There’s No Money Left?

“The British Government has run out of money because all the money was spent in the good years,”

George Osborne, Feb 2012

“…in the years of plenty they put nothing aside. They didn’t fix the roof when the sun was shining”.

David Cameron, March 2008

“There’s no money left”

Letter left by Liam Byrne, May 2010

For the last 4 years you will have seen or heard quotes like this in the media. How we were on the brink of bankruptcy and how “there is no money left”.  Those advocating a “Keynesian” response to the current crisis are rebuffed with the argument that we cannot increase borrowing now because we didn’t run budget surpluses in the years before the crisis – “Gordon Brown spent all the money”. Keynesianism has now been reduced to “surpluses in the good times, deficits in the bad”.

Liam Byrne’s famous note left as Labour left office was particularly heinous and the Coalition never miss an opportunity to use it as a stick with which to beat Labour. It may surprise you to hear this, but Liam Byrne is not an expert on the economy (or anything else), and should be ignored on all matters economic.

The Government say Labour want to increase borrowing by £200bn, and this would be disastrous as, if the ‘markets’ thought we were increasing borrowing, they would start to worry that we would be unable to repay our debt (or “pay our way in the world” as David Cameron is fond of saying), and interest rates would start to rise. This is basically what has happened in some of the states in the Eurozone, and Coalition ministers have not been shy in pointing this out (repeatedly and at length). Currently, Labour have no coherent response to this.

But is there any truth to this narrative? Is there an alternative path?

Perhaps surprisingly considering they have provided the intellectual cover for austerity, economists have long known that the idea of balancing budgets over the cycle is a bit like a fairy story we tell to frighten the kids. Here’s Paul Samuelson, “father of modern economics” and Nobel Prize winner, being interviewed in 1995:

“I think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked [that] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that the long-run civilized life requires. We have taken away a belief in the intrinsic necessity of balancing the budget if not in every year, [then] in every short period of time. If Prime Minister Gladstone came back to life he would say ‘uh, oh what you have done’ and James Buchanan argues in those terms. I have to say that I see merit in that view.”

So the idea that budgets must be balanced is a myth. Samuelson believed this myth was necessary to place a leash of governments who might be tempted to spend, spend, spend, but a myth it is never the less. But why is it a myth? Aren’t governments limited in their spending by what they can raise in taxation plus the amount the private sector is willing to lend them?

Categorically no! A country like the UK which issues its own floating currency, does not depend on anyone else for money. It can issue more currency at will and without limit. Therefore, it can never go run out of money and can always afford to purchase anything for sale in its own currency. This is a very simple (and perhaps obvious) point, but one that is generally ignored in all discussions about government finances. When it is discussed, it is discussed in somewhat hysterical terms: “PRINTING MONEY!! HYPERINFLATION!!” etc. etc. More sensible people realise that government creation of money is no more inflationary than bank creation of money. Creation of new money could be inflationary, but only at the point where output is unable to expand any more in response to new demand.

But if a government doesn’t need to collect taxes or borrow from the markets in order to spend, why does it do these things? In a country like the UK, taxes serve a number of purposes. Firstly, tax ensures there is a demand for the government’s currency. We must all pay taxes in pounds (some more than others), so we accept pounds as payment for goods and services so we can pay our taxes. Secondly, taxes make room for government spending. If the government just spent without taxing, very quickly we would reach maximum output and start to experience accelerating inflation. Taxation helps keep a lid on inflation. Finally, taxation is used to meet social aims. These may be to redistribute wealth or to discourage harmful activities, like polluting or smoking.

Why does the government sell bonds? It does this primarily to maintain its target rate of interest. If the government wanted, it could stop selling bonds altogether. This would mean the overnight interest rate would fall to 0%. Bonds also serve as a risk free asset which institutions like pension funds like to hold as part of their portfolios, so they serve a purpose in that way also.

So armed with this knowledge about government finances, what should government do?

  1. The do nothing approach. Like Paul Samuelson says, we can accept the truth about government finances, but also be concerned about letting governments spend without constraint, and so continue to tie our hands with regards to policy options. Taking this approach means we are in for a prolonged slump and a very slow recovery. We could still borrow more from the markets for investment, but this adds no new money to the system, just brings old money back into use.
  2. Use the knowledge that a government is not constrained by revenue and borrowing to actively pursue policies which would restore full employment and raise living standards. One possible approach would be to adopt an idea devised by the economist Abba Lerner (a contemporary of Keynes), known as functional finance. Lerner set out three rules for fiscal policy under functional finance:
    1. The government should ensure there is sufficient aggregate demand to ensure there is full employment. It should do this by lowering taxes and/or raising spending. If inflation beckons, government should do the opposite.
    2. Government should borrow money when it wishes to raise the interest rate and repay debt when it wishes to lower it.
    3. The government press shall print any money that may be needed to carry out rules 1 and 2.

I prefer option 2 as clearly it offers the shortest path back to prosperity. There are issues around how our political system would cope with functional finance, but this is a political problem, not an economic one. If the general public were fully aware of the realities of our monetary system, and the policy options that presented, we could all have a much more grown up debate about which course we should take.

For a full discussion of the nature of modern money, I recommend this video of a presentation given recently by Michael Hudson and L. Randall Wray. It’s a bit long, but well worth the effort:

Further Reading

The following are a few blogs I find useful for helping to understand economics:


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