Nima

I'd do it with boats and cash under the radar.

There's no justification involved in any of what I'm saying. If in a fiat money system there happens to be no other way to have full employment than through deficits, then that's a factual observation, not a moral justification of the fiat money system. "This just shows the silliness of using GDP as a figure. The government giving 20 units back the the people they took it from doesn't add to national wealth, but you did just add 20 unites to the GDP." < That's why I harp on the importance of the sequence of events. In a fiat money system the government imposes a tax (aka renders people unemployed) and spends the money into existence first, which does indeed generate employment to earn these tokens that they now know they'll need in the future. (From there you can of course have private bank lending and a larger ensuing private sector as a result.) Historically it was often some war or conquest that a particular fiat system started from, see for example the Greenback (https://en.wikipedia.org/wiki/Greenback_(1860s_money)). Whether or not the activity is moral or justifiable is a different topic altogether. "Yes it would mean that private net lending is also zero. However all this really means that individuals in the economy are borrowing the same amount of money they are lending. So far I see nothing here that is problematic to allow individuals to gain savings, so long as some other people are spending savings (retirement, large expenses, unemployment)" < If there is a government budget surplus and no foreign trade then there is indeed no additional net saving generated in the economy. This is not an opinion of mine, it's a mathematical identity. "Or net savings can be increased by reducing total expenditures or consumption." < No! reducing expenses or consumption doesn't change anything to net saving at all. Net saving is a net claim of the private upon the public sector. (For now, we can ignore the foreign sector by assuming no foreign trade for the purposes of this particular discussion.) When I decide to spend less, all that happens is that bank reserves remain in my bank, and don't go to someone else's bank, but there is no change in the net position between private and public sector.

... or just cut taxes "big league"

"How are bank reserves / private sector net savings and loans connected?" Each private bank has a checking account and a securities account at the fed. The money that's in this checking account at the Fed is the bank's "bank reserves". The Treasury also has such a checking account at the Fed. Bank reserves together with cash currency form what's referred to as high powered money (HPM), it is the ONLY money the treasury will accept in settlement of tax obligations. Banks shift some of their bank reserves into their securities account at the Fed to obtain government bonds that pay interest instead. You could roughly look at it like shifting money from checking into savings. Private sector net saving is the sum of all cash currency + bank reserves + government bonds. A loan occurs when a bank marks up your checking account with them, which means the bank owes you HPM (cash currency upon withdrawal or bank reserves upon writing a check to another person at another bank or to the government) on demand, and adds a loan on their books, which means you owe the bank checking account money in the future to repay the loan (note how this inherently creates a demand for checking account money, anyone owing money to a bank needs a checking account markup to pay the loan, much like taxes inherently create a demand for HPM). I've laid out the empirical sequence of events and definitions of these terms in my post https://beinglibertarian.com/mmt/starting under "The Central Banking System". Does that make sense?

Ah maybe I understand better now what you're trying to convey, and I don't think I disagree. Of course getting reserves and money creation via loan are two separate operations. That was precisely my point when I said that (a) new money induced via loan creation is different from (b) new money induced via new bank reserve creation. Private banks can do (a), not (b). The treasury and the Fed are the only entities that can do (b). Only (b) adds net saving to the private sector, where net saving means private sector claims upon the public sector, while (a) creates a new claim upon a bank in the form of the loan recipient's checking account markup, counterbalanced by a new claim upon the loan recipient, in the form of a loan on the bank's books. Both occur in the private sector and cancel each other out. There is no new net claim upon the public sector generated anywhere in this case.

Sorry, I'm not sure which point exactly you're arguing now? I'd just add that it always zeroes out, even if the money is used to purchase something: The purchase operation doesn't change private sector net saving at all. It reduces the buyer's bank's reserves and increases the seller's bank's reserves by that exact same amount.

You have to be precise with terms. What your link refers to is checking account money creation. Checking account money is not bank reserves, it's a claim upon bank reserves, and it's created within the private sector by creating a bank loan (a liability of the borrower) and a checking account markup (a liability of the bank to deliver bank reserves upon clearing or cash upon demand), but it nets out to zero within the private sector. The fact remains: There is no other way in a fiat system to induce private sector bank reserves and cash (aka net saving, a private sector claim upon the public sector) without a preceding government deficit. It's true that after the fact some choose to convert the bank reserves into government bonds to earn interest, or the Fed intervenes and sells treasury bills to keep the interbank rate from dropping to zero, but those things happen after the fact in terms of sequence. See https://beinglibertarian.com/mmt/where I've defined these terms in detail and laid out the empirical sequence of events.

I was just describing how the fiat money system functions, not claiming that it adds wealth to society, so I'm not sure I understand that question. If Nima didn't steal any of the induced fiat money AT ALL from the private sector via taxation, then there would be no initial demand for the NB to begin with and the entire fiat economy wouldn't form to begin with. There has actually been some research into hyperinflation under the Continental Dollar, identifying the lack of a tax to drain the money supply as one of the main causes. But this is important to note: The private sector in a fiat economy would not have ANY bank reserves or cash (aka net saving) in its possession unless the fiat government ran a deficit at some point and didn't drain the entire private sector net saving via future budget surpluses. I'm not sure I understand the notion that a deficit starves a government of its assets. If we want to introduce the accounting notion of assets into my example the only "asset" the government has initially is the future tax liability it has imposed upon the individuals living in its territory. The money that it then spends into existence is essentially a subsequent liability of the government, in that the government promises the money holder a discharge of any imposed tax debt over a certain amount printed on the token. Discharging said tax liability reduces the private sector's tax obligation by the amount discharged and thus constitutes a reduction on the liabilities side of their balance sheet. The number of money tokens surrendered is the corresponding accounting reduction on the private sector's asset side of the balance sheet. On the government balance sheet all that happens is that the public's tax liability is reduced on its asset side, and the act of extinguishing money tokens held in private hands reduces the government's liability side accordingly. I could literally use standard accounting T-balance sheets to illustrate this. But I'm not sure why we'd want to get that wonkish for the sake of this discussion? Now I don't understand the whole part about SS honestly, maybe you can rephrase or make your question a bit more concise? Edit: Maybe one thing to just throw out there is that in a fiat money system the government never really has nor doesn't have money. So to say that there was some kind of SS trust fund that was then raided is not really accurate from an MMT perspective. You have to look at a fiat government more as a monopoly bank. Nobody ever wonders how much money the monopoly bank has or doesn't have. It's just like a scorekeeper. It just so happens that one aspect of the scorekeeping involves picking initial recipients of money tokens via government spending. However, what the private sector does from there with the net saving left in private hands is up to them. So re/ SS: The government can always decide how much money to spend on SS in any given year. It's a political/budgeting decision that people are supposed to make, since the money directed towards that spending will obviously ultimately direct private sector resources away from others and towards SS recipients.

I didn't define employment, I quoted from very common definitions of unemployment.

Let's imagine we start from day 1 of the initiation of the very first fiat transactions: I become sovereign through some conquest with no foreign trade yet and I impose a total tax of 100 NimaBucks (NB) to be collected per year and hire public sector workers for 1000 NB throughout year 1. So for year 1 we have a public sector deficit of 900 NB and a corresponding private sector net saving of 900 NB (meaning 900 NB are left in private sector bank reserves or cash currency). Now let's say for year 2 I raise the total tax to be collected from the private sector to 500 NB but spend only 200 NB. This means in year two we have a public sector budget surplus of 300 NB and a corresponding private sector deficit (net dis-saving, see end of Clinton era for contemporary example) of 300 NB. At the end of year two there will only be 600 NB left in private sector bank reserves/cash.

You are not subject to much taxation in Yen I presume, so Yen doesn't even come into the picture. You are subject to dollar taxation or to whatever fiat currency regime you live under. Thus, for liquidity you generally mostly seek the token that is accepted in said taxation, either directly, or by proxy in that you don't owe taxes yourself but know that many others in your territory do, in the US that would be bank reserves plus cash currency in circulation for example. I agree!

Yes over all time that is correct. But once the private sector has accumulated some savings you may have certain years where more money is destroyed via taxation than is generated via spending, aka running a budget surplus for the year. Generally this has been a good depression indicator by the way. 6 out of 7 times the US budget went into surplus a depression followed. The 7th was the great recession.

Great!

I think you get the gist of things, but the only thing I would add is that as per historical evidence a fiat economy doesn't begin with the private sector producing units of value, it begins with a sovereign imposing a tax.

Think of the most simple, extreme scenario for illustrative purposes: Let's say there is me and 10 others in the room. I impose a tax on those 10 people in NimaBucks (NB), everyone owes me 10 NB within the next 24 hrs, and if they don't pay the tax my guy with 9mm gun at the door won't let them leave the room. Now imagine I don't proceed to spend said NimaBucks into existence. Nobody will have them in this mini private sector of 10 people. In fact, in within the next 24 hrs everyone is in debt to me and I get to begin expropriating things they actually have on their person to settle their debts. This is the simplest example of a "balanced budget" in an economy where I am the sovereign issuer of the currency. The private sector ends up being in debt to the public sector! Yes, you may have deflation, but it doesn't matter, there is no clearing price that can create full employment in this scenario because there's simply not enough tokens in the economy to pay the tax I've imposed. See this clip for a nice illustration in lecture format: If the government runs a deficit it's only inflationary if the deficit is larger than the private sector's demand for net saving of NB's. Remember: Without foreign trade, the the public sector's deficit equals the private sector's net saving, and net saving seems to be highly correlated with recessions/depressions/unemployment etc. (See evidence here: https://beinglibertarian.com/private-sector-saving-recessions/)

This is speculation as we don't really know. It's not exactly accurate that fiat currency is "backed by nothing", since the tax does create a demand on it. But we can see phenomena like Bitcoin emerging which could certainly become the payment system of a free society. The fact remains that there is lots of historical evidence that large scale monetary systems have always been fiat. Even gold coins under the Romans were essentially fiat money, and traded at a substantial premium on the gold price. I defined unemployed very clearly as someone who wants money but doesn't have it and is looking for a job that pays him said money. This is not an uncommon definition for unemployment amongst economists. Wikipedia says "Unemployment occurs when people who are without work are actively seeking paid work." (https://en.wikipedia.org/wiki/Unemployment). What I described is exactly how fiat money systems emerged and functioned for millennia as per historical evidence. Look up "Split Tally Sticks" for example: https://en.wikipedia.org/wiki/Tally_stick#Split_tally: "The most prominent and best recorded use of the split tally stick (or "nick-stick"[5][6]) being used as a form of currency was whenKing Henry I initiated the tally stick system in or around 1100 in medieval England. He would accept the tally stick only for taxes, and it was a tool of the Exchequer for the collection of taxes by local sheriffs (tax farmers "farming the shire") for seven centuries."

Good question. Anyone who has a demand for currency, but doesn't have a job offering said currency is unemployed for the sake of this definition. If I impose a tax on you, payable in 100 NimaBucks in 1 week, along with credible enforcement, then I have essentially rendered you unemployed because you now need NimaBucks, but don't know anyone offering them. Let's say I'm the monopoly issuer of said NimaBucks. You now depend on me to give you a job that pays NimaBucks so that you can pay the imposed tax in 1 week. This is essentially the fiat money system in a nutshell, if that makes sense? There is no disincentive to save money inherent in a fiat money system. People in the private sector in a fiat money system like to save up some money as a safety cushion to be able to pay bills when they don't have work that pays that money. (IF the fiat money system becomes inflationary, in other words when government budget deficits go beyond the private sector's demand for net saving, then that can certainly disincentivize from saving.) "In a fiat money system, what is the disincentive to taxing more and spending less?" < Taxing more than before and spending less than before could mean that the government budget deficit is reduced. It could also mean, depending on how large the change, that the government might generate a surplus. This essentially means that the government doesn't leave any money to the private sector to net save, which impels people in the private sector to cut spending enough to still be able to pay the tax. This can lead to unemployment via the mechanism I've outlined in the post above. "Can fiat currency exist in a voluntary society?" < Great question! I think it's conceivable, but haven't thought about this much. For example a private property owner could introduce a new currency on his property only, and require rent payment in that currency instead of an arbitrary compulsory tax.

This is an explanation why people accept fiat money as a means of payment, after all it's only a piece of paper with a number on it. The reason people do, is that many need that money in order to pay the tax imposed by the government. The tax creates demand for the money which gives that money value. In a fiat money system the government first imposes a tax in a certain currency (e.g. NimaBucks) on the population which it'll enforce violently, and then proceeds to spend NimaBucks into existence by hiring soldiers or building bridges etc. The recipients of that money will now find ready acceptance for NimaBucks in the private sector since virtually everyone in the territory needs those NimaBucks to pay the tax. Does that make sense?

Recently I posted my summary of MMT here because I think it can help us gain a better understanding about the public debt, budget deficits, taxes, etc. and their impact on growth. Now I am reposting one more (much shorter) post that I recently wrote on BeingLibertarian.com to show how and why MMT is highly relevant in today's world, in particular in Europe where high taxes & Austerity are choking economic growth, and to a degree the same applies to the US. The main point is that in a fiat money systems routine government deficits seem to be necessary to a degree to avoid unemployment if the government in question is the currency issuer. Here is the original post: In a recent post I provided a summary about how today's fiat money systems function according to Modern Monetary Theory, in particular drawing from L. Randall Wray's Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems. In chapter 7.6, titled "MMT for Austrians: can a Libertarian support the Job Guarantee?", the following paragraph caught my attention: "The problem with a monetary economy (...) is that from inception imposition of taxes creates unemployment (those looking for money to pay taxes). (...) It is sheer folly to then force the private sector to solve the unemployment problem created by the government's tax." To me, this has probably been one of the most eye opening statements about the fiat money system that I've heard in a long time, as I had never looked at it from this perspective before. We know about common causes of unemployment, such as minimum wage legislation, and other measures that raise employment cost above what the market can bear, such as mandated health care, or to sum it up: government intervention. But that doesn't mean we can't consider other potential causes. If you've read my post about Modern Monetary Theory you'll know that in a fiat money system the government imposes a tax in a currency, and then proceeds to spend that currency which is now in demand to satisfy said tax obligation. If you've read my post about Private Saving, deficits, and recessions you'll know that when private sector savings runs low or even declines, a recession/depression is on the horizon, and that in a fiat money system there's no other way to achieve sufficient private sector savings without government budget deficits. According to MMT, the reason low or negative private savings cause unemployment is that the private sector is scrambling to save enough on top making the required tax payments. This, in turn, leads to systemically induced shortage in demand for goods and services in the private sector, which in turn leads to declining corporate sales, which ultimately results in corporate layoffs and unemployment, unemployment meaning that someone is looking for money but isn't getting any. Warren Mosler has always explained this most vividly in the university lectures that I've seen him in. It goes a little something like this: He pulls out a stack of business cards and tells the audience that he's selling each for $50, which naturally nobody is interested in. Then he adds a factor to his simulation: He informs the audience that he's got a guy waiting a at the door with a 9mm who won't let anyone leave without presenting one of those business cards. He explains that now suddenly he has made everyone in the room unemployed. Everyone needs at least one business card, and nobody has one. So now Warren could find willing and able workers willing to trade labor for such a business card. But imagine he didn't follow through and didn't hire anyone, or only hired a few individuals in the room. By definition, he would have made people unemployed, without giving them a way to escape their unemployment. (Watch a clip where Warren Mosler explains this here.) This is essentially how the fiat money system is set up: We all (or most of us) need money in order to ultimately make a tax payment by year's end. In addition to desiring money to make tax payments, the private sector also desires to save a portion of the money received. But if the agency that has imposed the tax doesn't arrange their racket in a manner where enough money is left in private sector pockets on the net, some people will inevitably remain unemployed. Remember my explanation from "Sectoral Balances and Private Saving": This sectoral balance identity can be observed in this chart that I've put together on stlouisfed.org: You can see there that the private sector's surplus (blue) plus the foreign sector's surplus (green) consistently equal the inverse government budget deficit (red) to the cent. You may have noticed that the private sector surplus in the blue chart above is exactly the same chart as the one I presented a few weeks ago when I explained the correlation between private sector saving and recessions. What do we conclude from this? In order to achieve a sustained level of net private saving, which seems to be important to the health of the domestic economy in a fiat money system, a country either needs to run a sustained current account surplus, or a government budget deficit, or a mix of both. In the case of the United States, which runs a current account deficit at the moment, there is in fact no other way to accumulate net private savings than to run a government budget deficit. A balanced budget in a fiat money system implies not only insufficient money to satisfy saving demands, it implies that no money at all is left in private sector pockets, leading to systemically suppressed demand, which inevitably leads to systemic unemployment.

In a free floating irredeemable fiat currency system the government cannot be forced to default on its debts (it could of course choose to suspend interest and/or principal payments, but that would be a policy choice, not one of financial necessity) In such a fiat money system the government creates money by spending and destroys it by taxing Taxes drive money Government bonds are basically just like savings accounts at the central bank Private banks lend first, then obtain reserves Fractional reserve lending is naturally constrained by the creditworthiness of borrowers

A lot of issues are probably cultural, but to speak to the economic aspect: I think it's largely high taxes that are killing people's ability to save enough. Similar ailments have befallen many European countries, and the US to a degree. Taxes would have to be cut drastically in order to supply the private sector surplus needed to save up enough to feel comfortable spending/investing money again.

I haven't posted in a while on here, but would like to do more of it again. I wanted to share something I wrote in June for BeingLibertarian.com, mostly because studying this topic has opened my eyes to many blind spots and has helped me understand the fiat money system so much better, in particular the role that deficits and government debt play in such a system. I really think this info could help many others who are into Austrian Economics or economics in general. I've been told by economists from the MMT field that it's a very concise and helpful summary, but would of course appreciate feedback and disagreements as always! So here's the original piece: For quite a while now I've been pretty unsatisfied with mainstream as well as Austrian economics-based takes on the global economic situation, in particular phenomena such as record low to negative interest rates in countries with record debts (such as Japan), massive excess reserves, and QE 1 through infinity without much consumer price inflation, etc. No economic school I had learned about offered fully coherent answers regarding those. So I thought it may be worthwhile to throw another heterodox economic school of thought commonly labeled "Modern Money Theory" (MMT) into the mix. In particular, I've been reading L. Randall Wray's book Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems which I highly recommend. It's also available for free in online only format. I believe that a lot of what is being revealed in this book is of relevance to all of us, regardless where we stand politically. MMT offers prescriptions that can work within a libertarian context just as much as they can in the context of a more interventionist state. Most of all: MMT offers a plain and unbiased description of how fiat money systems actually work. In this post I will provide a rough overview. Spending and Taxation in a Sovereign Money System MMT primarily describes a monetary system in which a country's currency cannot be redeemed against anything else, such as a commodity or some other foreign currency, and in which the currency exchange rate floats freely on the foreign exchange market. Those are characteristics that apply to today's US dollar for example. (MMT then also helps understand redeemable and pegged currencies, but first we need to understand the workings of an unconstrained currency system to get there.) In such a monetary system, the government imposes a tax on the population it governs, that is, it claims the right to forcefully appropriate peaceful and innocent individuals' property on a recurring basis. It decrees, for example, that everyone shall owe an income tax in US dollars by year's end. It then proceeds to create and spend those dollars in the form of paper bills and coins with numbers on them (or in the form of electronic bank entries called bank reserves that are convertible into bills and coins on demand, but more on that later) representing their tax redemption value in order to obtain products and services. It moves resources from the private sector into the so-called public sector. Individuals who get paid in those dollars will then find ready acceptance of this money in the private sector, given that most individuals will need it to pay the imposed tax. Money prices and voluntary exchange in the private sector emerge as a result. On a side note: There is indeed lots of historical evidence suggesting that money has been issued in this manner for millennia. In earlier days some of the tokens issued and accepted in taxes and fines for punishment were precious or base metal coins with the sovereign's head minted on them (which would circulate at a significant premium on the metal value), or in some regions so-called tally sticks were used as money tokens by the king to obtain goods and services. Anyone possessing such a tally stick could return it to the crown in place of tithes which others would have to settle in real produce. The book I mentioned earlier also delves into commodity money (such as gold and silver coins) in that historical context, including redeemable token currency systems like the gold standard. The important point that MMT makes here is this: Taxes drive money. The sovereign's arbitrarily-imposed tax liability has to be discharged using the money tokens issued by that same sovereign. Government spending is a means of introducing money into the economy. Taxes then destroy that money. Spending and taxation are thus not fiscal, but rather monetary policy. The government doesn't first raise taxes in order to obtain money to spend, it rather creates the money first by spending it into existence and then removes it from the economy via taxation. The Central Banking System The government's treasury has a checking account bank, the so called central bank. In the US this is the Federal Reserve Bank (Fed). The US Treasury's balance in this bank account is replenished to $5 billion dollars at the end of every day, but is generally not counted as part of the country's money supply. The reasons behind this setup are of purely legal nature, but ultimately the processes of spending and taxing to create and destroy money respectively work exactly as outlined above. (In order to understand this system better, initially it really helps to view the central bank and the treasury as one and the same institution: the government. Even if the legal nature and partial ownership structure of certain central banks, such as the US Fed, may lead one to believe that it operates "independent" from government, the end result is for the most part the same. For details I highly recommend the chapters 3.6 and 3.7 in the primer I mentioned above.) Then there are the country's private banks where people can hand in their money tokens for storage and safekeeping and write checks against their balances for convenience's sake. As per the rules of the system, these banks also get to maintain their own checking accounts at the Fed. The money in these checking accounts is commonly referred to as "bank reserves". Say I present a $100 bill that was introduced via government spending into the economy to such a bank's teller. The bank takes the bill, marks up my bank deposit by $100, hands the bill to the Fed, and the Fed then marks up the bank's checking account at the Fed (its "bank reserves") by $100 as well. If I want to withdraw $25 in cash and the bank doesn't have the cash on hand, it needs to ask the Fed for $25 in cash. The Fed will deliver the cash and mark down the bank's reserves by $25. The bank hands me the $25 and marks down my bank deposit account by $25. As you can see, cash and bank reserves are interchangeable. Together they form what is called "high powered money". They are the only means of payment that the treasury will accept in tax payments. Let's say I owe $75 in taxes to the government and make payment via check. The treasury will ask the Fed to mark down my bank's reserves by $75 and the bank will mark down my demand deposit by that same amount. The money has disappeared from circulation. I have been made poorer in comparison to the sovereign currency issuer but the money didn't really "go anywhere" other than the treasury's account at the Fed which gets replenished anyway, no matter what taxes get collected or not. (By the way: If you were to withdraw your money and make tax payment in old paper bills, the money would simply get shredded!) Or let's say I bank at bank A and I make a check payment of $75 to Bob who has a checking account at bank B. Bob presents my check to bank B, bank B presents it to the Fed, and the Fed will mark down bank A's reserves by $75 and mark up bank B's reserves by that same amount. Bank A marks down my deposit account and bank B marks up Bob's deposit account in turn. So you can see that banks need bank reserves in order to (a) facilitate tax payments, (b) meet interbank settlement requirements, and © facilitate cash withdrawals. If a bank doesn't have the necessary reserves it'll incur an overdraft on its reserve account at the Fed and needs to obtain the reserves after the fact to cover that deficit. This is what's commonly referred to as the Fed's "lender of last resort" function. The bank obtains such reserves by offering savings accounts and CDs to individuals looking to earn interest instead of holding cash. Furthermore it can also borrow reserves for a short period from other banks who don't need them at the moment on the interbank lending market. Finally, it can also borrow reserves from the Fed directly, and generally only against safe collateral, such as treasury securities, or sell those securities to the Fed outright. Government Bonds and Interest Rates Cash currency in circulation and the aforementioned bank reserves at the Fed generally pay low to no interest. Thus banks like to move some of those reserves into interest bearing securities. Private individuals have that same option. This is why the government sells bonds of varying maturity. Ultimately government bonds are nothing but savings accounts or CDs at the Fed. All that happens when a bank or an individual buys a government bond is that bank reserves are debited and a securities account is credited with said treasury security. When an interest payment on a bond is made the Fed marks up the bond holding entity's bank reserves electronically. When the bond matures, the bond is removed from the securities account, and reserves are credited with the bond's face value amount via keystrokes. There is no tax money that the Treasury needs to raise anywhere to make this interest or principal payment. Since the private banks can always move their reserves into bonds of any maturity and since there is no default risk, the interest paid on those bonds constitutes a bottom level for interest rates. There would be no point in loaning out money to private borrowers at lower rates. Thus the Treasury and the Fed can manipulate the overall term structure of private loans by setting a floor below which rates won't go. This is most commonly the case for very short term instruments, such as Treasury Bills (1 year or less), which the Fed sells to private banks to move bank reserves away from the private banks if the overnight interest rate on the aforementioned interbank lending market drops below the desired policy rate. It should be noted that a few years ago the Fed started paying 0.25% on reserves, effectively making the sale of short term credit instruments obsolete. But the economic effect is ultimately the same: The interbank lending rate won't drop below this level. Why manipulate these interest rates in the context of this overall framework you may ask? That's a good question, and indeed, MMT suggests that in a sovereign money system there's really no reason to do so. If the Fed stayed out of it, the short term interest rate on the interbank lending market would probably tend towards zero, since banks will always want to get rid of their excess reserves to maximize interest earnings. Why sell longer term government bonds like the Treasury does, effectively setting a risk free rate and thus a floor for longer term loans? Again a good question! In fact, MMT ultimately suggests that beyond very short term Treasury Bills at most there's really no reason for the government to be floating long term bonds. Within the confines of today's fiat money system, MMT actually offers the most libertarian alternatives regarding interest rate management and government bonds: let the overnight rate go wherever market conditions amongst private banks let it go, and don't issue any long term government debt at all! Private Bank Lending As outlined above, private banks make it more convenient for people to store and use their money. When I deposit cash in my bank account, then the bank essentially writes me an IOU, saying that it owes me cash on demand, in the form of a checking account. The government, which can always create new bank reserves via spending, guarantees those IOUs via deposit insurance in case the bank runs out of reserves due to mismanagement, which is why they are widely accepted and generally considered as good as cash or "liquid". It is thus not a coincidence that checking accounts are generally considered part of the money supply. You can say that private banks are in reality public/private partnerships where the bank's deposit liabilities are publicly guaranteed and the rest (liabilities to bondholders, shareholders, etc.) is private. This explains why when a bank goes under its stock price tends towards zero (the shareholders lose), yet deposit holders are made whole by government's deposit insurance. But a much larger function of banks is lending. Lending occurs when a bank identifies a creditworthy borrower who is offering his rather illiquid IOU (in the form of the promise of future payments) to the bank, while the bank in turn offers its own very liquid IOU (a government insured promise to convert into cash on demand) in exchange. In return for offering a more liquid IOU the bank charges interest. The differential between the interest it pays to depositors and other creditors and the interest it charges on its loans determines its profit. In a very simplified yet relevant model of an economy with only one bank, you can think of a bank extending a loan to an entrepreneur, marking up his checking account by say $100,000. The entrepreneur then uses that money to pay sellers of labor (employees) and of commodities (vendors), marking down his own checking account while marking up the others'. (You can see here by the way how for every loan, there is a matching bank deposit. Not because the bank had to obtain deposits first, but rather because every loan generates a matching bank deposit.) He then produces widgets that he sells to those same people, so that ultimately his bank checking account is marked up again while the buyers' checking accounts are marked down. He can now repay the bank loan which ends the loan cycle and withdraws the previously issued money from circulation. We can see here that much like taxes do for high powered money, bank loans create a drain on and thus a demand for checking account money. However, if the entrepreneur is unable to sell the widgets (while the recipients of his payments hold on to their checking account money) he defaults on his loan. The bank needs to write it off and lose out on expected interest revenues, yet it still owes cash to the deposit holders on demand. If some deposit holders were to demand cash (or write checks if we add more banks to the model) then the bank would have to sell assets to the Fed to obtain the reserves needed. If it has no more assets to sell it would have to obtain a reserve loan from the Fed that it needs to repay at some point or face insolvency. So even if a bank can create new checking account money into existence without any bank reserves at all, it is only interested in extending loans to creditworthy borrowers or else it may face insolvency. This model can be easily extended by adding more banks and borrowers with the same net flow of funds over time. We draw two important conclusions: Banks don't wait to obtain bank reserves and then lend those reserves out later. They rather identify creditworthy borrowers first, create loans, and then obtain bank reserves from the Fed later if and when they're needed. Furthermore, in spite of their ability to create money out of thin air, banks have no incentive to create an indefinite amount of loans. Rather loans are made when willing and able individuals stand ready to make successful investments. If loans go sour, the bank is on the hook (as it should be). Conclusion To summarize, the most important things I took away from this exercise are: In a free floating irredeemable fiat currency system the government cannot be forced to default on its debts (it could of course choose to suspend interest and/or principal payments, but that would be a policy choice, not one of financial necessity) In such a fiat money system the government creates money by spending and destroys it by taxing Taxes drive money Government bonds are basically just like savings accounts at the central bank Private banks lend first, then obtain reserves Fractional reserve lending is naturally constrained by the creditworthiness of borrowers In my opinion MMT helps us explain and understand the current fiat money system much better than conventional or Austrian economics. This is coming from an Anarcho-Capitalist who has read books like Mises' Human Action, Theory of Money and Credit, Socialism, and many others, so don't think I say this lightly! Even if we find moral or economic flaws in a system, it is better for us to understand how it actually "works" right now in order to make policy recommendations down the road. I believe MMT offers a lot of insight on that front and I will provide some contemporary and relevant examples in subsequent posts.