The Deficit Myth: Should You Worry?

 

The Deficit Myth, a new book by Stephanie Kelton, a leading Modern Monetary Theory (MMT) theorist is genuinely mind-blowing. The book argues that when it comes to government spending, both liberals and conservatives are worrying about the wrong things. From an MMT lens, what matters is not debt, but inflation. Today’s article is a book summary extracted from Book Review - The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy by Devika Dutt and 3 Reasons to Read 'The Deficit Myth' by Joshua Kim.

The key point Kelton makes in The Deficit Myth is that government spending does not use the money collected in the form of taxes, but rather spending creates the purchasing power which can then be partially taxed back, if necessary. In many ways, the government creates money much like a bank does: by creating deposits, in keeping with the Keynesian insight. Banks do not wait for people to deposit money to create loans, or in other words, simply collect and disburse savings; instead, banks use loans to create deposits.

Government budgets are not like household budgets, where we were asked to spend less than we earn. This should not be applied to nations with a sovereign currency as they cannot run out of the currency that they issue. The only limitation on government spending is inflation. Kelton tells us that government deficit or debt are not evidence of overspending, but that inflation is. If inflation is kept in check, year-to-year budget deficits and accumulated debt matter little.

Next, the book claims that the idea of tax revenues collected are to fund government expenditure is wrong. The government can always print money to pay for everything it does. This situation will not be a problem if people and businesses can trust that the government can meet its obligations using money that will not lose its value. This trust depends not simply on the mismatch between tax revenues and expenditures (as with persistent deficits), but also on the ability of the government to create money and real resources needed to meet its obligations.

MMT tells us that what is important is not money, but the real productive capacity of the economy. This productive capacity is measured by how many goods and services can be produced, given the talents, resources and other inputs. With the pandemic hampering economic opportunity, there is lot of room for the federal government (the currency issuer) to run large deficits to get money into the hands of people.

To sum up, Kelton's book is an important and well-argued challenge to the conventional wisdom of government deficits and debt, especially at a time when policymakers may make a sharp turn towards austerity in response to the increase in the size of government debt. The Deficit Myth successfully argues that this would be a policy mistake. However, this framework has some gaps, which is not uncommon for an emerging and developing body of knowledge. Addressing these gaps is possible and should be done in order to strengthen and clarify this framework.

 

Reference:

1.     Devika Dutt, Book Review - The Deficit Myth: Modern Monetary Theory and How To Build a Better Economy, https://www.globalpolicyjournal.com/

2.     Joshua Kim, 3 Reasons to Read 'The Deficit Myth', https://www.insidehighered.com/

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