There is no need to issue public debt

At the London event last week, I indicated that governments should not issue any public debt as the benefits of doing so are small relative to the large opportunity costs. The Modern Monetary Theory (MMT) position is that there is no particular necessity to match public deficits with debt-issuance for a currency-issuing government and deficits should be accompanied by monetary operations which we now call Overt Monetary Financing (OMF). Surprisingly there was some arguments by audience members that governments should continue to issue debt, largely, as I understand them, to provide a safe haven for workers to save for the future. So the idea is that we maintain the elaborate machinery that is associated with the public debt issuance just to provide a risk free asset that workers can use to park their hard-earned savings in. It is a strange argument given the massive opportunity costs associated with debt issuance. A far simpler solution is to exploit the currency-issuing capacity of the government to guarantee a publicly-owned National Saving Fund. No debt would be required.

We start with Abba Lerner’s Functional Finance, which represents a major influence on the development of what we call MMT. He provided guidance on when governments should issue debt.

Lerner sought to explain that it is the responsibility of the currency-issuing government to ensure that total spending in the economy is maintained at a level consistent with full employment.

It does that by altering its spending and taxation policies to generate enough sales that with current productivity levels would provide jobs for all those who want to work.

He also knew that more often than not fulfilling those responsibilities will result in fiscal deficits and that there was nothing “bad about this”.

In his 1943 article – Functional Finance and Federal Debt – Abba Lerner said:

The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound. This principle of judging only by effects has been applied in many other fields of human activity, where it is known as the method of science opposed to scholasticism. The principle of judging fiscal measures by the way they work or function in the economy we may call Functional Finance …

Government should adjust its rates of expenditure and taxation such that total spending in the economy is neither more nor less than that which is sufficient to purchase the full employment level of output at current prices. If this means there is a deficit, greater borrowing, “printing money,” etc., then these things in themselves are neither good nor bad, they are simply the means to the desired ends of full employment and price stability …

[Reference: Lerner, A. (1943) ‘Functional Finance and the Federal Debt’, Social Research, 10(1), 38-51].

The focus on government should not be on the deficits but on the prosperity and inclusion that full employment delivers.

He also understood that people are “easily frightened by fairy tales of terrible consequences” when new ideas are presented.

The sense of fright is driven by a lack of education that leaves people unable to comprehend how the economy actually operates.

Neo-liberals magnify that sense of fright, by demonising what are otherwise sensible and viable explanations of economic matters.

They know that by elevating these ideas into the domain of fear and taboo, they increase the probability that political acceptance of the ideas will not be forthcoming.

That strategy advances their ideological agenda. The basic rules that should guide government fiscal policy are, as Lerner noted, “extremely simple” and “it is this simplicity which makes the public suspect it as too slick).

Neo-liberals who have vested interests in ensuring that the public does not understand the true options available to a government that issues its own currency manipulate that suspicion.

In the place of these simple truths, neo-liberals advance a sequence of myths and metaphors that they know will resonate with the public and become the ‘reality’.

So what did Lerner say about debt issuance?

In the context of governments maintaining “a reasonable level of demand at all times” and maintain interest rates that “induces the optimum amount of investment”.

In this Biography of Lerner you read the following (pages 218-19):

In 1943 Lerner published an article, “Functional Finance and the Federal Debt,” that announced a new approach to fiscal policy. (The subject was further developed in his Economics of Control and the Economics of Employment.) He noted that conventional fiscal wisdom was based on the principles and morals of good household management: don’t spend what you don’t have – a tacit reminder that the words “economy” and “economics” are etymologically derived from oikos, the Greek word for household.

Lerner, however, picking up on the summary Keynesian prescription of deficit spending, argued that governments should not be concerned with conventional morality but rather should consider only the results of their actions. The aim of government spending and taxing, he said, should be to hold the economy’s total spending at a level compatible with and conducive to full employment at current prices – in other words, no unemployment and no inflation. In doing this the government should not be concerned with deficits or debt. Second, the government should borrow or repay only insofar as it wants to change the proportions in which the public holds securities or money. Changing this proportion will raise or lower interest rates and hence discourage or promote investment and credit purchasing. If the only question, then, was how to finance a deficit, Lerner advocated printing money. Third, the government should put money into circulation or withdraw (and destroy) it as needed to effect the results called for by the first two principles.

So the only reason a government should issue debt is if it wanted to alter the “proportions in which the public holds securities or money”. It is clearly recognised that the government does not need to raise revenue.

In his 1943 article Lerner says (page 355) that the government would only issue debt “if otherwise the rate of interest would be too low”. So you start to understand that the “borrowing” is a monetary operation not a funding necessity.

He went further on this theme in his 1951 book when he says (pages 10-11) that the:

… spending of money … out of deficits keeps on increasing the stock of money (and bank reserves) and this keeps on pushing down the rate of interest. Somehow the government must prevent the rate of interest from being pushed down by the additions to the stock of money coming from its own expenditures … There is an obvious way of doing this. The government can borrow back the money it is spending (emphasis in original).

This is one of the fundamental insights of MMT – that debt issuance can assist the central bank to drain excess bank reserves that were generated by the net spending (deficits) in the first place.

That was the topic of yesterday’s blog.

The government just borrows its own spending back. If it didn’t do that and if the central bank didn’t pay a return on overnight reserves then the interest rate would fall to zero (or some support rate that the central bank did pay).

And for those progressives (the deficit-doves) – the “proponents of organized prosperity”, Lerner had this to say in his 1951 book (page 15).

A kind of timidity makes them shrink from saying anything that might shock the respectable upholders of traditional doctrine and tempts them to disguise the new doctrine so that it might be easily mistaken for the old. This does not help much, for they are soon found out, and it hinders them because, in endeavoring to make the new doctrine appear harmless in the eyes of the upholders of tradition, they often damage their case. Thus instead of saying that the size of the national debt is of no great concern … [and] … that the budget may have to be unbalanced and that this is insignificant when compared with the attainment of prosperity, it is proposed to disguise an unbalanced budget (and therefore the size of the national debt) by having an elaborate system of annual, cyclical, capital, and other special budgets.

MMT suggests that the policy interest rate should be maintained at zero, which means there is no need to have stocks of public debt in the hands of the non-government sector.

So why issue public debt at all?

Even if one adopts a fundamentally ‘market oriented’ approach there is no compelling case to issue public debt.

Some markets, including the labour market, exhibit cyclical asymmetries and high degrees of persistence following negative shocks that are so costly in terms of foregone output and employment that government intervention is compelling.

However, financial markets in general, allowed to operate within appropriate regulatory frameworks, are much closer to the parameters outlined in competitive theory and can generate reasonably efficient outcomes without direct government interference.

Government intervention into private markets is a serious matter and must be justified with a proper cost-benefit analysis.

Financial stability is a public good

The current financial system is linked to the real economy via its credit provision role. Both households and business firms benefit from stable access to credit.

To achieve financial stability: (a) the key financial institutions must be stable and engender confidence that they can meet their contractual obligations without interruption or external assistance; and (b) the key markets are stable and support transactions at prices that reflect fundamental forces.

There should be no major short-term fluctuations when there have been no change in fundamentals.

Financial stability requires levels of price movement volatility that do not cause widespread economic damage. Prices can and should move to reflect changes in economic fundamentals.

Financial instability arises when asset prices significantly depart from levels dictated by economic fundamentals and damage the real sector.

Collapses brought on by injudicious speculation that do not affect the real sector or that can be insulated from the real sector by appropriate liquidity provisions are not problematic.

The essential requirements of a stable financial system are:

1. Clearly defined property rights;
2. Central bank oversight of the payments system;
3. Capital adequacy standards for financial institutions;
4. Bank depositor protection;
5. An institutional lender-of-last resort when private institutions refuse to lend to solvent borrowers in times of liquidity crisis;
6. An institution to ameliorate coordination failure among private investors/creditors;
7. The provision of exit strategies to insolvent institutions.

While some of these requirements can be provided by private institutions, all fall in the domain of government and its designated agents.

However, none of these requirements rely on the existence of a viable government bonds market.

Private goods are traded in markets where buyers and sellers exchange at prices that reflect the margin of their respective interests.

At the agreed price, ownership of the good or service transfers from the seller to the buyer.

A private good is ‘excludable’ (others cannot enjoy the consumption of it without being party to the transaction) and ‘rival’ (consuming the good or service specific to the transaction, denies other potential consumers its use).

Alternatively, a public good is non-excludable and non-rival in consumption. Private markets fail to provide socially optimal quantities of public goods because there is no private incentive to produce or to purchase them (the free rider problem).

To ensure socially optimal provision, public goods must be produced or arranged by collective action or by government.

We conclude that financial system stability meets the definition of a public good and is the legitimate responsibility of government.

What are the alleged benefits of public debt issuance

Most of the arguments made in favour of sustaining public debt issuance can be reduced to special pleading by an industry sector for public assistance in the form of risk-free government bonds for investors as well as opportunities for trading profits, commissions, management fees, and consulting service and research fees.

It is ironic that these arguments are inconsistent with rhetoric forthcoming from the same financial sector interests in general about the urgency for less government intervention, more privatisation, more general welfare cutbacks, and the deregulation of markets in general, including various utilities and labour markets.

Specifically, government price level intervention into private markets is typically challenged by economists on efficiency grounds.

Public debt issuance is a form of government price level intervention in interest rate markets.

The burden of proof falls on those arguing in favour of such issuance to show that the market in question is incapable of viable operation without government intervention and will, unassisted, produce outcomes detrimental to the macro priorities we discussed earlier – full employment etc.

Pricing other products

One argument mounted to support public debt issuance is that it supports the yield curve and is used by financial markets as the benchmark risk free asset, which provides a benchmark for pricing any other debt security.

There are clearly alternatives:

1. The market could price securities against other securities with similar characteristics.

2. Market participants could price securities with respect to the interest rate swap curve.

Market participants already use the interest rate swap curve to price securities. Regardless, the term interest rate structure remains a meeting of supply and demand. Buyers and sellers of bonds desire to attract each other and meet at a price.

Are the proponents of retaining public debt issuance really claiming that without government intervention in the credit markets via such issuance borrowers and investors cannot sufficiently come together at a price?

Are they saying that the interest rate market does not have sufficient levels participation, information and competition to adequately determine price without government intervention?

It is doubtful that either position can be substantiated, and certainly not to the degree needed to support the issuance of public debt with their high real macro costs which I will outline below.

Managing financial risk

Another argument is that on-going public debt issuance supports a number of derivative markets that help private traders manage financial risk, particularly in relation to interest rate risk.

What are their real interest rate risks of these businesses? What are the real economic costs of these feared changes?

Without going into detail, it is important to ask which businesses ‘need’ to use public debt to manage risk. The reality is that it on-going public debt issuance supports and encourages speculation, rather than real investment behaviour.

Some financial market speculation (which is tied to helping real output producing firms off-load exchange rate risk, for example) is sound. But that is a tiny proportion of the financial market transactions that occur each day.

So can the support of particular businesses in this manner which add nothing to the well-being of the population be an appropriate use of public policy?

It is in this context that I use the term corporate welfare in association with the issuance of public debt.

It should also be understood that MMT advocates the simplification of financial markets and the phased elimination of speculative behaviour that provides no real benefits to the population.

Providing a long term investment vehicle

This argument was raised on Thursday night in London. The crude argument is that workers have a right to expect their savings will be held in risk-free assets and that public debt issuance provides those assets.

It is a simplistic argument and while I am supportive of workers being able to save (risk manage their futures) in a safe way, that doesn’t justify the massive corporate welfare that accompanies the issuance of public debt.

More specifically, it is argued if superannuation and life companies were unable to purchase government debt then they would struggle to match their long-dated liabilities with appropriate returning assets.

Further, the claim is that eliminating the government bonds market would deny workers of a risk free, $A denominated asset to invest there savings in. Retirement planning would become highly uncertain and risky.

What is not often understood is that government bonds are in fact government annuities.

Do the proponents of on-going government bonds really want the private sector to have access to government annuities rather than be directing real investment via privately-issued corporate debt, as an example?

This point is also applicable to claims that government bonds facilitate portfolio diversification. Why would we want to provide government annuities to private profit-seeking investors?

This interferes with the investment function of markets, and that direct government payments be limited to the support of private sector agents when failures in private markets jeopardise real sector output (employment) and price stability.

We would also require a comparison of this method of retirement subsidy against more direct methods involving more generous public health and welfare provision and pension support.

But there is a much more effective way to provide a risk-free savings vehicle for workers. The government could create a National Savings Fund, fully guaranteed by the currency-issuing capacity of the government, which could provide competitive returns on savings lodged with the fund.

There would be no public debt issuance (and the associated corporate welfare and government debt management machinery) required.

The government could meet any nominal liabilities at any time.

Providing a safe haven

Government securities are alleged to provide a ‘safe haven’ for investors when there is financial instability.

The ‘flight to quality’ argument suggests that it is beneficial to the macro economy for investors to have a risk free domestic asset available to avoid capital losses on other assets.

However, in addition to the previous point regarding subsidy through government annuities, government bonds compete directly with these other assets, thereby driving down their prices and exacerbating matters during ‘flights to quality’.

In a monetary economy, investors can always hold money balances by increasing actual cash holdings or banking system deposits.

Widespread use of deposit insurance would mean that bank deposits would be equivalent to holding government bonds anyway for all practical purposes.

That also passes the ‘risk’ to private banks when they select their assets and selection of assets is regulated by the central bank.

There is no compelling real macroeconomic reason why risk and return decisions by private maximising agents should be ‘further protected’ by retreat to a market distorting government annuity.

Further, during a ‘flight to quality’ only the relative prices of various fixed income securities can change, not the quantity, as investors compete for the existing stock of outstanding government debt.

At the macro level, this process does not reduce risk.

Implementing monetary policy

We have already learned from yesterday’s blog that the central bank can maintain any interest rate policy target it desires through the use of a support rate on excess reserves.

It requires no public debt in this regard.

There are many other arguments that are put forward to justify the ongoing issuance of public debt. All of them can be reduced to special pleading by speculators for risk free assets.

What are the real economic costs involved in issuing government debt?

The real economic costs involved in issuing government debt

The real costs of any resource-using activity are measured by the opportunity costs of not using these resources in alternative activities.

The operation of public debt markets absorb a diversity of real resources deployable elsewhere.

While this is difficult to assess in the context of an economy without public debt markets, some points can be made to structure our thinking.

The opportunity costs in terms of the labour employed directly and indirectly in the public debt ‘industry’ are both real and large.

The ‘cottage industry firms’ that characterise the public debt industry use resources for public debt issuance, trading, financial engineering, sales, management, systems technology, accounting, legal, and other related support functions.

These activities engage some of the brightest graduates from our educational system and the high salaries on offer lure them away from other areas such as scientific and social research, medicine, and engineering.

It could be argued that the national benefit would be better served if this labour was involved in these alternative activities.

Government support of what are essentially distributional (wealth shuffling) activities allows the public debt market to offer attractive salaries and distorts the allocation system.

While this labour may move within the finance sector if public debt issuance terminated, the Government could generate attractive opportunities by restoring its commitment to adequate funding levels for research in our educational institutions.

On balance, public debt markets appear to serve minor functions at best and the interest rate support can be achieved simply via the central bank maintainng current support rate policy without negative financial consequences.

The public debt markets add less value to national prosperity than their opportunity costs. A proper cost-benefit analysis would conclude that the market should be terminated.


This blog was drawn, in part, from an edited version of a submission that I made with Warren Mosler in 2001 to the Commonwealth Debt Inquiry, which sought to justify why the government should continue to issue debt when it was in fact running increasing surpluses.

That is enough for today!

(c) Copyright 2015 William Mitchell. All Rights Reserved.

This Post Has 45 Comments

  1. Dear Bill

    If a government provides free elementary and secondary education, free and adequate health care for all, and old age security for all seniors, and also runs an unemployment and disability insurance scheme, then the need for savings by ordinary working people can’t be very large. A comprehensive welfare state reduces the need for savings.

    It would be a miracle if we could both maintain full employment and have zero inflation. The question then becomes what we should tolerate, some unemployment or some inflation? I’m inclined to tolerate some inflation, if only because inflation affects everybody while unemployment hurts only a minority badly. Better have full employment with 3-4% inflation than zero inflation with 5% unemployment.

    Heiner Flassbeck’s blog is active again after a pause in August. A certain Günther Grunert has an article on Greece. In his bibliography, he mentions Eurozone Dystopia by a certain W. Mitchell.

    Regards. James

  2. “Better have full employment with 3-4% inflation than zero inflation with 5% unemployment. ”

    More posts like this and MMT will be claiming you as one of theirs.

    Good post.

  3. I agree with Bill that the arguments for interest yielding national debt are very questionable. Milton Friedman advocated that the debt be abolished in 1948. See para starting “Under the proposal…” here

    Second, I suggest the arguments against the debt are simpler and more common sense that Bill’s arguments. My “common sense” argument is: why should one lot of people have to pay tax to fund interest payments to another lot just because the second lot want to save and earn interest? There is no reason.

    Third, Kersten Kellerman argued against the popular notion that public investment should be funded by borrowing rather than tax. That was in a paper in the European Journal of Political Economy.

    Fourth, I’m puzzled by Bill’s argument for a “National Savings Fund”. That comes to exactly the same thing as national debt, far as I can see.

    Fifth, one argument for public debt or government borrowing is that it allegedly spreads the cost of public investments across the generations who benefit from such investments. The flaw in that argument is that it involves time travel: that is it just isn’t possible to consume real resources in 2050 (e.g. steel and concrete) to build a bridge in 2015. Nick Rowe has tried to demolish that time travel argument with his “overlapping generations argument”. However his argument doesn’t stand inspection. I dealt with his argument here:

  4. James Schipper,

    I’m a fan of Heiner Flassbeck because he advocates an idea which I favour, namely import tariffs as a solution for Greece. You put me onto that. Is there an English translation of his blog?

  5. The above arguments presume a closed economy. Consequently the conclusions may not always be appropriate for open economies.

    Firstly, even for the very large economies, it is not generally correct to assert that “the central bank can maintain any interest rate policy target it desires”.
    This will only be true if there are effective controls on international capital flows, or if most countries maintain similar interest rates (disregarding differences due risks of default or different expectations regarding inflation or exchange rate movements).
    Otherwise, if a country attempts to set its interest rates lower than elsewhere this will cause an outflow of capital and currency depreciation. Conversely, interest rates higher than elsewhere will cause an inflow of capital and currency appreciation. Such internationl capital movements and exchange rate adjustments will persist until market forces resore interest rates which are similar between countries. See Wikipedia regarding “International Fisher effect”.

    Secondly, there are two important reasons for government borrowing which are not mentioned:
    a. Desperate wars of survival may require more resources than can be obtained from the local economy, e.g. UK in WW2.
    b. Underdeveloped countries may have to borrow overseas to finance investment in order to escape from poverty.

  6. “This will only be true if there are effective controls on international capital flows,”

    A floating rate currency is an effective control on capital flows. You can’t sell currency you can’t obtain and you have to settle your contracts within two days in a market with no market maker of last resort.

    That means in any stress situation the liquidity dries up and those short end up having to pay through the nose to close their contracts. That limits the range of movement and causes an auto-reverse.

    It only stops working if you have an idiot central bank that thinks its job is to provide ‘liquidity’ into the FX market. It isn’t. That is the job of the other central banks in the world who want to export to you. The local central bank and its regulated banks should *never* create money to allow FX transactions to complete. No lending for financial speculation.

    Once that lesson is learned then this silly ‘open’ vs ‘closed’ argument – which has no basis in reality – can be put to bed as the FUD that it is.

    It always amuses me that classical theory assumes infinite liquidity in the FX market and limited liquidity in the bond market, when the truth is exactly the opposite.

    Since the assumptions are false, what they say follows is incorrect as well and can be disregarded.

  7. “Fourth, I’m puzzled by Bill’s argument for a “National Savings Fund”. That comes to exactly the same thing as national debt, far as I can see.”

    National Savings can only be held by named individuals with the right to retire in the country and are not negotiable (i.e. can’t be traded in a third party market). That stops foreigners, pension companies, corporations and all the other hangers on from benefiting from the government scheme.

    Think Indexed-linked savings certificates (granny bonds), or ‘income bonds’. Both of which were fairly prominent retirement savings vehicles in the UK until the financialisation period of the last 40 years.

  8. “It would be a miracle if we could both maintain full employment and have zero inflation.”

    That miracle is called a Job Guarantee.

    You can never have full employment just by manipulating financial ratios to ‘boost demand’, because you never solve the matching problem inherent in the standard jobs market.

  9. Neil, NS&I Income Bonds are making a comeback in the UK. Instant access, no penalties, 1.26%. No need for the little people to get ripped off in any public debt market. Could be used as a fiscal tool, similar to a central bank support rate for reserves?

  10. Ralph said:
    ” My ‘common sense’ argument is: why should one lot of people have to pay tax to fund interest payments to another lot just because the second lot want to save and earn interest? There is no reason. ”

    Wrong premise here Ralph. The interest paid on any Treasury securities does not have its origins in taxation.

  11. Neil,

    I accept your point that there are SOME DIFFERENCES between national debt and the National Savings Fund. But the NSF still pays interest. And if the argument for more national debt is invalidated by the argument that it’s wrong to pay interest just because loads of people WANT interest on their savings, then so too is the argument for an NSF.

    John Herrman,

    I fully accept that it’s POSSIBLE that interest on the debt comes from somewhere other than tax, e.g. it might come from more borrowing or from money simply printed by the central bank. But do you have any specific evidence as to where it comes from? Moreover, it’s perfectly possible that practice varies from one country to another.

    Another relevant point is that Warren Mosler is always going on about interest rate cuts being deflationary rather than, as commonly assumed, stimulatory. Strikes me his argument is crucially dependent on how interest is funded, a point he is never very clear on, far as I can see.

  12. Dear Ralph

    Heiner Flassbeck’s blog functions in the German language, but every so often they translate an article in English.

    Dear Neil
    I agree with you that there there will always be some mismatch between supply and demand in the labor market, which really isn’t one market but an agglomeration of small markets, simply because most skills are non-transferable and because it takes time to acquire new skills. Fiscal policy affects primarily aggregate demand. A large budget deficit can therefore raise demand for labor also in a segment of the labor market which is already tight, and it will therefore have inflationary effects. My argument has to be restated: it would a miracle if we could maintain full employment without anyone working for the JG and also have zero inflation.

    Regards. James

  13. Neil,

    “National Savings can only be held by named individuals with the right to retire in the country…”

    Well said, but I’m keeping out of it.

    I’ll mention, however, that (from memory, I hope I am not misrepresenting him) Boris Johnson was proposing that all private pension funds should be incorporated into a National Pensions scheme. A very socialist idea from a Tory. Since, as we see above, a high proportion of private pensions are vested in government “debt” for safe-keeping anyway, it does seem to make sense to cut out the middle man. If a National Pensions scheme (not the existing so-called National Insurance which isn’t insurance at all), was introduced I suspect people would rush to join provided the benefits were proportional to the amount paid in and subject to proper actuarial control. Private schemes would then become less popular – I don’t advocate banning them, if Standard Life can do better than the government that’s fine.

  14. Bill,

    It’s a question of risk management.

    “In a monetary economy, investors can always hold money balances by increasing actual cash holdings or banking system deposits.”

    But these do not pay an interest rate. And with no safe haven to provide base interest rates to investors these investors are more inclined to speculate on other assets. Having a safe haven paying interest allows investors to manage risk and take their risk off when then think the markets are getting crazy. This is much more difficult to do if you don’t provide a safe haven asset with some yield.

    Of course, you could open safe haven accounts to everyone rather than just savers. I’d be fine with that. But taking away any safe haven will only increase reckless risk-taking amongst the investment community. And, ultimately, this is often pension fund money.

  15. “And if the argument for more national debt is invalidated by the argument that it’s wrong to pay interest just because loads of people WANT interest on their savings, then so too is the argument for an NSF.”

    That’s not the argument.

    The argument is whether the holders of bonds are the correct entities that should receive a government income. The majority of current bond holders are not the correct entities to receive a government income. They should get out there in the private sector and do something useful, or have their money rot in a bank account.

    However there is an argument as to whether an individual should be able to buy a safe indexed linked annuity straight from the government to provide a graduated pension for retirement.

    That solves the additional pension argument, and the desire to create a ‘pension pot’ that people seem to like to coo over.

  16. “Strikes me his argument is crucially dependent on how interest is funded,”

    No government payment is ‘funded’. It is paid and the taxation consequences flow from that.

    Vital that causality is maintained.

    Always remember that if you have no saving, very large capacity and rapid transactions, you can recover all government spending of any size with a tax rate of 1%.

    To suggest that interest is ‘funded’ by taxation is simply wrong. They are not connected at all.

  17. Ralph,

    The idea of matching tax receipts to particular items of expenditure is misconceived, as is the particular idea that taxation is the source of funding for government interest payments. The MMT position is that central government spending is not actually funded by any sources of “revenue”, and therefore that government spending is not revenue-constrained. All governments rely on some combination of taxation, the sale of securities, and extraction of profits from state enterprises, as the means of withdrawing purchasing power from the real economy in order to keep a lid on inflation and also manage aggregate demand. However the precise “revenue” mix is not relevant to the task of achieving these objectives.

    As sovereign central governments possess the ability to create net financial assets (aka Treasury securities) out of nothing, and can roll over the terms of those assets without any problems in perpetuity, it is tempting to imagine that the interest payments would be factored in as a small component of the ongoing issue of new securities. And it would be a VERY small component at this point in time, as interest rates are ultra low all over the planet. I used to think this, and if one were determined to identify a particular source this would be the most rational and suitable choice. However I am now of the opinion that even this idea is not really correct.

    What I have no doubt about is that the story-line put put by those pushing the neoliberal agenda, that all public debt represents a cost to taxpayers and is a drag on their standard of living, is nothing more than a political statement aimed at justifying vicious spending cuts and a regime of austerity.

  18. @ Neil Wilson
    I can’t understand any of your comment at 16.26.
    There is substantial empirical evidence over many decades, currencies and currency regimes that deviations from Covered Interest Rate Parity are generally very small (less than one or two percent).
    This evidence conflicts with your statements that “A floating rate currency is an effective control on capital flows” and that the “silly ‘open’ vs ‘closed’ argument – which has no basis in reality – can be put to bed as the FUD that it is.”
    To the contrary, the evidence suggests that international capital flows respond to differences in interest rates, which limits the ability of any one country to pursue an independent interest rate policy.

  19. Why would any central government issue debt beyond the simple operation of paying creditors as and when required? Obviously there has to be a debt needing to be paid, but there’s surely no need to save for one.
    That’s what being monetary sovereign is about. Any government that does create savings, such as Norway’s sovereign wealth fund, is simply making money for the banks administering it. As if they had been conned into it by the bankers. There is no need for a government to hold savings for future pensions, for example. When the time comes the Treasury simply instructs the CB to send a cheque or to mark up the beneficiary’s account. A CB operation.

  20. In the UK something along the lines of a National Saving scheme is being rolled out over a two-year timescale whereby workes get an amount deducted from their salary automatically every month (in addition to National Insurance) which gets put into a government pension. But it doesn’t go nearly far enough and there is an element of coercion and an opt-out.

    I have seen it suggested that all existing private pension schemes shoud be nationalised. As they are all effectively invested largely in government securities it does seem sense to cut out the middle man. If the government were offering a competitive pension scheme and workers could be sure later governments are not going to change the goal posts I’m sure funds would flood in.

  21. These are some excellent points. Many retail investors are just looking for future security. If we had national pension security and medical security this would help a lot. Also education security would help people who try to save for their children’s future expense. And a nationally backed savings account would be a safe place to store money for emergencies.

    I do think foreign exchange is an important limitation to overt monetary financing. A currency has to prove its value usually by showing the power to create a currency area with effective taxation. This then gives it the power to obtain any foreign currency needed by exchange rather than by borrowing.

  22. I would propose allowing a saver to move their demand deposits into a savings account at their own bank for perhaps a 3 month period, with the option of automatic roll-over. The Federal Reserve would pay interest on these deposits at some rate that is basically whatever the current inflation rate is. Perhaps these savings would be denominated in even $100 certificates, with new certificates automatically created from interest earned.

    This program would be open to only US citizens. US owned businesses would also be allowed to participate, but limited to declared retained earnings. These certificates would not be allowed to be pledged as collateral for loans.

    The main motivation of this program is to allow those who wish to save to do so without fear that the value of their money will be inflated away. Their money would truly become a ‘store of value’. Of course this would act as a drag on current demand (which may or may not be desirable at the time), but the government could always spend more if need be.

    (For the record, I reside in the U.S., but other counties would have similar programs)

  23. John Hermann,

    I’ve supported MMT for several years and I’m well aware of the MMT point that extra public spending does not necessarily need to be funded, e.g. matched by extra tax. To be more accurate, if the economy is operating at below capacity, then the state can simply print money and spend it without inflationary consequences.

    However, if the economy IS AT capacity, the state cannot do that: it has to collect around $X in tax if it wants to spend an extra $X. Moreover, the reality is that every year, decade after decade, public spending is APPROXIMATELY matched by the amount government taxes and borrows, with the total amount printed, i.e. the addition to the monetary base each year being relatively small by comparison.

    Thus my assumption that interest paid on public debt has to be matched by extra tax is a perfectly reasonable one, if not 100% accurate.

  24. “It would be a miracle if we could both maintain full employment and have zero inflation.”

    As prices go down during a recession and rising unemployment, I would expect prices to go up during a recovery and up further as we approach full employment. But that’s not inflation, that’s just a one-off change in some price levels.

  25. Dear Phil (at 2015/09/03 at 21:05)

    You wrote:

    But taking away any safe haven will only increase reckless risk-taking amongst the investment community. And, ultimately, this is often pension fund money.

    Simple. Declare a range of speculative activities (those that cannot be tied to the real economy) illegal.

    But even if you do not want to do that, the government can just legislate that pension/superannuation funds can only invest in certain assets like the NSF.

    But even more simply, offer a return that drives the private pension funds out of business, given they claim management and other rip-off fees out of the workers’ returns anyway.

    That profit margin can be arbitraged by the public National Savings Fund to ensure workers shift their savings into it.

    best wishes

  26. The ethical position set out by Lerner is now known as consequentialism, or consequence ethics, whereby an ethical principle is judged to be good or bad according to its consequences. This paradigm isn’t about simply viewing the ends as justifying the means; it is more about whether the means bring about desired ends. Marx was in this sense a consequentialist when he contended that democracy is defined by the procedures by means of which ends are achieved; and, therefore, if a procedure brought about undesirable ends, something was amiss with the procedure or set of procedures that brought the given end about. As might be expected, there are different ways of interpreting this paradigm.

  27. I should have noted that bad procedures can, in practice, bring about desirable ends, but since they can bring about both undesirable as well as desirable ends, it is preferable to develop procedures whose end results are more often desirable than undesirable, hopefully reducing the possibility of unforeseen events diverting a procedure from its desired outcome.

  28. James Schipper,

    It would be a miracle if we could both maintain full employment and have zero inflation.

    To the contrary it would be quite easy to maintain a zero rate of inflation with only frictional unemployment. All that is required is, in addition to stronger automatic stabilizers, a Lernerian incomes policy (which he spent a great deal of his career researching) to control for inflationary sources other than spending.

  29. Bill –

    “Simple. Declare a range of speculative activities (those that cannot be tied to the real economy) illegal.”

    I can also see a market in search of a replacement for Treasury Securities being rather more stringent with their purchases of other debt, to the point where those who offer such debt might have go to much greater lengths to prove the value of their assets to investors, who now have no market distorting government annuities to take refuge in. And with the stability that MMT brings to the table, they might actually, effectively, self-regulate.

  30. “To the contrary, the evidence suggests that international capital flows respond to differences in interest rates, which limits the ability of any one country to pursue an independent interest rate policy.”

    The evidence *with CBs running liquidity policies*. There is no evidence with CBs allowing liquidity to run out and leaving it to the counterparty CBs to run liquidity.

    You may as well say: “Man cannot fly, because when he flaps his arms nothing happens”.

    There is *no* exchange rate theory that fits the available evidence. None. Anybody who thinks they do have an exchange rate theory are welcome to try that out in the FX market.

    I listen to what people like Warren Mosler says about things – from his retirement home in the Caribbean.

  31. “In the UK something along the lines of a National Saving scheme is being rolled out over a two-year timescale whereby workes get an amount deducted from their salary automatically every month (in addition to National Insurance) which gets put into a government pension”

    NEST is just another Government Pension Scheme Quango. It invests ‘in the market’ in the same way as any other pension fund (Gory details here:,PDF.pdf)

    All these asset based pension schemes, particularly in the public sector, are a stupid waste of time and just aggravate the lack of assets available to the private sector.

    But their accounts are interesting – since they show that the pension fund just takes in income in the form of contributions and the small return from their investment pool, and then distributes that pool first to their employees and then to the pensioners.

    Essentially private tax collectors, with a lot of busy work going on in between.

  32. “However, if the economy IS AT capacity, ”

    The economy is never at capacity. That’s the point. There is always capacity somewhere. You reach supply side limitations in specific areas well before general capacity would be exhausted.

    It would help if people stop banging on about the special case of ‘capacity’ when the system never gets there. It’s like assuming we’re always moving at light speed and analysing everything as though we have no mass.

    Capacity is a special case where classical economics makes a bit of sense. The problem is that no economy ever gets there, so none of the analysis ever makes any sense to the real world we live in.

    The assumption of capacity exhaustion is flawed in a dynamic economy – because productivity improvements and supply side action quickly opens up capacity.

    The ‘assume we’re travelling at light speed’ approach will just switch off anybody around here. We all know we’re moving a lot slower than that, and we’ve still sat in traffic jams.

  33. The degenerate case is of course foreign ownership of savings. The foreigners never spend the interest because they wish to control the exchange rate to maintain their export policy to your nation.

    Therefore any interest paid on the foreign held savings is simply saved and never spent (it ends up buying more bonds – if there are any on sale). The issuing of interest never generates any taxation. And it has no economic impact. It is just an accounting alteration to make foreigners feel happy.

    Since it is always the case that at least some of the interest paid is saved, and aggregate savings always accumulate over time, it can never be the case that interest is matched by taxation as a point of logic.

    Because net saving acts like a tax. A key understanding of MMT.

  34. The main barrier to governments providing adequate spending to provide
    full voluntary employment is not issuing bonds but political will.I would contend
    that the lack of political will is in essence the corruption of the wealthy via the faith
    in miracles of the unfettered market.That being the case the most important
    reason to stop issuing bonds is to win the battle of political will to expose the
    reality of a market which best serves those with most spending power.
    To support bond issue in order to support retirement income of the not so wealthy
    is a little bizarre especially in current times when pension funds have failed so
    badly to do just that.
    Whilst certainly no miracle ,as they do not exist, universal social credit (citizens wage)
    as a part of a progressive tax policy gives a very simple solution to the savings and
    retirement wishes of ordinary folk.All or part of the citizens wage could be saved for
    later payment as the wage would be indexed linked these savings would be inflation
    proof but not speculative in nature.

  35. Ralph Musgrave:

    I was going to make the point that Neil Wilson made, but he beat me to it. Economies are rarely, if ever, at capacity. I hear what you are saying, but I disagree with you .. for the reason that Neil gave, and for other reasons.

    Statistical data available for the past 100 years reveals that most economies (including the Australian economy) have been largely in deficit — for at least 80% of that time. And even when they were in balance or surplus, this circumstance did not last for long, and was more often than not followed by recession. And the long sustained periods of deficit budgeting cannot be simply attributed to the need to increase the money supply commensurate with the needs of growing economies for credit and currency. The real reason lies in their operating well below capacity.

    Moreover, it is incorrect to assert or assume that taxing and borrowing are the only factors at work on the deficit side of the central government’s fiscal operations (i.e. what the orthodoxy interpret as “revenue”). In many countries, governments still retain state-owned and operated enterprises which return a working profit. I am well aware that the trend, in line with the neoliberal agenda, has been to privatize all state owned enterprises and utilities which are perceived to return a useful profit, however that process still has some way to go in many countries outside of north america. In the future, after the neoliberal experiment has run its full course, that trend hopefully will be reversed. In addition, most countries retain a line of credit for Treasury with the central bank (including Australia). Even if that facility is rarely used in ‘normal’ times, it is always available for use in extremis. What the GFC revealed clearly is that if something really needs to be done in order to prevent the economy from plunging into depression, a way will be found to make it happen.

  36. ..Thomas Edison and Henry Ford were asked about the financing of a large infrastructure project at Muscle Shoals. Edison’s answer, as it appeared in the New York Times on December 6, 1921

    “….”Then you see no difference between currency and Government bonds? “Mr. Edison was asked.

    “Yes, there is a difference, but it is neither the likeness nor the difference that will determine the matter; the attack will be directed against thinking of bonds and currency together and comparing them. If people ever get to thinking of bonds and bills at the same time, the game is up.

    “Now, here is Ford proposing to finance Muscle Shoals by an issue of currency. Very will, let us suppose for a moment that Congress follows his proposal. Personally, I don’t think Congress has imagination enough to do it, but let us suppose that it does. The required sum is authorized -say $30,000,000. The bills are issued directly by the Government as all money ought to be. When the workmen are paid off they receive these United States bills. When the material is bought it is paid in these United States bills. Except that perhaps the bills may have the engraving of the water dam, instead of a railroad train and a ship, as some of the Federal Reserve notes have. They will be the same as any other currency put out by the Government: that is, they will be money. They will be based on the public wealth already in Muscle Shoals, and their circulation will increase that public wealth, not only the public money but the public wealth-real wealth.

    “When these bills have answered the purpose of building and completing Muscle Shoals, they will be retired by the earnings of the power dam. That is, the people of the United States will have all that they put into Muscle Shoals and all that they can take out for centuries-the endless wealth-making water power of that great Tennessee River-with no tax and no increase of the national debt.”

    “But suppose Congress does not see this, what then?” Mr. Edison was asked.

    “Well, Congress must fall back on the old way of doing business. It must authorize an issue of bonds. That is it must go out to the money brokers and borrow enough of our own national currency to complete great national resources, and we then must pay interest to the money brokers for the use of our own money.

    Old Way Adds to Public Debt.

    “That is to say, under the old way any time we wish to add to the national wealth we are compelled to add to the national debt.

    “Now, that is what Henry Ford wants to prevent. He thinks it is stupid, and so do I, that for the loan of $30,000,000 of their own money the people of the United States should be compelled to pay $66,000,000-that is what it amounts to, with interest. People who will not turn a shovelful of dirt nor contribute a pound of material will collect more money from the United States than will the people who supply the material and do the work. That is terrible the terrible thing about interest. In all our great bond issues the interest is always greater than the principal. All of the great public works cost more than twice the actual cost on that account. Under the present system of doing business we simply add 120 to 150 per cent. to the stated cost.

    “But here is the point: If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good also. The difference between the bond and the bill is that the bond lets the money brokers collect twice the amount of the bond and an additional 20 per cent., whereas the currency pays nobody but those who directly contribute to Muscle Shoals in some useful way.

    “If the Government issues bonds it simply induces the money brokers to draw $30,000,000 out of the other channels of trade and turn it into Muscle Shoals: if the Government issues currency, it provides itself with enough to increase the national wealth at Muscle Shoals without disturbing the business of the rest of the country. And in doing this it increase its income without adding a penny to its debt.

    “It is absurd to say that our country can issue $30,000,000 in bonds and not $30,000,000 in currency. Both are promises to pay: but one promise fattens the usurer, and the other helps the people.

    If the currency issued by the Government were no good, then the bonds issued would be no good either. It is a terrible situation when the Government, to increase the national wealth, must go into debt and submit to ruinous interest charges at the hands of men who control the fictitious values of gold.

    “Look at it another way. If the Government issues bonds, the brokers will sell them. The bonds will be negotiable: they will be considered as gilt-edged paper. Why? Because the Government is behind them, but who is behind the Government? The people. Therefore it is the people who constitute the basis of Government credit. Why then cannot the people have the benefit of their own gilt-edged credit by receiving non-interest bearing currency on the Muscle Shoals instead of the bankers receiving the benefit of the people’s credit in interest-bearing bonds?”

    Says People Must Pay Anyway.

    “The people must pay any way: why should they be compelled to pay twice as the bond system compels them to pay? The people of the United States always accept their Government’s currency. If the United States Government will adopt this policy of increasing its national wealth without contributing to the interest collector-for the whole national debt is made up of the interest charges-then you will see an era of progress and prosperity in this country such as could never have come otherwise….”

  37. I concur ,thank you RV Markov and Thomas Eddison.
    What a great lesson to Mr Corbyn.
    If our nation can issue a bond it can issue a bill (an account deposit)
    The element that makes the bond good also makes the bill good.
    Both are promises to pay.One fattens the usury the other helps the people.
    Excellent stuff.

  38. As to Neil’s point about savings being fundamentally a tax.
    Well that is to some extent true that aggregate savings are the gap
    between government spending and tax collected.Both are absolutely vital.
    Taxes to drive the currency and to limit the future claims on real resources of the wealthy.
    Savings to pay for things which income cannot without rising private sector debt and
    to support income when age or ill health limits earning capacity.
    This is why we need structural government sector deficits from a chartalist perspective.
    More vertical monetary transactions from government to the private sector than the other
    way around .This is true beyond counter cyclical fiscal stimulus .
    The question then becomes how do we insure a reasonably fair and just distribution of
    future claims on real wealth with the bounty of the earth and the labours of men past ,present and future.

  39. [Quote]
    Moreover, the reality is that every year, decade after decade, public spending is APPROXIMATELY matched by the amount government taxes and borrows, with the total amount printed, i.e. the addition to the monetary base each year being relatively small by comparison.
    [End quote]

    Ralph, this is done because of artificial constraints by the EU treaty – specifically, the treaty requires every £/‎€ to be matched by debt issuance in the private bond markets. It’s another façade carried out by neoliberals to convince the untutored that the market is the real boss of the economy (which it clearly is not). If you recognise this, then it’s easy to see why Government spending appears to be matched by tax/borrowing!

  40. hi kingsley,

    i think the distinction we make is that the central bank sets the price , and it can pick any number its particular set of tea leaves says it should, but that doesnt mean to say it gets the price right.

    its either trying to jaw bone or beating a hasty retreat, and history shows they generally get their pricing wrong, and thats why we are better off having no market intervention by the central bank in the price, and we set the support rate to zero.

  41. Dear Mark Kinnear (at 2017/07/22 at 10:42 pm)

    No, but their superannuation funds do.

    best wishes

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