Deficit Spending: Time to Reframe the Debate

April 8th, 2011
in Op Ed

kelton   Guest Author:  Stephanie Kelton, Associate Professor of Economics at the University of Missouri-Kansas City, Research Scholar at The Levy Economics Institute and Director of Graduate Student Research at the Center for Full Employment and Price Stability.  She writes at New Economic Perspectives.

As followers of New Economic Perspectives have discovered, we work within a framework that has been dubbed Modern Money Theory (MMT). The approach itself is fundamentally descriptive, although there are logical ways to apply the principles of the approach to any number of policy-oriented (i.e. prescriptive) economic problems. Above all, we are committed to describing the way government spending works in a modern money system.

Follow up:

 Once that is understood, it becomes apparent that a government with flexible exchange rates and a sovereign currency (US dollar, British pound, Mexican peso, etc.) can afford to purchase anything that is for sale in its own sovereign currency.

This means that debates about "affordability" become inapplicable. As this becomes more widely understood, we can begin to have a completely different -- and vastly more important -- debate about the size and role of government.  What do we, as Americans, want? Medicare for all? A job guarantee?  High-speed rail? Renewable energy?

As promoters of MMT, we are all very keen on Abba Lerner, who was one of the first to articulate the foundations of the approach. Lerner believed that the government should maintain the level of aggregate spending in the economy (either by reducing taxes, increasing its own spending or a combination of the two) at the rate consistent with full employment. We agree. This is the overarching goal. How we get there is, as I said, a matter of (political/social) choice.

But we cannot 'get there' until we dispense, once-and-for-all, with the erroneous belief that deficit spending is reckless and irresponsible, something akin to "fiscal child abuse", as Kotlikoff and Burns so disgracefully characterized it.

Instead, just remember this fundamental accounting identity:
Private Sector Surplus = Public Sector Deficit + Current Account Surplus

For me, this is the most important identity in economics.  It holds true in every nation at every point in time, and it is useful when you run thought experiments like, for example, "What will happen to the private sector's balance sheet position if the government's budget is cut by X% of GDP and the current account deficit remains Y% of GDP?"

So, for example, in the US we have a current account deficit of, roughly, 5% of GDP. This SUBTRACTS from the Private Sector Surplus. So, the only way the private sector can have positive net savings (i.e. a surplus) is for the government to run a deficit that is LARGER than the current account deficit. This is exactly what the government has been doing, and it is the reason the private sector has managed to sharply increase its savings in the downturn. Cutting the public sector deficit will reduce the private sector surplus one-for-one in a closed economy (i.e. one with no foreign trade and therefore no current account). It is an easy way to demonstrate that the government's deficit is the private sector's surplus.

So the next time someone tells you that the US government cannot "afford" to keep its promises to retirees, fund the arts, build bullet trains, and so on, ask them whether they understand any of this!

** And, no, it does not follow that because the US government "can" do something that it "should" do it.  It has the ability to puchase anything for sale in terms of its own currency.  Let us accept that point and then debate whether, when, and to what extent it should exercise this power.

Related Articles

The Dichotomy of Currency  by Derryl Hermanutz
The New Feudalism  by Derryl Hermanutz

This is Not a Credit Crisis  by Dirk J. Bezemer

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  1. derryl Email says :

    Stephanie is of course correct about the accounting identity involving the 3 sectors of GDP: private, government and current account. If government cuts its deficit, and the current account is unchanged, then the private sector will be reduced by the amount of the cut in deficit spending; UNLESS the difference is made up by an increase in private sector borrowing. In the current environment of private sector debt saturation and deleveraging, and the unlikelihood of a significant increase in US exports over imports, a deficit cut will yield a straightforward reduction of GDP, a recession.

    My only critique of MMT, which advocates using the government's deficit spending power to maintain GDP and employment (and using the government's taxation power to mop up inflationary excess liquidity), is the assumption or implication that government is in control of money issuing. On the contrary, Austrian School and monetarist critics of deficits advocate for a strongly independent central bank to "prevent" giving the government ready access to money.

    In fact the Fed is not a branch of the US government. It is a privately owned bank that has the exclusive legal power to issue US currency and to conduct monetary policy according to its own designs, regardless whether Fed policy conforms to the government's preferred monetary policy. That is the whole point of an "independent" central bank. In recent decades we have seen a revolving door where managers of Goldman Sachs, the Treasury, and the Fed move freely between these 3 "branches" of the monetary and fiscal authority. Congress is not included in this loop. Congress does not "decide" what is going to happen. At best Congress is "told" what the money men are going to do.

    For MMT to work, Congress must be in control of the nation's monetary and fiscal affairs, which is not currently the case. The money system, Big Banking, is in control. So the decision whether America can "afford to keep its promises to retirees, fund the arts, build bullet trains, and so on" is not, as Stephanie seems to be implying, a decision that America's representative government currently possesses the actual power to make.

  2. Douglas Roberts says :

    Of course! The government could take over everything too. Just put sand in all the gearboxes and load up all the balloons with lead.

  3. Admin (Member) Email says :

    Douglas - - -


    We have been trying to post a variety of opinion and analysis on money and will continue to do so. There is a clear logical basis for what Stephanie Kelton has presented. Unfortunately there are execution problems, which she herself touches on the article: What is it that we want to do with the country's resources? That devolves into a political discussion, not an economic one.

    Derryl's comment broaches one of the significant reasons why the political process is impotent.

    Ayn Rand once said she believed in separation of bank and state. How ironic that her most famous disciple held dominion over the ultimate merger of bank and state.

    Ultimately, in my opinion, the amount of debt is far less important than the use of debt. Debt can be used for the following:

    1. To support consumption;
    2. To enhance leverage and enable the derivation of more income for the titans of the debt (the holders of the debt - the debtees)at the expense of the debtors; OR
    3. To support the creation of means of production of things of economic utility.

    In recent decades the U.S. (and indeed much of the developed world) has pursued 1. and 2. The developing world (and Germany) have pursued more of 3.

    That is my simple view of the journey taken and a clear dictate for the way to make the road ahead more successful.

    If I can paraphrase Ronald Reagan: Some people look to the government to solve problems, but the government CONTROLLED BY RENTIERS is the problem. If government is controlled by productive capital the parasitic aspect of rentier capital have a counterforce. Marx had a philosophy that was widely interpretted to equate productive capital to labor capital and to ignore the important role of financial capital.

    Marx's idea of alientated labor derives from a view that a truly parasitic use of financial capital would lead to the collapse of capitalism because of a proletarian revolution. What Marx failed to realize was that Adam Smith's animal spirits were in fact a strong motivator of human economic action and that action could produce much good.

    So, what is the role of government? I say it is to provide a system in which the productive use of capital is rewarded and the rentiers' profitability is limited to the extent that it can not syphon off too much of the capital that otherwise would be put into productive use.

    There is much talk about the government squeezing out the private sector. What I see as the problem is the rentiers squeezing out the productive sector. There are those who say the government should not play favorites in the economy. I think our current problems result in large part because the government has played favorites and the favorites are the rentiers.

    Douglas, I suggest you study the lead and sand you mentioned and consider just where it is coming from. And what can be done with it. Perhaps your sand could be used to make concrete and build something productive. You know - lemons and lemonade.

    John Lounsbury

  4. Stephanie Kelton says :


    You said, "In fact the Fed is not a branch of the US government. It is a privately owned bank that has the exclusive legal power to issue US currency and to conduct monetary policy according to its own designs".

    But you cannot be serious. Who pray tell gave the Fed exclusive legal power to issue US currency? Could it be the government? Congress: Federal Reserve Act.

    And how are the seven members of the Board of Governors chosen? Do the Fed's (non existent) shareholders choose them? Well, not quite. They're appointed by the President of the United States and confirmed by the U.S. Senate.

    And what happens to the Fed's profits? Can the Fed use them to pay dividends (to its non-existent shareholders) or open a new Federal Reserve branch in Hoboken, NJ just like any private firm? Sadly, no. The Fed is allowed to retain only a tiny fraction of its profits. The vast majority MUST be returned to ... wait for it ... the US Treasury.

    Congress established the Fed. The Federal Reserve is the government's bank and it is, indisputably, a public institution.

    I don't mean to sound flippant, but it is quite frustrating to have to correct such basic facts.

    From the Fed's own mouth:

    "The Federal Reserve System is considered to be an independent central bank because its decisions do not have to be ratified by the President or
    anyone else in the executive branch of government. The System is, how- ever, subject to oversight by the U.S. Congress. The Federal Reserve must work within the framework of the overall objectives of economic and financial policy established by the government; therefore, the description of the System as “independent within the government” is more accurate."

    Look it up:

  5. Stephanie Kelton says :

    For the record:
    "After it pays its expenses, the Federal Reserve turns the rest of its earn- ings over to the U.S. Treasury. About 95 percent of the Reserve Banks’ net earnings have been paid into the Treasury since the Federal Reserve System began operations in 1914. (Income and expenses of the Federal Reserve Banks from 1914 to the present are included in the Annual Report of the Board of Governors.) In 2003, the Federal Reserve paid approxi- mately $22 billion to the Treasury."

    From the same Fed publication referenced in my previous reply

  6. Admin (Member) Email says :

    Stephanie and Derryl - - -

    Great exchange. You both have positions based on facts and I think the real difference of opinion comes down to the political elements.

    Derryl can correct me but I don't think he would debate Stephanie's facts about the relationship between the Fed and the government. I don't think Stephanie has argued that the congressional "control" of the Fed has been so effective that the financial system has run smoothly. Again I'm sure Stephanie will correct me if I am reading too much between her lines.

    I would come to a bottom line where I think both debaters are agreeing: The body politic (Congress and the administration) and the American people have not come to a consensus about how the nation's resources should be spent and/or invested. In my reply to Douglas Roberts you see my bias is strongly on the side of investing more than spending.

    Finally, let me use my straw to stir the debate a little further: How do we define whether the government controls the banks or the banks control the government?

    The answer to that question is quite Einsteinian: It's a matter of perspective.

  7. John,

    Well, that's easy -- and I never meant to suggest otherwise -- the banks control the government.

    But fiscal policy has far more to do with the money supply than is usually recognized. Deficit spending injects (net) reserves into the banking system. Both HPM (high-powered money) and narrow money (M1) increase proportionately. The net injection of reserves pushes the overnight lending rate (fed funds) down. Thus, deficit spending pushes the rate of interest DOWN -- something that is very much misunderstood by conventional economists of the crowding-out variety. Before the Fed began paying interest on reserves, it would hit its interest rate target by sopping up the excess by selling bonds. Thus, bond sales were conducted (by the Fed) in a defensive manner, in order to hit the Fed's (postive) overnight lending rate. Today, the Fed pays interest on reserves, so there is no ECONOMIC reason for the Treasury to issue bonds. It could change the rules (they are self-imposed afterall) and decide not to issue new debt. That would allow the government to finace all sorts of useful projects (particularly a job guarantee) without the backlash that accompanies the run up in the public debt.

    I do appreciate the dialogue and I think we may have far more in common than it may have appeared at the outset.

  8. admin (Member) Email says :


    First of all, i would like to thank you for posting on an economically neutral website. Many influential economists choose to post on only their own website where alternate views in practice are suppressed.

    It is always safer to speak to an audience of people who are your supporters.

    the public deficit debate, however, has an improper focus. The problem today is funding tomorrow's projected spending based on the way we fund or account for spending in the government.

    based on the current economic gearing, eventually the current accounting approach melts down if government spending growth continues to exceed gdp growth.

    debt requires someone to lend, and in return payment of interest. It is this interest that is a budgetary problem.

    and based on most economic projections i have seen - budget growth exceeding gdp growth is the case for the next 20 years.

    continual deficit spending is not a problem only if the government stops deficit accounting. in other words - stops issuing treasury bills and notes, or decides to evaporate portions of the debt.

    As long as we choose to account for sovereign debt in the same way as private sector debt, the long term deficit build seems like a very serious problem.

    steven hansen

  9. Derryl Hermanutz Email says :


    As John said earlier in this comment stream, we essentially differ on perspective rather than facts. I thought I was agreeing with you in principle. 

    But I do want to expand on some factual points. I am sure that much of what I will write here is well known by you but, just in case others read this discussion, I want to give some details that may not be well known to some readers.

    You write, "the nonexistent shareholders" of the Fed, but in fact the Fed has always been owned by its member banks on the model of the original central bank, the Bank of England, which was privately owned from its founding in 1694 until 1964 when ownership was transferred to the government. By that time the US$ had completely supplanted the Pound sterling as the world's currency so the money men had no critical interest in overtly owning the B of E. Instead they owned and operated the Federal Reserve Bank of the US, as they continue doing to this day. 

    It wasn't until sometime after WW II(if memory serves) that legislation or policy was changed and the Fed began rebating its profits to Treasury. Prior to that change the Fed's owners collected all of the bank's profits, no different than shareholders of other private banks collect bank profits as dividends. But, even today, the member banks receive a statuatory dividend of 6% on their capital investment. The Fed also maintains an account surplus. After all this, however, the Fed did transfer $79 billion of its $82 billion profit to the U.S. Treasury for the year 2010.

    That the Fed is a creature of government legislation is true, just as every "depository institution", i.e. "bank", is a government chartered enterprise. 1913 saw passage of both the Federal Reserve Act and the Bank Act. The former granted the privately owned Fed exclusive right to create US$ currency - Federal Reserve Notes - and exclusive authority to devise and conduct monetary policy. The latter Act merely codified the long established practice of private banks, creating monetary "credit" by issuing bank deposits as "loans". Bank deposits comprise an overwhelming share of total money supply. 

    In the gold standard era of "fractional reserve banking", the Fed's printing of banknotes was limited to a multiple of its holdings of gold bullion; and the chartered banks' issue of credit money was limited to a multiple of the quantity of the Fed's banknotes they had in their vaults or on "reserve" in their account with the master bank, the Fed. 

    The mechanics of American money creation is not in dispute.  The Fed enjoys exclusive right to issue "cash" (paper currency, Federal Reserve notes), and the chartered banks enjoy the right to create bank deposit money. The Fed issues money to the banks and the banks lend money to the economy and to the government. 

    The issue is, who is in control of this process of money issuance, which is the foundation of monetary and fiscal policy and is the command and control system of the private economy.  Who decides what gets funded: Congress or bankers? The straightforwardly accurate answer is, bankers make these decisions. 

    By the 4th 1/4 of 2008 it was clear that the banking systems of OECD nations were grossly insolvent. Bankers had grown rich by engineering 'profits' via what Michael Hudson and Bill Black call "accounting control fraud". Like Enron's kleptocratic managers, American and European bankers sucked personal fortunes of 10s and 100s of miilions of dollars out of the banks they were managing while systematically driving those companies toward collapse. 

    But when the banks they had mismanaged failed they didn't "collapse". They weren't taken into receivership and resolved, as Kansas City Fed President Thomas Hoenig advocated in his 2009 "Too Big Has Failed" paper. Their owners did not lose all their investment in the bankrupt banking companies. The thieving bank managers and other employees were not charged for their crimes and their personal fortunes were not seized under RICO as proceeds of crime. 

    I can't remember his name or find the link, but in a post-Lehman video a former member of Gerald Ford's administration put it like this,

    "It used to be that there were criminals and there was the government, and the government would try to catch the criminals. But now the criminals are IN the government."

    It remains a straightforward fact that the money system, not Congress, decides who gets how much money and for what purposes the money will be loaned. Bankers, not politicians, make these decisions. When thieving bankers destroy their banks they use their CONTROL of monetary and fiscal policy to bail themselves out and charge the bailout costs to taxpayers. 

    Stephanie, if we are supposing that Congress is a representative government serving the interests of the American people and the US economy and nation, then why are criminal bankers still rich and why are American taxpayers being squeezed to make bank owners and creditors whole? Simon Johnson calls this "regulatory capture", which is to say, the criminals are IN the government, and their policy is that financial crime is no longer illegal. 

    So once again, my critique of MMT is not mechanical. In theory, a sovereign nation issuing its own currency enjoys control over its financial and economic policies. MMT is completely correct about the mechanics of fiat money. 

    But in point of fact sovereign nations (except China) are not the entities who issue national currencies. Central banks issue currency to chartered banks who then distribute money into the economy by making loans that create bank deposit balances. If Congress wants to spend money, Treasury either has to get that money from the economy via taxes, or borrow that money from the economy and from banks by selling bonds. The government does not "issue" money as MMT requires. The government has to earn/tax or borrow money just like you and I have to do. And if nobody will lend money to the government, Congress cannot deficit spend regardless of any financially impotent "fiscal policies" it wants to enact. Congress is not in control of deficit spending. Money lenders are in control. 

    There are two sides to fiat money balance sheets: creators/lenders on one side (the supply side of money) and borrowers on the other (the demand side). You, me and the government are on the "borrower" side. All of our money is "debt". The banking system is on the "lender" side. All of our debts are the banks' "assets". 

    Public sector vs private sector is the wrong dichotomy in monetary matters. The correct dichotomy is the banking system that issues money as its private property vs the economy that uses money, with the government as part of the economy side of the equation. MMT proponents like Warren Mosler speak as if the government is on the supply side of the monetary balance sheet, enjoying the power to create its own money. That is simply inaccurate. Government is on the demand side of the monetary equation. Only bankers are on the supply side. 

    The Fed is not a branch of government or an arm of the Treasury that does the government's bidding. The Fed does not issue money to the government or on behalf of the government. Ths Fed does not even lend money directly to the government. 

    The Fed is legally prohibited from buying bonds from the government. QE "monetizes" government debt via the primary dealer banks. The Fed buys 'old' Treasuries from the PDs, and PDs buy 'new' Treasuries from the government using the money they got from selling old Treasuries to the Fed. All of the 'money' exists only as numbers in bank accounts, but the privately owned PDs extract their pound of flesh on each iteration of debt monetization. 

    Bankers, not politicians or bureaucrats, own and operate the monetary accounting system which functions as the economy's and the government's command and control system ("free markets" are not free of control: the economy is governed by finance).  The Fed can decide to end QE2 in June as proposed, and if the government can find no other buyers for the bonds it must sell to fund its deficit spending, the government would be forced to spend only as much as it earns by taxing. The independent privately owned Fed could thus dictate fiscal policy by refusing to create money to fund deficit spending.  The Fed's managers, not Congress, make these decisions. 

    For MMT to "work" as Mosler et al describe, government must have the power to issue its own money so that government policy is "independent" of bankers' decisions. The US government gave up that power with its passage of the 1913 banking legislation. Until that legislation is revoked and the money issuing power restored to Congress, MMT is merely a nice description of how money "could" serve the interests of the nation. But right now money is the private property of the private banking system that issues all the money, and bankers, not government, decide whose "interests" will get financed and whose will be rejected. 

    The battle between bankers and politicians over the power to issue the nation's money is older than the Republic. The Continental governments battled "European banking interests" over the issuance of America's money and, despite the apparent 'permanent' victory of the bankers in 1913, the issue is rising again to the forefront of public debate. 

    MMT assumes there is no battle and it assumes the money issuing power currently resides in the hands of government. But that is not the case in the real world. The bankers are still sitting on the victor's throne enjoying their legal power to extract economic rents from the economy for the 'privilege' of using the money they create by typing numbers into bank computers. 

    If you believe it is a trivial matter to defy the money powers, rewrite banking legislation and restore money issuing power to the government, try it, like Lincoln and Kennedy tried it. Monetary reform that makes MMT viable is technically very easy to do. But this is a no holds barred war over the greatest power on Earth: the power to create and issue money. Until this battle is fought again and won by governments, bankers will continue to be the real rulers of the world and aspects of MMT will continue to be moot.

    Randy Wray had an article posted a few days ago at GEI Opinion entitled "A Modest Proposal for Ending Debt Limit Gridlock" ( ). He proposed the use of Treasury warrants issued to the Fed in order to create currency necessary to meet government spending obligations and exclude these warrants from debt limits by act of Congress. While I do not see how this is useful for anything beyond short-term cash flow shortfalls, it is illustrative of the lack of Congressional abilty to maintain active control of the constitutionally defined responsibility to issue currency.  

  10. D.B. Clark Email says :

    Very well stated - except that many of us trying to wrap our arms around MMT and its implications - are being spun around.
    I'm happy to spin and look forward to Steve, John and Stephanies insight into your (logical) view.
    Thanks for your comment.

  11. D.B. Clark Email says :

    BTW - my simple opinion is that MMT does not - is not - a solution for rectifying and/or allowing growing gov't deficits...especially deficits at a ratge higher than GDP growth.

    From an MMT perspective, very understandable that 'some' deficit spending will further monetary expansion.

    As Derryl points out, it seems MMT does not answer the final and true control of money creation. MMT also doesn't answer how the system can be rigged to the benefit of the elite powers.

    Bill Black has certainly demonstrated the fraud and lack of enforcement. We can chat about MMT potential until we can't eat supper - but it rings hollow with real world control and the abuse we're still subject to.

    Without back up or links - my understanding is that the TBTF's are now 30% bigger than pre-Lehman.

    Reinstating Glass-Steagall would seem to be a wise first step....GS et al needs to lose a good portion of their grip of control. Maybe MMT theory would have more real world application...



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