Sunday, September 8, 2013

CMMT - Cate's Modern Monetary Theory

CMMT is a very simple model that helps expose the real impact of spending, taxes, and bonds on things like the money supply,  inflation, and hyperinflation.  With a few simplifications it is easier to understand at a high level what is going on.   One big simplification is that the central bank and government are lumped together, as if in one big black box.

Here is the model:
  1. The central bank is part of the government
  2. All government spending is from newly made money (electronic or paper)
  3. All money from taxes is destroyed (electronic or paper)
  4. All money collected from government bond sales is destroyed
  5. All government bonds are paid off with newly made money

If the government is spending more than it is getting from taxes, and it is not selling bonds, then the money supply will go up.

In this model the government can make as much money as it wants, so the only reason for taxes and bond sales is to control inflation.   Since money from taxes is destroyed, taxes reduce the money supply.   Bond sales temporarily reduce the money supply.   As far as the effect on the money supply, a bond sale is equal to a tax and then later a stimulus check.


In this model it is easy to explain hyperinflation.   If the total value of the  bonds is multiples of the money supply, and government spending is twice taxes, then it will be forced to make lots of money if people stop buying bonds.   The money supply will increase because spending is twice taxes, so creation is twice destruction, and because money is created to pay off bonds.   If people get worried that in the future the value of money will be less then they don't want to hold bonds.   However, the faster people get out of bonds the faster the government makes new money to pay off bonds, so once this process starts it is a positive feedback loop that feeds on itself and gets out of control.  If over a year or two people get out of bonds then the money supply will increase very rapidly and you get hyperinflation.   

Another way to think about it is that bond sales temporarily control inflation, but if too many bonds are paid off at the same time it can result in hyperinflation.

Increasing taxes to destroy more money works to fight normal inflation; however, taxes are not up to the job of fighting the rapid death spiral of hyperinflation.  The total debt can be many times the amount of taxes collected in one year, so this rapid monetization of debt is far greater than increasing taxes can cope with.

This CMMT model is just a slight correction to MMT or Modern Monetary Theory.   While they have #1,#2,#3 above they are not consistent in how they treat bonds and do not have #4,#5.    They say all government spending is from new money but then also have the government spending money from bonds.   They say all spending is from new money but also say new money is not spent to pay off bonds.  These errors make standard MMT far more complicated and not match reality.   In particular, hyperinflation really happens but in MMT there is no reason for it.   They have to say that the cause of the hyperinflation of money is outside their theory of money.   This is just silly.  With this little fix hyperinflation is easily explained.  So CMMT is a big improvement over MMT.   CMMT also stands for  Corrected Modern Monetary Theory. :-)

An existing country, like the USA, could do everything it does exactly the same as it currently does and just with changes in accounting it could be like this model.   Recycling tax money to be part of the money spent, instead of printing all new money, should be viewed as just a slight cost saving measure and not fundamentally changing things. 

In the current system the US central bank pays its profits back to the government.   So interest paid on government bonds held by the central bank mostly comes back to the government.   So accounting for these as if they did not exist would not be far off.  We can think of the government as just printing and spending money, instead of borrowing from the central bank, and not be far off.  In reality governments never seem to reduce their  total debt.  We can imagine a black box around the central bank and government and ignore any accounting that goes on inside this box (social security trust fund, money owed by the government to the central bank, etc) as it does not change things in the real world.

This model is just a different way of thinking about what is really going on.  The government can print money, so it really could burn all money collected from taxes and bond sales.   We can match the current system by just saying that money inside the central bank and government is not part of the money supply.  In fact, the definitions for M1, M2, and M3 do not include bank reserves or excess reserves, so this is already matching reality.   Government spending adds to the money supply and bond sales and taxes reduce the money supply.  With this definition we can save a lot of money burning and printing. 

Note that in this model there is no difference between a bank keeping money at the central bank as excess reserves and buying a bond from the government, since the government and central bank are lumped together.   In both cases the money is removed from the money supply and earns interest for the bank.  In this model increasing excess reserves is not increasing the money supply.  This model fits with the low inflation seen over the last few years even as base money in the form of excess reserves has shot up.  

In real life, when things get desperate enough that hyperinflation is a real risk, the independence of the central bank always vanishes.   If the government is spending twice what it gets in taxes and needs the central bank to buy government bonds and fund the deficit it always gets it to do so.   So ignoring the official separation of central bank and government is reasonable when looking at hyperinflation. 

This simple model makes it easier to think about some economic issues and it is reasonable to think about existing countries in these terms.

48 comments:

  1. I like the new theory, but I don't understand

    4. All money collected from bond sales is destroyed

    Isn't the money spent, just like creating from thin air? (please explain a bit more)

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    1. It is my model I get to say what happens. :-) See below.

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  2. Well... It seems I beginning to understand that.
    Bonds just temporarily reduce inflation. (while people still buy them)

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    1. Imagine a 10 year bond for $100,000 US with 2% interest. When the government sells the bond it gets $100,000 and destroys that $100,000. After 10 years it pays off the bond with $121,000 in newly made money. So for 10 years there is $100,000 less money but after that there is $21,000 more than at the start. So for 10 years it helps to control inflation.

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  3. In your model there is no interest rate on bonds, so bonds and money is really the same. However, yes, a government can create hyperinflation by spending to much, it just takes a lot of money.

    In the real world bonds pay interest, so people will buy them. However, the CB could buy all the bonds and pay zero interst on their liabilities. That will reduce the risk of hyperinflation.

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    1. I did not state it but in another example in the comments I did do interest. The real world 10 year bonds in Japan are paying 0.74% interest per year. They are increasing the money supply by about 1% every 10 days. In the real world people are getting out of Japanese bonds and I predict will get out much faster in the coming months.

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  4. Sorry Vincent, but your understanding of MMT is off. T-bonds are part of the money supply. Just because you deposit your money into a CD account at your local bank instead of your checking account, this doesn't change the supply of money. Same thing goes for when people choose to deposit their money at the Fed into time deposit savings accounts. Your money never goes anywhere when you buy a Treasury. It stays as an accounting notation on the Feds books under "Securities" accounts and when the maturity date arrives, the Fed simply debits your securities account and credits your reserve or deposit checking account.

    When the Govt spends, these are new credits or money that Congress through the Treasury orders the Fed to mark up or down in the corresponding SS check recipient's bank's reserve account at the Fed. Which in turn forces the bank to credit the SS recipients account with new bank credits.

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    1. I really do understand standard MMT. In that monetizing a bond is "just an asset swap" and "does not change the money supply" because they define the money supply to include bonds. In standard MMT runaway monetization does not matter. But in the real world runaway monetization causes hyperinflation. So MMT does not match experimental results. It is wrong. I am fixing it so it matches reality.

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    2. I'm sorry Vincent you are right. When I have money in my checking account, its called money. But if I get a CD, THE MONEY IS GONE!!!, what a ridiculous thing to say. The only reason you seem to be fixated on this bond issue is because without it your entire model and theory falls apart. I recognize that people are loathe to admit when they're wrong, but come on, this is some pretty basic stuff.

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    3. In MMT they think about it as if all tax money were just burned up. With a government that can print money, it could do that. Why is it ridiculous to think that when the government sells a bond they just burn up the money they get from selling the bond? It makes for a very clean way of thinking about what taxes and bonds really do.

      In reality the government would recycle the money from taxes and bonds to save some printing cost but that is just a little detail. It is very clean to think about the real impact of taxes and bond sales to just imagine they burned all money collected.

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    4. Auburn, buying a CD from your local bank does not make money go away. It is paying taxes or buying a government bond that reduces the money supply.

      As an MMT person you view money paid as taxes as reducing the money supply, right?

      You view government spending as increasing the money supply, right?

      If you are doing these, why not view bonds the same way?

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  5. I made a short URL for this post. I was hoping that would get around the ban on links to my blog in comments on wordpress blogs, but it did not work. I would like to post a comment with link to this post on some MMT sites but have not been able to. Here is the short URL: http://goo.gl/B9QGzG

    If anyone knows how to get wordpress to unban a site, please let me know.

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    1. Vincent, it's time for you to adopt a whole new identity. ;)

      ... or if you don't want to do that, why not just set up another blog? ... put a link in the new blog post to this post. Or just tell people how to get here via google.

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    2. I tried setting up vincecate.wordpress.com with a link to this blog but wordpress spam fighter saw through this. I should not have used my normal email. Ug.

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  6. "In the current system the US central bank pays its profits back to the government. So interest paid on government bonds held by the central bank mostly comes back to the government. So accounting for these as if they did not exist would not be far off."

    I think you have to account for the central bank buying the bonds in the first place though. I get what you're doing: draw a line around the Fed and gov and say they're the same... but then the gov issues bonds and buys some of them back. Did you account for that detail? It's almost like they reach maturity early (in your model). And then of course they might be sold again by the Fed. And it's not just the Fed that buys them... social security and Fed worker retirement plans do as well. They also sell them.

    So there's continual bond sales and purchases by the government.

    Again... that's for CMMT, not MMT.

    However, how are you going to count the bonds held by the Social Security trust fund (and related gov funds)? The public doesn't have direct control of those bonds, but they belong to the people that put money into the fund.

    Those bonds are a HUGE amount of the total debt of the US Tsy! About 1/3.

    You write:

    "In reality governments never seem to reduce their total debt."

    It might be important here to qualify that as "nominal debt."

    It's possible to inflate and essentially pay down real debt... even while adding to nominal debt.

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    1. Yes, imagine a big black box around the central bank and government. All the real world cares about is the net of what goes in or out of this box. Any accounting for an imaginary social security trust fund inside this box does not change the real world in any way. We can ignore it when looking at things like the money supply and inflation.

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  7. "In reality the government would recycle the money from taxes and bonds to save some printing cost but that is just a little detail." I'll let you in on a little secret - it is not printed.

    "In the current system the US central bank pays its profits back to the government. So interest paid on government bonds held by the central bank mostly comes back to the government. So accounting for these as if they did not exist would not be far off." What about the capital losses? Speaking of which, when added up like an honest adult the fed is insolvent.

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    1. Yes, most money is electronic so there is not even any printing cost to worry about.

      Yes, the Fed is or soon will be insolvent. The site that Tom linked to is a very good way to understand the problem.

      http://www.csun.edu/~hceco008/realbills.htm

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  8. Hey Vincent, wondering about foreign aid - does that have a place in a revised MMT theory as well? Saw 'foreign aid' hitting the headlines recently and realized that it's a possible vector for currency management.

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    1. My simple CMMT model does not tell us anything about foreign aid in particular. If a government is spending money on foreign aid then it just counts as part of their total spending.

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  9. We don't need new schemes aimed at maintaining the current fiscal detachment from the natural limits on growth provided by the Earth's resources. This is a bad idea even if it is perfect...it would be perfectly bad in that it allows government to grow at will...THAT is the problem that can only be addressed by shutting off the ability for congress to create new money.

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    1. I don't see this as a new scheme. I see it just as a way of explaining what is really going on so that people can understand the danger of too much debt and deficit spending.

      I think the world would be better off if governments did not deficit spend or print money like crazy.

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  10. Well congrats on getting some comments from Mike Sproul on your Real Bills post Vincent!

    Now if only Warren Mosler would show up for this one...

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    1. And Mark is looking at my hyperinflation stuff! It is a dream come true. So far I have not had to cross off the whole post.

      http://www.interfluidity.com/v2/4706.html

      If I can survive Mark I think I can take Warren. :-)

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  11. "If the total value of the bonds is multiples of the money supply, and government spending is twice taxes"

    The US federal government debt is not 'multiples' of the money supply, and government spending is not 'twice taxes'.

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  12. I don't think I implied that the US was primed for hyperinflation.

    The US debt is around $17 trillion and the base money supply is around $3 trillion. However, much of this $3 trillion is really hidden inside the Fed as excess reserves, so in this model counts the same as government debt and not as part of the money supply. So it is multiples.

    I agree US government spending is not twice taxes. Japan's is though.

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  13. The monetary base is only a small part of the money supply. MZM (money zero maturity) is around $12 trillion dollars.

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  14. "I agree US government spending is not twice taxes. Japan's is though."

    No it's not.

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    1. In the URL below both in 2012 and 2013 the money for total expenditures came about half from taxes and half from selling bonds. Also note that "national debt service" is about half taxes.

      http://www.mof.go.jp/english/budget/budget/fy2013/01.pdf

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    2. Japan government spending is over 40% of GDP, and the govt budget deficit is about 9% of GDP.

      I think they might be counting contributions to the social security trust fund as a government 'expense'.

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    3. My information seems very clear and comes from the Ministry of Finance of the Government of Japan. Do you have any link for your numbers or your opinion?

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    4. http://www.heritage.org/index/country/japan#limited-government

      Also

      http://www.tradingeconomics.com/japan/government-budget

      http://en.wikipedia.org/wiki/Government_spending#As_a_percentage_of_GDP

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    5. The heritage informaton does not say what year it is from. Probably it is old. The stuff I linked to on the Ministry of Finance web site is last year and this year.

      I don't understand tradingeconomics where they have "government budget value". I suspect this is not including interest expense.

      The wikipedia just has government spending not deficit or taxes.

      Japan is trying to get taxes above new bond sales but for the last 4 years they have not been. See this:
      http://www.reuters.com/article/2013/01/29/us-japan-economy-budget-idUSBRE90S0AP20130129

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    6. the heritage foundation stats are from 2013. Their figures are from the OECD and IMF etc. The tradingeconomics chart shows the govt budget deficit as a percentage of GDP, the text at the top explains. The wikipedia page shows government spending as a percentage of GDP and taxes as a percentage of GDP, but it's from 2011.

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    7. So Kyle Bass also says that they are spending twice what they get in taxes and interest on the debt is about half their taxes.
      http://www.youtube.com/watch?v=7kFcDKBpdII

      If Kyle says so, I figure the Ministry of Finance web site is probably right. :-)

      So the puzzle is how are we seeing such different things. People often talk about a "primary budget deficit" which just means ignoring the interest paid. If your sites were doing that then things would fit. The interest in Japan is huge, so ignoring it cuts the deficit in half. Ignoring interest, the deficit is only 1/3rd of spending and spending is only 50% more than taxes.

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  15. "hyperinflation really happens but in MMT there is no reason for it"

    Yes there is.

    See, for example:

    http://www.economonitor.com/lrwray/2011/08/24/zimbabwe-weimer-republic-how-modern-money-theory-replies-to-hyperinflation-hyperventilators-part-1/

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    1. I skimmed all 3 parts and could not see where it explains hyperinflation in MMT terms. Can you point me to the section? In other papers I have seen "hyperinflation is a political event not a monetary event" and while MMT guys love their debits and credits normally, when it comes to hyperinflation they have none.

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    2. http://www.netrootsmass.net/fiscal-sustainability-teach-in-and-counter-conference/marshall-auerback-inflation-and-hyper-inflation/

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    3. Looks like over an hour of video and I really doubt it explains hyperinflation in MMT terms. All I ever see by MMT people is that hyperinflation is not caused by printing money. So can you tell me at what point in the video (minute) he explains how hyperinflation happens using MMT theory? After your last link not explaining hyperinflation in MMT I don't want to waste and hour on this one. MMT types always say it is external to the theory. That it is political. That it is war. Etc.

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    4. In my latest post I explain hyperinflation from many different views. I try to explain what MMT does as well. Let me know what you think or if you have links to MMT doing anything different than what I said.

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  16. Your Debt Clock is biased. Accounting 101 tells us that where there's a deficit there's a surplus.. You should have a a green calculator bar showing net financial assets which are equal to the penny to public sector deficits.And the total debt is equal to total national savings.

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    1. It is not "my debt clock". I am just linking to it.

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  17. You can easily figure out how much GDP can be generated with the new money supply. Ask yourself “If the government was going to collect the total money supply by current taxation, how much GDP would the existing money supply need to generate before the debt was gone?”.

    The answer is exactly GDP = MS / Tax Rate.

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    1. By your GDP = MS / TaxRate formula, if they cut the tax rate in half does the GDP double?

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    2. Yes. And if they cut the TR to zero, GDP can become infinite.

      At zero tax, we could think of an economy without any government taxation.

      We could also think about government paying expenses as usual without taxation.

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    3. My understanding is there are no taxes in much of Somalia but the GNP is not infinite. I doubt the accuracy of your equation.

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