Pure banking vs central banking
In my tutorial, 'printing press, fact vs fiction' (ECB-Watch), I imagined a two banks model, A and B, the clients of which are the grocer's customer and the grocer, and I asked the question what happens when the customer pays the grocer with a credit card? A faces a treasury shortfall, which has to be funded in order for the transaction to clear. In PB, A borrows the required from B.
In DW, the CB takes the role of B: the CB creates a deposit—now called 'reserve'— in A's name and it is immediately transferred to B, leaving A with a loan obligation towards CB by same amount. The DW rate on the loan determines, in turn, the interest on the grocer's customer overdraft.
In OM, banks can lend each other reserves, the supply of which is controlled by the CB. The CB adjusts it—drains or adds liquidity—so as to meet an interbank rate target, itself chosen to meet an inflation target. A particular aspect of this set up is that the money multiplier theory as taught in the average economics class is incorrect.
Criticism of MMT
MMT argues that the government is not revenue constrained. That taxing and spending are merely macroeconomic levers for steering the economy in a particular direction. The only constraint is inflation. These postulates allow the very progressive MMT to promote a government job guarantee program (JG) also know as employer of last resort (ELR).
The PB model is a two level hierarchy: the interbank market—banks supplying credit to each other, and banks supplying credit to the economy. Ignore, for the sake of argument, the incentives, micro or macro, that have led banks to fuel a credit bubble in the 2000s. The key driver of private credit, under this hypothesis, is demand for loan by credit worthy customers.
I'm going to assume the government receives the same treatment as private sector in the PB model: it must be credit worthy in order to obtain a loan from banks: the government is credit worthy—solvency—constrained. A corporation pays back its debt from net revenue and so does the government; revenue is the form of sales and taxes, respectively (ignore sale of asset).
In transiting from PB to DW/OM, the CB becomes the monopoly supplier of interbank credit—reserves, and thus can set its price—interbank rate. Is the government no longer credit worthy constrained? I don't see how, but such is proposition implied in the MMT claim that the government is only 'inflation constrained'.
To make their case, MMT relies, I think, on the fact that CB can ultimately print as much money as needed to fund the government. How does that guarantee or void the notion 'credit worthy'? That's for them to explain. I never see MMT comparing the PB model to the OM model. MMT should explain why they rely on OM rather than DW for reasoning about macro policy. Remember Einstein's motto: a model should be as simple as possible, but not less.
Perhaps it's time they tackled this challenge.
A response to my tutorial was that MMT does not deny private banks are not revenue constrained, adding 'what would that even mean'? I said: indeed, what does that even mean (for government)? By the same token I should ask them why debt issued by government is called a 'net asset'. This implies the corresponding liability is void. It's absurd: one's asset (financial claim) is another's liability (financial obligation).
The same person added private banks were 'capital constrained'. That's confusing the means (capital ratio) with the end (constraint on private credit growth).
- MMT, old and new ideas (Thomas Palley)