That Doesn't Mean What You Think It Means

Over the past month, I’ve been trying to pin down exactly what’s wrong with Modern Monetary Theory. Or perhaps a less presumptuous way of putting it is that I’ve been trying to figure out what mainstream economists believe is wrong with MMT.

Here I’ll list 6 MMT ideas. I’ll first explain the kernel of truth in each claim. Then I’ll explain the mistaken way that MMTers interpret these claims. Finally, I’ll explain how and why these claims don’t mean what MMTers think they mean. I’ve taken this approach because I believe that MMT is based on a series of basic misunderstandings:

1.Banks don’t loan out reserves.

2. There is no money multiplier.

3. Money is endogenous.

4. Interest rates are an exogenous monetary policy instrument.

5. Investment is not very responsive to interest rates.

6. In a closed economy, net saving equals the budget deficit.

1. Banks don’t loan out reserves.

It’s true that most bank loans are executed by crediting the borrower with a new bank account, and thus the reserves usually don’t immediately leave the banking system.BTW, for any given monetary base, the only way that reserves can leave the banking system is as currency notes.

From this mostly valid claim, MMTers wrongly conclude that an injection of new reserves into the banking system does not boost bank lending.

As I explain in this post, the injection of new base money by the Fed (initially as bank reserves) sets in motion a series of price and quantity changes that has the effect of boosting bank lending.

2.There is no money multiplier.

It’s true that the money multiplier is not a constant, a point well understood by mainstream economists.

From this valid claim, MMTers wrongly conclude that a permanent and exogenous injection of new base money by the Fed does not have an expansionary effect on the monetary aggregates.

As I explained in this recent post, the injection of new base money has a multiplier effect on all nominal variables in the economy.

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