An MMT Perspective –
Should governments ever borrow from the private sector?
MMT stands for Modern Monetary Theory. It calls itself ‘Modern’ because the theory deals with the monetary world that emerged post 1971 when the Bretton Woods monetary system was abandoned mainly because it had been undermined by attempts by the US government to pay for the Vietnam War by printing dollars.
In 1971 the value of currencies ceased to be tied to a physical object like gold. Money became fiat money. Governments could create unlimited amounts of this money. MMT attempts to explain how this modern monetary economy works. A big question for governments is what to do if their expenditure is greater than their tax revenue.
To better understand the issues here we need to consider some different scenarios.
Consider first the scenario of the GFC in 2008. The private sector was in panic. Households increased savings. Businesses cut investment. As a result demand dropped and tax revenues dropped. The government deficit ballooned. According to mainstream economics the government should finance its deficit by borrowing the money from the private sector. According to MMT the government should (electronically) print the money.
Mainstream economics says that it is necessary for the spending of the private sector to be reduced by the amount the government will spend into the economy otherwise there will be inflation. Borrowing from the private sector is a way to reduce the private sector’s spending. However the MMT economists believe that the reason the government must spend into the economy is precisely because the private sector has decided not to spend into the economy. They therefore see no danger of inflation and therefore no reason to issue bonds to the private sector. Issuing bonds simply changes the nature of the portfolio held by the private sector from cash to interest earning, risk free government bonds. It’s as if the government sector is rewarding the private sector for creating the drop in aggregate demand which forces the government to spend into the economy if unemployment is to be avoided. MMT economists see no reason for doing that.
Now consider the scenario created by the Coronavirus crisis. How would an MMT economist analyse and address the economic problems raised by this crisis? Well some 25-30% of the workforce will be unable to work due to health safety rules and are on furlough. The government announced that it would pay some 80% of the earnings of these furloughed workers.
Rishi Sunak expects to spend £300 billion more than will be raised in taxes. According to the Institute for Fiscal Studies (IFS) this £300 billion will be borrowed from the private sector. The MMT folks would disagree and would instead argue that the government should simply create the money by marking up the bank accounts of those it wants to pay. In the national statistics this will show up as an increase in the national debt. But, since the government is borrowing from the Bank of England (BoE), it is effectively just borrowing from itself so the debt will never have to be repaid.
The IFS would argue that creating money in this way would be inflationary. But let’s examine the logic. Suppose Sunak expected 20% of the workforce to be unable to work because of the lockdown. Let’s call this segment of the workforce the Out Of Work Segment (OOWS). 80% of the workforce is able to continue working. Let’s call this segment of the workforce the In Work Segment (IWS). Then the economy will experience a drop in demand of some 20%. Also the OOWS would typically spend about 80% of their wages on the produce of the IWS. Because of the lockdown the OOWS workers will lose all income and be unable to sustain themselves. Although the IWS has work they will experience a drop in demand from the OOWS of some 16% (80%x20%). By making furlough payments to the OOWS of 80% of their earnings Sunak allows them to survive and to continue to buy from the IWS and so reduces the possibility of unemployment in the IWS because of a drop in demand from the OOWS. So it’s a win-win situation. And there are no inflationary pressures on the produce of the IWS since no more is being consumed than would normally be consumed. Sunak’s furlough spending into the economy broadly matches the drop in demand caused by the inability of the OOWS to work.
Why does the IFS argue that Sunak should borrow this money from the private sector? In general that argument is based on the assumption that the private sector would have spent the money into the economy if they had had it. Government spending financed by creating money would therefore be inflationary. But as we can see the OOWS will be spending nothing into the economy other than what they receive from Sunak. So creating the money will not be inflationary and will stabilize the society.
Now the IWS would of course, in normal times, be spending some 16% into the OOWS. They can no longer do this since the OOWS is producing nothing. Will they instead spend it on goods produced by the IWS thus creating inflation? It’s a possibility. But the evidence so far suggests they will either save it or use it to reduce their debt. But that might change if the lockdown were to continue for years.
A lockdown, in which a large number of people are not allowed to work for health reasons, is not too dissimilar to a war situation where large numbers of people are taken away from producing household consumables and into producing war fighting machines. The furloughed workers correspond to those engaged in the production of war equipment, although in this case they are producing good health by being on furlough.
Those remaining in work will initially become involuntary savers. If, after a period, they decide to increase their consumption of the reduced number of household consumables then inflation might result. To prevent this, their involuntary savings could be taxed away or some sort of Coronavirus bond could be introduced with a minimal interest rate to make them feel less resentful of their forced, involuntary savings.
Perhaps, in this situation of a long term lockdown, it might make sense, even from an MMT perspective, to issue bonds. But the bonds would be issued to remove the possibility of inflation and not to raise money for the state.