Ongoing Debate Over Currency Value

In this post, I outline how I see the questions of demand for state money and domestic value of state money. My perspective is informed by neo-chartalism (modern monetary theory). Hopefully the post can serve as a basis for discussion and we can identify some of the sources of disagreement. I am mainly referring to disagreements between Modern Monetary Realists (MMRers) and Modern Monetary Theorists (MMTers), but others have expressed opinions such as John Carney at CNBC and John Kay at the Financial Times.

A few issues need clear treatment from the outset, because disagreements may be stemming from one or other of the issues without it being clear to both sides in a given instance.

Domestic Value. What I am considering is domestic value of the currency. I take no account of exchange rates between different state monies or potential private monies that are not denominated in the government’s unit of account.

Positive Demand. If at least somebody needs to get hold of the government’s money, there is some demand for the currency, but not necessarily widespread use of the government’s money.

Extent of Use/Demand. In principle, the government’s money could be used for all monetary transactions in a nation or only for some transactions, with alternative monies used at other times.

Role of Taxes

There seems to be disagreement over the significance of taxes. The MMRers appear to acknowledge that taxes play an important role (perhaps necessary?) but argue that they are insufficient to ensure the viability of the government’s money. My interpretation of MMT has been that enforceability of taxes (or fees or some other obligation to the state) is sufficient but not necessary (i.e. that other factors could conceivably be sufficient), even though historically this does not appear to have been the case.

In thinking about the possible necessity and/or sufficiency of tax enforceability in relation to government money, the question that springs to mind is, “necessary and/or sufficient for what?”

I suspect MMRers are thinking in terms of widespread use of the currency whereas MMTers have in mind the minimum requirement for the viability of the government’s money. For this reason, the MMRers stress that there are other factors relevant to the widespread acceptance of the government’s money, whereas MMTers point out that, at minimum, all that is necessary is the introduction and successful enforcement of a lump-sum tax.

The way I see the MMT position is this. Whether or not people think there are great things to be had by trading in the government’s money, that is immaterial to the question of whether the government can create sufficient demand for its currency to transfer resources as desired from the private to public domain. If there is a lump-sum tax, and it is successfully enforced, that will be sufficient. End of story.

That does not mean that the government’s money will be widely used beyond what is necessary to extinguish the tax obligation. Nor does it mean that if the government’s money is widely used, this will be solely due to the enforced tax obligation. MMTers agree that many other factors come into play including convention, convenience, other legal measures (e.g. contract law), and so on.

In the MMT view, it would not ultimately matter if people, having met their tax obligations, transacted in other monies the rest of the time. A reason governments try to restrict people as much as they can to use of the government’s money is that they have introduced consumption and income taxes, which can be avoided by transacting in other monies. However, if governmental attempts to restrict use failed and people largely adopted other monies for private transactions, the matter could be resolved by the government imposing only lump-sum taxes to the extent necessary to transfer the desired resources to the public domain. This, in itself, would be sufficient for viability of the government’s money.

Domestic Value of the Currency

In terms of the (domestic) value of the currency, the MMT position is that it is determined by the scarcity of the government’s money relative to the enforced tax obligation. The government, through its fiscal policy, should keep its money just plentiful enough to facilitate tax payments and any non-government net saving desire in the government’s money.

In a sense, enforced lump-sum taxes determine the minimum scope of the currency. That is, they define the minimum use the non-government could make of the government’s money while still abiding by the tax laws. Provided tax enforcement is successful, the government’s money will be used at least to that extent.

If the government’s money were not used beyond that, and most goods and services were for sale in some other money (or monies), the point of interest for other transactions would be the value of whatever money was in use. This would not impact on the (domestic) value of the government’s money. There would be fluctuations in exchange rates between these different monies, but that would have no bearing on the (domestic) value of the government’s money, which is what matters for dealings in that money.

In other words, lack of access to quality output or resources for sale in the government’s money beyond what was necessary to extinguish the tax obligation would result in the government’s money only circulating in a narrow sphere, but this would not impact on its value within that sphere. Provided that sphere was wide enough to enable the desired transfer of resources – which it would be, provided the lump-sum tax obligation was enforced – viability of the government’s money would be maintained.

Note on Productivity

Having said all that, as long as the government is maintaining the (domestic) value of its currency, there is little reason for the non-government not to opt for it rather than other monies.

This is irrespective of a nation’s level of productivity. The problem declining productivity causes for exchange rates will apply irrespective of the money in use within a nation. Using a money other than the government’s money will not resolve this problem. The difficulty in obtaining a foreign state money for the purposes of purchasing goods not for sale in domestic monies (whether the state money or private monies) will remain. The problem would be low productivity, not domestic value of the currency.

So it seems to me that successful tax enforcement and keeping the currency sufficiently scarce relative to the tax obligation and non-government net saving desire is both sufficient to ensure the viability of the government’s money and in all likelihood conducive to its widespread use, albeit in combination with a wide array of other factors.