Econ Bro | Associate | Free Market Foundation | mail me |
The charts below, and others like them, are frequently used online and in presentations by economist and author Stephanie Kelton. She uses them to support the Modern Monetary Theory (MMT) claim that, contrary to conventional wisdom, government deficits are not harmful. Instead, she argues they represent a gain to the economy.
These charts juxtapose government deficits against private sector balances in the US. They appear to show a correlation between government deficits and private sector financial health.
Government red ink and MMT narratives
Kelton and other MMT theorists argue that government red ink (referring to deficits) benefits the private sector. They claim this is because it causes private sector balances, referred to as black ink, to rise.
This claim is not only Kelton’s personal view. It reflects a broader MMT proposal that increasing government spending boosts the financial net worth of the private sector, including both individuals and businesses.
On this point, MMT theorists do not diverge from mainstream Keynesian economists. John Maynard Keynes also asserted that government spending could have a multiplier effect on the private sector.
According to Keynes, when the government spends money, it flows to businesses and individuals. These recipients then use it to spend on other people and businesses, creating a ripple effect throughout the economy. However, MMT departs from Keynesian orthodoxy in a crucial way.
Although MMT theorists often claim otherwise, they minimise the role of taxes. They argue that taxes are not necessary except for managing inflation. While Keynesians advocate that some government spending should be tax-funded, MMT asserts that all government spending can be funded through deficits, by issuing new currency, not borrowing.
MMT’s rebuttal to critics
In response to critics, Kelton has written the following:
“The idea is that government deficits eat up some of the dollars that would otherwise have been invested in private sector endeavours that promote long-term prosperity. We will see why the reverse is true—fiscal deficits actually increase private savings, and can easily crowd in private investment.”
Is the MMT claim valid?
You might think this is the correct question to ask when evaluating MMT. However, it is not. MMT theorists welcome this question. They are trained to answer it with a resounding “yes”, often backing their answer with charts like those mentioned above.
It is true that when the government issues new currency to fund projects, the money goes to government officials, contractors, vendors and others.
Ultimately, all these individuals, including government employees, return home to spend or save their earnings from working for the government. In that definitional sense, government red ink becomes private sector black ink.
The right question – are deficits beneficial?
The more appropriate question for a sound economist is not whether government red ink becomes private sector black ink. Instead, we should ask whether deficits, especially those promoted by MMT, are actually good for the economy.
Unfortunately for MMT advocates, the answer is no.
Is the government’s red ink harmful?
From the Austrian economic perspective (which I represent), theory is essential to interpreting data. Without solid theoretical grounding, economists cannot draw reliable conclusions from data alone.
Sound economic theory shows us that an increase in a nation’s financial net worth does not necessarily result in greater social benefit. When the government spends newly issued currency, as MMT suggests, the new money does not create new resources. It doesn’t magically produce factories, oil fields, skilled workers or other tangible goods.
Since currency issuance does not create wealth, higher private sector balances do not indicate real economic growth. Instead, they signal redistribution of existing wealth.
When more money chases the same amount of goods, prices rise. This inflation occurs because the new currency increases demand without increasing supply. The end result is higher prices, not greater prosperity.
MMT harmed Zimbabwe
Zimbabwe illustrates this danger vividly. The government, following MMT-style policies, issued vast amounts of Zimbabwean dollars. As a result, private sector balances soared. Children were worth billions, if not trillions, of Zimbabwean dollars.
Yet no one would seriously argue that Zimbabweans experienced an increase in real financial net worth. On the contrary, the currency became nearly worthless.
MMT harmed America
We also saw this pattern in the US. During a zero-hedge debate between MMT economist Nathan Tankus and Austrian economist Dr. Robert Murphy, Tankus defended MMT by citing the COVID-19 stimulus.
He claimed that stimulus payments increased Americans’ financial positions during the pandemic. That may be true in nominal terms. However, inflation quickly followed. Although Americans held more cash, they were poorer in real terms.
In conclusion
Government red ink is in fact private sector black ink as MMT claims, but this isn’t a good thing, and we must not let MMT theorists mislead us into thinking it is.
