Modern monetary theory (MMT) makes clear that the only genuine constraint on fiscal policy in a flexible exchange-rate fiat-currency system (a ‘modern monetary system’) is real-resource availability. As the currency issuer, the government is always in a position to purchase goods and services that are available for sale in its own currency if this is considered desirable. Attempting to spend beyond this point would be inflationary, and devalue the currency. With this in mind, it is worth considering how, in the view of modern monetary theorists, the value of the currency is determined. Here, the concern is with the value of the currency domestically as opposed to the determination of exchange rates with other currencies. In considering this topic, it will be possible to address some related questions concerning the connections, if any, between productivity, job guarantees, and the value of the currency.
The starting point of modern monetary theorists is that demand for the currency is underpinned by taxation. By imposing a tax obligation on the non-government sector that can be met only through payment in the government’s fiat money, the government creates a necessity for members of the non-government sector to obtain the currency. This, in turn, ensures the non-government sector, in aggregate, will transact with the government, which enables the government to transfer some goods and services from the private to the public domain. Provided the tax obligation is sufficiently enforceable – backed by brute force if the government is capable of such brute force and deems it necessary – the government commands real goods and services with its fiat money.
Clearly, then, in this view there is compulsion underpinning demand for the currency. There is no suggestion that this compulsion is a good thing, although I have put forward my own view (which is in no necessary relation to the views of modern monetary theorists) that the compulsion of taxation is preferable to a variety of other forms of compulsion (e.g. a sole resort to brute force), and probably necessary until and unless we reach a stage where we all cooperate and share resources of our own volition.
In any case, at a minimum, an enforceable tax obligation is all that is required, in the view of modern monetary theorists, to make the government’s fiat money functional. It does not matter particularly for current purposes whether in its everyday activities the non-government sector transacts in some other money, a commodity, or barters in preference to the fiat money. As long as the non-government sector abides by, or is compelled to abide by, the tax laws, it will demand the government’s fiat money to the extent necessary to facilitate the government’s transfer of some goods and services to the public domain.
At the same time, provided the government is able to enforce its tax laws, members of the non-government sector can be assured there is a demand for the currency, and this will tend to induce them, for reasons of convenience and safety, to transact among themselves using the government’s fiat money, and also to save to some extent in the government’s money or by holding financial assets denominated in it. But this decision by the non-government sector is not strictly necessary to the viability of the government’s fiat money.
According to MMT, not only does taxation underpin demand for the currency, but the more difficult it is to obtain the means for paying taxes, the more valuable the currency. Further, the difficulty of obtaining the government’s money – its scarcity – is at the discretion of the government. This scarcity depends on the size of the tax obligation relative to the government’s expenditures, while the price level itself ultimately depends on the prices the government pays for goods and services when it spends (and also the collateral it demands when it lends – see comment below by Warren Mosler).
In this context, it is necessary to clarify what counts when it comes to determining the value of the currency. In the MMT view, the difficulty of obtaining the government’s fiat money depends on the non-government sector’s net financial assets relative to its net saving desire.
The focus on net financial assets is important because the credit-creation activities of private banks, usually conceived as endogenous money creation in Post Keynesian theory, create and destroy demand deposits, resulting in expansions and contractions of the broader money supply (usually defined as currency plus deposits). However, a private loan always creates a corresponding private liability, and so creates no change in the level of non-government net financial assets. The endogenous money circuits are characterized in MMT as ‘horizontal’ transactions (i.e. transactions between non-government sector participants).
Net financial assets can only change as a result of ‘vertical’ transactions between the government and non-government sectors. Most notably, government expenditure injects high-powered money into the monetary system and increases the net financial assets of the non-government sector; taxes destroy high-powered money and reduce net financial assets.
Not all policy operations by the government sector alter the difficulty of obtaining money. Specifically, most central bank operations leave the amount of non-government net financial assets unaffected, since the amount of high-powered money its operations create or destroy is typically offset by an inverse change in other non-government financial assets. (The exceptions are the ‘fiscal components’ of monetary policy.) For example, bond sales and purchases exchange one financial asset (reserves) for another (government bonds), leaving the net financial assets of the non-government sector unaltered. In these cases, the difficulty of obtaining high-powered money has not changed. To obtain any high-powered money created in this manner the non-government sector has had to run down financial assets previously spent into existence (via government deficit expenditure).
In contrast, fiscal policy almost always alters the amount of non-government net financial assets. Budget deficits increase, and budget surpluses decrease, the net financial assets of the non-government sector. So, in MMT, it is fiscal actions of the government (and any ‘fiscal components’ of monetary policy) that govern the value of the currency.
When there is a balanced budget, the amount of high-powered money injected into the system exactly matches the tax liability of the non-government sector, and there will be no build-up or drawing down of non-government net financial assets. But, ordinarily, the non-government sector wishes to net save (i.e. it typically demands more of the government’s fiat money than is necessary merely to meet its tax obligation). To the extent the non-government sector succeeds in net saving, a budget deficit of equal magnitude will occur as a matter of accounting.
To the extent the budget deficit is brought about by intentional non-government net saving, it will not create an inflationary impulse, because this portion of the currency on issue is demanded as a form of saving rather than a source of spending power. However, if the budget deficit exceeds the non-government sector’s desired level of net saving, there will be inflation and a reduction in the value of the currency.
The ‘right’ level of government deficit expenditure, from the perspective of MMT, is the amount just sufficient to enable non-government net saving intentions while still purchasing all the output it is possible to produce at current prices (i.e. without causing inflation). If deficit expenditure is below this level, unemployment results. If deficit expenditure goes beyond this point, there will be inflation and a decline in the value of the currency.
This aspect of the modern monetary theorists’ approach is explained in an excellent book chapter by Pavlina Tcherneva:
Wray concludes that ‘unemployment is de facto evidence that the government’s deficit is too low to provide the level of net saving desired’. In a sense unemployment keeps the value of the currency, because it is a reflection of a position where the ‘government has kept the supply of fiat money too scarce.’
But we still need to clarify what exactly is meant by value of the currency. In MMT, the value of the currency is defined as what must be done to obtain it. Tcherneva writes:
For example, if the state required that to obtain one unit of HPM [high-powered money], a person must supply one hour of labour, then money will be worth exactly that – one hour of labour (Wray, 2003b: p. 104). Thus, as a monopoly issuer of the currency, the state can determine what money will be worth by setting ‘unilaterally the terms of exchange that it will offer to those seeking its currency’ (Mosler and Forstater, 1999: p. 174)
A government that sets a minimum wage defines the value of the currency in terms of an amount of minimum-wage work – or an amount of ‘simple’ labor time. If the minimum wage were $10/hr, the value of $1 would be 6 minutes of simple labor. More skilled labor can be considered as a multiple of simple labor – ‘complex’ labor. For instance, a high-skilled worker who received $60/hr would take 1 minute to obtain what required 6 minutes of simple labor. The value of $1 could be expressed as 6 minutes of simple labor or 1 minute of complex labor. If a generalized increase in prices (including wages) occurred, and the minimum wage increased to $15/hr, the value of $1 would fall to 4 minutes of simple labor. So inflation represents a reduction in the value of the currency.
Another question to consider is the connection, if any, between the value of the currency and productivity. Productivity improvements will mean that the entire money supply will buy more real stuff (goods and services), and it also means that 6 minutes of simple labor will produce more real stuff than previously, but if money wages remain constant, obtaining one dollar will still require the same amount of simple or complex labor, implying no change in the value of the currency. So there is no direct relationship between productivity and the value of the currency. There can be an indirect relationship. If workers are able to win wage increases alongside the rise in productivity, there will be a reduction in the value of the currency. This does not necessarily mean we are all getting less real stuff for $1. It simply means that $1 corresponds to an expenditure of less labor power. Therefore, the difficulty of obtaining what is necessary to meet tax commitments (fiat money) is reduced. There is a decline in the value of the currency. Provided the rate of inflation is less than the rate of growth of nominal output, there will be an increase in both nominal and real income, yet a decline in the value of the currency. This explains how it is possible for the value of the currency to decline over time to the point where it becomes a tiny fraction of the value it had, say, a century ago, and yet real living standards (society’s command over real stuff) has grown enormously over the same period.
One reason the value of the currency may be a difficult concept to grasp is that it is a monetary phenomenon. As we have seen, changes in real measures, like productivity, don’t directly affect the value of the currency, even though they do mean that the entire money supply, whatever its size, buys more real stuff.
To see this point more clearly, imagine – to take a hypothetical scenario – an economy with a constant (non-expanding) labor force that operated continuously at full employment in which all distributional changes occurred through price adjustments at constant money wages. Under this scenario, as productivity improved over time, the trend in prices of individual commodities would be downward (individual commodities would become cheaper to produce), the trend in real wages would be upward (because constant money wages could purchase more real stuff as prices fell), but the sum of all prices (Marx’s ‘total price’) would remain constant and the value of the currency would also remain constant (since constant money wages would mean that the difficulty of obtaining the currency for meeting tax obligations – a certain simple labor-time commitment – had not changed). In sum, as productivity improved, one dollar would buy more real stuff, but the value of the currency would remain the same.
Under this hypothetical scenario, no extra fiat money would be required over time to purchase full-employment output, because the same amount of money could always purchase it, whatever real stuff it comprised. There would still need to be budget deficits whenever the non-government sector desired to net save, because a portion of the income produced would not be spent, making it necessary for the government to fill the gap through net expenditure (we know this has happened in the hypothetical scenario because the economy has delivered continuous full employment). But the appropriate level of deficit expenditure would create additional fiat money just sufficient – and no more than sufficient – to offset the intended net saving of the non-government sector and maintain full employment without altering the value of the currency.
Of course, in reality, there is inflation and unemployment (as well as a growing labor force), so the amount of high-powered money expands to accommodate higher prices and money wages (and also varies with output and employment). To the extent prices and money wages rise, there is a reduction in the value of the currency. If government expenditure is too low relative to the tax obligation, unemployment occurs, whereas if it is too high, inflation and a reduction in the value of the currency results.
The fact that in the real world we do not typically observe constant money wages, a constant value of the currency and a falling general price level – in contrast to the hypothetical scenario described above – suggests that inflation is the way in which incompatible real income claims (e.g. between the wage demands of workers and the profit aspirations of capitalists) are resolved. It could be, for example, that a perception of insufficient competition in product markets leads workers to suspect prices will not fall sufficiently to deliver satisfactory real-wage growth at constant money wages. It could be, to take another possibility, that workers attempt to gain improvements in their share of real income relative either to capitalists, other workers, or other income groups (e.g. pensioners) through nominal wage increases. Equally, it could be that firms with market power succeed in raising prices above competitive levels. Or more likely, any combination of these factors plus many others result in rising money wages and prices over time, and a reduction in the value of the currency. The relevant point for present purposes is that this conflict or negotiation over income distribution is ultimately resolved in a monetary way through the rise in money wages and prices (i.e. inflation), with the real distribution of income – as well as the value of the currency – emerging in the final wash-up.
Now, the government as monopoly issuer of the currency can exogenously set the price it pays for goods, services, and financial assets. This gives it the capacity to exert strong influence over the general price level through its spending and taxing decisions. At a minimum, it is only necessary for the government to set one price to anchor the value of the currency and the general price level.
One method of doing this that is consistent with the modern monetary theorists’ approach is for the government to introduce a job guarantee at minimum wage – and only minimum wage – to anyone who is without a job and wishes to work. A job guarantee, from this perspective, is an effective way of achieving numerous things simultaneously.
First, by setting the price of one hour of simple labor (the minimum wage level), it exogenously determines the value of the currency.
Second, the minimum wage then provides a nominal anchor for other wages and the price system. For instance, the level of the minimum wage can be expected to have some influence over wage levels applying to complex labor, through its effects on the relative bargaining power of workers and employers.
Third, the job guarantee ensures full employment without itself being inflationary. It is not inflationary because the job-guarantee provider never bids against employers in the broader economy (whether public or private) for labor. If demand for labor rises in the broader economy, the job-guarantee provider does not permit itself (or, if provision is private, is not permitted) to compete on wages.
Fourth, the job guarantee stabilizes prices (and fluctuations around the value of the currency) by putting a floor on demand during downturns while automatically withdrawing demand when private-sector activity recovers. The expenditure associated with the job guarantee is non-discretionary and varies immediately and inversely with demand in the broader economy. In other words, it acts as an automatic stabilizer.
In the absence of a job guarantee, it is difficult to achieve full employment with low inflation because some sectors hit supply constraints before others as demand and economic activity approach the full-employment level. This is why orthodox economists and policymakers intermittently re-estimate ‘full employment’ as occurring at various high rates of unemployment (such as a 5% , 7%, or even higher NAIRU) to define the problem out of existence. Without a job guarantee, aiming for full employment (2% to allow for frictional unemployment) would cause price pressures in overheated areas of the economy.
In contrast, a job guarantee could achieve higher overall employment with less, but more targeted, government expenditure. Private-sector spending power (and government spending) could be lower for any given level of employment. There would still be a need for discretionary fiscal policy to ease inflationary pressures during booms (higher taxation or cuts to other forms of government expenditure), but this could be carried out alongside full employment, rather than an inflationary limit being hit well before this.
Although critics frequently claim that true full employment is unrealistic, something like this was actually achieved in numerous countries in the post-war period up until the early 1970s. Unemployment averaging 2% alongside low inflation was not atypical throughout the period. This was achieved by governments acting as employer of last resort, essentially providing an implicit job guarantee.