Global Perspectives & Solutions

 A quick synopsis of MMT: A sovereign nation with its own fiat currency, its public debt denominated in its own currency and
a floating exchange rate cannot go broke. The only limit on public spending is inflation, and this is not a binding constraint for
the U.S. In some versions of the MMT, the price level is set by the government.

 What’s right is not new: (1) To consolidate the finances of the central government and the central bank for the assessment
of overall sovereign indebtedness. (2) To acknowledge that the State has a monopoly on money issuance. (3) To analyze this
monopoly in the context of profitable seigniorage, which can loosen the budget constraint. Already incorporated into
consolidated budget math is seignior age worth at least 0.3 % of real GDP, or around $64 billon, and possibly twice that.

 What’s new is not right: (1) Government deficits are logically prior to surpluses because tax payers have to pay their taxes
in government money. This ignores the fact that the State can lend to the private sector. (2) The public debt is not a burden
on the future. This assumes that any previous public debt issuance was sufficiently catalytic on the private sector to generate
the where-with-all to repay the borrowing, with interest. MMTers and supply-siders are odd bed-fellows here. (3) The
government need only set one nominal price and then let market forces determine relative prices while printing money at will
creates an inconsistency with monetary equilibrium. Experience with the gold standard is relevant in this regard.

 What’s left is too simplistic: (1) The proposition that the State will not default ignores the case where the inflationary
consequences of monetary finance (hyperinflation, say) dominates. (2) The proposition that the U.S. State always has the
‘exorbitant privilege” skips over evidence from both currency and U.S. Treasury markets that this privilege is not immutable.
(3) That stock-flow consistency gravitates to the ZLB ignores scenarios where real-side responsiveness of investment and
consumption dominate monetary finance, either to yield crowding-out or a supply side response. (4) MMT gives short-shrift to
the role of financial intermediaries or asset price inflation in the transmission of monetized fiscal deficits into price inflation or
into growth.

 MMT in the Current Conjuncture: (1) On monetized deficits and quiescent inflation and low interest rates, MMT has a lot of
current evidence on its side. (2) Rationales for monetized deficit finance include a jobs guarantee program and a Green New
Deal. Their merits are separate, logically, analytically, and politically from MMT. (3) The amount of fiscal monetization is not
as important as fiscal choices given monetization. Fiscal choices – more than fiscal monetization -- either make for good
countercyclical or structural economic sense, or end in an inflationary ambush.


April 2019

Willem Buiter Catherine L Mann

Special Economic Advisor Global Chief Economist

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April 2019 Citi GPS: Global Perspectives & Solutions 2

Introduction
Modern Monetary Theory (MMT) has been the subject of widespread debate ever
1
since it was linked to the funding of the New Green Deal.

The fundamental idea of the MMT, according to Fullwiler, Grey, and Tankus (2019)
(henceforth FGT) is that “ … a monetarily sovereign country like the United States
with debts denominated in its own currency and a floating exchange rate cannot “go
broke”.” We find his statement is both true and trivial.

Therefore, “…. the only limit on government spending is inflation” (FGT (2019)). The
government budget constraint should be replaced by an inflation constraint. This
second statement is at best half true, in our view. Key factors relevant to the
consequences of a fiscal stimulus and its financing other than inflation include
‘crowding out’ of private activities, fiscal choices, and wealth distribution
consequences of asset valuation. The opportunity costs and distribution
consequences of public spending and of monetization of public sector deficits
should not be ignored by the MMT, because they affect the both the demand side
and the supply side and therefore the inflation constraint.

This then leads us to the question of what causes inflation, an issue on which MMT
adherents have differing views and incomplete assessments. One view is utterly
conventional — excess demand and cost-push drives inflation see (e.g., FGT
(2019)). Another view is utterly unconventional and, in our view, incorrect — that the
government (via fiscal policy and monetary financing) set the general price level
(e.g., Tcherneva (2002) and Mosler (2010)). Regardless, both of these views appear
simplistic and incomplete. Neither addresses the way fiscal choices and asset and
price inflation resulting from monetary finance affect the growth and distribution of
income and wealth.

To see where MMT is right, wrong, or simplistic, it is useful to break the fundamental
ideas into multiple steps.

Where MMT Makes Sense

Consolidate the central government and the central bank

A first tenet of MMT is that the central government and the central bank is a single
entity — the State or the Sovereign —- and therefore should consolidate their
accounts to understand the financial and funding options open to the State.

This is correct. Regardless of the formal ownership structure of the central bank
(and there are many unusual ones), the central government Treasury is the
beneficial owner of the central bank — it receives its profits and (unless it invokes a
form of limited liability) may be responsible for its losses. From an economic
perspective and whatever the formal degree of operational independence of the
central bank, the central bank is just the liquid window of the Treasury. We should
therefore think of a single consolidated budget constraint for the State, shown in
equation (1) below:

1
The New Green Deal proposal is an economic stimulus program proposed for the US
that addresses climate change and economic inequality. Representative Alexandria
Ocasio-Cortez and Senator Ed Markey released a fourteen-page resolution[41] for their
Green New Deal on February 7, 2019, see https://ocasio-cortez.house.gov/sites/ocasio-
cortez.house.gov/files/Resolution%20on%20a%20Green%20New%20Deal.pdf

© 2019 Citigroup
 April 2019 Citi GPS: Global Perspectives & Solutions 3

M B B
  G T i
P P P (1)

where M is the nominal stock of base money (assumed to be non-interest-bearing

for simplicity) B is the nominal net stock of non-monetary debt of the State, G is
real spending on goods and services, T is the real value of taxes net of transfers
2
and i is the nominal interest rate on the public debt. The use of the consolidated
budget constraint of the State in mainstream macroeconomic analysis goes back a
long way, at least to Blinder and Solow (1973) (see also Sargent and Wallace
(1981)).

The State has a monopoly on money issuance

A second key tenet of MMT is that the central bank (and therefore the State) has a
monopoly of base money issuance. It therefore has the unique ability to borrow by
issuing fiat monetary base liabilities.

This is correct. The monetary base is made up of fiat currency in circulation plus fiat
reserves held by commercial banks with the central bank. The monetary base can
be expanded by any amount at effectively zero marginal cost. Currency has a zero
R
nominal interest rate. Reserves (required and excess) have an interest rate, i set
by the central bank. Except when the economy is in a liquidity trap at the zero lower
R
bound (ZLB) (aka the effective lower bound (ELB)), i today is usually set at a rate
just below the safe interest rate on assets the central bank can invest in, including
the interest rate on government bonds of the same duration, i .

The State (Central Bank) Profits from Issuing Money

Figure 1. Remittances by the Fed to the U.S.
Treasury A third key assumption of the MMT is that central bank monetary issuance is
140 ($bn) profitable for the State. This is correct for two reasons. First, unless the economy is
Millions

120 in a liquidity trap with the short risk-free nominal interest rate stuck at the ZLB/ELB,
100
80
currency, with its zero nominal interest rate will be a source of profits for the central
60 bank. The same applies to reserves held with the central bank as long as the
40 interest rate on required and excess reserves is below the safe, short nominal
20
0
market rate of interest on instruments the central bank can invest in. The second
2000 2003 2006 2009 2012 2015 2018 reason is that central bank money is irredeemable. The holder of central bank
Source: Citi Research money cannot demand from the central bank its exchange for anything else. This
means that although central bank money is undoubtedly viewed and treated as an
asset by the holders, it is not in any meaningful sense a liability of the issuer — the
central bank and the State. Figure 1 shows how balance sheet expansion at the
ELB boosted the profitability of the Fed and its profit remittances to the U.S.
Treasury.

2
For simplicity we are considering a closed economy.

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April 2019 Citi GPS: Global Perspectives & Solutions 4

Figure 2. Central Bank Assets (% of GDP)

Where MMT Is Simplistic
140 The State will not default
U.S.
120 Euro area A fourth key assumption of the MMT approach is that domestic-currency-
100 Japan denominated government debt can always be serviced through additional monetary
UK issuance by the central bank.
80
Switzerland
This is correct, but simplistic. It does not mean that a government that owes only
60
domestic-currency which is the kind that produces high inflation or even
40 hyperinflation, that government may choose to default on its domestic-currency
denominated debt even though it has the technical means (through monetary
20
issuance) to remain solvent (see Reinhart and Rogoff (2009)).
0
1990 1994 1998 2002 2006 2010 2014 2018 Since the great financial crisis (GFC) there has been an explosion in the size of the
balance sheets — and of the monetary liabilities — of many advanced economy
Source: Citi Research central banks, as shown in Figure 2, with some more detail provided in Figures 3
and 4 for the U.S.

Figure 3. U.S. Federal Reserve Assets Figure 4. U.S. Federal Reserve Liabilities
$ bn 5,000 ($bn)
5000
Treasury Debt Notes in Circulation
Federal Agency 4,000 Bank Reserves
4000 MBS
Foreign Exchange Reserves Non Monetary Liabilities
Other Assets Financial Net Worth
3,000
3000

2000 2,000

1000 1,000

0 0
2006 2008 2010 2012 2014 2016 2018 2006 2008 2010 2012 2014 2016 2018

Source: Citi Research Source: Citi Research

The state always has the ‘exorbitant privilege’

A fifth key assumption of the MMT is that the U.S., because it is the supplier of the
world’s leading reserve currency, can borrow abroad through the issuance of U.S.
dollar-denominated debt instruments. This relaxes the budget constraint of the State
and of the private sector.

We view this as correct but simplistic. This ‘exorbitant privilege’ is unique to the
U.S.; because of its currently deep, liquid, and stable market for government debt,
foreign investors choose to fund U.S. government deficits by buying U.S.
government debt to a greater degree than any other country. (Figure 5).

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April 2019 Citi GPS: Global Perspectives & Solutions 5

However this privilege is not immutable, nor does it eliminate a constraint. At some
point (which admittedly has not been reached yet, and which cannot be estimated
3
with any degree of confidence) the foreign holders of U.S. sovereign debt will begin
to fear either a (selective) default on the foreign debt they hold or future public debt
and deficit monetization which would erode the real value of their holdings of
nominally denominated US sovereign debt.

At times, foreign holders of U.S. obligations have priced into the exchange value of
Figure 5. U.S. Current Account Deficit, Net
the dollar and/or newly issued U.S. Treasury securities their concerns regarding the
Stock of Foreign Assets and Net Foreign
size of the fiscal deficit and debt and/or the external deficit, and net stock of foreign
Investment Income, % of GDP, 1976-2018
liabilities (Mann, 2002; Mann and Pluck, 2006). Moreover, both the exchange value
(% GDP) (% GDP) of the dollar and the interest rates on borrowing will be affected by monetization of
2 15
fiscal deficits and these two factors feed back to affect growth, inflation, and
distribution and therefore the ‘exorbitant privilege’.
0 0

An implication of the arguments thus far in this section is that the debt that has to be
-2 -15 serviced and is potentially subject to default risk is not gross or net general
government (GG) debt, but the net non-monetary debt of the State — the
-4 -30 consolidated general government and central bank.
Current Acct Bal
-6 Net Foreign Invst. Income -45 Stock-Flow Consistency and a Summary of MMT
U.S. Net Stock-Foreign Assets (RHS)
-8 -60
A sixth key assumption of the MMT is that we have to model all agents and markets
1976 1983 1990 1997 2004 2011 2018 in a stock-flow consistent manner.

Source: Citi Research This is correct, but we believe simplistic. The interpretation of ‘stock-flow-consistent’
adopted by the MMT is narrower than it needs to be (it is easy to provide a stock-
flow-consistent version of the textbook IS-LM model (see e.g. Buiter (1975)), but it is
also possible to cast the entire argument rigorously in terms of the ‘end-of-period’
asset market equilibrium approach of the MMT (see Buiter (1975) and Tobin and
Buiter (1980)). Monetary equilibrium, in the MMT approach, is the equality of end-of-
period money demand and the sum of the beginning-of-period money stock plus
any net monetary issuance during the period.

Consider the following closed economy with, for the moment, a given price level and
expected rate of inflation — an economy with material excess capacity. We start off
with the economy being in IS-LM equilibrium away from the zero lower bound.
Consider a monetized fiscal stimulus in a diagram with the nominal interest rate, i ,
on the vertical axis and real income/output, Y , on the horizontal axis. This is shown
in Figure 6.

3
All we know about the unsustainable is that it cannot go on forever. It will stop (Stein’s
law). The Dornbusch corollary is: But it will go on longer than you considered possible
and will end when you least expect it.

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April 2019 Citi GPS: Global Perspectives & Solutions 6

Figure 6. A Money-Financed Fiscal Stimulus

Source: Citi Research

The initial goods market equilibrium schedule is IS1, and the initial (end-of-period)
monetary equilibrium schedule is LM1. The initial equilibrium is E1 with initial output
Y1 and initial interest rate i1. Assume the initial budget is balanced. A monetized
fiscal stimulus (an increase in public spending or cut in taxes funded by monetary
issuance) will immediately, that is, in the period when the fiscal stimulus is initiated,
shift the monetary equilibrium schedule (the ‘end-of-period LM schedule’) down and
to the right, to LM2. In that same initial period, the fiscal stimulus shifts the goods
market equilibrium or IS equilibrium schedule up and to the right, to IS 2, which will
raise the market rate of interest. The new equilibrium at the end of period 1 is E2
with interest rate i2 and real output Y2; i2 could be below i1: the monetary financing
of the fiscal stimulus in the initial period can mitigate or even reverse that ‘IS-driven’
interest rate increase.

In all subsequent periods, the fiscal stimulus and the associated deficit are assumed
to remain constant in real terms. In all subsequent periods, the deficit will continue
to be financed by monetary issuance. This will shift the LM curve down and to the
right each period (to LM3 in period 2), lowering the interest rate and boosting output
each period. It will also shift the IS curve up and to the right (to IS 3 in period 2)
through the wealth effect on household consumption of a larger stock of base
money. This will tend to raise the interest rate and boost output further. The net
effect on the interest rate is in principle ambiguous; the net effect on output is
unambiguously positive. Given the small size of wealth effects on aggregate
demand, however, it is likely that, after the initial period, monetary financing on
balance lowers the interest rate and raises aggregate demand and output. This is
what we have drawn in Figure 6. The MMT assumes that monetary financing of a
fiscal stimulus lowers interest rates, which is consistent with the scenario drawn in
Figure 6. As this monetization of the deficit continues, the interest rate could be
4
driven down to the effective lower bound, which we take to be zero. This is an
entirely ‘stock-flow consistent’ analysis.

4
The ECB has its deposit rate at -40bps and the central banks of Sweden, Denmark and
Switzerland reached lows for their deposit rates of -75bps. The reason this is possible
when the interest rate on cash is zero is the carry cost of currency, the cost of safely

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April 2019 Citi GPS: Global Perspectives & Solutions 7

In Figure 6 we assume we start out in a situation of excess capacity with a constant

price level and a constant expected rate of inflation (presumably equal to zero).
Monetary financing of a fiscal deficit resulting from a fiscal stimulus can land the
economy in a liquidity trap when monetary financing of a given real public sector
deficit on balance lowers the interest rate: the downward shift to the right of the LM
curve, driven by the increasing stock of base money, dominates the upward shift to
the right of the IS curve, driven by the wealth effect of the growing stock of base
money. If such is the case, in due course the LM curve will hit the ELB and the
demand for the monetary base becomes infinitely elastic at the zero nominal
interest rate. The natural or neutral nominal interest rate is indeed zero in this case.
There are of course other ways of landing in a liquidity trap. A large enough
negative shock to aggregate demand for goods and services (a shift down and to
the left shift of the IS curve because of a collapse of animal spirits, say) can land an
economy on the ELB, without any help from monetary expansion.

The stock-flow consistency as described in the previous paragraphs is simplistic for

two reasons. First, the maintained assumption is that monetary financing ultimately
leads to the ZLB/ELB because monetary finance dominates real-side
responsiveness of investment and consumption. This example — of the relative
shifts of the IS and LM curves — represents a particular case. Empirical analysis of
recent data would suggest this example has salience today: Large fiscal deficit,
large balance sheet, low interest rates, and not very strong real investment
response nor consumption response through the wealth effect. However, we could
have other parameters of responsiveness (greater investment response if
businesses were more confident, greater consumption response if wealth were
more equally distributed) and so on whereby interest rates do rise and there is
crowding out of the monetized fiscal expansion.

Second, it assumes no feedback effect from interest rates to the supply side of the
economy — e.g., it sticks with the traditional monetary theory of money neutrality in
the long-run. This second assumption is an important link to the drivers of inflation
(see below).

Taking advantage of the ELB

One of the conclusions of the stock-flow consistency story is that the economy
naturally gravitates to the ZLB. This supports the conclusion that there is no fiscal
constraint since it makes sense to issue public debt when interest rates are below
the rate of growth of the economy.

This is true but it is simplistic. We can rewrite the State budget constraint in
equation (1) as follows:

r  
b    b  sˆ
 1   (2)

B
where b  is the rate of public debt to GDP, r is the real interest rate,  is
PY
T G M
the growth rate of real GDP and sˆ   is the augmented primary
Y PY
(non-interest) budget surplus of the State as a share of GDP.

storing, transporting and insuring cash and the cost of engaging in large transactions
using cash.

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April 2019 Citi GPS: Global Perspectives & Solutions 8

Clearly, having a real interest rate on the public debt that is below the growth rate of
real GDP is good news, because you can stabilize the debt-to-GDP ratio without
ever running an augmented primary surplus: the augmented primary surplus that
r  
stabilizes the debt-to-GDP ratio, ŝ , is given by ˆ    b which is negative
 1  
when b is positive and r   .

This analysis is simplistic in that a situation in which the interest rate is below the
growth rate cannot endure forever. We would need to be in the world of Ponzi
finance where the interest due on the outstanding stock of debt can always be
covered by additional debt issuance. A borrowing and spending boom would result
in invalidating the assumption that the interest rate never rises above the growth
rate again.

Sustainability is not the only consideration that is relevant when considering

borrowing by issuing non-monetary debt. The debt has to be absorbed willingly in
private portfolios (at home or abroad) and this will, in general raise interest rates
and crowd out (displace) private interest-sensitive spending. In Figure 6, debt
issuance shifts the IS curve up and to the right and the LM curve up and to the left,
5
both through wealth effects, unambiguously raising the rate of interest.

Some Dubious MMT Propositions

Government deficits are logically prior to surpluses

This proposition, which can be found in Forstater and Mosler (2005), is supposed to
follow from the assumption that tax payers have to pay their taxes in government
base money. So to pay your taxes there has to be base money in the private
economy. This money can only get there by the government running prior deficits
6
financed, at least in part, by printing money.

This is wrong because it ignores the budget constraint of the State in equation (1).
Clearly, the government can increase the money supply held by the private sector
with a balanced budget or a budget surplus by lending to the private sector
(  B  0 ). It is also not correct that for the government to lend it has to buy back
public debt held by the private sector. It could instead buy private sector securities
or (through the central bank) engage in collateralized lending to the private sector.

The public debt is not a burden on the future.

Mosler (2010, p. 3) states that “Everything produced in the future will be consumed
in the future. How much will be produced depends on how productive the economy
is at that time. This has nothing to do with the public debt today; a higher public debt
today does not reduce future production — and if it motivates wise use of resources
today, it may increase the productivity of the economy in the future.”

5
We assume there is no Ricardian equivalence in this economy, so an increase in the
stock of public debt, even if it is matched by an equal PDV increase in future taxes will
have a positive wealth effect.
6
“From inception, the government cannot collect more money in taxes than it spent.
Expenditure comes first”, Tcherneva (2002, p. 130).

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We say this is wrong for two reasons. First, the past public debt issuance that
produced the current stock of public debt will have crowded out capital formation
along the way, unless the catalytic impulse on the private sector of the fiscal
impulse is so large as to generate the where-with-all to repay the borrowing, with
interest. Here again the MMTers and the supply-siders have an uneasy alliance. If
instead there is some private sector crowing out, today’s and tomorrow’s capital
stock will likely be lower than they would have been with less government
borrowing.

Second, debt is serviced through some combination of future monetary issuance,

taxes or public spending. If higher taxes or lower public spending are used to satisfy
the intertemporal budget constraint of the State, say because there are
unacceptable current and/or future inflationary pressures, then higher debt
redistributes lifetime resources away from future tax payers and future beneficiaries
of public spending. So the public debt is most definitely, a burden on the future and
on future generations. That burden may be worth bearing, if it has helped fund
critical public expenditure. Only in the special case of radical private catalytic
response is it not a burden.

The government sets the general price level.

There exists a much more extreme version of the “currency demanded for payment
of taxes” argument. In Tcherneva (2002), the government imposes taxes in dollars
— taxes that have to be paid in dollars — and, because the government is the
monopoly issuer of its currency, it sets the money prices of goods and services.
That is, prices and the general price level are exogenous and set by the
government. Mosler (2010) also makes it clear that he has in mind a world in which
the government sets the money price of goods and services.

“…, the currency itself is a public monopoly, which means the price level is
necessarily a function of prices paid by the government when it spends, and/or
collateral demanded when it lends.” (Mosler (2010, p. 113)) and “… since the
economy needs the government spending to get the dollars it needs to pay taxes,
the government can, as a point of logic decide what it wants to pay for things, and
the economy has no choice but to sell to the government at the prices set by the
government in order to get the dollars it needs to pay taxes, and save however
many dollar financial assets its wants to.” (Mosler (2010, p. 114)).

Following this logic the government would only have to set the nominal price of one
good or service and let market forces adjust all other prices to reflect relative
values. The government could, e.g., select baked beans as the single item whose
money price it fixes. To set the money price of baked beans, the government would
effectively run a buffer stock commodity stabilization scheme for baked beans,
offering to buy or sell any amount of baked beans at that price.

The government having set the money price of baked beans, the market
mechanism (which determines all relative prices of goods and services in the
economy independently of what the government is doing to the price of baked
beans) then determines the money prices of all goods and services other than
baked beans and, bingo, the government has set the general price level. Apart from
the fact that the government could run out of baked beans, the assumption that
fixing the nominal anchor and fixing relative prices can be treated as two
independent processes is not acceptable. Neither is the assumption that the general
price level determined by this government-directed process would be compatible
with economy-wide monetary equilibrium. The experience of the gold standard is
instructive in this regard.

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April 2019 Citi GPS: Global Perspectives & Solutions 10

This central planning assumption has to be rejected as an acceptable

representation of a market economy. If the Cherneva/Mosler universe means the
government sets the prices of all individual goods and services, and thus also the
general price level, there is no reason to believe that these would be market-
clearing prices. Excess supply (unwanted inventories) and excess demand (queues
for scarce, underpriced goods and services) would be the rule.

Let’s assume that the government does not set relative prices but ‘just’ the general
price level. There is still no guarantee that the demand for real base money (the
nominal stock deflated by the government-determined general price level) will equal
the real value of the initial base money stock plus any net monetary issuance. This
approach will in general not be stock-flow-consistent. There will be excess demand
for or excess supply of money which will lead to spending spillovers that will
challenge the government-set price level. Only at the ELB, when the demand for
money is infinitely interest-sensitive, will there be no first order monetary
disequilibrium. We return to this issue when we discuss how much seigniorage can
be extracted.

So Where Does Inflation Come From In MMT?

Excess demand

The FGT view on what drives inflation in the mainstream MMT world of FGT is
utterly conventional. “If the government prints and spends money when the
economy is at or near full employment, MMT counsels (correctly) that this will lead
to inflation, and prescribes deficit-reducing tax increases to reduce aggregate
demand and thereby control inflation” (FGT (2019). Logically, deficit-reducing cuts in
public spending could take the place of tax increases, but there is nothing that
anyone from an Old-Keynesian, New-Keynesian, or Neo-Keynesian tradition would
disagree with. Even someone coming from a New-Classical, flexible price level
tradition would be able to live with this.

Market structure and supply side response

But, FGT and other MMT proponents argue that not all inflation is caused by excess
demand, first because labor and product market structures have loosened the
transmission mechanism between cost drivers and inflation outcomes (e.g., the
Phillips curve is flat) and second because fiscal policy (even when fully monetized)
can boost the supply side of the economy, keeping it ahead of demand. The former
outcome is temporary, and the latter is a fortuitous outcome is for which empirical
support is lacking. Note that neither of these controversial observations is unique to
MMT.

With regard to the first point, the MMT proponents have a lot of evidence on their
side. Large fiscal deficits that have effectively been monetized via the Federal
Reserve’s large balance sheet have boosted employment and economic activity, but
inflation remains quiescent. A substantial body of research (Yellen, as an example)
has been devoted to explaining the apparently ‘missing’ inflation, with culprits from
labor scaring, technological-bias in market competition, globalization, all playing a
role. These factors would not appear to be permanent.

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April 2019 Citi GPS: Global Perspectives & Solutions 11

With regard to the second point, that monetization of fiscal deficits will keep supply
ahead of demand, only a version of supply-side thinking (odd bed-fellows to the
MMT advocates) would agree. These two adherents to deviations from centrist
norms argue that fiscal policy choices (tax reductions from the supply siders vs.
public policy spending from the MMTers) catalyze private sector economic activity
and boost aggregate supply. Thus inflation is kept in check through dynamic
responses of the economy. While in principle the argument may be true, the
evidence is limited on the effectiveness of monetized fiscal choices in generating
supply side responses that ensure that inflation stays low and real interest rates
remain below demand growth.

Asset price inflation

One particular aspect of the transmission from monetized fiscal policy that receives
short shrift in the MMT discussion is the financial sector’s role and asset prices. The
financial system is the intermediary between the monetized fiscal deficit and the
performance of the economy. Case-in-point: the large fiscal deficit and the large
central bank balance sheet have not led to price inflation but they are correlated
with asset price inflation. The transmission of asset inflation to real-side growth
(both demand and supply) is limited in part by asset choices (buy-back and M&A) vs
investment in demand- and supply-enhancing real investment, and in part by the
concentration of asset valuation gains to a limited set of consumers.

MMT and Today’s Economic Conjuncture

Figure 7. Policy Rates in U.S., EA, and Japan
7 (%)
U.S. Euro Area Japan
Being at the ZLB
6
We believe the proposition that the nominal natural or neutral rate of interest is zero
5
(see e.g., Forstater and Mosler (2005)) is incorrect as a general proposition,
4
although there are circumstances under which an economy can be in a persistent
3 zero nominal interest rate/ELB equilibrium. Away from the ELB the neutral real rate
2 of interest is the equilibrium real interest rate that would prevail when actual output
1 equals potential output and inflation is stable at its target rate. The neutral nominal
0
rate of interest is the neutral real interest rate plus the stable inflation rate that
defines the neutral real interest rate. The determinants of the neutral real interest
-1
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 rate are the marginal product of capital, productivity growth and the fundamental
Source: Citi Research drivers of investment and saving behavior.

What this means is that, with long-term real rates today well below long-term real
growth rates for the U.S., this is as good a time to borrow as any, from the
perspective of fiscal sustainability: the public debt will have to be repaid (in present
value terms) in the long run, but the pain is less than it would be with the growth
rate below the interest rate.

We cannot be sure, of course, for how long this configuration of extraordinarily low
real interest rates and reasonable real growth rates of GDP will endure. That calls
for borrowing at as long a duration as possible. Consols (perpetuities) would make
sense.

Only when the economy is in a persistent liquidity trap at the ELB will the risk-free
nominal interest rate equal zero in equilibrium. Japan has been in a liquidity trap
longer than any other country and shows as yet few signs of leaving it. Figure 5
shows the policy rates for the U.S., Japan and the Euro Area since 1999.

© 2019 Citigroup
April 2019 Citi GPS: Global Perspectives & Solutions 12

How much seigniorage?

A liquidity trap/ELB equilibrium is unlikely to be a permanent affair. But continued

increases in the base money stock from funding the fiscal deficit will continue to
boost consumer demand through wealth effects (albeit more or less depending on
concentration of wealth). This should continue to shift the IS curve to the right until
the economy hits full employment (capacity output or potential output). At this point
(absent that fortuitous supply shock) prices will begin to rise.

What is the value of being at the inflation target (if we could maintain the economy
M
there) as measured by seniorage? Let i be the average rate of interest on the
monetary base,  the rate of inflation and  the growth rate of real GDP, and
M
m  . The share of real GDP that is extracted through monetary issuance is
PY

M
 (1   )(1   ) m  (1  i
M
) m 1 (3)
PY

For the U.S., suppose the economy was at its inflation target (assumed to be 2%)
and real GDP growth were also 2% (a reasonable growth rate of potential output)?
We will assume that the interest rate on required and excess reserves is zero (i.e.,
 0 ), which flatters the magnitude of the seigniorage calculations.
M
we set i

As of March 13, 2019, the total monetary base was $3,430 billion, split almost
equally between Currency in circulation ($1,717 bn) and Total balances maintained
7
($1,713 bn). U.S. nominal GDP in 2018 was $20,513 billion. The monetary base is
therefore 16.72 percent of annual GDP. The ‘non-inflationary’ seigniorage that can
be extracted according to equation (2) (assuming that m  m  1 , that is, the real
money stock as a share of real GDP is constrained by a constant demand for real
money balances as a share of real GDP) is therefore 0.68% of GDP. If we narrow
down the seigniorage concept to just the change in the stock of currency in
circulation, the non-inflationary seigniorage as a share of GDP would be 0.34% of
GDP.

Therefore, the amount of seigniorage as a share of GDP that can be extracted at

any constant rate of inflation is surprisingly low as well, given reasonable estimates
of the responsiveness of currency demand to the nominal interest rate and thus to
inflation (Buiter, 2013).

At the ELB, seigniorage as a share of GDP (given by equation (2)) can take on any
virtually value because the demand for real money balances becomes very large, or
8
even unbounded at the ELB, so m can be larger than m  1 . But, once the
economy has left the liquidity trap behind, the inflation risk associated with
persistent monetization of fiscal deficits rises. This is not a theoretical curiosum.
Consider Venezuela today, Zimbabwe in 2008, Yugoslavia in 1994, Hungary in
1946, Greece in 1944, and Weimar Germany in 1923, to name but a few of the
most spectacular and catastrophic instances.

7
See Federal Reserve Board https://www.federalreserve.gov/releases/h3/current/
8
For the Cagan money demand function, the demand for real money balances when the

nominal interest rate is zero is a finite number k Y .

© 2019 Citigroup
April 2019 Citi GPS: Global Perspectives & Solutions 13

So the statement, “set real government spending and taxes to achieve full
employment and finance any resulting deficit by printing money” does not appear to
be a sustainable strategy for an economy outside a (lasting) liquidity trap.

Funding a job guarantee program

The pros and cons of a federally funded employment backstop are, in principle,
separate, logically/analytically and politically, from the rest of the MMT. However,
when considering the idea of removing the fiscal constraint, MMTers point to this
kind of objective. Monetizing budget deficits resulting from the implementation of the
government employment backstop is no different from monetizing a budget deficit
resulting from any other program of public spending increases or tax cuts. Although,
we certainly can get ‘more bang for the buck’ in some strategies than others (both in
terms of demand incidence and supply side consequences) with implications for the
inflation constraint.

The employer of last resort option is, in part of the MMT literature (see e.g.,
Tcherneva (2002)) combined with the assumption that the government sets the
nominal price of some of or all labor — at least the money wage for the federally
guaranteed and funded jobs it offers. Since it already sets the general price level in
the Tcherneva/Mosler world, the government therefore sets the real wage. At that
exogenous wage it pays any and all comers. The merits of the employer of last
resort scheme are, however, independent of whether one subscribes to the
Tcherneva/Mosler model of price and wage determination. The jobs could be
offered at market wages for identical or similar jobs. The merits of such a scheme
remain an interesting issue even if we don’t have the government setting the
general price level and/or the money wage.

A federally funded job guarantee program would only make economic sense if the
government always has a portfolio/inventory of productive, meaningful jobs and job
openings at its disposal, ready to be filled at short notice in the public sector or
through secondment in the private sector – jobs that would not be available but for
the government acting as an employment intermediary and/or employer of last
resort. If instead the State were to offer pro forma public sector employment in
activities that add little or no economic value or maintenance of skills, the job
guarantee — at some guaranteed wage — would simply be unemployment benefits
disguised as sinecures in the public sector. In any case, the current economic
conjuncture, with low unemployment, would not appear to be consistent with the
need for a jobs guarantee.

Funding a Green New Deal

Funding a Green New Deal is another potential purpose that MMTers emphasize of
loosening the fiscal constraint. Some aspects of the Green New Deal reflect the
reality that only the public sector can underpin the collective action and provide the
catalyst for the private sector to undertake the changes needed to react to climate
change. But, the issue should be framed not just in terms of the budgetary costs of
the Green New Deal (spending on public employment, health, education, housing,
and the environment) but also required decisions on budgetary reallocation. That is,
fiscal choices must be addressed.

© 2019 Citigroup
April 2019 Citi GPS: Global Perspectives & Solutions 14

The net of new vs. old fiscal activities will have to be paid for by current and/or
future monetary issuance, cuts in other public spending, tax increases, or increases
in actual and potential output that boost tax receipts at given tax rates. Not-with-
standing supply side benefits of some of these actions, there is no experience
where supply-side economics comes to the rescue of fiscal extravagance. It failed
to do so under Reagan and it is failing to do so in response to the supply-side
friendly aspects of the fiscal stimulus enacted at the beginning of 2018.

The limits to non-inflationary monetary financing were discussed above. With the
U.S. economy at or close to full employment and full capacity utilization, any fiscal
stimulus, including a fiscal stimulus associated with increased spending on the
Green New Deal, will put upward pressure on inflation above its target level and
crowd out interest-sensitive and exchange rate-sensitive private spending. This put
even greater onus on any Green New Deal to address fiscal choices and be
catalytic in its own right.

Helicopter money and fiscal choices

Our skepticism of parts of MMT does not mean that we are opposed to budget
deficits and/or to the monetization of such deficits.

Clearly, in a liquidity trap, a fiscal stimulus, however financed, may be the best way
to escape the clutches of the ELB. When there is cyclical excess capacity, a
countercyclical temporary fiscal stimulus is the appropriate response. If there are
concerns about the amount of sovereign debt outstanding, the funding of these
temporary deficits through monetary issuance for the duration of the countercyclical
stimulus is appropriate.

But a temporary monetized fiscal stimulus (countercyclical helicopter money,

broadly defined to include a monetized boost to public spending on goods and
services as well as a tax cut) is very different from a policy of funding a permanent
government deficit of more than half a percent of GDP through permanent monetary
issuance, when the economy is not in a liquidity trap.

Moreover, the amount of fiscal monetization is not as important as fiscal choices

under the monetization umbrella: Monetizing a fiscal policy set of activities with low
multipliers is far worse than the same deficit that achieves desired distributional
outcomes and supply-side benefits. So, fiscal choices — more than fiscal
monetization — either make good for countercyclical or structural economic sense,
or end in an inflationary ambush.

© 2019 Citigroup
April 2019 Citi GPS: Global Perspectives & Solutions 15

References
Bell, Stephanie (2000), “Do Taxes and Bonds Finance Government Spending?”,
Journal of Economic Issues, Vol. 34, No 3, September.

Bell, Stephanie, "The role of the state and the hierarchy of money", Cambridge
Journal of Economics, Vol. 25, 2001, pp. 149–163.

Blinder, Alan and Robert Solow (1973), “Does fiscal policy matter?” Journal of
Public Economics, 1973, vol. 2, issue 4, 319-337.

Buiter, Willem H. (1975), Temporary Equilibrium and Long-Run Equilibrium, Yale

PhD Thesis, 1975, Garland Publishing, Inc., New York, 1979. Republished in
Routledge Revivals, March 16, 2014.

Buiter, Willem H. (2013), "The Role of Central Banks in Financial Stability: How Has
it Changed?", in The Role of Central Banks in Financial Stability, World Scientific
Studies in International Economics: Volume 30, edited by Douglas D Evanoff,
Cornelia Holthausen, George G Kaufman and Manfred Kremer.

Eichengreen, Barry (2011), Exorbitant Privilege: The Rise and Fall of the Dollar and
the Future of the International Monetary System, Oxford: Oxford University Press,
215pp. ISBN: 978 0 19 959671 3 (hb).

Forstater, Mathew and Warren Mosler (2005), “The natural rate of interest is zero”,
Journal of Economic Issues, 39:2, 535-542, June.
DOI: 10.1080/00213624.2005.11506832

Fullwiler, Scott, Rohan Grey and Nathan Tankus (2019), “An MMT response on
what causes inflation”, Financial Times, Alphaville.

Gagnon, Joseph E. (2017) “The Unsustainable Trajectory of US International Debt”.

Peterson Institute for International Economics, blog post.

Mann, Catherine L. (2002) Perspectives on the U.S. Current Account Deficit and
Sustainability”, Journal of Economic Perspectives, 16:3, Summer, pp 131-152.

Mann, Catherine L and Katharina Plück (2006), “The United States as a Net Debtor:
How much longer the ‘Exhorbitant Priviledge?’” in Jens van Scherpenberg and
Katharina Plück (eds). Share the Growing Burden of World Order, SWP: Berlin.

Mann, Catherine L and Katharina Plück (2007), “Understanding the U.S. Trade
Deficit: A Disaggregated Perspective: Catherine L. Mann, Katharina (p. 247 - 282) in
Richard H. Clarida editor, G7 Current Account Imbalances: Sustainability and
Adjustment, University of Chicago Press 2007, pp. 247-282.

Mosler, Warren (2010) “Seven Deadly Innocent Frauds of Economic Policy”,

Valance Co. Inc.

Reinhart, Carmen M. and Kenneth S. Rogoff (2009) This Time is Different; Eight
Centuries of Financial Folly, Princeton University Press.

Roche, Cullen (2019), Modern Monetary Theory (MMT) Critique, Pragmatic

Capitalism, Practical Views on Money & Life.

Sargent, Thomas J. and Neil Wallace (1981) “Some unpleasant monetarist

arithmetic”, Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.

© 2019 Citigroup
April 2019 Citi GPS: Global Perspectives & Solutions 16

Tcherneva, Pavlina R. (2002), “Monopoly Money: The State as a Price Setter”,

Oeconomicus, Volume V, Winter.

Tobin, James and Willem Buiter (1980), "Fiscal and monetary policies, capital
formation and economic activity," with J. Tobin, in G. von Furstenberg, ed., The
Government and Capital Formation, Ballinger, Cambridge, MA, 1980.

Wray, L. Randall (2015), Modern Money Theory, Second Edition, A Primer on

Macroeconomics for Sovereign Monetary Systems, Palgrave Macmillan.

Wray, L. Randall and Mathew Forstater eds (2005). Contemporary Post Keynesian
Analysis, Edward Elgar, Cheltenham, UK.

Wray, L. Randall (2018), “Public Service Employment: A Path to Full Employment”,

Research Projects Reports, April, http://www.levyinstitute.org/pubs/rpr_4_18.pdf.

Yellen, Janet (2015), “Inflation Dynamics and Monetary Policy,” Speech delivered at
the Philip Gamble Memorial Lecture, University of Massachusetts-Amherst,
Amherst, Massachusetts.

© 2019 Citigroup
April 2019 Citi GPS: Global Perspectives & Solutions 17

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