Why modern monetary theory isn’t worried about federal budget deficits, why budget deficits never go away and what are the risks if budget deficits get too large. We also explore what else proponents of modern monetary theory believe.
In this episode you’ll learn:
- What are the core principles of modern monetary theory.
- How federal budget deficits increase private sector savings.
- What is crowding out as it relates to interest rates.
- What are the risks of running too large of budget deficits.
Many are concerned about the continuous and growing federal government budget deficit. But could it actually be helpful to the overall economy? David Stein unpacks the basic principles of Modern Monetary Theory—the view that the budget deficit contributes to the health of the private sector economy, and that a budget surplus would actually be detrimental. Listen to the entire episode to learn about the pros and cons of MMT and what makes a balanced viewpoint on the federal government budget deficit.
Is taxation destroying money?
The first principle of MMT is that, “Taxes create demand for otherwise worthless fiat money.” David explains that fiat money is money that is not backed by anything. Fiat money in the U.S. can be traced to the Federal Reserve Act of 1913 when the U.S. central bank was created and Federal Reserve Notes were produced—what we know now as the U.S. dollar. Some economists believe that the reason people still continue to use the dollar bill and trust the currency is because of taxation. People pay their taxes in US dollars. Tax liabilities create the need for the economy to run off of the US dollar because people need it to pay their taxes, but in reality there isn’t anything backing the US dollar, such as gold.
The second principle of MMT is that, “taxes and government bonds do not finance the federal government.” According to the theory, the government doesn’t need funding from the private sector to function. When the federal government spends, the Federal Reserve reduces the government’s checking account and credits commercial bank reserves, who in turn adjust the account of the intended recipient. These are just accounting entries that change digits. In essence, the federal government doesn’t have to wait for tax money to come in to fund its operation. When the government accounts go down, the private sector accounts go up. Be sure to listen to the entire episode for further explanation of why taxation is the birthing place and burial ground for money.
The influence of the private sector on the budget deficit
According to MMT, the federal government budget deficit allows the private sector to save money because it increases the financial assets of the private sector. Economist Warren Mosler explains that, “The US government deficit exactly equals the total net increase in the holdings of US financial assets of the rest of us.”
David explains that in order for the private sector to save, there has to be some other entity that spends more than it receives in income. Savings is achieved by spending less than you earn. One person’s income is someone else’s spending. The government spends more than it receives in taxes, thereby allowing the private sector to save money.
In addition, it’s the private sector that determines the size of the government budget deficit! In order to save, you have to spend less, which creates less cash flow in the private sector. When some people pay less, then other people are paid less and earn lower incomes. Lower incomes equal fewer taxes spent, which raises the budget deficit.
The prominent concerns with Modern Monetary Theory
While MMT does make sense in many respects, there are concerns with its view of how the US economy works. David shares his concern that people might lose faith in banks and the stability of interest rates. When a lack of trust occurs, then rates grow higher, leading to a crowding out, reducing the ability for the private sector to invest in some capital projects because interest rates are too high. Another concern is that there must be spending constraint. Otherwise, unlimited government spending could lead to such a large influx of funds into the private sector that businesses and industries can’t keep up in terms of the their ability to produce goods and services. This ultimately could lead to much higher inflation.
Do federal budget deficits really matter?
While there are some aspects of MMT that should make us pause, David encourages us not to throw out the theory entirely. There are many aspects of it that are correct and encourage reflection. Wealth is ultimately created by the private sector, since it is the spending and saving, creation of jobs, and innovation of the private sector that determines wealth. David explains that the issue of how much the government should be allowed to spend is a topic that must be explored and discussed in the near future. There must be a balance. The budget deficit does matter, and its size is something that must be kept in reign. The current size (at 4.2% and slowly rising over the next several years) isn’t something to cause worry. But if it rose to much higher percentages, that would be a cause for concern. It is important to take into account the principles of MMT, as it accurately reflects how the economy moves and functions. Be sure to listen to the full episode for a complete understanding of what Modern Monetary Theory claims and how it could affect monetary decision-making.
- [0:22] What is Modern Monetary Theory?
- [3:20] Taxes create demand for fiat money.
- [5:32] Taxes and government bonds don’t finance the federal government.
- [8:56] Budget deficits increase the net financial assets of the
- private sector.
- [13:16] Taxes destroy money.
- [13:46] The private sector determines the size of the budget deficit.
- [14:58] The concerns of crowding and losing faith.
- [19:08] Even government spending has to be constrained.
- [20:02] The dangers of the Federal Reserve controlling interest rates.
- [21:45] Modern Monetary Theory is correct in terms of how the economy actually works.
- [23:25] Do federal budget deficits matter?
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