Modern Monetary Theory (MMT) and the Deficit Myth

Adopting this framework could enable us to spend money on solving all the problems we have in this country.  It really sounds too good to be true, but it is real.

— from David Turnoy —

The current pandemic and resulting economic crisis have produced a situation calling for trillions of dollars to be pumped into our economy. As Congress continues to debate the size of the stimulus, where is this money going to come from? Does it actually have to come from somewhere, or can the federal government simply make an adjustment to its financial books to provide the money we need? Wouldn’t this explode the deficit, or do we really even need to worry about the deficit?

A new book called The Deficit Myth (June 9, 2020) addresses these questions. The author is Stephanie Kelton, a university professor of economics and public policy at Stony Brook University. She is also the former chief economist to the US Senate Committee on the Budget, and she served as Bernie Sanders’s economic adviser during his two presidential runs.

The first thing to understand is that the federal government’s budget is not like that of states or even households. While a state or a household has to have the money it wants to spend before it can spend it, the same does not hold true for any national government that is a currency issuer. Countries like the US, Britain, and Japan issue their own currencies: the dollar, the
pound, and the yen. The US conjures money into existence from a computer keyboard each time the Federal Reserve carries out a payment to the Treasury. Many other countries don’t issue their own currencies, instead using one of the commonly accepted currencies like the dollar. As
long as people around the world continue to have faith in the dollar as a reliable money standard, there is no worry for the US about issuing more money.

The United States used to be tied to a gold standard. Supposedly the US had as much gold as paper money that it printed. However, as the US spent more and more money on the Vietnam War, there came to be worries from other countries that the US might no longer have adequate gold supplies. As a result, President Richard Nixon took the US off the gold standard temporarily in 1971 and then permanently in 1973. Therefore, the amount of money put into the economy by the US Government no longer has the backing of gold reserves, so this is not a limitation on printing more money. We now have a purely fiat currency, as there is no longer a promise to convert dollars into gold. Therefore, the US government will never run out of money, as it can always create more. This allows the government to focus NOT on budget outcomes, i.e., balancing the budget, but instead on prioritizing human outcomes while budgeting responsibly with an eye toward recognizing our economy’s real resource constraints.

Instead of the government having to borrow money or collect revenue through taxes before spending it (injecting it into the economy), it actually spends money first before borrowing (selling Treasuries) or taxing. It may come as a shock, but the government does not impose taxes to acquire revenue; it can issue all the money it wants with a computer keyboard
stroke. Instead, taxes have a number of other purposes. Requiring the payment of taxes motivates people to work longer hours so they can pay their taxes, and this makes for a productive economy that provides goods and services. If the government didn’t require taxes, fewer people would need to work those longer hours, which means it would be harder to fill the
jobs we need filled in a productive economy. Taxation is also a method for controlling inflation, for without having taxes to pay, people would end up with more money than there are goods and services to purchase. With consumers competing for these precious items, prices will be raised
by sellers. Thirdly, taxes are a way to alter the distribution of wealth and income; this is necessary when the wealth gap gets too big, for if tax cuts funnel most of this money to the already well-off, who save it rather than spending it, the economy will not be as productive as when taxation leaves those lower on the scale with more disposable income to be spent on goods
and services, which fuels more employment to produce goods and services that will be bought. Finally, government uses taxes to encourage or discourage certain behaviors; cigarette taxes discourage smoking, while government rebates on energy-efficient cars and appliances encourage producing less carbon in the atmosphere.

If tax revenue is not needed for government spending, as just detailed, what purpose does government borrowing serve? The government borrows through selling Treasury bonds. It does not need to borrow before it spends, in fact it is simply offering people a different kind of government money that pays a little interest. US Treasuries are simply interest-bearing dollars.
For more than 100 years, the government chose to sell US Treasuries in an amount equal to its deficit spending, but it doesn’t need for these two items to be equal. From an MMT perspective, the purpose of selling bonds is to prevent a large infusion of excess bank reserves from pushing the overnight interest rate below the Fed’s target rate. Deficits push the overnight interest rate down. Deficit spending fills the banking system with excess reserves, and a huge increase in the supply of bank reserves will push the federal funds rate to zero. Historically the Fed sold bonds to drain off the excess reserves to keep the interest rate in positive territory, but today it simply declares that it has reached the target rate.

Congress has imposed limits on itself related to spending such as the PAYGO rule, the debt ceiling law, and other rules that can be waived or suspended as Congress sees fit, so these really don’t limit deficit spending. Can Congress simply spend as much as it wants with no restraint? The real limit on spending is inflation. The US can continue to put money into the system as long as inflation remains under control. Inflation remains under control if there are enough goods and services for people to spend their money on. If the government puts more money into the system than productive capacity, i.e., the goods and services available, inflation will result, so government economists need to monitor this. Deficits themselves are not evidence of government overspending; in fact, deficits are evidence that government is merely pumping money into the economy to make it more productive. Professor Kelton argues that the US has kept its deficits too small, accepting a certain level of unemployment in exchange for maintaining a low deficit. She argues that unemployment is evidence that the deficit is too small, that the US is capable of full employment if the deficit is the right size. If some people are unemployed, that is a sign that there is productive capacity in the economy that is not being used, which means we are living below our collective means. Instead of our goal being a balanced budget, our goal should be a balanced economy where jobs are sufficiently plentiful and inflation is low. In order to maintain full employment, there should be a federal job guarantee where the government provides public service work for any worker unable to currently find a private sector job. If the economy passes through a rough stretch, as is inevitable in a capitalist economy, these government-funded jobs can provide the bridge until the private sector picks up. [Many MMT economists advocate for orienting these public jobs around building a care economy, e.g., child care, elder care, etc.] Once the economy improves and private companies are ready to hire, there is a ready pool of workers from the government-funded jobs, avoiding a shortage of workers which would lead to rising wages and thus inflation.

Does our rising deficit pose any kind of threat to us? No, not at all. We spent our way out of the Great Depression and through World War II with huge deficits. [By the way, the gold standard was suspended during the Great Depression and WWII.] We never “paid this money back,” yet we came out of WWII the strongest economic power on the planet. The debt clock
simply is a historical record of how many dollars the federal government has added to people’s pockets without subtracting (taxing) them away. We need to shift our thinking from a household budgeting mode to a currency issuer paradigm where the issuer can run deficits in the interest of a productive economy without going broke. A fiscal surplus would actually be
counterproductive, because it would suck money out of the economy, whereas a deficit can help maintain a good economy by supporting incomes, sales, and profits. Each time the government has substantially reduced the national debt, the historical records shows that the economy fell into depression. Government surpluses siphon away a portion of everyone else’s financial savings, leaving us with less purchasing power to support the spending that keeps our economy going, ultimately driving the federal budget back into deficit. The debt is something we need to stop worrying about, as fiscal deficits increase our wealth and collective savings.

Deficits can be used for good or bad purposes. Tax cuts for the wealthiest individuals and corporations benefit only a small slice of the public. Deficits can be used to fund unjust wars. But if the goal is broadly shared prosperity, we need deficits that channel resources more equitably. They can be used to sustain life and build a more just economy that works for the many and not just the few.

Does America’s trade deficit mean America is losing at trade? Actually, looking through an MMT lens, America’s trade deficit is its surplus of stuff, and imports are a benefit to us. Other countries want to build up their holdings of American dollars, which results from our trade deficit, and they can use those dollars to buy food, medicine, and other critical imports,
especially in developing countries. If we adopt a federal job guarantee, free trade is no longer a threat to our own full employment, and trade wars are not necessary to prevent unemployment. Trade negotiations can focus on labor standards and environmental sustainability, with the US using its market power to promote acceptable working conditions and environmental standards worldwide. Trade is not about winning and losing, it should be about real resources, social needs, and environmental benefits. And with the power of the US dollar, the hegemonic world currency, we can supply all the dollars at home to reach full employment and all the dollars needed by the rest of the world to build up their reserves and protect their trade flows. We could lead the effort to mobilize resources for a Green New Deal, and we can run our currency so that global full employment is possible.

Will so-called entitlement programs like Social Security, Medicare, Medicaid, and antipoverty programs bankrupt the US, as conservatives often claim? First of all, they should be called earned entitlements, which was the term used until some conservative academics got rid of “earned” in the 1970s. And as we have already learned, the federal government has the ability to fund any programs it wants, as long as it has the legal authority to pay benefits and the economy has the productive capacity to deliver real program benefits. In 2005, in a Congressional hearing, Congressman Paul Ryan asked Alan Greenspan, chair of the Federal Reserve, whether he agreed that Social Security was in financial trouble. Greenspan, a noted conservative, responded: ”There’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody.” If Congress commits to funding the program, the money is there. What we will need to focus on as more and more people retire and need medical care is to have enough doctors, nurses, hospitals, assisted living housing, and other related items so that the resources are there to be used.

The deficits that matter are in good jobs, access to healthcare, savings for retirement, education, quality infrastructure, a clean environment, a sustainable climate, and democracy. These are the deficits that affect ordinary Americans and have been ignored for too long. Our government can issue the money, and we can maintain the productive capacity needed to take care of these deficits. President Kennedy asked his economic adviser James Tobin if there were any economic limits to the deficit. Tobin’s answer was that the only limit was inflation. Kennedy used that information to announce America’s program to send a man to the moon by the end of the decade, realizing we could make the money available while managing our scarce material resources. As a result of managing the inflation risk, the economy grew, unemployment fell sharply, and inflation remained below 1.5% for the first half of the 1960s.

With MMT, we can have a people’s economy, creating a robust economic system while taking care of everyone. We can ask what programs we want to have, then allocate the money to spend on them. The whole idea of spending money we don’t have sounds so counter to everything we have always believed. Even Professor Kelton was slow to accept this concept, as
it seemed so counterintuitive. But without a gold standard, where does that money come from? It comes from the government creating it. And as long as we keep inflation under control by maintaining the productive capacity on which people can spend their money, we can fund the programs we want.