The Pros And Cons Of Modern Monetary Theory

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Modern monetary theory (MMT) Modern monetary theory explains exclusively how the government, central bank and the commercial banking sector interacts, with some economists arguing that understanding of reserve accounting is critical to understanding monetary policy options. This theory was developed by a group of economist including Randal Wray (2009) and Bill Mitchell. All of the commercial banks will also have an account with the central bank. This permits the banks to manage their reserves that is, the amount of available short-term money that a particular bank holds. So when the government spends, treasury will debit its cash operating account at the central bank, and deposit this money into private bank accounts (and hence into the commercial…show more content…
In most countries, commercial banks’ reserve accounts with the central bank must have a positive balance at the end of every day; in some countries, the amount is specifically set as a proportion of the liabilities a bank have that is on its customers. This is known as a reserve requirement. At the end of every day, a commercial bank will have to examine the status of their reserve accounts. Those that are in deficit have the option of borrowing the required funds from the central bank, where they may be charged a lending rate which is also referred to as the discount rates on the amount they borrow. In a balanced system, where there are just enough total reserves for all the banks to meet requirements, the short-term interbank lending rate will be in between the support rate and the discount rate. Both the Treasury and the central bank are involved in these reserve management operations to maintain interest rate stability (Palley, 2012). This applies to the relationship between the Central Bank of Kenya and its regulatory requirement to maintain a capping that is below 14%. CBK finances commercial banks at much lower rate on their borrowing so that the banks can fix their interest charges on borrowed money at certain percentage that must not exceed the limit set by the

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