MMT part III – conclusion, and a conversation with Ben Bernanke

My last two blogs have revisited the issue of whether or not base money is a liability of the state. The issue played a central role in a discussion over the future of monetary policy at the Brussels think-tank, Bruegel, earlier this month.

“Why does it matter?”

That was Ben Bernanke’s question, when we briefly discussed the subject in Washington several years ago.

“It matters because if base money is not a liability of the state, the net government debt declines by around 30% and there has been no significant increase in government debt since the financial crisis.”


As it happens, I also briefly discussed MMT with Bernanke, at least the parts I think are sensible. He’d never heard of it. His comment:

“Isn’t that just economics?”

Bernanke’s smart. He’s also read Friedman and Tobin and (I bet) Lerner.

Many readers are probably also wondering why I am spending so much time on MMT. I’m not really. I think a misunderstanding of the value and power of money lies at the heart of policy impotence, as the debate in Brussels and the Peterson Institute reveals.

Macroeconomic policy failures are a very significant factor behind huge potential political turmoil in Europe. If money was understood better, we would be redesigning our central banks and our societies would be functioning a lot better. In extremis, I am an economic determinist.

Also MMTers are not alone in believing that accounting convention is the truth. In central bank accounting, base money is treated as a liability. I have argued (as have many – Willem Buiter, Simon Wren-Lewis, Nick Rowe, and others), that this convention is false. In simple terms, no one owes you anything for your $10 bill. Now, many mainstream economists have been confounded by the payment of interest on reserves in the US. So even though you are not owed anything for a dollar bill, banks now get paid for holding reserves at the central bank. “Paying interest” on reserves makes them look like liabilities of the central bank (although less so when you realise the banks can’t return the reserves if they don’t like the interest rate). Treating reserves as central bank liabilities because of the IOR allows John Cochrane and Chris Sims to resuscitate the fiscal theory of the price level, because money leaves their model and everything is a government debt [1].

So on the one hand we have conventional economists arguing that money is a state liability (debt), because ‘interest is paid’ on reserves and unconventional economists (MMT) arguing it is a liability because we use to it to pay our taxes (and other payments to governments such as fines, utility bills etc.).

MMT’s position is counterintuitive, at best. I think I have shown it is worse than that: MMT systematically adopts an obvious linguistic sleight of hand – it uses the same terms to identify two distinct phenomena, attempting to prove that different things are the same. Randall Wray has elevated this ‘skill’ to the level of genius – hence the Randall Wray Fallacy (RWF).

So how do MMT argue that by paying taxes (etc) we render money a state liability? Randal Wray’s clearest exposition uses the example of airline miles. I think we can all agree that some estimate of outstanding air miles should be treated as a liability of the airlines. There is at least some reputational or brand risk if an airline makes them too hard to use, or repeatedly changes the terms of the programme. However, even though air miles are a liability, the book value of this liability would not be the face value of outstanding miles, because a reasonably predictable percentage of air miles are never used, availability is also targeted at inventory that will otherwise not be fully utilised, and the airline can change the terms.

Wray tries to apply the same argument to money issued by the state: the government creates money, and money is used to pay taxes, fines, and other services provided by the state, so money is a liability of the government.

So we have two arguments as to why money is a liability of the state: 1) reserves pay interest, 2) governments issue money and they receive money as payment for taxes.

(1) is superficially convincing, although by implication reserves and notes & coins are different – because there is currently no interest rate on notes and coins. And so is (2), if one buys the analogy with air miles.

Let’s start with some obvious objections and then try to explain the remaining conundrums.

The obvious problem is that I am still not owed anything for a $10 bill. I am not ‘owed’ flights, because I can spend $10 on anything. But I am owed something by GE if I own a GE bond. And my neighbour owes me money if I lend her $10. Notes and coins are assets we use to pay for things, liabilities are things people owe. So money and debt are distinct phenomena. As I have said before, debts have and still are often used as money. But this doesn’t make money a debt. Cigarettes are used as money in prisons, this does not make money a cigarette. In fact, as soon as a debt is used as money, it has an independent value and the market value of the debt should trade at a premium to the book value. If that makes no sense, think of it like this. If everyone else starts using the air miles as money – i.e. storing them as wealth, exchanging them for other goods etc., the actual liability to the airline starts to decline. They could sell $1000 of air miles, and receive $1000 in cash, perhaps only $500 are used for flights, and the cash generates a return. Warren Buffett makes a similar argument about the accounting treatment of insurance float, which I have discussed before. (Unfortunately, many of those, including Randall Wray, who are dismissive of Buffett, haven’t read him. Buffett does not advocate changing the accounting treatment, he just argues why it is under-estimating value. As with many things, understanding a liability actually requires thought).

There’s another fundamental difference between money and air miles. An airline can over-produce miles relative to the amount of flights it can provide. In which case it will not honour the miles. But the government can’t over-produce money relative to taxes. Governments can only over-produce money relative to the supply of total goods and services in the economy. Yes, too much money causes inflation. Too many liabilities result in default. This is true even in the case of government liabilities. If the government can only honour its liabilities by producing too much money and creating inflation, it is still too much money that is creating the inflation, and the probability of default rises, because the government at some point might decide that the cost of inflation outweighs the cost of debt restructuring. This can happen under any institutional structure, as we saw in Russia in 1998.

If you are still unsure about the difference between air miles and money, ask yourself the following question: what would you require to take on the ‘liability’? If an airline approached another firm and said ‘we have these outstanding air miles would you honour them?’, the firm would require payment. An airline would have to pay another airline to transfer this obligation to provide flights. That is because a liability or a debt has a negative present value to the debtor. But if the government approached you and said, please accept the money that we have issued as payment for work, goods and services, you would reply, ‘that’s what I aready do!’.

My synthesis of MMT, which I think most people agree with, is that taxes have been used historically to establish the dominance of a monetary standard. That is what the wealth of historical evidence shows. But this does not make money a liability of the state, nor does it mean that once a dominant network is establish continued payment of taxes or other levies is essential to the value of the money. In my view, this is the position of smart chartalism/MMT – it is a theory which helps explain network dominance.

So a key difference between money and air miles, is that money issued by the central bank is used to settle payment for everything, not just government services. Perhaps if the government issued vouchers which could only be used to pay for government services (as has been discussed in Italy), they would be state liabilities. In other words, imagine we use bitcoin to pay for everything including government services, but the government sells non-transferable vouchers to all citizens which can be used to pay for taxes or any government-related service. We can also buy these vouchers with bitcoin. The government could raise money – bitcoin – by selling vouchers, and the vouchers would be a government liability, because it has to either provide a service or cancel a tax bill every time a citizen shows up with a voucher.

I think these vouchers are government liabilities, but they differ fundamentally from money, and it’s worth thinking why. The crux is that the government has to sell them, it can’t use them to buy things at will. If we already have enough vouchers to buy things from the government, we may not accept any more, and the government will not be able to sell vouchers to raise revenue, or it will have to sell them at a discount. Immediately, you can see why money has a value to the government in a way that non-transferable tax or government service vouchers do not.

For the same reason the IOR is not really an interest rate. The government doesn’t create money by selling it into the market; it creates money by spending it, by buying assets, or by giving it away. Interest rates are the price paid in a market to induce lenders to lend or an investor to buy a bond or lend money. The ‘interest’ on reserves is really a transfer payment to support the profitability of banks. It will also influence the price at which they are willing to lend reserves. But paying no IOR, or setting an arbitrary IOR to either shrink or expand base money, in no way constrains the government from creating money.

Finally, a couple of additional MMT idiosyncrasies are worth debunking. Using reverse reasoning, MMTers will argue that the government can ‘default’ on money. I put the word ‘default’ in inverted commas because this is a classic RWF. They do not mean ‘default’, they mean refuse payment. So the government ‘defaults’ by refusing to accept money as payment for taxes. In the past there are examples where governments have changed the means of payment eligible for tax payment. It is clear that refusing to accept payment is not a default. It is almost always the opposite. If I refuse to accept your repayment of a loan, I would be forcing you to default. In fact, Randall Wray says as much at one point:

“ … referring to the exchequer’s specific promise to accept his own coins in tax payment. If he refuses to do so, you cannot redeem yourself.”

Odd. But MMT say the government is breaching a promise if it refuses to accept money as payment for taxes. Now I don’t know if it is the case everywhere that it is legally binding for governments to accept state issued money to take payment for taxes. It’s an unnecessary law in most well-ordered societies. But breaking a commitment, refusing to take payment and breaking the law are not defaults. They are only defaults if they involve failing to honour a liability. But refusing payment is not failing to honour a liability. As I have said (and Randall Wray implies) it may cause someone else to default.

There are lots of pitfalls with this convoluted argument. What if the CB creates the money, and the Treasury raises taxes? Is money a liability of the Treasury or the CB, or the ‘state’? What if the state raises all its revenues through land sales and the land sale department uses commercial banks to receive payments? What if the CB is privately owned, as in Switzerland? What if the state decides to finance all its activities through money printing and uses no taxes or other forms of revenue? What if the state decides to sell its tax receivables to the private sector, which it is not compelled to by law, and the private sector collects the taxes? Would money stop being a liability?

Accounting is not economic truth, nor is law, nor is prevailing convention.

In conclusion, the denial of money’s uniqueness has a long and recurring history in economics. It likely betrays the counter-intuitive nature of network effects. There are many misunderstandings around the nature of money – it is a property of things, which can disappear; it does have intrinsic value, but often no value in alternative use, and no physical value; it is not a liability or a debt, even though debts are frequently used as money in order to establish the network. The economics of language teaches you more about money than studying central banks’ balance sheets. Understanding the true nature of money is hard, but important. Most importantly, when it is properly understood we recognise that permitting sustained shortfalls in demand, deflation, and high unemployment in deregulated free-market economies is always and everywhere unforgivable.

[1] Curiously, Sims provides a definition of ‘default’ which he correctly distinguishes from ‘inflation’: “Economists and journalists sometimes treat inflation as a form of default, but it is not. Default is a situation where the contracted payments cannot be delivered, and the contract does not specify what happens in that eventuality. For private firms, this leads to renegotiation and/or court proceedings. There can be a long period in which investors cannot get access to their investments and the amount that will be returned to them remains unknown. Creditors holding different maturities or types of debt may suffer different degrees of loss, and the allocation of losses across creditors may be uncertain. For example, a minor default may involve a modest delay in returning principal of a short term debt. Other creditors may be unaffected, or, if the holder of the short debt goes to court, all debtors may find themselves impaired. Similar, or perhaps more severe, uncertainties surround sovereign default.” Oddly, he persists in describing base money as a liability. Nowhere, however, does he explain how, if the government cannot default on money, it can be a liability.

About The Author

Eric Lonergan is a macro hedge fund manager, economist, and writer. His most recent book is Supercharge Me, co-authored with Corinne Sawers. He is also author of the international bestseller, Angrynomics, co-written with Mark Blyth, and published by Agenda. It was listed on the Financial Times must reads for Summer 2020. Prior to Angrynomics, he has written Money (2nd ed) published by Routledge. He has written for Foreign AffairsThe Financial Times, and The Economist. He also advises governments and policymakers. He first advocated expanding the tools of central banks to including cash transfers to households in the Financial Times in 2002. In December 2008, he advocated the policy as the most efficient way out of recession post-financial crisis, contributing to a growing debate over the need for ‘helicopter money’.

24 Responses

  1. Nick Edmonds

    Bernanke’s question hits the nail on the head.

    The answer given prompts the question of why we might care about the level of debt, beyond the politics of claims about debt reduction. From an economic point of view understanding why we might care about the level of debt will tell us whether we would want to include money in that measure or not (regardless of the philosophical issue).

    In general, MMT does not see the level of debt as important anyway.

    In more mainstream models, what actually matters is not what liability the state might have, but the level of private sector assets – basically private savings less holdings of real assets. So from that point of view the “debt” we care about is a measure that includes state issued money.

    There are models, like Buiter’s, in which money is different, but they have to include ad hoc assumptions, which do little more than assume the thing they purport to show.

    I don’t really care about whether money is a liability or not, but I would object to a claim that money finance achieves something useful by avoiding an increase in the level of public debt.

    • Eric Lonergan

      If there is a structural increase in the private sector’s demand for base money post-financial crisis, the public sector has a fiscal free lunch. There was no net increase in public sector debt and no inflation. ‘Austerity’ and claims of elevated public sector debt were analytical failures. If MMT views money and public debt as liabilities they have to worry about both – not to amounts to saying they’re not liabilities.

      • Nick Edmonds

        It’s only a freer lunch than debt finance if you believe that people will be willing to hold money indefinitely, but that they won’t be willing to hold government debt indefinitely. You can certainly show why that might be the case if you assume that people derive utility simply from holding cash, but it’s hard to justify that assumption.

        I wouldn’t call myself MMT (even though I think most of it is fairly sensible), but I think it is worth remembering that one of the key points it stresses is that instruments issued by a sovereign government denominated in its own currency are fundamentally different to instruments issued by a private entity, in terms of the burdens they convey. To the extent that this means that state issued money does not create the same obligations on the state as private debt does on private issuers, then this view seems entirely aligned with your own.

        Where perhaps you differ is that MMT would go on to say that state debt (denominated in the sovereign currency) and state money are of the same character, since debt places no greater burden on the state than money does. This is the substantive issue.

        That MMT chooses to label both as liabilities, rather than neither as liabilities, seems to me trivial. It’s an accounting convention and it’s useful, but nothing rides on labels. The only way this might matter is if you are trying to argue that there is a distinction between state money and state debt, not simply as a philosophical, legal or political matter, but as one that has specific economic consequence.

      • Eric Lonergan

        Hi Nick. I think this comment is clear and correct. I am precisely saying that money and debts/liabilities are distinct economic phenomena. It is obviously helpful to keep the terms distinct, too. We can use the same words for distinct phenomena if we really want to, but it aids confusion rather than clarity. The distinction between state debt and state money is obviously complex, but there is a significant distinction, clearly. State bonds can have money-like characteristics, they can be risk assets like equities etc., it depends on the institutional structure and economic regime. It is fashionable to describe them as ‘risk-free’, but this is patent nonsense. I also think institutional structure is a spectrum, and not binary as MMT often suggest – ie either Greece or a fictional nation where the Treasury runs the central bank. Greece is one extreme and there are no developed countries where the Treasury has unconstrained power over the central bank. There is a reason why we have separated institutional power – it is a recognition that money and public debt are distinct. I don’t really believe in anything being ‘indefinite’, but I think central banks have unlimited counter-cyclical power under deflation/low-flation. This power resides in the fact that they produce money and not debts. Governments may have considerable fiscal power, it depends on the regime, but absent control of money, they almost certainly don’t have the same degree of power. Which again is recognition that debt and money are different. Typically, those that assume unlimited fiscal power simply assume the government controls money. I would say the free lunch to the state after the financial crisis was a structural increase in demand for base money, in many jurisdictions one could certainly view short-dated government bonds as close substitutes, but this is and was contingent. Heavily contingent in the EZ, even Germany had a failed bond auction at the height of the crisis, and in the US, Congress could easily render short-dated bonds risky again. Government debt is different to base money in a way that can have huge economic consequences.

      • Eric Lonergan

        I also don’t see why the accounting convention is ‘useful’. Quite the reverse, it is reasonable to argue that there has been a structural increase in the financial sectors demand for government debt due to an increase in its ‘moneyness’, which is why it should not be a liability at book value. This further undermines the case for austerity. I think shoddy accounting has been decidedly unhelpful.

  2. Charles Adams

    Very interesting thanks and I like your final 2 sentences:

    “Understanding the true nature of money is hard, but important. Most importantly, when it is properly understood we recognise that permitting sustained shortfalls in demand, deflation, and high unemployment in deregulated free-market economies is always and everywhere unforgivable.”

    Except that there are no deregulated free-markets (can I substitute ‘regulated market economy’), one might be to make a distinction between unemployment and underemployment, and deflation is hard to define (e.g. does real wage deflation a count?).

  3. Stephen Ferguson

    “The obvious problem is that I am still not owed anything for a $10 bill”

    A $10 bill is just a fancy scrap of paper that says “IOU $10”, and you are absolutely correct in saying you won’t get anything for it. That is you wont get anyTHING – as in no stuff or anything at all to with the material world.

    In fact if you hand in a $10 note at the US Fed they will say ‘thank you’ and promptly hand you back another $10. An IOU only gets you an IOU back. The actual dollars promised, or pound sterling etc. are never actually seen. Isn’t this ‘end of the rainbow’ money utterly useless?

    Absolutely not, because that ‘useless’ dollar IOU is the ONE AND ONLY means of paying off an equivalent dollar UOI (which, when you boil it down, is what US tax is). The US government, by law, has the power to tell each and every citizen U.O.I! So

    IOU $10 + UOI $10 = 0

    …Tax paid. Everybody’s happy (apart that is from ideologues who believe tax is theft).

    So it matters not a jot that you are “not owed anything for a $10 bill”.

  4. Jerry Brown

    I don’t think you understand what MMT says about money and taxes. And while I think MMT is more correct than any other economics I have learned, there are some implications of the theory that are disconcerting. In MMT, when you are alive you owe taxes to the government- that obligation comes first. You owe the taxes and whether there is a currency or not, you owe taxes and the government will collect them in some way or you will be punished. When the government allows those taxes to be paid in its currency, which it spends into existence, it is doing taxpayers a favor by allowing them to avoid the punishment by accumulating currency in more voluntary ways. In that sense the currency is in fact a liability of sorts of the government that would always collect the tax in some other less palatable way- because it agrees that the currency will be accepted as payment of something it is already owed and would collect otherwise- tax. Government, in MMT, is not some friendly thing, it is not Mr. Nice Guy in any sense. Most MMT economists like to point out the many positive things that governments enable society to achieve, and are not so happy to explain the implied force behind the theory here. But they are still correct.

    • Stephen Ferguson

      MMT economists are more than happy to discuss that aspect. There are laws that tell us if you do X, you go to jail. This is just another law.

      Am guessing you’ve come across Warren Mosler’s amusing business card-as-currency analogy to clean up the classroom?

      • Jerry Brown

        Yes Stephen, you are right. I have seen Warren Mosler’s very good business card analogy. They become valuable when there are armed men at the exit who demand them when you want to leave. So yes, Mosler is willing to explain how and why money has value. My original comment was meant to be directed at Eric although it ended up below your comment. You are not the ‘You’ I was referring to there :).

  5. Jerry Brown

    Since I am already criticizing Mr. Lonergan, I might as well ask why he named his last post “MMT part II: a synthesis, an olive branch, and a defence of Twitter”.

    Bringing an olive branch and then using it to whack away at Randy Wray is different from the general understanding of what the olive branch represents. I think.

    • Eric Lonergan

      It’s an olive branch, because by dropping the ‘liability’ confusion, and embracing recognition that taxes establish networks, but once established they are no longer essential, MMT is a more convincing and coherent set of ideas.

      • Jerry Brown

        MMT says taxes are sufficient to establish demand for an otherwise worthless piece of paper that we use as money. And therefore, taxes are sufficient to impart value to a fiat currency. MMT is more or less agnostic as to what other factors might influence that value once a currency has been established.

        Warren Mosler’s business card analogy to money always seemed great to me. Why would you call it dreadful? Have you ever dealt with the IRS? They won’t shoot you thankfully, but they are no joke if you end up on their list. Don’t get on that list.

  6. Eric Lonergan

    If someone holds a gun to your ahead they can force you to do anything. Anything can be valuable. It reveals the power of force and sanction. But that is not how money works. The baby-sitting coop and pokemon examples are far more insightful. They are both voluntary. And they illustrate the diverse ways in which standards are established. In the baby-sitting example it is by agreement among a group. I suspect that is how bitcoin was established too. In the case of pokemon cards it actually happens spontaneously – as Hume argues. No one planned it, kids just created a monetary standard. Government fiat is just one way to establish a standard. But actually doesn’t tell you much about how money works.

    • Stephen Ferguson

      Hi Eric,

      In your reply to Jerry above, you said “no one is standing at the door (anymore)”.

      How can that be true? Tax is still collected to this day? e.g. in UK ~90% of gov. spending is taxed back.

      PS My, possibly incorrect, understanding of your thesis is that, IF there is no ONGOING tax, ‘network effects’ take over and the currency maintains its value.

      PPS Apologies for use of UC (am not shouting, just don’t know how write italics in this comment box)

  7. Eric Lonergan

    You also need money to buy food. ‘Fiat’ means ‘by decree’. The government can require us to use legal tender for almost all transactions. So my point is that money has value because it is a) incredibly useful; and b) used by a large number of other people, and once established this network dominance is very very difficult to break. Like a telephone monopoly or a software monopoly etc. Software has no physical value, nor does Facebook. There is no great mystery in need of explanation – lots of ‘worthless’ things are hugely valuable (language!) and the significance of taxation is wildly exaggerated.

    • Jerry Brown

      So I supposedly own a house here in my city, which is very nice because it keeps me dry when it is raining and warm in the winter and so on. But twice a year the city requires me to find 3500 U.S. Dollars and pay it to them for the priveledge of keeping this house. This is not very easy to do- that amount of dollars is not something you can find on the sidewalk. And the city doesn’t want bitcoins or Pokemon Cards or baby-sitting thingys- the city wants US Dollars.

      I happen to believe that constitutes a considerable part of my demand for US Dollars. Maybe I am just silly for thinking that. There is no network effects or duping a dope or worrying about whether other people will accept US Dollars involved there. I need 7000 of them a year minimum just to stay in my house. So I work for those dollars. Its a fairly simple story- what is wrong with it?

      • Eric Lonergan

        Sure. But your HOA is the same. Dollars are damn useful because people accept them as payment. That is the network effect.

      • Eric Lonergan

        Randall Wray’s discussion of Airline miles is actually very useful at explaining why money is different and is NOT just a tax-paying voucher.

    • Newton Fawcett

      well now, couldn’t you have spared a lot of words by just saying that in the first place?

  8. Lee

    Hi Eric.

    I liked this a lot. Thanks for sharing it.

    I have one question: why do you think “too much money causes inflation”?

    I ask because it seems strange to me.

    Firstly, what is “too much” and who decides?


    If you and I both have a million dollars, neither set of a million is worth more or less than a million simply by virtue of the fact we both have a million.

    A million is still a million regardless of how many people have a million.

    What would change, if we all suddenly had a million, is how much stuff we could all buy with it.

    It seems to be sellers who cause inflation when they hike their prices in response to a perceived abundance of money, and or lack of product, or some other reason.

    If everyone suddenly did have a million, you can bet Mercedes would increase the cost of their cars. Why? To maintain their brand’s perceived exclusivity and thus value.

    If everyone had a Mercedes, the prestige of owning one would diminish.

    In that sense, it is Mercedes who would be causing inflation, because they wouldn’t necessarily have to increase the price of their cars.

    I guess you could say the same may be true if the resource supply began to dwindle, irrespective of the amount of money in circulation.

    Mercedes may up the price of its cars if the resources used to build them become more expensive to procure. Again, in this sense, the seller is causing inflation.

    Maybe it’s a pointless or minor or too subtle a distinction I’m getting at. I don’t know.

    What do you think?

    My only other point is that if the only currency I can be paid in, or pay my taxes in, is issued by the government, then I would say that seems like a liability to them.

    They owe it to me to pay me in their currency – something only they can provide – so I can pay my taxes in their currency. Given that, they are obliged to issue the currency. Does that not make it a liability? A risk? A formal duty?

    If I could be paid in Bitcoin or pay my taxes in potatoes, there is no problem.

    However, I don’t think it’s a liability from the perspective that no formal contract exists between me and the government.

    They wouldn’t owe me anything in exchange for the currency / bills they issue though E. G. Gold, Sterling etc.

  9. Paul Lebow

    Revealing the intense gaslighting MMT is engaged in is a major public service, Eric.

    I think the whole ‘money-as-debt’ rabbit hole is a huge distraction, not worth expending mental energy on. Even your claim that a $10 bill is not a debt because nothing is owed, can be countered if one expands what it means to be “owed”. Clearly the economy owes me $10 worth of goods or services – on demand. But so what?

    Money is just not as mysterious as these discussions make it out to be if one agrees that the state should be empowered to create it for public purpose along with the cessation of bank-created credit-money. Then money becomes ultra-intuitive and transparent.


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