We saw, in part 14, that government spending increases the net financial assets of non-government, whereas taxes do the reverse. The level of net financial assets at a point in time is a stock. The change in net financial assets over the period is the result of flows.
Now that we have introduced ‘government money‘ and ‘commercial bank money‘, we are in a position to understand in basic terms how fiscal policy (government spending and taxing) is conducted and its direct financial effects. At this stage, the treatment is still cursory. There are more details that can be added in at a later time.
We have seen that a national currency enters the economy when government spends, and that the recipients of the government spending can use the currency for various purposes, including to purchase goods and services. Government is therefore an original source of funds.
There is another original source of funds that gives people the ability to make purchases. This other source is private credit creation. Put simply, a household or firm can borrow from a bank or other financial institution and use the funds to spend.
We saw in part 2 that to establish a currency, government needs to do three things:
1. Define a unit of account (e.g. dollar).
2. Impose taxes that can only be paid in that unit of account.
3. Spend or lend the currency into existence.
The most basic purpose of taxation (introduced in step 2 of the sequence) is to create a demand for the currency. Provided taxes are effectively enforced, we in the non-government will have a need to obtain the currency, because it is the only means of paying taxes.
This is a presentation by Professor Bill Mitchell at the University of Victoria, Wellington, New Zealand on July 28, 2017. It addresses framing of the macroeconomic policy debate and touches on the most fundamental insights of Modern Monetary Theory. Most here will be avid readers of the professor’s blog, but this talk is too good not to post. While in New Zealand, Professor Mitchell also did an interview for the public broadcaster. A link can be found in the billy blog post of July 31, 2017.
From inception of a monetary economy with a government-issued currency, it is clear that government spending must come before tax payments or purchases of government debt. The order of requirements is basically: (i) government defines its monetary unit of account; (ii) government imposes taxes and other obligations that can only finally be settled in that currency; (iii) government spends (or lends) its currency into existence; (iv) non-government can now obtain the currency and, among other things, pay its taxes and purchase government debt. It is clear that government spending must logically come before tax payments or purchases of government debt because non-government must be able to get hold of the currency before it can do these things
This is an excellent introductory video, scripted and narrated by Geoff Coventry. It is mentioned in the YouTube comments that Stephanie Kelton and others advised on the work. No doubt the video has already appeared on other blogs. The link was provided by acorn in the comments.
Money can be thought of as an IOU (“I owe you”). The issuer of an IOU can buy goods or services from anybody who is willing to accept the IOU as payment.
It was mentioned (in part 2) that a currency-issuing government issues its currency in the act of spending. An implication of this is that a currency-issuing government does not need income in order to spend. We have also noted (in parts 5 and 9) that a household or business can spend independently of current income. They can do this either by drawing down past savings or through borrowing.