OPINION
Learn To Love Trillion-Dollar Deficits
Our country’s myth about federal debt, explained.
June 9,
2020
By
Stephanie Kelton
Dr. Kelton,
an economist, is the author of “The Deficit Myth.”
https://www.nytimes.com/2020/06/09/opinion/us-deficit-coronavirus.html
Last week,
a bipartisan group of 60 members of the U.S. House of Representatives sent a
letter to congressional leadership, raising concerns about mounting debt and
deficits that have come as a result of the federal government’s response to the
coronavirus pandemic. “We cannot ignore the pressing issue of the national
debt,” they wrote. The letter warned of “irreparable damage to our country” if
nothing is done to stem the tide of red ink. Senator Mike Enzi, Republican of
Wyoming, chairman of the Senate Budget Committee, echoed their concerns.
It’s an
ominous sign for the smaller businesses and millions of unemployed Americans whose
survival may very well depend on continued government support in this crisis.
While these Democratic and Republican lawmakers stopped short of calling for
immediate austerity measures, their remarks demonstrate that they have fallen
prey to what I call the deficit myth: that our nation’s debt and deficits are
on an unsustainable path and that we need to develop a plan to fix the problem.
As a
proponent of what’s called Modern Monetary Theory and as a former chief
economist for the Democrats on the Senate Budget Committee, intimately familiar
with how public finance actually works, I am not worried about the recent
multitrillion-dollar surge in spending.
But there
was a time when it would have rattled me too.
I
understand the deficit myth because in the early part of my career in economics
I, too, bought into the conventional way of thinking. I was taught that the
federal government should manage its finances in ways that resemble good
old-fashioned household budgeting, that it should hold spending in line with
revenues and avoid adding debt whenever possible.
Prime
Minister Margaret Thatcher of Britain — President Ronald Reagan’s partner in
the conservative revolution of the late 20th century — captured these
sentiments in a seminal speech in 1983, declaring that “the state has no source
of money other than the money people earn themselves. If the state wishes to
spend more, it can only do so by borrowing your savings or by taxing you more.”
That thinking
sounds reasonable to people, including me when I first absorbed it. But
Thatcher’s articulation of the deficit myth concealed a crucial reality: the
monetary power of a currency-issuing government. Governments in nations that
maintain control of their own currencies — like Japan, Britain and the United
States, and unlike Greece, Spain and Italy — can increase spending without
needing to raise taxes or borrow currency from other countries or investors.
That doesn’t mean they can spend without limit, but it does mean they don’t
need to worry about “finding the money,” as many politicians state, when they
wish to spend more. Politics aside, the only economic constraints
currency-issuing states face are inflation and the availability of labor and
other material resources in the real economy.
It is true
that in a bygone era, the U.S. government didn’t have full control of its
currency. That’s because the U.S. dollar was convertible into gold, which
forced the federal government to constrain its spending to protect the stock of
its gold reserves. But President Richard Nixon famously ended the gold standard
in August 1971, freeing the government to take full advantage of its
currency-issuing powers. And yet, roughly a half-century later, top political
leaders in the United States still talk as Thatcher did and legislate as though
we, the taxpayers, are the ultimate source of the government’s money.
In 1997,
during my early training as a professional economist, someone shared a little
book titled “Soft Currency Economics” with me. Its author, Warren Mosler, a
successful Wall Street investor, argued that when it came to money, debt and
taxes, our politicians (and most economists) were getting almost everything
wrong. I read it and wasn’t convinced. One of Mr. Mosler’s claims was that the
money the government collects isn’t directly used to pay its bills. I had
studied economics with world-renowned economists at Cambridge University, and
none of my professors had ever said anything like that.
In 1998, I
visited Mr. Mosler at his home in West Palm Beach, Fla., where I spent hours
listening to him explain his thinking. He began by referring to the U.S. dollar
as “a simple public monopoly.” Since the U.S. government is the sole issuer of
the currency, he said, it was silly to think of Uncle Sam as needing to get
dollars from the rest of us.
My head
spun. Then he told me a story about an experiment of his: Mr. Mosler had a
beautiful beachfront property and all the luxuries of life anyone could hope to
enjoy. He also had a family that included two teenagers, who resisted doing
household chores. He wanted the yard mowed, beds made, dishes done, cars washed
and so on. To encourage them, he promised to compensate them by paying for
their labor with his business cards. Nothing much got done.
“Why would
we work for your business cards? They’re not worth anything!” they told
him. So Mr. Mosler changed tactics.
Instead of offering to compensate them for volunteering to pitch in around the
house, he demanded a payment of 30 of his business cards, each month, with some
chores worth more cards than others. Failure to pay would result in a loss of
privileges: no more TV, use of the swimming pool or shopping trips to the mall.
Mr. Mosler
had essentially imposed a tax that could be paid only with his own monogrammed
paper. And he was prepared to enforce it. Now the cards were worth something.
Before long, the kids were scurrying around, tidying up their bedrooms, the
kitchen and the yard — working to maintain the lifestyle they wanted.
This,
broadly speaking, is how our monetary system works. It is true that the dollars
in your pocket are, in a physical sense, just pieces of paper. It’s the state’s
ability to make and enforce its tax laws that sustains a demand for them, which
in turn makes those dollars valuable. It’s also how the British Empire and
others before it were able to effectively rule: conquer, erase the legitimacy
of a given people’s original currency, impose British currency on the
colonized, then watch how the entire local economy begins to revolve around
British currency, interests and power. Taxes exist for many reasons, but they
exist mainly to give value to a state’s otherwise worthless tokens.
Coming to
terms with this was jarring — a Copernican moment. By the time I developed this
subject into my first published, peer-reviewed academic paper, I realized that
my prior understanding of government finance had been wrong.
In 2020,
Congress has been showing us — in practice if not in its rhetoric — exactly how
M.M.T. works: It committed trillions of dollars this spring that in the
conventional economic sense it did not “have.” It didn’t raise taxes or borrow
from China to come up with dollars to support our ailing economy. Instead,
lawmakers simply voted to pass spending bills, which effectively ordered up
trillions of dollars from the government’s bank, the Federal Reserve. In
reality, that’s how all government spending is paid for.
M.M.T.
simply describes how our monetary system actually works. Its explanatory power
doesn’t depend on ideology or political party. Rather, the theory clarifies
what is economically possible and shifts the terrain of policy debates
currently hamstrung by nagging questions of so-called pay-fors: Instead of
worrying about the number that falls out of the budget box at the end of each
fiscal year, M.M.T. asks us to focus on the limits that matter.
At any
point in time, every economy faces a sort of speed limit, regulated by the
availability of its real productive resources — the state of technology and the
quantity and quality of its land, workers, factories, machines and other
materials. If any government tries to spend too much into an economy that’s
already running at full speed, inflation will accelerate. So there are limits.
However, the limits are not in our government’s ability to spend money or to
sustain large deficits. What M.M.T. does is distinguish the real limits from
wrongheaded, self-imposed constraints.
An
understanding of Modern Monetary Theory matters greatly now. It could free
policymakers not only to act boldly amid crises but also to invest boldly in
times of more stability. It matters because to lift America out of its current
economic crisis, Congress does not need to “find the money,” as many say, in
order to spend more. It just needs to find the votes and the political will.
Stephanie
Kelton, a professor of economics and public policy at Stony Brook University,
is the author of “The Deficit Myth,” from which this essay was adapted.
Book Review - The Deficit Myth: Modern Monetary
Theory and How To Build a Better Economy
By Devika
Dutt - 18 February 2021 WORLD ECONOMY, TRADE AND FINANCE
Book Review
- The Deficit Myth: Modern Monetary Theory and How To Build a Better Economy
The Deficit
Myth: Modern Monetary Theory and How To Build a Better Economy by Stephanie
Kelton. London: John Murray Press, 2020. 336 pp., £20 hardcover 9781529352528,
£10.99 paperback 9781529352566, £20 e-book 9781529352542
Stephanie
Kelton's new book The Deficit Myth has stirred up a storm since its release and
has generated a robust and interesting debate on the limits to government
spending. Kelton's work is especially relevant at this time when governments
around the world have been engaged in substantial spending to respond to the
Coronavirus pandemic. By laying out the insights of Modern Monetary Theory,
Kelton questions the real limits to government spending, especially for the
Federal Government of the United States. This book challenges the most basic
assumptions about government finances and the role of the government, by laying
out the main propositions of Modern Monetary Theory and its related evidence.
Myth.jpgIn
The Deficit Myth, Kelton argues that government budgets are not like household
budgets, and that governments with monetary sovereignty do not face a budget
constraint as they cannot run out of the currency that they issue. This is
because tax revenues, according to MMT, do not finance government expenditure.
Therefore, tax revenues being structurally lower than expenditures for several
years is not in and of itself a problem as governments can always issue more of
its currency to spend further. She argues that taxation is not important for
raising revenue, but for regulating inflation, encouraging and discouraging
certain activities, and redistributing income and wealth to reduce inequality.
In fact, taxation is only necessary to create demand for the currency issued by
the currency issuing government and to make people produce goods and services
for the government.
She argues
that budget deficits are not evidence of overspending, but that inflation is
evidence of overspending. It follows, therefore, that inflation is the only
constraint on government spending, not the government deficit or debt. Kelton
argues that the government can and should use fiscal policy to get the economy
to full employment or zero unemployment, not the natural rate of unemployment,
and keep it there. The level of government deficit is immaterial.
The
excellent narrative provided in this book goes through the intricacies of how
government spending is operationalized in governments with monetary
sovereignty, especially the Federal government of the United States. The key
point she makes is that government spending does not use the money collected in
the form of taxes, but rather spending creates the purchasing power which can
then be partially taxed back, if necessary. In many ways, the government
creates money much like a bank does: by creating deposits, in keeping with the
Keynesian insight. Banks do not wait for people to deposit money to create
loans, or in other words, simply collect and disburse savings (as is posited by
the loanable funds theory); instead, banks use loans to create deposits.
Similarly, government spending creates the spending power instead of allocating
tax revenues to expenditure. Furthermore, interest rates on government debt are
a policy variable, and for the most part not determined by market forces.
This book
has many important insights that are made in a clear, concise, and approachable
manner for a non-technical audience, and has many key insights for economists
and public policy experts that are consistent with the Keynesian literature on
public finances, even though it takes a somewhat distinct approach to arrive at
these conclusions. Critics of MMT have often argued that there is not much that
is novel about it as it is a mere revival of Keynesian economics and Functional
Finance (and admittedly this was also how I previously understood it). The
Deficit Myth makes it evident that this is not the case. However, this
distinction from Keynesian economics and Functional Finance raises challenges
for the MMT framework in Kelton's book. Here I will articulate three challenges
and opportunities that need further exploration and exposition that, in my
view, can strengthen and clarify Kelton's framework.
First,
Kelton's argument that taxation is first and foremost a mechanism to create
demand for the national sovereign currency and to provision the government is
an interesting one. However, this view of state money requires an articulation
of a Modern Monetary Theory of the State. It appears that the MMT State has
monopoly over the national currency and uses it to regulate output and
employment in the economy. The government uses taxation to provision itself and
to get people to produce goods and services for itself. Why does the state need
taxation to provision itself? Can it not simply purchase what it needs from
private producers if needed even if it did not have the monopoly over the
currency? Or is it the case that people would not produce goods and services or
conduct business in the currency of the state if there were no taxation? Why
can it not be the case that economic agents acquire a sufficient amount of the
national currency to pay taxes and yet have a different or multiple other
moneys in which business is conducted? The sub-text here is that state money is
the most reliable and stable one because economic agents can trust that the
government can always honor its obligations. But the source of this trust is
not immediately evident. The primary function of taxation in creating demand
for the national currency is perhaps the weakest link in the argument, but it
does not need to be so.
Second,
Kelton convincingly shows that the way monetary sovereign governments actually
conduct expenditure is by simply creating the money for its spending by “a few
key strokes” and not by using tax collections. However, this situation will
continue to not be a problem if people and businesses can trust that the
government can meet its obligation using a money that will not lose its value.
This trust depends not simply on the mismatch between tax revenue and
expenditures (as is the case with persistent deficits), but also on the ability
of the government to create the money and real resources needed to meet its
obligations. This trust in the government is a key component of monetary
sovereignty, which is not a part of Kelton's definition. According to Kelton,
monetary sovereignty requires that a government issues its own currency that it
not pegged to any other currency or gold, does not have a fixed exchange rate,
and does not borrow in a currency that is not its own. However, even if a
country issues its own currency that is not pegged to another currency, several
governments, especially those of several developing economies, are unable to
run persistent deficits as economic agents believe that this situation is not
endlessly sustainable. Therefore, the US government can have an outstanding
national debt of close to 100 percent of GDP and the Japanese government can
have an outstanding national debt of 200 percent of GDP, but investors get
skittish about debt sustainability if the public debt in Turkey is higher than
40 or 50 percent of GDP. This is partly a result of present day global economic
institutions and partly a result of the lack of trust in governments to meet their
obligations due to real resource constraints that either the government cannot
alleviate or because people do not trust that it can. Some governments, such as
those of the United States and a handful of other advanced economies, can meet
their obligations in their respective currencies and even in the currencies of
other advanced economies because of present institutional arrangements and
imperial power. To Kelton's credit, she does discuss the global currency
hierarchy that follows from this differential trust in different governments
but stops short from discussing the full implications and policy prescriptions
for a national government that is not the Federal government of the United
States. Especially since the adverse consequences of loss of trust in the
government's ability to meet its payment obligations can materialize even if
the government issues bonds exclusively in its own currency.
Third,
while Kelton has devoted a full chapter to questions of trade and development
and whether the insights of the book apply to countries outside the handful of
advanced economies, there is still a lack of attention to the details of
structural features of developing economies. Apart from the issues of real
resource constraints mentioned above, Kelton argues that inflation, and not the
fiscal deficit, is an indicator of overspending. However, there are several
structural features of developing economies that might create inflation even
when aggregate demand is low. For instance, many developing economies in the world
today are struggling with inflationary pressures despite the massive
contraction in economic activity because of the Coronavirus pandemic. The
source of these inflationary pressures varies from disruptions in supply chains
of essential commodities, like food, to pressures on their exchange rates. This
includes countries that issue their own currency and do not have fixed exchange
rates. Therefore, in these contexts, inflation is not an indicator of
overspending and reflects a more complex phenomenon. Similarly, Kelton argues
that in addition to issuing their own currency with flexible exchange rates, to
create monetary sovereignty, governments should not borrow in currencies that
are not their own. This is good policy advice in some instances, but an unfeasible
proposition in many others. Especially since private borrowers in the economy
can and do borrow in currencies that are not the domestic currency, creating a
source of financial instability. Therefore, the executors of spending on behalf
of governments, Central Banks, often need to ensure a stockpile or secure a
source of flows in foreign currency in order to maintain financial stability.
As a result, even if the government does not itself issue debt in foreign
currency, the government or the central bank may need to respond to the
emergent currency composition of foreign borrowing, creating an additional
limit to the stability of the domestic currency. This is not a concern for the
Federal Government of the United States as it issues the key currency of the
global monetary system, but it is a concern for many countries lower in the
currency hierarchy. Furthermore, Kelton also does not explore why some
countries decide to maintain currency pegs and/or fixed exchange rates despite
their many challenges. She does argue for greater capital controls to mitigate
this, but a revised definition of monetary sovereignty which accounts for these
concerns is needed.
To sum up,
Kelton's book is an important and well-argued challenge to the conventional
wisdom on government deficits and debt, especially at a time when policymakers
may make a sharp turn towards austerity in response to the increase in the size
of government debt due to the pandemic. The Deficit Myth successfully argues
that this would be a policy mistake. However, this framework has some gaps,
which is not uncommon for an emerging and developing body of knowledge.
Addressing these gaps is possible and should be done in order to strengthen and
clarify this framework.
Devika Dutt
is a PhD Candidate in Economics at the University of Massachusetts Amherst.
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