All Govt spending comes back as taxation eventually. Where else can it go? So, there’s no such thing as “unfunded promises” or “unfunded spending”. Now that the UK’s election campaign is well underway we are hearing accusations along the lines that their opponent’s sums “don’t add up” , or “they haven’t done their costings properly” . It is from both sides. It’s not just the right wing that doesn’t understand how money flows in the economy. Labour is just as bad, and maybe even worse, than the Tories at the present time.
Money arrives in the economy when government spends it in and leaves the economy when government taxes it out. More can’t leave than arrive for other than a limited amount of time. It’s physically impossible.
The government doesn’t tax it out because it needs the money. Why would it? It’s created it in the first place. The UK government hasn’t adopted the euro, the UK government still has total control over the issuance of its own currency. It’s like saying a theatre needs to collect its theatre tickets because it needs the tickets. Or the Post Office needs to collect back its stamps because it needs the stamps.
The government imposes taxes to cancel its stamps and tickets – effectively. It does that to prevent high inflation in the economy. So, providing inflation is under control, government spending can be allowed to rise – especially if there is slack in the economy and there is an unemployment and underemployment problem. If inflation isn’t under control spending needs to be trimmed back or taxation increased.
If we are worried about the future economy that our children will live in, we only need think about the one we live in now to know what the real worries should be. What do we thank or blame our predecessors for? We thank them for the railway network, the road system, the health service , the education system etc. We blame them for some of their past environmental practices which mean that rivers have to be cleaned up, buildings which should be white are actually black with accumulated soot, some of their slipshod practices over the disposal of nuclear waste etc.
Do we worry about the ‘debts’ they accumulated? Not at all. They are of no consequence to us now.
Modern Monetary Theory: Real Economics 
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Remember to mention saving money leads to a ‘deficit.’ And UK currency is a closed area and non convertible so trade deficits lead to foreigners saving pounds.
This is potentially true but not actually true. Neoliberals have ceded money creation to banks who create 97% of the money supply as credit (mortgages, credit cards, loans to companies, etc).
The Maastrict and lisbon treaties have imposed a corset on government deficit spending (3% of GDP) and forbids monetisation of government debt through the central bank.
Governments borrow and tax, they do not create very much money (less than 3% as cash).
It is true that they can create money via deficit spending, and tax it back later, or write it off, but they have forgotton that they have that right, or they work for the City ceding this authority to banks.
Ms Crawford,
Most Government IOUs are in the form of gilts rather than cash. Most of the National debt (so called) consists of gilts and other government backed securities. When government spends more than it receives in taxes the banks end up with a surplus of real Government money. That doesn’t pay them any interest, so they shift that money into gilts which does, and at the same time replace Govt money with Commercial bank money in customers’ accounts.
We need to recognise that commercial bank money is the liability of the issuing bank, not the liability of Government.(except to the extent that Govt guarantees bank deposits up to a certain level). So the banks effective issue parallel currencies: Lloyds Pounds, Barclays Pounds etc which are pegged on a 1:1 basis to Government or BoE issued pounds. They use their financial assets to guarantee that peg. But if the bank is financially weak that peg could conceivably break.
To pay our taxes we need to pay in real Govt pounds. Our banks have to stump up from their reserve accounts whenever we write out a cheque to govt.
The banks can’t issue pounds with BoE printed on them. Or their digital equivalent. If they could they could never go broke of course.
PS The 3% limit you refer to, applies only to euro using countries, and countries who aspire (if that’s the right word), to be accepted into the eurozone. It doesn’t apply to the UK.
Sandra,
When the state spends into bank accounts it *causes* the creation of bank money. That’s what a reserve add does when there is a peg between the central bank and the commercial bank.
The commercial banks are under licence from the Bank of England and the Bank of England is controlled by the Treasury. So what commercial banks create *is* government money – by licence.
If they are being stupid about it, then you just change the terms of the licence and they immediately have to be less stupid or go bust.
So all of it is public money, in the same way that refuse is a public service – even if the guys emptying the bins are private contractors
So the ‘less than 3% cash’ thing is just pure propaganda put out there by people who like to twist the truth a lot for their own ends. It completely ignores central bank reserves. Ask yourself what else they are ‘over-emphasising’ that might not actually be the case and why you are repeating something that simply isn’t true or remotely relevant.
The government spends first and issues bonds later for the same reason that a bank lends and then gathers in deposit later. By doing that you get a better price.
It doesn’t have to issue bonds or pay interest and a determined sovereign parliament of the UK could just dispense with the pretence of bonds and run an overdraft at the BoE. There is no binding enforcement on a UK parliament from the EU treaty. It has power here only by virtue of the European Communities Act. So if you don’t want a bit to apply to the UK, you just change that act and that is the end of the matter.
If a government Treasury runs over-drafts at the central bank, because it spends primarily to nonbanks, this adds both reserve assets to the accounts of banks kept at the central bank, and checking assets to the accounts of nonbanks kept at the banks. The banks in a growth economy do not want to hold zero-interest reserves, and will leverage up loans in the effort to reduce reserves, which are constantly being added by the government deficit and overdraft. The nonbanks in a growth economy do not want to hold the low or zero-interest checking accounts, and will try to convert these to interest-bearing liabilities and capital investment in banks. So I think every system in a growth environment ends up having either Treasuries paying interest or a central bank paying interest on reserves or issuing time deposits to banks. The government pays interest in a growth economy one way or the other, as I see it, but I am not sure if the injected money could be absorbed without harm by allowing bank-nonbank interaction to drive conversion of money to investments, I just sense there is such a harm because governments have decided to pay interest by injecting securities rather than injecting zero-interest money.
Joe, I’d put it that Govt issue bonds to remove excess reserves as part of their monetary policy on interest rates. If Govts want to reduce longer term interest rates they buy back the bonds as they’ve done in the QE program.
It might make more sense to stop issuing bonds and instead just vary the level of interest on cash deposits. They wouldn’t have to be time deposits as bonds always are sellable for cash anyway. In that sense bonds are just another form of money.
IMO people get over concerned at the amount of interest paid by govts. They might have a point if that interest was much higher than inflation but it rarely is. On the other hand those same people complain that their National Savings accounts don’t pay enough interest to offset inflation.
So its hard to know just what their point really is. Or even if they have one.
“Now that the UK’s election campaign is well underway we are hearing accusations that their opponents sums “don’t add up” , “haven’t done their costings properly ” etc etc from both sides. It’s not just the right wing that doesn’t understand how money flows in the economy. Labour is just as bad, and maybe even worse, than the Tories at the present time.”
… Labour is also a hostage to this dominant narrative about ‘sums’ and ‘adding up’. They’re playing the neoliberal game on its own terms, so it’s safe to suggest they are no different to the Tories with respect to having no idea about government finance. The punter in the street really doesn’t want to think too hard, hence we have the kind of politics that simply divides between who are the goodies, and who are the baddies (as Sir Humphrey would say).
Sandra, I have a bit of a problem with the description of banks creating money. Please correct me if I’m wrong, but banks create credit – ie. inside money. If they created money in and of itself, surely they wouldn’t have needed Federal bailouts in the GFC.
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For those who have a problem with banks creating money I can give many references. See list below;-
Positive Money Group (see their website).
Richard Werner (Professor of Banking, Southampton University) Has talks on youtube.
Professor Steve Keen – has blog, you tube videos with Max Keiser).
Lord Adair Turner, speeches and talks, videos online.
Martin Wolf, Chief Economics Editor of the Financial Times, wriiten and spoken about this any times.
Cartoon beginners guide on youtube called “Money as Debt” by Paul Grignon.
Web of debt, by Ellen Brown.
Money Masters and the Secret of Oz by Bill Still.
“Treatise on Money” by John Maynard Keynes
Irving Fisher.
Also for those who have a problem with banks creating money, please watch this debate in the House of Commons.
http://www.parliament.uk/business/committees/committees-a-z/commons-select/backbench-business-committee/news/mps-debate-money-creation-and-society/
Sandra,
We don’t have “a problem with banks creating money”. We know they do. But what sort of money?
A casino issues chips which are the IOUs and the liabilities of the casino. If the casino was sufficiently financially stable, then in principle those chips could be used as money outside the casino too. Why not? Shopkeepers in the area would just need to feel sufficiently confident that: a) they were genuine and b) the casino wasn’t about to go bust.
So that’s all bank money is, except in digital form. Right?
Agreed?
Listen to the link I gave. Banks create money. The form is irrelevant. What matters is that they create it mostly for real estate lending and increase debt on housing bubbles, thereby sucking out the economic surplus of the nation in debt service. Very little is created for productive purposes, and banks avoid tax, so the profits of money creation and interest cascade up to the rich.
Debt deflation results because we have increasing debt and falling incomes.
The problem also is that governments do not recognise the problem which could be solved by government created money and progressive taxation
Somebody above quite clearly stated that they had a problem with banks creating money!.
Banks create money. The form is irrelevant.
Yes banks create “money”. Yes economists, such as Steve Keen, are quite right to suggest that the way they do that has major implications for the workings of the economy. That’s not at all in dispute.
But, if we are to truly understand what money is, we can’t dismiss the different forms of it as irrelevant. Knowing the identity of the issuer of the money, the person or organisation which accepts liability for that issuance has to be highly relevant.
Its a big mistake to think there’s only one form of “money” even within the same currency. We can’t settle a tax bill with liabilities created by Barclay’s bank for example. We can’t even directly pay someone who has an account at the RBS with Barclay’s liabilities. The banks have to go through the process of swapping their own liabilites, with each other, via the clearing system. Any imbalances, at the end of each working day, have to be settled from their reserves using real BoE money.
Petermartin2001
That is why they needed the 370bn bailout in 2008. They had created too much credit, and traded toxic assets from other banks which were worthless, because other banks had created too much credit (the NINJA loans).
Your first “they” is presumably the government? The Govt needed that money to keep the economy moving when their usual source of “borrowing” via their issue of gilts temporarily dried up in the aftermath of the GFC.
The cost of “bailing out” the UK private banks would have accounted for about ….well ,er, … whatever you want that figure to be! It depends on whether you include loans, liquidity guarantees, implied insurance cover etc. It also depends on whether the acquired assets are counted in the balance sheet of the exercise or just the cost of buying them.
Your second “they” is presumably the private banking sector? They had created too much credit? Well, yes they would, if they were allowed to, wouldn’t they? The banks could be nationalised, and controlled by Govt/BoE, in which case all pounds would be effectively BoE issue. But if they carried on with the same lending practices, nothing would change. They’d still create too much credit if they lent too much.
So, whether or not they are nationalised, the banks still require better regulation to reduce their tendency to indulge in stop-start lending, and credit creation, patterns.
In my papers on SSRN I argue that the US government provides financial security systems through the Fed/Treasury battery. If this occurs through an overdraft to inject money, as advocated by some MMT authors, then it adds money which banks and nonbanks do not wish to hold in a growth economy. Bank balance sheets expand when banks and nonbanks do not want to hold money and prefer to hold investments, so I conclude that the government or central bank must pay interest on liabilities to have any influence over bank balance sheet expansion in the system as it exists. It may be that government can drive interest short term interest rates to zero and keep long term rates very low without adverse consequences. This also means, however, that a conservative unit attempting to save for retirement must save much more from current income due to reduction in the compound growth rate. I think zero interest government policies only emerge in mature economies or those saturated with efforts to pay down old debt and not float net new debt.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2458563
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2552733
Sandra @April 12, 2015 at 9:31 pm,
Been there done that with your references.You have to ask though do they make a cohesive whole? I’m afraid they don’t.
For example Steve Keen (who I rate and is v. close to MMT) recently tweeted this on the “Money as Debt” film…
“Money as Debt’s title is correct but virtually everything else in it is wrong.”
Positive Money proposals by the way have little academic support. For example, like many monetary ‘cranks’, they propose “debt-free money”, which is nonsensical in the face of anthropological evidence to the contrary (that ‘money’ is an IOU)…
http://www.theguardian.com/commentisfree/2014/mar/18/truth-money-iou-bank-of-england-austerity
http://neweconomicperspectives.org/2014/07/debt-free-money-non-sequitur-search-policy.html