OPERATIONAL REALITIES OF MODERN MONEY
This working paper is an INTRODUCTION to Collected Works of Warren Mosler (www.collectedworksofwarrenmosler.com)
RAJENDRA RASU
Research Fellow, Global Institute for Sustainable Prosperity
ABSTRACT
The Purpose of this paper is to demonstrate clearly that every country can realize the optimum productive potential of its real resources with an appropriate monetary system and measures. The Collected Works of Warren Mosler is a compilation of Mosler's work on the operational realities of money and the monetary system, which got the name Modern Monetary Theory (MMT) subsequently. It is collated under various relevant topics, with his simple, penetrating revelations bringing out the truths of profound significance about misused monetary measures and the real economy. Mosler has brought a totally new perspective to the way the economy is understood by revealing how fundamental misunderstandings of the real economy have resulted in deprivation and economic suffering for billions of people. For each topic, he offers practical policy options based on alternate undistorted operational realities of the current monetary system that are needed to achieve full employment, price stability and productivity. In the process, he exposes many of the artificial nominal constraints put forth to prevent real economy's productive performance, and ultimately, the economic wellbeing of all. He calls these 'innocent frauds,' which are defined in his book: The Seven Deadly Innocent Frauds of Economic Policy.
Keywords: Modern Money Theory; Budget Deficits; Sovereign Debt; Warren Mosler; MMT; Fixed Exchange Currency; Floating Exchange Currency; Job Guarantee
JEL Codes: B52; D42; E4; E12; E42; E58; E62; H62; H63
OPERATIONAL REALITIES OF MODERN MONEY
This working paper is an INTRODUCTION to Collected Works of Warren Mosler (www.collectedworksofwarrenmosler.com)
RAJENDRA RASU
Research Fellow, Global Institute for Sustainable Prosperity
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Foreword by Warren Mosler:
The Purpose of this paper is to demonstrate clearly that every country can realize the optimum productive potential of its real resources with an appropriate monetary system and measures.
Birth of Collected Works of Warren Mosler and its presentation
Mosler has been extremely active in promoting Modern Monetary Theory (MMT is a description of how the monetary system actually works; it describes how money & monetary system operates under the present currency regime and it shows that Government’s purchases/spending has to be kept at a level to purchase/procure, together with the non-government sector, the full employment level of output at current price, unlike the fixed exchange rate currency era under which government spending has to be restricted to the extent of gold or foreign currency reserves to which the currency is pegged and unemployment is the evidence that the currency monopolist is restricting the currency supply) through twitter posts, interviews, seminars, paper presentation, policy papers and various other fora, including meeting policy makers throughout the world. Soft Currency Economics and The 7 Deadly Innocent Frauds of Economic Policy are the earliest books authored on MMT by Mosler. I, myself, have benefited from his vast, varied, and comprehensive posts and contributions, which led me to the current project of collecting and presenting, within a single space, Mosler’s collected works with the his approval. When I started collating the data and organizing them under various topics, I was amazed at the value and opportunity his blog posts and replies hold for learning. The Collected Works of Warren Mosler will be a comprehensive guide to those in policy making and governance, for the wellbeing of humanity. It is presented under various topics of interest and those not covered under the topics are listed under the General category. At Warren’s suggestion, posts are presented chronologically under each of the topics. In addition, selected posts are presented at the top for each topic before the year listing. The Collected Works compiles Mosler’s works relating to MMT, including twitter posts and responses, policy papers, presentations, interviews, research papers, working papers, notes, white paper and podcasts.
Let us go ahead and explore his works; however, before we begin, let us first acquaint ourselves with some basic insight into the terms used, for making further reading both meaningful and easier. Let us do that, starting with these questions: what is money? Are there different categories of money? Who creates the money? How does it enter the economy? What are the different monetary systems/regimes? Does the monetary regime determine the quantum of currency created/supplied by the Government? What difference does that make to policy making? Do policy options differ from regime to regime? Once we’ve considered these questions, we are well placed to explore the monetary operation of governments, central banks, institutional structures as well as how free the free market is, what are reserves, how money is created and how is it available for a livelihood activity including that of the last man in the circle. Approaching Mosler’s work, through this trajectory, will hopefully aid the reader in acquiring a richer, more informed understanding of how money works in the real world.
In real economies that do not use money, there is no unemployment; monetary measures are the culprit
In the pre-money economy, anybody willing to work could work. Given the availability of vast resources and tecnological development in the modern economy, the minimum one could ask for is a decent living condition that meets the basic needs of everyone. Economic development is defined as a sustained improvement in the quality of life and living standards of each and every individual. But, we are putting up with a system in which a small segment of people keeps on building their material wealth with the resources and at the cost of entire society. Society’s focus on income and wealth instead of consumption is taking it in the wrong direction, wasting vast resources, which include the years of legislative hours, policy marking & productive labour of billions of people, in false pursuit of vain glory. The real resources (people, land, plant and machinery and other material resources) which could be put to productive use, are what really matters to the economy. Instead, we see the adoption of abstract measures such as “deficit, debt, and debt ceiling". In money-using economies, money is used to measure and express, in nominal monetary units, the value of work, goods, services, other real outputs and real resources. However if these nominal monetary measures deprive people of their work, then this function of the monetary economy itself becomes counterproductive, raising questions about its continued usage. Let me reiterate here that this is not the primary function of money, despite it also serving this function. As Professor Paul Davidson states, there is never an unemployment problem in real economies that do not use money or among herds of animals or schools of fish.
What is money; all the evidence about the origins of money points to state involvement and its decision in what functions as money
What is money and where did it come from? There is no evidence of barter-based markets (outside trivial prisoner-of-war cases), and all the evidence about the origins of money points to state involvement. This is not to say that there have never been private monies. From the beginning, the government played an important role in determining what would function as money (Modern Money by L. Randall Wray).
Coins - pay tokens, State's debt, tax credit; State mints its own money to spend
Coins appear to have originated as government "pay tokens". Coins, then, were mere tokens of the crown's debt, like the tally. But why on earth would the crown's subjects accept hazelwood tallies or token coins? Mitchell Innes supplies the answer: The government, by law, obliges certain selected persons to become its debtors. This procedure is called levying a tax, and the persons, thus forced into the position of debtors to the government, must in theory seek out the holders of the tallies and acquire from them the tallies, by selling to them some commodity in exchange, for which they may be induced to part with their tallies. When these are returned to the government treasury, the taxes are paid. (Innes, 1913, p. 398). It was likely recognized from the very beginning that the purpose of the coin was to give the population a convenient means for paying taxes. Use of these early coins as a medium of exchange was probably an "accidental consequence of the coinage", and not the reason for it. So, from the very beginning, coins were intentionally minted to provide "state finance" (Modern Money by L. Randall Wray, Working paper No.252. September 1998). In other words, the state intentionally minted its own money to spend.
Ability of State to impose tax debt and misplaced focus of economists
The inordinate focus of economists on precious metal coins and market exchange is then misplaced. The key concept is debt, and specifically, the ability of the state to impose a tax debt on its subjects; once it has done this, it can choose the form in which subjects can "pay" the tax. Certainly the government's tokens may also serve as a medium of exchange, but this derives from its ability to impose taxes, and indeed is necessitated by imposition of the tax (if one has a tax liability but is not a creditor of the crown, one must offer things for sale to obtain the crown's tokens). (Modern Money Theory, L. Randall Wray). So, the state defines money as that which it accepts in payment of taxes.
One cannot conceive of Stateless money; monopolist of currency creates unemployment, by design, by imposing tax liability
Money is a creature of the State; at least in the case of modern money, one cannot conceive of Stateless money (“Money and Taxes: The Chartalist”, L. Randall Wray). The State Money view has important policy implications. Money is a Government liability, an IOU, and a tax credit, and Government through its agents, is the sole creator of its tax credit/currency. The money story begins with the Government imposing a tax liability, payable in its own currency, therefore creating a scarcity for the currency of which it is the monopoly supplier. This, in turn, creates sellers of goods and services that need the Government's spending of the currency to pay their taxes. In this process, by imposing tax liability, the Government creates unemployment by design and provisions itself. Once the state imposes a tax on its citizens, payable in a money it creates, it does not "need" the public's money in order to spend; rather, the public needs the government's money in order to pay taxes. This means that the government can "buy" whatever is for sale in terms of its money merely by providing its money. (Modern Money by L. Randall Wray). Therefore, the only constraint for a Government is the availability of real goods and services for sale, as it is not financially constrained.
State needs real resources, not tax money; money a “real resource transfer mechanism”
The state does not need “tax money” to spend; it needs real resources. A welfare state in particular needs an army, public school teachers, a police force, food inspectors, and any other resources necessary to fulfil its public purpose. In a way, the modern state, as in ancient Greece, continues to serve a redistributive function in the economy, where it collects real resources (labor) from the private sector, and then redistributes them back to the private sector “more equitably” in the form of infrastructure, public education, health, government research and development, and via any other social welfare functions voters have asked it to fulfil. The role of taxation in modern market economies remains the same as in ancient times: it is not a “funding mechanism,” but a “real resource transfer mechanism”. Far from being a simple medium of benign exchange, the history of money as a creature of the state indicates that it is instead a means of distribution, a tool of transferring real resources from one party to another, subject to the power relationship of the specific historical context - (Pavlina 2016) (Money, Power, and Monetary Regimes).
No reason for the unemployed human resources not to be deployed productively; operational realities differ for monetary regimes
As money is a creature of the State, there is no reason for the unemployed human resources to be kept idle, as
(i) it allows the unemployment created by tax liability, by design, remains unreversed.
(ii) the monetary system is meant to serve everyone, and it cannot keep certain segments as sacrificial lambs
(iii) the optimum productive capacity of the economy remains unrealized
Then, why is the Government not employing all available human resources and how does it get away with it? Is it the monetary regime that restricted currency creation?
Exchange Rate Regimes
Exchange rate regimes are typically divided into broad categories like Fixed Exchange Rate Regime and Floating Exchange Rate Regime. The economics that apply to convertible currency-fixed exchange rate systems, such as the gold standard, bear no relation to those of the fiat currency-flexible exchange rate systems prevailing in most economies today (Gold standard and fixed exchange rates – myths that still prevail Bill Mitchell, 2009).
Fixed Exchange Rate Regime — Gold Standard
When we talk about the gold standard we are referring to the system that once regulated the value of currencies around the world in terms of a certain amount of gold. During the 19th and 20th centuries, it was the major way that countries adjusted their money supply. How does it work? First, a currency might be valued for its intrinsic value (so gold or silver coins). This is a pure commodity currency system. In the 18th century, a shortage of silver proved problematic for the commodity, which led to central banks issuing paper money backed by gold. So the idea was that a currency’s value can be expressed in terms of a specified unit of gold. So we might say that a unit of paper currency (a dollar note) might be worth X grains of gold. To make this work, there has to be convertibility which means that someone who possesses a paper dollar will be able to swap it (convert it) for the relevant amount of gold (“Gold standard and fixed exchange rates – myths that still prevail,” Bill Mitchell, 2009)
Central bank (CB) had to maintain stores of gold sufficient to back the circulating currency and fund trade imbalances
Britain adopted the gold standard in 1844 and it became the common system regulating domestic economies and trade between them up until World War I. During this period, the leading economies of the world ran a pure gold standard and expressed their exchange rates accordingly. For example, say the Australian Pound was worth 30 grains of gold and the USD was worth 15 grains, then the 2 USDs would be required for every AUD in trading exchanges. The monetary authority agreed to maintain the “mint price” of gold fixed by standing ready to buy or sell gold to meet any supply or demand imbalance. Further, the central bank (or equivalent in those days) had to maintain stores of gold sufficient to back the circulating currency at the agreed upon convertibility rate. Gold was also considered to be the principle method of making international payments. Accordingly, as trade unfolded, imbalances in trade (imports and exports) arose and this necessitated that gold be transferred between nations (in boats) to fund these imbalances. Trade deficit countries had to ship gold to trade surplus countries. In another example, assume Australia was exporting more than it was importing from New Zealand. In net terms, the demand for AUD (to buy the exports) would thus be higher relative to supply (to buy NZD to purchase imports from NZ) and this would necessitate New Zealand shipping gold to Australia to fund the trade imbalance (their deficit with Australia). This inflow of gold would allow the Australian government to expand the money supply (issue more notes) because they had more gold to back the currency. This expansion was in strict proportion to the set value of the AUD in terms of grains of gold. The rising money supply would push against the inflation barrier (given no increase in the real capacity of the economy) which would ultimately render exports less attractive to foreigners and the external deficit would decline. From the New Zealand perspective, the loss of gold reserves to Australia forced their Government to withdraw paper currency which was deflationary – rising unemployment and falling output and prices. The latter improved the competitiveness of their economy which also helped resolve the trade imbalance. But it remains that the deficit nations were forced to bear rising unemployment and vice versa as the trade imbalances resolved (“Gold standard and fixed exchange rates – myths that still prevail,” Bill Mitchell, 2009).
Fixed Exchange Rate Regime — Monetary policy became captive to the amount of gold that a country possessed
The proponents of the gold standard focus on the way it prevents the government from issuing paper currency as a means of stimulating their economies. Under the gold standard, the government could not expand base money if the economy was in trade deficit. It was considered that the gold standard acted as a means to control the money supply and generate price levels in different trading countries which were consistent with trade balance. The domestic economy however was forced to make the adjustments to the trade imbalances. Monetary policy became captive to the amount of gold that a country possessed (principally derived from trade). Variations in the gold production levels also influenced the price levels of countries. In practical terms, the adjustments to trade that were necessary to resolve imbalances were slow. In the meantime, deficit nations had to endure domestic recessions and entrenched unemployment. So a gold standard introduces a recessionary bias to economies with the burden always falling on countries with weaker currencies (typically as a consequence of trade deficits). This inflexibility prevented governments from introducing policies that generated the best outcomes for their domestic economies (high employment). Ultimately the monetary authority would not be able to resist the demands of the population for higher employment (“Gold standard and fixed exchange rates – myths that still prevail,” Bill Mitchell, 2009).
World War I interrupted the operation of the gold standard — UK abandoned the gold standard in 1931
The onset of World War I interrupted the operation of the gold standard and currencies were valued by whatever the specific government wanted to set it at. The ensuing 25 odd years saw significant instability with attempts to go back to the standard in some countries proving extremely damaging in terms of gold losses and rising unemployment. The UK abandoned the gold standard in 1931 as it was facing massive losses of gold. It had tried to maintain the value of the Pound in terms the pre-WW I parity with gold but the war severely weakened its economy and so the pound was massively over-valued in this period and trade competitiveness undermined as a consequence (“Gold standard and fixed exchange rates – myths that still prevail”, Bill Mitchell, 2009).
Fixed Exchange Rate Regime — Gold replaced by US$ — Bretton Woods System was introduced in 1946
After World War II, the IMF was created to supercede the gold standard and the so-called gold exchange standard emerged. Convertibility to gold was abandoned and replaced by convertibility into the USD, reflecting the dominance of the US in world trade (and the fact that they won the war!). This new system was built on the agreement that the US government would convert a USD into gold at $USD35 per ounce of gold. This provided the nominal anchor for the exchange rate system. The Bretton Woods System was introduced in 1946 and created the fixed exchange rates system. Governments could now sell gold to the United States treasury at the price of $USD35 per ounce. So, now a country would build up USD reserves and, if they were running a trade deficit, they could swap USD (drawing from their USD reserves) for the local currency. (“Gold standard and fixed exchange rates – myths that still prevail”, Bill Mitchell, 2009)
Fixed exchange rate system rendered fiscal policy relatively restricted
The fixed exchange rate system however rendered fiscal policy relatively restricted because monetary policy had to target the exchange parity. If the exchange rate was under attack (perhaps because of a balance of payments deficit) which would manifest as an excess supply of the currency in the foreign exchange markets, then the CB had to intervene and buy up the local currency with its reserves of foreign currency (principally $USDs). This meant that the domestic economy would contract (as the money supply fell) and unemployment would rise. Further, the stock of $USD reserves held by any particular bank was finite and so countries with weak trading positions were always subject to a recessionary bias in order to defend the agreed exchange parities. The system was politically difficult to maintain because of the social instability arising from unemployment. So if fiscal policy was used too aggressively to reduce unemployment, it would invoke a monetary contraction to defend the exchange rate as imports rose in response to the rising national income levels engendered by the fiscal expansion. Ultimately, the primacy of monetary policy ruled because countries were bound by the Bretton Woods agreement to maintain the exchange rate parities. They could revalue or devalue (once off realignments) but this was frowned upon and not common. Whichever system we want to talk off – pure gold standard or USD-convertible system backed by gold – the constraints on government were obvious. The gold standard as applied domestically meant that existing gold reserves controlled the domestic money supply. Given gold was in finite supply (and no new discoveries had been made for years), it was considered to provide a stable monetary system. But when the supply of gold changed (a new field discovered), then this would create inflation. (“Gold standard and fixed exchange rates – myths that still prevail”, Bill Mitchell, 2009).
Central Bank could not expand their liabilities beyond their gold reserves
So gold reserves restricted the expansion of bank reserves and the supply of high-powered money (Government currency). The CB thus could not expand their liabilities beyond their gold reserves (although it is a bit more complex than that). In operational terms, this means that once the threshold was reached, the monetary authority could no longer buy any government debt or provide loans to its member banks. As a consequence, bank reserves were limited and if the public wanted to hold more currency, the reserves would then contract. This state defined the money supply threshold. Some gymnastics could be done to adjust the quantity of gold that had to be held. But overall the restrictions were solid. The concept of (and the term) monetisation comes from this period. When the government acquired new gold (say by purchasing some from a gold mining firm) they could create new money. The process was that the government would order some gold and sign a cheque for the delivery. This cheque is deposited by the miner in their bank. The bank then would exchange this cheque with the CB in return for added reserves. The CB then accounts for this by reducing the government account at the bank. So the government’s loss is the commercial banks reserve gain. The other implication of this system is that the national government can only increase the money supply by acquiring more gold. Any other expenditure that the government makes would have to be “financed” by taxation or by debt issuance. The government cannot just credit a commercial bank account under this system to expand its net spending independent of its source of finance. As a consequence, whenever the government spent it would require offsetting revenue in the form of taxes or borrowed funds (“Gold standard and fixed exchange rates – myths that still prevail,” Bill Mitchell, 2009).
Bretton Woods collapsed in 1971 – US suspended US$ convertibility
Ultimately, Bretton Woods collapsed in 1971. It was under pressure in the 1960s with a series of “competitive devaluations” by the UK and other countries who were facing chronically high unemployment due to persistent trading problems. Ultimately, the system collapsed because Nixon’s prosecution of the Vietnam war forced him to suspend US$ convertibility to allow him to net spend more. This was the final break in the links between a commodity that had intrinsic value and the nominal currencies. From this point on, governments used floating exchange rate fiat currencies as the basis of the monetary system (“Gold standard and fixed exchange rates – myths that still prevail”, Bill Mitchell, 2009).
Floating Exchange Rate Regime - Fiat Currency
The move to floating exchange rate currencies fundamentally altered the way the monetary system operated even though the currency was still, say, the $AUD. This system had two defining characteristics: (a) non-convertibility; and (b) flexible exchange rates. You need to recognise this major shift in history before you can understand why the economic policy ideas that prevailed in the previous monetary systems (based on convertibility) are no longer applicable. You cannot assume that the logic that applied in the ‘fixed exchange rate-convertibility days’ translates into the floating exchange rate currency era. The fact is that it doesn’t. What I call neo-liberal macroeconomic reasoning is really the sort of reasoning that prevailed in the days prior to floating exchange rate currency. While there were debates about how to conduct macroeconomic policy in those days, there were some obvious key constraints that I have outlined above. This is irrespective of whether you want to call yourself a Keynesian or a Monetarist. The shift in history also renders most of the textbook economics outdated and wrong in terms of how they depict the operations of the floating exchange rate fiat monetary system. When I talk about modern monetary theory, I refer to the floating exchange rate fiat monetary system. In doing so, I recognize that when Bretton Woods collapsed, a fundamental shift occurred in history; one that has dramatically altered the opportunities available to sovereign governments (“Gold standard and fixed exchange rates – myths that still prevail,” Bill Mitchell, 2009).
Under a floating exchange rate monetary system, “state money” has no intrinsic value
First, under a floating exchange rate monetary system, “state money” has no intrinsic value. It is non-convertible which means that you can take a $AUD coin to the government and in return you will get a $AUD coin back. There is no responsibility to do more. So for this otherwise “worthless” currency to be acceptable in exchange (buying and selling things) some motivation has to be introduced. That motivation emerges because the sovereign government has the capacity to require its use to relinquish private tax obligations to the state. Under the gold standard and its derivatives, money was always welcome as a means of exchange because it was convertible to gold which had a known and fixed value by agreement. This is a fundamental change (“Gold standard and fixed exchange rates – myths that still prevail,” Bill Mitchell, 2009).
How much the national government spends is entirely of its own choosing. There are no financial restrictions on this capacity
Second, a government is revenue independent as the monopoly issuer of its fiat currency, which is not limited by the commodity (gold) backing it. It can spend however much it likes, subject to there being real goods and services available for sale. This is a dramatic change. Irrespective of whether the government has been spending more than revenue (taxation and bond sales) or less, on any particular day, the government has the same capacity to spend as it did yesterday. There is no such concept of the government being “out of money” or not being able to afford to fund a program. How much the national government spends is entirely of its own choosing. There are no financial restrictions on this capacity. This is not to say there are no restrictions on government spending. There clearly are – the quantity of real goods and services available for sale including all the unemployed labour. Further, it is important to understand that while the national government issuing a floating exchange rate currency is not financially constrained, its spending decisions (and taxation and borrowing decisions) impact the interest rates, economic growth, private investment, and price level movements. We should never fall prey to the argument that the government has to get revenue from taxation or borrowing to “finance” its spending under a floating exchange rate currency system. In the past, it had to under a gold standard (or derivative system) but not under a floating exchange rate currency system. Most commentators fail to understand this difference and still apply the economics they learned at university which is fundamentally based on the gold standard/fixed exchange rate system. Under a floating exchange rate currency system, if the government sets limits on its spending – for example, a rule restricting real growth of spending to be two percent – then this is purely voluntary. It might be a sensible rule given the scale of nominal demand relative to real capacity but it is purely voluntary. These rules, however, usually arise from some mis-perception that the size of the budget deficit is a concern or the growth in public debt is a concern. Neither are particularly relevant to anything germane (“Gold standard and fixed exchange rates – myths that still prevail,” Bill Mitchell, 2009).
In a floating exchange rate currency system, government borrowing doesn’t fund its spending
Third, in a floating exchange rate currency system, the government does not need to finance spending in which case the issuing of debt by the monetary authority or the treasury has to serve other purposes. One function of government debt is to allow the CB to maintain its target interest rates by providing investors with an interest-bearing asset that drains the excess reserves in the banking system that result from deficit spending. If these reserves were not drained (that is, if the government did not borrow), then the spending would still occur but the overnight interest rate would plunge (due to competition by banks to rid themselves of the non-profitable reserves) and this may not be consistent with the stated intention of the CB to maintain a particular target interest rate. Importantly, the source of funds that investors use to buy the bonds is derived from the net government spending anyway (that is, spending above taxation). The private sector cannot buy bonds in the floating exchange rate currency unless the government has spent the same previously. This is a fundamental departure from the gold standard mechanisms where borrowing was necessary to fund government spending given the fixed money supply (fixed by gold stocks). Taxation and borrowing were intrinsically tied to the government’s management of its gold reserves. So in a floating exchange rate currency system, government borrowing doesn’t fund its spending. But it has historically helped the CB curtail interbank competition which allows the CB to defend its target interest rate (“Gold standard and fixed exchange rates – myths that still prevail,” Bill Mitchell, 2009).
Monetary policy is freed from defending some fixed parity & thus Government spending can target full employment
The flexible exchange rate system means that monetary policy is freed from defending some fixed parity and thus fiscal policy can solely target the spending gap to maintain high levels of employment. The foreign adjustment is then accomplished by the daily variations in the exchange rate (“Gold standard and fixed exchange rates – myths that still prevail,” Bill Mitchell, 2009).
Different monetary regimes have different operational realities
The two monetary systems are very different. You cannot apply the economics of the gold standard (or USD convertibility) to the modern monetary system. Unfortunately, most commentators, professors, and politicians continue to use the old logic when discussing the current policy options. It is a basic fallacy and prevents us from having a sensible discussion about what the government should be doing. All the fear mongering about the size of the deficit and the size of the borrowings (and the logic of borrowing in the first place) are all based on the old paradigm. They are totally inapplicable to the floating exchange rate monetary system (“Gold standard and fixed exchange rates – myths that still prevail,” Bill Mitchell, 2009).
The Paradigm Constraint
In no case must the government fund itself in its own currency. Spending is limited by what is offered for sale, not by revenues. Taxes function to create a need for currency, so the government can use currency to purchase real goods and services. Borrowing functions to allow excess currency created by deficit spending to earn a positive rate of interest. Deficits pose no funding risk since borrowing need only take place after spending, and only to support and maintain a desired interest rate. Interest rates and prices are subject to exogenous control by the issuer of the currency.
There is no evidence that government understands this paradigm. Government budgeting assumes the paradigm that dollars must be raised through taxing or borrowing to fund expenditures at market prices. The monopolist (the government) has decided to let market forces price its product (dollars). Therefore, it must constrain the quantity of spending to maintain sufficient unemployment and excess capacity to prevent a decline in the value of its product (inflation) (Full Employment AND Price Stability, Warren Mosler).
The Source of the Price Level; Price level is a function of prices paid by the state when it spends
With the state the sole supplier of that which it demands for payment of taxes, the economy needs the state’s currency and therefore state spending sets the terms of exchange; the price level is a function of prices paid by the state when it spends. There are two primary dynamics involved in the determination of the price level. The first is the introduction of absolute value of the state’s numeraire, which takes place by the prices the state pays when it spends. Moreover, the only information with regard to absolute value as measured in units of the state’s currency is the information transmitted by state spending. Therefore, all nominal prices can necessarily be traced back to prices the state pays when spending its currency. The second dynamic is the transmission of this information by markets allocating by price as they express indifference levels between buyers and sellers, and all in the context of the state’s institutional structure. The price level, therefore, consists of prices dictated by government spending policy along with all other prices subsequently derived by market forces operating within government institutional structure (A Framework for the Analysis of the Price Level and Inflation - Warren Mosler).
The Indian Parliament has designated agents to work on its behalf. These include the Reserve Bank of India which operates the monetary system, commercial bank members of the Reserve Bank System that are federally regulated and supervised, and the Treasury which executes purchases and sales as directed by legislation, by instructing the Reserve Bank of India to debit or credit appropriate accounts. Commercial bank members of RBI have demand accounts at the RBI called reserve accounts. Federal tax liabilities are discharged by either the payment of currency notes or by the RBI debiting a member bank reserve account, and, if it is a bank client initiating the payment, by the member bank simultaneously debiting the bank account of the client making the payment.
Banks, as agents of the government, likewise influence the price level, as bank lending supports client borrowing to spend on goods and services. Government regulation and supervision controls the prices paid with funds borrowed from the commercial banks. And, with the unlimited liquidity inherent in a floating exchange rate policy, without regulation banks could lend without limit and without collateral requirements or other means of controlling the prices paid by borrowers, which could quickly impair the government’s ability to provision itself and catastrophically devalue the currency (A Framework for the Analysis of the Price Level and Inflation - Warren Mosler).
The Determination of the Price Level
The state sets the terms of exchange for its currency with the prices it pays when it spends, and not per se by the quantity of currency that it spends. For example, if the state has an open-ended offer to hire soldiers at Rs 300,000* per year, the price level as thereby defined will remain constant regardless of how many soldiers are hired and regardless of the state’s total spending. The state has set the value of its numeraire exogenously, providing that information of absolute value that market forces then utilize to allocate by price with exchange values of other goods and services determined in the marketplace. Without the state supplied information, however, there would be no expression of relative value in terms of that currency.
Should the state decide, for example, to increase the price it pays for its soldiers to Rs 330,000* per year, it would be redefining the value of its currency downward and increasing the general price level by 10%, as market forces reflect that increase in the normal course of allocating by price and determining relative value. And for as long as the state continues to pay soldiers Rs 330,000* per year, assuming constant relative values, the price level will remain unchanged. And, for example, the state would have to continually increase the rate of pay by 10% annually to support a continuous annual increase of the price level of 10% (A Framework for the Analysis of the Price Level and Inflation - Warren Mosler).
The policy rate adds to price increase and then if the Government also pays the higher price whenever there is a temporary price-hike, it makes the price increase permanent. Also, the Government set the policy rate, being a monopolist. Natural rate of interest is zero and by keeping the policy rate at 0%, the Government will not contribute to price increase due to the positive policy rate and need not provide higher income for those who already have money, being the net payer of interest to the economy.
Critical challenge to Government spending is corruption which has to be plucked totally. Substantial portion of this spending could be sucked out by corruption, particularly in less developed countries. If this is not eradicated, it will only enrich corrupt people, depriving productive utilization of government spending, thereby contributing to inflation. A highly decentralised developmental model may be very helpful to address this problem and also offer good vehicle to deploy resources productively.
Governments as a policy always keep unemployment at a particular level
Lack of understanding of what causes inflation under floating exchange regime has pushed the Governments and their CBs to adopt NAIRU, the non accelerating Inflation rate of unemployment, as protection and weapon against price increase. That is, Governments think, if more people are employed, which will increase the overall purchasing power and demand, it could lead to price increase. So, Governments as a policy always keep unemployment at a particular level to reduce demand and prevent price increase. In advanced economies, unemployment could be lower but substantial in numbers. In emerging and poor countries, as the informal sector is large, unemployment and underemployment are always very high. Globally, the above wrong policies affect a massive number of people, keep them as poor. These policies are not only exploitative and unnecessary, they are also flawed and inapplicable, as they were formulated in a different context and regime.
Inapplicable policies take everyone on the wrong direction; for decades, entire government machinery and human endeavour is on the wrong path
Economic policies and operational realities meant for a different currency exchange regime, lack of understanding of the present regime, and policy options thereof are preventing Governments from achieving full employment and optimum economic development. Also, these inapplicable policies have taken Governments in the wrong direction, involving years and years of legislative hours, ill-suited implementation involving enormous government machinery throughout the country, wasting all the resources spent. It keeps enormous productive resources, including human resources, idle, thereby imposing misery & suffering on vast number of people.
Warren Mosler showing the operational realities of floating exchange regime
These innocent frauds were brought to the fore by Warren Mosler during the early 90s. He pointed out the simple fact missed by most economists and policymakers — that the Government, through its agents, is the sole creator of its currency, and in so doing, showed the world that the monopolist of currency has to spend currency, first, for borrowing to take place and for taxes to be paid in that currency; taxes create a demand for the Government’s currency; bond sales by the Government are not really a borrowing operation but rather are used to drain excess reserves from the banking system; the Government cannot run out of its own currency; and government ought to provide jobs at minimum wages to fight unemployment (Randall Wray, 2020). Mosler also reminded that the Government is the price setter as explained above and rate hike adds to inflation. And, he showed that imports are a benefit, while exports are a cost to the economy.
Government spending is all done by data entry on its own spreadsheet.
Most of the modern money is created electronically through keystrokes. When Government spends, it didn’t take currency and shove it into a computer. All it did was change a number in your bank account by making data entries on its own spreadsheet, which is linked to other spreadsheets in the banking system. Government spending is all done by data entry on its own spreadsheet called “monetary system”. Currency creation and transfers are entries in the spreadsheet maintained at CB and their member banks. These are the realities of how modern money & the monetary system operate in the floating exchange regime. When government spends, it just changes numbers up in our bank accounts. More specifically, all the commercial banks we use for our banking have bank accounts at the CB called reserve accounts. These reserve accounts at the CB are just like current accounts at any other bank. When government spends without taxing, all it does is change the numbers up in the appropriate current account (reserve account) at the CB. This means that when the government makes a Rs 2,000* Pension payment to you, for example, it changes the number up in your bank’s current account at the CB by Rs 2,000*, which also automatically changes the number up in your account at your bank by Rs 2,000* (7 Deadly Innocent Frauds of Economic Policy, 2010). Government spending adds reserves to the banking system.
Treasury security is nothing more than a deposit account at the CB
A Treasury security is nothing more than a deposit account at the CB. When you buy a Treasury security, you send your rupees to the CB and then some time in the future, they send the rupees back plus interest. The same holds true for any deposit account at any bank. You send the bank rupees and you get them back plus interest. Let’s say that you decides to buy Rs 2,000* worth of Treasury securities. To pay for those Treasury securities, the CB reduces the amount that your bank has in its current account at the CB by Rs 2,000* and adds Rs 2,000* to your bank’s deposit account at the CB (7 Deadly Innocent Frauds of Economic Policy, 2010). Government borrowing drains reserves from the banking system.
When the government does what’s called “borrowing money,” all it does is move funds from current accounts at the CB to deposit accounts (Treasury securities) at the CB. And what happens when the Treasury securities come due, and that “debt” has to be paid back? The CB merely shifts the rupee balances from the deposit accounts (Treasury securities) at the CB to the appropriate current accounts at the CB (reserve accounts) (7 Deadly Innocent Frauds of Economic Policy, 2010)
Operational realities described in the above three paragraphs are:
(i) Government spending and borrowing are all done by data entries in the spreadsheet at the CB
(ii) Government spending adds reserves to the banking system and borrowing drains reserves from the banking system.
(iii) Added reserves have to be drained to maintain the target CB policy rate, otherwise, it will fall to zero. Borrowing is the part of ‘maintaining policy rate’ process.
It is very clear that availability of currency is not an issue for the currency issuer, as it can always spend by issuing its own currency (it is done by data entries in the spreadsheet at the CB). As described in detail and summarised under ‘The Paradigm Constraint’, taxes and borrowing serve other purposes, not to acquire money to spend, as modern Governments pay for their expenditures by issuing their own liabilities. If Government spends Rs 1,000*, taxes Rs 900* and borrows Rs 100*, you could say that Government collects the Rs 900* & Rs 100* and then spends that Rs 1000* or you could say that Government spends Rs 1000* and then collects the Rs 900* & Rs 100*. What difference does it make to a currency issuer? Constraints of maintaining target CB policy rate dictate that the government cannot spend money without borrowing (or taxing). Government spending has to be offset by taxes and borrowing to maintain control of the CB's policy rate. Balancing of the budget happens for a reason, but it is portrayed differently. Economists, caught in the fixed exchange regime paradigm, say that Government spends tax and borrowed money. Those who understand the operational realities of floating exchange regime state that Government spends by issuing its own money.
We dedicate this work to the common man and we wish that every country will utilize the favourable floating exchange rate currency regime with appropriate policy measures to realize the optimum productive potential through full employment and price stability. We hope that this introduction is helpful to the reader so that he or she may benefit from this book. You are welcome to write to us with your feedback and suggestions.
Rajendra Rasu
REFERENCES
Mosler, Warren. 1995. Soft Currency Economics, West Palm Beach, FL: AVM.
Mosler, Warren. 2010. The Seven Deadly Innocent Frauds of Economic Policy. Guilford, CT: Valence Co
Mosler. W. 1997-98. “Full Employment and Price Stability.” Journal of Post Keynesian Economics 20(2).
Wray L. R. 1998. Modern Money, Levy Economics Institute Working Paper No. 252
Tcherneva, Pavlina R. 2016. Money, Power, and Monetary Regimes, Levy Economics Institute Working Paper No. 861.
Mitchell, W. 2009 “Gold standard and fixed exchange rates – myths that still prevail.” Blog: http://bilbo.economicoutlook.net/blog/?p=2562.
Michael McLeay, Amar Radia and Ryland Thomas. 2014. Money creation in the modern economy. Bank of England Quarterly Bulletin, Q1.
