Debt/Deficits Disadvantage Answers

Congress can fiat spending on anything it wants

Dr. Stephanie Kelton, 2020, Stephanie Kelton is an American economist and academic. She is currently a professor at Stony Brook University[1] and a Senior Fellow at the Schwartz Center for Economic Policy Analysis at the New School for Social Research[2]. She was formerly a professor at the University of Missouri–Kansas City.[3] She also served as an advisor to Bernie Sanders’ 2016 presidential campaign, . The Deficit Myth Kindle Edition.

There are two parts to the federal budget. There’s the discretionary part, over which Congress has, well, discretion to change the amount of money it puts into existing or new programs each year. Most of the money that gets spent on defense, education, environmental protection, and transportation comes from annual, discretionary budget appropriations. But there’s also a nondiscretionary or mandatory part, which is more or less preordained by statutory criteria. Spending on programs like Social Security, Medicare, and Medicaid fall under this category. Unemployment insurance, Supplemental Nutrition Assistance Program (SNAP, formerly food stamps), interest on US Treasuries, and student loans are also binding commitments that cause spending to rise or fall independent of congressional action. When someone becomes disabled, retires, loses a job, turns sixty-five, invests in US Treasuries, or takes out a federal student loan, federal dollars are automatically released to meet those expenditures. In total, mandatory spending accounts for just over 60 percent of federal expenditures, and interest accounts for nearly 10 percent.7 That means that 70 percent of the federal budget is essentially on autopilot, leaving just 30 percent under the discretionary control of lawmakers.8 Of course, with enough votes, Congress has the power to change any part of the budget. It could stop issuing Treasuries and leave it to the Federal Reserve to supply interest-bearing securities.9 Over time, that would completely eliminate interest expenditure from the federal budget.10 It could vote to pass a single-payer, Medicare-for-all bill that would substantially increase mandatory spending, while saving the rest of us trillions over time.11 Or it could simply appropriate more discretionary funding for things like transportation and education. As we learned in the first chapter of this book, Congress is a legal body with the power to suspend or modify any self-imposed constraint (e.g., PAYGO, Byrd rule, debt ceiling, 302(a) allocation, no overdraft, etc.) that might otherwise prevent lawmakers from appropriating funding or stop the Federal Reserve from clearing authorized payments on behalf of the Treasury. Even the CBO and the House and Senate budget committees, which were themselves created through an act of Congress Congress in 1974, could be dissolved or instructed to follow new protocols.12 And, of course, the Federal Reserve is a creature of Congress, with a mandate that is subject to change. Kelton, Stephanie. The Deficit Myth (p. 238). PublicAffairs. Kindle Edition.

We pay for stuff all the time

That might seem like a double standard. As Congresswoman Alexandria Ocasio-Cortez put it, “We write unlimited blank checks for war. We just wrote a $2 trillion check for that tax, the GOP tax cut, and nobody asked those folks, ‘How are they are going to pay for it?’”16 She’s right. Somehow, there’s always money for war and tax cuts. For just about everything else, however, lawmakers are expected to show that they can “pay for” their spending. At least on paper. Kelton, Stephanie. The Deficit Myth (p. 240). PublicAffairs. Kindle Edition.

Deficits don’t crowd out economic growth, spending frees-up more money for the private sector to save and invest

The fourth myth we’ll tackle is the notion that deficits are harmful because they crowd out private investment and undermine long-term growth. This myth is mostly circulated by mainstream economists and policy wonks who should know better. It relies on the faulty assumption that in order to finance its deficits the government must compete with other borrowers for access to a limited supply of savings. Here, the idea is that government deficits eat up some of the dollars that would otherwise have been invested in private sector endeavors that promote long-term prosperity. We will see why the reverse is true—fiscal deficits actually increase private savings—and can easily crowd-in private investment. Kelton, Stephanie. The Deficit Myth (p. 10). Public Affairs. Kindle Edition.

Every dollar of debt creates money and savings in the private economy

It’s a most powerful observation, and one that deals a fatal blow to the simple crowding-out story. To see why, let’s translate Godley’s model into even simpler language. We’ll need just two buckets. The goal is to look at the part of the crowding-out story that claims that government deficits eat up part of our savings. First, let’s look at an example of how financial payments move between the two parts of our economy. Suppose the government spends $100 on a fleet of new vehicles for the presidential motorcade. The vehicles will be produced by workers and businesses in the nongovernment part of the economy. Every dollar the government spends has to go somewhere, and there is only one place those dollars can go—into the nongovernment bucket. Let’s also assume that the rest of us, collectively, pay the government $90 in the form of taxes. If these were the only payments made by and to Uncle Sam, the CBO would report that the government had run a fiscal deficit, and it would record a minus $10 in its annual budget report. But wait! That’s not all that happened. The government’s fiscal deficit is mirrored by an equal and opposite financial surplus in the nongovernment part of our economy. Uncle Sam’s red ink is our black ink! His deficit is our financial surplus. Just follow the money: $100 goes into our bucket; $90 goes back out to pay taxes; $10 is left in our bucket. Every fiscal deficit makes a financial contribution to the nongovernment bucket. Godley was a stickler for details. His models were, as he put it, stock-flow consistent. It’s a fancy way of saying that all of the financial contributions that flowed into our bucket over time would exactly match the stockpile of dollar assets we must end up accumulating. In other words, every financial outflow had to become a financial inflow, and over time, those flows must accumulate into corresponding stocks of financial assets. To grasp the point, think of your bathtub. Water flows into the tub when you turn on the faucet, and water flows out of the tub when you open the drain. If the water is draining at least as fast as it’s flowing in, the tub will never accumulate any standing water. But if you add water faster than you siphon it away, the water level will rise as the tub begins to fill. That’s what’s happening in Exhibit 3 above. The government is letting $100 dollars flow into our bucket and only siphoning $90 down the drain. The flow of red ink lamented by Jason Furman fills our bucket with dollars. Fiscal deficits don’t eat up our savings; they enlarge them! If Uncle Sam continues to deficit spend at this pace, he will drop another $10 into our bucket every year. Over time, those dollars will accumulate and build up our financial wealth. At this pace, a decade from now, we’ll end up with a stockpile of $100 in our bucket. We’ll get to the borrowing in just a bit. But first, let’s consider what would happen if Congress had followed Furman’s advice, eliminating budget deficits and running its budget on a PAYGO basis, as shown in Exhibit 4. Kelton, Stephanie. The Deficit Myth (p. 108). PublicAffairs. Kindle Edition.

Low deficits suck money out of the private economy

Once again, we’ve eliminated the dreaded red ink on the government’s balance sheet. Indeed, Uncle Sam is now in the black. But don’t break out the champagne just yet. Remember, on the other side of every financial surplus is a financial deficit of equal size. That means the government’s black ink became our red ink! The Clinton surpluses forced us to sacrifice some of the dollars we had been saving in our bucket. The crowding-out story gets it completely backward. It’s fiscal surpluses, not fiscal deficits, that eat up our financial savings. Why do so few economists bother to point this out? When the CBO publishes its annual budget outlook, they’re only telling half the story. They report the government’s current (and projected) financial balance, but they don’t bother to point out what it implies for those of us in the other bucket. They supply the data—big scary deficit numbers—that politicians and pundits use to terrorize the population, but they make no attempt to show how those deficits necessarily impact our financial balances. So, the public is bombarded with one-sided coverage that only looks at fiscal deficits from one vantage point. For example, in July 2019, the editorial board at the New York Post ran an opinion piece under the headline “Locking in a Future of Trillion-Dollar Deficits.”8 A year earlier, the Wall Street Journal had foreshadowed this with a similar headline: “Why Trillion-Dollar Deficits Could Be the New Normal.” The problem is that no one bothers to show readers how the pieces fit together. The government’s fiscal outlook is considered the whole story. It’s not…. To improve the public discourse, we need to think like a deficit owl. Those hawks and doves we met in Chapter 3 spend too much time squawking about red ink and not enough time helping the public to see what that red ink means for the rest of us. To see the full picture, you have to be able to look at the flow of payments from a different angle. That’s what makes the deficit owl a better budget bird. (Say that three times fast.) The owl has full range of motion: it can turn its head to see what the others are missing. A handy guy to have around if you want the entire picture. Godley was a deficit owl. That’s why he was able to see what so many others were missing as the government’s budget moved into surplus beginning in 1998. While Democratic politicians and the vast majority of economists cheered the Clinton surpluses, Godley sounded the alarm.9 Because his model didn’t leave anything out, he was able to see that the government’s surpluses were siphoning away a portion of our financial savings. As the president’s Council of Economic Advisers was busy drafting the infamous “Life After Debt” report,10 Godley was publishing reports that shined a spotlight on the private sector deficits that nearly everyone else was ignoring. He was virtually alone in predicting that the Clinton surpluses would undermine the recovery and ultimately drive the federal budget back into deficit.11 That’s because fiscal surpluses rip financial wealth away from the rest of us, leaving us with less purchasing power to support the spending that keeps our economy going. Godley’s approach shows that in purely financial terms, every fiscal deficit is good for someone. That’s because government deficits are always matched—penny for penny—by a financial surplus in the nongovernment bucket. At the macro (big picture) level, Uncle Sam’s red ink is always our black ink. When he spends more dollars into our bucket than he taxes away, we get to accumulate those dollars as part of our financial wealth. But who, exactly, is we? Kelton, Stephanie. The Deficit Myth (p. 111). Public Affairs. Kindle Edition.

There is no fixed savings amount for the government and the private sector to compete for

The financial crowding-out story asks us to imagine that there’s a fixed supply of savings from which anyone can attempt to borrow. Picture an enormous mountain of US dollars sitting in some corner of the world. Now imagine that those dollars were put there by savers, people who have dollars but don’t wish to spend everything they have. Savers make those funds available to borrowers, but only at a price. Savers earn interest on the money they lend, while borrowers pay savers for the use of those funds. It’s a straightforward supply-and-demand story, where the interest rate balances the demand for funding against the available supply. In the absence of government deficits, all demand comes from private borrowers. There’s still competition for these loanable funds, but companies are just competing with other private sector actors for a slice of the available supply.14 With no competition from Uncle Sam, all savings are used to finance private investment. But, if the government’s budget moves into deficit, Uncle Sam will lay claim to some of that cash. As a consequence, the supply of funds available to fund private investment is diminished, borrowing costs go up, and some companies are left without financing for their projects. It’s not government deficits, per se, but deficits financed by borrowing that supposedly leads to crowding out via higher interest rates. MMT rejects the loanable funds story, which is rooted in the idea that borrowing is limited by access to scarce financial resources. As MMT economist Scott Fullwiler put it, the conventional “analysis is simply inconsistent with how the modern financial system actually works.”15 To see why, let’s take a closer look at what’s actually happening when the federal government sells bonds in coordination with its deficit spending. Since MMT recognizes that the federal government doesn’t operate its budget like a household, we reject the (TAB)S model and use the currency issuer’s S(TAB) model instead. Remember, this model recognizes that the government is not revenue constrained (like a household) so it can spend first and then tax or borrow. Suppose Congress authorizes $100 of new spending. As the government begins making payments, those dollars flow into the nongovernment bucket. Let us again assume that $90 is used to pay taxes. As Exhibit 6 shows, the government’s deficit deposits $10 into the nongovernment bucket. If that’s all that happened, those dollars would simply sit in the form of digital or physical currency—green dollars. (Recall our use of green dollars from Chapter 1. Green dollars exist in the form of bank reserves or notes and coins.) If the government simply left us holding green dollars, it could run a fiscal deficit without selling the government bonds that end up adding to the thing we (unfortunately) call national debt. But that’s not the way things currently work. Under current arrangements, the government sells US Treasuries whenever it runs a fiscal deficit. This is normally referred to as borrowing, but as we learned in Chapter 3, that is very much a misnomer. That’s because the government’s own deficit supplies the dollars that are needed to purchase the bonds. To match its $10 deficit with bond sales, the government simply pulls 10 green dollars out of our bucket and recycles them into 10 yellow dollars—US Treasuries. Exhibit 7 shows the government removing green dollars from the nongovernment bucket and replacing them with interest-bearing government bonds.

When the whole process is over, Uncle Sam will have spent (S) $100 into our bucket, taxed $90 (T) back out, and transformed the remaining $10 into yellow dollars called US Treasury bonds (B). Those bonds are now part of the wealth that is held by savers at home and around the world. As Godley’s model reveals, government deficits always lead to a dollar-for-dollar increase in the supply of net financial assets held in the nongovernment bucket.16 That’s not a theory. That’s not an opinion. It’s just the cold hard reality of stock-flow consistent accounting. So fiscal deficits—even with government borrowing—can’t leave behind a smaller supply of dollar savings. And if that can’t happen, then a shrinking pool of dollar savings can’t be responsible for driving borrowing costs higher. Clearly, this presents a problem for the conventional crowding-out theory, which claims that government spending and private investment compete for a finite pool of savings. The reason the loanable funds story is not in sync with reality is that it asks us to treat the federal government like a currency user. When we reject this naïve lens, we see that countries like the US aren’t dependent on borrowing to fund themselves, nor are they at the mercy of private investors when they do sell bonds.17 Uncle Sam is not a beggar, who must go hat in hand, in search of funding to support his desired spending. He’s a muscular currency issuer! He can choose to borrow (or not), and Congress can always decide what rate of interest it will pay on any bonds it decides to offer. That’s not true of all countries, but it is true of those with monetary sovereignty.18 The distinction is incredibly important, for there is an element of truth in the conventional narrative that budget deficits can force interest rates higher. But we must be careful in telling that story. By focusing on the monetary arrangements and the actual mechanics of deficit financing, MMT helps us avoid an overly simplistic story about how this can happen. What matters most is the currency regime under which the country is operating. Unlike Greece, Venezuela, or Argentina, countries with monetary sovereignty are not at the mercy of financial markets. To see why, let’s take a closer look at what happens when a monetary sovereign like the US runs a fiscal deficit. MMT shows that the US government spends by crediting the reserve balances of private banks, which in turn credit the bank accounts of those receiving payments from the government. If you deposit $1,000 check from Uncle Sam, your bank will get a $1,000 credit to its reserve account at the Federal Reserve, and you will get a $1,000 credit to your own personal bank account. Payments made by you to the federal government have the opposite effect. For example, if you write a $500 check to pay your federal income taxes, your bank will subtract that much from your current balance, and the Fed will subtract $500 from your bank’s reserve balance. When the government is spending more than it’s taxing away, it leaves the banking system with a larger quantity of reserve balances. In other words, fiscal deficits increase the aggregate supply of reserve balances.

History proves high deficits don’t lead to higher interest rates

From 1942 until 1947, the Federal Reserve—at the behest of the Treasury Department—actively managed the government’s borrowing costs. Even as spending to fight World War II drove the federal deficit to more than 25 percent of GDP in 1943, interest rates trended lower. That’s because the Fed pegged the T-bill rate at 0.375 percent and held the rate on twenty-five-year bonds at 2.5 percent. As MMT economist L. Randall Wray put it, “the government can ‘borrow’ (issue bonds to the public) at any interest rate the central bank chooses to enforce. It is relatively easy for the central bank to peg the interest rate on short-term government debt instruments by standing ready to purchase it at a fixed price in unlimited quantities. This is precisely what the Fed did in the United States until 1951—providing banks with an interest-earning alternative to excess reserves, but at a very low rate of interest.”30 The Treasury-Fed Accord of 1951 ended the Fed’s official commitment to managing rates on behalf of the Treasury, but it did not usurp its power to do so. Indeed, the Federal Reserve retains the ability to move rates lower even if deficits soar. It’s a reality that should be obvious to any casual observer of Fed policy over the last decade. When the bottom fell out of the US economy in 2008, the budget deficit rocketed to more than 10 percent of GDP. As deficits climbed, the Federal Reserve cut the overnight rate to zero and held it there for seven straight years. In addition, the Fed conducted three rounds of quantitative easing, buying US Treasuries and mortgage-backed securities, which allowed the Fed to push long-term interest rates down as well. Anyone who tells you that fiscal deficits must force interest rates higher has forgotten their World War II history and ignored recent experience, and not just in the United States. Since 2016, Japan’s central bank has been explicitly targeting its yield curve.31 That means the BOJ isn’t just controlling the overnight interest rate (as the Fed does in the US) but also effectively setting long-term rates as well. The practice is known as yield curve control because it literally involves controlling the yield on ten-year government bonds. Today, the BOJ is committed to holding the ten-year rate at around zero percent. To do that, the central bank simply buys bonds in whatever quantity is necessary to prevent yields from rising above zero. It’s a bit akin to quantitative easing in that lower interest rates are the objective. However, yield curve control is a stronger form of commitment since the quantity of bonds the BOJ will buy in any given time period is not determined ahead of time. Yield curve control is about committing to an interest rate (price) target rather than committing to purchase a certain amount (quantity) of bonds. The BOJ’s policy clearly demonstrates that the central bank can set both short-term and long-term interest rates, even as government borrowing rises. By exercising its power as a sovereign currency issuer, Japan can always prevent the kind of interest rate pressure imagined in the loanable funds story.

China won’t sell off its Treasury holdings

Although China is the largest foreign holder of US Treasuries, it owned less than 7 percent of the publicly held total at the time of this writing. Still, some people worry that this gives China enormous leverage over the US because China could decide to sell off its holdings, driving the price of US government bonds down and the yield on those bonds (i.e., the interest rate) up. The worry is that Uncle Sam could lose access to affordable financing if China refuses to keep buying Treasuries. There are a number of problems with this thinking. For one thing, China can’t avoid holding dollar assets without wiping out its trade surplus with the United States. That’s not something China wants to do, since shrinking its exports to the US would tend to slow its economic growth. Assuming it wants to keep its trade surplus intact, it’s going to end up holding dollar assets. As financial commentator and former investment banker Edward Harrison put it, “the only question for China is which dollar assets [green dollars or yellow dollars] it will buy, not whether it will go on a US dollar strike.”5 And even if it does decide to hold fewer US Treasuries (yellow dollars) in its portfolio, this situation won’t leave Uncle Sam strapped for cash. Remember, the US is a currency issuer, which means it can never run out of dollars. Moreover, as Marc Chandler, popular television commentator and author of the book Making Sense of the Dollar, observed, China reduced its holdings of US Treasuries by 15 percent from June 2016 through November 2016, and the ten-year Treasury yield “was virtually unchanged.”6 Kelton, Stephanie. The Deficit Myth (p. 84). Public Affairs. Kindle Edition.

The Greece situation is difficult – they switched to the Euro

Even though it can’t happen to the United States, it is possible for a country to lose access to affordable financing. That’s what happened to Greece in 2010. But that’s because Greece undermined its monetary sovereignty by abandoning the drachma in favor of the euro in 2001. Adopting the euro changed everything. All of the Greek government’s existing debt was redenominated into euro, a currency that the Greek government could not issue. From that point on, anyone who bought bonds from the Greek government Even though it can’t happen to the United States, it is possible for a country to lose access to affordable financing. That’s what happened to Greece in 2010. But that’s because Greece undermined its monetary sovereignty by abandoning the drachma in favor of the euro in 2001. Adopting the euro changed everything. All of the Greek government’s existing debt was redenominated into euro, a currency that the Greek government could not issue. From that point on, anyone who bought bonds from the Greek government. Kelton, Stephanie. The Deficit Myth (pp. 85-86). Public Affairs. Kindle Edition.

High debt won’t raise interest rates

Compare that with what happened in currency-issuing countries like the US or the UK, where fiscal deficits more than tripled from 2007 to 2009. By 2009, both countries saw deficits rocket from less than 3 percent to around 10 percent of GDP. And yet, over the same period, the average interest rate on ten-year government bonds fell from 3.3 percent to 1.8 percent in the United States and from 5 percent to 3.6 percent in the United Kingdom. That’s because both countries have a central bank that acts on behalf of the government as a monopoly supplier of the currency. That backstop reassures investors, who understand that the central bank has ironclad control over its short-term interest rate, along with substantial influence over rates on longer-dated securities.7 Greece gave up that backstop when it adopted the euro. It could literally run out of money, and everyone knew it. That’s why it couldn’t keep the bond vigilantes at bay. The term bond vigilantes refers to the power of financial markets (or, more accurately, investors in financial markets) to force sharp movements in the price of a financial asset like government bonds so that the interest rate swings unexpectedly. Ultimately, the European Central Bank did keep the vigilantes at bay, but not without helping to impose painful austerity on the Greek people. Kelton, Stephanie. The Deficit Myth (p. 85). PublicAffairs. Kindle Edition. Kelton, Stephanie. The Deficit Myth (p. 84). Public Affairs. Kindle Edition.

Congress can always spend more money – one program does not crowd-out another

Dr. Stephanie Kelton, 2020, Stephanie Kelton is an American economist and academic. She is currently a professor at Stony Brook University[1] and a Senior Fellow at the Schwartz Center for Economic Policy Analysis at the New School for Social Research[2]. She was formerly a professor at the University of Missouri–Kansas City.[3] She also served as an advisor to Bernie Sanders’2016 presidential campaign, . The Deficit Myth Kindle Edition.

MMT flips this around, showing that the more appropriate, real-world sequencing is S(TAB). The government spends first, making dollars available to pay taxes or purchase government bonds. Take an example. Suppose S (spending) equals $100, meaning that the government spends $100 into the economy. Now suppose that the government taxes $90 away from us, meaning the government’s deficit has left us with $10 to hold on to. Currently, the government coordinates any deficit spending by selling an equivalent amount of securities—that is, “borrowing.” The important point is that the $10 that is needed to buy the bonds has been supplied by the government’s own deficit spending. In that sense, the currency issuer’s spending is self-financing. It’s not selling bonds because it needs the dollars. Bond sales just allow holders of reserve balances (green dollars) to trade them in for US Treasuries (yellow dollars). It’s done to support interest rates, not to fund the government. Since our lawmakers have not yet had the benefit of seeing MMT’s insights, they view debt service as a growing financial burden on the federal government. That’s a mistake. In truth, paying interest on government bonds is no more difficult than processing any other payment. To pay the interest, the Federal Reserve simply credits the appropriate bank account. Right now, Congress looks at the federal budget as a zero-sum game. Lawmakers look at rising interest expenditure the way we might look at a rising cable bill—it means less money to spend on everything else. So, when the CBO says that the federal government is on track to “spend more on interest payments than the entire discretionary budget, which includes defense and all domestic programs, by 2046,” many lawmakers begin to panic.15 They think it shrinks the amount of money that’s left over, forcing them to spend less on other priorities. That’s just not true. The congressional budget is limited only by Congress. To avoid cutting back on programs people value, Congress can simply authorize a larger budget to fund its other priorities. There’s no fixed pot of money. Kelton, Stephanie. The Deficit Myth (p. 88). PublicAffairs. Kindle Edition.

The interest the US government pays benefits the US economy

The federal government is a net payer of interest, and all of the interest it pays out is received by holders of government securities. At least some of that interest income goes to people who turn around and spend it back into the economy, buying newly produced goods and services. If a high percentage of interest income was spent back into the economy, it could potentially push aggregate spending above potential, fueling some inflationary pressure. Though, as Vice President Joe Biden’s former chief economist, Jared Bernstein, notes, it seems unlikely that the government’s interest payments will fuel overheating anytime soon, in part because “about 40 percent of our public debt [is] now held by foreigners,” which means “an increasing share of interest payments now leak out of the country.”16 Even if bondholders aren’t spending enough of their interest income to fuel ordinary price inflation (like the CPI), they might The federal government is a net payer of interest, and all of the interest it pays out is received by holders of government securities. At least some of that interest income goes to people who turn around and spend it back into the economy, buying newly produced goods and services. If a high percentage of interest income was spent back into the economy, it could potentially push aggregate spending above potential, fueling some inflationary pressure. Though, as Vice President Joe Biden’s former chief economist, Jared Bernstein, notes, it seems unlikely that the government’s interest payments will fuel overheating anytime soon, in part because “about 40 percent of our public debt [is] now held by foreigners,” which means “an increasing share of interest payments now leak out of the country.”16 Even if bondholders aren’t spending enough of their interest income to fuel ordinary price inflation (like the CPI), they might Kelton, Stephanie. The Deficit Myth (pp. 88-89). PublicAffairs. Kindle Edition.

Most of the world’s leading central banks focus on setting just one interest rate—a very short term interest rate known as the overnight rate. They rigidly fix this rate and then allow longer-term rates to reflect market sentiment about the expected future path of the short-term policy rate. That means that the interest rate that’s paid on longer-term government bonds is related to the overnight rate that its own central bank is setting. As Fullwiler put it, “This means that longer-term rates are based upon current and expected actions of the [central bank].”28 That leaves investors with some influence over the interest rate that the US government pays on Treasuries or the British government pays on gilts. (In the UK, government securities are known as gilt-edged bonds or gilts for short.) But—and this is really important—the government can always strip markets of any influence over the interest rate on government bonds. Indeed, that’s exactly what the Federal Reserve did during and immediately after World War II, and it’s what the Bank of Japan is doing today.29 To keep a lid on interest rates during World War II, the Federal Reserve “formally committed to maintaining a low-interest-rate peg of 3/8 percent on short-term Treasury bills” and “also implicitly capped the rate on long-term Treasury bonds at 2.5 percent.”30 Even as deficits exploded and the national debt climbed from $79 billion in 1942 to $260 billion by the time the war ended in 1945, the federal government paid just 2.5 percent interest on long-term bonds. To hold rates at 2.5 percent, the Fed simply had to buy large quantities of US Treasuries. It required an open-ended commitment on the part of the Fed, but it was an easy commitment to fulfill since the Fed purchases bonds (yellow dollars) simply by crediting the seller’s account with reserves (green dollars). Even after the war ended, the Fed continued to anchor the long-term interest rate on behalf of the government. Coordination with fiscal policy officially ended in 1951, with an agreement known as the Treasury–Federal Reserve Accord, which freed the Fed to pursue independent monetary policy.31 Elsewhere, central banks are returning to explicit coordination of fiscal and monetary policy.32 For more than three years, the BOJ has been engaged in a policy known as yield curve control. In addition to anchoring the short-term interest rate, the BOJ committed to pinning rates on ten-year government bonds (known as Japanese Government Bonds or JGBs) near zero. In carrying out that policy, the BOJ has purchased massive amounts of government debt, buying up ¥6.9 trillion in June 2019 alone.33 As a result of its aggressive bond-buying program, the BOJ now holds roughly 50 percent of all Japanese government bonds. So, while Japan is often described as the most indebted developed country in the world, half of its debt has already been essentially retired (i.e., paid off) by its central bank. And it could easily go all the way to 100 percent. If it did, Japan would become the least indebted developed country in the world. Overnight. Kelton, Stephanie. The Deficit Myth (pp. 93-94). PublicAffairs. Kindle Edition.

Low deficits suck money out of the economy and trigger a depression

Fiscal surpluses suck money out of the economy. Fiscal deficits do the opposite. As long as they’re not excessive, deficits can help to maintain a good economy by supporting incomes, sales, and profits.42 They’re not imperative, but if they disappear for too long, eventually the economy hits a wall.43 As Frederick Thayer, the prolific writer and professor of public and international affairs at the University of Pittsburgh, wrote in 1996, “the US has experienced six significant economic depressions,” and “each was preceded by a sustained period of budget balancing.”44 Table 1 details his findings. The historical record is clear. Each and every time the government substantially reduced the national debt, the economy fell into depression. Could it have been a remarkable coincidence? Thayer didn’t think so. He blamed the “economic myths” that drove politicians to wrestle their budgets into surplus on the flawed belief that paying down debt was both morally and fiscally responsible.45 As we see from the insights of MMT, government surpluses shift deficits onto the nongovernment sector.46 The problem is that currency users can’t sustain those deficits indefinitely. Eventually, the private sector reaches the point where it can’t handle the debt it has accumulated. When that happens, spending grinds sharply lower and the economy falls into depression. The Deficit Myth (pp. 93-94). PublicAffairs. Kindle Edition.

Recession puts 2 million kids in poverty

The Great Recession, which lasted from December 2007 to June 2009, left permanent scars on communities and families across the United States and beyond. It took more than six years for the US labor market to recover all 8.7 million jobs that were lost between December 2007 and early 2010.6 Millions struggled for a year or longer before finding employment. Many never did. And some who were fortunate enough to find work often had to settle for part-time employment or take jobs that paid substantially less than they had been earning. Meanwhile, the foreclosure crisis swallowed $8 trillion in housing wealth, and an estimated 6.3 million people—including 2.1 million children—were pushed into poverty between 2007 and 2009.7 Kelton, Stephanie. The Deficit Myth (pp. 6-7). Public Affairs. Kindle Edition.

High debt doesn’t make us dependent on foreigners

The fifth myth is that deficits make the United States dependent on foreigners. This myth would have us believe that countries like China and Japan have enormous leverage over us because they hold large quantities of US debt. We will see this is a fiction that politicians wittingly or unwittingly propagate, often as an excuse to ignore social programs in desperate need of funding. Sometimes this myth has used the metaphor of irresponsibly taking out a foreign credit card. This misses the fact that the dollars aren’t originating from China. They’re coming from the US. We’re not really borrowing from China so much as we’re supplying China with dollars and then allowing them to trade those dollars in for a safe, interest-bearing asset called a US Treasury. There is absolutely nothing risky or pernicious about this. If we wanted to, we could pay off the debt immediately with a simple keystroke. Mortgaging our future is yet one more instance of not understanding—or willfully misconstruing for political purposes—how sovereign currencies actually work. Kelton, Stephanie. The Deficit Myth (pp. 10-11). PublicAffairs. Kindle Edition.

High debt does not hurt future generations

While this rhetoric is powerful, its economic logic is not. History bears this out. As a share of gross domestic product (GDP), the national debt was at its highest—120 percent—in the period immediately following the Second World War. Yet, this was the same period during which the middle class was built, real median family income soared, and the next generation enjoyed a higher standard of living without the added burden of higher tax rates. The reality is that government deficits don’t force financial burdens forward onto future populations. Increasing the deficit doesn’t make future generations poorer, and reducing deficits won’t make them any richer. Kelton, Stephanie. The Deficit Myth (pp. 9-10). Public Affairs. Kindle Edition.

There really are no financial limits – the government can fiat paying for what it wants

You’ve probably already seen MMT’s central insights in action. I saw them up close when I worked in the US Senate. Whenever the topic of Social Security comes up, or when someone in Congress wants to put more money into education or health care, there’s a lot of talk about how everything must be “paid for” to avoid adding to the federal deficit. But have you noticed this never seems to be a problem when it comes to expanding the defense budget, bailing out banks, or giving huge tax breaks to the wealthiest Americans, even when these measures significantly raise the deficit? As long as the votes are there, the federal government can always fund its priorities. That’s how it works. Deficits didn’t stop Franklin Delano Roosevelt from implementing the New Deal in the 1930s. They didn’t dissuade John F. Kennedy from landing a man on the moon. And they never once stopped Congress from going to war. That’s because Congress has the power of the purse. If it really wants to accomplish something, the money can always be made available. If lawmakers wanted to, they could advance legislation—today—aimed at raising living standards and delivering the public investments in education, technology, and resilient infrastructure that are critical for our long-term prosperity. Spending or not spending is a political decision. Obviously, the economic ramifications of any bill should be thoroughly considered. But spending should never be constrained by arbitrary budget targets or a blind allegiance to so-called sound finance. Kelton, Stephanie. The Deficit Myth (p. 4). … Take military spending. In 2019, the House and Senate passed legislation that increased the military budget, approving $716 billion, nearly $80 billion more than Congress had authorized in fiscal year 2018.15 There was no debate about how to pay for the spending. No one asked, Where will we get the extra $80 billion? Lawmakers didn’t raise taxes or go out and borrow an extra $80 billion from savers so that the government could afford to make the additional payments. Instead, Congress committed to spending money it did not have. It can do that because of its special power over the US dollar. Once Congress authorizes the spending, agencies like the Department of Defense are given permission to enter into contracts with companies like Boeing, Lockheed Martin, and so on. To provision itself with F-35 fighters, the US Treasury instructs its bank, the Federal Reserve, to carry out the payment on its behalf. The Fed does this by marking up the numbers in Lockheed’s bank account. Congress doesn’t need to “find the money” to spend it. It needs to find the votes! Once it has the votes, it can authorize the spending. The rest is just accounting. As the checks go out, the Federal Reserve clears the payments by crediting the sellers’ account with the appropriate number of digital dollars, known as bank reserves.16 That’s why MMT sometimes describes the Fed as the scorekeeper for the dollar. The scorekeeper can’t run out of points. Kelton, Stephanie. The Deficit Myth (p. 29). Public Affairs. Kindle Edition.

Debt ceiling always raised

And, of course, we have all borne witness to the recurring dramas over the debt ceiling limit. In theory, this limit, first enacted in 1917, is there to do just that—limit the size of the national debt. In practice, lawmakers have increasingly viewed any approaching debt ceiling limit as a political opportunity to grandstand or extract legislative concessions. But, at the end of the day, Congress always musters the will to avert default by raising the limit. It has done so some one hundred times since the limit was enacted. Kelton, Stephanie. The Deficit Myth (p. 39). PublicAffairs. Kindle Edition.

Inequality collapses capitalism

Third, taxes are a powerful way for governments to alter the distribution of wealth and income. Tax cuts, like those passed by the Republicans in December 2017, can be structured to widen the gap between the rich and the poor, delivering windfall gains to large corporations and the wealthiest people in our societies. Today, there is more income and wealth inequality than at almost any time in US history. About half of all new income goes to the top 1 percent, and just three families own more wealth than the bottom half of America. Such extreme concentrations of wealth and income create both social and economic problems. For one thing, it’s hard to keep the economy strong when most of the income goes to the thinnest slice of people at the top, who save (rather than spend) much of their income. Capitalism runs on sales. You need a reasonable distribution of income so that businesses have enough customers to stay profitable enough to provide enough employment to keep the economy running well. Extreme concentrations of wealth also have a corrosive effect on our political process and our democracy. Just as tax cuts can be used to exacerbate inequities, governments can exercise their taxing authority to reverse these dangerous trends. Stepping up enforcement, closing loopholes, raising rates, and establishing new forms of taxation are all important levers to enable the government to achieve a more sustainable distribution of income and wealth. So, MMT sees taxes as an important means to help redress decades of stagnation and rising inequality. Kelton, Stephanie. The Deficit Myth (pp. 33-34). Public Affairs. Kindle Edition.

Strengthening worker bargaining power increases wages and inflation

No one knows how long the current bout of low inflation will last or what will eventually give rise to higher prices.1 Economists typically distinguish between cost-push and demand-pull drivers of inflationary pressures. As Texas Christian University economist John T. Harvey puts it, cost-push inflation can happen because of “acts of God” or “acts of power.”2 For example, a serious drought could lead to massive crop failures and food shortages that send prices soaring as supply collapses. Or powerful storms could wipe out oil refineries, causing the price of energy to spike. A sustained increase in food and energy costs, which feed directly into the CPI, can therefore set off an inflationary process. Prices could also increase when workers gain enough bargaining power to bid up their wages. To prevent the increase in wages from squeezing profit margins, businesses may pass these costs on to consumers in the form of higher prices. As the battle over income shares rages back and forth, it can set off a wage-price spiral that results in accelerating inflation. Kelton, Stephanie. The Deficit Myth (pp. 46-47). Public Affairs. Kindle Edition.

Full employment leads to inflation

When there’s that much slack in the economy, it’s easy for businesses to increase supply in response to more spending. But as an economy moves closer to its full employment limit, real resources become increasingly scarce. Rising demand can begin to put pressure on prices, and bottlenecks can develop in industries that are experiencing the greatest strain on capacity. Inflation can heat up. Once the economy hits this full employment wall, any additional spending (not just government spending) will be inflationary. That’s overspending, and it can even happen if the government’s budget is balanced or in surplus. Kelton, Stephanie. The Deficit Myth (p. 47). PublicAffairs. Kindle Edition.

Humans are sacrificed to fight inflation

Recall that the Fed chooses its own definition of full employment. For them, maximum employment is defined as the level of unemployment it believes is necessary to hit its inflation target. In other words, although it’s legally responsible for full employment and price stability, one goal takes clear priority over the other. If it takes eight or ten million unemployed people to stabilize prices, then that is how the Fed defines full employment. It’s counterintuitive to define full employment as a certain level of unemployment. But politically speaking, it is useful for the Fed as it means they get to claim success by defining away the very problem they were tasked to solve. No matter how many people remain jobless, the Fed can claim it’s done its best, and there’s simply no way to reduce unemployment further without causing inflation. For those who are still without jobs, tough luck. Thanks for your service in the inflation war. There’s nothing more the Fed can do to help you. Kelton, Stephanie. The Deficit Myth (p. 55). Public Affairs. Kindle Edition.

Job training and education do not work as solutions to unemployment

Most economists are content to allow the market to figure out how many jobs to provide. Congress, if it is to play any role at all, might dedicate some resources to helping the jobless acquire more skills to make them more attractive to potential employers. More education, better workforce training, subsidized private sector employment, and the like are seen as pathways out of poverty for the unemployed. MMT sees these proposals as half measures that do little to address the problem of chronic underemployment and unemployment. When there is a chronic lack of jobs, the best these solutions can offer is a sort of shuffling around of joblessness or taking turns experiencing bouts of unemployment. As Nobel Prize–winning economist William Vickrey put it, when the number of jobs is insufficient, “attempts to push [the unemployed] into jobs is simply a game of musical chairs in which local agencies instruct their clients in the art of rapid sitting.” Kelton, Stephanie. The Deficit Myth (p. 57). Public Affairs. Kindle Edition.

Lowering rates doesn’t increase employment

The truth is, we have placed far too much responsibility on central banks, not just in the US but around the world. They cannot alter taxes or spend money directly into the economy, so the best they can do to promote employment is to try to establish financial conditions that will give rise to more borrowing and spending. Lower interest rates might work to induce enough new borrowing to substantially lower unemployment. But they might not. As Keynes famously observed, “You can’t push on a string.” What he meant was that the Fed can make it cheaper to borrow, but it cannot force anyone to take out a loan. Borrowing money puts companies and individuals on the hook for the debts they incur. Loans must be repaid out of future income, and there are good reasons why the private sector might be reluctant to increase its indebtedness at various stages of the business cycle. Remember, households and businesses are currency users, not currency issuers, so they do need to worry about how they’re going to make their payments. Kelton, Stephanie. The Deficit Myth (p. 57). Public Affairs. Kindle Edition.

Using monetary policy increases inequality

The problem is that the recession pushed the budget deep into deficit, and Congress had already passed a $787 billion stimulus package to fight the effects of the Great Recession. When Bernanke made his not-so-subtle plea for additional help in 2011, it fell on deaf ears. Congress had become preoccupied with the state of its own balance sheet. When the Fed realized it was essentially on its own, Bernanke pushed in all the chips with an open-ended round of quantitative easing that some experts believe contributed to widening inequality and risky speculation in financial markets. Kelton, Stephanie. The Deficit Myth (pp. 58-59). Public Affairs. Kindle Edition.

Trump tax cuts didn’t help the broader economy because they went to those at the top

The reason Trump’s personal income tax cuts did little to boost the overall economy is because they were heavily skewed in favor of those at the very top of the income distribution. More than 80 percent of the benefits went to those in the top 1 percent. Compared with lower- and middle-income earners, who would spend a high percentage of any new dollar you give them, the rich just don’t spend all that much more when you shovel more money into their pockets. Kelton, Stephanie. The Deficit Myth (p. 62). Public Affairs. Kindle Edition.

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