Government can print money to fund

Recently, economists such as Stephanie Kelton, who belong to the economic school called modern money theory (MMT), have been trying to get governments to realize that the idea that they have to come up with money before they can spend is reverse logic. In reality, spending itself creates money.23 The thinking builds on the work of Hyman Minsky, who wrote about the theory of money beyond the notion that it simply oils the wheels of commerce. Here’s how it works when applied to governments that are issuing their own currency, and are thus the monopoly issuers of that currency. The process logically starts with government spending/investing money. This is obvious, given that citizens cannot get their hands on money that is issued by government if the government had not spent or lent it into existence in the first place. Every time the government spends money, it taxes some of it back afterwards. If the government spends £10 and taxes £4, it can be said to be in deficit by £6. But that £6 is also in the hands of people and businesses. They are £6 better off. The other side of a government deficit is a private surplus. In other words, the government’s and the private sector’s balance sheets must be mirror images of each other (it is more complicated when we include exports and imports, but we do not need to do that for this discussion). A government deficit ‘blows’ British pounds onto balance sheets, while a government surplus ‘sucks’ pounds off balance sheets. A sustained fiscal surplus means constant sucking, which means that the private sector is losing financial assets, as maturing bonds are not reissued. Thus, fiscal surpluses weaken private-sector balance sheets.

It is useful to consider how budgeting actually works. A government department must first decide what it wants to do – and hence what missions are worth pursuing. Then it must persuade Parliament or Congress to accept a line in the national budget dedicated to that mission. If Parliament or Congress is persuaded, the relevant agency appropriates the budget and gets on with the job. Reducing or removing a budget in one department does not necessarily mean that more money is created for another department. Cutting NASA’s funding in the 1960s, for example, would not automatically have released more cash for the US Agency for International Development or Department of Health and Human Services.

What happens to the money government is spending when it gets into private hands? Much of it is invested in government bonds. Unlike mere pounds or dollars, these bonds pay interest at a guaranteed rate. They are also highly liquid. In fact, government bonds are the lynchpin of the financial system and the core of many portfolios: pensioners who complain about government profligacy are probably living off income partly derived from government bonds. The national debt, which so exercises many politicians and citizens, is actually the historical accumulation of money spent by government, not taxed back, and now a privately held asset.24 Government red ink equals private-sector black ink.

In 2020, events around COVID-19 took this theory of money creation in an unexpected direction. In March that year, the US Congress was terrified that the coronavirus pandemic would cause an economic disaster to rival the Great Depression of the 1930s. It voted for a $2 trillion rescue package. And the Governor of the Bank of England, Andrew Bailey, revealed in June 2020 that the bank had bought £200 billion worth of UK government bonds in April because there was a danger that the government could become insolvent.25 What set the US package apart, however, was not just its size. It was the absence of an offset. When Congress agrees to spending measures, it usually sends two instructions to the Federal Reserve. One is to add dollars by computer to the credit of the US Treasury, which distributes the dollars to be spent as agreed. The other is to subtract dollars in the form of agreed taxes. In the case of the $2 trillion package, however, the instruction was only to add dollars. Money was indeed created out of thin air.

While there are many controversies around who actually benefits from the relief packages, with many arguing that too large a part of the funds went to bailouts for companies rather than to proper relief for workers and citizens, the exceptional size of the package raises fundamental questions about the choices we have during more normal times. On an average night in the 2000s, about 500,000 Americans are homeless. Why had Congress never been able to find money to house them? Or to feed millions of hungry children? Or to provide clean drinking water for the residents of Flint, Michigan and other places who have been plagued for years by polluted water supplies? Why, for that matter, given the pandemic, had Congress not ensured that the USA had a health-care system that adequately covered the entire population? There are, of course, political answers to these questions – answers often to be found in the power of lobby groups. But the choices are not principally financial because, as we have seen, sovereign governments can (and do) create money.26 What convinces them to consider something urgent enough to be acted on without asking the false question: is there enough money in the piggy bank to do it?

Of course, this does not mean that money can or should be created without limit. The real question is, what is the limit? The answer is inflation and how much of it can be tolerated. The key issue, as Greenspan explained, is how productive the spending is. Social security can look like a Ponzi scheme because the number of workers per social security retiree in the USA has fallen from 16:1 in 1950 to about 2:1 today. But if those two workers are much more productive than their sixteen grandparents were in 1950, the pensions will go on being paid. Similarly, as long as additional spending fuelled by government money creation does not bump up against the real resources of the economy – supply of workers, factories, machines, raw materials, technical know-how and so on – the risk of excessive inflation is low.27 And of course that supply is not static – it can grow. Investments in physical capital (machinery, factories) and the underlying organizational and technological innovation can expand capacity.

There is no reason why investing and spending will cause inflation as long as the economy has room to grow and is not running at full capacity (human and physical). This means that making investments which expand the economy due to their strategic nature (patient, long-run and mission-oriented) – as opposed to investments that just pour money into a static economy – rarely cause inflation. They expand the pie rather than increase the money in an existing pie.