Thursday, September 23, 2010

Would Keynes have endorsed Modern Monetary Theory/Neochartalism?

There are a number of academics and commentators who appear to believe that Keynes was not actually a Keynesian, whatever that assertion is supposed to mean.

However, I don’t wish to examine this specific question in detail. In the sense that Keynes, for a good part of his life, was a monetary economist, it might be said that “Keynes was not a Keynesian.”

But in truth such an idea is fatuous. By the same type of reasoning, we might as well say that Newton was not really a “Newtonian,” because he only published his scientific classic Philosophiae Naturalis Principia Mathematica in 1687 when he was 45 years old and had lived for more than half of his lifespan of 84 years. Clearly, we have to take account of the mature and considered opinions of someone to determine how to characterise their thought in an historical sense. It can also be noted that Keynes was certainly not an advocate of the neoclassical synthesis Keynesianism that became mainstream macroeconomics after the Second World War. Keynes was himself far closer to the modern Post Keynesian school of thought on many issues.

My purpose in this post is to ask: what would Keynes have thought of neochartalism/modern monetary theory (MMT)?

It must be emphasised that modern monetary theory (MMT) is not simply classical Keynesianism or neoclassical synthesis Keynesianism, where the budget is balanced over the business cycle. MMT is far more radical than classical Keynesian economics.

MMT developed from Abba Lerner’s theory of functional finance, as well as G. F. Knapp’s theory of chartalism, as propounded in his book The State Theory of Money. I consider modern monetary theory (MMT) to be a branch of Post Keynesian economics (others might disagree). Neochartalism/MMT provides the best theory and empirically-sound explanation of how our modern fiat monetary systems actually work. MMT tells us that the government is the monopoly issuer of its own currency. Hence the government is not revenue-constrained. Taxes and bond issues do not finance government spending. No entity with the power to create and destroy money at will requires anyone to “fund” its spending. Having said this, one must immediately say that, even though deficits are not “financially” constrained in the normal sense, they do face real constraints in the inflation rate, exchange rate, available resources, capacity utilization, labour available (= unemployment level), and external balance. But these constraints are very different from the fictional “financial” constraints imposed on governments in the modern world, where monetising budget deficits (itself an inaccurate and redundant expression and a relic of gold standard thinking) is hysterically denounced from virtually all quarters. MMT says that governments should have the power to create money to “fund” a budget deficit in whole or in part, without the need for issuing bonds. The purpose of government deficits and spending is to manage the economy and create full employment and stabilise demand. Whether a budget deficit is necessary or not depends not on the state of the business cycle, but on other factors such as maintaining full employment and ensuring that the nation can reach its potential GDP (see Bill Mitchell, “Deficit spending 101 – Part 1,” 21 February 21, 2009).

According to MMT and even in Abba Lerner's earlier theory of functional finance, it is not even necessary to balance the budget over the course of the business cycle, since the government can exercise its powers of money creation to ensure that the stock of government debt and the interest on that debt does not reach problematic levels. In the quite memorable words of L. Randall Wray, “the need to balance the budget over some time period determined by the movements of celestial objects, or over the course of a business cycle is a myth, an old-fashioned religion” (see L. Randall Wray, “Paul Samuelson on Deficit Myths, Time to Drop that Old-Time Religion,” April 30, 2010). This of course does not mean that the government should let its debt rise to too high a level or that it should run deficits during periods of full capacity utilization and full employment. On the contrary, in these periods, when inflationary pressures occur, the government should run a budget surplus and destroy money, a process which can contract demand and cool the economy down.

One could also say that there will probably always be a need for government bonds as risk-free financial assets, so that retirees or people saving for retirement do not have to gamble their money on casino-like financial markets and asset price speculation. Government bonds can thus be considered a type of welfare instrument, so that completely eliminating the stock of such bonds would just hurt savers looking for safe financial assets.

As we have seen above, one of the founders of neochartalism/MMT was a Keynesian economist called Abba Lerner (see Bill Mitchell, “Functional finance and modern monetary theory,” 1 November, 2009), who was also probably the first to recommend Keynesian deficit spending and demand management as a clear and consistent economic policy (see Lerner 1944 and 1951).

Abba Lerner described the fundamental ideas of functional finance in an article called “Functional Finance and the Federal Debt” (Social Research 10 [1943]: 38–51).

Now we come to the main question: what did John Maynard Keynes think of Abba Lerner’s functional finance theory, the early form of MMT?

My discussion is based on the fundamental article by David Colander on this subject (“Was Keynes a Keynesian or a Lernerian?” Journal of Economic Literature 22.4 [1984]: 1572–1575).

In 1943, Keynes gave a lecture at the Federal Reserve, and apparently disagreed with Lerner’s post-war policy recommendation of classic Keynesian deficit spending to induce enough spending in the private economy. Later, according to Abba Lerner, Keynes withdrew this opposition (Colander 1984: 1572–3).

There is some evidence that Keynes might eventually have agreed with Abba Lerner on functional finance (if of course Keynes properly understood the argument of Lerner’s 1943 article), and that he may have been sympathetic to what later became Modern Monetary Theory.

I quote from the article of David Colander:
“As Lerner said …, Keynes retracted his characterization of Lerner’s ideas as ‘humbug.’ According to Lerner, ‘in reading … [The Economics of Control] later, at leisure, … [Keynes] found the logic less escapable and the resistances more obvious’ … Keynes admitted to being at least a closet Lernerian in a letter to Lerner (September 1944) congratulating him on The Economics of Control. Keynes wrote:

I have marked with particular satisfaction and profit three pairs of chapters-chap. 20 and 21, chap. 24 and 25 [where Lerner had discussed functional finance], chap. 28 and 29. Here is the kernel of yourself. It is very original and grand stuff. I shall have to try when I get back to hold a seminar for the heads of the Treasury on Functional Finance. It will be very hard going-probably impossible. I shall have to temper its austerity where I can. I think I shall ask them to let me hold a seminar of their sons instead, agreeing beforehand that, if I can convince the boys, they will take it from me that it is so!

It was not only in this letter that Keynes retracted his initial remarks about Functional Finance. In 1945, when Keynes again visited the United States, he repeated his praise of Lerner at another Federal Reserve Seminar. In this meeting Keynes spoke in glowing terms of Lerner’s contribution and ‘without any provocation, he held forth a panegyric on Functional Finance’ … Later that evening, at a dinner Alvin Hansen had arranged for Keynes, Lerner and Keynes had another exchange which is also worth noting. Lerner approached Keynes and asked: ‘Mr. Keynes, why don’t we forget all this business of fiscal policy, public debt and all those things, and have some printing presses.’ Keynes, after looking around the room to see that no newspaper reporters could hear, replied: ‘It’s the art of statesmanship to tell lies but they must be plausible lies.’”
David Colander, “Was Keynes a Keynesian or a Lernerian?” Journal of Economic Literature 22.4 (1984): p. 1574.

I would draw attention to the last exchange between Keynes and Lerner (see D. C. Colander and H. Landreth (eds), The Coming of Keynesianism to America: Conversations with the founders of Keynesian economics, E. Elgar, Cheltenham, 1996, p. 202, for another account of this exchange).

Was Lerner by his “printing press” remark suggesting that the government should create its own money to fund deficit spending (in whole or part, as required), a principle that he certainly advocated in Lerner 1943: 40–41?

And what did Keynes mean by his remark: “It’s the art of statesmanship to tell lies but they must be plausible lies.” Was Keynes saying that the idea of having a central bank create money for government spending was too radical an idea for the public and contemporary politicians, and that the government could not do it in practice because it was too unconventional? And was Keynes even hinting at his own essential agreement with Lerner on the issue of functional finance?

And that raises the question: if Keynes were alive today would he have supported MMT?


Colander, D. 1984. “Was Keynes a Keynesian or a Lernerian?” Journal of Economic Literature 22.4: 1572–1575.

Colander, D. C. and H. Landreth (eds), 1996. The Coming of Keynesianism to America: Conversations with the founders of Keynesian economics, E. Elgar, Cheltenham.

Lerner, A. P. 1943. “Functional Finance and the Federal Debt,” Social Research 10: 38–51.

Lerner, A. P. 1944. The Economics of Control, New York, Macmillan.

Lerner, A. P. 1951. The Economics of Employment, New York, McGraw Hill.

Mitchell, B. “Functional finance and modern monetary theory,” 1 November, 2009.

Mitchell, B. “Deficit spending 101 – Part 1,” 21 February 21, 2009

Wray, L. R. “Paul Samuelson on Deficit Myths, Time to Drop that Old-Time Religion,” April 30, 2010


  1. Lord Keynes, if you bothered to channel yourself, you would surely realize that the answer is yes.

    Keep up the good work.

  2. As a follower of MMT, I disagree with this statment:

    "MMT tells us that the government is the monopoly issuer of its own currency."

    I would say, "With authority given to them by the government (through the federal reserve and the payment system), commercial banks are the monopoly issuer of money."

    This is my understanding from Basil Moore's Horizontalists and Verticalists. Banks create money, when they grant mortgages or purchase corporate or government debt.

    Money are bank liabilities. Government's issue excess reserves (so-called high powered money) and government securities (T-bills are really no different than excess reserves), which induce banks to create money on their behalf. Banks issue money a liability to acquire these government assets. Since, these assets are riskless, banks will not require an interest rate premia and banks would always be willing to create deposits to acquire riskless interest-bearing assets. But as Mosler says, "Government's neither have, nor don't have money," Taxes do destroy money, but it is actually the banks, which create it.

    1. The correct view is to see the Bank's liabilities pegged to the State government/CB entity's liabilities.

      Then they operate like any pegged currency. The Bank has to promise to delete its liabilities and deliver the state's liabilities on request (aka a cash withdrawal), or create its own liabilities when presented with the state's liabilities (aka a cash deposit).

  3. Banks create money, when they grant mortgages or purchase corporate or government debt.

    Private banks create money as measured by M1, M2, and M3.

    But then surely a central bank can in theory create money, provide that money to the government, and then the government can inject it into the economy directly by deficit spending (as the US government did in WWII when deficits were partly "monetized").

    No debt creation is necessary in this process.

  4. I disagree with Anonymous; the true creator of money/government debt/government financial assets/government credit/hpm/base money is the government of course. I think it is better to sometimes forget 20th century innovations (gymnastics?) and use terminology that applies to earlier days also. Thou I haven't read Moore's book - maybe in a few months.

    Banks need the reserves to buy the government debt, of course they can always get them from the Fed, and the bank money they create is just that - not explicitly and precisely government money.

    No interest bearing debt creation is necessary in the process, but imho it is always better to think of money - hpm - as noninterest bearing government debt.

    "Governments neither have, nor don't have money" - yes, but that is because (base) money is government credit - and this is true of anyone - banks neither have nor don't have bank money, etc.

  5. Here is more evidence that Keynes WOULD have supported MMT. First, Keynes seems to have been well aware of the possibility (a la Lerner) of having government print money in a recession instead of borrow it.

    In an open letter to Roosevelt (1943) Keynes said “public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money.” (see 4th para) at:

    2. More evidence that Keynes agreed with Lerner, but didn’t think the public would accept Lerner’s ideas. Keynes said "(Lerner's) argument is impeccable, but heaven help anyone who tries (to) put it across to the plain man at this stage of the evolution of ...” See:

  6. In response to Anonymous @ SEPTEMBER 29, 2010 11:42 AM

    According to MMT, there two types of money creation, 1) vertical or exogenous, which is government created (deficits increase nongovernment net financial assets), and 2) horizontal or endogenous, which is bank created (loans create deposits, zero net).

    Final settlement of all transactions in the economy takes place in what MMT calls "vertical money," and "exogenous money," that is, bank reserves and currency, created by government.

    Moreover, government controls the interest rate, which sets the price of money, and is also able to control the yield curve if it wishes.

    Government is the monopolist.

  7. LK,

    Governments in currency areas only face real constraints - stuff and services available in exchange for the currency of issue.

    The 'external balance' is just an accounting artefact. It has no causal bearing on anything.

    The question is what is available to and can be produced *within the currency area*

    There is far too much emphasis on the notion of things being 'external', which is a mistake of analysis IMV and leads to bad thinking. There is one world with a set of interacting currency areas. Entities operate within one or more currency areas.

    Working from that viewpoint leads to much clearer thinking in a world where national boundaries aren't as firmly drawn as they were in Keynes day.

  8. "One could also say that there will probably always be a need for government bonds as risk-free financial assets"

    Since they float against the principal between issue and redemption, they are not really a good vehicle for retirement.

    Saving for retirement is really a fallacy of composition. It's just a tax paid to retirees via asset swaps in the finance sector. Completely pointless really when you think about it.

    Much better that the state simply pays people who are retired out of thin air based upon some social contribution index and people spend what they want while working, with the tax levels set appropriately on a functional finance basis.

    Or if the politics doesn't allow that an indexed linked savings account at National Savings achieves the same effect in a capitalised 'individual pot' way.