I'm thinking about my M5 model and how it works. Here are some examples:
§1. Imagine an island with 4 people on it. Let's call it Gilligan's Island. The people are Mr Howell, representing the private sector; the Skipper, representing the US Treasury; and the Professor, representing the Federal Reserve. Gilligan is your typical American consumer who spends money as fast as he has it. There are other people on the island (Mary Ann and Ginger) too, but they don't know what is going on.
The first 3 form a conspiracy. Howell claims ownership of all the seashells on the beaches, which are used as a form of currency. The Skipper claims ownership of all the land and coconut trees, on behalf of the residents. The Professor claims ownership of all the mineral rights. Private citizens own their own huts, although some rent.
The Professor has the brilliant idea to form a bank which will be called the Fed. It will be capitalized with $1 million of gold that is in the ground and can be mined. He also has a mechanical printing press and he can print "money" on banana leaves. He prints up $1 million worth of banana leaf money and buys $1 million of Howell's seashells. The Skipper then prints up a banana leaf bond and borrows the $1 million at 5% interest from Howell. Howell also forms his own private bank, called Chase Bank, which will take deposits and make loans.
At this point, what is M5? There is no money in circulation (outside the Treasury's hands), so it is $1 million, which is the national debt.
§2. Now the Skipper, wanting to be popular, creates "jobs" and starts paying salaries. He of course gets a salary as the Secretary of Treasurer of the Island Government. He gives Gilligan the "job" of surfing. He gives an economic development grant to Mrs Howell so she can open a restaurant and she hires cooks and waitresses. It doesn't take long before there is a thriving private sector. And it doesn't take long for the Skipper to blow through the $1 million. This is called "deficit spending".
Howell's bank has lent out $500,000 to island citizens. Howell also has rental income from huts that he owns. And he lends money to himself from his bank, which is a conflict of interest, but no one knows about it or cares. He also issues Mortgage Backed Certificates which are backed by the huts that he owns and sells some of these to the Fed.
The amount of money in circulation is now $1.5 million and the national debt is now $1 million, so M5 is $2.5 million.
§3. The Treasury is now out of cash, but no problem. The Skipper prints up another banana leaf bond for $1 million and sells it to Howell, who uses cash on deposit in his bank and new loans to buy it. This is called "increasing the national debt".
The national debt is now $2 million and the money in circulation is $1.5 million, so M5 is $3.5 million.
§4. Steps 2 and 3 repeat many times, until one day there is a hurricane which causes massive destruction. The Skipper decides it is an emergency and will distribute $10 million in banana leaf money to the citizens as disaster relief. But he doesn't have the cash, and this time Howell doesn't have enough money to buy all the bonds. The Professor has the brilliant idea of doing Quantitative Easing. The Skipper prints up a banana leaf bond for $1 million and sells it to Mr. Howell, who then sells it to the Professor in exchange for $1,050,000 in newly printed banana leaf cash. They repeat this 10 times, until the Skipper has the $10 million.
§5. The real purpose of this thought experiment is to determine what changes M5 and what doesn't. M5 is the money in circulation (M2) plus the marketable national debt, less the government debt that is owned by the Fed. If the government sells a bond for $1 million, this has no effect on M5 because the government debt increases but the money in circulation decreases. If the Fed buys a bond from the private sector for $1 million (with newly printed cash), then this has no effect on M5 because while the money in circulation increases, the bonds in circulation (outside the Fed's hands) decrease. If Chase Bank lends money to a person, this increases M5. If a loan is paid back, this decreases M5. If the government does deficit spending, then M5 increases.
§6. My theory is that inflation (call this monetary inflation as opposed to consumer price inflation) is directly caused by increases in the total money supply (M5). The expansion of the Fed balance sheet, if it is used to buy government bonds, has no effect on this. The only way to create monetary inflation is with loans and with deficit spending. (And the problem with loans is that they have to be paid back with interest, and there isn't enough money in circulation to pay back all the loans with interest). Thus the only way to really increase M5 is with government deficit spending, but you want to limit how much of a deficit you run.
Is this a good explanation of the Magical Money Tree (MMT) or could it use some adjustments?
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