Money for nothing?

Whenever I write anything about public expenditure and taxation, I’m likely to get someone commenting that Modern Monetary Theory has shown that a government with its own currency does not need taxation to finance public expenditure. I’ve tried a couple of responses to this, but now I think I can explain better why this argument is
(a) wrong in terms of (what I understand to be) the central claims of MMT
(b) regressive in terms of taxation policy
(c) politically pernicious

Starting at the beginning, as I read the central argument of MMT on fiscal policy, it is based on the idea of functional finance. The idea is that governments should first decide on the appropriate level of public expenditure, that is on the allocation of resources between public and private consumption and investment. Next, they should consider the requirements of macroeconomic policy to determine appropriate levels of money creation and issue of public debt. Finally, they should set the desired level of taxation as residual, to balance the sum of total income (seignorage+net debt+ tax revenue) and total expenditure.

That’s one way of looking at things, and useful in a lot of ways. But now consider what happens to this story if governments decide that an increase in public expenditure is warranted. Assuming that levels of money creation and debt issue were already set appropriately in terms of macroeconomic policy, there is no obvious reason for them to change. But then the identity between income and expenditure implies that the increase in public expenditure must translate, dollar for dollar into an increase in tax revenue. Perhaps there is an explanation for why an increase in desired public spending would change the settings of macro policy in the direction of more money creation, but if so, I haven’t seen it. If the increase in public expenditure is only temporary (on a war, for example), it might make sense to run up public debt. But because this debt has to be serviced, it implies the need for lower spending or higher taxes in the future.

To turn this around, suppose you think, as most MMTers do, that the stance of macroeconomic policy is almost invariably too contractionary. Then, you would advocate more money creation and larger deficits. That implies lower taxation but, on the functional finance view, no increase in public expenditure. And, again, if you don’t accept that inference and say that higher public expenditure should be part of the fiscal policy mix that in turn implies that the level of taxes must be correspondingly higher than if public expenditure did not increase.

Turning to regressiveness, if the economy is fully employed (more precisely, if an expansion in public consumption and investment will take up resources that would others be used for private consumption and purposes) then any expansion of the money supply is effectively an inflationary tax on money balances – it must be, or else no resources would be transferred from private to public use. Considered as a tax, inflation is similar to a consumption tax (since money balances are used to provide liquidity for consumption) but more regressive, since high income households are likely to hold less of their assets in cash or near-cash forms. Either way, inflation is regressive when compared to an income tax with a progressive scale, or even a threshold.

Finally, the claim that government expenditure does not require taxation is politically pernicious. Even if it is true in some limited cases (I don’t think it is), the way it is made leads people to dodge the issue that taxation is the price of civilisation. One way or another we have to pay for what we consume, and it’s silly to try and dodge this. It’s particularly damaging to the extent that MMT is associated with the left. The last thing the left needs is to be portrayed as offering a deceptive ‘free lunch’, which is exactly what the misreading of MMT discussed here would seem to be.

92 thoughts on “Money for nothing?

  1. @PaulJ

    I’m thinking that you cannot have a capitalist economy without a government and/or a foreign sector.

    If so, then, how does this become sustainable merely by including these sectors?

    If the current account is zero, how does a government sector create a sustainable capitalist economy?

    It can create a sustainable socialist economy – but I cannot see how this works for a capitalist economy.

    The role of (I-S) + (G-T) + (X-M) = 0 should be unchanged if (X-M) is zero.

    Under socialism, government would not need to spend more than what it collects – so this term theoretically cn also go to zero at the same time as (X-M) is zero.

    So we end up with I = S. This causes no problems under socialism.

    However capitalism is different, and adding in all the MMT seems to miss identifying what is really going on.

    Under capitalism, I is not equal to S, because now I = (S + iou’s). This logic either results in a falling rate of profit to zero (ie socialism) or to a final GFC.

  2. @Chris Warren

    “I’m thinking that you cannot have a capitalist economy without a government and/or a foreign sector”

    Why would we have to have a foreign sector? The world economy is a closed system and it doesn’t have a foreign sector (we can’t trade with Mars yet).

    I think you would have to have a government sector. Of course if you follow to the end game where machines do everything and people aren’t needed to work then of course capitalism fails unless the government provides the people with money. I suspect any economic system is an artificial construct.

    “The role of (I-S) + (G-T) + (X-M) = 0 should be unchanged if (X-M) is zero.”

    It is.

    “Under capitalism, I is not equal to S, because now I = (S + iou’s). This logic either results in a falling rate of profit to zero (ie socialism) or to a final GFC.”

    Under capitalism with (G-T) = 0 in a growing economy I suspect capitalism would fail in the sense that unemployment would skyrocket. We would return to a subsistence level of existence for a large subset of the population.

    What do you mean by iou’s and how it relates to a falling rate of profit?

  3. IOU’s are essentially the increase in the money supply + increase in debt from banking [just call it ‘injections’]. In theory they do not have to emanate from banks, but modern societies require that they do.

    IOU’s flowing into a circular flow facilitate capitalist profit accumulating within the circular flow – provided workers wages are held steady. Under capitalism, workers as a whole only consume enough to balance the circular flow by borrowing (ie using IOU’s).

    The falling rate of profit is then automatic (everything else remaining equal) when these IOU’s also demand a return during the next cycle, plus repayment of whatever component becomes due.

    This may appear vague. With the amount of financial innovation our capitalists get up to, it is not possible to be definitive about what all injections are. Possibly some injections from government just go to fund pensions or stimulus payments.


    I = S + injections.

    So (I – S) cannot equal 0 under capitalism, because I is capitalised.

    Under socialism, I is not capitalised, so there is no need for injections. A capitalist would see the lack of injections as causing deflation. A socialist would see it as causing an increase in the purchasing power of wages.

    Socialism would have some injections but just to lubricate the cycle – not to monetise the extra production normally produced by growth and innovation [hence my point 2 noted earlier].

    The bottom line is that (I – S) = 0 only where there is no increase in debt. [Assuming no increase in population]

  4. Hi Chris,

    At the risk of misconstruing what you are trying to get at, I think the logical construction you are seeking can be found in an explanation of ‘horizontal’ and ‘vertical’ money; the maintenance of the target policy rate and fiscal sustainability.

    Bill Mitchell covers these topics from the MMT perspective in the ‘Debriefing 101’ section of billy blog.

    Not many people are willing to do it I know, but sometimes you just have to settle down and read, gather up the facts – before you can frame your questions in the context of the subject (MMT) rather than in the context of your own understanding which at this stage is not inclusive of the subjective approach. JohnQ’s post above is a good example of this ….(am hoping, he too through the comments offered and the literature extant of his peers – and equals – will resolve to dig deeper).

    Another factor of course, is new tunnels have to be literally ‘dug in the brain’. Once again, this makes people feel uncomfortable and reactive. The sense of self (a polite way of saying ego) is bound to the old paths! It takes a little bit of discipline and focus.

    ‘There is no religion higher than a truth’ – including the religion that is frocked up as economics.

    MMT is just one of those subjects, but well worth a thorough dig! Sorry to be so nebulous, but blog commentaries are more like signposts than anything else and everybody has to do the work for themselves as you know.

    Cheers ….

  5. @PaulJ

    I suppose (for clarity’s sake) we can assume there is no government. Then it has to be private, because all economic activity is then private.

    Anyway, S + I = k where k is a balancing item driven by the increase in debt (not debt itself).

    This seems closest to reality.

  6. @Chris Warren

    I am beginning (I think) to get a blurry picture of what you are driving at.
    Correct me if I’m wrong, but you seem to be inferring that continuous growth in profits is unsustainable when financed (or not) by incurring debt to drive investment.

    Also it is unsustainable under conditions where gains from increases in productivity do not accrue proportionally to wages.

    If that’s what you are saying then we are in agreement and have been from the beginning. (But this has little to do with MMT. MMT is just a tool to clear the fog obscuring the inner workings of the economic system). Sustainability of various activities that change the equilibrium of the system must be evaluated separately.

    Further, it appears to me that if there is no direct government spending profits would eventually lead to the overall economy eating itself as money is extracted and set aside (accumulated as wealth). This is essentially what is happening in the Eurozone.

    To clarify another point, when you say…

    “So (I – S) cannot equal 0 under capitalism, because I is capitalised.”

    (I-S) is a snapshot of a flow at some instant in time thus it can be zero by definition. If you look at the sectoral balances chart you will see that it has crossed the zero line several times.

    Debt is a component of Investment (spending on plant, equipment and wages). Debt is also a component of consumption spending but consumption is canceled out in the derivation of the sectoral balances relationship.

    I am having trouble getting from there to the idea that (i-S) cannot be zero. I can see where debt can exert a force on the system, moving the equilibrium toward growth but I fail to see why you think it can’t be accounted for.

  7. @Chris Warren

    In the absence of the government and foreign sectors by definition I = S however I is not constant in time. Such a system can still in theory grow because it is not S what determines I but the other way around. Whether the system would be stable or converge to full employment is another issue (it is known to not converge to full employment in some cases).

    The explanation of this is simple but requires throwing away the loanable funds market theory. (That market is supposed to equlibrate S and I). Money is not only monetary base but also deposits in the banking system.

    Investment is also financed by the new loans extended by the banking sector. Deposits are created “ex nihilo” on the balance sheet of a bank (obviously if certain conditions are met). We know that banks do not lend reserves (the multiplier story is incorrect) but rather seek reserves after extending loans.

    These deposits are initially spent on buying capital goods and then circulate in the banking system until being either finally saved by someone as a long-term deposit or used to repay a loan (destroyed).

    Assuming no repayment, the derivative of the stock of loans dL/dt is equal to an additional monetary flow adding to the investment financed from retained profits.

    I recommend reading “Theory of Economic Dynamics” by Michal Kalecki and papers published by prof Kazimierz Laski (WIIW – Vienna).

  8. @Chris Warren
    Chris, you have one of the signs wrong. The public sector deficit should have a positive sign, not a negative one. If you change the signs, you will see that the sums sum up correctly.

  9. @Rich C

    If the identity has explanatory relevance then it would need to explain a long-run, general sinking in the aggregates of CPI, Ue, CAD, public sector borrowing.

    This is clear see:

    Producing a three-cornered identity, where one seeks to respond to the gaps of the others, does not really assist.

    If you define A=B, C=D, E=F, then always

    A-B + C-D + E-F = 0

    However when you look at it closely, for example, savings does not equal investment because of increased debt. There is no economic reason for exports to equal imports.

    Not only this, but there is still the fundamental issue of a general sinking trend as, based on the link (above).

    Maybe the question should be asked: If there was no government, why would S-I, and X-M, total to zero particularly if extra debt (IOU’s) is thrown into the system?

    Having a government sector (ie injector of money) – as a balancing item of last resort – seems to blur what is really going on.

    In fact presumably you do not need a government – just a central bank.

    If I S, and M X, then, hoping that an adjustment by a Central Bank can fix this in a meaningful way, is fraught with logical difficulties. Exponential growth in M3 could result.

    I would expect that this would happen even if there was no foreign sector.

    In fact, the National Accounts showed that:

    (S – I) + (X-M) + [statistical discrepancy] = 0, for all of 1973 to 1987. [ABS 5204.0]

    The university lecture room theory was “that any shortfall in saving by the domestic sectors must be made good by the overseas sector”. [See Dudley Jackson, The Australian Economy, pg 673] and table 13.1.

    The underlying textbook belief is that “total value added must be equaled by total value supplied”. It is but only when you add in “net lending”.

    But this does not mean that the total prices paid equals the total prices received. But with a bit of innovation I suppose you can define money in such a way to produce this outcome if you add in a balancing item.

    Anyone would agree with the 3- cornered identity:

    Income – costs + net lending = 0

    But then this does not help when net-lending balloons out of control.

  10. Irrespective of the interpretation of the MMT, the theory has nothing to offer on the actual problem, namely the international financial system, including the lack of an adequate and appropriate financial transactions recording system.

    Here is yet another example of the actual problem – Dexias’s latest gambling debts.

    Note, the Greek public debt ‘crisis’ is not the critical problem in Dexia’s mess. Those who have some understanding of the relative size (population, trade, GDP, even debt) of Greece in the EU may have always doubted that Greece can ‘destabilise’ the Euro.

    The point regarding the inadequate financial transactions recording system is that governments cannot exercise discretion on the transactions which do not warrent ‘bailing out’ and those which do for economic reason. It is as if the casino element operates without a licence.

  11. It would seem to me that governments puts money into an economy and take it out countercyclic to when the private sector is putting it in and taking it out. Or at least that is what Keynes said a sane government should do.

    A government borrows (takes it off people who aren’t using it) when they put it in, in short they make dam sure the private sector is not going to put it in because they don’t have it any more (the right focus on this) and they give it back when the private sector is investing heavily, making sure the private sector has enough money to really get a good bubble going.

    It’s easy to say, simple solution; when the money supply has to be expanded just flip the bits in the computer and start spending soak up that spare labour, the question is, how do you pull the money back out.

    The answer is for the government to lend it. Have the reserve bank buy up bank debt (oh wait they are doing that) when things need to be pumped up, so the bank can lend more, insist the banks buy the debt back when the economy takes off (what? they are doing that!).

    If the government creates money to build a bridge when the private sector goes on holidays, how do you shrink the money supply when all that money sloshing around (held in gold bullion or whatever) starts working again. Solve that and MMT might work.

  12. Ernestine. true, but is it true that MMT offers “something from nothing” in a finite world and thus we are getting to something better dealt with by metaphysics?

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