Ending Fiscal Stimulus: A Case For Sensible Fiscal Policy

Whenever the economy isn’t doing so well, the talk inevitably turns to fiscal stimulus. This usually means proposals for some kind of infrastructure improvements – often long overdue – and a preference for so-called “shovel-ready” projects that are intended to move money into the economy quickly (whether they do or not is another matter). Such proposals are often attacked as too slow to have any effect, or being poorly planned and resulting in wasted spending or even graft.

Anyone who has been following my posts for long will know that I am a proponent of significant investment to develop national capital (infrastructure, health, research, education, ecology, arts, etc.), but here I would agree that infrastructure is a poor economic stabilizer and provides weak stimulus in the near term when it is most needed. Infrastructure and other investments should be made if and when such projects are needed or deemed beneficial to the nation, not because the economy needs a kick-start.


When the economy is in a downturn then businesses and households increase their savings, sales and revenues fall, investment is cut back, and unemployment rises as companies cut costs. But while our politicians and pundits debate stimulus packages something else is already going on: a powerful government fiscal response kicks in all by itself (as it was designed to do).

What is happening is that the government is adding more spending power into the economy than it removes via taxation. Tax payments drop due to slower sales and lower incomes; simultaneously there is an increase in unemployment and welfare payments which add money directly into the economy. Such targeted spending is mostly spent by those in need, increasing sales for businesses and slowing the economic decline. These intentional net increases of government monetary contributions to the economy are what economists call automatic stabilizers, and they are the main reason we don’t have regular great depressions. It is also a major reason why the government “deficit” and “debt” rise during recessions and fall during economic expansions (as much as Presidents from both parties love to take credit!)

It should be obvious from this that we could do a better job of designing our automatic stabilizers to optimize their effect in maintaining a healthy economy during downturns. We can do much more to shorten a recession and maintain employment and incomes for people during times when businesses are struggling. Too little attention has been given by economists to analyze what tax structures and progressive rates will act best to stabilize our economy during business cycles to more effectively maintain a fully productive and employed economy. But there is a bigger problem with our approach.

Fiscal stimulus is simply the wrong paradigm. We need currency management.

There is a more fundamental issue with how we discuss responses to the economy and what is in the public interest. The term “fiscal stimulus” betrays an ignorance of our currency and appropriate fiscal policy.

The idea behind fiscal “stimulus” is that the economy is a big market that operates generally on its own, but once in a while it can get stuck. It is during these times that the government can step in temporarily to help give it a push start. But otherwise, the government should behave like all other market participants and not "intervene".


This framework is erroneous for many reasons, but most fundamentally, it ignores the fact that the national government is the sole issuer of the nation’s currency. The currency-issuer plays a unique and vital role in the overall economy in addition to the government's role of issuing currency to fulfill public purpose. The management of the currency must also take into effect the changes in the demand for its currency that occur during ebbs and flows in the economy. Failure to do so results in painful results for portions of the population.

Public Purpose

The reason why the typical nation has its own currency is to fulfill public purpose in ways that markets can never do and that meet the needs of its inhabitants: provisioning for defense, building infrastructure, investing in long term research, providing incomes for the elderly and education for the young, etc. Via our democratic process and representative government, decisions are made as to what the government should pay for. This defines the base budget which sets the amount of its currency the government is expecting to add into the economy during a given time-frame.

Currency Management

While we have a basic tax structure that generally removes a large amount of this newly-added currency back out of the economy, effective currency management becomes critical at this stage. If the government taxes too much out, then it will create unemployment. If it leaves too much in there can be periods of unwelcome levels of inflation. And all of this is also affected by the trade balance (how much currency is being saved abroad), along with the general state of the domestic economy (heavily influenced by levels of private credit growth).


Imagine a Public Water Utility that exclusively serves a city and has an unlimited source of water (just as the government has an unlimited ability to create its currency). If some residents started building bigger swimming pools and some businesses began bottling and selling the water abroad, but the Utility refused to add more water into the system to compensate for the water being stored and exported, many local residents would go thirsty and maybe even die – probably the poorer ones who lacked money or political clout to get relief.


That's basically what happens when the currency isn't managed appropriately.

A Different Framework

The currency exists to provision the government and fulfill public purpose, but must be managed to also account for broader economic effects. The following are some of the more essential concepts:

• Taxation simultaneously creates demand for the government’s currency (we need it to pay the tax), while also reduces spending power (less income gets spent buying what businesses make).
• Government spending creates new currency as it pays for resources and labor, filling the “gap” created by taxation.
• In this sense, it can be said that taxation creates some unemployment, and government spending restores (or should result in the restoration of) full employment.
• It would make no sense for a government to create more unemployment via taxation than it intends to restore by buying enough resources from the private sector and paying for all remaining unemployed workers.
• It also makes no sense that the government allows for or encourages trade and the saving of its currency by trading partners, which not simultaneously ensuring the domestic economy can maintain full employment.
• Likewise, it makes no sense for the government to allow its currency to be saved domestically, and not ensure that this was factored into the amount it taxes so as to allow the economy to maintain full employment.
• So we can say that unemployment is a primary indicator that the currency issuer is not doing its job well, and needs some combination of appropriate tax reductions and spending increases.

The Currency and the Job Guarantee: A Perfect Match

It should now be clear why it makes economic sense, not just social and moral sense, for the currency issuer to fund a transition job for anyone who is able and willing to work but is not currently employed in the public or private sector.


By setting a price for “unused labor” and guaranteeing availability of work, the contributions of the government’s currency will rise and fall automatically during economic cycles, the economy will maintain a base of productivity during downturns, and our workers will be able to retain employment and incomes until they find their next job.


It should also be clear that “stimulus” is a misguided concept for a currency-issuing government. Appropriate fiscal policy is what is most needed. While government investments in infrastructure may vary over time, they should be driven not by "stimulus" goals, but by what is in the national interest and the furtherance of increasing national capital and general well being in all realms of life, including the arts and our ecosystems.


If unemployment is persisting, then the government has a responsibility to remove the constraints is has placed on its currency that are giving rise to the problem. Tax policy should be carefully reevaluated with these concepts in mind, but most importantly, we need a job guarantee as the anchor for our economy, our currency, and our society.

















































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Taxes. Can't live with 'em. Can't live without 'em.

The question of taxation boils down to how much and from whom should the government take back out of the economy after it spends. It is a critical question of public purpose, morality, and economic stability. The problem is that we're asking the wrong questions because we don't understand our own national currency. 

There's a lot of emotion and bravado when the topic of taxes comes up. You hear a lot of "me" & "mine", and accusations of the big bad government "stealing" or "taking" what was "hard earned" and "deserved". In some pockets of the USA, it seems there's nothing folk love more than to hate their federal government and its overbearing taxes (even from those who draw their salary or rely on support from it)!

Now unlike state and local governments, (which do need to collect taxes to pay their bills and make payments on their bonds), the federal government makes its own money - the US Dollar. Every time it spends or makes a payment (usually via its bank, the Fed), it adds US Dollars into bank accounts. Brand spanking new money just shows up in the form of bigger balances in our accounts.

Now sure, some of us work and collect wages from private companies that don't have government contracts, so it doesn't appear that our money came from Uncle Sam. But we're all part of a bigger economy which would be that much smaller without these US Dollars contributing to private sector sales and incomes. More than likely, there's a fairly short chain of transactions from some recipient of US Dollars from the Government and a purchase at the company you work for, and therefore some percentage of your pay check may well be said to be comprised of Uncle Sam's currency.

In any case, here's the point. Taxation by Uncle Sam takes BACK some of the US Dollars it FIRST created when it spent. Federal taxes redeem what the federal government first issued.

Federal taxes don't fund anything. Zip. Zilch. Zero. They are there to ensure we use & accept US Dollars and to remove their added purchasing power from the economy when needed. We're so used to talking in terms of how to "pay for" what our government does, we've forgotten that we issue our own sovereign currency, and that since we left the gold standard, we have no threat of insolvency since no one can demand convertibility.

This is profoundly different than how the average person thinks about our sovereign government. And it completely changes how we should think about taxes and tax policy.

To repeat the opening statement: the question of taxation boils down to how much of its currency, and from whom, the government should take back out of the economy after it spends.

When you look at it in this light, ideas like the flat tax suddenly sounds quite irrational and even unethical. Taxes are not about asking everyone to chip in to fund Uncle Sam.

Rather, we should be asking questions like:

• Who is disproportionately benefiting from Uncle Sam's spending? 
• Where are the US Dollars accumulating? 
• What parts of the economy need to be "cooled down"?
• Are there entities that are using wealth to destabilize our democratic institutions?
• Are there entities or individuals that have too many claims on the nation's limited natural resources and are restricting access in ways that undermine the general welfare or the pursuit of happiness for all?
• Are there sectors of the economy that are using their access to money to harm the health of people, living ecosystems, water/air/soil quality, and could a different tax structure result in different outcomes that would bring positive changes?
• What kind of incomes do we want to encourage and to leave those receiving them with more purchasing power (e.g. should we lower payroll taxes on lower- & middle-income wage earners) and which kinds of earnings should be discouraged, reduced, or eliminated (such as carried interest)?
• How can we better calibrate the tax rates on many of our major tax structures such that they function in a more optimal manner to provide counter-cyclical, stabilizing currency flows to keep the economy healthy?

A tax system overhaul is certainly in order, but until we ask the right questions and are solving the right problem, we won't be able to make the right choices. The first place to start is to understand our modern monetary system. #MMT.

Modern Money: The Basics

Money is a wonderful human invention – perhaps one of our greatest. Most nations have a monetary system designed to provide for private commercial needs, but also, simultaneously, to enable governments to access sufficient resources to create safe, just and ever-improving societies.

How does this work?

Since there are many different kinds of money and ways to define money (e.g. banks create a different kind of money than governments), we will use “currency” to distinguish the money that the government issues from all other money forms.

The core concepts:

• Why do we have a national currency? When nations and governments are formed, they need a way for the government to obtain the resources it needs to fulfill its role, whatever that may be. In most developed nations, this is typically done using a national currency.
• What and whose money do governments use? Governments actually create their own currency. There is a basic formula most countries use to create a national currency: (i) decide on a national money unit (e.g. Japan called theirs the “Yen”; the United States the “Dollar”, etc.); (ii) the government issues various forms of money “things” denominated in that unit (Yen or Dollar bills, coins, or electronic bank credits); (iii) impose a broad-based tax that can only be paid using the government’s newly created money. And now the government can issue and spend its own currency to obtain resources.
• Why is government currency accepted and how does it have any value? The tax obligation causes the government’s currency to become in demand and have value. Since businesses and households must obtain the government currency in order to pay their taxes, it becomes universally adopted in that economy.
• Does the government need to collect taxes before it can spend? Note above how taxes simply return to the government the money it first created. The spending has to happen first since the only way we can pay taxes in government currency is by first obtaining government currency. The government never needs our taxes in order to spend since it creates the money that it spends.
• If the government doesn't need our taxes to spend, what are taxes for? Taxes cause demand for the government’s currency so we accept it in payment for goods and services. Taxes also reduce spending power in the economy so that when the government spends to obtain necessary resources, it doesn’t create excessive inflation. Taxes are also useful as incentives and disincentives to influence behavior in the rest of the economy for public policy.
• If national governments can just create money, are there any limits to what they can spend? Yes, there are definitely limits. A big constraint on government spending is the political process. It is usually difficult to get spending approved and funded, and the public generally require their government to act responsibly and to avoid excessive inflation. The availability of the real resources that can be obtained with the state currency is a firm constraint. So governments can’t use their currency to buy what is not for sale in their currency, but they are never limited by the availability of their own currency.
• Can sovereign governments go bankrupt? A nation that issues its own currency can never go bankrupt or be unable to pay its bills, as long as those bills are due in the money they create. Governments that owe debt in a currency or commodity they don’t create can certainly become insolvent and default. So too can governments who promise to exchange their currency for another currency they don’t control. However, fully sovereign nations are the monopoly issuer of their currency, and they can always issue their money to make any payment due in their currency.
• Do governments borrow to fund their spending? Since currency-issuing governments create money when they spend, they do not need to – and in fact can’t – borrow their own self-issued currency. Government bonds can only be purchased with government currency that is already spent into the economy. This means that government bonds are serving some other role in the economy aside from funding the government. It is easiest to say that bonds simply provide a safe interest-earning way to save government-created money. A more complicated reason is that bonds help the central bank manage interest rates, but bonds are never needed to finance government spending.
• Does understanding modern money provide policy guidance? The knowledge that sovereign nations issue their own currency means that they are not constrained in the same way that currency-using governments are constrained. This has a profound impact on the range of policy options available to such governments that are not available to those with less monetary sovereignty. The debate over public policy is important and differences of opinion will remain: however, the debate should not place artificial constraints on the monetary system, but rather look at the effects of each policy on the economy and the general welfare of the people. An important example is unemployment: we now know that governments can afford to employ everyone who is willing to work for the government’s money, and that the effects of doing so can stabilize and grow the economy while enhancing the general welfare of the nation.

Credits: As usual, this post relies heavily on the work of other economists and MMT scholars. The inspiration & much of the content here came from Randy Wray's many works, including the excellent presentation Modern Money Theory: Intellectual Origins and Policy Implications.