The economic upheaval caused by the spread of coronavirus and the lock down measures introduced to contain it has forced the UK government to follow other Western nations in increasing its fiscal intervention to levels not seen since World War II. These policies were introduced so rapidly that media pundits barely had time to ask their favourite fiscal policy question: “How do you pay for it?”. They seem to have now caught up, however, and in the midst of job losses and the mounting death toll they cannot help but place increasing focus on the looming horror of an unsustainable deficit. Many on the left are concerned that another wave of austerity will follow to “pay” for the COVID-19 crisis, leading some to insist on taxes for the wealthy instead.

 

But this only demonstrates how far the left has bought into a flawed understanding of government finances – one that the present crisis is clearly challenging. “How do you pay for it?” is always a politically loaded question. It implicitly demands an answer that balances income and spending, in much the same way as households do. It takes for granted that government spending must ultimately be funded through taxation, and can only stretch as far as our own personal finances can. The reality is the opposite. We need the government to intervene precisely because we cannot. The question is aimed at making us fear necessary government action, and distracting attention from the real costs of this crisis and who bears them.

 

Modern Monetary Theory

A very different way of looking at government finances is provided by Modern Monetary Theory (MMT). Once a fringe theory promoted only by a few heterodox economists, MMT is quickly becoming mainstream. Its central thesis is that a government that issues its own currency, has a floating exchange rate and no significant foreign currency debt faces no purely financial constraints. Instead, the constraints they face are related to the real human and ecological resources they command.

 

The reason for this is that currency-issuing governments do not have to wait for someone else – lenders or taxpayers – to give them money before they spend it. Currency-issuing governments create currency every time they spend – regardless of whether bonds are issued or taxes are gathered. Conversely, taxes remove money from the economy. Spending and taxation can be equated to adding and deleting digits on bank balances in a computer. Taxes serve to generate demand for the currency, control inflation by removing excessive demand and to redistribute wealth, but not to finance central government spending.

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MMT assertions have radical policy implications. If government spending is not dependent on tax revenue or bond markets, fiscal policy can be determined solely in consideration of the needs of the real economy and not the imagined need to balance a budget.

 

MMT builds on the work of heterodox economists who interpreted John Maynard Keynes’ work differently to the neoclassical economists who have become hegemonic since the 1980s. MMT recognises that our understanding of economics changed at a fundamental level when the world abandoned the gold standard in 1971. Before this, currency was ultimately backed by quantities of real stuff: gold reserves. Governments were limited in how much currency they could issue, depending on the quantities of reserves and agreements between states on how to manage international exchange rates. But when this system was abandoned, we entered the era of “fiat currency”, where sovereign states can issue as much currency as they need.

 

Full recognition of the implications of this shift has been impeded by the rise of neoclassical economics. In the Keynesian post-war era, economic policy was dominated by fiscal policy: government used taxation and spending to plan and control economic activity. Monetarism, which came to the fore in the 1980s, foregrounds monetary policy – manipulating the money supply through regulating credit – as the main tool to control inflation and regulate overall economic activity. It involves adjusting interest rates in order to encourage businesses to save (high interest rates, meaning saving generates high returns) or invest (low interest rates, meaning low returns for savers and lower borrowing costs for enterprises wishing to raise capital for investment). Central bank independence was encouraged to curb government profligacy and maintain price stability. The premise of this approach was that resource allocation was best left to individuals and firms. The implication was that private borrowing (and household debt) became the primary driver of economic growth.

 

The following decades have exposed the inadequacy of monetary policy, even for its primary objective of price stability. At best, interest rate changes have only controlled inflation with a significant lag; at worst, they have been wholly ineffective. Moreover, monetary policy is a crude, macro-level tool: unlike fiscal policy, it cannot be targeted at regions or industries in particular need. Investment has instead tended to concentrate in areas which already enjoyed high employment levels, where demand for goods and services is typically high. Over the years this has exacerbated regional inequalities and displaced vast numbers of workers, causing high demand for housing and spiralling rents in some areas while others endured permanent decline.

 

MMT provides the theoretical basis for fiscal policy to replace monetary policy as the main driver for the creation of employment and control of inflation. Government spending can generate demand by directly shaping incomes and investment can be directed to regions most in need. Inflation can be controlled primarily through taxation, which can, for example, bring effective demand for goods and services into line with available supply, discourage wasteful practices and so on. Furthermore, a job guarantee – an offer of employment by the public sector at a living wage – can be used to maintain full employment consistent with price stability. This would establish an effective minimum wage, which the private sector would have to surpass in order to attract workers. In times of economic contraction, the pool of job guarantee workers would expand, increasing government spending and stimulating the economy. Conversely, in a boom, the pool of job guarantee workers would contract and government spending would fall, reducing the potential for excessive stimulus. Thus the job guarantee is a counter cyclical automatic stabiliser protecting the economy against swings in private investment while also protecting workers against unemployment.

 

MMT Goes Mainstream

The irony is that while the left worries about how we’re going to pay for the crisis, the right is (perhaps unconsciously) increasingly relying on an MMT lens to justify its policies, embracing policy options that the left has not yet allowed itself to support.

 

In 2019, the supposedly radical Labour Party ran on a platform of binding “fiscal rules”, promising to balance taxes and day-to-day-spending and only borrow to invest. By contrast, the Conservative chancellor Rishi Sunak has promised “unlimited” funding for the National Health Service (NHS) and for supporting businesses and subsidising wages in the midst of this crisis.  

 

To achieve this, the British government has resorted to extending the UK’s “ways and means” facility: the Bank of England has agreed to buy Treasury debt when needed, instead of issuing bonds to private markets. This demonstrates that the government’s reliance on bond markets is illusory and merely the result of institutional arrangements which can be easily changed to respond to political requirements.

 

This is clearly a stunning divergence from fiscal orthodoxy, reminiscent of the “people’s Quantitative Easing (QE)” policy proposed in 2015 by the then Labour leader Jeremy Corbyn. This proposal was swiftly abandoned amid mockery of Labour’s “magic money tree”. As pointed out previously on The Full Brexit, it was the Tories who found the “magic money tree” did exist after all (see Analysis #48 - How Will the Tories Rule? Understanding Boris Johnson’s Political Project). Now they are shaking it vigorously.

 

But if the COVID-19 pandemic teaches us that the government cannot run out of money, it also teaches us that it can certainly run out of real goods and services: personal protective equipment (PPE), ventilators, masks, nurses, hospitals, intensive care unit beds, and so on. Why are there shortages? In part, because previous governments felt that stockpiling goods like PPE was too expensive – that is, because of their belief that they were financially constrained. But the human and economic costs of not stockpiling – not to mention decades of underinvestment in healthcare – are now proving far more significant. Better infrastructure, more equipment and staff could have gone a long way into mitigating the early spread of the virus and thus the loss of life (see After Brexit #3 – COVID-19 and the Failed Post-Political State).

 

Other consequences of austerity – such as wage freezes, insecure employment and high levels of household debt – will also surely be exacerbated by the pandemic’s economic impact. Financial pain and social unrest could entail real costs larger still than those incurred during the last decade of spending cuts. The pandemic teaches us that economic figures cannot be assessed in isolation from their effect on people and consequently neither can costs.

 

“Who Will Pay?”

Although real-world practices are increasingly proving MMT correct, political imagination is struggling to keep up. This creates the very real danger that the right will again succeed in persuading the public of the need for austerity after the crisis subsides. Current proposals include transferring the costs of COVID-19 onto state pension recipients and delaying minimum wage rises. These cuts would gratuitously place the financial burden upon the weakest shoulders and commit us to yet another cycle of destructive real costs in the future.

 

The left is countering these proposals, but only within the orthodox framework. Former shadow chancellor John McDonnell, for instance, concedes that repaying the deficit is necessary, but that its cost must be borne by the richest, as part of a general reduction in inequality. This only seeks to redirect austerity, rather than rejecting it as unnecessary.

 

By coupling its demand for better public services with its desire to tackle inequality, the left risks achieving neither. Thatcher promoted the idea that government had no money of its own in order to make public spending dependent on the consent of the rich. If the government relies on taxes for income, then it must ensure that those paying the highest taxes are not spooked by the demands placed upon them. This then creates a political constraint on spending – one which the left repeatedly fails to surmount.

 

The true answer to the question “who will pay for the COVID-19 crisis?” is: the government. The government cannot run out of money; but individuals can. As we have already seen, the only constraint on government spending is the availability of real resources (labour, raw materials, etc). Under-spending in the past now means that the government is paying a higher price for essential goods, as other compete for supplies. Moreover, if the lockdown continues, goods shortages could arise as key industries lack the workers needed to produce and distribute them. This could create inflationary pressures, as supply outstrips demand.

 

However, this does not mean that government should restrict the supply or use of money to avoid inflation or reduce public debt. Rather, it means how the government spends money is vital. It must focus on ensuring that goods and services continue to be produced and distributed safely to where they are needed most, by creating jobs and mobilising resources to achieve security for its population. Well-directed government spending could lead to reduced inequality, a healthier workforce, and more efficient and secure supply chains, now and in the future. Meanwhile, tax policy should be aimed at addressing inequality and preventing the rich from hoarding scarce real resources at the expense of the poor. Tax policy should be about balancing the allocation of real resources, not financial ones.

 

The risk of failing to recognise this reality is that the costs of the COVID-19 crisis will be borne by those already punished by the political class’s reluctance to use the state’ fiscal capacity to protect its citizens. Indeed, most of the real costs of the crisis are already being paid by some of the poorest in society, including those vicitimised by unnecessary fiscal austerity for decades: the elderly and infirm; underpaid public sector staff; people on insecure employment contracts; those living in cramped accommodation due to unaffordable rents.

 

A true recognition of these costs as unnecessary ones would also allow us to change how we organise our economy on a permanent basis. We have discovered that we are dependent upon industries and workers that, until recently, we undervalued; we find ourselves able to live without some of the best-paid professions. Rather than entrust market forces to make this value judgement for us, we can choose to protect industries that are essential and dismantle those which are wasteful or even destructive. But we can do this only when we understand that costs are measured by real human outcomes, rather than inexhaustible digits on a computer screen.

 

About the author

Patricia Pino is an associate of the Gower Institute for Modern Monetary Studies and a research fellow at the Global Institute for Sustainable Prosperity. She co-hosts the MMT Podcast.

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This work represents the views of the author only. It is licensed under a Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International License.