 2013 19:07 CST


Guns and Butter – April 18, 2012 at 1:00pm

Click to listen (or download)



Also, please see MMT Summit: A Debate on How to Get Out of the Euro.

One thought on “Dr. Stephanie Kelton: Modern Money Theory Explained

  1. Is money more important than physics?

    She does not discuss the manufacture of technology. But that technology wears out because of PHYSICS. Where does “Planned Obsolescence” fit into it? How many trillions have Americans lost on the depreciation of badly designed junk?

    Google “Economic Wargames” timgar

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