Demand for the Currency & Value of the Currency

Modern Monetary Theory (MMT) makes clear that the only genuine constraint on fiscal policy in a sovereign currency system is real-resource availability. The reason government can always command available resources with its currency is that it is able to ensure a demand for the currency – a need within non-government to obtain the currency. With a demand for the currency established, government has the capacity to purchase whatever goods and services are available for sale in its own currency. Attempting to spend beyond this point, however, would be inflationary, and tend to devalue the currency. With this in mind, it is worth considering how, in the view of Modern Monetary Theorists, a monetarily sovereign government establishes a demand for its currency and, with this demand established, how the value of the currency is determined.

Establishing a demand for the currency

According to MMT, taxes drive demand for the currency. Government, by imposing a tax obligation that can only be met (finally settled) in the currency, creates a need within non-government to obtain the currency. This, in turn, ensures that non-government, in aggregate, will transact with government, which enables a transfer of some goods and services from the private to public domain. Provided the tax obligation is effectively enforced, government can command real goods and services with the currency.

An enforceable tax obligation ensures, at minimum, that government can carry out its socioeconomic program by commanding the resources necessary to do so. Ultimately, it would not matter if members of non-government, in everyday activities among themselves, transacted in some other money, a commodity, or bartered in preference to the government’s currency. So long as taxes are enforced, non-government will still need to transact with government to the extent necessary to pay taxes, and this ensures the capacity of government to command the resources necessary to its purpose.

At the same time, so long as taxes are enforced, non-government is assured of an established demand for the currency, and this will tend to induce them, for reasons of convenience and safety, to transact among themselves in the currency. They will also be inclined to save, holding financial assets denominated in the currency. But this preference of non-government to adopt the currency more generally, while being typical, and perhaps ideal, is not strictly necessary to the viability of the currency.

Value of the currency

The value of the currency is something distinct from demand for the currency. Government, by its authority to tax, can establish a demand for the currency that is largely independent of the currency’s value. On the proviso that taxes are enforced, the currency will be demanded to some extent even if the currency becomes almost worthless. Having said this, so long as taxes are enforced, the currency can never be completely worthless, because the currency will be commanding some goods and services – namely, the goods and services that non-government must exchange for currency merely to pay its taxes. But the amount of goods and services exchangeable for a unit of the currency could be very high, or very low, while a demand for the currency remained in place.

In MMT, the value of the currency is defined as “what must be done to obtain it”. As Pavlina Tcherneva expresses it,

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)

In practice, government sets some wages and prices while leaving others to be determined in the marketplace. Even so, a government that sets a minimum wage in effect equates a unit of the currency to an amount of minimum-wage labor, which we can think of as ‘simple’ labor. If the minimum wage were set at $15/hr, one dollar would command 4 minutes of simple labor power.

Even if government set no other wages or prices, the setting of the minimum wage would have a considerable influence over other wages and prices. The wages of more highly skilled workers – whose labor can be considered ‘complex’ labor – will be influenced by the level of the minimum wage. If the minimum wage were doubled or halved, there would be pressure – whether through competition, collective wage bargaining or centralized wage determination guided by notions of relative wage justice, and other socioeconomic factors – for the wages of complex labor to rise or fall, though the process may take some time. The minimum wage places a nominal floor below other wages. When the minimum wage is altered, the floor shifts, and there is pressure to maintain wage relativities.

With a minimum wage of $15/hr, a highly skilled worker paid $60/hr will take 1 minute to obtain what requires 4 minutes of simple labor. To the extent that relative wages reflect labor complexity, the wages of complex labor can be regarded as payments for equivalent amounts of simple labor. In the present example, one hour of complex labor is equivalent to four hours of simple labor, each paid the minimum wage of $15/hr.

In reality, government sets many more wages than just the minimum wage. It sets the entire pay scale within the public sector. Employers in the private sector need to offer wages competitive with public-sector wages. For this reason, the wages set by government influence all wages to some degree.

The average wage, which will be influenced by the choice of minimum wage and the setting of public sector pay and conditions, will then influence the price level. Prices are typically set as a markup over money wages. At the aggregate level, the capacity of firms to set prices above money wages depends on the ratio between non-wage and wage expenditures. Non-wage expenditures are equal to capitalist expenditures (both consumption and investment), plus net exports, plus the government deficit, minus worker saving. Expressing all variables in nominal terms (i.e. unadjusted for inflation),

k = 1 + (CP + I + GD + NX – SW) / W

where k is one plus the aggregate markup, CP is capitalist consumption, I is private gross investment, NX is net exports, SW is worker saving, and W is total money wages.

The fractional part of k is the markup. The numerator of the markup is total realized profit. At the micro level, firms compete over this realized amount of profit which has been determined, in aggregate, by the level of non-wage expenditures. The total level of nominal expenditure (including both wage and non-wage expenditures) will, in general, reflect both real command over resources and nominal effects. The latter will feed into the price level. A bidding up of private-sector wages and prices is possible through private credit creation (the endogenous creation of new deposits) or a drawing down of retained earnings (savings accumulated in previous periods). A slump can result in the reverse situation, where some private-sector wages and prices fall relative to the policy set minimum wage and public sector pay scale.

Evidently, then, both the value of the currency (what must be done to obtain a unit of the currency) and the price level (the weighted average of all prices) are susceptible to general demand conditions as well as the capacity of workers to bid up wages and the capacity of firms to bid up prices (which will increase the markup in nominal terms).

Government, as monopoly issuer of the currency, is uniquely positioned to moderate demand and to set various wages and prices. The setting of the minimum wage can be regarded as setting the value to which the currency tends. However, varying demand conditions, and variations in the wages of complex labor relative to simple labor, will result in the value of the currency oscillating around the value to which it tends.

Specifically, if wmin is the minimum wage and w is the wage that is paid, on average, for the equivalent of one hour of simple labor, the value of the currency z will tend to the value z* but in general vary around this level:

z = 1 / w

z* = 1 / wmin

For example, if the wage paid for labor power of complexity x happened to equal xwmin for labor of any complexity, the value of the currency would be z*. But whenever some wages diverge from levels strictly reflecting labor complexity, the value of the currency will in general differ from z*. Nevertheless, z will always tend toward z* so long as there is a tendency for wages to reflect labor complexity.

Deviations of z from z* are likely to occur over the business cycle as demand conditions fluctuate. Government can moderate demand through its use of countercyclical fiscal policy. MMT’s proposed job guarantee would function as an automatic stabilizer, with government spending on the program varying endogenously and countercyclically in accordance with the number of individuals wanting a job-guarantee position.

The “right” level of government net 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 the government’s net expenditure is below this level, unemployment results. If its net expenditure goes beyond this point, there will tend to be both inflation and a decline in the value of the currency.

In connection to an economy without a job guarantee, Pavlina Tcherneva writes:

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.’

In an economy with a job guarantee there would be no involuntary unemployment. The relevant index of demand would then be the ‘buffer employment ratio’, defined as job-guarantee employment divided by total employment. In principle there would be a level of the buffer employment ratio that was consistent with stable inflation – the ‘non-accelerating buffer employment ratio’ or NAIBER (analogous to the NAIRU in economies without a job guarantee). Buffer employment ratios above or below the NAIBER would be associated with demand-side inflationary or deflationary pressures (relating to the general price level). These impacts on the price level would partly be the result of private-sector wage pressures, with implications for the value of the currency.