’We do not need to fix our debt. We need to fix our thinking’

Economist Stephanie Kelton argues for a radical shift in economic thinking to better deal with crucial challenges societies face—from poverty and inequality to creating jobs and reversing global warming.

There are two stories about the origins of modern money. One is the story as most of us know it: Money started as shells to facilitate barter between, say, fishermen and farmers. Gradually coins replaced the shells. In that popular story, governments do not create money. The other story is that taxes were the vehicle that allowed ancient rulers to introduce their own currencies. In this story, the king—the government—needed to create the money for their subjects—citizens—to pay taxes demanded by the ruler. Because of the tax liability, people started looking for work to be paid in the king’s currency.

More and more historians and anthropologists support the creation of money for taxation story. The history of money matters and lies at the root of a current conversation between economists with profound implications for the lives and needs of people around the world. If one accepts that states have always created money at will—unrelated to the amount of taxes they required back—, one is free to think what a state may do with money it creates now. The state can create money to facilitate transactions for the benefit of everyone in society. In that vision, money creation is not dependent on tax income. Money becomes a tool for the people instead of an instrument for governments to fix their budgets. 

The vision leads to a radical shift in economic thinking. All individuals know they cannot spend more than they earn. Such a lifestyle ultimately leads to bankruptcy and, if individuals autonomously begin to create their own—counterfeit—money to pay their bills, they end up in jail. States, however, can create money without going bankrupt, argues Modern Monetary Theory (MMT), a relatively new economic theory that is fast gaining influence. Stephanie Kelton, professor of economics at Stony Brook University in the United States, is a leading proponent of MMT and author of the recent bestseller The Deficit Myth (see excerpt on page 50). She was an advisor to Bernie Sanders’ 2016 presidential campaign and subsequently became part of Joe Biden’s economic team.

“We always hear that a government ought to operate its budget as a household. It is a familiar story that resonates with us. But the reality is that the story is wrong. It is backwards,” says Kelton. She points at the big difference between a government and everybody else: the government is the issuer of the currency; the rest of us are currency users. Currency users have to live within their means, they can run out of money. The currency issuer, however, can create money when there is a need for it, he cannot go broke. Kelton: “The currency issuer gets to operate his budget differently from the rest of us”.

It sounds like heresy, and the truth is that many leading economists dismiss MMT as fantasy economics. It is also true that most economists tend to avoid ‘the money question’, arguably the very key economic topic that impacts the daily lives of most of us. Who does not wonder why there always seems to be work that needs to be done but not enough money to pay someone to do it? Why is there not enough money in society to facilitate the transactions we all need?

Critics argue that MMT offers a vision of ‘free money’. Governments can simply keep printing money to meet their challenges. Kelton dismisses this criticism: “There are limits. However, the limits are not in a government’s budget deficit, but in inflationary pressures. A government should not be worried about running out of money. The only concern is that you do not want to cause inflation.”

Kelton is fierce in her own critique of mainstream economic theories. In The Deficit Myth she writes about the United States (but the same applies to most western governments): “The federal government has historically almost always kept its deficit too small. Yes, too small! Evidence of a deficit that is too small is unemployment.” In other words: Governments cause unnecessary suffering when they do not bring enough money into circulation. 

That perspective goes back to the theories of John Maynard Keynes who—during the Great Depression in the 1930s—argued that free markets alone could not provide full employment. Keynes reasoned that total spending in the economy determined the overall level of economic activity (employment) and that governments had to step in with fiscal and monetary policies to mitigate the negative impact of economic cycles. In the 1970s, Keynesian thinking lost influence when the world economy was confronted with economic stagnation and inflation at the same time—mostly because of spiking energy prices as a result of a politically engineered cartel of oil-producing countries. Keynes’ policies did not offer a solution for that combined challenge.

Milton Friedman and other ‘monetarists’ stepped into the void with their vision that governments—apparently—could not favorably regulate business cycles through the coordination of fiscal and monetary policies. Instead, they should focus on monetary policies only and monitor and regulate the money supply. Through controlling the growth of the money supply, they could control inflation.

However, the economic response of the monetarists is also increasingly proven to be insufficient or ineffective. During and after the financial crisis of 2007-2008 governments’ deficits and debts exploded without causing inflation. Consequently, the question arises whether the famous ‘austerity policies’ as advocated for decades by organizations like the Internal Monetary Fund (IMF) and the World Bank, and conservative politicians around the world were necessary at all?

Indeed, recently during their 2020 annual meetings IMF and World Bank—in response to the Covid19 pandemic—seemed to bury austerity. After decades of fiscal orthodoxy in response to the inflation of the 1970s, the international financial institutions are encouraging a new fiscal activism. As one World Bank economist says: “First you worry about fighting the war, then you figure out how to pay for it.” And the head of the IMF, Kristalina Georgieva, borrowed a line from Russian novelist Fyodor Dostoyevsky: “Only one thing matters—to be able to dare.”

The words must have been music to Kelton’s ears. “I am tired of waiting”, she said when we spoke over Zoom earlier in 2020. In her vision it is clear that traditional economics has failed to deliver the best possible outcomes to society. “Things are falling apart. We have two options: We can pick up the pieces and try to reassemble them to look like they looked before. Or, we can put the pieces together in new and different ways pushing us towards a future where people have better, more secure and more stable employment.” As she writes in the first pages of her book: “What if I can convince you that we can have an economy that puts people and planet first? That finding the money to do this is not a problem.”

Contrary to her critics’ accusations, it is not a reckless exercise. The first objective of economic policy should be to balance the overall economy—not the budget of the government. Kelton: “When we run our economy below its productive capacity, it means that we are living below our collective means. The government budget might be in deficit, but we are underspending whenever there is unused capacity.” Underspending means that there is not enough money in the economy to pay for work that can be done, for jobs that can be generated, and for prosperity that can be shared. “The way governments have used and misused the power of the public purse has led to decades of gratuitous suffering”, she argues. Her point is that as long as a government deficit does not push inflation higher, that deficit should not be labeled as overspending. The government is not a household (see page 50).

We are used to politicians running to government budget agencies with their plans to have the deficit and tax consequences calculated and projected. That leads to questions like: Can we afford to invest billions in new infrastructure projects? Will we see increased economic activity as a result of these investments that will generate higher tax revenue? Kelton: “I would not ask these questions. I would not try to raise taxes or carve money out of some other budget area to pay for investments in infrastructure. I would only want to know whether the economy can safely handle the spending—would growth pick up, would unemployment go down and would inflation stay within the 2 percent target of the central bank? You need to do a careful analysis of the inflation risk.”

Kelton argues that “the best defense against inflation is a good offense”. Today, politicians are not talking or thinking about inflation risks when they are voting for new spending. For instance, there is a Congressional Budget Office (CBO) in the US, but not a Congressional Inflation Office. In Kelton’s vision, that should change.

Before the pandemic hit, employment in the US was about 3.5 percent, the lowest level in the past 20 years. At the time, many economists said the US economy was at full employment. However, as Kelton explains, a team of financial analysts investigated the economic situation and published a report stating that there was about $500 to $600 billion “non-inflationary fiscal space” left in the “full employment” US economy. “You can do a lot with half a trillion dollars in government spending”, she says.

One of the most revolutionary elements in Kelton’s economic policy is the “job guarantee” provided by the government. Based on the priorities of local communities, the government determines which work needs to be done. Existing job centers keep a list of jobs that anyone who lost their employment can sign up for with a guaranteed minimum income. Kelton gives a pandemic-related example. If the government decides that it is in the overall interest of society that people shelter in place, it could define a job as “stay at home and help us flatten the curve and save lives”. 

Kelton presents the job guarantee as an “automatic stabilizer” for the economy. During an economic downturn, the system automatically pushes money into the economy. “MMT fights involuntary unemployment by eliminating it”, she writes. Moreover, because the job guarantee smooths the ride through the inevitable boom-bust cycle, it helps to stabilize inflation. The argument is that the more economies swing, the more prices move in response. “The job guarantee also helps to stabilize inflation by anchoring a key price in the economy—the price paid to workers in the job guarantee program”.

As governments keep ‘investing’, state debts keep growing. For example: In 1990, US national debt totaled just over $3 trillion, which equaled about 50 percent of GDP at the time; today the debt stands at $27 trillion or 135 percent of GDP. That comes to more than $80,000 per US citizen as the debt clock on Times Square in New York City keeps reminding bypassers. Politicians echo the message: We need to get our fiscal house in order; we face tough choices; we need to tighten our belts, et cetera. 

“The truth is, we are fine”, writes Kelton in her book. “The debt clock on West 43rd Street simply displays a historical record of how many dollars the federal government has added to people’s pockets without subtracting (taxing) them away. Those dollars are being saved in the form of US Treasuries. If you are lucky enough to own some, congratulations! They are part of your wealth. While other may refer to it as a debt clock, it is really a US dollar savings clock.”

This is the point where MMT challenges almost every brain. How can such a huge debt not be a problem? How can the same debt be seen as savings? In fact, Stephanie Kelton herself was skeptical when, as a graduate student of economics at Cambridge University, she was first introduced to this perspective by a Wall Street investor named Warren Mosler. “I remember thinking: This absolutely cannot be correct.” She did extensive research to disprove MMT. Instead, she became its leading champion. “We do not need to fix our debt; we need to fix our thinking”, she says provocatively. “Why do we insists on speaking about government deficits? It is every bit as much a surplus.”

Take an example. A government spends $100 into the economy but it only collects taxes for $90. The missing $10 is called the ‘government deficit’. At the same time, the government has ‘invested’ that $10 in another part of the economy where it has created a ‘surplus’. Habitually, governments sell bonds—treasuries—to match their spending ‘deficit’. They remove $10 in cash and replace it with a $10 bond. The important point is that the $10 that is needed has been supplied by the government’s own deficit spending: The currency issuer is self-financing, Kelton explains. The government is not selling bonds because it needs the dollars. Bond sales just allow holders of cash dollars to trade them for interest-bearing treasuries. Kelton: “It is not borrowing. It is recycling dollars into an interest-bearing form. It is done to support interest rates, not to fund the government.”

The interest payments become part of the government’s budget. That is where most lawmakers get confused. The higher the budget amount for interest payments, the less money seems to be available for important government programs like education, health care, renewable energy et cetera. However, according to MMT, rising interest payments function as a ‘fiscal stimulus’—more money is brought in circulation. The people who receive the interest can spend that income back into the economy. At the same time, if politicians want more money for government programs, they can simply authorize a larger budget with a larger ‘deficit’. There is no need to increase taxes. The only—very real—limit to the money circulation is inflation.

Kelton says that governments that issue their own currencies do not have “real debt obligations”. There are bad examples of inflation and debt crises from the German Weimar Republic and Argentina in the past to Greece and Venezuela more recently. All these cases have in common that governments own money in gold or foreign currency—not in their own sovereign currency. It is often argued that the US is vulnerable because China owns such a large part of the US federal debt. Kelton is not concerned: China only holds some 7 percent of outstanding US bonds. However, more importantly, China needs dollar assets—that is US currency with interest controlled by the US Federal Reserve Bank—to maintain its trade surplus with the United States. 

Another ‘mind-blowing’ part of MMT-theory is that any state debt can be wiped out with a simple bookkeeping exercise. A central bank can create the necessary money and purchase the entire stock of outstanding government bonds without any cost to tax payers. In the prevailing monetary theories, such a move would have devastating inflationary consequences. However, Kelton argues that canceling the state debt has no effect on the net wealth of a country and does not cause inflation. The people who were holding interest-bearing bonds, now have cash. The difference is that they are no longer receiving income (interest). And because they lose that income, it is very unlikely that they are going to go on an inflation provoking spending spree. To the contrary, lower income as a result of the loss of the interest payments will tend to push prices lower. 

Lowering the income of its citizens is not a successful government policy. Kelton concludes: “Paying down government debt is not a virtue. It is a leak. It is how money leaves the economy.” There is nothing inherently dangerous for a ‘currency-issuing’ government to offer a safe, interest-bearing way for people to hold on to their currency through owning bonds. There is no debt. There are only different types of money circulating in the economy. “The idea that taxpayers are funding what governments spend is pure fantasy,” she says.

There is still a place for taxes. The foremost MMT argument for taxes is that—going back to the ancient rulers--they legitimize the government currency. They can also help prevent that government spending creates inflation. When people begin to spend too much, raising taxes will temper their purchasing power.

Finally, taxes are important to redistribute wealth. “The government does not need Jeff Bezos (Amazon)’ money to eradicate poverty, but the government may decide that an extreme concentration of wealth and rising inequality are problematic and unhealthy for society,” says Kelton. Taxing the super wealthy is especially critical because current statistics show that the money that accumulates with them is not matched by a rise in investments. 

With a new president in the US, the days for MMT to shape the economic policies of the world may have come. Leading economists may still reject the theory. However, at the same time, one can argue that as a practical policy MMT is already being deployed. First in the financial crisis of 2008 and now in the Covid19 pandemic, central banks have taken an aggressive role in making sure they keep supplying economies with enough liquidity disregarding—short term—debt concerns. The policy is now even supported by the IMF that stimulates countries to issue debt and to spend money into economies without worrying about the looming danger of austerity in the future. The approach comes straight out of the MMT playbook. 

Economics is still struggling to capture the dynamics of market capitalism. The responses as designed first by Keynes and subsequently by Friedman have proven to be incomplete. That alone should open the door for MMT to offer new ways to regulate economies and control inflation. Beyond the debate between economists, lies an opportunity in the interest of all to—in the words of Kelton—“judge policy by the way it works, and to look beyond narrow budgetary impact: does it control inflation, sustain full employment, and bring about more equitable distribution of income and wealth?” 

Ultimately, economic policies should be designed to solve problems. Kelton lists a series of big crises in the United States in her book: from the painful fact that more than 20 percent of the children in America live in poverty to the country’s crippling infrastructure and from the millions of ex-students saddled with $1.7 trillion in student loan debt to a—because of supposed lack of money—failing response to global warming. “These are real crisis. The national deficit is not a crisis”, she says. “We do not have a debt problem. We do not have a deficit problem. We have a language problem.” [JK]

More information: stephaniekelton.com