Understanding Modern Monetary Theory (2) - A Different View of Government Spending

Image credit. Continued from Understanding Modern Monetary Theory (1) - A Different View of Government Spending

Taxes - the Thermostat of the Economy

The government-issued currency, say the Dollar, being an IOU on the part of the Government and a tax credit in the hands of the public, the debt incurred by the Government is repayed and thereby eliminated with every Dollar the PS returns to the Government to pay its taxes. In other words, taxes can be used to drain Dollars from the PS and thus "control the temperature of the economy," by aiming at an appropriate rate of inflation.

The Government Does Not Borrow 

There is a second way in which Government can control inflation. It issues its own bonds (Treasury Bonds). These are IOUs which absorb some of the (non-interest earning) money held by the PS, removing these Dollars from the economy and tying them up in an interest rate paying "account," analogous to switching some of your money from a non-interest paying checking account to an interest paying time deposit. The PS is being drained of money, as more Dollars are "parked" in Treasuries than are channelled back - as interest payments - into the economy. While offering the PS a means of saving money, incurring Government debt in the form of Treasuries is not actually an act of borrowing on the part of Government. Government does not stand in need of borrowing its own IOUs, as it is perfectly free to issue whatever IOUs it happens to need. Like imposing taxes, treasuries are issued to control "the temperature of the economy."

The Government does not need anyone's money to be funded. And it does not make sense for the Government to borrow from anyone IOUs that it is perfectly free to produce itself at any time and in any amount it deems necessary. 

If we visualise the FG as a pot containing Dollars (see below diagram), we note that in our model, Dollars are flowing out of that pot, but there are no Dollars flowing into it through a stream originating in the PS Dollar pot. Government is never funding its operations from a source other than itself - if it is a truly sovereign issuer of currency, rather than using foreign currency or a commodity money.

No Flows into the FG Pot

When the PS is paying off its tax debt, the PS Dollars disappear (offsetting an initial obligation by handing in Government IOUs) rather than adding to the FG pot. Dollars flowing from the FG to the PS pot have not been originated or borrowed from the PS, but are created by the FG ("the Sovereign Currency Issuer," in the below chart) and spent into the PS pot. And what the PS pays into the Treasury pot (principal) and gets out of it (interest), does not either add to the FG pot, but is fed from the FG pot in as much as interest is being paid out or principal is being repaid, and otherwise represents a to-and-fro between the "Treasury Bond Savings Accounts" and the PS - the public choosing alternatively to hold liquid non-interest bearing money or less liquid interest bearing Treasuries.

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To be continued in Understanding Modern Monetary Theory (3) - A Different View of Government Spending