Rudiments of monetary macroeconomics
Here is a restatement of some of the rudiments of MMT which bear on this debate:
- Modern monetary economies use fiat currencies within a flexible exchange rate system, which means that the monetary unit defined by the sovereign government is convertible only into itself
and not legally convertible by government into gold as it was under the gold standard, or any real good or service. The currency of issue is defined as the only unit that which is acceptable for
payment of taxes and other financial demands of the government of issue.
- Government spending is not revenue constrained. Unlike the government of issue, a private citizen is constrained by the sources of available funds, including income from all sources, asset
sales and borrowings from external parties. Government spends simply by crediting a private sector bank account at the central bank. Operationally, this process is independent of any prior
revenue, including taxing and borrowing. When taxation is paid by the private sector cheques (or bank transfers) that are drawn on private accounts in the member banks, the RBA debits a private
sector bank account. No real resources are transferred to government. Nor is government’s ability to spend augmented by said debiting of private bank accounts.
- A household, the user of the currency, must finance its spending, ex ante, whereas government, the issuer of the currency, necessarily must spend first (credit private bank accounts) before
it can subsequently debit private accounts, should it so desire. The government is the source of the funds the private sector requires to pay its taxes and to net save (including the need to
maintain transaction balances), making government solvency in its currency of issue a given and a non issue. A sovereign government can always afford to purchase anything that is available for
sale in the currency it issues and pay any entitlement/liability that is denominated in the same currency.
- National income accounting defines the government deficit (surplus) as equal ($-for-$) to the non-government (residents and non-residents) surplus (deficit). In aggregate, there can be no net
savings of financial assets of the non-government sector without cumulative government deficit spending. In other words, the only entity that can provide the non-government sector with net
financial assets (net savings) and thereby simultaneously accommodate any net desire to save and thus eliminate unemployment is the government.
- The systematic pursuit of government budget surpluses is necessarily manifested as systematic declines in private sector savings. Pursuing budget surpluses is necessarily equivalent to the
pursuit of non-government sector deficits.
- Unemployment occurs when the private sector, in aggregate, desires to earn the monetary unit of account, but doesn’t desire to spend all it earns, other things equal. Accordingly,
unemployment occurs when net government spending is too low to accommodate the need to pay taxes and the desire to net save.
- The central bank necessarily administers the risk-free interest rate and is not subject to direct market forces. The central bank can choose to leave it at 0, regardless.
- Government debt functions as interest rate support and not as a source of funds. When the government spends there are substantial liquidity impacts in the banking system. Budget deficits
operationally place downward pressure on short-term interest rates because they will eventually, presuming the increased private demand for cash is less than the injection, manifest as excess
reserves (cash supplies) in the reserve accounts the commercial banks keep at the central bank for clearing purposes. Exchanges between reserve accounts in settlement sum to zero in terms of the
system-wide balance and so in net terms the money market cash position is unchanged. The system cash position (excess reserve balances) have crucial implications for central bank monetary policy,
which targets the level of short-term interest rates.
- A fiscal deficit results in a system-wide surplus, after spending and portfolio adjustment has occurred. The commercial banks will be faced with earning the lower default return on surplus
reserve funds which will put downward pressure on the cash rate. If the central bank desires to maintain its current cash (target) rate then it must ‘drain’ this surplus liquidity by selling
government debt. So government debt does not finance spending but rather serves to maintain reserves such that a particular cash rate can be defended by the central bank.
- The concept of ‘debt monetisation’ is a non sequitur. Once the cash rate target is set, the central bank should only trade government securities if liquidity changes are required to support
this target. Given the central bank cannot really control the reserves then debt monetisation is strictly impossible.
We do have a choice – we just need to identify it
So the fundamental principles that arise in a fiat monetary system which are relevant here are as follows.
- The central bank sets the short-term interest rate based on its policy aspirations.
- Government spending is independent of borrowing which the latter best thought of as coming after spending.
- Government spending provides the net financial assets (bank reserves) which ultimately represent the funds used by the non-government agents to purchase the debt.
- Budget deficits put downward pressure on interest rates contrary to the myths that appear in macroeconomic textbooks about ‘crowding out’.
- The “penalty for not borrowing” is that the interest rate will fall to the bottom of the “corridor” prevailing in the country which may be zero if the central bank does not offer a return on
- Government debt-issuance is a “monetary policy” operation rather than being intrinsic to fiscal policy, although in a modern monetary paradigm the distinctions between monetary and fiscal
policy as traditionally defined are moot.
Some myths about modern monetary theory and its
Now the recognition of the national accounting relationships which underpin modern monetary theory are not matters of opinion. These include (but the list is not exhaustive):
- That a government deficit (surplus ) will be exactly equal ($-for-$) to a non-government surplus (deficit).
- That a deficiency of spending overall relative to full capacity output will cause output to contract and employment to fall.
- That government net spending funds the private desire to save while at the same ensuring output levels are high.
- That a national government which issues its own currency is not revenue-constrained in its own spending, irrespective of the voluntary (political) arrangements it puts in place which may
constrain it in spending in any number of ways.
- That public debt issuance of a sovereign government is about interest-rate maintenance and has nothing to do with “funding” net government spending.
- That a sovereign government can buy whatever is for sale at any time but should only net spend up to the desire by the non-government sector to save otherwise nominal spending will
outstrip the real capacity of the economy to respond in quantity terms and inflation will result.