Modern Monetary Theory: An Introduction

Modern Monetary Theory (MMT) is a heterodox macroeconomic framework that argues a government issuing its own currency, such as the United States, is not fiscally constrained in the same way households or businesses are when it comes to federal spending.

Currency Users vs Currency Issuers.

A core principle of MMT is the fundamental distinction between a currency user and a currency issuer.

Currency users include regular people like you and me, who work to earn wages; businesses, which provide goods and services to generate revenue; and state and local governments, which rely on taxation. Most people, unsurprisingly, experience money only from the perspective of a currency user.

Examples of currency issuers include the United States (U.S. dollar), the United Kingdom (British pound), and Japan (Japanese yen), each of which has a central bank responsible for managing its currency. However, not all governments operate this way. Some, like the countries in the Eurozone, use a shared currency, the Euro, which is issued by the European Central Bank. Since these countries do not control their own currency, they function as currency users rather than currency issuers.

Other governments issue their own currency but fix its value to another currency or a commodity, limiting their control over monetary policy. For example, some peg their currency to the U.S. dollar, requiring sufficient foreign reserves to maintain the fixed exchange rate. A historical example is the gold standard, where governments could only issue money backed by gold reserves. Because these systems restrict a government’s ability to manage its economy independently, they are not true currency issuers.

How are they different?

The core characteristic of currency users is that they are fiscally constrained, meaning the resources they can access are limited by the amount of money they have.

As a currency user, your financial decisions are governed by the money available to you. Whether you’re an individual, a business, or a local government, you must earn, borrow, or receive money before you can spend it. Running out of money means you cannot acquire more resources unless you find new income or take on debt. This fundamental constraint shapes how currency users manage their finances, making budgeting, saving, and debt management essential aspects of financial stability.

In contrast, a currency issuer, such as the federal government of a nation that controls its own currency, is not fiscally constrained in the same way. Unlike households, businesses, or local governments, a currency-issuing government does not need to earn money before it can spend. Instead, it spends first and then collects taxes.

However, this does not mean a government can spend without limits. While it cannot “run out” of its own currency, it is constrained by the availability of real resources, such as labor, materials, and productive capacity. If a government issues more money than the economy can support then inflation can occur.

The Mechanics of Issuing Currency

The idea that a government must spend before it can collect taxes can be tricky to grasp, so let’s break it down with an example.

Imagine a brand-new colony or settlement-perhaps the United States in the late 1700s or even the first colony on Mars. The settlers are establishing a new government, which will require taxes to “fund” its expenditures. To do this, the government implements a tax that must be paid in its newly created currency. Continuing with the Mars example, the newly established Martian Government requires taxes to be paid in Martian Dollars (MDs).

The problem is that people won’t be able to pay their taxes in Martian Dollars for the simple reason that they don’t exist yet. How can anyone pay taxes in MDs if there’s no way to earn them? In order for Martian Dollars to exist in the first place, the new Martian Government must issue the currency into the economy first.

Issuing Currency Is Government Spending

So how does a new government issue a currency into existence? Do they simply print money, toss it into the air in the town square, and let people grab it like candy from a piñata? Well, I suppose a government could do that, but it wouldn’t lead to any productivity.

A more effective approach would be for the Martian Government to offer jobs to its citizens; for example, they could build infrastructure, maintain life-support systems, or research ways to grow food in the Martian environment; in return, they would be compensated with newly minted Martian Dollars. Now that the people have a way to earn Martian Dollars, they will be able to pay their tax obligation.

Taxation is the Destruction of Money

Now, the next question you might be asking yourself is: if the government can simply issue new money to fund its expenditures, why does it even need to collect taxes?

While taxes serve as a source of revenue for non-currency-issuing governments, such as state and local governments, they play a different role for a government that issues its own currency. In this case, the primary function of taxes is to reduce inflation by removing excess money from circulation. Additionally, taxes create demand for the currency by requiring individuals and businesses to obtain it in order to meet their tax obligations. If spending creates money, then collecting taxes destroys money, helping to regulate the economy.

The Government Debt is the Non-Government Surplus.

Now that we’ve described the mechanics of money for a currency issuer, let’s apply double-entry accounting to this concept. This will lead us to one of the most fundamental insights of MMT, that the government debt is mirrored by the non-government surplus.

In the scenario where the Martian Government issues new currency as wages to hardworking Martians, let’s take a close-up look at the transactions involving two Martians, Alice and Bob.

Alice is an engineer who works on maintaining and repairing the oxygen generators that keep the colony’s atmosphere breathable. Without her expertise, the Martians would have a hard time breathing!

Bob is a terraformer who is part of a team experimenting with ways to enrich Martian soil so that future generations can grow crops instead of relying on Earth imports.

Recording the Transactions

Lets say Alice and Bob each earn 1,000 MDs for their work. Lets see how that would look as a transaction.

Martian Government Pays Wages to Alice & Bob

The Martian Government spends money into existence by paying 2,000 MDs in wages, increasing wages as an expense (debit) and issuing currency as a liability (credit).

Alice’s & Bob’s Accounts (Receiving Wages)

Alice and Bob receive 1,000 MDs each, recording it as an increase in cash (debit) and an increase in income (credit).

Calculating Net Worth

Now that we have the double-entry accounting laid out for these transactions lets checkout each entity’s net worth.

The formula for Net Worth (Equity) is:

Net Worth = Assets - Liabilities

Martian Government’s Net Worth (Government Sector)

The government has issued 2,000 MDs into existence (a liability). However, it has no assets recorded to offset this liability, meaning its net worth is -2,000 MDs.

Alice’s & Bob’s Net Worth (Non-Government Sector)

Alice and Bob each have 1,000 MDs in cash (assets) and no liabilities, making their net worth 1,000 MDs each.

Total System Net Worth

If we sum everything together:

(−2,000 MDs) + (1,000 MDs + 1,000 MDs) = 0

This confirms that the system balances to zero. The government’s negative net worth (debt) is mirrored by the private sector’s positive net worth. What an amazing insight!

Why Understanding MMT Matters

Understanding Modern Monetary Theory (MMT) offers a new way to think about government spending, debt, and economic policy. MMT challenges the common idea that the federal government should manage its budget like a household. Unlike households, governments that issue their own currency operate under different rules.

According to MMT, the real limits on government spending are the availability of resources, like labor, materials, and technology, and the potential for inflation, rather than budget deficits. This perspective shifts the focus from asking, “How will we pay for it?” to “Do we have the resources to support it?” This can help us better understand how different economic policies are funded.

MMT also provides a different way to view national debt. Rather than seeing deficits as a sign of poor financial health, they can be understood as part of the flow of money within the economy, supporting various activities like employment and business growth.

Overall, learning about MMT helps people think critically about economic systems and government policies. It encourages a deeper understanding of how money works at the national level, helping individuals make more informed decisions when considering economic issues.