Governments are not households. Governments can – with the threat of their monopoly use of violence – invent taxes that people have to pay; households can’t. Governments can change bank regulations such that banks effectively have to buy their debts; households can’t. Monetary sovereigns like the United Kingdom can invent brand new money to pay their bills; households can’t.*
But if governments can invent brand new money to pay their bills, why do they bother inventing taxes or borrowing at all? Inventing money sounds a lot easier than taxing people so it’s worth asking why more governments don’t just do it. More specifically, what are the arguments against the United Kingdom engaging in monetary financing? Or, in the parlance of British politics, why not use the actual real life magic money tree that definitely does exist despite the protestations of our leaders?
One argument against tapping the magic money tree is the illegality of so doing under the Maastrict Treaty. But given the successful efforts of Brexiteers, this looks soon to be irrelevant as we exit the European Union and Take Back Control.
A second answer that lots of people yell is Zimbabwe.
To be fair, pretty much *everyone* agrees that monetary financing budget deficits is very problematic when *too big*. It’s just that no one can quite agree what *too big* means. In extremis, monetary finance will certainly threaten/ destroy monetary stability. But plenty of countries have deployed monetary financing without collapsing into hyperinflation. Hyperinflation is something that tends to be associated with the collapse of a state’s ability to project power within its borders (with an unclear direction of causality!) rather than simple monetary financing. Indeed, of the 152 countries for which the IMF researched the central bank legal framework in 2012, 101 permitted monetary financing. Hyperinflation has not been quite so widespread.
However, we run into trouble way before we get to Zimbabwe. And while I’m planning to return to this issue with a bit more nuance in the future, I think we can imagine the sort of trouble that might lie ahead with a very basic hand-wavy thought experiment.
When there is unused slack in the economy – people unemployed or underemployed, idle hospitals, schools, factories, offices etc – the government can run budget deficits, spend money and deploy these unused resources without generating cost-push inflation. This is not contentious. The counterpart to this budget deficit will be either new claims on government (assets in the form of bonds for folks with a low propensity to spend to switch their money into), or brand new money plucked from the magic money tree.** Both forms of fiscal stimulus create demand and use up economic slack. Yay! Adair Turner reckons that a pound imagined into existence by the government and spent would likely be more stimulative than a pound borrowed from folks who can afford to save, and I’m not going to quibble with him on this. But even advocates of monetary finance like Turner worry out loud that maybe it might become too tempting for politicians to restrain themselves from inventing more and more money as elections draw close.
However, rather than retread these worries let’s think about the political difficulties attached to *unwinding* these differently funded fiscal stimuli.
It’s pretty simple (when times are good) for politicians to make the case that we should prudently pay down debt (delivering a fiscal tightening). Blair and Brown did it. Clinton did it. Even though governments are *not* households, people generally think that they are near enough the same thing (they’re not) that such a line resonates.
The politics of unwinding monetary financing look harder. If governments invent new money when times are bad (delivering a fiscal stimulus), I think it would be tricky to sell the message when the economy improves that things are just so great that taxes need to rise to fund a big bonfire of money (delivering a fiscal tightening). I can’t prove it, but I think that ordinary (voting) people would get very cross about this idea, maybe cross enough to vote out the idiots trying to set light their money. Someone might even suggest that instead of a money bonfire, maybe taxes shouldn’t rise at all. Or maybe the tax proceeds could be used to build something that most folks might agree is needed at any given time – a new school, hospital, bridge, or something else that involves bidding real life people away from what they would otherwise be doing into some particular government-directed endeavour. But the whole point about raising taxes in this scenario would be to unwind the prospectively inflationary impact of an economy running at full tilt – precisely the sort of thing that comes from trying to build a new bridge when everyone is fully-employed already.
Some folks reckon that the whole point if monetary finance is defeated if you articulate its reversibility, and so concern about unwind is not only premature but completely misses the point. But it seems quite possible that absent a well-articulated exit strategy, folks in financial markets will infer that any future tightening will need to come through tighter monetary policy than the counterfactual pushing interest rates up.
And so while governments are *not* households, the household budget constraint *doesn’t* apply, there definitely absolutely really *is* a magic money tree, (and the problems of governance are not necessarily insoluble), it is not clear that this insight solves as many problems as one might hope.
PS: The brilliant people at Planet Money have done a podcast on this subject which is *much* better than this blog – do listen! Since I pulled a muscle and stopped running my podcast consumption has dropped so it’s only now (as finishing) the blog that I caught up on it. I thought about just tweeting the link to their show instead of hitting post on this blog but didn’t as they don’t quite get into the politics of unwinding monetary finance which I thought might be of interest.
* OK, crypto. Maybe even stock. I’ll deal with this another time.
** Many will argue that money is a claim on government, as a form of tradable deferred tax obligations. Ok, fine. But putting that in the middle of my otherwise semi-readable paragraph isn’t hugely helpful.