MMT explained

 The Government Doesn’t “Borrow Our Money”: A Simple Case for Modern Monetary Theory

We are constantly told the same story about government finance:

The government taxes us.
Then it borrows money from investors.
Then it spends the money.
And if it borrows too much, the debt becomes dangerous.

It sounds intuitive.

But there is a problem.

That is not how modern monetary systems actually operate.

The most important insight of Modern Monetary Theory is not that governments have discovered a magical source of free money.

It is much more mundane:

A government that issues its own currency does not operate financially like a household.

A household must obtain pounds before it can spend them.

The UK government is the issuer of pounds.

That distinction changes everything.

Start with what happens when the government spends

When the government pays a contractor, employee or pensioner, the banking system records an increase in the recipient’s account.

The government’s spending creates a financial asset for the private sector and a corresponding liability within the consolidated government/central-bank system.

Taxes subsequently remove money from private-sector bank accounts.

This is why the familiar phrase “the government needs to collect the money before it can spend it” is misleading as a description of the monetary mechanics.

The Bank of England itself explains that commercial banks do not simply take existing deposits and lend them out. In modern banking, bank lending creates deposits; reserves are not multiplied into loans in the way the old textbook “money multiplier” story suggests. (spaceecon.blogspot.com)

So perhaps we should stop imagining the government as a gigantic household with a bank account that can eventually hit zero.

Then what is the national debt?

Here is where things get even more interesting.

We are told that the government “borrows” from the bond market because it needs the money to spend.

But consider what a government bond actually does.

When a government security is issued, the private sector exchanges one government liability for another.

A bank deposit is exchanged for an interest-bearing government security.

The private sector hasn’t handed the government some mysterious pile of pre-existing national wealth that the government can no longer access.

It has swapped one government financial asset for another.

As the New Wayland bond primer puts it, government securities operate alongside government spending and taxation as a policy choice: they provide the private sector with an interest-bearing government asset. (new-wayland.com)

That changes the way we should think about the national debt.

Government debt is also somebody else’s financial asset.

Your gilt is the government’s liability.

Your pension fund’s gilt is its asset.

Your bank, insurer or investment fund holding government securities has not been handed a claim on some imaginary vault containing “taxpayers’ money.”

It owns a government promise denominated in the government’s own currency.

So can the government spend without limit?

No.

And this is where serious MMT is much more interesting than the caricature.

The constraint isn’t fundamentally:

“We might run out of pounds.”

The constraint is:

“What happens when government spending pushes total demand beyond the economy’s ability to produce real goods and services?”

There are only so many nurses.

Only so many builders.

Only so many engineers.

Only so much steel.

Only so much energy.

Only so many houses that can be constructed this year.

Money can be created. Real resources cannot be created merely by changing numbers in bank accounts.

That is the genuine constraint.

If the government spends £10 billion on genuinely unused resources, the economic consequences are completely different from spending £10 billion into an economy already operating at full capacity.

The first can mobilise idle resources.

The second can bid up prices.

That is why the meaningful question isn’t:

“Where will the government get the money?”

It is:

“Does the economy have the workers, materials, technology and productive capacity to carry out what the government wants to buy without causing unacceptable inflation?”

That is a much more useful question.

And what about “printing money”?

This phrase causes enormous confusion.

Most modern money isn’t physically printed.

Bank accounts are updated electronically.

Government spending and taxation involve changes to balances within the banking system.

Calling every increase in a government balance sheet “printing money” makes monetary operations sound like someone has turned on a giant photocopier.

It obscures the economic question that actually matters:

What does the newly created spending cause people to do with real resources?

If additional spending mobilises unemployed workers and unused factories, it can increase output.

If additional spending simply competes for resources that are already fully employed, prices can rise.

Same currency.

Different economic circumstances.

And this makes government bonds look very different

Suppose the government spends and the private sector ends up holding additional financial assets.

The government then issues a gilt.

What has happened?

The private sector has exchanged one government liability for another.

Instead of holding a non-interest-bearing bank deposit, it holds an interest-bearing government security.

The bond is therefore not simply “the government getting money from the market.”

It is also a mechanism for determining what form of government liability the private sector holds.

That is why the idea of “bond vigilantes” can become misleading.

Bond yields matter enormously for financial markets.

But it does not follow that a currency-issuing government is financially equivalent to a household, a company or a country that has borrowed in a foreign currency.

The operational details matter.

A government that issues the currency in which its debts are denominated is in a fundamentally different financial position from someone who has to obtain that currency before paying the debt.

What about interest rates?

This creates another uncomfortable question.

We are normally told that raising interest rates cools the economy because people borrow less and save more.

But there is another side to the story.

Higher rates also increase the income received by holders of interest-bearing financial assets.

And the interest paid by borrowers becomes someone else’s income.

At the aggregate level, financial assets and liabilities have to fit together.

The New Wayland discussion of the “loan lock” illustrates the point: if someone holds a deposit as a financial asset, there is a corresponding liability somewhere in the financial system. (spaceecon.blogspot.com)

So interest-rate policy is not simply a magic dial labelled:

HIGHER RATES = LESS SPENDING

It redistributes income as well as affecting borrowing conditions.

That matters.

Now consider unemployment

Here is perhaps the most morally important implication.

Conventional policy often treats unemployment as something the economy must tolerate to control inflation.

MMT asks:

Why should the inflation buffer be unemployed human beings?

Why not establish a Job Guarantee?

The government offers a job at a socially useful fixed wage to anyone willing and able to work.

When the private economy contracts, more people enter the programme.

When the private economy expands, businesses hire workers out of the programme.

Instead of maintaining a buffer stock of unemployed people, we maintain a buffer stock of employed people.

Those jobs could involve environmental restoration, community services, care work, local infrastructure, maintenance, conservation and other socially useful activities. (spaceecon.blogspot.com)

This is not merely a welfare payment.

It changes the mechanism by which the economy stabilises employment.

The big idea

MMT does not say:

“Deficits don’t matter.”

It says:

“Stop treating the financial balance sheet as though it were the real economy.”

A government deficit means that, in accounting terms, the private sector is receiving more government financial assets than it is surrendering in taxes.

A government surplus means the opposite.

The important question is what those financial flows are doing to employment, production, distribution and prices.

A £100 billion deficit could be inflationary in one economy and completely manageable in another.

A £100 billion reduction in the deficit could reduce inflation—or it could simply destroy incomes and employment.

The number itself doesn’t tell you enough.

You have to look at the real economy.

And that is the uncomfortable conclusion

We have spent decades arguing about whether governments can “afford” schools, hospitals, infrastructure, environmental restoration or employment programmes.

But “Can we afford it?” is often asked as though the UK government were a household that must first find pounds before it can spend them.

The better questions are:

Do we have the workers?

Do we have the materials?

Do we have the productive capacity?

Will the spending create unacceptable inflation?

Who gets the income?

Who gets the financial assets?

What real resources are being diverted from other uses?

Those are economics questions.

“Where will the government get the money?” is often accounting presented as economics.

The revolutionary part of MMT isn’t the claim that governments can create currency.

We already know that modern monetary systems create money electronically.

The revolutionary part is asking us to stop confusing money with wealth.

Money is a claim on real resources.

Real wealth is the houses, hospitals, machines, knowledge, energy systems, infrastructure, food, technology, skills and human labour that actually make life better.

A country cannot become richer by creating money alone.

But neither does a country become poorer simply because someone says the government has “too much debt.”

The real limit is the productive capacity of the economy.

And once you understand that, the entire debate about deficits, debt, bonds, interest rates and public spending starts to look very different.