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Miscommunicated Monetary Theory

T Sabri Öncü ( is an economist based in Istanbul, Turkey.

The Modern Monetary Theory is described as an integration of endogenous money, state money, credit money, and functional finance theories. Despite departing from a faithful narration of what actually happens in the real world, the MMT arrives at a new world in which the government can spend as it pleases. Not only this and several other difficult-to-swallow claims, but also academic concepts such as vertical and horizontal components of money supply introduced along the way are what make MMT difficult to communicate to the general public and also difficult to fully appreciate.

Let me start by mentioning that while I am not an adherent of the Modern Monetary Theory (MMT) like James K Galbraith, I am one of those MMT-friendly economists (Abrahamian 2017):

MMT’s adherents like to point out that the federal government never “runs out” of money to fund the military, but routinely invokes budget constraints to justify defunding social programs. Money, in other words, isn’t a scarce commodity like silver or gold. “To people who’ve worked in financial markets, who work at the Fed, this isn’t controversial at all,” says Galbraith, who, while not an adherent, can certainly be described as “MMT-friendly.”

Money Creation Is Very Simple

One of my favourite baseball movies is Bull Durham (1988) which stars Kevin Costner as “Crash” Davis, a veteran catcher. Towards the end of the movie, Crash says:

A good friend of mine used to say, “This is a very simple game. You throw the ball, you catch the ball, you hit the ball. Sometimes you win, sometimes you lose, sometimes it rains.” Think about that for a while.

The same goes for money creation. It is a very simple game. You make the loans or buy the assets, you create the deposits, and you collect the reserves.

Given that baseball was invented in the United States (US), I focus on the money creation process in the US. Just as the ball moves around bet­ween the pitcher, the catcher, the batter and seven others on the field in baseball, money moves around between the Treasury (the pitcher: Department of the Treasury, the US finance ministry), the Fed (the catcher: Federal Reserve System, the US central bank), the banks (the batter) and the rest of the economy (the seven others on the field), including non-bank financial institutions (NBFIs), in money creation.

The money creation processes of many countries are more or less the same these days, provided that they are not Greece, without their own central bank, or Turkey, where US dollars can be used to back domestic money deposits, and the like. One implication of this is that the MMT is not valid everywhere, but it does not claim that it is a universal theory that is valid for every country.

Further, I emphasise that the process I describe is about domestic money creation. In countries with fully open borders to money flows, foreign money can also be created; but I put this aside.

Baseball vs Money Creation

In baseball, while the batter is an offence player from one team, the rest of the players on the field are defence players from another team. And, this is where money creation starts to deviate from baseball. The teams in money creation are not as easily identified as in baseball.

While the Treasury (the pitcher) and the Fed (the catcher) are easily identified to be defence players, and the banks (the batter) to be offence players, the NBFIs and real estate companies are also on the offence, despite the fact that they cannot bat. Whether the rest are on the offence or defence depends on what they are doing.

The collection of the financial (banks and NBFIs are in this sector), insurance (some of the NBFIs are in this sector), and the real estate sectors is known as the FIRE sector. While the FIRE sector is the sector of rentiers extracting rents, the non-FIRE sector is the payer of rents, although there are rent extractors in the non-FIRE sector also. Further, there are many that are in both.

The MMT consolidates the Treasury and the Fed into a single entity and, together with other government branches, calls this entity the government. So, according to the MMT, there are govern­ment and non-government sectors, where the non-government sector includes the foreign sector. I should mention that I fail to see a distinction between the FIRE and non-FIRE sectors—more generally, rent extractors and rent payers—in the MMT, but this could just be my failure.

The second difference between baseball and money creation is that the ball manufactured by some sporting goods company comes to the field from the outside. Because of this, the economists would call this ball exogenous.

In money creation, money is endogenous in economists’ parlance because it is created inside the field as the game progresses. Of course, some money might have been created even before you turned your television on to watch the game.

Mapping Light to Money

The three primary colours of light are green, blue, and red, whereas the three primary types of money are cash (banknotes and coins), reserves (deposits of the banks with the Fed), and deposits with the banks, that is, deposits.

Let me mention that, by law, only banks, the Treasury, foreign central banks, several international organisations, and a number of government-sponsored enterprises can maintain deposit accounts with the Fed. It is clear that deposits of institutions other than banks with the Fed do not belong to any of the above primary money types, so they are also a type of money that I call “other deposits with the Fed.”

The most important part of this money consists of the deposits with the Fed in the Treasury General Account (TGA) through which all official Treasury payments are made. The Treasury has other accounts called the Treasury Tax and Loan (TT&L) accounts with some banks called the TT&L banks, but since the Treasury cannot make payments from these accounts by law, deposits in these accounts must be transferred to the TGA to make payments.

I now perform the mapping by assigning the colour green to cash, blue to reserves and red to deposits. Lastly, I assign black to the other deposits with the Fed. A distinguishing feature of the MMT is that it brings “black money” into the picture while none of the other theories I know of pay that kind of attention to it.

Banks Create the Deposits

Although the MMT is not just about banking, since I focus only on the clearing and settlement aspects of it, let me summarise the extant banking theories for further discussion. Full descriptions of the MMT can be found in the original papers available from the University of Missouri–Kansas City and Levy Econo­mics Institute of Bard College websites, and elsewhere.1

Three of the major banking theories are (Werner 2016):

(i) Intermediation theory: The currently prevailing theory which says that banks collect deposits and then lend these out, just like other non-bank financial intermediaries.

(ii) Fractional reserve theory: The older theory which says that each individual bank is a financial intermediary without the power to create money, but the banking system collectively is able to create money through the process of “money multiplication” where the multiplier is the reciprocal of the required reserve ratio.

[Both of the above theories are exogenous money theories because for them money comes to the economy from the outside, although in the second it gets multiplied. I will describe the required reserve ratio later.]

(iii) Credit creation theory: This is the oldest theory, which prevailed about a century ago and says that each individual bank creates credit and money newly when granting a loan.

Put differently, banks do not collect deposits and lend them out. They provide financing through new money creation. This is the magic of double-entry accounting. The loan is an asset and deposit in the account of the borrower a liability of the bank. And, they balance when you type them in.

Recall that deposits are coloured in red, this is how red money would have been created had lending been the only way to create it. But, banks also create red money when they purchase financial (and even real) assets from a seller in the same way when they make a loan. For example, when a bank buys a Treasury bond in the secondary market from a non-bank seller, it creates red money in the account of the seller. Why I insisted that this should be a non-bank seller will become clear later.

My first amendment to the credit creation theory (CCT) is that banks create new red money when granting a loan to or purchasing an asset from a non-bank counterparty. Indeed, this ability by their charter is what distinguishes the banks from the NBFIs: while the NBFIs are financial intermediaries, the banks are red money creators.

My second amendment to the CCT is based on the idea that it takes two to tango, because a bank cannot create red money unless there is a borrower or a seller of an asset. Banks and their non-bank counterparties create new red money when a non-bank counterparty borrows from or sells an asset to a bank.

It can be observed that red money is endogenous because it is created inside the field during the game, and that red money gets destroyed when a non-bank counterparty pays its debt to or purchases an asset from a bank. The magic of double-entry accounting is at work here, again. You just erase the same amount from both sides of the balance sheet.

Government as Creator

Recall that the MMT consolidates the Treasury and the Fed into a single entity called the government. Although opponents of the MMT disagree with this because since 1935 the Fed is prohibited from purchasing Treasury bonds to monetise Treasury debt—despite exemptions such as financing wars from time to time until 1981—and supposedly acts independently, this is not why I call the MMT a miscommunicated theory.

It is a historical fact that at least from 1836 until the creation of the Fed in 1913, the Treasury and the central bank in the US had been one and the same. My only criticism of the MMT’s consolidation of the Treasury and the Fed into a single entity is the confusion it creates regarding government spending as commonly understood by others. But, this is a minor issue that can be easily fixed.

However, nobody can question that the government creates green money, that is, cash which is not backed by anything nowadays. The Treasury prints banknotes (Federal Reserve Notes) through its Bureau of Engraving and Printing, and mints the coins through its Mint Department for delivery to the Fed, which in turn delivers them to the banks on demand.

Hence, green money is also endogenous.

All the bank account holders who withdrew money from their red money acco­unts through a teller know that what they get is green money. This means bank-created red money is a claim on government-created green money. As I will explain, bank-created red money is a claim also on blue money that the Fed creates through:

(i) loans it makes from its discount window and certain liquidity facilities to the banks and qualified others;

(ii) reverse repurchase agreementtransactions with its counterparties to buy Treasury and other securities it deems fit;

(iii) purchases of Treasury and other securities it deems fit in the secondary market.

The above transactions create new deposits in the accounts of the banks with the Fed. While the second type of tran­sactions are called open market operations, the third type is how the Fed injected money essentially into the FIRE sector of the US economy after the onset of the ongoing global financial crisis.

Reverse repurchase agreements are oppo­sites of repurchase agreements (repos) in the sense that, in the former a security is bought, whereas in the latter it is sold. Evidently, when the Fed sells a security either directly or in a repo, or a bank pays its loan to the Fed, blue money is destroyed. In addition, since the banks pay for the cash they buy from the Fed with reserves, when banks buy green money from the Fed, blue money is destroyed again.

Except the counterparties involved, since this creation/destruction process of blue money is identical to the process through which red money gets created/destro­yed, blue money is also endogenous.

Among the several banking regulators in the US, the Fed determines the amount of reserves the banks must hold as a percentage of the deposits they owe their depositors. It is this percentage which is the required reserve ratio (RRR), and any reserves beyond the required reserves are called excess reserves. Note that the reserve requirement can be met by vault cash, that is, green money, also.

It is evident from the Reserve Maintenance Manual of the Fed that, unlike what is claimed in the fractional reserve theory, banks do not obtain reserves first and then create deposits through a multiplication process. They create deposits first and then collect reserves, as described in the “Reserve Computation and Maintenance Periods” section of the manual (Federal Reserve System 2017). Put differently, there is no money multiplier (reci­procal of the RRR), but there is a money divisor (RRR), although the US banks have been evading the reserve requirements through the so-called “sweep accounts” since the 1980s, if not since the 1970s.

As for why red money is a claim not only on green, but also on blue money, consider the many electronic red money transfers between two banks. At the end of the day, one bank becomes a debtor to the other and this debt is settled in blue money on the books of the Fed. That is, the amount is debited to the account of the debtor bank and credited to the account of the creditor bank at the Fed. Of course, this settlement could have been done in cash also, but that happens very rarely.

‘Black Money’ and the MMT

The CCT, or more precisely, the endogenous money, is one of the building blocks of the MMT. Indeed, as Wray (2012) des­c­ribes, the MMT is an integration of the endogenous money, state money, credit money and functional finance theories.

And, in this integration, black money is the main tool of the MMT.

Recall that the Treasury deposits in the TGA (existed since January 1916) with the Fed are the major part of black money and all official payments of the Treasury must be made through the TGA. Further, recall that the Treasury maintains TT&L accounts (existed since May 1917) with some private banks called the TT&L banks also. These TT&L accounts are the tools of the TT&L Program executed by the Fed and the Treasury, under which tax payments go to these accounts rather than directly to the TGA with the Fed in order to stabilise the reserves with the banking system. For, otherwise, all the tax payments made in red money should be erased from the bank accounts and an equal amount of blue money should be converted to black money, meaning reserves are drained by a huge amount. This is a major red money and blue money supply contraction that would harm not only the monetary policy the Fed is implementing, but also the economy immediately.

Indeed, as stated in a Fed article (Santoro 2012), the TT&L Program “has long been an exemplar of cooperation between the Federal Reserve and the Treasury.” So, despite the confusion it creates regarding government spending that I mentioned earlier, the MMT’s consolidation of the Treasury and the Fed has some merits. But, then, despite departing from the above-mentioned faithful narration of what actually happens in the real world, the MMT arrives at a new world in which the government is the monopoly supplier of its currency (they actually mean cash and reserves), and hence spends simply by crediting it in the accounts of private banks with the Fed (that is, by transforming black money to red money through blue money). This is a highly controversial claim and there are many other controversial claims that can be found in Wray (2012) and elsewhere. Introducing into the fray such difficult- to-communicate concepts as vertical (actually green and blue) and horizontal (actually red) components of money supply does not help either.

Hence, the title of this article.

However, I am of the opinion that if the adherents of the MMT can find better ways to communicate their ideas to the general audience, they have a lot to offer to the world.


1 New Economic Perspectives,


Abrahamian, Atossa Araxia (2017): “The Rock-Star Appeal of Modern Monetary Theory,” Nation, 8 May,

Federal Reserve System (2017): Reserve Maintenance Manual, Board of Governors of the Federal Reserve System, November.

Santoro, Paul J (2012): “The Evolution of Treasury Cash Management during the Financial Crisis,” Current Issues in Economics and Finance, Federal Reserve Bank of New York, Vol 18, No 3.

Werner, Richard A (2016): “A Lost Century in Economics: Three Theories of Banking and the Conclusive Evidence,” International Review of Financial Analysis, Vol 46, pp 361–79.

Wray, Randal L (2012): “What Is Modern Money Theory?” MMP Blog #30, 1 January,

Updated On : 9th Feb, 2018


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