Whenever a government initiative is proposed, the automatic questions are:
Where will the money come from? What will you cut to pay for it?
Much better questions are:
Where will the money go? What will it achieve? Will it come back to the Government as tax? If not, why not?
They are not easy questions, but they are what we should be asking.
Starting point
The Bank of England says that most money in the economy is bank deposits created through commercial-bank lending – not money originally created by government spending (Bank of England: How is money created?).
However, every £ is an IOU from the Bank of England. If you have good enough eyesight, you can see that it says this on any banknote.
The Bank of England allows the government to write these £ IOUs to cover government spending. It also allows banks to write £ IOUs to make loans. Most people don’t realise that every £ in existence is an IOU that was written at some time in the past, either for government spending or as a loan from a commercial bank.
But where will the money go?
If the government creates and spends new £ IOUs, normally they will circulate in the economy and gradually come back to the Government as tax. It doesn’t matter whether the tax comes back quickly or slowly, as long as it continues to come back. Banks recover their £ IOUs as the loan is repaid, plus extra government-created £ IOUs as interest.
An important difference
When the government gets its £ IOUs back as tax, those who are better off are likely to pay a higher rate. With bank loans, those who can least afford it pay the highest rate of interest. One process will tend to reduce inequality, the other will tend to increase it.
If a billionaire gets an extra £1 million, it makes a minimal difference to their life. Providing 1,000 struggling households with £20 a week for a year costs roughly the same amount, but will make far more difference to their lives.
What happens to £ IOUs after the government spends them?
When those who are barely surviving receive more £ IOUs, while they may not pay tax directly, they will spend the money immediately, helping create jobs, providing profits for businesses and boosting the economy. Those other workers and businesses will pay tax, so the money will come back to the Government indirectly through later transactions.
Perhaps more jobs and higher profits might create actual growth?
In contrast, if those who have enough money already get more, they may not spend it productively. Also, when there is a crash, as in 2008, £ IOUs can just disappear into thin air.
What about inflation?
Some orthodox economists argue that if you direct £ IOUs to where they will be of most help, they will be spent, altering the balance between demand and supply and leading to inflation. Thus a simple way of controlling inflation is to keep money out of the hands of those who really need it.
But the intractable drivers of inflation are on the supply side, infrastructure, available workers and materials (plus global shortages). Raising interest rates will not open the Straits of Hormuz or make it rain in Sussex.
Perhaps moving towards a fairer, more prosperous society with a growing economy will always tend to generate some degree of demand-driven inflation. But perhaps it will be worth it.
No easy answers
All Chancellors of the Exchequer have “fiscal rules” (rules limiting government borrowing or debt) which they adhere to, but these rules tend to follow from asking the wrong question. Their need to “balance the books” is based on too many false assumptions, including treating the economy as if it were a household budget.
It’s not – the money is there. Keynes recognised this 80 years ago – “Anything we can actually do, we can afford”. Keynesian economists will counter that the primary financial risk to manage isn’t running out of money, but rather preventing inflation by ensuring total demand doesn’t outstrip that physical capacity to supply (the workers, equipment, businesses and materials available to produce goods and services). Modern Monetary Theory can be considered a successor to Keynes. To my mind it is a method, not a theory. It is best used as a way to encourage detailed analysis, rather than being yet another model.
Not all the £ IOUs that the government writes will ever be presented. At a minimum, it is free to write extra £ IOUs to replace those that have disappeared.
The government does not need to borrow. It can write more £ IOUs. Buying back existing £ IOUs is a choice. It diverts spending from those who need help to those with money to spare. Neither does the government need to sell off state assets – an easy but disastrous option.
However, this does NOT mean the government can just write £ IOUs at will. Before spending, it has to ask the hard questions:
‘Where will the £ IOUs go? Can you follow the trail?’
‘Will they eventually come back as tax? If not, why not?’
‘Will they disappear? How?’
Conclusion
“How will we pay for it?” is not the real problem. Regardless of “fiscal rules”, good government spending will still be good. It will pay for itself and help create a better society. The key question is what makes good government spending – what will it achieve? Will it pay for itself? This is what a Labour government should be asking.
Footnote
Last night, at our Community Centre, I attended a packed showing of Chris Packham’s film on the climate crisis. The clear message was that by spending large, but not impossible, sums of money immediately, the worst can be averted. Necessary, but of course completely outside “fiscal rules”.
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