Skip navigation

Category Archives: Basics

An automatic stabilizer is a non-discretionary item in a government budget which kicks in automatically when economic activity decreases.

Unemployment benefits are an example of automatic stabilizers. As economic activity decreases & workers are laid off, the automatic stabilizers kick in to provide a floor of support.

This is a critical concept when talking about Government deficits, because it means that the deficits themselves are outside of the direct control of the budget process. We could say the deficit result is endogenously determined, that is, it is determined by events in the private sector of the economy.

Targeting a desired deficit outcome (such as a balanced budget) becomes impossible because if private sector activity decreases, as people are laid off the automatic stabilizers will kick in and throw the desired deficit result off track.

When economists talk about stocks and flows of money, they are essentially adding time to the equation.

A flow is a quantity of money measured over a given time period. For example, the Government deficit is a flow, typically measured over a quarter or a year.

The Government debt is a stock, which is the cumulative total of Government deficits. In this way, the deficits accumulate to become the debt. So we say flows accumulate to stocks.

One common measure we frequently see is the Debt to GDP ratio. In my opinion, this is a difficult ratio to draw meaningful conclusions from because it compares a stock to a flow. Presumably a high debt to gdp ratio is bad because it means you are getting less productivity out of each dollar of debt. However, it could also mean that the population has a high amount of savings relative to economic activity. Not necessarily a bad thing.

The Monetary Base (also known as high-powered money, or M0) is made up of coins, currency, and bank reserves. The Monetary Base is considered the most liquid form of money for final payment in bank transactions.

In a Nation-state that has Monetary Sovereignty, the Central Bank is the monopoly issuer of the monetary base, although in the US, the Treasury is the issuer of coins and the Central Bank issues the Physical Notes and bank reserves.

As we learned in our post, What are bank reserves?, bank reserves are an IOU of the Central Bank to the commercial banking system. Bank Reserves do not circulate among the public, they are simply an electric entry in the Central Bank’s accounts which can be swapped for physical currency.

The currency in the monetary base consists of both currency is circulation and in bank vaults.

In other posts, we will learn about other measures of money, typically measured by levels of M, such as M1, M2, etc.

According to mainstream economics, customer deposits allow banks to on-lend those deposits and make loans. Banks then hold a portion of those deposits in “reserve” for customer withdrawals. You may have heard of this referred to as the “money multiplier.”

The reality is, of course, exactly the opposite: banks don’t need deposits to make loans because the loan itself creates the deposit.(1)

Banks make their loan determinations based on the credit-worthiness of the customer, their capital requirements (2) and the cost of obtaining any reserves it would need ( if any) after creating the loan.

This is called endogenous money, because the money supply is determined by the preferences of actors in the real economy. For example, your need to spend on credit expands the money supply and didn’t come from anyone else’s pre-existing deposit. So the appropriate causation says: Loans Create Deposits. Banks create loans ex nihilo (out of nothing).

(1) Marc Lavoie, Credit And Money: Overdraft Economies, And Post-Keynesian Economics, pp 67-69, Money And Macro Policy, ed. Marc Jarsulic, 1985.

(2) SEC rule changes in 2004 make even capital requirements a suspect drag on bank lending, particularly for investment banks.

Understanding Monetary Sovereignty (MS) is one of the most critical, if not the most critical, concepts toward an understanding of Modern Money.

A nation having the characteristics of Monetary Sovereignty flips the traditional understanding of the hierarchy of control over the money supply, leaving the Government in control of interest rates (rather than private banks and investors) and ensuring solvency.  For a nation displaying the characteristics of MS, insolvency or bankruptcy is an impossibility, as they are always able to produce the necessary funds to pay or roll over its bills.

A nation with Monetary Sovereignty is described as a currency issuing entity displaying four characteristics:

1. The currency issuer–typically the nation’s central bank– is a monopoly. In other words, no one else (such as another state) can issue the currency.

2. The currency floats on international currency markets. In other words, there is no peg to another currency (such as the dollar) or commodity (such as gold).

3. The Central Bank of that nation-state sets the interest rate. This could be done with long or short term rates or both, although typically this is done with the shortest (overnight) rate.

4. The Central Bank has not borrowed heavily in a foreign currency.

According to these rules, examples of Monetary Sovereignty include the US, the UK, Japan, Canada and Australia.

Conclusions that could be drawn for Monetary Sovereign nations include an inability to go bankrupt or default (except by political choice).  They can always pay or roll over their debts.

US states, firms and businesses are currency users, not issuers.  Therefore, they do not have Monetary Sovereignty.

Euro nations are not Monetarily Sovereign. They have ceded sovereignty to the European Treaty which gives monopoly power of currency issuance to the European Central Bank (ECB).  The ECB could not issue currency at the behest of Greece, just as the Federal Reserve could not issue currency at the behest of California.  This makes Greece more like a US State than a Sovereign Nation.

Consider the case of Greece in contrast to Japan.  The case of Greece is well known of late.  It’s government is having difficulty in acquiring the Euros necessary to fund itself and provide the level of services and support to its economy that it has grown accustomed to.   They are paying interest rates on long-term bonds of upward of 7% to acquire Euros from private banks and investors.  This is because they have broken rule #1:  by joining the Euro, they have given up currency sovereignty.  Japan, however, has a debt to income (GDP) ratio of nearly 200% (considerably higher than Greece) and maintains the lowest bond rates (less than 2% for 10 year bonds) in the developed world.  Only Monetary Sovereignty explains this difference among nations in seemingly similar situations.

Economists, Politicians and Media who conflate Monetarily Sovereign nations with non-sovereign nations  (Such as the US or Japan with Greece) are misunderstanding the dynamics of Modern Money and perpetuating that misunderstanding with the public.




The Gold standard is the practice of Governments to fix their currency to the price of Gold, and to offer to exchange their currency for an equivalent amount of it.

For example, if the price of the currency was set at $100 per ounce of gold, then $1 would be worth and exchanged for 1/100th of an oz. of gold.

Other commodities or a basket of commodities could also be used to set the price of the currency.

The United States officially went off the Gold Standard in 1971.

Sound money is the concept of the Government balancing it’s budget over the business cycle  (Typically represented as one year).

In Austrian economics, sound money is tied to a commodity money regime, such as the gold standard.  When used this way, Government spending is limited by the amount of gold in the world (and held by the Government) which prevents runaway spending and inflation.

In a fiat money regime (absent the gold standard), there is no such limitation. Governments are operationally unconstrained in their spending, so political, social and ideological constraints are placed upon Governments to prevent profligate spending.

Nearly all modern Governments profess a goal toward sound money.  In addition, nearly all economists, conservative and progressive alike, profess sound money principles to be a natural law of economics.

Very few Governments actually achieve it in practice.  The reason for this is simple: a growing economy requires a growing supply of money.  The only other way  for the money supply to grow is for entrepreneurs to spend bank credit.   When sound money principles are put into use, recession, depression and volatile business cycles are the result.


An ELR (employer of last resort) program is a government jobs program to employ labor for which there is no bid in the private market. An ELR program would provide a “buffer stock” of jobs to ready, willing and able labor; typically at some minimum wage.

Proponents of a job guarantee argue five primary points:

1.  The job guarantee would allow unused labor resources in the economy to match up with needed infrastructure improvements such as building bridges, roads and levees.  This would provide greater infrastructure for private sector activity.

2.  The job guarantee would allow for greater price stability in the economy.  As there is effectively “no bid” for the labor, government could spend modestly on a program without causing inflation.  Furthermore, as the economy improved and workers transitioned back to the private sector, the job guarantee program would employ fewer workers and result in less government spending.

3.  The job guarantee would allow for a greater level of economic activity in the economy, increased spending on other goods and services and cushion against downturns; preventing many personal bankruptcies and foreclosures.

4.  The job guarantee would enable the government to spend less on other “welfare” type transfer payments and keep the skills of employed workers sharp, enabling them to more easily transition to private sector employment when growth resumes.  In addition, “need” based crime would be reduced.

Finally, proponents argue, a job guarantee is the only way to to fully close the spending gap (resulting from government taxes and private savings) and eliminate unemployment.

Warren Mosler, a former candidate for Senate in Connecticut, proposes an $8 per hour wage here.

For more information on how a job guarantee could be implemented, see  here and here.



You won’t hear this phrase uttered by the mainstream media, but a balance sheet recession is economist Richard Koo’s term for an economic condition of private sector over-indebtedness. Koo termed this phrase based on his experiences during the still-ongoing Japanese malaise which began over 20 years ago, resulting in low government bond rates, minimal economic growth and fits of deflation.

The Japanese event was triggered by a Real Estate boom and bust.  It resulted in corporate balance sheets being over-leveraged. As firms paid back debt (destroying money), it resulted in lower incomes and decreased economic activity.

This is the exact scenario we find ourselves in today in the US, although it is households which are experiencing the balance sheet recession, more so than firms. Our financial institutions, the largest of which were propped up by government support in 2008-2009 are also still experiencing a balance sheet crisis.

During the 1990’s and early 2000’s, households increased their debt as confidence in new technology companies and portfolio wealth exploded. Unfortunately, President Clinton then exacerbated the private-debt explosion by running government surpluses in the late 90’s. This meant that, as the US was running an account deficit (importing more than exporting), Private Sector savings necessarily had to turn negative. The tech bubble then popped, only to be propped up by the housing bubble of the early 2000’s.   All of this reinforced the private debt explosion, ultimately reaching heights greater than the Great Depression, which then reversed course in late 2008.

As a result, housing prices have plummeted, incomes have been reduced and households find themselves servicing a greater amount of debt on smaller income. This is a balance sheet recession, and only when private debt levels return to a sustainable level will significant economic growth resume.