MMT Economics Jargon Buster - Part 1 (A Thu to F)
If you’re new to MMT, you’ll need a reference. In this series of articles, I define the most commonly used terms.
Jargon: essential for experts but a barrier to understanding for learners. In fact, for many, I suspect it feels like there’s an entirely separate course that needs to be taken before they can even begin studying the topic.
So, in this series of articles, I aim to cover the basic MMT terms you need to know. In the future, I will continue to add to this article (and all future articles that are part of this series) and when they are all done, I’ll create a downloadable resource.
Note that, in these explanations, I can’t avoid using some jargon myself. Where I do, I’ll either explain within the text, or if I’ve not yet covered the topic, I’ll link to relevant resource.
MMT economics jargon buster 1: A thru F.
Let’s get started.
Aggregate demand
Aggregate demand is the total amount of money spent on goods and services in an economy during a specified time period, based on the overall price level. It includes the combined spending of households, businesses, the government, and exports minus imports. The term "aggregate demand" was first coined by John Maynard Keynes. It was a central concept in his seminal work, The General Theory of Employment, Interest, and Money (1936).
What did Keynes mean by the phrase ‘based on the overall price level?’
When prices are lower, more goods and services are purchased, i.e. aggregate demand increases . When prices are higher, less goods and services are purchased, i.e. aggregate demand decreases. This relationship is typically measured over a specific time period, such as one year. You can think of the price level as a 'control variable’. I.e. controlling for the price level allows us to compare aggregate demand across different time periods.
What’s the difference between undirected and directed aggregate demand
Undirected boosting of aggregate demand would include tax cuts for all income levels. Or spending on general infrastructure projects, without considering whether they will tackle unemployment in particular areas or sectors. An example of directed aggregate demand would be a job guarantee programme that directly employs unemployed workers. Or offering tax incentives in sectors that have the potential to create jobs and contribute to sustainable growth—for example, investing in renewable energy projects.
Base Money
Economists categorise money based on how easily it can be used to buy things or pay for services—this is known as its 'liquidity.' For example, cash is considered very liquid because you can spend it immediately, whereas something like a savings bond is less liquid because you must sell it first before using the money to buy something.
The most liquid form of money is called base money, sometimes referred to as vertical money, high-powered money, or the monetary base. Base money consists of two types: physical currency in circulation and central bank reserves, both of which can be used immediately without any conversion or delay.
Physical Currency: Physical currency refers to the banknotes and coins in circulation, i.e., circulating among the public and businesses, as well as the physical cash held by commercial banks in their vaults and tills.
Central Bank Reserves: Central Bank Reserves are the deposits commercial banks hold at the central bank. In the UK, that’s the Bank of England. These deposits are held exclusively in digital form.
Both physical currency and central bank reserves are considered liquid assets. They do not need to be converted into something else before they can be spent.
The MMT Perspective – Base Money is Created by Government Spending
MMT economists Bill Mitchell points out that base money is created by government spending or central bank operations, and it forms the foundation of the monetary system.
“Base money underpins the banking system, but unlike other forms of financial wealth, it is a liability of the central bank and not created through lending or private sector activity. Its quantity is determined by the government’s fiscal and monetary actions, not private demand” Bill Mitchell – Modern Monetary Theory and Practice: An Introductory Textbook 2019.
As Randall Wray states,
“For a government that issues its own currency, the concept of ‘high-powered money’ is misleading when presented as a scarce resource. The central bank can supply as much base money as needed to support the government’s fiscal stance, and it plays a key role in ensuring the banking system’s stability” Randall Wray, Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems 2015
Capital Controls
Capital controls mean placing restrictions on the flow of foreign currency in and out of a country to limit speculative attacks (i.e., when traders sell off a currency in large volumes, believing it is about to lose value. The sell-of leads to a sharp drop in the currency’s value: making it a self-fulfilling prophesy.). Restrictions can include limits on the holding of foreign currency and/or restrictions on repatriating profits. The downside to capital controls is that they can deter foreign investors, which could impact long-term investment inflows.
For an MMT perspective on the use of capital controls Bill Mitchell’s article provides a good overview, ‘Why capital controls should be part of a progressive policy’.
“…our focus here is on the alleged benefits of capital flow liberalisation and the refusal of governments to countenance capital controls as a major policy vehicle to defend their nations against unproductive and venal currency speculation, which the financial markets consider to be their right.” Bill Mitchell
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Central Bank Reserves
In the UK and in the US, larger banks and financial institutions that are part of the payments infrastructure—such as clearing banks—hold accounts at the central bank. In the UK, this is the Bank of England, and in the US, the Federal Reserve (the Fed for short).
The deposits that commercial banks hold at the central bank are called reserves. These reserve deposits are held exclusively in digital form. In this brief overview, I will use the UK central bank as an example to describe the role of central bank reserves.
Central Bank reserve accounts have many uses. Here are a few examples.
Carrying Out Government Spending Decisions. When the UK government decides to pays for services or projects, such as purchasing a new fighter jet, the funds are transferred via the reserve account held by the commercial bank at the central bank. The government credits the commercial bank's reserve account, and the commercial bank then credits the contractor's bank account. The commercial bank satisfies the payment to the contractor by creating a matching deposit in the contractor’s bank account.
Settling payments between customers. Central bank reserve accounts also provides a way to settle payments from one customer to another when they have accounts at different banks. For example, if you get a loan from your bank to purchase a new home and I’m selling mine, assuming you want to buy it, we need a way to complete the transaction. If we both have accounts at the same bank, the bank just transfers the value of your loan into my account. And I give you the keys to your new house. End of story. However, if we both use different banks, that’s when reserve accounts come in to play. Although the loan you got to buy my house was put into your bank account, that money is not transferred directly from your bank account into mine because, of course, I don’t have an account at your bank. Therefore, the money is transferred between the banks reserve accounts Instead. Your bank uses its reserves to send the appropriate amount of money into the reserve account of my bank. Once my bank’s reserve account is credited, they update my personal bank account.
Monetary policy management. Reserves are important for controlling aspects of monetary policy. This can be a complex area, however, one example relates to the fact that central banks, in both the UK (since 2006) and the US (since 2008). pay interest on reserves held by commercial banks. Banks are only going to lend to each other if they get a higher interest rate than they are already getting from their reserves. This mechanism influences the interbank rate (i.e., the interest rate at which banks lend reserves to each other, usually for short-term loans). The central bank seeks to influence this rate because it affects the rates that commercial banks charge customers to borrow. And this is seen as important by orthodox and neoliberal economists as it encourages/discourages growth in the economy. Note, that MMT economists do not view the cost of borrowing (interest rates) as the key mechanism for controlling economic growth or inflation. They argue that government spending, financed by the sovereign currency issuer, is the primary tool for managing the economy.
Deficit Spending and Debt
When a government spends more than it brings in in taxes or other earnings over a specific period of time, (I.e. a ‘fiscal year’), it is said to be running a deficit. Historically most governments have ran deficits. For example, on the Fred (Federal Reserve Economic Data) website you can find graphs for both the US and the UK showing historic deficits spending as a percentage of GDP.
The consequences of running a deficit are markedly different for monetary sovereign governments than they are for governments that use another countries currency.
Monetary sovereign governments (countries that issue their own currency and do not have foreign debt) are not financially constrained. The word ‘debt’ is still used to describe the historical accumulation of their deficits; however, this is not a debt in the same sense that a business or household would understand it. When ‘debts’ are in the currency of the issuer, there are no debts that cannot be paid in full.
In this scenario, MMT economists would say that deficits can be used as a policy tool - there is no fear of running out of money. There are, however, still policy constraints: the possibility of inflation and a shortage or lack of things to buy in the governments currency. That said, the freedom to run a fiscal deficits free’s up the government to enact the policy choices they were elected on and to enact policy choices that reflect their values.
This contrasts with countries that use another country’s currency. For example, Ecuador, which uses the US dollar, or eurozone countries that use the euro. These countries do not have full monetary sovereignty: they cannot create the currency they use. They rely on earning, borrowing, or receiving funds from other sources. This dependence limits their ability to engage in deficit spending (because it is a debt in the way it is understood by you or I or a business owner) or to control their own monetary and fiscal policies. For example, countries that use the Euro have often been constrained by deficit rules set by the European Central Bank. As Greece found to its cost, such countries are more vulnerable to financial crises if they can't, or are not allowed to (by the currency issuer) obtain enough currency to meet their needs.
Any debt denominated in a foreign currency is a debt that needs to be paid in that currency, which means the government has to obtain that currency. They can obtain it by borrowing or by designing government policies that generate the appropriate foreign currency. Activities that earn foreign currency include tourism, exporting goods and services, foreign investments, bond issuance in foreign markets, and selling the country’s natural resources.
Most countries have historically run deficits and accumulated national debts. However, as I’ve illustrated above, the impact of those deficits is not the same in all countries.
Chartalist
The word Chartalist comes from the Latin word charta, which means 'token' or 'paper.' It was in Georg Friedrich Knapp’s The State Theory of Money (1905) that the term Chartalism became explicitly linked to the idea of state-issued money. Knapp argued that money derives its value from the authority of the state rather than from its material content. Money, he wrote, is a token (charta) accepted because the state designates it for payments, particularly taxes. A ‘token’ is something (a physical or digital object) that represents something else—whether it’s value, permission, membership, or obligation—rather than having any intrinsic worth of its own.
Fiat Currency
A Fiat currency is a currency whose value is wholly derived from trust in the issuer of that currency. For example, the UK Government issues the UK Pound, the UK Government has declared it to be the legal tender and therefore, it is accepted in exchange for goods or services wherever the UK Government has jurisdiction.
A fiat currency is not backed by a physical commodity like gold or silver. It has no intrinsic value. For example, if you have a gold watch, you could visit a pawn shop and exchange it for British Pound notes (assuming you are in the UK). You would expect the pawn broker to evaluate the worth of your watch and give you what he or she thinks it is worth. A gold watch has intrinsic value. Read more my explanation of a fiat currency in my more detailed SubStack article on the topic.
Fiat currencies are central to the the development of an MMT perspective
“The essential insight of Modern Monetary Theory (or “MMT”) is that sovereign, currency-issuing countries are only constrained by real limits. They are not constrained, and cannot be constrained, by purely financial limits because, as issuers of their respective fiat-currencies, they can never ‘run out of money.’” Dale Pierce in What is Modern Monetary Theory, or “MMT”? In New Economic Perspectives
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Fiscal Rules
‘Fiscal rules’ is a term mostly used by orthodox and/or neoliberal economists in relation to government spending and taxation. They relate to the balance between what the government spends and what the government brings in in taxes, borrowing and other income. The EU’s stipulation that countries using the Euro must not run a deficit above 3% of their GDP (Gross Domestic Product) is an example of a fiscal rule.
These rules are based on the assumptions that excessive government deficits and the resulting debt can be harmful to the health of the economy. From a orthodox/neoliberal economics point of view: fiscal rules help keep government finances under control and ensure that the country's economy stays healthy.
The idea is that by following these rules, governments can avoid getting into too much debt, keep taxes from getting too high, and make sure that public services are funded properly. Overall, fiscal rules are like a roadmap that helps governments make smart decisions about their money to keep the economy running smoothly.
Other economic schools of thought do not agree that such fiscal rules are a good thing. For example, MMT advocates do not agree that, for monetary sovereign countries, taxes are used to pay for services. They point out that all spending creates new money—that spending is not sourced from existing savings or tax income. When it becomes clear that taxes are not the source of government spending, the relationship between those taxes and spending, as implied by fiscal rules, is broken. Taxes do have other roles, but raising money to spend on services is not one of them.
It also becomes clear that, for monetary sovereign governments, debts—provided they are not in a foreign currency—do not constrain policy decisions. There is no risk of such debts limiting spending choices.
For Monetary Sovereign Countries, Fiscal Rules as Proposed by Orthodox/Neoliberal Economists Make No Sense
MMT advocates would characterise such rules, as they relate to monetary sovereign countries, as artificial limits based on arbitrary GDP percentages. Such deficit constraints are misguided and can be damaging to the health of the economy and the wellbeing of citizens. Government spending should primarily be determined by what is required to fulfil real needs in the economy, not by spreadsheet rules based on a logic that does not apply to monetary sovereign governments.
“Labour’s fiscal rules are a dead end for the party and for society. Being a good steward of public money isn’t about closing “fiscal holes” and “paying it back.” It’s about closing real deficits—health, infrastructure, education, etc—-and paying it forward for future generations.” Stephanie Kelton
“I knew that the larger federal deficits were what was fixing the broken economy, but I watched helplessly as our mainstream leaders and the entire media clamored for fiscal responsibility (lower deficits) and were prolonging the agony.” Warren Mosler
“The concept of fiscal sustainability is more appropriately defined in terms of societal goals such as well-being.” Professor Bill Mitchell
That’s all for now. At this point I time, I don’t know how many more articles there will be before I get to the end of MMT alphabet, but I suspect there will be a few. :-)
All The Jargon I’ve Missed From A To F
I know I’m missed out many, many pieces of jargon in this list from A through to F. So please add your own list of MMT words I should have covered in the comments section below. I will add them in a future update of this article. Thanks.
And of course, if you disagree with my definitions your comments are welcomed.
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Might be worth including Automatic Stabilisers, which are conventionally income tax and social security payments. Describing how they work from an MMT point of view would be useful, and could lead on to the Job Guarantee.