Canada entered this election with the biggest deficit in its history: $354 billion for the last fiscal year.
Yet, that deficit is not a major flashpoint in the campaign. All but one of Canada’s political parties, Maxime Bernier’s People’s Party of Canada, accept that Canada will run large deficits for years to come. Maxime Bernier, who pledges to eliminate the deficit in four years through massive cuts to income programs, and full cancellation of federal funding for anything in provincial jurisdiction (like health care), at least is honest about what a balanced budget requires.
That can’t be said for Erin O’Toole’s Conservatives. Clearly uncomfortable with explicitly advocating deficits, as his own list of expensive promises gets longer, O’Toole makes a claim that a Conservative government would balance the budget, “within 10 years, and without cuts.” That’s not arithmetically possible. And if he was serious about balancing the budget, Canada would experience a decade of fiscally induced stagnation akin to Europe’s Great Recession following 2008.
Canadians, for the most part, aren’t losing sleep over budget deficits or the national debt. One poll found just 9% identified government finances as their top issue. Nor should they. This change in attitude reflects a transformation in economics, not just politics.
Canada, like all industrial economies, fell deeply into deficit after the 2008 global financial crisis. That meltdown caused a worldwide recession, and governments spent trillions bailing out banks and paying income supports. Some countries – primarily in Europe – then tried to restore balanced budgets as soon as possible. They cut spending deeply, on the assumption the economy would right itself once the immediate financial chaos had subsided.
But that assumption was dead wrong, and deep spending cuts made matters worse. As a result, Europe entered a decade-long funk – termed the Great Recession – marked by slow growth, unemployment, political turmoil and, perversely, continuing deficits.
That caused economists around the world to rethink their approach to fiscal policy. The chilling effect of spending cuts on economic recovery means fiscal contraction can actually deepen deficits, since government revenues are undermined by continuing stagnation.
Moreover, it turns out that governments can run deficits for years without inflation nor big drama. Interest rates plunged after the financial crisis, and stayed there, hovering around 2% (close to zero after inflation). So long as GDP grows faster than super-low interest rates (nominal GDP typically grows 4-5% per year in Canada), accumulated debt will shrink automatically relative to the economy, even with continuing deficits.
Fast forward to the pandemic.
This time, economists and bankers were near-unanimous that deficit spending should be pumped up quickly – and kept there. So it’s not a sign of “fiscal mismanagement” that Canada’s deficit surged. It is prudent, recommended and essential to economic recovery.
Theresa May famously said there is no “magic money tree.” Modern Monetary Theory says she is wrong.
Last year, in the pandemic, the world’s advanced economies were entering a new age: the age of “magic money” guided by Modern Money Theory (MMT). Everything we thought we knew about public finance over the past 50 years has been wrong. A new economic theory has emerged that rewrites our understanding of how governments create and spend money and what type of society we can afford to build.
People should be furious. Because Modern Money Theory (MMT) will show that the political elite can afford to spend far more than they are, on public health and education, social housing, social programs, scientific research and green energy schemes, while eliminating unemployment. And yet they’re not – either from a misunderstanding of government finances or because they don’t want to.
However, to embrace this transformative economic theory you will have to forget what you’ve learned in Economics 101 about budget deficits (that they’re bad) and government debt (that it burdens future generations).
Why? Because proponents of MMT say that far from being a problem, budget deficits are usually a good thing – they are the source of healthy economic growth.
A country like Canada or the U.S., that controls its own fiat currency doesn’t need to tax or borrow before its national government can spend money – the government can create all the money it needs to fund itself – within limits. (“Fiat” money is government-issued currency that isn’t backed by any commodity, such as gold – it’s paper or digital money that has no intrinsic value.)
Countries that issue their own fiat currency can afford to buy anything that’s available for sale in their own currency, and they can never go bankrupt in their own currency.
Supporters of the theory – who are growing exponentially in numbers, especially among academics and central bankers and Wall Street financiers – say that many of the world’s problems today (extreme wealth inequality, poorly funded public hospitals and schools, chronic unemployment and underemployment, stagnant wages) are consequences of misunderstanding government financing. Macroeconomic Theory – which looks at the bigger picture of how the national economy works – has gotten too many major questions wrong.
Modern Monetary Theory (MMT) is challenging the Neoliberal economic orthodoxy that has dominated policymaking in the United States, Canada, the United Kingdom and many other Western industrialised countries since the mid-1970s of Reagan and Thatcher. The reigning Neoliberal orthodoxy assumes that the national government needs to collect taxes, or borrow from savers, before it can spend money. Politicians repeat this point incessantly. When you hear a politician saying the government must “live within its means,” what they’re really saying is the government must not spend more than it collects in taxes or borrowings.
However, MMT economists want to turn these orthodoxies on their head, among others.
MMT economists make several claims:
Firstly, they say we’ve been thinking about budget deficits incorrectly. Budget deficits are not always bad.
The U.S. national debt is rising at a pace never seen in the history of America, with a current debt exceeding USD$28.43 trillion – an increase of nearly $5.7 trillion in 18 short months. The U.S. national debt is expected to approach $89 trillion by 2029. Canada’s national debt is CD$1.085 trillion.
Fiscal conservatives are apoplectic, about “saddling future generations with crippling debt.”
Modern monetary theory says not to worry.
In fact, deficits are most often necessary and beneficial. A budget deficit is merely evidence of extra government spending, and government spending boosts the wealth of private sector businesses and households. It all depends what deficit spending is used for. Increasing the deficit to finance a war is not the same thing as increasing the deficit to fund social programs, education, healthcare and to build more hospitals and schools. Investments that will enhance productivity through better health, greater knowledge and skills, improved transport, increased employment and the like are worth funding, even if it results in a budget deficit.
Secondly, MMT economists say we’ve been thinking about government spending incorrectly.
They say the argument (promoted famously by British prime minister Margaret Thatcher) that national governments must tax or borrow before they can spend is wrong. MMT argues it’s the other way around – national governments have to pump money into the economy before they can tax or borrow. Government spending actually precedes taxation.
Thirdly, MMT says taxes are necessary, but not for the reasons you may think.
MMT economists say governments use taxes to create demand for their own currency – that is, if a citizen has to pay tax then they’re going to have to work to earn the currency to pay the tax in that currency. Essentially, governments use taxes to put everyone to work. It’s not our tax money the government wants. It’s our time. To get us to produce things for the state, the government invents taxes or other kinds of payment obligations.
When you pay taxes, the money is literally destroyed. If you pay by check, they debit your account and those funds are gone. Just like shutting off a light switch. If you somehow paid with actual cash, they would send the currency bills to be shredded. You can buy shredded dollars online.
Taxation effectively takes money out of circulation in the economy. Government spending effectively pumps money into circulation in the economy. The federal deficit is simply the difference between these amounts.
MMT also proposes that tax policy should become an anti-inflationary monetary tool. If there is too much money in the economy the government should tax more of it, thereby taking it out of circulation.
MMT economists say “full employment” is not only possible, it’s a moral imperative. Anyone who wants a job should have one. They say we must prioritise genuine full employment and governments should spend whatever is necessary to achieve it – no matter the debt or deficit. MMT economists say the national government should run a permanent “Job Guarantee” (JG) program to provide a job to everyone who wants one. They say it could be linked to other economic and social programs, such as a “Green New Deal” – a policy advocated by MMT proponents like US Democratic senator Bernie Sanders and Alexandra Ocasio-Cortez, to create jobs by shifting to zero-emissions technologies. The Job Guarantee (JG) is a central component of MMT. MMT economists say the national government should ensure that everyone who wants a job has a job. The private sector treats labour as a cost to be minimised, so it cannot be expected to achieve full employment without government creating jobs through a Job Guarantee.
Why? Because unemployment is socially destructive and wasteful. “Full employment” should be a national priority, replacing an acceptance of the so-called “natural rate” of unemployment, which is assumed to be around 4% or 5% unemployment.
Which countries could MMT apply to?
MMT’s principles couldn’t be applied everywhere immediately. MMT economists say they’re specifically talking about countries with floating exchange rates that issue their own fiat currencies – countries like Australia, Japan, the UK, Canada and the United States. The theory couldn’t be applied as easily in European Union nations, for example, because those countries have ceded currency sovereignty by all agreeing to use the same currency, the Euro.
What’s so special about fiat currencies?
MMT’s theorists say world leaders still haven’t come to terms with the demise of the Bretton Woods monetary system in 1971. During the era of the Bretton Woods monetary system (1945 to 1971), certain currencies were pegged at agreed fixed rates against the US dollar, and the US dollar was supposed to be backed by gold reserves so it could be exchanged on demand for a fixed amount of gold held by the US government. But US president Richard Nixon dismantled the Bretton Woods monetary system in 1971 when the US admitted it did not have enough gold to back its currency. After that, the US and other major sovereign currency issuers (including Canada) adopted “fiat” currencies – currencies with no intrinsic value, that aren’t backed by gold – with floating exchange rates. MMT economists say this is significant because it means those countries (such as Australia, the US, Canada, the UK, Japan) no longer have to fear a shortage of gold, and that leaves them free to print as much money as they need to fully employ their “real” resources – workers, factories, machines, raw materials – within the limits of there being enough goods and services for for that extra money to soak up.
That insight is not new, nor particularly radical.
In a speech in 1997, then-US Federal Reserve chairman Alan Greenspan said central banks in the modern era could issue currency without limit. “When there is confidence in the integrity of government, monetary authorities – the central bank and the finance ministry – can issue unlimited claims denominated in their own currencies and can guarantee, or stand ready to guarantee, the obligations of private issuers as they see fit,” Greenspan said. “Central banks can issue currency, a non-interest-bearing claim on the government, effectively without limit.” MMT theorists say there is no limit to the amount of money a government with its own currency can create, and as long as economic production and employment are not maxed out, inflation will remain under control.
Does MMT apply to all levels of government?
No. MMT only applies to the national government level, because that’s the level of government with the power to issue the sovereign currency. The Ontario provincial government and the local city government of Sault Ste Marie must behave like households when making spending decisions because they are currency users, not currency issuers like the national government.
According to MMT economists, we’ve been thinking about government spending and budget deficits the wrong way. They say Margaret Thatcher’s dictum that federal governments must tax or borrow before they can spend is fundamentally wrong, and it’s the other way around – federal governments have to spend, creating (printing) money and pumping it into the economy before they can tax or borrow. Margaret Thatcher was a champion for fiscal austerity and small government. MMT economists say that when Thatcher argued that government finances were constrained in the same way as household budgets, she committed the “household fallacy” – and that fallacy has had a deleterious impact on politics and society. National governments are not the same as households – national governments have the power to print money and impose taxes, households don’t. Thatcher wasn’t comparing apples with apples. Another former British Conservative prime minister, Theresa May, made the same mistake when she told a nurse that wages for British nurses hadn’t increased for years because the UK government didn’t have a “magic money tree.”
MMT economists say the “household fallacy” leads to socially destructive outcomes.
Why? Because it makes politicians think they can’t afford to spend more on socially important programs until they “find the money” to pay for them. According to MMT adherents, that view is misguided – because a sovereign government that issues its own currency can print as much money as it needs to pay for all the goods and services it needs in its own currency – within the limits of reaching full employment and economic production.
Former Fed chairman Alan Greenspan, again, made a similar point in 2005 when he admitted that the US Social Security system couldn’t run out of cash. Greenspan explained government money creation: “There’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody,” he said. The fundamental and crucial question was whether the US economy had the ability to soak up the extra cash the government printed, he said, whether there were enough goods and services for that extra money created (printed) to purchase.
What about inflation?
For many people, the thought of governments printing unlimited amounts of money conjures images of shoppers pushing wheelbarrows of cash in 1928 Weimar Germany, or the hyper-inflation of more recent times in Zimbabwe or Venezuela. Some of MMT’s critics like to draw that comparison deliberately. But MMT economists say that’s a misleading caricature.
Why did hyperinflation occur in Zimbabwe? Because when you damage the productive capacity of an economy, as Robert Mugabe did (by transferring ownership of the country’s agriculture from White settler farmers to Black former soldiers who couldn’t farm), it can’t produce the same volume of goods and services. When you have households fighting over a shrinking amount of goods (agricultural output dropped 60%), prices soar and you end up with inflation. If you start feverishly printing money in that situation, you’ll make things even worse, and you end up with hyperinflation and one hundred trillion dollar Zimbabwean bank notes.
Something similar happened during the Weimar Republic (1918-1933), when the German government, in defeat after World War l, printed money to pay its bills. Hyperinflation set in and people needed wheelbarrows full of cash just to buy loaves of bread. World War l had destroyed Germany’s productive capacity. But the Allies were insisting it pay reparations far in excess of the ability of the shattered German economy to pay. So the government printed money. When a lack of productive supply due to the shattered economy met demand from excess cash, hyperinflation was the result.
It is the lack of goods – or labour, or capacity – that triggers inflation.
In 2009, former Fedaral Reserve chair Ben Bernanke was interviewed on CBS’s 60 Minutes about the federal government’s $1 trillion bailout of the banking system in the 2008 financial crisis. Bernanke was asked if the $1 trillion came from taxpayers. He said no. It was printed: “It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. It’s much more akin to printing money than it is to borrowing.”
“You’ve been printing money?” the 60 Minutes correspondent replied.
“Well, effectively. And we needed to do that, because our economy is very weak and inflation is very low,” Bernanke says. This admission – that creating money out of thin air is not by itself dangerous and may even be advantageous – is the key principle to understanding Modern Monetary Theory.
In fact, MMT advocates observe, new money creation is a very common event and hyperinflation is a relatively rare event. As of 2021, the Japanese public debt is estimated to be approximately USD$13.11 trillion, or 266% of GDP, the highest of any developed nation. Japan has been printing more money to pay for it for 20 years, and has not experienced runaway inflation. Their deficit means that the government has spent a sum vastly greater than the entire value of the Japanese economy, but has not been able to take in enough tax revenue to cover that expenditure, and is thus floating it with debt. The inflation rate in Japan is currently -0.29%.
That’s negative inflation.
Japan isn’t alone. The U.S. Fed was forced to lower interest rates close to zero in order to counter deflation in the U.S. while Bernanke was adding $1 trillion to U.S. bank accounts. (Actually, the scale of quantitative easing in 2009 was estimated by many sources to be many times the stated figure of $1 trillion.) Many economists predicted that the Fed’s ballooning cash creation would crash the dollar. But it didn’t happen. The US Fed had to slash interest rates to flush money out of bank accounts, in hopes of generating inflation. Even to the point of seriously considering Negative Interest Rates, as Switzerland, Spain, Denmark, Sweden and Japan have implemented.
MMT economists say inflation would only be a problem (in a country like Canada or the US, if the federal government injected too much money into an economy that was already running at, or close to, full capacity (full employment) and full production. If your economy’s “real resources” are underutilised – its workers, factories, machines, land and raw materials – government spending won’t create concerning inflationary pressures.
MMT is not a political project. It’s simply a macroeconomic way of looking at the world. Anyone – left or right – can view the world through an MMT framework and you can use MMT principles to pursue a leftist or rightist agenda.
On the other hand, MMT’s supporters advocate for a framework that would overhaul politics. It would take the responsibility for price and employment stability away from the central bank and put it back into the hands of elected politicians and the voters.
COVID-19 will reshape economics
There’s nothing like a crisis to turn conventional wisdom on its head, and that is precisely what COVID is doing to macroeconomics.