By Phil Armstrong, University of Southampton Solent and York College.
The UK government’s significant fiscal expansion – in line with its ‘do whatever is required’[1] mantra – is, of course, welcome. However, I would argue that it is still far too small to deal with the massive demand shock associated with the coronavirus pandemic (Mitchell 2020a, 2020b) and also that it is incorrectly targeted. It pays insufficient attention to the poorest groups in society; the government has failed to take the necessary steps required to ensure the income of those most in need is adequately supported during the crisis. Clearly, the situation is evolving on a daily basis and, looking forward, it is highly likely that there will be continual calls for the government to increase its fiscal intervention from many sectors in society – not least business leaders who fear the effects of rapidly declining demand.
However, I would stress that the intervention is being enacted against an inapplicable theoretical and ideological backdrop, specifically the mistaken neoliberal framing of the so-called ‘government budget constraint’ (GBC). The logic of the GBC conceptualises the government as a currency-user, which might finance its spending by taxation, by borrowing (debt issuance) or ‘printing money’ (Mitchell 2011). According to mainstream thinking, each of these methods carries problems; increased taxation reduces non-government sector spending power and allegedly generates disincentive effects, ‘excessive’ borrowing leads to higher long term interest rates, in turn, causing ‘crowding out’[2] and ‘money printing’ inevitably results in inflation. There is also an underlying ideology implicit in neoliberalism; that state expansion soaks up real resources which would be better (or ‘more efficiently’) used by the private sector.
In extremis, it appears that the Conservatives (who have shown a marked distaste for expansionist state intervention in the recent past) and even business leaders who would normally be opposed to increased government spending and enlarged deficits are now prepared to put their weight behind the fiscal expansion[3]. However, the underlying framing based upon the GBC is likely to come back to bite us all – hard – in the future. In line with the erroneous conceptualisation of the state as a currency-user, the government is presenting its current additional spending as being ‘financed’ by borrowing. The story is founded upon the idea that the government needs to spend significant extra sums now – owing to the severity of the crisis – and heavy borrowing is, therefore, essential (reinforced with the contention that it is cheaper for the state to borrow now than in the past as long term interest rates are very low) in the manner of household who accepts a very large credit card bill because there is no other way it can survive[4].
However, following this line of thinking will lead to a damaging and erroneous conclusion. It is highly likely that in the future – when the crisis has passed – mainstream economists will argue that there is a financial ‘mess’ to fix; ‘unacceptably’ large public sector deficits may well persist beyond the crisis alongside an ‘excessive’ national debt as a proportion of GDP. The narrative will then, no doubt, suggest that they need to be ‘dealt with’– possibly with another, even harsher, round of austerity than last time – and it will those least able to cope who are most likely to be the ones asked to bear the greatest share of the burden (as was the case the last time austerity was imposed).
This conceptualisation of the government as a currency-user suggests that money printing and bond issuance are alternative ways of financing a deficit, however, advocates of MMT conceptualise the state as a currency-issuer. From this viewpoint, in reality, they are not alternatives. The government always spends by the creation of new money – both taxes and borrowing logically and historically follow spending (or lending). Only money that has already been issued by the state can be collected in taxes or used to buy state debt. When the government spends, it does so by crediting the bank accounts of its target recipients, simultaneously increasing the target’s bank’s reserve account by the same amount. When taxes are paid by a private sector agent, her deposit balance falls and her bank’s reserve account balance at the central bank (CB) is correspondingly marked down[5]. The purchase of government debt is best conceptualised as a reserve drain (Mosler 2012) which changes the composition of non-government sector holding of risk-free state debt but not its size.
I would argue that having this correct conceptualisation is the key to avoiding the return of austerity. In reality, the government sets its aims, determines its budget and spends by the ex nihilo creation of new money. When the operational reality of the financial system is correctly understood, then the expectation of a post-crisis ‘mess’ to fix disappears. Once the economy has recovered, that does not necessarily mean a need for austerity or even fiscal retrenchment – only the post-crisis economic outcomes such as growth, employment and price stability matter. If unemployment persists after the crisis has passed, then government net spending should still be regarded as being too low, irrespective of the size of the government deficit both in absolute terms and as a proportion of national income. Only in an economy suffering from inflation from excess demand would fiscal contraction be required.
These are challenging times for us all, but in the current crisis we have the opportunity to push forward the insights of MMT and to challenge established thought – particularly with respect to the inapplicable government budget constraint. If our understanding of the operational reality of the monetary system can be characterised by the insights of MMT, the full scope of existing fiscal space can be understood and importantly, the likely post-crisis push for fiscal retrenchment can be effectively countered.
[1] See Islam (2020).
[2] The crowding hypothesis is based on the contention that higher interest rates will lead to lower private sector investment, meaning that large government deficits effectively ‘crowd out’ private investment. Little, if any, empirical support for this hypothesis exists (Armstrong 2015).
[3] For example, Richard Branson expressed his support for fiscal retrenchment in 2010 (Stratton 2010) but changed his mind in 2020 when arguing in favour of a £7.5 billion government support package for the airline industry (Hockaday 2020).
[4] ‘We are in an entirely new world. A wartime effort, with wartime deficits to cover it’, Rishi Sunak, quoted in Islam, F., BBC News online, 17 March 2020.
[5] It is important to stress that private sector debt or bank money cannot provide the final means of settling a tax bill which occurs when a taxpayer’s bank’s reserve account at the central bank is debited in favour of the Treasury account (Armstrong 2019).
References
Armstrong, P. (2015), ‘Heterodox Views of Money and Modern Monetary Theory (MMT)’
https://moslereconomics.com/wp-content/uploads/2007/12/Money-and-MMT.pdf
Armstrong, P. (2019), ‘A simple MMT advocate’s response to the Gavyn Davies article ‘What you need to know about modern monetary theory’, Gower Initiative for Modern Money Studies,
https://gimms.org.uk/2019/05/27/phil-armstrong-gavyn-davies-response
Hockaday, J. (2020), ‘Airline bosses to ask for £7,500,000,000 bailout to survive coronavirus.
The Metro online, https://metro.co.uk/2020/03/14/airline-bosses-ask-7500000000-bailout-survive-coronavirus-12399300/
Islam, F (2020), ‘Coronavirus: Chancellor unveils £350bn lifeline for economy’, BBC News online, 17 March, https://www.bbc.co.uk/news/business-51935467
Mitchell, W. (2011), ‘Budget Deficit Basics’ 4 April
http://bilbo.economicoutlook.net/blog/?p=14044
Mitchell, W. (2020a), ‘The coronavirus crisis – a particular type of shock – Part 1’, March 10,
http://bilbo.economicoutlook.net/blog/?p=44484
Mitchell, W. (2020b), ‘The coronavirus crisis – a particular type of shock – Part 2’, March 11,
http://bilbo.economicoutlook.net/blog/?p=44488
Mosler, W. (2012), Soft Currency Economics II, US Virgin Islands: Valance
Stratton, A (2010), ‘Richard Branson backs Tory plans to cut spending sooner rather than later’, The Guardian, 16 February,
https://www.theguardian.com/politics/2010/feb/16/branson-back-tory-deficit-cuts
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Excellent piece. We really need to get away from this notion of Government ‘borrowing’. There is nothing going on here that the average person in the street would refer to as ‘borrowing’ if they were informed about how Government spending works.
The government ‘issues’; it does not ‘borrow’ in any common sense notion of the word.
If people are that bothered by the idea of the National Debt (another misnomer) increasing, we could always issue fewer gilts rather than matching them to the so-called ‘deficit’.
‘Borrowing,’ ‘debt’, ‘deficit’ – these words all have negative connotations in people’s minds because they think about them in terms of their own personal or household spending. They don’t apply in the same way to the UK Government.
Thanks, John.
The real “National Debt” is the one created by unbalanced international trade and the accrual of current account deficits. The current account debt and deficit goes across national boundaries and between national currencies. The fiscal debt and deficit is local so in what way or sense can it be claimed to be “National” ?
The National Debt (or total govt. debt.) equals the total net saving of the non-government sector (whether held domestically or overseas).
The current account deficit (CAD) represents a foreign desire to net save in our domestic currency. There is no ‘imbalance’ involved. If overseas sellers have a desire to net save our currency then we can run a CAD, if they don’t then we can’t!