Misunderstanding MMT

MMT continues to generate debate. Recent contributions include Jonathan Portes’ critique in Prospect and Stephanie Kelton’s Bloomberg op-ed downplaying the AOC and Warren tax proposals.

Something that caught my eye in Jonathans’ discussion was this quote from Richard Murphy: “A government with a balanced budget necessarily denies an economy the funds it needs to function.” This is an odd claim, and not something that follows from MMT.

Richard has responded to Jonathan’s article, predictably enough with straw man accusations, and declaring, somewhat grandiosely, that “the left and Labour really do need to adopt the core ideas of modern monetary theory … This debate is now at the heart of what it is to be on the left”

Richard included a six-point definition of what he regards to be the core propositions of MMT. Paraphrasing in some cases, these are:

  1. All money is created by the state or other banks acting under state licence
  2. Money only has value because the government promises to back it …
  3. … because taxes must be paid in government-issued money
  4. Therefore government spending comes before taxation
  5. Government deficits are necessary and good because without them the means to make settlement would not exist in our economy
  6. This liberates us to think entirely afresh about fiscal policy

Of these, I’d say the first is true, with some caveats, the second and third are partially true, and the fourth is sort of true but also not particularly interesting. I’ll leave further elaboration for another time, because I want to focus on point five, which is almost a restatement of the quote in Jonathan’s Prospect piece.

This claim is neither correct nor part of MMT. I don’t believe that any of the core MMT scholars would argue that deficits are required to ensure that there is sufficient money in circulation. (Since Richard uses the term “funds” in the first quote and “means [of] settlement” in the second, I’m going to assume he means money).

To see why, consider what makes up “money” in a modern monetary system. Bank deposits are the bulk of the money we use. These are issued by private banks when they make loans. Bank notes, issued by the Bank of England make up a much smaller proportion of the money in the hands of the public. Finally, there are the balances that private banks hold at the Bank of England, called reserves.

What is the relationship between these types of money and the government surplus or deficit? The figure below shows how both deposits and reserves have changed over time, alongside the deficit.


Can you spot a connection between the deficit and either of the two money measures? No, that’s because there isn’t one — and there is no reason to expect one.

Reserves increase when the Bank of England lends to commercial banks or purchases assets from the private sector. Deposits increase when commercial banks lend to households or firms. Until 2008, the Bank of England’s inflation targeting framework meant it aimed to keep the amount of reserves in the system low — it ran a tight balance sheet. Following the crisis, QE was introduced and the Bank rapidly increased reserves by purchasing government debt from private financial institutions. Over this period, and despite the increase in reserves, the ratio of deposits to GDP remained pretty stable.

The quantity of neither reserves nor deposits have any direct relationship with the government deficit. This is because the deficit is financed using bonds. For every £1bn of reserves and deposits created when the government spends in excess of taxation, £1bn of reserves and deposits are withdrawn when the Treasury sells bonds to finance that deficit.

This is exactly what MMT says will happen (although MMT also argues that these bond sales may not always be necessary). So MMT nowhere makes the claim that deficits are required to ensure that the system has enough money to function.

It is true that the smooth operation of the banking and financial system relies on well-functioning markets in government bonds. During the Clinton Presidency there were concerns that budget surpluses might lead the government to pay back all debt, thus leaving the financial system high and dry.

But the UK is not in any danger of running out of government debt. Government surpluses or deficits thus have no bearing on the ability of the monetary system to function.

The macroeconomic reason for running a deficit is straightforward and has nothing to do with money. The government should run a deficit when the desired saving of the private sector exceeds the sum of private investment expenditure and the surplus with the rest of the world. This is not an insight of MMT: it was stated by Kalecki and Keynes in the 1930s.

If a debate about MMT really is at “the heart of what it is to be on the left” then Richard might want to take a break to get up to speed on MMT (and monetary economics) before that debate continues.



  1. I agree. But it might be useful to point out the monetary options MMT suggests for utilizing unproductive assets in the material productive economy. More specifically, what institutional entities have agency to enable productive resources? The left’s slant on such activity is to create economic activity outside of firm centered return to capital considerations.


  2. Quality stuff there from Jo Michell. My only quibble is that there is no sharp distinction between base money and government debt as Martin Wolf and others have pointed out. E.g. £X of government debt which pays almost no interest and matures in a week’s time is virtually the same thing as £X of base money, which pays no interest at all (e.g. a wad of £10 notes).

    So the statement that “deficits are required to ensure that the system has enough money to function” is arguably true if one is using the word “money” in a very vague or broad sense: i.e. to include all forms of very liquid assets, like government debt with less than a month to maturity, for example.

    But to repeat, that’s a minor quibble, not an attempt to contradict Jo Michell.

    Liked by 2 people

  3. Sorry Jo you don’t understand money. As Kalecki whom you mention said ‘ Money is what we need to buy stuff ‘ . And it doesn’t matter who that whom is . So government created money ( when it spends ) makes up a large percentage of money in circulation. Your trope ‘ bank loans create money ‘ variously computed at around 97% is simply bollocks. I’ve made film about money creation ( Money for Nothing ) which has been on YouTube for three months with 5000 plus views . It tells exactly and precisely how money is created and by whom.


    1. If you want anyone to look at your film, it would have been an idea to give a link to it. I tried Googling, but found nothing. That all rather calls into question your competence.


  4. In order to purchase reserves from the central bank the clearing banks (commercial banks) need the money to do so. From a macro-accounting perspective this money can only come from government deficit spending. For the clearing banks to be able to create their own “government” reserves would result in control fraud!


      1. You need to do the macro-accounting but let’s do it your fully complex way. Where do they get the money in macro-accounting terms from to buy government debt to set up as a bank in the first place? Second where do they get the money from again in macro-accounting terms to buy government debt to use as collateral to “buy” government debt to expand their loan book? I am of course assuming in my questions you do understand one function of government reserves is to facilitate the payments settlement system the other to control the base interest rate and that the government central bank can create reserves without a corresponding balance sheet liability. In other words it doesn’t have to borrow the money from anybody else to create the reserves.

        Liked by 1 person

  5. You’re right. What depresses me is that this needs saying at all. I remember the debates in the 80s about over- or underfunding the PSBR (as it was then) which established that there was no necessary link between govt borrowing and money creation because as you say bond issues reduce the money stock. I also remember reading the BoE’s “counterparts to M4” press releases every month as part of my job (they still issue something like it) which showed clearly that it was banks that created most of the M4 stock (until the 08 crisis!). It saddens me that people still need to learn what we all knew back in the 80s.


  6. Murphy’s statement is mostly true *in practice.* Assuming a balanced current account, then keeping the financial assets of the private sector fixed will place deflationary pressure on an economy over time. Private credit can provide an assist, but it is unsustainable, because there is only so much debt the private sector can carry. The financial assets available to the private sector has to grow with growth in output (this is price stability 101) as well as with a growing population size. Thus, on average, and assuming a closed economy, deficits will have to be run annually.

    Now throw in an external sector. A country with a current account surplus (Norway, Germany) has an inflow of financial assets from abroad. Depending on the size of the surplus, this nation’s government may not need to run deficits to sustain growth and stave off deflation. But a country with a current account deficit (US, UK) has no choice but to run even higher deficits than would be necessary in a closed economy, because in addition to staving off deflation and growing the economy, it has to replace the *outflow* of financial assets from the current account deficit.

    All of this flows from sectoral balance analysis, i.e., accounting identities. It cannot be reasonably disputed, and it cannot be avoided. Luckily, what MMT shows us is that monetarily sovereign countries have no problem supplying their private sectors with however much financial assets are needed to make use of all available resources within it.


      1. I don’t disagree, but I was specifically defending the original comment from Murphy you quoted and were taking issue with, which was that “[a] government with a balanced budget necessarily denies an economy the funds it needs to function.” This is true for a closed economy, which Murphy may have had in mind for simplification when he wrote it. And while not technically accurate as written for an open economy (because of the “necessarily”), the thrust of it is nevertheless true, and I think is generally a fair comment. Especially as Murphy is in the UK and writes primarily for a UK audience. The UK has a large current account deficit, so he may even be contemplating an open economy with a current account deficit.

        While Murphy did make the statement you make, the statement that appears in the Portes piece was different. It was: “Experience in recent years has suggested that total tax revenues should be less than total government spending or additional money supplies required to ensure the liquidity to permit growth is not present in the economy.” This is (1) directed at the UK economy and (2) not as broad as the statement in your piece. All this to say, I’m not sure there’s much to criticize here.

        (And, just for the record, Murphy is not an MMTer. He considers himself “sympathetic,” but (from the post you linked to) has “for some time been quite critical of some of its leading exponents.” So all of the writing about what he says is not really discussing MMT or any of the literature produced by its developers.)


  7. Under current institutional arrangements, the fiscal arm of government (the Treasury) is not permitted to overdraw at its account held at the central bank (the monetary arm). For this reason, the government must issue bonds BEFORE it deficit spends into the real economy.

    Further, tax receipts are not destroyed by the government on receipt. Instead, there is a transfer at the central bank from bank deposits to government deposits. To suggest otherwise is to jettison double-entry principles, which is odd since MMT prides itself on its accountant’s approach to economics.

    Modelling bond issues as happening before deficit spending takes place does not alter Jo’s point, which if I understand it correctly, is that deficit spending does not, per se, increase the money supply. An exception may arise when purchases of fresh issues of bonds are funded by the lenders borrowing from the commercial banks. Under those circumstances new money is injected into circulation.


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