November 27, 2017

MMT, money creation, stealth taxation, and redistribution

Own post, no external Blog-Reference

The MMT message is: “The only limit to how much a currency issuing government can spend is inflation. Not the debt. Not the deficit. Inflation.” (see Twitter and the blogosphere)

This joyful political message is based on MMT economic theory which, as a matter of fact, is provably false. Needless to emphasize that the general public cannot see that MMT economics is proto-scientific garbage, a feature that it shares with Walrasianism, Keynesianism, Marxianism, and Austrianism. But lack of sound scientific foundations has never been a disadvantage in discussions about economic policy.#1

Because economics is a failed science it has to be reconstructed from scratch. As the new analytical starting point, the pure production-consumption economy is defined with this set of macroeconomic axioms: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X.

Under the conditions of market-clearing X=O and budget-balancing C=Yw in each period, the price is given by P=W/R (1), i.e. the market-clearing price is equal to unit wage costs. This is the most elementary form of the macroeconomic Law of Supply and Demand. For the graphical representation see Figure 1.#2


The price is determined by the wage rate, which takes the role of the nominal numéraire, and the productivity. The quantity of money is NOT among the price determinants. This puts the commonplace Quantity Theory forever to rest.

From (1) follows W/P=R, i.e. the real wage is equal to the productivity. So, for a start, labor gets the whole product.

Monetary profit for the economy as a whole is defined as Qm≡C−Yw and monetary saving as Sm≡Yw−C. It always holds Qm≡−Sm, in other words, the business sector’s surplus = profit (deficit = loss) equals the household sector’s deficit = dissaving (surplus = saving). This is the most elementary form of the macroeconomic Profit Law. Under the condition of budget-balancing total monetary profit is zero.

What is needed for a start is two things (i) a central bank which creates money on its balance sheet in the form of deposits, and (ii), a legal system which declares the central bank’s deposits as legal tender.

Deposit money is needed by the business sector to pay the workers who receive the wage income Yw per period. The need is only temporary because the business sector gets the money back if the workers fully spend their income, i.e. if C=Yw.

Overdrafts are needed by the household sector for consumption expenditures if the households want to spend before they get their income. This time sequence is no problem for the central bank because the temporary overdrafts vanish with wage payments.

For the case of a balanced budget C=Yw, the idealized transaction sequence of deposits/overdrafts of the household sector at the central bank over the course of one period is shown in Figure 2.#3


The household sector’s deposits/overdrafts are zero at the beginning and end of the period. The business sector’s transaction pattern is the exact mirror image. Money, that is, deposits at the central bank, is continually created and destroyed during the period under consideration. There is NO such thing as a fixed quantity of money. The central bank plays an accommodative role and simply supports the autonomous market transactions between the household and the business sector.

From this follows the average stock of transaction money as M=κYw, with κ determined by the transaction pattern. In other words, the average stock of money M is determined by the autonomous transactions of the household and business sector and created out of nothing by the central bank. The economy NEVER runs out of money.

The transaction equation reads M=κYw=κPX=κPRL in the case of budget balancing and market clearing and this yields the commonplace correlation between the average stock of money M and price P for a given employment level L, except for the fact that M is the DEPENDENT variable. If employment is doubled the average stock of transaction money M doubles. Because the central bank plays an accommodative role there is, as a matter of principle, NO MONETARY obstacle to full employment in the elementary production-consumption economy.

Let us now introduce government deficit spending. Total expenditures consist now of household sector spending Ch, with Ch=Yw, and government sector spending Cg. The money for government spending is created out of nothing by the central bank.

The market-clearing price is according to the macroeconomic Law of Supply and Demand P1=(Ch+Cg)/X0=P0+Cg/X0, that is, there is a hike of the market-clearing price which depends on the amount of additional nominal government demand Cg. Employment, productivity, and output are kept constant, i.e. O1=O0=X1=X0. The one-shot price increase has NOTHING to do with inflation. The price increase effects the redistribution of output between the household and the government sector in the period under consideration.

The real share of the output of the household sector, which was initially 100 percent, is now lower, i.e. Oh1=Xh1=Ch1/P1<Oh0=Ch0/P0 with Ch1=Ch0. In real terms, the household sector is taxed. The real tax is given with Oh0−Oh1 and it is proportional to government spending Cg and, in turn, to money creation. The government simply uses the price mechanism for real taxation. The households cannot see that they are taxed.

The profit of the business sector was zero in the initial period and is now positive, i.e. Qm=Cg, i.e. equal to the budget deficit. It always holds Public Deficit = Private Profit. This configuration can go on for an indefinite time with public debt vis-a-vis the central bank rising continuously and with the business sector’s pile of cash rising continuously. As MMT claims, there is no operational limit to government deficit-spending/money-creation.

The steadily increasing cash pile of the business sector is normally a transitory phenomenon. It vanishes as soon as the government consolidates its short-term debt vis-a-vis the central bank by issuing interest-bearing bonds and selling them to the business sector or to the household sector in the case of fully distributed profits.

With MMT policy, the business sector is clearly better off. The household sector, on the other hand, holds the bag. It is taxed in real terms in the period of government deficit spending without realizing it. It is taxed in subsequent periods if the interest on government debt is greater than zero, and it is taxed in nominal terms in the indefinite future, i.e. beyond the time horizon, in order to eventually redeem the accumulated government debt.

The policy of deficit-spending/money-creation is an economic shell game with massive and virtually unlimited redistributive effects to the detriment of the ninety-nine-percenters.#4

Egmont Kakarot-Handtke


#1 For details see cross-references Political Economics
#2 Wikimedia AXEC31 Elementary production-consumption economy
#3 Wikimedia AXEC98 Idealized transaction pattern, household sector, balanced budget
#4 For the full-spectrum refutation of MMT see cross-references MMT


Related 'MMT is ALWAYS a bad deal for the 99-percenters' and 'Deficits matter for distribution' and 'Q: How are you going to pay for it? MMT: By stealth taxation!' and 'Money and time' and 'Additional proof of MMT’s inconsistency'.