Book Summary: The Deficit Myth by Stephanie Kelton

A book summary of the key ideas from The Deficit Myth: Modern Monetary Theory and the Birth of the People's Economy by Stephanie Kelton, along with informal notes and quotations.

The Book in a Nutshell

The Deficit Myth is an introduction to Modern Monetary Theory (MMT), an economic school of thought that is growing in popularity. It seeks to explain why for countries with monetary sovereignty the federal budget is fundamentally different to the household budget, and why deficits are generally good for the economy. Instead of focusing on self-imposed budget constraints, Kelton suggests we should instead use inflation and real resource limits as the measuring stick for public spending.

Book Summary: The Key Ideas

#1: Distinguishing currency issuers and currency users. Where the state issues its own currency, the federal budget is not the same as a household budget because it is a currency issuer, not a currency user. A country with monetary sovereignty cannot spend without limit but should not be confined by the same budgetary ideas as a household.

#2: The myth of overspending. Governments with monetary sovereignty should use inflation as the measuring stick for overspending, and not the deficit. An economy becomes inflationary when combined public and private spending brings it to “full employment”.

#3: The truth about national debt and “crowding out”. As debt is in its own currency, such countries can always overrule market sentiment on interest rates. Under MMT, it’s therefore inflation, not the relationship between interest rates and growth rates, that matters.

Book Notes: The Key Ideas in Detail

The below book notes outline the key ideas from The Deficit Myth in more detail. These notes by no means provide complete coverage of the ideas in the book. They are instead intended to consolidate and serve as an introduction to decide whether the full book is worth further attention.

Key Idea #1: Distinguishing currency issuers and currency users

Governments love the conflation of household budgeting with the public finances. This narrative provides greater relatability and connection to constituents, but Kelton believes it’s not founded in the reality of our economic systems.

The starting point of the MMT view is that the national currency comes from the government (e.g. the US government for USD). Crucially, MMT draws a distinction between currency users and the currency issuer.

MMT postulates that the currency issuer, not the taxpayer, finances all government expenditure. This assumption relies inextricably on a state of monetary sovereignty.

“Having monetary sovereignty means that a country can prioritise the security and well-being of its people without needing to worry about how to pay for it.”

Monetary sovereignty has two important characteristics:

  1. The currency issuer doesn’t promise to convert currency into something that could run out, e.g. it’s not pegged to gold.
  2. The currency issuer refrains from borrowing in currencies that aren’t their own.

The conventional views: TAB(S). In the conventional way of thinking about fiscal policy, we assume taxes and borrowing precede spending. TAB(S).

The reality: S(TAB). In reality, currency issuers spend before they tax and borrow.

In other words, when governments spend, it isn’t funded by taxes; it’s funded by digital currency creation.

The question, then, is why do we bother taxing at all?

Kelton identifies four reasons for taxation:

  1. To incentivise production and allow governments to provision themselves. Taxes give value to an otherwise worthless bit of paper by requiring payment in it. In turn, that achieves the objective of getting us to produce things.
  2. To manage inflation. Too much overall spending (public and private) pushes up prices. Taxes are one lever to control total spending in the economy.
  3. To redistribute wealth and income. Taxes can help redress stagnation and rising inequality.
  4. To encourage or discourage certain behaviours. For example, taxes can help discourage damaging actions for the environment.

Key Idea #2: The myth of overspending

In the MMT view, a deficit is only evidence of overspending if it sparks inflation. At the point in which an economy hits “full employment”, further spending (public and private) will be inflationary.

MMT recognises that there are limits to spending and that pushing beyond those limits leads to inflation.

“If the government tries to spend too much into an economy that’s already running at full speed, inflation will accelerate. There are limits. However, the limits are not in governments’ ability to spend money, or in the deficit, but in inflationary pressures and resources within the real economy. MMT distinguishes the real limits from behavioural and unnecessary self-imposed constraints.”

The Federal Reserve has for some time based its monetary policy on the Monetarism view, following a dual mandate on inflation and unemployment. This perspective assumes that once NAIRU (that’s the non-accelerating inflationary rate of unemployment) is reached, inflation can spike. Interest rates have therefore been used to preempt this natural rate of unemployment, sometimes with disastrous consequences.

In the MMT view, inflation is only realised once we achieve full employment and not an arbitrary level.

“Even as scientists and engineers constantly innovate, creating new medicines, technologies, and techniques to eradicate diseases and solve human problems, the majority of economists remain wedded to a fifty-year-old doctrine that relies on human suffering to fight inflation.”

Given the assumed flexibility on spending in one’s own currency, MMT recommends a federal job guarantee, which flexes during business cycles and smooths the unemployment impact of recession.

We should direct our attention not at the fiscal deficit, but at deficits in good jobs, education, health, and democracy.

Key Idea #3: The truth about national debt and “crowding out”

A government that borrows in its own sovereign currency (e.g. UK, US and Japan) can always maintain the condition of interest on debt being below the economy’s growth rate. Why? Because it doesn’t have to accept the market rate of interest. As debt is in its own currency, it can always overrule market sentiment.

Under MMT, it’s therefore inflation, not the relationship between interest rates and growth rates, that matters.

Kelton also observes that government surpluses tend to push deficits onto the private sector. As the private sector is a currency user and not an issuer, these deficits cannot be sustained indefinitely. Ultimately, this drives down spending and precipitates recessions.

“Meganumaphobia – the fear of large numbers – might not be a medical recognised anxiety disorder, but plenty of politicians seem to think it’s real enough.”

The reverse condition is the counterargument for the crowding-out hypothesis.

The crowding-out view suggests that fiscal deficits drive up borrowing and force the state into competition with other private sector borrowers. Competition then drives up borrowing costs and drives down private investment.

But Kelton observes that the reality of the economy is that for every deficit in one part of an economy exists an opposite surplus in another part. Simplistically, that means a government deficit comes with a corresponding nongovernment surplus.

The crowding out story therefore doesn’t hold in countries that borrow in their own sovereign currencies.

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