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Deficit Narratives

What's the media saying?

Soon after the onset of the Covid-19 lockdown, the mainstream media became increasingly exercised about the ballooning UK government deficit. Subsequently, the established narrative on deficits is becoming translated into justifying yet more austerity, otherwise "our grandchildren will have to pay, but is this true? Modern Money Scotland argues that deficits matter, but not in the way we have been led to believe.

So what is a a government deficit?

A government deficit is simply the difference between what the government spends-out into our economy and what it taxes-back from us. As the UK government is the monopoly issuer of our currency, then logically, government spending must come first and taxation and borrowing must follow.


Many of our politicians and much of our media frequently tell us that the UK government must 'balance' its budget and that it must therefore 'borrow' to achieve this. However, government bookkeeping cannot be compared with either businesses or households, who are currency users, not currency issuers. Moreover, the language used to describe government accounting is not factually descriptive - imagine if you could legally print your own money supply in your garage, would you ever be in debt? At this point, its important to remember that a currency is not a real resource, as in water, energy, food or labour. Money creation and possession cannot guarantee the acquisition of real resources if they are unavailable. The most recent example of this was the desperate international scramble for Personal Protective Equipment (PPE) at the onset of the pandemic.

In reality, most governments need to run deficits, otherwise there would be no savings in the private sector if the government taxed back all of the money that it had spent-out in the first instance. The UK government is the monopoly issuer of the UK currency and our economy cannot function without government money.

From 2019 - 2020, the UK government's deficit was £55billion but this year it could grow by more than £300billion. The media response has been predictable and according to the BBC, the government must reduce this deficit via three options:

  1. Cut government spending - better understood as austerity. For example; freezing payments for public sector workers such as, firefighters or nurses, reduce social security spending and/or including removing the triple lock from pensions.

  2. Raise taxes.

  3. 'Borrow' more, in the form of long-term bonds.

However, there is a fourth less frequently mentioned option, which the UK government is already doing and that is increasing the money supply. The UK and other monetarily sovereign countries, such as the US, Canada, Japan and Australia can all increase their money supplies as their respective currencies are fiat and free-floating.

Nowadays, most money is electronic, so government money is created when someone at the Bank of England types numbers into a computer and deposits money into the bank accounts of hospitals, councils, devolved governments etc. Due to the huge economic impacts of the current pandemic, countries all around the world are issuing more bonds and increasing their money supplies.

Figure 1: M4 Money Supply in the United Kingdom from February to July 2020. Source: Bank of England. Note that the measurement for money is thousands of millions.

NB - [1 Billion is 1000 Million]

So why is the concept of governments creating money so feared by so many? Inflation is always the main concern for politicians and pundits, as it should be. However, unfortunate frequent referencing to instances of hyperinflation in the Weimar Republic and Zimbabwe do not enrich the debate.

These very extreme examples of hyperinflation were not caused by increased money supplies but by the contraction of real resources, which came beforehand. The occupation of the Ruhr industrial heartland removed real resources from the Weimar Republic and in Zimbabwe, poorly implemented land reforms quickly translated into huge reductions in food production. Both vividly illustrate the importance of real resources over currency.

Fundamentally, spending causes inflation not increased money supply, more specifically the type-of-spending. When government-created money is deposited into a commercial bank as their reserves and not lent out, it will not cause inflation. Furthermore, facilitating the growth of offshore bank accounts and their burgeoning contents, via lax taxation, will not cause inflation either - but is it desirable? Perhaps it is for a small minority of our population but creating money to keep your citizens alive, well and working, when and where possible, is surely the desired aim of any civilised, humane modern society. It is clear that paying much of the UK population to stay at home with the furlough scheme has also not caused overt and undue inflationary pressure.

Figure 2: Consumer Price Index and Housing, Consumer Price Inflation and Owner Occupier Housing Costs. Source:Office for National Statistics

Since the Covid-19 pandemic we have witnessed some profound supply-side and demand-side shocks, which has caused some price inflation, for example PPE. Also, a very notable example of profound deflation was with the price of North Sea oil. These two examples give a little insight into the complexities of inflation, which the succinct description of is, a rise in average price level sustained over time. Other factors influencing price levels are; taxation, trading levels, interest rates and the velocity of money, that is the speed at which money is exchanged. However, these influences can be short-lived.

Figure 3: M4 Money Supply in the United Kingdom from 2008 until 2020. Source: Bank of England.

Governments, financial bodies and much of the media actively promote the idea that government are like households and that the government can only spend-out what it receives in taxes. In fact, Her Majesty's Revenue and Customs use the term 'tax return’ - this is because tax is government money literally returned. Governments with their own sovereign currencies can and do create money via their central banks and in the case of the UK this is the Bank of England, which is an essential arm of government and whose Governor is appointed by the Chancellor.

So who doesn't like a deficit?

The stock markets can take a negative view of government deficits as increased bond sales provide a much safer investment environment for those with savings to invest, so bond sales can be viewed as competition for investment. Conversely, when a country invests in large infrastructure projects, this can increase the attractiveness of a country as a possible investment vehicle. Witness the recent increase in the value of the pound when increased infrastructure spending was announced in the pre-pandemic UK.

What is MMT?

The central thesis of Modern Monetary Theory (MMT) is that monetarily sovereign governments can operate with higher deficits, without causing significant inflation. MMT is not a political policy, it is a macroeconomic observation which describes and analyses how fiat monetary systems operate and the governmental capacities available within this system. MMT is evidence-based, observing government accounting and the subsequent macroeconomic landscapes that result. Orthodox economics, on the other hand is less concerned with actual evidence.

Modern Money Scotland states that the government deficit is also the private sector surplus and that fiscal deficits are neither good nor bad for a country's economy as context is always required. However, we would argue that human suffering and ecological degradation should be avoided and that combined social, ecological and economic success are possible and not mutually exclusive.

A fiscal surplus might sound better to us than a fiscal deficit, but only because we have been conditioned to think that the management of our nation's finances operates in the same way as households or businesses. When you create and control your own money supply, household and business budgeting rules don't apply. As voting citizens trying to maintain the efficacy of our fragile democracy we have to start viewing government deficits through a different lens, to better see how we hold our elected representatives to account. Then together, we can begin the work of creating a modern, inclusive, successful and kind society, which educates and nurtures its people and provides equality of opportunity for all.

Further Reading/References:

Kelton S, The Deficit Myth. 1st ed. London: John Murray; 2020

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