Introduction to Consumer Monetary Theory

Money as a Pricing Standard


Alex Howlett

3 years ago | 20 min read

Consumer Monetary Theory (CMT) is a framework for understanding the role of money in giving consumers access to the economy’s output.

The economy exists for the benefit of the people. A well-functioning market economy serves us all. It promotes our well-being by producing goods and services for us to consume. We are all consumers.

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer.
— Adam Smith | The Wealth of Nations | 1776

Without someone to consume the economy’s products, there’s no point in having any products. The consumer is central to the market economy because the people come first. Workers and firms are important only insofar as their products benefit actual people.

Money as a Pricing Standard

A market economy requires a standard unit of value in which to set the prices of its products. The use of spendable standard-value tokens makes it a simple matter for people to pay those prices. This standard unit and its standard-value tokens are the things we call currency and money.

As John Hicks explained in A Market Theory of Money, markets and money go hand in hand. You can’t have one without the other. A market will always find a standard unit to use as its currency.

[T]he function of money as a standard, if it is no more than a standard, is to make it possible to form a price-list, in which the values of a number of commodities are reduced to a common measure.
— John Hicks | A Market Theory of Money | 1989

We consumers spend our standard-value money tokens — that is to say, our dollars — to buy goods and services from the economy’s producers. People who lack access to dollars can’t be consumers. They can’t buy goods and services. They can’t buy food. The market economy cannot promote their well-being.

Our dollars represent claim tickets against the economy’s production. Whenever we spend a dollar, we claim for ourselves one dollar’s worth of the economy’s productive output. Consumers are continually buying and using the goods and services that support their livelihoods. They’re redeeming their money tokens in exchange for the economy’s products.

As consumers pump money into the economy, the economy pumps back out food, books, cars, computers, etc. Money flows in one direction while goods and services flow in the opposite direction.

The Income Theory of Money

For the economy to set reliable prices, people need to know what a dollar is worth. The dollar’s purchasing power and, therefore, the general level of consumer prices must remain steady, at least over the short-run. That is to say, one dollar has to be able to claim the same amount of stuff tomorrow as it did today.

Stable currency implies that the flow of consumer spending remains commensurate to the opposite flow of production. If spending levels change, then production levels must change to match, and vice versa. Whenever spending outstrips production, prices increase; we see inflation. Whenever production outstrips spending, prices decrease; we see deflation.

Because reliable prices are important to the smooth functioning of markets, institutions have necessarily emerged to maintain the currency’s stable purchasing power. These institutions are called central banks and their monetary policy influences the financial sector so as to modulate the spending flow to ensure that it continues to match the production flow.

The framework for describing prices and the general price level in terms of flows is called the Income Theory of Money.

The income theory of money is a theory of nominal prices. Its aim is to explain the process of the determination of monetary prices in the market economy. It is a flow oriented approach which distinguishes it from the stock orientation of the naive quantity theory of money.
— Josef Menšík | The Origins of the Income Theory of Money | 2014

The Quantity Theory of Money provides an alternative explanation for the general price level. Unlike Income Theory, Quantity Theory focuses on the amount of money tokens “in existence.” This, of course, requires that there actually exists a definable quantity of money tokens.

We call this hypothetical quantity the “money stock.” Quantity Theory imagines that the money stock continually passes through the economy from person to person at a turnover rate called the “velocity of money.” The money just keeps circulating at that velocity.

On the face of it, Income Theory and Quantity Theory appear to be two different ways of describing exactly the same thing. Indeed, under Quantity Theory, we can derive the spending level simply by multiplying the money stock by its velocity. And if the velocity is fairly steady, then the money stock itself can even stand in as a proxy for the spending flow. To understand changes in the general price level, we need look no further than the money stock.

The problem with this clever description is that money does not circulate. Money flows in a direction from consumers to producers. Furthermore, the money stock is not so easy to define either in theory or in practice. This makes it difficult for Quantity Theory to map onto reality in any meaningful way.

By contrast, Income Theory focuses on spending, which is where prices are actually paid. Income theory works regardless of whether prices happen to be paid using official, or measurable, money tokens. To buy a ten-dollar hamburger, you could pay with a ten-dollar bill, with ten dollars’ worth of jelly beans, or even with a scrap of paper that says “I owe you ten dollars.”

It doesn’t matter how you make the payment. It still counts toward the economy’s spending flow. All that matters is that the price is denominated using the standard currency unit. You paid the price and that price is the price.

Consumers vs. Producers

“Consumer” and “producer” are roles that people play in the economy. While it is true that producers ultimately serve consumers, it is also true that some people do both. Workers are people who consume and produce. They contribute their labor to the economy in exchange for money.

We could imagine a world in which everyone consumes exactly in proportion to what they produce. In such a world, everyone is a worker. Each worker produces something, gets paid for it, and buys stuff from other workers. Naturally, those who contribute more labor are the ones who are able to consume more goods and services. Money is recycled perfectly and the Quantity Theory of Money starts to look a lot more plausible.

In this world, dollars merely serve as a medium of exchange that facilitates trade and allows people to benefit from the fruits of each other’s labor. Unfortunately, this is impossible. The real world doesn’t work that way. It can’t.

Perhaps there was a time in history when the market economy behaved more like a system of mutual exchange among workers. But with the industrial revolution, the idea that consumers and producers were the same people became largely a fiction. Industrialization caused the market economy to become less like a system of exchange among workers and more like a system of distribution from producers to consumers.

Despite industrialization making this more extreme, it has always been true and will always be true that some people produce more than they consume while others consume more than they produce.

The possibility of accumulating money (financial wealth) acts as an incentive for people to produce in excess of their consumption. People enjoy having the power to claim more goods and services than they’ll ever actually claim. This is a feature, not a bug. Producers are motivated by profit to make more than they take.

Meanwhile, the rest of us get to take more than we make. In theory, consumers can access some amount of the economy’s production without having to work for it. Producers are happy to siphon off money while consumers enjoy the benefit of the economy’s products. This is a good thing. As I said before, the economy exists for the benefit of the people. The more benefit we receive, the better off we are. That’s kind of the whole point.

What ultimately makes this possible is that market incentives induce us collectively to produce the output we collectively want to consume. It doesn’t matter who happens to be doing the work, or how much each individual happens to be working. As long as producers want to produce, consumers can consume.

The Wage-Price Gap

An efficient labor market does not continually recycle the economy’s money back to consumers. Recall that producers are always siphoning off their profits. But consumer spending hasn’t gone to zero, so consumers must be getting their money replenished somehow.

During World War I, British engineer Major C.H. Douglas noticed that it was impossible for workers to collectively spend their wages to buy the full product of their own labor. There would always be a gap between wages and product prices. Troubled by this observation, he devoted the rest of his life to explaining this problem and developing his “Social Credit” economic framework.

[T]he persons who want and cannot do without the goods which the productive and industrial system can, and is anxious to supply, have not in their possession the tickets, the possession of which is essential before these goods, under present conditions, can be handed over.
— C.H. Douglas | Social Credit (revised edition) | 1933

This was an important insight. Producers won’t produce what consumers lack the money to buy. Douglas proposed to close the wage-price gap by issuing new money and handing it out to everyone in what he called the National Dividend: an income stream unconditionally paid to every individual person.

Today’s readers will recognize this as a basic income or UBI. If consumers need a constant stream of new money in order to keep the economy going, then providing them a constant stream of new money is the obvious solution.

But Douglas was concerned that his National Dividend plan might cause inflation. Sadly, he only understood the price level from a Quantity Theory perspective. Douglas failed to develop a coherent theory of money, banking, and credit. He never recognized that prices would be kept stable simply by matching the flow of consumer spending to the flow of production.

To address any potential inflation his National Dividend might cause, Douglas developed a convoluted, unworkable system of subsidies designed to pay producers to keep their prices down.

Not only did Douglas have this kooky anti-inflation scheme, but he also espoused anti-Semitic conspiracy theories about rich bankers controlling the global economy. None of this did him any favors in intellectual circles. He was largely written off as a crackpot by serious thinkers. Nevertheless, he was a crackpot with some important insights.

An efficient market economy requires a wage-price gap. It also requires that we fill in the gap with another source of consumer spending power. And we need to do all this while maintaining the currency’s stable purchasing power.

Money vs. Jobs

In our society, instead of embracing the wage-price gap, we have attempted to close the gap. We use economic policy to create jobs and to stimulate the financial sector. Rather than ensuring sufficient distribution of consumer incomes, we’ve been distracted by the “problem” of unemployment.

The so-called unemployment problem is really a problem of leisure, and the only thing, which differentiates, let us say, myself from one of the unemployed, is that I happen to be fortunate enough to have a certain amount of purchasing power, whereas the unfortunate unemployed has not.
— C.H. Douglas | Money and the Price System | 1935

Standard economic theory incorrectly suggests that an efficient market economy provides consumers their incomes through jobs. As we have seen, this theory is wrong. Yet, our economic policies dutifully do their best to ensure that everyone has a job. What doesn’t work in theory, we’re forcing to make work in practice. And the result hasn’t been great.

That result is make-work. To the extent that we create jobs to push money to workers, we’re not creating those jobs because we actually want the product of the labor. The insidious thing about make-work is that it doesn’t usually look like make-work. Private-sector firms aren’t generally going to hire workers they don’t actually need. But, with the goal of job creation, we use economic policy to keep firms alive that would otherwise fail.

Make-work hurts the efficiency of the labor market. Our workers become less productive. To some extent, workers are not even producers anymore. They’re merely consumers being kept needlessly busy as an excuse to give them money. Many workers are painfully aware that their labor contributes nothing to society. Others have no clue.

The way we get people their money is broken. Prices might be stable, but our economy is under-producing and allocating labor inefficiently. Furthermore, many people remain unable to access the goods and services that a well-functioning market economy would be fully capable of providing them.

We’re so focused on trying to get everyone a job that we’re failing to ensure that everyone has money. Getting people jobs is hard and counterproductive. Giving people money is necessary. Basic income is easy.

The Business Cycle

Recall that central banks are responsible for managing the flow of consumer spending to ensure price stability. In the US, our central bank is the Federal Reserve System (the Fed). The Fed keeps track of how well they’re doing by measuring the average price of consumer goods.

There are multiple ways to do that and plenty of disagreement over which way is the best. Nevertheless, the purchasing power of money is defined in terms of consumers and it can’t be any other way.

The Fed’s monetary policy manages consumer spending by encouraging or discouraging borrowing in the financial sector. The more money people can borrow, the more money they can spend. When the Fed discourages borrowing, it’s called monetary tightening. When they encourage borrowing, it’s called monetary stimulus.

Monetary tightening works by increasing the interest rate at which the government borrows from the financial sector. Lenders won’t lend to someone who isn’t willing to pay more interest than the government pays. When the government pays more interest, it forces everyone else to pay more interest to compete with the government. The result is that people borrow less as borrowing becomes more expensive.

Monetary stimulus has the opposite effect. Lower interest rates make it cheaper for everybody to borrow. This allows the private sector to borrow more. In fact, our financial institutions both lend and borrow. They borrow money only to lend it out again at a higher interest rate. This practice of lending to borrow can increase the total amount of private-sector lending and borrowing by a lot.

Monetary stimulus impacts the wage-price gap in three important ways. The first two ways are obvious and the third is more subtle. The first impact is that the stimulus allows consumers themselves directly to borrow more money and therefore to spend more. This is straightforward. The additional consumer spending power helps fill in the wage-price gap.

The second, larger, impact is that firms can borrow money to hire more workers. This is the primary mechanism by which economic policy “creates jobs” and helps to narrow the wage-price gap by boosting wages. Of course, having unproductive, unprofitable firms hire more workers just means we’re keeping people needlessly employed.

The third impact has to do with the distribution of borrowing. The people who are able to borrow the most money are the ones who already have the most money. When fewer people have more money to spend, it becomes more profitable for firms to produce fewer goods and services at higher prices.

Economists call this a steeper aggregate demand curve. It helps narrow the wage-price gap by reducing the flow of production. Each unit of production has the same price as before, but there is less total production.

At the end of the day, the flow of consumer spending matches the flow of production. We have achieved price stability. But the economy is under-producing, some people are being forced to do unproductive work, and consumers lack the money to buy goods and services the economy would otherwise be able to provide them. In other words, people are over-worked and needlessly poor.

There’s another problem too. In order for the economy to keep churning along, people and firms have to continue borrowing more and more money. This process is not sustainable.

It creates instability in the financial sector. New debt continues to stack on top of old debt and the financial system grows increasingly brittle over time. Eventually, the bubble pops and it all comes crashing down. And then we do it again!

Even during boom times, some people are left behind. We have the resources to provide a better standard of living, but those resources are not being properly activated.

I’ve just described for you the status quo. Our economy has looked like this for a while. We are continually subjecting ourselves to a cycle of booms and busts without ever reaching our full potential. Economists call this the business cycle and they generally take it as an unavoidable natural feature of the economy. It is not.

Perry Mehrling — Economics of Money and Banking Lectures

There is much more to monetary policy and financial markets. If you’d like to explore deeper, you can start with Perry Mehrling’s incredibly engaging and insightful online course, Economics of Money and Banking. I can’t recommend his course highly enough.

The financial sector doesn’t need to be as big and as complicated as it has become. Our aversion to giving people money directly has caused us to over-engineer the financial markets. We continue to develop new financial innovations and regulations. Just to sustain consumer spending, we grow the bubble a little bit larger and make it last a little bit longer.

Calibrated Basic Income

By now, I’ve covered the nuts and bolts of Consumer Monetary Theory (CMT). CMT describes the economy as a system that produces goods and services for consumers.

It explains how the flow of standard-value money tokens distributes the flow of economic output from producers to consumers. CMT reveals the danger in treating people as workers and the harm caused by pursuing a full-employment agenda and over-stimulating the financial sector.

We currently rely on monetary over-stimulus, make-work, and under-production to narrow the wage-price gap. We then fill the remaining gap with consumer debt and various inconsistent policies to assist people who were “unfortunate” enough not to get a job.

We can do better.

The fact that we even think of the wage-price gap as a gap is somewhat strange in the first place. People need money, not jobs. They need incomes, not wages. The labor market is a market for getting people to spend their time doing something other than what they’d normally do. Most of the important work done by humanity is not paid. Jobs are only important when, for whatever reason, we need people to do different work.

The labor market is a market for allocating the resource of labor. It’s not supposed to be a tool for funneling money to consumers.

By calibrating a basic income to match the economy’s productive capacity, we can close the gap between what consumers actually get and the economy’s full potential to provide for them.

This is a gap that’s actually useful to close. Calibrated basic income allows the labor market to be efficient such that jobs exist only because we actually want the product of the labor and the only purpose of wages is to provide an incentive for people to perform that labor.

Directly funding consumer spending allows the Fed to tighten its monetary policy and rein in the financial sector. We can maintain stable sustainable levels of lending and borrowing. No more runaway growth of private debt and asset bubbles that invariably cause the financial system to collapse in on itself. No more recessions caused by anything other than a drop in the economy’s real productive capacity. No more business cycle.

We can’t know ahead of time what the optimal level of basic income is. That’s why we calibrate it. We gradually increase the amount of the payout until further increases provide no additional benefit. We’ll know we’ve hit the sweet spot once output stops increasing or we’re happy with the level of private-sector investment.

If we accidentally overshoot and set the basic income too high, then we’ll get a period of inflation until the inflation brings the purchasing power of the basic income back down to a level the economy can match with production of goods and services. If we accidentally undershoot and set the basic income too low, we’ll have to over-stimulate the financial sector and generate make-work to compensate. That’s what’s happening now. Our basic income is zero. Oops.

Once we actually do get the basic income to the natural level for our economy, we can continue to calibrate it on an ongoing basis to match the economy’s productive potential. This ensures that consumers can fully benefit from that potential even as it grows.

Basic income aligns the incentives of the market with what’s good for consumers. When consumers are the ones who have the money, then the way for firms to profit is by serving consumers directly through the production of goods and services. Not only does a calibrated basic income activate the economy’s full productive capacity, but it ensures that new capacity will also be activated. This creates an incentive to build that further capacity. If you build it, they will come.

Some economists believe in a rule called Say’s Law, which says that supply creates its own demand. A calibrated basic income makes Say’s Law true. It turns the dream into a reality.

It is unnecessary and therefore unacceptable for anyone to have to live in poverty. We can do better. By definition, a calibrated basic income is the highest basic income we can afford. To the extent that our economy has the resources to end poverty, a calibrated basic income ends poverty.

Consumer Monetary Theory vs Modern Monetary Theory

You may have noticed that I haven’t said anything about taxes. The level of basic income we can afford has nothing to do with how much tax revenue we collect. It only has to do with how much consumer spending the economy can match with a commensurate flow of production.

Derek Van Gorder and Alex Howlett discuss CMT vs. MMT

In recent years, there’s been some buzz surrounding what’s called Modern Monetary Theory (MMT). As with CMT, MMT is a framework for understanding money’s role in the economy. MMT is famous for claiming that taxes do not fund government spending. CMT agrees.

Government spending is made possible by there being something for the money to go toward. It all comes down to matching streams of production with the streams of spending. The government can spend money to allocate resources directly for infrastructure or public services. In the case of basic income, the government delegates the resource allocation to consumers acting through the market.

Taxes can certainly be used to change market incentives and free up resources. For example, meat is a very resource-intensive form of food. A tax on meat would free up land for other uses. Indirectly, this may allow the government to spend more, either on their own projects or on a higher basic income. But there is no 1-to-1 relationship between spending and taxes.

To put it another way, when the government spends money, they are not spending taxpayer dollars. The only way to “pay for” a basic income is by having an economy that can productively respond to the resulting flow of consumer spending.

There are many important differences between CMT and MMT. CMT takes a consumer-oriented perspective on the economy and treats money as a fundamental property of markets that is necessarily managed by institutions. MMT focuses on labor and workers and treats money as a government monopoly that’s enforced through taxes.

CMT describes how money supports the economy’s role in providing goods and services to consumers. MMT seeks to understand the monetary system in a way that allows policymakers to bring the economy to full employment.

But if we define “full employment” as an economy where everyone who wants a job has one, we can achieve full employment either by giving everyone a job or just by raising the basic income high enough that nobody without a job actually wants one anymore.

There are other important similarities and differences between CMT and MMT. To get an overview, see my recent discussion with Derek Van Gorder.

For a more in-depth look at CMT, inflation, calibrated basic income, and the contrast with MMT, see our Boston Basic Income discussion from 2018.

MMT is very much aligned with orthodox macroeconomic theory in its focus on labor and employment. Even during the Great Depression of the 1930’s, John Maynard Keynes was trying to understand the “problem” of unemployment. In the 1930’s, our economy had more productive capacity than in the 1920’s, yet we were producing less. The problem was never a lack of jobs. It was a lack of consumer spending power.

Economic theory is only as good as the assumptions it makes. For our macroeconomic framework to accurately reflect the real-world economy’s role in serving the people, we must put consumers first, not workers or firms.

Andrew Yang is a presidential candidate running on basic income as the main plank of is platform. The first time I met him, he asked me if I was an MMT guy. I said, “I get that a lot.”

To the untrained eye, CMT can look almost like a shoehorning of basic income into the MMT framework. That’s not exactly right. CMT is its own thing and the differences matter.


Our intuition tells us that money perpetually circulates through the economy, but that’s not the reality. Our intuition tells us that the economy is more productive if everyone’s a worker, but that’s not the reality. And trying to make it our reality by reaching for full employment only causes problems. We prop up consumer spending by over-stimulating the financial sector.

Consumers are the heart of the economy. The people are the heart of the economy. And for the economy to serve the people, those people need money to spend. As consumers spend, they activate production by pumping money through the economy. Money flows away from consumers while goods and services flow toward them.

Basic income supporters have hit on something that’s even more important than they realize. The economy needs sustainable consumer spending and not an over-stimulated financial sector. Calibrated basic income is a critical piece of economic infrastructure that we happen to be missing.

A friend of mine once chided me.

Come on, Alex! Basic income is not some magic wand that fixes all the world’s problems.

Of course not. Basic income only fixes the problems that are caused by lack of basic income. I don’t know how many of our society’s problems fall under that umbrella, but I’m sure it’s more than a few.

Basic income has no place in macroeconomic models that assume consumers get their incomes through jobs, that money keeps circulating, and that the Quantity Theory of Money determines the general level of consumer prices.

If Andrew Yang and other basic income advocates want to be taken seriously, then they’re going to have to have to start backing up their rhetoric with economic theory that’s actually compatible with basic income.


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Alex Howlett







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