Thursday, June 21, 2012

General theory and special cases in Modern Monetary Theory

In the general - special case theoretical approach of Modern Monetary Theory (MMT). The general theory sets forth the parameters of a fiat currency, showing what falls in bounds and out of bounds operationally. The major alternatives regarding monetary systems are convertible or non-convertible currency, or fixed or floating exchange rates. MMT focuses on the non-convertible floating rate regime since it is operative globally at present, since FDR ended convertibility during the Great Depression in order to increase policy space, and Nixon shut the gold window internationally for the same reason.

Within those basic parameters, various options are available for constructing special cases. One of the sets of alternatives that MMT describes for constructing a special case as an option within those parameters of a non-convertible floating rate regime involves issuing bonds as a reserve drain for rate setting, or not issuing bonds and paying IOR instead, or setting the rate to zero permanently, or setting the rate to zero as a general rule and only using rate setting as need by unusable conditions.

While it is possible to run more than one of these at the same time, only one is dominant in setting monetary policy. For example, the US has chosen politically to issues bonds but the law allows the Fed to override bond issuance as a reserve drain operation by paying interest on reserves (IOR) to manage the interest rate as an alternative.

This shows that bond issuance is a political choice within the bounds of the general theory, rather than an operational requirement of the present monetary regime. The operational requirement of the system is that if the central bank opts to set the rate, then in must manage reserves to do so, or else pay IOR if it chooses to let the amount of reserves float free.

Thus, the general theory accounts for why and how choice among these alternatives is optional in constructing institutional arrangements that result in special cases within a monetary regime. There are many alternative such as this on involving interest rates. Every country selects from a variety of alternatives in establishing a special case as an option for running a non-convertible floating rate regime.

Note that some alternatives that can be selected are out of bounds. If the politicians that choose among alternatives in constructing a special case do not realize this, then the special case will run into problems due to deficiencies in the institutional arrangements. MMT economists and others cognizant of the general theory points this out at the time the Eurozone treaties were being entered into.

Secondly, there are economic consequences of these choices — monetary, financial, and non-financial — that MMT economists also articulate. Different choices of alternative policies used in constructing special cases as options define in law and regulation the institutional arrangements that result in the special cases we observe in the different countries. MMT analyzes these special cases by inspecting laws and regulations, as well as a county's behavior, since work-arounds are used when deemed necessary in extraordinary conditions.

These special cases, exhibited by the different countries in the global economy, which is now on a non-convertible floating rate regime generally all have different implications for the nation's policy space, for example, as well as the interests that are winners and losers. Thus, the institutional arrangements that define a national monetary system also affect its application of monetary economics, with macro implications as well.

Not all countries in the global economy choose to run a floating rate system, however. Emerging countries may choose to peg their currency to another currency like the $dollar (USD). China does this, instance. Switzerland has also set a floor for its currency against the euro. These are special cases within the special cases of non-convertible floating rate currency.

But such extraordinary measures are ordinarily presumed to be temporary, erected under special conditions that are not expected to be permanent. They are extraordinary means for increasing policy space internationally due to the effects of exchange rate fluctuation on the domestic economy. When those conditions cease to exist, the nation again conforms to the norm of floating rates.

As far as recommending policy, MMT uses the MMT macro approach to show how choosing wider policy space and using certain tools — such as the MMT JG (job guarantee), which includes a buffer stock of employed and a wage floor as price anchor — lead toward a potential balancing production, employment and price stability.

These macro conclusions derived from the general theory must be applied differently in different countries, owing to the special case differences set forth in law and regulation,and adapted to political exigencies prevailing at the time. These are strategic and tactical considerations that are subservient to the general theory, which only deals with general operational parameters.

Macroeconomists in general take these three factors to be macro goals, which are used as criteria for evaluating the effectiveness and efficiency of a set of assumptions on policy and policy on anticipated outcomes. All approaches to macro seek to optimize efficiency and effectiveness with respect to these three persistent challenges that a modern economy faces and the overall challenge is to do this in integrated way that enhances them all. The objective is policy formulation based on theoretical insight that yields overall beneficial effects for the country socially, politically, and economically.


Here's a comment I put up at The Center of the Universe in explication:

Basically, what this says is that countries can decide on an international monetary standard and the choice is essentially between convertible or non-convertible currency, and fixed or floating rates. There are other choices, too, such as a system that generally relies on central banking or on that does not. These and other options have historical precedents.

This post focus on having made the choice in favor of non-convertible currencies and floating rates, which is now enshrined in international treaty post-1973 when Nixon’s unilateral decision to shut the gold window two years before was formally ratified.

That established a framework within which countries agreed to operate but it let considerable choice to individual countries regarding specifics. The general theory articulates the framework in terms of the boundary conditions that the agreement imposes. The specific ways to implement this in each county constitutes the actual special cases, although other cases are also possible since all the options are likely not exhausted. Countries are also free to alter the specifics within the general framework that has been agreed to.

What is so difficult to understand about this? It’s all legally formalized in international agreements and laws and regulations of the different countries.


Ramanan said...

(Only for Tom)

You know Tom - most nations can't even float in the sense you require (pure float). Only a few have that luxury because they industrialized early & lot of related Et ceteras such as success in international trade. They are able to float because their currencies are highly acceptable.

(Btw, the example you give - Switzerland and China have supreme external positions).

phil said...

This general vs specific discussion smells like a bad case of revisionist history.

AndyCFC said...


Just a question (not an argument lol)
as you say there the first industrial countries currencies seem to be highly acceptable but as far as i can see there is no real reason apart from being first and may not have been succesful for a long time. I am curious as to it misconception or lack of trust of their own currencies/governments?

Tom Hickey said...

phil "This general vs specific discussion smells like a bad case of revisionist history."

It based of a paper that Scott Fullwiler wrote a August, 2010, and well as numerous discussion in comments since then here and elsewhere.

Here's a link to the paper.

Scott T. Fullwiler, Modern Monetary Theory - A Primer on the Operational Realities of the Monetary System

Educate yourself.

Tom Hickey said...

Ramanan: "You know Tom - most nations can't even float in the sense you require (pure float)."

The only thing that the general theory requires is staying within the boundaries of what the system makes possible. Countries could even opt out of the international system running at the time by introducing convertibility. If the country was influential enough, that might ever result in a change of the existing system.

There seems to be misunderstand about requirements, and some think that the MMT analysis requires certain strategy and tactics within the parameters of the general case. That is not so. The claim is simply that the operational rules (institutional arrangements) of a monetary system have certain boundary conditions. Within those boundary conditions many policies, strategies, and tactics are options. But choosing policy, strategy and tactics has consequences that limit the liberalism of the system by imposing political restraints. However, these political restraints don't alter the operational reality of the system from the standpoint of the general theory.

Central banks, Treasury issuance of term securities, etc. are options but not requirements of the system. An option can work perfectly well without them — in principle. What may be possible politically for a country is another matter and that is a question of the special case that the country represents.

Sovereign countries presumably will choose what they deem best for their interests, but that often means choosing what is best for special interests. For example, "what is best for America" is not necessarily best for all American, but beneficial for only the privileged.

While country like the US could go to direct Treasury issuance of currency and no bond issuance and tight regulation of bank credit money that would be difficult to a legislature that captured by financial interests to pass. Even though there are many arguments that this would benefit most American by reducing the financial instability and recurrent crisis, while eliminating an unnecessary subsidy for bondholders. Such matters have been explored in the comments here and elsewhere, with various views and reasons forthcoming.

Everyone can float operationally under the parameters of the monetary system, but there are consequences if some nations do this, so they choose to modify policy away from the purely liberal stance that is possible. Some do it long term by adopting a peg, others short term depending on conditions.

The general theory that lays out the operational parameters that bound the system functions like the sectoral balance approach wrt fiscal stance. In the sectoral balance approach, any stance within the mathematical boundary of the sectors summing to zero is possible operationally, but countries choose different policy options depending on social, political and economic conditions, and changing economic conditions, chiefly changes in propensity of non-government save and economic cycles, also affect the specifics of the balances in a way that endogenously determined.

Ryan Harris said...
This comment has been removed by the author.
Tom Hickey said...

For those following the feed, I updated "general v. specific" with a comment of mine at Warren's here.

Anonymous said...

It would be helpful if you would spell out the first instance of each acronym. Not doing so precludes handing your article along to another who is not familiar with the jargon.

Tom Hickey said...

"It would be helpful if you would spell out the first instance of each acronym."


Ramanan said...


I couldn't really understand your question.

Btw, as you suspected, I am not generally in a mood to debate this given the history since long back .. it usually happens that there are commenters to whom I feel the need to defend and then it all becomes long debates. So I try to stay out unless I can't resist!

Once I was raising funds for my startup and the angel investor told me people invest for all vague reasons .. for example if they like your face.

Now, a nation has to make its currency acceptable in international trade. Usually people allocate their wealth into assets in their own currency. This is home bias. To make its currency acceptable a nation has to by hook or crook make foreigners accept it.

The reason people/institutions may not hold debt denominated in say Bangladesh's currency is because they think there is a risk of impairment of the asset - due to depreciation, default by the government default by the debtor etc. Simple enough ...

Ramanan said...


I can't make sense of your argument. Untypical because whether I agree or not, I can usually.

Tom Hickey said...

Ramanan "Now, a nation has to make its currency acceptable in international trade."

Right. Domestically a currency gets value because taxpayers have to obtain it.

Unless tariffs payable only in the importers currency are imposed, the exporter doesn't need the importer's currency. And even if there are tariffs, only the amount of the tariff is required and that is not enough of an incentive to promote saving.

So unless the exporting countries is either using the importing country's currency to import reciprocally, there is no incentive to hold the currency in itself.

The currency has to be attractive as a saving vehicle, or the exporter has to have enough incentive to fund the importers CAD by saving to generate a corresponding KAS.

Tom Hickey said...

Ramanan "I can't make sense of your argument. Untypical because whether I agree or not, I can usually"

No big deal. I guess have have not stated my meaning clearly enough, but I am done with it for now. I am sure it will continue to come up though, since there seems to be continuing misunderstanding fo the MMT position about general and specific.

So I'll think about how to make it better.

John Zelnicker said...

Tom -- I just got caught up to this post. Thanks for an excellent essay. BTW, re: Ramanan, I saw this not so much as an "argument", but as an explication of a lot of confusion about MMT.