In a recent blog I talked about “Taxing Times Ahead” and suggested there were two ways to deal with government deficits (the annual amount the government spends in excess of its income) and debt (the accumulated sum of the annual deficits). One way, to reduce your expenditure, the other, to increase your income. In debates about public expenditure there is a tendency for those on the right to emphasise the former represented by Austerity with a capital A. Those on the left on the other hand are more focused on the latter but concentrating on taxing the income and wealth of the rich.

There is, however, a third way being proposed by a number of economists promoting what has become known as Modern Monetary Theory. This is radical stuff. In essence it claims that a state which has sovereign control over its currency does not have to bother borrowing or taxing in order to spend, it can just print money.

I can already hear the guffaws of disbelief and the shouts of “what about inflation?” and “what about the cost of borrowing”. Do you want to make us like Weimar Germany or Argentina, Zimbabwe or Greece? Interestingly the theory has a strong focus on inflation which it sees as being “… at the centre of the debate over spending limits.”

It sees inflation as a real constraint on spending as opposed to the availability of cash, which should never be a problem for a sovereign state which has its own fiat currency, that is a currency not backed by some other limited store of value e.g. gold or someone else’s currency. Taxation should not be seen as funding government with taxpayers money it should be seen as the government taking back its money to control inflation.

Stephanie Kelton has produced a clear and easy to read presentation of the theory which is remarkably compelling. It starts out making the fundamental point that government’s finances should not be confused with those of households. Households are currency “users” whereas governments are currency “issuers” and there is a categorical distinction between the two. The former has limited access to cash, the latter can print all it needs within the real economy constraint of inflation.

In the traditional model governments first, tax and borrow, then they spend. However, MMT sees this as back to front. Governments first spend and then tax and borrow. Because governments require you to pay taxes in their currency the currency gains value, and becomes a wider medium of exchange.

One of the most attractive elements of the MMT theory as expounded by Kelton is the focus it has on the whole economy. She makes the point that whenever the government spends some money it moves into the private sector and becomes someones income. The red ink on government ledgers is balanced exactly, as a matter of accountancy, with black ink somewhere else in the non-government economy.

Coming back to inflation, central banks have a role in keeping inflation in check which they do by setting interest rates and they do this per Kelton by targeting a rate of unemployment. If unemployment gets below something known as NAIRU which is the non-accelerating inflationary rate of unemployment then they anticipate inflation taking off. To prevent this they increase interest rates as unemployment reduces and approaches the NAIRU level.

In the US the NAIRU level is somewhere between 5% and 6% unemployment. This means of course that Federal policy requires 5% or 6% of the workforce to be unemployed at any point in time. Kelton is highly critical of this approach, pointing out that in recent years unemployment has been significantly below the NAIRU level and there has been no sign of inflation taking off.

This approach has two negative impacts. First and foremost a devastating affect on the lives of many thousand of people who are condemned to unemployment. Secondly it means that the productive capacity of the economy is limited artificially for no good reason.

MMT’s radical alternative is to shift responsibility for the creation of full employment and inflation control from unelected central banks to elected governments operating through direct control of the money supply via its tax and spend powers.

Further the government should allow the private sector to get to as close to full employment as possible but even more radically MMT suggest that the discretionary application of tax and spend policies should be supplemented by an automatic stabiliser of a federal job guarantee. In other words the government would guarantee a job for any one seeking employment at a rate it determined, $15 [£12] per hour is suggested, the current federal minimum wage is $7.25 [$5.84] per hour, together with benefit package.

Such a model is seen as having many positive benefits, not least providing millions of people with the opportunity to have a reasonable income and thus life. It would also establish a minimum compensation floor in the economy, keep the workforce trained and job ready for opportunities in the private sector and enable valuable work in the care economy to be carried out.

Perhaps most significantly the job guarantee would automatically increase government expenditure when the economy weakened and reduce as the economy grew, providing a counter cyclical automatic stabiliser.

As can be seen the perspective of MMT and its policy proposals are counter to much we are often told and also our own daily experience. Mrs Thatcher talked about governments only having taxpayer’s money, Mrs May said there was no such thing as a money tree and Mrs Merkel has often referred to the balanced budget habits of the Swabian housewife, and George Osbourne pointed to Greece as an example of what happens if you ignore deficits.

But equally it is true Greece was not a sovereign currency issuer trapped within the Euro zone; the Swabian housewife does not have a currency printing press; when wars, credit crunches, or pandemic’s hit money trees are found by the forest; and it is only governments that can make money, tax payers use it.

Kelton pints to a number of real world examples which, at the very least, raise serious questions about the “common sense” homilies we get from politicians and some economists about the dangers of deficit finance. Japan has a debt to GDP ratio of 240%. Incidentally close to the 250% the UK had at the end of the second world war just before it established the National Health Service.

The Bank of Japan, the country’s Central bank, manages interest rates and has committed to pinning ten year government bonds to near zero. In order to do this it intervenes in the market and will, when necessary, aggressively purchase Japanese Government Bonds, ie. government debt. It now owns 50% of all those bonds. How does it buy these bonds? By pressing a key on a trading screen. It transforms one form of money in the economy, bonds which pay interest, into another, cash which does not.

In essence the government has bought its debt via the Central Bank.

MMT involves a paradigm shift which reverses the flow of cash from one where governments tax and borrow before they spend to one where they spend before they tax and borrow. What is more they do not tax and borrow in order to be able to afford spending they do it for quite different reasons. They tax to control inflation and they borrow to control interest rates.

Pre the credit crunch such a theory would have been laughed out of court. However, with quantitative easing and other exotic monetary manipulations it is not so obviously nonsense. Covid-19 has had the printing presses working overtime. It will be interesting to see how much of the MMT theory gets taken up in a world where deficits are at war time levels and the economy is devastated.

This is a theory with progressive potential to know about and keep an eye on.