The key points to understand Modern Monetary Theory (MMT) .

Economy

The Japanese government’s response to the COVID-19 outbreak has been a disaster.

Especially the fiscal policy is not acceptable at all.

This incompetency made me think about how can MMT (Modern Monetary Theory) be explained in a more accessible way.

In other countries (such as the US and the UK), governments have asked to stay home and at the same time providing adequate support.

However, the Japanese government, bound by neo-liberal austerity policies, still does not provide adequate allowance to its people.

MMT (Modern Monetary Theory) supports the view that it is perfectly adequate for the Japanese government to hand over enough money to the nation to survive this difficult time.

How can be possible?

To know about MMT is the first step to understand the Japanese government which has no financial problems within and to saves people when necessary.

In this article, I am going to explain the following points to understand MMT better.

  1. What is MMT (Modern Monetary Theory)?
  2. What is the role of taxes?

 What is MMT (Modern Monetary Theory)?

Modern Monetary Theory (MMT) is one of the macroeconomic theories in the vein of the Keynesian school of economics espoused by Randall Wray, Stephanie Kelton and Bill Mitchell.

Well.  Usually, we do not learn economic theory so deep as scientists.

So it’s OK to have a rough idea of what MMT (Modern Monetary Theory) is.

Actually, in order to understand MMT, we only need to know the following three points

  • Governments with a sovereign currency have no fiscal budget constraints
  • All economies and governments have limits on supply and demand.
  • Government deficits are surpluses for the rest of the economy

Governments with a sovereign currency have no fiscal budgetary constraints

In other words, countries such as Japan, the US, and the UK have no budgetary constraints.

There are several countries that have sovereign currencies: Japan has the Japanese Yen, the US has the US Dollar, and the UK has the British Pound.

A country with a sovereign currency can purchase goods and services and redeem debts in its own currency under a floating exchange rate system.

Even if the exchange rate fluctuates, the government can pay for whatever is sold in its own currency, and because it is its own currency, there is no risk of default.

More to the point, a country with a sovereign currency means it has the supply capacity to earn money from abroad as well as responding internal demands.

A country with a sovereign currency is able to accumulate foreign exchange reserves on its own.

Countries with no sovereign currency

On the other hand, countries that have their own currency but use a fixed exchange rate system do not even have the capacity to supply domestic needs.

Consequently, countries without a sovereign currency usually depend on imports, and very hard to build foreign exchange reserves on their own.

In order to maintain a stable supply, foreign exchange reserves are created by issuing debt denominated in foreign currencies (usually US dollars) and adopting a fixed exchange rate system.

If the foreign currency is depleted, the country’s own currency will collapse.

Then it leads to malignant inflation and default on its foreign debt, resulting in financial ruin.

This is the difference between a country with a sovereign currency and one without.

All economies and governments have limits on supply and demand

All economies and governments have limits on the balance between supply and demand.

This means that they cannot meet needs far in excess of their ability to provide.

For example, a country with a sovereign currency has no financial constraints.

Thus the government can buy as many domestic goods and services as necessary.

However, if the supply has no capability to meet requirements, prices will rise, i.e. inflation will occur.

Two types of inflation

There are two types of inflations.

Demand-driven inflation occurs when demands are slightly higher than the supply side.

In this situation, the country’s capacity to supply is pulled up by the needs and causes lowering unemployment and raising wages.

Supply- shortage inflation is when supply capacity does not keep up with demands.

That is why it is necessary to use fiscal and monetary policy to keep inflation at an appropriate level.

The difference between supply and demand, or the gap between supply and demand plus 2% (inflation rate of 2%), is said to be an appropriate level.

The Bank of Japan has been easing monetary policy to achieve this level of inflaion.

For countries without a sovereign currency, inflation is a terror.

If the government stimulates demand by fiscal stimulus when there is no supply capacity, it is only natural that malign inflation (supply- shortage) will happen.

Government deficits are surpluses for the rest of the economy

A simple way of explaining ‘money’ is that it is a record of how much money the government has issued.

Imagine a balance sheet of a company or organization.

On the right are the liabilities and the left are the assets, and the final total is the same for both assets and liabilities.

From the balance sheet’s point of view, we can see the essence of money much more clearly.

The government is the issuer of the money and the owner of the liabilities, while the people are the users of the money and the owners of the assets.

As the government expands its liabilities, the assets of the people expand at the same time.

Conversely, as the government’s liabilities shrink, people’s assets also shrink.

Do you get the picture?

What is the role of taxes?

To understand MMT, you need to know about the role of taxes.

The more you learn about MMT, the more you will wonder about the relationship between taxes and MMT.

If a government with a sovereign currency has no financial constraints, then why are taxes levied?

There are four main reasons why the tax exists.

  • Taxes move money
  • Inflation control
  • Redistribution of wealth
  • Industry support and penalties

Taxation drives money

“Taxation drives money”, as MMT guru Professor Randall Wray reiterates in his book ‘Introduction to Modern Monetary Theory’.

In a sovereign state, the only means of paying taxes is through the currency issued by the government itself.

I don’t know if any government has a means of payment other than the currency issued, but in Japan taxes are paid in Japanese yen, and the same is true in the US and UK.

Taxes cannot be paid other than a country’s sovereign currency, such as real estate or, in extreme cases, in Bitcoin.

We cannot pay our tax obligations in real estate or bitcoins, so we try to get a currency to pay for it.

The obligation to pay taxes with a sovereign currency “makes us use the currency” (Randall Wray).

Let’s look at another example from Professor Stephanie Kelton, who explains the concept of currency and taxation in simple terms.

Issuer and user

In her book ‘The Deficit Myth: How to Build a Better Economy’, Professor Stephanie Kelton writes about Warren Mosler and his sons.

In a nutshell, Warren Mosler wanted his sons to help out at home, so he gave them business cards as a form of money.

Mr. Mosler gave his name cards to the kids initially.

If the kids don’t pay some name cards to Mr. Mosler for helping out, they would be sent straight to their rooms without TV after dinner, and they wouldn’t be allowed to play.

The business cards are the price kids pay for their help, and kids pay it as a tax so that they don’t have to suffer punishment such as no TV.

The important point ‘much of the world gets wrong’ here is that business cards are not collected from children in order to pay them for their help.

First of all, Mr. Mosler issued the business cards and collected them as a tax.

If you think about it, the currency that we have now would not exist if someone had not issued it.

And currency is not something that we can create on our own, it is something that the government has issued through due process.

Controlling inflation

Taxation has many roles, but one of them is to control inflation.

According to Professor Randall Wray, the role of taxation is to reduce overheated demand.

As he says in his book “Introduction to MMT”, federal government expenditure is about 20% of GDP and tax revenue is 17%.

If 20% of GDP spending is injected into the economy and 0% of tax revenue, this can lead to overheated consumption and significant inflation.

In other words, taxation serves to control inflation by reducing too much demand.

When the economy is overheated, tax increases can be used to cool the economy to an appropriate level.

When the economy is cold, tax cuts can be used to warm the economy.

The problem of consumption tax

I would like to write a few words about the consumption tax.

Actually, the problem is not the consumption tax itself but how and when the consumption tax is used.

When inflation is heating up too much, the consumption tax can be used to cool demand to some extent, as a means of controlling inflation.

But to introduce or increase the consumption tax during a deflationary period when demand is low, freeze up the demand even further.

Furthermore, taxation is not the only way to calm inflation or stimulate demand, but it can act as a regulator of the economy.

Redistribution of wealth

Taxation also has the role of redistributing wealth.

You may have heard this sentence “The rich get richer and the poor get poorer”.

This idea has been with us since the beginning of time.

In the Bible, for example, Matthew 13:12 says,

For those who have will be given and will have abundance, but those who do not have will have even what they have taken away.

And 25:29 says the same thing.

But those who do not have will have what they have taken away from them.

The economist Thomas Piketty, in his book ‘Capital in the 21st Century’ presents the phenomenon that ” The rich get richer…”.

Ultimately, if economic activity is left as a natural phenomenon, this disparity will lead to instability in the country as it divides the rich from the poor.

It is the function of tax systems such as progressive taxation and corporate taxation to redistribute this gap between the rich and the poor.

Industry support and penalties

The role of taxation is also to support certain industries as well as the aspects of penalties.

For example, if a country wants to develop its technology sector, it is easy to imagine that tax relief for related industries would stimulate demand.

On the other hand, if the government wants to increase taxes on alcohol and tobacco, increase the taxes to reduce consumption.

In other words, taxes can be arbitrarily applied to manipulate which areas of demand will increase or decrease.

Summary of MMT (Modern Monetary Theory)

In this article, I have tried to focus on the following points about MMT (Modern Monetary Theory).

  1. What is MMT (Modern Monetary Theory)?
  2. What is the role of taxes?

If you are serious about learning about MMT, you need to learn about the economy from a broader perspective.

But if you are not an expert,  it would be enough that you understand the general framework of MMT (Modern Monetary Theory).

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