First acquaintance with MMT can bring clarity on key aspects of the monetary system that may previously have seemed unclear, yet likely also calls other questions to mind. For instance, if taxes do not finance a currency issuer, why are they necessary? And if banks create deposits ex nihilo (“out of nothing”), how is it that (other than the central bank) they are financially constrained and subject to risk? Or, considering that issuance of the currency is essentially costless to the issuer, how can the currency nonetheless have value to its users? MMT has clear answers to each of these questions. Q1. If taxes do not provide the initial finance for the spending of a currency-issuing government, why do we need taxation? A1. Taxes drive money. The most fundamental reason for taxation is
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First acquaintance with MMT can bring clarity on key aspects of the monetary system that may previously have seemed unclear, yet likely also calls other questions to mind. For instance, if taxes do not finance a currency issuer, why are they necessary? And if banks create deposits ex nihilo (“out of nothing”), how is it that (other than the central bank) they are financially constrained and subject to risk? Or, considering that issuance of the currency is essentially costless to the issuer, how can the currency nonetheless have value to its users? MMT has clear answers to each of these questions.
Q1. If taxes do not provide the initial finance for the spending of a currency-issuing government, why do we need taxation?
A1. Taxes drive money. The most fundamental reason for taxation is that “taxes drive money”. Government, by imposing taxes settled only in money that it alone issues, and by assessing income and wealth for tax purposes in its nominated money of account, drives currency acceptance. Any citizen desiring income or wealth at taxable levels is directly motivated to accept the currency in exchange for goods and services. Even those without tax liabilities will be indirectly motivated to accept the currency by the circumstance that others have been directly motivated to accept it. If we want the currency to be viable – to be generally acceptable in exchange – we need taxation. As a corollary, taxation underpins the functioning of markets for goods and services denominated in the currency.
Taxation also has other important functions. The tax system can be designed to influence the relative remuneration of different activities, such as by discouraging environmentally harmful production and encouraging environmentally beneficial production. Taxes can also be designed to moderate income and wealth inequalities.
Q2. If bank loans create deposits, how could there be any limit to private bank lending?
A2. Deposits are honored in government money. A bank deposit is a bank’s promise to pay (or supply) not just any money but the specific money things, denominated in the money of account, nominated by government. In short, bank deposits are commitments that, ultimately, can only be honored in ‘government money’.
Under present arrangements, government money comprises currency (notes and coins) and reserves (exchange-settlement balances). Bank deposits are a bank’s promise to supply currency on demand or at a specified date and to have reserves sufficient to ensure final settlement of payments drawn from customers’ accounts.
This is why banks (other than the central bank) are financially constrained and why their lending is subject to risk. They promise to pay or deliver something that they themselves do not issue or create. They are currency users.
If banks were simply promising to honor IOUs in their own money rather than in government money, they would face no financial constraint. Their difficulty, per Minsky, would then be to get those promises accepted. Since they lack the authority of government – in particular, the authority to tax – they do not in themselves have the capacity to coerce a widespread acceptance of IOUs denominated in their own money.
Of course. when banks get into financial distress they can be bailed out by the currency issuer, but this is at the discretion of the currency issuer and on terms dictated by it.
Q3. How can a currency that is essentially costless to issue have any value?
A3. The value of the currency depends on how difficult it is to obtain. This difficulty needs to be viewed not from the perspective of the currency issuer, for whom the cost is negligible, but from the perspective of currency users. The more that currency users must do to obtain the currency, the greater its value. Accordingly, currency value depends on the government’s chosen terms – and extent – of currency issuance.
Inflationary or deflationary episodes will be associated with a weakening or strengthening of the currency’s value and call for tightening or loosening of fiscal policy and other policy levers. On the fiscal front, MMT prescribes the job guarantee as an automatic stabilizer, the job-guarantee wage anchoring the economy’s wage and pricing structure, notwithstanding the need for discretionary actions at times.
Currency value (Q3) relates to, but is distinct from, currency acceptance (Q1). Currency acceptance is necessary for the currency to have at least some value but is not what determines the extent of that value. Taxes drive money (currency acceptance) while the terms and extent of currency issuance influence what must be done to obtain it (currency value).