Home > General Politics, Socialism, Terrible Tories > Fiscal deficit, causality and inflation: debunking a capitalist myth

Fiscal deficit, causality and inflation: debunking a capitalist myth

In my last piece, I said that fiscal deficits as a problem are a convenient fiction for the right, and that it is perfectly logical for a country with its own sovereign currency to have as high a deficit as is needed to guarantee full employment.

Barney poses his regular, perfectly understandable, question: why won’t we get inflation if we ‘just print money’? Paul Sagar raised the same issue when I saw him on Saturday, but I was keen to get to the pub.

Now, I could just ask them to read the links I’ve already provided which cover this (see below), but he’s right that I should try and summarize the issue myself as I don’t think I’ve ever put it in my own words.

So if you’re sitting comfortably…..let’s do brief fundamentals.

Two basics we’ll take as read.

1) What is inflation?  It’s ongoing price rises.  In general, no-one minds a bit of inflation; its just a fact of 20th/21st century life, so lets assume that Barney’s issue is around the threat of ‘rampant inflation’.  

2) When does inflation happen?  It happens when demand outstrips supply.  Conversely, deflation happens when supply outstrips demand.

Now, what causes demand to outstrip supply to create rampant inflation? Well, mostly it’s when supply is constrained in some way.

Why was there huge inflation in Weimar Germany?  Not because the government printed money, but because production in the Ruhr  suddenly collapsed when the French and Belgian armies took over the  area, after the Germans defaulted on the massively punitive reparations payments, and production collapsed.

What drove inflation in the mid-1970s?  Not governments printing money, but the OPEC cartel suddenly whacking up the price of oil barrel, with all the knock on effects of that.  Why did inflation stabilize? Not because of monetarism, but because natural gas came on stream and forced down the price of oil.

Why was there hyperinflation in Zimbabwe?  Not because the government printed dollars, but because production on both farms and industry collapsed.

The important thing is the causality.   ‘Just printing money’ is a reaction to a screwed demand/supply balance.  If money had not just been printed, in Zimbabwe, more people would have starved.

That’s the first conceptual leap we need to make.

The second one is about tax.

If we can ‘just print money’, why do we need tax at all?  We need it because it is both what drives production of everything, and because it regulates aggregate demand.

Governments do not need tax in order to create money for themselves to spend.  They do not need to do that.  They have the power to create money by making coins, printing notes or changing numbers on a computer.

As Mosler says:

Taxes aren’t about money to spend, they are about regulating our spending power to make sure we don’t have too much and cause inflation, or too little which causes unemployment and recessions.

Taxation (taking money out of circulation) is the way to curb inflation by decreasing supply at one point in the cycle, and deficit spending is the way of increasing supply at the other point.  That’s how to manage a market economy with near full employment and optimum use of resources.  Monetarist methods (interest rate manipulation) are a side show.

Why do people not get this? 

Well, it’s a conceptual leap for people used to thinking in terms of household and /or business budgets, where revenue DOES need to be lower than spend if you’re not to default eventually. 

The leap that needs to be made is based on the understanding that the state has total ultimate control over the money supply.   The creation of money has been privatized and the authority handed over to bankers, who have used that freedom to create credit from thin air to become very wealthy, but who have the ultimate backstop of the state when it goes wrong.

That is, it is not in the interests of financial capitalism for us to understand what money and taxation really is.  It is in their interests for us to believe in the myth that a state must ‘balance its books’, even though this leads states to ignore the needs of its citizens for fear of a mythical default position.

This myth has been reinforced recently, and shamelessly exploited by the Coalition by the plight of the Eurozone countries, who have given up control of their sovereign currency, but who currently operate without a sovereign bank.  This can be resolved by the creation of a:

supranational fiscal authority similar to the U.S. Treasury that is able to spend like a sovereign government (Randall Wray).

This is the single biggest problem with the EU; it is institutionally locked into neoliberalism, whatever the politics of national governments.  The Maastricht treaty sets out limits to deficit spending, which do not allow for responsible fiscal policy in times of recession, or to avoid recessions.

This is a short as I can make it.  Much better, fuller accounts are here (Bill Mitchell), here (Warren Mosler) and here (Randall Wray).

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  1. paul cockshott
    June 28, 2010 at 9:29 am | #1

    Governments can not dispense with tax and simply print money because the value of money arises from the need for it to settle tax bills. If the government withdraws too little of the money it creates from circulation as tax, for too long the value of money will fall. Attributing inflation just to supply shortfalls is too simple, it can also arise from a weakness in the tax system.

  2. Barney Stannard
    June 28, 2010 at 11:21 am | #2


    The historical argument essentially runs – both Zimbabwe and Weimar Germany suffered massive supply shocks without correlative demand shocks. Thus demand outstripped supply. Thus inflation. Therefore we don’t need to use printing money as an explanation for why their was hyperinflation.

    There are at least two flaws in this argument. 1) why wasn’t their a correlative contraction in demand? 2) Inflation is a sliding scale.

    Bill Mitchell uses the Keynesian cross as his model. It’s just too simplistic to be of any real use. Which goes for most of this stuff. It’s just quasi-philosophical “if you think about it logically”. There are no micro-foundations of consumers’ behaviour, no real models. There’s no maths, and whilst maths is not an unmitigated good in the study of economics, it is the one way of rigorously addressing these issues and not getting lost in the assumptions.

    We could sit here all century and debate these issues with “but surely people would do x”, “but surely they would do y”. I could make the argument that for every £1 you increase the money supply all £1 must go to increasing aggregate supply for it not to be inflationary. I could argue that this is implausible as the natural reaction of a shopkeeper when hearing that the money supply will be increased is to increase his prices at a given supply level.

    Is this argument prima facie plausible? I guess so – I can’t really be bothered to think it through. Why? Because it is reliant on so many unspoken and uncrystallised assumptions that it just isn’t convincing.

    The default position is that printing money causes inflation. Why is that the default? Because most economists think it does. Does it make it right? Of course not. But it does mean that you need better arguments than these to rebut it. Arguments which not just have logical integrity but actually set out systematic and plausible descriptions of economic realities. Models which provide predictive power and testable conclusions.

    I realise that this is just perhaps a bit much for you to do, you are a blogger not an economist. So I’m not criticising you on that basis. But I just feel that the papers you refer to just aren’t convincing. They are almost pre-scientific in their analysis, and all of them are far too brief to adequately cover the ground.

  3. paulinlancs
    June 29, 2010 at 8:12 am | #3

    Barney/Paul: I’ll come back to these points in a separate post. Thanks for input.

  4. vimothy
    June 29, 2010 at 2:30 pm | #4

    I agree that MMT does not deal with inflation well. Although Godley and Lavoie model financial flows admirably, they do not model real production in a satisfactroy way–in the end, real flows are obtained simply by multplying the financial flows by a constant factor.

    This is MMT’s fatal flaw–obssessed with stock-flow-consistency and the flow of funds, it cannot explain prices.

    WRT the OP I think that the focus on not funding the deficit is a mistake, though it could function as a useful thought experiment that helps to reduce the general level of deficit hysteria.

    Better strategy IMO is to not question the use of bonds, but instead to try to move some of the operational constraints that govt has placed itself under (e.g. the Fiscal Responsibility Act (falsely so-called)).

    Also, to question the wisdom of austerity during a global downturn, paying particular attention to the state of *private* balance sheets and sectoral financial balances, in a way that gathers up the broadest alliance possible–”crazy talk” about printing money is probably only going to put people off.

    Finally, to question the premises of austerity–the national debt, the promises of a private sector led recovery, with monetary policy back on its throne and the rest of us heavily in debt.

  5. George
    July 19, 2010 at 6:26 pm | #5

    Bare with me Dave, it’s a while since I finished studying econ and I’m getting pretty rusty. The real economy is in equilibrium (we’re assuming no growth or shrinkage) and the government deficit finances by printing money…so there’s more paper notes same goods for them to buy things with…and there’s no general price rises (inflation) how?!

  6. July 19, 2010 at 9:36 pm | #6

    That would be Paul’s article old boy, not mine.

  7. ChrisBern
    July 22, 2010 at 9:22 pm | #7

    I can’t speak to Weimar Germany or Zimbabwe. But I do believe the author of the article is stretching things with this statement:

    “Why did inflation stabilize (from the 70s oil shocks)? Not because of monetarism, but because natural gas came on stream and forced down the price of oil.”

    Does the author believe doubling the Fed Funds rate to 19% was less important to stemming the tide of inflation than changes in the natural gas market? Or does he believe that raising the rates to 19% had no effect whatsoever?

  8. August 12, 2010 at 4:35 am | #8

    I agree with the basic thrust of Barney Stannard’s comment. I also agree with Vimothy when he says that “MMT does not deal with inflation well”.

    Paul seems to argue that because some inflation is cost push, therefor almost ALL inflation is cost push, i.e. that money printing or excess demand has nothing to do with it. That is over-simple.

    I also don’t agree with this passage.

    “‘Just printing money’ is a reaction to a screwed demand/supply balance. If money had not just been printed, in Zimbabwe, more people would have starved.”

    What, so printing money saves loads of people from starvation? Oxfam will be interested in this idea.

    Agricultural production halved in Zimbabwe because Mugabwe’s cronies do not have the technical competence (or cannot be bothered) to run farms 21st century style. Why would printing loads of money make good this cronyism and technical incompetence? I don’t get it.

    That said, I agree with the two or three paras towards the end of Paul’s article that starts “The creation of money has been privatized….”

  1. July 18, 2010 at 8:35 pm | #1
  2. October 8, 2010 at 11:05 pm | #2
  3. April 29, 2012 at 9:28 pm | #3

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