Short & Simple 10 – Spending Independently of Income

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.

Now, if we think about past savings, these are the result of saving in an earlier period. This saving of an earlier period was only possible because of income received in that period. We know this because saving, by definition, is that part of disposable income not consumed. It is impossible to save unless you have an income.

The significance of this is that, in trying to explain how spending can occur without prior income, the role of past savings does not get us very far. This is because those savings were themselves the result of past spending. If we went all the way back to the beginning, before any spending had occurred and so before any income had been created, there would be no savings.

Imagine a monetary economy at its inception. The very first act of spending would have to come from something other than income or past savings. It could not come from income because initially there would be no income, no spending having yet occurred. And it could not come from prior savings, because there can’t be any savings before the first income has been created.

If we exclude past savings, that leaves two main ways that spending can occur. It can occur either through:

1. government spending; or
2. private spending financed by borrowing.

From inception of a monetary economy with a national currency, government will be the first spender in the currency, because it needs to put various institutional arrangements in place, and this requires paying staff a monetary wage (see part 2). But once the monetary economy is up and running, it is also possible for a household or business to spend in the national unit of account without prior savings, through borrowing.

At first glance, these solutions to our apparent riddle may seem to raise more questions than they answer.

In relation to the first solution, it might be wondered, doesn’t a government need tax revenue before it can spend? Or, lacking tax revenue, doesn’t it need to borrow from the private sector? Without income or prior savings already in existence, wouldn’t government spending be impossible?

In relation to the second solution, it might be asked, doesn’t a bank or other private lender need funds to be deposited with it before it can lend?

Without any income, there would be no tax payments, nor any funds deposited with lenders. So, logically speaking, how could spending possibly occur?

It might seem as if we are facing a “chicken and egg” problem.

But fortunately we are not. Spending does indeed come first.

A currency-issuing government can, and does, spend without an income. And commercial banks can, and do, extend loans without drawing upon the funds deposited with them.

To see how these things are possible, we need to think a little about the nature of money. In particular, we will need to understand:

  • government money; and
  • commercial bank money.

But before considering these, it will be helpful to consider the nature of money in general.

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9 thoughts on “Short & Simple 10 – Spending Independently of Income

  1. Worth having a read of USA 2017 Q1 Sectoral Balances Update. If you run yearly $500 billion deficits with the rest of the world, the rest of the world ends up with a lot of US Dollars. That’s how the US Dollar became the world’s reserve currency. Likewise in the UK, foreigners end up with a lot of Pounds Sterling, not much good for paying the workers that made the stuff the UK imported; but that is the start of another story. 😉

  2. It’s really a sign of blinkered thinking among anyone interested in the economy to imagine taxes are fuel for Government spending. Apart from taxes coming after spending you also have to have earned money to establish what your tax liabilities are.
    Also the government didn’t only start the cycle once. It has to do it continuously. The unit of currency gets a tax bite taken out at every exchange and ends up worth almost nothing. Deficit spending has to be continuous and only needs reining in in boom times.

  3. Agreed, John. I went through the thought experiment of “from inception” to make it clear that spending logically has to come first. But as you say, continual spending, and particularly government spending, is needed to keep the economy going.

    A difficulty in explaining this point, as I’m sure you are aware, is that once the economy is up and running and government has already spent more into the economy than it has taxed out, it can arrange things so as to make it appear that tax payments come first. I am referring, here, to the constraints governments voluntarily impose on their own actions.

  4. Most people don’t realize that government spending and lending and bank credit extension both result in nongovernment deposit accounts being credited in the unit of account.

    This adds to the money stock called M1, which is essentially deposits held at commercial banks and currency in circulation (notes and coin).

    This are the funds used in an economy for monetary transactions. These funds are saved through all the various transactions, since sellers accept money in the form of the unit of account.

    The funds that government spends or lends into nongovernment are destroyed by either repayment of obligations to the government that government creates, such as taxes, tariffs, fines and fees, or else repayment of loans that government extends.

    Government securities outstanding are the funds that have not yet flowed back to government through payments of nongovernment entities make on obligations imposed by government.

    The funds that bank create by extending credit are destroyed by repayment of the loans that were created, along with the interest due.

    Thus the money stock that is used for transactions in an economy is increased by government spending and lending and banks’ credit extension in the unit of account, and the money stock is decreased by repayment of obligations.

    Banks are privileged as public-private partnerships to create deposits in the unit of account Modern banks have access to the central bank as the lender of last resort as long as they are solvent. Bank deposits may also be guaranteed by the government at least to a certain amount. In return for this privilege, banks agree to close regulation and inspection by government.

  5. A difficulty in explaining this point, as I’m sure you are aware, is that once the economy is up and running and government has already spent more into the economy than it has taxed out, it can arrange things so as to make it appear that tax payments come first.

    Explaining tax policy clearly and simply in terms of the operational POV (MMT) is a high priority.

    Taxes are needed to generate ongoing demand for the currency by imposing obligations that can only be met by obtaining the government's unit of account, of which the government is the sole issuer.

    Taxes also serve to regulate the size of the money stock available for transactions. This is important in regulating the price level and controlling inflation.

    There is no necessary connection between spending and taxing.

    Taxes inhibit behavior that is taxed.

    Tax credits encourage behavior and taxes and fines discourage behavior.

    A good tax policy encourages the development of both economic and social value.

    Economic and social value are inhibited by free riding. In economics, free riding is called "economic rent," which is unearned gain.

    A primary negative behavior that tax policy can be used to discourage is free riding (rent-seeking behavior).

  6. A difficulty in explaining this point, as I’m sure you are aware, is that once the economy is up and running and government has already spent more into the economy than it has taxed out, it can arrange things so as to make it appear that tax payments come first.

    There is nothing "wrong" about taxing back spending if there is reason. For example, military spending is inflationary since it puts spendable funds into the domestic economy without corresponding production of goods for sale, so it is potentially inflationary. Traditionally, military spending has been taxed away to control inflationary tendencies of such spending.

    In the US especially, military spending is used to inject funds into the domestic economy in lieu of spending on social welfare and public investment in infrastructure, R&D, education, and health care, etc.

    Moreover, military spending is exempted from pay as you go.

  7. Thanks, Tom. Good insights,

    Just to clarify, I certainly didn’t mean to suggest that taxing back government spending is wrong. I just meant that once the economy is up and running, it can be made to appear (through various operational constraints) that tax payments come before spending.

  8. Of course I realize that, Peter. Was attempting to emphasize that a clear, concise and precise explanation is the way to go strategically and tactically.

    Seeding the media with soundbites that are catchy and also accurate is also key to creating MMT memes that stick.

    There is a reason that advertisers use jingles, too — for the MMT musicians.

    Music drove the countercultural revolution.

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