Monopoly Money Redux

The Model

Our model works as follows. Time occurs in discrete steps. The government sells fiat money into the economy (for labor or goods), and then once in the economy, it can be “resold” by private sellers. The government collects money out of the economy when taxes are paid. We will accordingly deal with two prices: the price that the government offers, and the price that prevails in the private “resale” market. Both of these are the price of money in terms of real things, e.g. how much labor you have to do to get one dollar. The question will be whether its possible for the prevailing market price to be different from the government price in the long run.

The Steady-State

Obviously, by design the prices in the two markets don’t have to be equal in every period. The question is what happens in the long-run: is there a long-run steady-state solution where the private price is different from the government price? To figure this out, we have to find the steady-state.

Discussion

The key feature of this model is the price competition between the private sector and the government, and the fact that the government doesn’t have to blink while the private sector does. If the government is paying better than the private sector, then not only will private sales drop to zero, but the large increase in the money supply from the increase in government spending will further hurt private sellers, increasing supply while they face zero demand, forcing them back to the table, to bring their price down to match the government’s.

Conclusion

This model demonstrates the possibility of a key claim of MMT, namely that government is price-setter for its currency, acting through the prices it pays when it spends or lends. The purpose of the model isn’t to suggest policy or prove anything, only to demonstrate the plausibility of MMT’s theory of the price level: given a very loose set of assumptions, we can build a model in which the price level in the private markets tends in the long-run towards prices set exogenously by government.

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