PG #80: The Deficit Myth

Governments around the world have increased spending dramatically to support economies affected by the pandemic.

This rapid and necessary shift shook loose conservative ideologies that seemed rusted on, and made us rethink the foundations of the old arguments around economic progressives and economic conservatives. In Australia, the traditionally conservative Liberals designed and implemented massive spending programs (JobKeeper, etc.) that would have previously been unimaginable for them.

These policies were widely successful, keeping millions out of poverty and the economy intact. But the fact that this unprecedented expenditure didn’t end up sending us broke raises some questions: why was government debt ever a problem? And where does money even come from?

Without a background in finance, I have to admit that I never really knew the answers to these questions. That is, until I read Stephanie Kelton’s book, The Deficit Myth.

Here’s what I learned: governments in charge of their own sovereign currency can never run out of money. (That is, countries like Australia. It’s a different story for countries on the Euro.) They don’t borrow the money from the ‘world bank’, and it long ago stopped being directly tied to gold deposits.

But if Australia’s currency doesn’t come from a bank, where does it come from? Well, we print it. (It’s slightly more involved than that, but there isn’t space to go into the detail here.)

In that case, why can’t Australia just spend whatever it wants and have the RBA print all the money it needs to fund everything?

The traditional answer was that if you engage in too much money printing, you’ll end up with too much inflation. Print too much money, and the value of that money goes down. This, the popular theory goes, is how you end up with trillion dollar notes (as happened in Zimbabwe).

There’s a competing economic theory gaining favour though, which shows that the inflation story is not so simple. This theory – Modern Monetary Theory, or MMT – states that inflation will not occur while there is spare labour capacity in the economy.

So you can print all the money you want until an economy reaches full employment. As long as there is spare labour capacity, the money printed will be paid to workers and fed back into the economy when they spend it, so its value won’t decrease. Once a society reaches full employment, printing more money dilutes the value of it. One way to think about it is that our dollar is now on the ‘labour standard’ instead of the gold standard.

I’ve left out a lot of nuance, so if you want to learn more, you should read the book. (This article will get you started in the meantime.) But we are essentially in a moment where central banks, and most progressive governments (including Biden in the US) are embracing the central tenets of MMT: spend like you never have before, to get employment low.

The Liberal Government has achieved significant economic success (and political kudos) for embracing previously unthinkable economic policies that go against their ideological grain. They spent (and thus created) vast amounts of money in order to keep people employed and the economy intact.

That money is still circulating in the Australian economy, and the value of the dollar hasn’t spiralled.

With the worst of the pandemic seemingly over, the government is now backing away from these successful policies. If we want to tackle the far larger problem of climate change, our governments are going to have to get comfortable with massive spending programs and increasing debt. Their economics will have to evolve.