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Examining the Impact of Modern Money Theory on Non-Traditional Means of Increasing Aggregate Demand Storm Boris Connecticut College, [email protected]

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Examining the Impact of Modern Money Theory on Non-Traditional Means of Increasing Aggregate Demand Storm Boris Connecticut College, Sboris@Conncoll.Edu Connecticut College Digital Commons @ Connecticut College Economics Honors Papers Economics Department 2017 Examining the Impact of Modern Money Theory on Non-Traditional Means of Increasing Aggregate Demand Storm Boris Connecticut College, [email protected] Follow this and additional works at: http://digitalcommons.conncoll.edu/econhp Part of the Economic Theory Commons, and the Political Economy Commons Recommended Citation Boris, Storm, "Examining the Impact of Modern Money Theory on Non-Traditional Means of Increasing Aggregate Demand" (2017). Economics Honors Papers. 28. http://digitalcommons.conncoll.edu/econhp/28 This Honors Paper is brought to you for free and open access by the Economics Department at Digital Commons @ Connecticut College. It has been accepted for inclusion in Economics Honors Papers by an authorized administrator of Digital Commons @ Connecticut College. For more information, please contact [email protected]. The views expressed in this paper are solely those of the author. EXAMINING THE IMPACT OF MODERN MONEY THEORY ON NON- TRADITIONAL MEANS OF INCREASING AGGREGATE DEMAND Author: Storm Boris Thesis Advisor: Professor Edward McKenna, Ph.D Abstract: The recent period of ultra-low interest rates and chronically inadequate aggregate demand has led to a series of prominent new proposals of nontraditional means of increasing aggregate demand. That same stagnation has allowed for the increasing influence within the field of Modern Money Theory, a theoretical framework derived from historical observations regarding the role of money. I will explore the impact of Modern Money Theory (MMT) on two of the most prominent proposals for increasing aggregate demand, helicopter money and negative interest rates. I will explain why MMT would suggest, not only are these policies either limited in their effectiveness, or redundant; it is a mistake to refer to both as monetary policy. I present MMT’s solution to inadequate aggregate demand, a Job Guarantee program, and explain the inadequacy of strictly monetary solutions in countering low aggregate demand. Connecticut College New London, Connecticut May Fourth, 2017 Table of Contents Introduction – Welcome to ZIRP .................................................................................................1 Chapter One - The Foundations of Modern Money Theory......................................................4 1.A – MMT and the Neoclassical Perspective of Money.............................................................4 1.B – Government’s Role in the Development of Currency ........................................................4 1.C – Sectoral Balances and MMT Accounting ...........................................................................6 1.D – Sectoral Balances and the Deficit .......................................................................................7 1.E – The Effect of a Budget Deficit on Interest Rates ................................................................9 1.F – The Purpose of Bond Issues ..............................................................................................10 1.G – The Affordability Constraint on Government Spending .................................................13 1.H – The Purpose of Taxes .......................................................................................................19 1.I – The Independence of the Federal Reserve .........................................................................23 1.J – The Myth of Neoclassical Money Creation .......................................................................24 1.K – Control of the Money Supply vs. Interest Rates ..............................................................27 1.L – The Function of Banks and the Creation of New Loans ...................................................29 1.M – Currency Regimes and the European Union ...................................................................31 1.N – The Purpose of Taxation Without a Budget Constraint ...................................................32 Chapter Two - Helicopter Money and a Government IOU .....................................................34 2.A – The Theory of Helicopter Money .....................................................................................34 2.B – The Wealth Effect, Ricardian Equivalence, and Irredeemably ........................................38 2.C – Liquidity Trap and the Superiority of Helicopters to Traditional Monetary Policy .........41 2.D – Bernanke’s MFFP and a Hypothetical Economy .............................................................43 2.E – The Independence of the Central Bank and Helicopter Money ........................................45 2.F – Government Bonds vs. Fiat Currency as an IOU ..............................................................46 2.G – Helicopter Drops are Fiscal Operations ...........................................................................49 2.H – The Safe Asset Shortage ...................................................................................................51 2.I – Helicopter Money and the Neoclassical MMT Debate ......................................................53 2.J – The True Purpose of Helicopter Drops ..............................................................................55 Chapter Three - Negative Interest Rates vs. Fiscal Expansion ...............................................56 3.A – The Liquidity Trap and the Zero Lower Bound ...............................................................56 3.B – How the Zero Lower Bound Impacts Central Bank Operations ......................................57 3.C – Why Central Banks Want to Go Below Zero ...................................................................59 3.D – The Current Lower Bound ...............................................................................................61 3.E – The Digitalization of Money, Stamped Currency .............................................................62 3.F – Ending the Redemption of Physical Currency at Par ........................................................64 3.G – A Paper Currency Card ....................................................................................................69 3.H – A Tax on Currency and the Limits of Interest Rates ........................................................70 3.I – What Holds Back Investment, What Inspires Investment .................................................72 3.J – QE, NIRP, and Balance Sheet ...........................................................................................73 3.K – Modern Money Theory, Full Employment, and Interest Rates ........................................75 Chapter Four – The Jobs Guarantee Program .........................................................................77 4.A – The Resting State of Inadequate Employment .................................................................77 4.B – Why to Focus on Full Employment as Well as Full Output .............................................79 4.C – The Modern Money Solution and the Job Guarantee .......................................................80 4.D – The Effect of a Job Guarantee Program ...........................................................................81 4.E – The Absence of a Budget Constraint and the Role of Inflation Constraint ......................85 4.F – Responding to Criticism ....................................................................................................86 Conclusion – The Inevitability of Fiscal Stimulus ...................................................................90 Works Cited .................................................................................................................................93 Acknowledgements This work would simply not have been possible were it not for the actions of the following persons. Professor Edward McKenna graciously volunteered his time and effort, the first of which was so limited, the second, limitless, towards my completion of this project. His class and teachings have changed how I approach the science of Econ, and I am forever grateful. His guidance through Modern Money Theory is an inspiration intellectual and personal. It was in Professor Mark Stelzner’s class I made the realization that would eventually inspire this paper. He was and is adept at fostering intellectual curiosity, and has never allowed students to forget the lives affected by deductions of economics. Professor Spencer Pack was instrumental in my willingness to explore non-traditional economic frameworks. Professors David Chavanne, Candace Howes, and Yong Jin Park taught me the analytical rigor necessary to have confidence, statistical or otherwise, in economic deductions. The faculty and staff of the Connecticut College Library and Information Services department have curated an excellent research section, one which informed many of the following passages. Ms. Lillian Liebenthal and Ms. Barbara McLlarsky never ceased working on my behalf in my time at Connecticut College, and remain some of the greatest assets this institution has. Mr. Zachary Brookman never let the stress or effort of composing the following work take over my dedication to the project. I am lucky to call him a friend. Ms. Sarah Sovia never wavered in her belief that I could and would complete this work to the best of my ability. I can never thank her enough for this. Introduction – Welcome to ZIRP In recent years, economic stagnation has plagued much of the
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