Modern Monetary Theory and Fiscal-Monetary Policy Frameworks

by Dr. William Van Lear, professor emeritus, Belmont Abbey College

Abstract: The U.S. federal government fiscal – monetary policy framework is the organizational and operational structure that ties the state’s budgeting to the means of payment. There have been eras of government activism and eras of restraint. Policy frameworks either facilitate action or restrain action. The modern era has seen frequent use of fiscal and monetary tools to combat cycle downturns and financial crises but orthodox thinking concerning government action and framework design hinder effective policy. An additional impediment to public spending arises from finance capital political pressure. This paper advocates for a new fiscal – monetary framework in the U.S. The paper examines the policy framework suggested by modern monetary theory and makes the case for reform in the U.S. government’s fiscal – monetary framework to fully operationalize MMT’s framework.

JEL codes: E12, E42, E58

Keywords: Government Policy Frameworks Modern Monetary Theory

I. Fiscal - Monetary Models in History

The federal government fiscal – monetary policy framework (FMPF) matters for what the United States federal government is capable of doing in the economy. This framework is the organizational and operational structure that ties the state’s budgeting to the means of payment. American history, since the nation’s Founding, has been a near constant push and pull between the contending forces of government restraint and government activism. Cyclicality in government activism has been famously addressed by the historian Arthur Schlesinger Jr. (1986). Periods of government restraint and laissez-faire are followed by government intervention and regulation; the latter undertaken to correct the private excesses of the prior period. Cycles turn when government activism comes under criticism for overreach and inefficiencies that lead to a pullback in intervention.

The 19th century saw no modern central bank in any sense, and much of the early and late 19th century FMPFs constrained government spending, first by a bi-metallic monetary base standard and later by the mono-metallic gold standard. The freeing up of government fiscal action of Civil War finance was replaced by the restraining monetary framework of greenback resumption and government budget balancing.1 Nineteenth century philosophical debate featured Federalism vs Anti-federalism, and the American Plan vs Classical economic thinking.

The 20th century brought meaningful reform to fiscal and monetary thinking. Episodic financial crises, deflations, and depressions compelled policy reform action. The Federal Reserve Act of 1913 ushered in a modern central bank, but tied the Bank to the gold standard until the mid-1930s. Early 20th century Progressivism elevated the acceptability of regulatory action but it took the Great Depression of the 1930s, and the funding needs of WWII, to make government deficit spending acceptable. Keynesian economic philosophy overcame the constraints on policy action imposed by economic orthodoxy.2

The modern era of the last 45 years has seen frequent use of fiscal and monetary tools to combat both economic stagnation in the real economy and asset price booms in the financial economy (Palley 2012). The reemergence of classical / traditional ideas on public finance and on government activism have created contentions in politics and in the economics profession. Despite the use of policy activism by both major parties, popular and professional economics expositions have favored a classical / neoclassical orthodoxy over heterodox thinking. Government intervention and deficit financing are to be relegated to emergencies. Government spending outside of emergency must be limited to what can be raised through taxation with a minimum of borrowing. Deficit spending crowds out private investment and puts upward pressure on interest rates. Monetary policy should take precedence over fiscal policy, and central banks should maintain an upward bias to interest rates to ward off inflation; low-rate regimes can be employed to address economic slumps and then for only short periods.

It is in this context that this paper addresses the subject of creating a new fiscal – monetary framework in the U.S. for the 21st century. To do this, the paper first examines the policy framework suggested by modern monetary theory (MMT). The paper identifies the key MMT ideas that apply to a policy framework with respect to the U.S. economic system. How MMT is exposited by its supporters is compared to that of MMT critics. The third section presents an understanding of the current and actual fiscal and monetary framework, and addresses whether this framework is fully congruent with the MMT policy framework perspective. The fourth and final part reflects on what has been written and makes the case for reform in the U.S. government’s fiscal – monetary framework.

II. The Fiscal – Monetary Policy Framework of MMT

This section develops the fiscal – monetary policy framework as understood by the macro-financial paradigm called Modern Monetary Theory. The first important aspect of MMT’s fiscal – monetary policy framework is the integration of government fiscal policy actions (spending, taxation, and bond sales) with central bank policy effects on borrowing rates and financial market liquidity.3 The MMT framework is one where fiscal policy (FP) and monetary policy (MP) are interdependent and institutionally integrated (Mosler 1996; Wray 1998; Bell 2000; Mosler 2022). Additional aspects of MMT most applicable to describing a FMPF are addressed below.

A second aspect is the state theory of money (Knapp 1924; Wray 1998). Money is that asset used by an economy to make payments. MMT argues that all sovereign governments produce that money. Money is defined by the national government that issues it. Sovereign states don’t tie the nation’s money to gold or to another country’s currency. Sovereign states are both currency users and currency issuers. Sovereign governments therefore have no financing constraints and can in theory fund any program they desire. A government’s fiscal and monetary powers should be seen as integrated, and therefore the financial constraint that binds the spending of private citizens and firms is not relevant to national governments (Kelton 2021: 15-31). Private actors can default but there is nothing in economics that could force sovereign borrowers into default; state defaults would be by choice for political purposes.

The state money concept leads to a novel view of the purpose of taxation and bond sales. The purpose of taxation is not to fund the government but to give value to money. Taxation requires private agents to pay their tax liabilities to the government in what the government has issued as currency. The requirement to pay taxes to the state creates value in whatever the nation state has determined is the currency of the economy. Changes to tax liability is a policy tool to affect after-tax income distribution and aggregate demand. Higher tax payments slow spending while tax cuts increase spending. Tax changes affect private income and therefore the volume of private spending.4

The purpose of bond sales is not to fund the government, nor are bond sales a borrowing operation. Security sales are meant to affect cash flow positions and to provide the private sector an interest earning asset (Bell 2000; Kelton 26 May, 2023). The national government is a currency user but simultaneously a currency creator or issuer. The operation of spending and selling bonds, by affecting capital flows in the economic system, affects market interest rates. While bond sales are not needed to fund the government, they do have the role of assisting the central bank in its interest rate target policy. By the government offsetting it spending (an injection of funds into the economy) with its bond sales (a leakage of funds), central bank interest rate targets are not up-ended by fiscal policy.5

A third aspect is that of functional finance (Lerner 1943; Snider 1965: chap 4). Fiscal orthodoxy argues for economic agents to run budget balances (income equals spending) or budget surpluses. That notion is applied to governments, and is thought necessary to ensure macroeconomic stability and a non inflationary economic system.6 MMT claims that state budgets should be set whereby the excess of spending over taxes (a budget deficit) is driven by national needs. Sovereign governments should produce budgets that have social purpose or function as opposed to rigidly matching spending with taxation regardless of human needs. Government deficit levels should be functions of public purpose. Societal needs to combat unemployment, low entrepreneurial profit expectations, inequality, financial instability, and other challenges, should drive the state’s financial balance. Aspect one supports the second aspect by providing the state with the financial means to meet social objectives.

MMT advocates and heterodox economists have long thought that there is a necessity for government intervention in an entrepreneurial economy. Private commercial societies, based on the profit motive to compel investment and employment, tend to concentrate too much income over time and require entrepreneurs to face fundamental uncertainty when contemplating investment decisions. Private demand is likely to fall short of the employment needs of the working class, resulting in unemployment (Keynes 1936: chap 3, 11, 12, 18). Policy action can assist private investment in creating a fully employed and prosperous society (Davidson 1988; Galbraith 1997). An additional application of functional finance is to that of financial instability (Minsky 1992; Kindleberger and Berstein 2000). Cycle expansions are propelled by animal spirits and deficit spending requires debt financing. Commercial banks provide new money to borrowers endogenously. Cycle peaks and downturns follow, a consequence of rising borrowing rates accompanied by contractions in private cash flows. Profit squeeze creates collapses in investment returns (Keynes 1936: chap. 22). Government and central bank interventions are warranted to avert or lessen the severity of financial crises.7

A fourth aspect is that of fiscal policy priority. Because governments must spend money into the economy prior to any draining of currency, Treasury spending is viewed as new money injection and taxation and bond sales as money destruction. Treasury spending adds to money circulation and income, while taxation and security sales withdraw funds out of the private economy.8 Budget deficits lower rates and increase private spending, and budget surpluses increase rates and lower private spending. Fiscal policy has an immediate supportive or undermining effect on macro demand conditions.9 This fiscal understanding leads MMT advocates to argue for the reduction in importance of monetary policy as a macro policy tool. Most private spending is not sensitive to borrowing cost changes and rate changes have no direct bearing on corporate pricing policies. To generate more private demand, monetary policy must encourage private sector indebtedness. The use of very high interest rates to fight inflation typically leads to financial crises; a high-rate policy typically fails to reduce inflation without great social costs. Fiscal policy has both direct monetary and income effects while monetary policy indirectly affects income and spending after affecting borrowing costs. In other words, the government finances all of its sending via money creation and creates net private financial wealth when governments deficit-spend. Central bank actions create no net private financial wealth but do set the policy rate that all other short-term rates are influenced by (Kelton Blog 22 January 2023; Fullwiler 2007: 1018-1031; Bell 2000: 613-615; Lerner 1943).10

A fifth aspect is that of government spending limitations. The conventional view of public finance posits a strict funding constraint to national government expenditure. Spending by any economic actor is limited to their income earned and the proceeds they can borrow. From the MMT perspective, there is no funding constraint that pertains to a sovereign national government that issues the currency used by the economy.11 The limit to the government’s spending comes from the capacity of the economy to produce and the resources it can access or induce into productive activity. If the government spends beyond the output potential of the system and / or prompts the private economy to build capacity when the specific resources needed are unavailable, price inflation is the consequence. Inflation is indicative of the inability to match production with demand, and therefore the inflation outcome is evidence of a limit to the government’s spending.12

In the MMT fiscal-monetary policy framework, government deficits do indeed matter but differently from what conventional wisdom dictates. Government deficits can be used to increase aggregate demand when private expenditures fall short of producing full employment. Deficits also matter for determining the size of the private sector’s cash balance surplus; positive balances foster financial stability. And finally, deficits do not drive inflation unless the economy lacks the necessary resources and technology to accomplish what the spending is directed toward producing.13 The limitation is not a funding one, but a resource one.

III. Institutions and the MMT Fiscal – Monetary Policy Framework

Part four of this paper reflects on what has been written and makes the case for reform in the government’s fiscal – monetary framework. But to get to that subject requires a consideration of whether the theoretical MMT FMPF as described above can / does characterize contemporary state fiscal means in the way in which U.S. government institutions are currently arranged. An answer to this requires consideration of (1) the congressional appropriations process vs executive branch expenditure, (2) central bank (CB) money creation vs executive branch expenditure, and (3) rentier influence in the existing policy framework.

Lavoie (2013) challenges the basic notion that government can be seen as a Treasury – central bank integration. Lavoie accepts the fiscal policy effectiveness theorem but underscores the importance of actual institutional design when assessing policy action. MMT insistence on a “counter-factual integration” in order to convince people that government has no funding constraint may prove counter productive in the public debate over government’s role in the economy. In particular, many readers of MMT literature may not understand the mechanics of the bank settlement system and normally regard the government and the central bank as independent institutions. The MMT integration model may then prove to be confusing, undermining the hoped-for acceptance of the notion of a no-funding constraint. Lavoie stresses that in actual practice, the federal government must borrow from the private sector under existing institutional rules. I elaborate on Lavoie’s position below by applying the fundamental American notion of institutional power separation (see also Van Lear 2002: 184-185).

I think that MMT undervalues the role importance of the congress and employs a partial misunderstanding of CB and Treasury operations. The MMT perspective provides a sometimes implicit and at other times explicit integration of the CB with the Treasury that is an incorrect inference from recognition of CB / Treasury interdependence. I think the explication of CB, Treasury, and congressional institutional practice is better understood when placed into U.S. constitutional context:

In terms of the congressional role in government spending, the legislative branch authorizes executive branch spending and determines the limits of spending for individual programs. The Treasury cannot spend without authorization nor can it set programmatic spending levels.14 This institutional characteristic is the basic separation of powers constitutional principle. The congress also does not provide money / currency to the government despite the MMT recognition that all money is state money. When the executive spends, it spends its own money (state money), but spending authorization and spending limits are centered in a different and independent branch. Moreover, the executive branch’s access to currency is subject to monthly tax intake, bond sales, and its cash balance held at the Fed. The congress does not supply money to the Treasury.

The Treasury department clearly enunciates that it must fund its spending from taxes and borrowings. The government’s mandatory spending is driven by the requirements of existing law and its discretionary spending is driven by each year’s appropriations process. When Congress approves spending bills and these bills are signed by the President, the Treasury issues funding to specific agency accounts. The funding proceeds are raised through tax payments and by selling Treasury bonds. Treasury report excerpts say that

The U.S. Treasury market is the deepest and most liquid government securities market in the world and serves as the primary means of financing the U.S. government. Treasury securities play a critical role in global finance as a risk-free benchmark from which many other financial instruments are priced. Domestic and foreign investors use Treasury securities as a vehicle for investment and the Federal Reserve uses Treasury securities in its implementation of monetary policy (Treasury Department, 2017: 71). … Government revenue is income received from taxes and other sources to pay for government expenditures. The U.S. government has collected $678 billion in fiscal year 2024. … The primary sources of revenue for the U.S. government are individual and corporate taxes, and taxes that are dedicated to funding Social Security and Medicare. This revenue is used to fund a variety of goods, programs, and services to support the American public and pay interest incurred from borrowing (Fiscal Data).15

In terms of CB integration with the Treasury, MMT does this for ease of illustration and to simplify the mechanics of Fed and Treasury operations.16 While this integration provides clarity on how state spending and funding could be done, and helps greatly to clarify the effects of the public sector finance on the private economy, there is in fact no such actual integration. The Federal Reserve System is established as an independent institution from the executive and legislative branches. This arrangement was established by the Federal Reserve Act of 1913, the Banking Act of 1935, and the Federal Reserve Reform Act of 1977. This institutional separation follows the constitutional principle of separation of powers. The power to create the means to purchase in the form of new money supply is separated from the power to spend. Modern central banks do the former while modern governments (Treasury departments) do the latter.

Consider the following model of the relationship among three sectors, namely the private financial sector, the government sector, and the central bank. Think in terms of CB open market operations (OMO) whereby bonds are either purchased from or sold to financial sector participants. Consider what I will call the ME model and the MT model. The ME Model describes a Monetary Easing action, a form of OMO where bonds of short and long maturities are purchased. The MT Model describes a Monetary Tightening policy where bonds of short and long maturities are sold. The models imply opposite effects of CB action on private sector liquidity and interest rates, and on the third sector, the government sector.

The ME Model works the following way. First, the financial sector purchases government securities from the Treasury when it runs a deficit budget. Private savings flow to the government to pay for the securities and savers receive the bonds. Next, the CB conducts ME which distributes newly created money to the financial sector for bonds held by that sector. Money flows to the financial sector and bonds are delivered to the central bank. The third connection is between the CB and the Treasury. By the fact that the CB has purchased bonds from the financial sector, they have in effect provided new money indirectly to the Treasury, that is then spent into the economy. The central bank ME policy replenishes the savings of the financial sector and in effect becomes the funder of government. The Treasury is funded with its own currency (state currency) vis-a-vi the Fed, and the economy is lifted to increased activity from higher aggregate demand and income. This process, model ME, conforms to the MMT perspective on state finance where the constraint on state spending is not from limits to available finance but from whether or not the economic system can provide the necessary resources to do the job the government intends to be done.

Key inferences from the ME model:

1. Money creation comes from the central bank. Aggregate demand and income rise.

2. The CB supplies the government its currency.

3. Liquidity rises in the economy and financial system.

4. Interest rates fall and asset prices rise.

5. Central bank / Treasury coordination, where the Treasury sells bonds that are purchased in the private marketplace by the central bank, frees the Treasury from a financial constraint on its spending. The central bank ME policy is an autonomous policy action.17

6. The state is made more financially free to pursue social objectives that are under – or not – addressed by the private economy.18

The MT Model presents a contrasting effect on state finance and the economy when the CB conducts a policy of monetary restriction. The CB begins a MT action by selling bonds to the financial sector for money payments. Money flows from the financial sector to the central bank and bonds are delivered to the financial sector. If the government is running a deficit, the financial sector will also be purchasing government securities from the Treasury. Private savings flow to the government to pay for the securities and savers receive the bonds. Note that the Treasury and the central bank are sellers of bonds; these bond sales create a rising interest rate environment over time. The third connection is again between the CB and the Treasury. But in this case, the CB interacts only with the financial sector and there is no transaction, direct or indirect, between the Treasury and the CB. The Treasury spends via deficits and it spends its own currency, but the degree of stimulus to economic activity is less than had policymakers employed the ME model. Eventually, economic activity will be in outright decline if MT is followed long enough to drive loan rates substantially higher.19 This process, model MT, does not conform to the MMT perspective on state finance. This model shows government spending to be constrained to the available (or raised) private funds (state money). Government spending is as well limited by the inflation constraint that can arise for the reasons enunciated by MMT theorists.

Key inferences from the MT model:20

1. Government finance constrained to the private control of state money reduces the stimulative effects of government budget deficits.

2. Government spends its own currency, a currency limited to the available private funds. The money supply may increase endogenously via bank lending, but this money is controlled by private interests.

3. Liquidity falls in the economy and financial system.

4. Interest rates rise and asset prices fall.

5. Non-coordination of Central bank / Treasury policy, where the Treasury sells bonds that are not purchased in the private marketplace by the central bank, places a financial constraint on Treasury spending. The Treasury must raise the funds it wants to spend from private savers.21 The central bank MT policy is an autonomous policy action.

6. The state is restricted financially to private savings in pursuing social objectives that are under – or not – addressed by the private economy.

The takeaways from part 3 of the paper are these:

(1) Treasury / CB rate effects: When the central bank follows the ME model, the effect is to create a lower interest rate regime over time. The policy adds liquidity to the financial and economic systems by augmenting private savings with new money.22 When the central bank follows the MT model, the effect is to create a higher interest rate regime over time. This policy extracts liquidity from the financial and economic systems by withdrawing private savings via bond sales.

(2) Institutions matter: The US political economy structure is one of separation of powers and operational independence. These institutional features make monetary and fiscal decision-making autonomous, and therefore policy may run cooperatively or at cross-purpose.23

(3) Public policy matters: Are the government and central bank employing expansionary policy (deficit expansion and / or ME) or are they employing contractionary policies (deficit contraction and / or MT)? The former increases the money supply, creates a lower interest regime and boosts aggregate demand and income. The latter enhances the role of private capital in setting interest rates, is likely to create a higher interest regime,24 and either slows or lowers aggregate demand and income.

IV. Reflections and Analysis

The Neoclassical economics school has been for a long time the dominating set of principles in the economics discipline, a social science field that includes various heterodox perspectives. By justifying a favorable political – economy for finance capitalists, the Neoclassical school has been instrumental in creating and maintaining fiscal – monetary policy frameworks that restrain state spending. The mainstream of the profession is boxed in, however, by its economic thinking, making it philosophically inflexible to understand and advocate for novel institutional arrangements to better meet societal challenges (see Palley 2012: chap 2, 11). Economics should be about “a struggle [to] escape from habitual modes of thought, … the difficulty lies [in doing this], not in the new ideas, but in escaping from the old ones (Keynes 1936: xii). Moreover, Keynes tells us why the Classical school’s ideological impact on public policy thinking was so significant (Keynes 1936: 32-33). Constraint on public action produced an environment, he thought, that ‘was austere and often unpalatable, … [explained away] social injustice … as an inevitable incident in the scheme of progress, … [created a justification for the unhindered activities of the capitalist class] attracted to it the support of the dominant social force [in the economy].’ My takeaway from Keynes is that ideas matter for why institutions are designed the way they are, but also that the ‘dominant social force’ will have an outsized impact on institutional design. Because vested interests in business and finance benefited from government restraint, government policy models never allowed for unhindered action. Substantial economic and social inequality and hierarchy were the result.

Government spending constraints also have their roots in the country’s constitutional and economic design. The public policy of the nation would be constructed to act as a sufficient restraint on state encroachment into the economic, financial, and political affairs of the landed and capitalist classes. Property owners desired a private for-profit economy whereby resource allocation and investment were driven by private interests and built a government and financial system heavily restricted in affecting social concerns and economic demands of non-propertied people. Push back to this design occurred episodically to combat socio-economic problems that threatened the system. Galbraith tells us in The Affluent Society (1958: chap. 1) that events influence ideas. Episodes of depression, financial crisis, inflation, and pandemic often reveal weaknesses in the accepted ideas of the day that operate as obstacles to possibilities of new thinking and approaches. New ideas lead to system design changes. Post Keynesian and Modern Monetary Theory are paradigms portraying economic policy as operationally constructive and flexible. These paradigms escape the restraints of convention and offer functional policy actions to alleviate problems and address design flaws.

The weakness in MMT explication is not the thinking that all modern money is state money or that at some time in the past states monetized their economies by spending money into the economy prior to taxing it out. Moreover, the contemporary FMPF employs MMT framework aspects of state money, fiscal policy action, and functional finance. The weakness lies in seeing by what means the state gets access to its own money and whether the central bank is facilitating that access through money creation, or whether the central bank and / or the political-economy regime of the day is forcing the state to access already existing money. The government spends funds electronically, just as transactions are accomplished between private sector agents. But when the government does spend, it will either access existing money via taxation and bond sales, or will access funds from central bank provision of new money. In what is an indirect provision of new money by the CB for the Treasury to spend, that money is always state money. But at issue for interest rate levels and policy effectiveness is whether that state money is limited to privately controlled financial capital or whether the central bank is adding to the volume of state money via money creation. Once new state money is circulated through the economy however, much of it becomes the private property of people or organizations. If the state is being limited to acquiring that private capital, by some restrictive financial convention, or is financially freed from such convention, matters for state policy efficacy.

The finance capitalist is advantaged by any institution designed to compel state spending dependence on private savings, an important component of private wealth concentrated in the dominate corporations, banks, and money management companies. Significant wealth concentration occurred during the era of finance capitalism (1896 – 1935) and money manager capitalism (1980 – 2020).25 In both of these eras, and throughout much of US 19th century economic history, the financial system and central bank operations impeded state public investment. The imposition of private control over savings capital, and the forced reliance of the state on privatized state money, at times had negative social consequences. Private finance capital has been the arbiter of what investment was funded and at what cost.

Epstein (2002: 17-21, 24-25) developed a rentier model of income contextualized by financialization and a rentier-oriented central bank. Central banks are contested arenas of policy construction where economic classes compete for influence, particularly over interest rate setting. Epstein sees central bank independence as a prescription for finance class favoritism and understands financialization to have pulled industrial capital into a rather common bond with financial capital for low rates and asset price inflation. Low rates and capital gains increase aggregate demand to generate growth and profits for commercial interests and, by creating booms in equity and bond values, benefit financial interests. The achievement of asset price appreciation more than offsets lower interest income for money managers and creditors. What had been a conflict between the two classes of property owners has become an alliance between the propertied classes; acceptable sector profit rates are now had at optimal interest rates that are lower and similar in level where in the past the optimal rate levels were farther apart. The central bank role is now to put downward pressure on rates to encourage capital gains on assets while also working to contain commercial price inflation. On this matter, also see Seccareccia (2017).

Keynes recognized an issue with capital supply in his era. He tells us that the Classical school argued for a ‘moderately high rate of interest’ to induce savings which was thought necessary to promote spending and growth. Yet in reality, savings is the product of raising income via increased spending; more spending elevates savings. To achieve full employment, the agency of the state could be utilized to augment national savings to drive interest rates sufficiently lower to obtain full employment. He writes that there is ‘no intrinsic reason[s] for the scarcity of [financial] capital.’ Moreover, the state needs to ‘exercise a guiding influence on [private spending] … partly by fixing the rate of interest. … it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment.’ He concludes that a ‘somewhat comprehensive socialisation of investment will prove the only means of securing … full employment’ (Keynes 1936: 374-378).

Keynes sought change in the agency of the state and in the composition of investment. A 21st century interpretation of these notions might be the following: the state is to be seen as an institution freed to be a contributor to the capital formation of the country; the state should be financially freed from the private control of state money by institutionalizing a state fiscal – monetary arrangement that routinely supplies additional state money to fund public investment.26 In this thinking, public sector goals and initiatives are elevated in importance, and some level of public investment should be funded by creating new state money to meet social objectives. And these objectives can be met in a non – or – low inflationary manner where resource supplies are to be augmented to meet spending demands, in compliance with the MMT framework.

The above literature leads me to think that the key component of a new fiscal – monetary framework must be for the congress to require (1) direct central bank financing of Treasury’s deficit spending.27 Direct financing augments the available privately controlled state money to meet public purposes, and breaks the dependency on privately controlled state money. Expansion of investment capital would create a low-interest rate regime, where the Treasury yield curve would likely be very flat, and the corporate bond yield curve would slope upwards. Yields would be a positive function of risk and maturity.

Three other components would complement direct financing: (2) a change in the role of the Federal Reserve System (FRS), (3) a change in who has responsibility for inflation, and (4) the legal requirement for congress to assess resource constraints.28 The FRS’s new main role elevates to preeminence its historic reason for its coming into being, namely to promote financial stability, but in this proposal largely via supervision and regulation of speculative banking and financial markets, not OMO. Financial stability can be had, even in a low-rate regime, through strong regulatory measures on what wealthy financial interests can do with their own money and the money of the public.

The third component shifts inflation responsibility to government. Democratically elected branches make policy on public investment, income distribution, business cycle shifts, and economic growth. These bodies should also make policy on inflation. The congress passes a budget with a certain deficit level to be funded with money creation from the FRS. That responsibility requires careful consideration of and research into resource constraints. This is the fourth component of reform of the fiscal – monetary policy framework. Both the legislative and executive branches are to submit preliminary budgets to offices such as the Council of Economic Advisors and the Congressional Budget Office to obtain detailed reports estimating the impact of proposed paths of government spending laid out in preliminary budget options. These reports are to assess output, employment, and inflationary impacts of competing budgets. An additional third report could be requested from non-governmental organizations for consideration.29 Congress is to pass budgets that produce low inflation and take action to assist the private sector in developing the necessary resources and technology required to accomplish budget objectives. The final approved budget will meet all five of the MMT framework tenets: (1) public policy integration, (2) the recognition that all money is state theory, (3) budgets should be products of functional finance, (4) fiscal policy should be prioritized over conventional monetary policy, and (5) resource limits exist to government spending levels.

It is noteworthy that changes in FRS operations and powers have occurred in the past. These changes have been initiated sometimes by the FRS and at other times imposed through congressional action. Consider the table below. Table 1 identifies 1 example of institutional change (the creation of the Fed) and 10 examples of important changes in fiscal and monetary operations within existing institutions.

Table 1. Institutional Change at the Fed

Author will supply table upon request.

Summation of paper:

This paper considers the contemporary fiscal – monetary policy framework of government. American history is replete with an ongoing push and pull between the contending forces of government restraint and activism. The era after the 1920s has seen frequent use of fiscal and monetary intervention to combat recessions, inflations, and financial crises. This paper confronts the subject of creating a new fiscal – monetary framework in light of the framework suggested by Modern Monetary Theory.

The paper identifies the key aspects of MMT’s fiscal – monetary policy framework. The fiscal and monetary notions advocated by MMT supporters are compared to that of MMT critics. MMT’s policy framework I believe consists of five underlying precepts: (1) central bank – government integration, (2) the state theory of money, (3) functional finance, (4) state fiscal dominance, and (5) resource constraints, not finance, limit government spending.

The paper contends that the MMT framework perception undervalues the role importance of the congress and employs a partial misunderstanding of actual central bank and Treasury operations. The paper constructs two, three - sector models that differ in the way budget deficits and money creation work. The two models differ in their effects on interest rates and aggregate demand stimulus. The weakness in the MMT framework explication is in not identifying by what means the state gets access to its own money. The MMT framework does not decipher whether the central bank is facilitating access through money creation or whether the central bank is forcing the state to access already existing money. The former situation fully frees the state to spend and the latter imposes a supply of funds constraint. Finance capital creates political pressure to impose state spending restraint, and is advantaged by any institutional arrangement designed to compel state spending dependence on private savings. State financial independence better serves the public purpose.

The work finishes by making a case for reform in the U.S. government’s fiscal – monetary framework. The paper advances a reform option consisting of four components: explicit direct funding of government by the central bank, a change in the role of the Federal Reserve System, a change in who has responsibility for inflation, and lastly, the legal requirement for congress to assess resource constraints. The article’s contribution is to pin-point the defects in the MMT fiscal-monetary policy framework as applied to the U.S., and then to offer an institutional reform option to correct the defects. The paper explains why and where the MMT framework is defective, and then incorporates the remaining MMT framework aspects into the reform proposal.

Author will supply footnotes upon request.

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