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Modern monetary theory, the economy and the virus – Steven Hail

The Covid-19 epidemic is obviously the biggest global emergency of its kind for more than a century. The social and economic impacts are without precedent and some will be long-lasting. Its lessons will be profound. Some of them will take years to unravel. Others are clear to many, and should be clear to all, even now.

One of these lessons is that in countries like ours the limitations on the ability of the government to engage in very large amounts of spending to support people, organisations and the economy are entirely political. They are not financial.

Governments with very high levels of what is commonly regarded as ‘national debt’ have not been and will not be con- strained by that debt. Those currency issuing institutions described below as monetary sovereigns simply gain the necessary political approval for additional spending and are then able to do it.

The spending is self-financing. It does not have to be funded. That is not the way modern monetary systems work [1]

A street scene in Downtown, Vancouver (GoToVan, 18 March 2020, Flickr cc)

Even now, some of our politicians and of our most prominent neoclassical (i.e. deluded) macroeconomists inhabit the land of denial – rather than the real world the rest of us live in.

Recently the Treasurer of the Common- wealth of Australia claimed – apparently seriously – that the fact the Government had been on the brink of balancing its budget, and that Australia consequently has a relatively low government debt to GDP ratio, placed him in a better posit- ion to finance what most people are wrongly calling a stimulus package. He is wrong. [2]

Countries like Japan, the United Kingdom and the United States have levels of government debt far in excess of our own. This in no sense constrains their budgetary response to the crisis. In the United States, the constraint, as ever, is Congress. The United Kingdom, despite its high government debt and its trade deficit, has been able without any problem, to ‘pay for’ a support package much larger than our own. [3]

What should be clear to everyone now is that federal or central governments like those of Australia, New Zealand, the USA, the UK and Japan face no purely financial constraints at all. Never mind a ‘money tree’. They just have a money computer. They can create limitless amounts of their currencies when they need to do so. They are not dependent on the goodwill of the bond market, or of credit ratings agencies.

They are monetary sovereign currency issuers.

To enjoy such status, you need your own currency. To be fully monetary sovereign, you need to have a floating exchange rate – you cannot be on a gold standard, or a guarantee of the convertibility of your currency at a fixed rate into any foreign currency or into anything you could run out of. Ideally, you should have no foreign currency denominated debt.

Then, beyond getting parliamentary approval for your spending, or using some mechanism such as the declaration of a national emergency to by- pass that approval, the only constraint on your ability to spend, is what is avail- able for you and your people to purchase with your currency. The constraint on your spending is the supply side of your economy. [4]

That is clearly the issue right now. This started as a largely supply-side shock coming out of China, because of the impact of Covid-19 on the Chinese economy. The scale of the shock was not immediately obvious, due to Chinese New Year. It has now permeated the whole world, as the greatest shock in modern history to global supply AND demand. This is obvious. Whole countries and whole industries are in lock- down. Massive numbers of people have lost and are losing their jobs and their incomes. Governments are responding, with deficit spending which would have seemed unthinkable a few months ago, in most cases undertaken by governments who were arguing very recently that even a fraction of this additional spending could not possibly be afforded.

This additional spending is not being paid for by taxpayers and is not imposing any burden whatsoever on future generations. Anyone who says other- wise either does not understand the monetary system or is deliberately not telling the truth, or is perhaps engaging in some complicated combination of these things. People often lie to them- selves, after all.

Every dollar spent by a central government like ours is a new dollar. Governments engage in spending every day. At the federal level, this spending marks the birth of additional currency units.

Don’t call it ‘printing money’. Nothing much is printed. It is digital. They spend new dollars into your bank account.

Then they tax at least some of those dollars away again. Taxes simply delete dollars. Taxes involve the death of a dollar. They vacuum up dollars. They throw dollars in the bin. If you are a currency issuing government, like ours, you can’t meaningfully ‘save up’ the currency you create, at will and without limit. The macroeconomic purpose of taxation is to limit the ability of the private sector to spend, and to create space within the productive capacity of the economy for the government to spend. That is all. [5]

When the government spends more than it taxes, which most monetary sovereign governments do nearly all the time, we call that a budget deficit. That sounds like a bad thing, right? But it isn’t. A government deficit means a surplus for us. It is simply a deposit made by the government into the banking system somewhere. Perhaps you are the recipient of those new dollars.

Perhaps I am. Or perhaps it is Gina Reinhart. It certainly matters who gets them. But a government deficit implies a non-government surplus.

They choose to issue government bonds, to match their deficit spending. They don’t need to borrow their own currency. These bonds simply offer savers the opportunity to buy a safe interest-bearing asset with their dollars. The pros and cons of issuing government bonds at all is complicated, but the important point is that it is not essential to issue them. It is a choice. And now, following the announcement that the Reserve Bank is using quantitative easing, the government is buying some of them back, via its wholly owned central bank. It never needed to sell them in the first place. [6]

What is the constraint? Our ability to produce and offer for sale the goods and services people and the govern- ment want to buy with the dollars which have been created. In other words, the constraint is the threat of inflation. With so much of the economy shut down, the issue is the maintenance of supplies of essential goods and services and supporting people’s ability to buy those goods and services, without leaving anyone behind. On top of that, we want to avoid business insolvencies, so that once the threat of the virus has passed, we can start up something like the economy we had before. There will be many changes to our economic management which we should then roll out, after careful consideration. My own personal favourite is a federal job guarantee. But it is vital that we don’t throw away the institutional framework on which our economy usually depends.

Meanwhile, we will need to support people’s ability to demand goods and services and keep them in their homes.

and out of poverty, while ensuring there is enough of a supply of those goods and services to meet those demands. If we get this wrong, or if the crisis is more prolonged and severe, war-time measures like price controls and rationing would be on the table. Let’s hope that doesn’t happen.

But let’s get a couple of things clear. Our government, like any government with a similar monetary system any- where in the world, has no problem, and will have no problem, paying for any of this, other than parliamentary approval. Institutional structures which obscure this fact do not prevent it from being a fact. ]7]

In other words, the modern monetary theory economists, like Prof Stephanie Kelton in the USA and Prof William Mitchell in Australia, have been proved right. [8] Something to remember, when the crisis is in the past.

An empty Penn Station, Baltimore MD (Elvert Barnes, 19 March 2020, Flickr cc)

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  3. workers-wages-during-pandemic
  6. australia-we-might-just-need-130182
  7. steps-in/news-story/ab070170b6b70ad4dd1fb4319ae1947a

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