A budget we didn’t need to have: a modern monetary theory perspective
This has been a controversial federal budget, to put it mildly. We are being told by the federal government, their advisors, their friends in the media, and their fellow travellers, that it is the
budget ‘we had to have’. The many cuts, some immediate and others promised for future years, are said to be justified as the ‘budget is in a mess’, the government has ‘maxed out on its credit card’, ‘we’ are ‘borrowing to pay interest’, we have to ‘fix the budget’, we must ‘return to surplus’, there is a ‘budget black hole’, and the previous government had ‘spent like a drunken sailor’, and has ‘mortgaged the future’.
Meanwhile, the opposition takes issue with much of the above, and reasonably points out that Australian government net debt is tiny (only about 14% of our annual output), that the annual budget deficit (if you don’t cook the books) is moderate, and that the idea we have a ‘budget crisis’ is so far from the mark
as to be an extraordinary proposition. They also point out that nearly all the measures proposed to ‘fix the budget’ do so by targeting the weak, the disabled, the aged, the unemployed, single parents health care, education, foreign aid, our environment, our climate, and the state premiers.
All this is true, but it misses the point. A point which neither the government nor, sadly, the opposition have yet to fully grasp.
The point is that the Government is not a household, government budgets are nothing like household budgets, government debt is not debt in the sense you and I understand it at all, and a government budget deficit is a normal characteristic of our economy, nothing to worry about, and indeed is normally a necessary element in guaranteeing financial stability and full employment.
There is no ‘budget black hole’. The budget is not ‘in a mess’. The government neither has, nor needs to have, a ‘credit card’. It does not and will not need to ‘borrow to pay interest’. We have not ‘mortgaged the future’ (not in a financial sense, anyway). None of this language and none of these metaphors are useful when discussing the public finances. It is all misleading. It is all propaganda.
Perhaps you have your purse or wallet to hand. Perhaps it has some notes inside. Take a note out. Look for the signatures. One of them is that of the Governor of the Reserve Bank of Australia, and the other is that of the senior public servant of the organisation which owns the Reserve Bank of Australia – the Secretary to the Treasury of the Commonwealth Government.
The Australian government is not in the same position as you and I. It is a currency issuing monetary sovereign. It owns a printing press – for the most part these days it is an electronic ‘printing press’, but that doesn’t change the facts. It doesn’t need to take its money off you in tax, or to borrow its money from you by issuing debt. It creates new money every time it spends. It puts new money into the economy every time it pays for anything. It can in principle afford to buy anything which is for sale in Australian dollars. It can never run out of money. Never.
The obvious question to ask at this stage relates to the purpose of taxation. If the government can never run out of money, why do we pay taxes at all?
The answer may seem offensive. The government needs to tax us in order to destroy some of our spending power. This is the only way to create room in the economy for the government to spend its money without causing inflation. It is important to understand,
though, that the taxes do not ‘pay for’ government spending. They allow for the government to spend without causing inflation, but they don’t fund that spending. The government owns a printing press, remember.
A supplementary question is, why does the government borrow at all? The real reason for this might come as a surprise too. When the government spends, it puts money into the accounts that commercial banks have at the Reserve Bank of Australia. These reserve accounts are used to facilitate the millions of transactions every day which are the lifeblood of our economy.
To ensure each bank has enough money in its account each morning to meet its obligations, the banks lend to and borrow from each other every day. They do this at what is called ‘the cash rate’. This is the rate of interest which the Reserve Bank of Australia publish- es a target for, and which influences the rate you receive on your term deposit or pay on your mortgage. To stop the cash rate falling below its target, it is essential there isn’t too much cash in the banking system.
Government spending puts cash into the banking system. To maintain control of the cash rate, either the Treasury or the Reserve Bank – it doesn’t matter which – has to make sales of government debt to drain cash from the system.
So the government only borrows its money (for which it has a printing press) in order to stop the cash rate falling below the Reserve Bank’s target. Simple, really. It doesn’t ‘need’ to borrow at all.
So, what have we established?
- The Government can never run out of money
- Taxes don’t pay for anything. That isn’t the purpose of taxation in a modern economy.
- The Government doesn’t need to borrow its own money.There is no need to worry about the government budget being in deficit, unless there is too much spending in the economy as a whole, and this is causing inflation.
But there is much more for our leaders to learn. Once again, we’ll take it a step at a time. For every borrower, there is a lender. This obvious fact is the reason why, when you look at the national flow of funds accounts, you always find the following result:
Private sector financial balance + Government financial balance + Foreign financial balance = 0
The rest of the world has run a surplus with Australia for years, and this is unlikely to change any time soon. So the third statistic above is a plus number, and usually at least 3% of GDP. In a healthy financial system, the private sector is normally in surplus. It was in large deficit during the Howard/Costello years, as households built up big debts at an alarming rate.
Suppose the private sector chooses to net save 1% of GDP each year. This would force the Government to run a budget deficit of 4% of GDP, to allow for the Australian private sector to increase its savings as desired.
Any attempt by the Government to introduce ‘austerity’, to ‘fix the budget’, to ‘get back to surplus’ could only work if the rest of the world started to borrow from us, or (more likely) the private sector chose to take on even more debt, making our financial system even more prone to instability and crisis, and a possible future collapse of the property market. If the private sector were to choose not to go further into debt, all that government cuts would do would be to push the economy into a recession, until the government budget returned to deficit once again.
Right now in Australia, the government deficit is already too small, and as a consequence the private sector has now moved back into a small financial deficit. The problem isn’t that there is too much government debt – it is that there is not enough.
A long story, and I have had to simplify it to keep it this short, but it is the truth. And ‘they’ cannot be completely unaware that this is the truth. It isn’t that complicated to understand. The obvious question, then, is why are they lying to you?
Steven Hail is visiting lecturer at Adelaide University (economics) as well as Flinders University and UniSA, with special interests in financial economics and heterodox macroeconomics.