What is the purpose of fiscal policy?

In my understanding of what Modern Monetary Theory is and observing the public discourse as journalist attempt to explain MMT, I am encountering the narratives and metaphors I had to break in order to appreciate how MMT helps transform the political debate.

This article by Ross Gittins is a good example. The article starts out as follows

Many people are alarmed by “modern monetary theory”, the seemingly radical idea that the government should cover its budget deficit simply by creating money. But in his new book, Reset, Professor Ross Garnaut, one of our most respected economists, has joined the young turks.

I wrote in How the Mainstream are Trying to Stay Relevant how Ross Garnaut still discusses ‘budgets’ in terms of needing to be funded.

With an understanding of the difference between a currency issuer and a currency user and the institutionalised arrangements of how government spending works – it should lead an economist to understand fiscal deficits are residual. That is they are an outcome and shouldn’t be the target of a particular fiscal position.

The currency issuer spends via an appropriation bill and marks up exchange settlement accounts. These are the accounts Authorised Deposit Taking Institutes (Financial Institutions) hold with the Reserve Bank of Australia. Given that logic, spending has to precede taxation and bond issuance.

When treasury who is authorised to use fiscal policy (spending and taxes) deficit spends (spends more than it collects in taxes) it leads to increasing reserves in the exchange settlement accounts. It is then a choice to issue Australian Government Securities (what we refer to as government debt). This drains the exchange settlement accounts and creates a ‘securities account’. These can be traded and earn an interest paid for via appropriation bills created through parliament. There is no reason (other than political) the Australian government will default on any payment denominated in Australian dollars.

This varied under a gold standard or fixed exchange rate where spending required governments to fix the money supply in relation to a quantum of a precious metal. In Australia Prior to 1945 note issuance required gold reserves or British sovereign of 25 percent of the note issue. Then under the Bretton-Woods system of fixed exchange rates (Post 1945) a governments priority was to defend its currency in relation to a particular exchange rate. Usually the US dollar which was then exchangeable for gold.

Policy settings may have required governments to cut spending as imports rose to reduce imports and avoid using their foreign currency reserves to defend the agreed exchange parity. The cut to government spending creates unemployment and this led to increasing politically instability and the demise of the Bretton-Woods system. You can read about the shift in this article in Vol. 91, No. 4, A Cause for Celebration: A Paradigm Shift in Macroeconomics is Underway (OCT–DEC 2020), pp. 18-29 (12 pages)

By now we should be grasping The Australian Government is a monopolist of the Australian dollar. It can always spend in Australian dollars. Irrespective of past fiscal positions or levels of ‘debt’ (which is really just corporate welfare as it is akin to a savings account for rich people) does not impede it spending now or in the future. Never.

The idea that somehow deficits are dangerous or ‘debt’ will need to be paid back rely on a myth that a government is like a household that must finance its expenditure by taxing, borrowing. Neither taxes nor issuance of bonds finances the Australian governments ability to spend. Rather under our current fiat system of monetary operations the spending creates the reserves that enables citizens to pay taxes.

All of that describes the intrinsic nature of how the Australian Government spends. There shouldn’t be any controversy about that. There are no values anybody holds by understanding the spending operations of the Australian government.


For reason that remain oblivious to me discussing the above has rooms full of awkward silence such as what happened on the latest episode of QandA where Luke McGregor articulated what I described above.

There will usually be an ‘economist’ that interrupts and admits ‘yes, governments don’t face insolvency but…’ and they bring out stories of;

  • printing money and hyperinflation.
  • rising interest rates and increasing cost of servicing government debt
  • limited pools of funds for private investment as government spending ‘crowds out’ the available pool.
  • Inflation if levels of unemployment are to fall below the natural accelerating inflation rate of unemployment (NAIRU)

When you grasp the functions of how government spending works under a fiat currency and the shift that happened from gold standard/fixed exchange rate – you can appreciate the term ‘printing money’ doesn’t apply to any spending operation. This used to refer to the operation where governments literally ‘printed’ notes in excess of the legislated gold reserves and ‘devalued’ the currency in respect to the amount of gold they would exchange for their own currencies. I describe in more detail in The Mythology of Printing Money Part II

Rising interest rate arguments links to what is called the Quantity Theory of Money. It is assumed there are a limited pool of funds and as governments deficit spend and compete for these funds it leaves less available funds for the private sector and drives up the interest rate and cost of servicing government debt.

That is nonsense. Central Banks all over the world now acknowledge bank loans create deposits. There are no limited ‘pools’ of funds that are competed for. The second part of the argument is that interest rates begin to rise and costs are passed on to households and businesses creating inflationary pressures.

What should be obvious to everybody is that the interest rate is a policy decision. The monetary policy committee of the Reserve Bank of Australia makes a decision on what the overnight cash rate (the rate banks pay each other) is. More recently they have been targeting the yields of Australian Government Securities and State and Territory bonds. The yield is rate of return on a financial investment – in this case government bonds. As the Reserve Bank as been purchasing bonds it increases the demand (and cost of the bond) and thus lowers the yield (interest earned over the life of the bond)

The financial markets have no power over central banks when they decide to do this. None. We’ve seen interest rates being held low since the financial crisis in Europe and the USA (and Japan for much longer) as well as more recently in Australia. Remember the issuance of these bonds for an entity that issues a currency is entirely voluntary. The issuer has to spend first and sell bonds that financial institutes obtain from deficit spending.

I won’t repeat NAIRU logic here but will direct you to how a Job Guarantee is a replacement for the NAIRU framework. We do not need unemployed people to be used to discipline the inflation rate.


If fiscal policy doesn’t have to balance and target a particular fiscal balance or debt to GDP ratio as there is no need to issue public debt, what should it target?

Once we break the myths of intergenerational debt, governments needing to borrow to invest and all the usual nonsense that assumes governments need to find revenue sources we ask what real goals should we as a society be targeting?

A starting point is understanding differences between non-monetary base and monetary based societies. In non-monetary based societies we have neither employment or unemployment. If you take an economics class propaganda shoved down you is that money evolved from barter

‘Money’ wasn’t created and injected into some well functioning ‘market’ rather it is a creature of the state. That is it is created via legislative capacity of the state. Taxes then have to serve a purpose other than funding.

“Historians of the African colonial experience have often remarked on the manner in which the European colonizers were able to establish new currencies, to give those currencies value, and to compel Africans to provide goods and services in exchange for those currencies.”

Tcherneva, P., Monopoly Money: The State as a Price Setter, Oeconomics Volume V, winter 2002

Tcherneva cites Sticher (1985)

[In Malawi there was an] imposition of a Sh.3 annual hut tax over the whole colony in 1896. This was a high figure for the northern areas. And undoubtedly stimulated further labor migration [to find work paying shillings].

Further evidence of taxation driving a currency can be found during the colonisation of Nyasaland.

“It is sometimes forgotten that the plantation sector in Nyasaland dates from as early as the 1890s. During the early years of colonial occupation, most officials shared the opinion of Sir Harry Johnston, the first Commissioner and Consul General, that “the one hope of this, country lies in plantation work and in the cultivation of coffee, tobacco, sugar, etc., for which cheap labour is necessary”.3 Some 800,000 acres were alienated to settlers in the Shire Highlands, the most fertile and densely populated area in the country; hut tax was introduced from 1891 as a means of introducing “the native labourer to the European capitalist”4 and coffee was grown with such success that in 1900 a thousand to exported worth 62,00 making Nyasaland the centre of European agricultural enterprise in Central Africa” (McCracken, 1982)

McCracken, J.,Peasants Planters and The Colonial State: The Case of Malawi, 1905-1940; Journal of Eastern African Research & Development, Vol. 12, 1982, pp. 21-35

A simple way to think about the purpose of taxes is that the tax liability forces citizens to seek the currency to redeem the tax obligation. Thus anyone that has nothing of use to sell to the currency issuer is unemployed. The issuer then must employ those citizens so they can earn the currency to pay the tax. So unemployment is a political choice caused through insufficient government spending.

Conclusion

To summarise government spending happens first and intrinsically must be done before citizens are able to obtain the currency to pay the tax. One purpose of taxes is to ensure labourers as they seek employment to fulfil their tax obligations.

The many myths used to demonise public spending range from insolvency myths and fear mongering about rising interest rates (which are a policy choice) devalued currency (devalued in relation to what? $1 credit will always redeem $ tax liability) and fears of massive debts that future generations will need to pay off.

What really matters is our own well being. Ensuring everyone as access to healthcare and an education. Ensuring secure work for all and the ability to partake in our communities. We need to create work with meaning. We need to ensure affordable housing for all. We need to mitigate against climate change.

Government ‘budgets’ are statements about values. Our values determine how we should organise our societies and the institutions we create. These institutions with our labour set about to create the public services we desire.

Our wealth isn’t a series of abstract numbers in computers recorded in spreadsheets. It is our labour and what we are able to produce. That is our material well being.

As a nation we have enough real goods and services to provide for all. We need to ensure that everyone in our society as an opportunity to contribute. We should not be using a flawed paradigm of assuming we need to find money when we have millions of people with insufficient and exploitative work.

Budgets Should Target Socioeconomic Well-Being.

It is custom in Australia to make an event around the various state/territory and federal budgets. In the past achieving some fiscal ratio has been seen as ‘responsible’ In 2016 Economics professor Ross Garnaut stated (source)

These measures should be backed by moderate and gradual cuts in spending, and moderate and gradual tax increases to repair the budget.

Post COVID, the framing when discussing a budget, has moved from achieving a fiscal outcome (balanced/surplus) to targeting a particular employment rate within a framework called the ‘natural accelerating inflation rate of unemployment’ (NAIRU)

I wrote a little more on this in my post The Mainstream are Trying to Stay Relevant and Modern Monetary Theory and The Job Guarantee. I have rejected the NAIRU as a nonsense concept. It effectively uses the unemployed to discipline the rate of inflation, to which you can use a ‘buffer stock of employed’ to achieve the same end.

As a society we literally leave masses unemployed because economists believe unemployment must not fall below this NAIRU rate. Costs of unemployment are huge:

  • loss of current output
  • social exclusion and the loss of freedom
  • skill loss
  • psychological harm, including increased suicide rate;
  • ill health and reduced life expectancy
  • loss of motivation
  • the undermining of human relations and family life;
  • racial and gender inequality
  • loss of social values and responsibility.

Even ‘the left’ have changed the framing for how they think about governments fiscal positions.

In 2019 the ACTU was concerned with excessive debt levels. I wrote a critique Solving inequality requires getting macro right!

“Globally most respected economic institutions believe the risk of recession has increased and some pundits fear “winter is coming”.……Stimulus measures by the Chinese authorities will exacerbate already excessive debt levels and add to vulnerabilities

The report continued to discuss Australia and the ‘limited’ tools in response to the ‘economic challenges’ we face.

Economic fear is mounting and because of very high debt levels and limited scope for expansive monetary policy governments have limited tools in responding to these challenges

Post COVID ‘we are no longer discussing ‘fiscal repair’ and the treasurer wants an unemployment rate ‘comfortably under 6 percent’ (source) Further articles are stating the unemployment rate could’ve been much lower with headlines like ‘Reserve Bank and Treasury admit ‘full employment’ is not what they thought it was. And it’s held the country back’

Although the NAIRU framing is still incorrect. And the left still talk about currency issuing governments as ‘borrowing’ to invest!

The ACTU report on the upcoming federal budget still says

The government has ample fiscal capacity to manage those deficits moving forward, thanks to record-low interest rates and the actions of the Reserve Bank (whose bond purchase program has supported low interest rates and facilitated the government’s fiscal response to the pandemic).



“Borrowing to finance long-lived, productive investments is the exact same rationale that leads other parts of our economy – notably businesses and households – to also take on debt.”

For a Stronger, Balanced and Inclusive Recovery, April 2021, p36-37

The report suffers as a result of that illogic. The Federal Government issues the Australian dollar. It must spend first (that is logic101). It is nothing like a household or business that must borrow to finance expenditure in excess of what it earns. The fiscal position is residual. It needs to satisfy the savings desires of the non-government sector if we desire full employment (more jobs advertised than demanded)

I gather that I am a nobody but when I was discussing modern monetary theory with ‘progressive’ institutes such as the Australia Institute (affiliated to the organisation that helped prepare the ACTU report) or PerCapita, I would cop hostility from people within those institutes for articulating

  • Government debt was an after the fact operation and a tool of monetary policy (interest rates) (there is no need to issue it) It doesn’t fund a currency issuing governments ability to spend.
  • The unemployment rate is a political choice; Governments can always purchase idle labour. They issue the currency and;
  • A Job Guarantee is a replacement of the NAIRU framework

I have been called ‘simplistic and naive’ and accused of being ‘anti-tax’ because I stress the purpose of taxation (or bonds) are not a funding mechanism. Which I wrote about here and in various other places throughout this blog.

I have some people write to me now asking for further explanation and I can direct them to appropriate sources. The blog is not intended as an education resource but to document my own understandings of macroeconomics and the impacts how a flawed framework leaves us materially poorer as a society.


I recently attended a Northern Territory budget briefing with Treasury officials. I was disappointed to the whole approach that the government was taking to the budget. The reality is the NT Government is a currency user (the largest source of its revenue being the GST)

Though the framework it is taking to the budget process and the policies of wage freezes and cuts too spending will ensure the most vulnerable in our society suffer.

The spending measures taken in the budget are aimed at subsidising private investment (tourist vouchers, local jobs fund) and not at direct job creation. The public sector has a wages freeze and staffing caps.

Budget paper two says (source)

The 2021‐22 Budget includes investment aimed at accelerating economic recovery through a $120 million expansion of the Local Jobs Fund and additional funding to support growth and development of new and existing industries recommended by the Territory Economic Reconstruction Commission. 

When I pressed the treasury officials for more detail on that programs, they were described as measures that subsidised businesses to employ people. When I asked why there were no direct job creation programs the answer was because The Government doesn’t want to do that and that they were more interested in subsidising private investment.

I prodded with further questions on debt, the RBAs Quantitative Easing program (which means the states/territories owe dollars to the RBA) and the inadequacy of relying on a consumption tax to fund the majority of our public expenditure. Treasury agreed the GST was not fit for purpose though insisted the largest priority must be getting rid of public debt (according to treasury that means wage freezes, staffing caps and subsidies to private business)

The GST is a consumption tax (at a federal level) that then is hypothecated amongst the states/territories. It is a terrible way to determine funding to these jurisdictions who are required to have the revenues to deliver healthcare and educational systems because of the structure of how we are federated and the responsibilities within the constitution. States and Territories have the responsibility for those services while the federal government issues the currency.

By using a consumption tax to hypothecate the revenue allocated that is then used to deliver the above services is what requires the states/territories to issue bonds (and thus make interest payments)

If the non-government sector desires to save more and thus reduce consumption then the collection of GST falls (relative to GDP) and the states/territories have less to spend and either need to make up the shortfall by issuing bonds or raising taxes.

The states don’t have the power to impose income taxes and they’ve been reliant on increasing stamp duties and in some cases payroll taxes. (Two taxes that are not efficient and are not achieving much in terms of socioeconomic outcomes)

Conclusion

Discussion of government budgets has moved to needing to spend more but are still within a framework that Governments must tax, borrow or print in order to spend. At a federal level that is false. In terms of the states/territories we need to be questioning just how fit for purpose the funding mechanisms to deliver public services are.

While it is pleasing to see the public discourse move to discussing employment levels this is still operating under a NAIRU framework. A mythical number that is not known by anybody. This has been the definition used for full employment for the past 40 or so years and any progressive should reject it.

Full employment is a society as one in which there are more jobs on offer than people seeking them, so that work providing a secure dignified existence may be easily obtained by all.  

(Beveridge, 1944, Full Employment in a Free Society)