MMT continues to generate debate. Recent contributions include Jonathan Portes’ critique in Prospect and Stephanie Kelton’s Bloomberg op-ed downplaying the AOC and Warren tax proposals.
Something that caught my eye in Jonathans’ discussion was this quote from Richard Murphy: “A government with a balanced budget necessarily denies an economy the funds it needs to function.” This is an odd claim, and not something that follows from MMT.
Richard has responded to Jonathan’s article, predictably enough with straw man accusations, and declaring, somewhat grandiosely, that “the left and Labour really do need to adopt the core ideas of modern monetary theory … This debate is now at the heart of what it is to be on the left”
Richard included a six-point definition of what he regards to be the core propositions of MMT. Paraphrasing in some cases, these are:
- All money is created by the state or other banks acting under state licence
- Money only has value because the government promises to back it …
- … because taxes must be paid in government-issued money
- Therefore government spending comes before taxation
- Government deficits are necessary and good because without them the means to make settlement would not exist in our economy
- This liberates us to think entirely afresh about fiscal policy
Of these, I’d say the first is true, with some caveats, the second and third are partially true, and the fourth is sort of true but also not particularly interesting. I’ll leave further elaboration for another time, because I want to focus on point five, which is almost a restatement of the quote in Jonathan’s Prospect piece.
This claim is neither correct nor part of MMT. I don’t believe that any of the core MMT scholars would argue that deficits are required to ensure that there is sufficient money in circulation. (Since Richard uses the term “funds” in the first quote and “means [of] settlement” in the second, I’m going to assume he means money).
To see why, consider what makes up “money” in a modern monetary system. Bank deposits are the bulk of the money we use. These are issued by private banks when they make loans. Bank notes, issued by the Bank of England make up a much smaller proportion of the money in the hands of the public. Finally, there are the balances that private banks hold at the Bank of England, called reserves.
What is the relationship between these types of money and the government surplus or deficit? The figure below shows how both deposits and reserves have changed over time, alongside the deficit.
Can you spot a connection between the deficit and either of the two money measures? No, that’s because there isn’t one — and there is no reason to expect one.
Reserves increase when the Bank of England lends to commercial banks or purchases assets from the private sector. Deposits increase when commercial banks lend to households or firms. Until 2008, the Bank of England’s inflation targeting framework meant it aimed to keep the amount of reserves in the system low — it ran a tight balance sheet. Following the crisis, QE was introduced and the Bank rapidly increased reserves by purchasing government debt from private financial institutions. Over this period, and despite the increase in reserves, the ratio of deposits to GDP remained pretty stable.
The quantity of neither reserves nor deposits have any direct relationship with the government deficit. This is because the deficit is financed using bonds. For every £1bn of reserves and deposits created when the government spends in excess of taxation, £1bn of reserves and deposits are withdrawn when the Treasury sells bonds to finance that deficit.
This is exactly what MMT says will happen (although MMT also argues that these bond sales may not always be necessary). So MMT nowhere makes the claim that deficits are required to ensure that the system has enough money to function.
It is true that the smooth operation of the banking and financial system relies on well-functioning markets in government bonds. During the Clinton Presidency there were concerns that budget surpluses might lead the government to pay back all debt, thus leaving the financial system high and dry.
But the UK is not in any danger of running out of government debt. Government surpluses or deficits thus have no bearing on the ability of the monetary system to function.
The macroeconomic reason for running a deficit is straightforward and has nothing to do with money. The government should run a deficit when the desired saving of the private sector exceeds the sum of private investment expenditure and the surplus with the rest of the world. This is not an insight of MMT: it was stated by Kalecki and Keynes in the 1930s.
If a debate about MMT really is at “the heart of what it is to be on the left” then Richard might want to take a break to get up to speed on MMT (and monetary economics) before that debate continues.