The Fiscal Deficit Condition (4a) — Notes on Modern Monetary Theory

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Modern Money Theory (MMT) tends to stress the ability of the private sector to engage in the accumulation of net financial assets, the difference between assets and liabilities held in the sector. I was wondering the other day, why it might not be good enough to have a balanced position with intra-sectoral assets exactly offsetting liabilities. I couldn't figure out a sound and consistent answer. So I thought about the issue and read up this or that source. Here is a two-part first approximation to an answer.

Part I

The answer to the question why net financial assets by the non-governmental sector may be desirable in an economy is quite important because it is related to another foundational issue: do you believe in economic intervention by the government or not?

If you believe that the private sector may get stuck at a level of economic activity where economic resources are seriously underutilised (especially with high unemployment) and can not get out of that rut (at all or fast enough) without an external stimulus by the government then you are already giving a good reason in support of the accumulation of net financial assets by the non-governmental sector.

Under these circumstances, you need an injection of spending from somewhere into the private sector; and this job can be accomplished only by the government. Spending by the private sector is insufficient, whereas the government—being the issuer of currency—is in a position to create new money available for injection into the economy.

If the government takes more resources out of the economy than it puts into it, i.e. if it runs a budget surplus with taxes greater than government spending, this will obviously only worsen the situation. A balanced government balance will not alter the predicament. Rather, what is required is that the government puts more into the economy than it takes out of it, that is: it will have tp spend more than it takes out of the economy in the form of taxes. Put differently, government has to run a budget deficit, in order to be able to offset deficient spending by the private sector.

Fortunately, government is in a position to spend without a budgetary constraint. It can and ought to spend as much as it takes to bring the economy back to full capacity (and especially full employment).

(I concede that government might abuse this ability. By its spending it may support activities and projects that are detrimental to an economy's efficiency, social coehsion, political health etc. However, nothings precludes the possibility that government may be reasonable in its spending and attain considerable success in restoring an economy to a fuller and more desirable level of capacity utilisation. The fact that spending may take place in irresponsible manner does not entitle us to abandoning government spending in principle but should teach us to keep a vigilant and carefully discerning eye on government spending.)

Part II

In a world without a government sector, all ecocomic activity depends on spending by the private sector. 

Private or non-governmental spending may be separated into 

consumption (C) by households, 

investments (I) by firms, and 

net external spending (X-M) — i.e. export revenue (X) minus import spending (M) —, that is, the difference between spending received into the economy from the rest of the world in return for exports and spending draining out of the economy to sustain imports. 

Any decline in these sources of spending will reduce economic activity.

Insufficieny of private spending produces a so-called spending gap. The latter being defined as the additional spending needed to create demand that supports output levels which at current productivity levels will ensure enough jobs are avaialble for all the workers who desire to work.

So if private spending declines below a position at which full employment is sustained, government has the ability to reestablish a zero spending gap, either by direct government spending and/or a tax cut (that increases private disposable income and stimulates subsequent private spending).

At the end of the day, the answer to my initial question is:

If the private sector's aggregate spending is insufficient to avoid a spending gap, and if therefore it requires injections of spending from an outside source, government needs to put more into the economy (private sector) than it takes out of it, i.e. it must spend more into the private sector than it receives from it, thus creating government net financial liabilities that show up as net financial assets in the private sector. 

Inspired by this source.

[Unter welchen Bedingungen ist es wünschenswert, dass die Netto Finanz-Aktiven ( = Finanz-Aktiva übersteigen Finanz-Passiva) des privatwirtschaftlichen/nicht-staatlichen Sektors einen positiven Betrag ausmachen, so dass also die Finanzforderungen — die durch Finanztitel verbrieften Forderungen — des Sektors als Ganzes dessen Finanzverbindlichkeiten — die durch Finanztitel verbrieften Verbindlichkeiten — übertreffen?

Wenn es so ist, dass die Privatwirtschaft Ausgaben in einem Umfang tätigt, der insofern unzureichend ist, als er nicht ausreicht, um die Ressourcen der Wirtschaft auszulasten und insbesondere für Vollbeschäftigung zu sorgen, wäre es wünschenswert, wenn eine andere Kraft imstande wäre, diese Ausgaben-Lücke zu schließen. Diese Rolle kann der Staat übernehmen. 

Der Staat kann Ausgaben in unbegrenzter Höhe tätigen, da er der Emittent der in seinem Herrschaftsgebiet gültigen Währung ist. Das heißt, er ist insbesondere dazu befähigt, mehr Mittel in die Privat-Wirtschaft zu stecken als er dieser entnimmt. Er kann also die Ausgaben-Lücke dadurch schließen, dass er Ausgaben in der benötigten Höhe tätigt. Solange seine Ausgaben diesem wünschenswerten Ziel dienen, ist deren absoluter Umfang unproblematisch.

Im Sinne der volkswirtschaftlichen Sektoren-Salden bedeutet der Umstand, dass der Staat mehr in die Wirtschaft "steckt" als er aus ihr "heraus nimmt", dass ein Defizit des Staatshaushalts entsteht. Die Verbindlichkeiten des Staats (gegenüber der Privatwirtschaft) übersteigen seine Forderungen (gegenüber der Privatwirtschaft). Dieser Überschuss der staatlichen Verbindlichkeiten gegenüber dessen Forderungen ist das Gegenstück zum positiven Saldo der Netto-Finanz-Aktiva, die die Privatwirtschaft als Ganzes aufweist.]

Fortgesetzt hier.