Out of Thin Air: Public Debt, the Pandemic and Beyond
Governments around the world are currently creating vast quantities of money ‘out of thin air’ to fund their emergency responses to the coronavirus pandemic.
As this happens, we can safely disregard scaremongering about a ‘crippling burden of debt’ supposedly being left to our children.
The truth is, this money never has to be paid back in any meaningful sense and can cost us basically nothing.
Crucially, this could also be the case for money created to fund other things we might choose to prioritise in the future, such as de-carbonising our economy.
We’re usually taught that when the government needs to spend more money than it will raise in taxation, it borrows the extra money that it needs from the private sector.
According to the familiar story, it does this by issuing bonds which are purchased by domestic and foreign investors such as pension funds and institutional investors.
The government is then supposed to pay this money back over time, along with a usually modest amount of interest; all up the interest bill on Australian government debt was $18 billion in 2019.
The way that government debt has been described and treated by generations of public figures has also left a deeply engrained belief that governments must, or at least should, fund their spending this way.
But now, the need to pay for the response to the coronavirus pandemic has put so much pressure on governments around the world that some, including Australia’s, appear to be doing things differently.
What we’re seeing at the moment is the Reserve Bank of Australia (RBA) itself enter the bond buying process by purchasing many billions of dollars worth of existing bonds from the private sector on the ‘secondary market’.
Crucially, the RBA is not doing this by dipping into some fund of existing money that it has stashed away for a rainy day. Rather, it’s doing it by creating new money out of thin air. This practice is known as quantitative easing (QE).
Significantly, the Bank of England and the US Federal Reserve have already taken the next step by creating money out of thin air to purchase government bonds directly from their governments, on the ‘primary market’. This practice is known as ‘monetary financing’.
The Governor of the Reserve Bank, Dr Philip Lowe, has emphasised that Australia’s approach is, for now, strictly QE and not monetary financing.
But whether it’s QE or monetary financing, the outcome is the same, with one part of the government (the central bank) creating new money and effectively loaning it to another part of the government.
The ABC’s Alan Kohler asks the inevitable question:
“The Reserve Bank might be independent but it is part of the government. What happens when that debt has to be repaid – to the Reserve Bank? Well, no one knows […]”
The renowned economic historian Robert Skidelsky is less coy, explaining exactly what happens:
“A government with its own central bank […] incurs a liability to ‘its’ bank but not to anyone else, which the central bank agrees to hold indefinitely, rebating any interest received to the Treasury. Its debt to its own bank never has to be paid back – a debtor’s dream! […] (For it to have its full effect, the increase in the money supply must be seen as permanent).” (appendix 8.1)
The advantage of monetary financing is that the government can spend more than it will raise through taxation without resorting to borrowing from anyone outside of the government, enlarging the national debt or incurring an interest bill to the private sector.
Generally, this is advocated as a policy of last resort which should only be used in a worst-case scenario.
Clearly a global pandemic is considered to be sufficiently ‘worst-case’ to warrant wheeling out these big guns.
But what’s to stop the government using monetary financing to spend as much as we need it to on other priorities? Such as fighting climate change. Or poverty.
The mind-blowing answer is: nothing.
Well, almost nothing.
A common fear is that if we accept that monetary financing is a feasible policy option, there is a risk that politicians may abuse the power by using it excessively and causing inflation.
As Alan Kohler went on, “What [Reserve Bank Governor] Dr Lowe won’t be keen to do is give politicians the idea that there’s a magic tree of printed money. There sort of is… just don’t tell the politicians.”
It is true that when new money is created and spent into the economy faster than the rate of growth in productive output then price inflation occurs.
The times when the spending of publicly created money has resulted in high inflation or even hyperinflation in this way are well known, resulting in the widespread and strongly held misconception that money creation by the government will always result in inflation.
However, we’ve learned the wrong lessons about public money creation from these dramatic cases because the times when governments have created money in a careful and responsible manner to grow the economy are usually ignored or overlooked.
The truth is that new government-created money spent into the economy will not be inflationary when it is spent in a way that sufficiently enhances the productive capacity of the economy.
A twist in this story is that the use of monetary financing isn’t just a secret tool that governments only tend to use when they’re facing crises.
Technically, all government spending is done this way, all the time – they’re just not upfront about it and seem to go out of their way to perpetuate a false and restricting narrative.
Here’s how it works in practice:
- The Parliament of Australia passes a spending bill;
- The Department of the Treasury, acting for the government, puts together the money orders and sends it to the RBA;
- The RBA processes the money orders by simply marking up the relevant reserve accounts on a computer with newly created money. At this moment, the spending has now been ‘paid for’;
- The government can then choose, if it wants to, to cover the money it has already spent by:
a) Taxing more, less, or the same amount of money out of the economy; or
b) Issuing bonds equal to the gap between its spending and its taxing.
It’s a fine nuance, but the money we pay in taxes does not, and actually cannot, ‘pay for’ the government’s spending because it has already been paid for by keystrokes at the RBA.
In practice, what taxing and borrowing does is help to stabilise inflation by ‘draining cash’ from the rest of the economy.
Oddly, even when governments are being honest about their use of monetary financing, as the UK and US are at the moment, they still go to the trouble of getting the money from the central bank by selling bonds to it – even though this step is technically not necessary.
It would seem that the great fear of politicians abusing the ‘magic money tree’ has led to such elaborate efforts to keep up the false pretence that the money government spends has to come from somewhere outside the government itself and must eventually be paid back – even in the absurd scenario where it is coming from and being paid back to different parts of the same government.
While the fear that if “central bankers lose their ability to say no to treasuries, things could turn out badly” is a valid concern, it is not so valid that we need to tie ourselves up in a straitjacket of false narratives and false constraints; especially with such urgent need for investments in health, education, energy and the environment.
WITH GREAT POWER COMES GREAT RESPONSIBILITY
The government’s ability to create money is a great power and there are different schools of thought about precisely how it should best be used and monitored.
One comes from the UK advocacy group Positive Money, which suggests that we need an independent committee that decides how much new money to create to promote non-inflationary growth in the economy; similar to the way that the Board of the Reserve Bank independently sets interest rates.
By their proposal, the state would then spend the new money into the real economy.
A system like this was once proposed by the great economist Irving Fisher in the 1930s.
Fisher argued that it would dramatically reduce business cycles, end bank runs and drastically reduce public debt. A 2012 study by International Monetary Fund staff found this plan could work well now.
The Financial Times chief economics commentator, Martin Wolf agrees that such a system would bring huge advantages, beyond the considerable expansion in the state’s power to spend in the public interest:
“It would be possible to increase the money supply without encouraging people to borrow to the hilt. It would end ‘too big to fail’ in banking. It would also transfer seigniorage – the benefits from creating money – to the public.”
The value of seeing government finances in this way is not in trying to prove that governments can spend without limit, but in emphasising that its spending is not constrained by what it can raise in taxation or borrow from the private sector.
While the power to create money should certainly be carefully monitored one way or another, it should not be to the extent that we wrap ourselves in a straitjacket of false constraints.
The groundwork is already being laid for the government debt to be used as a pretext for austerity and other ideological projects when we emerge from this public health crisis. A proper understanding of government finances will be a powerful tool to push back with.
We should also keep it firmly in mind when attention returns to the other great challenges of our times, such as fighting climate change. If we can finance our response to one public emergency in this way, then we could finance our response to another, without debt, without interest, without inflation and without austerity.
If the public comes out of the crisis with a greater understanding of this and puts it at the centre of policy moving forward, it will be a silver lining.
Picture: Bim Hilder, sculptural wall enrichment, foyer of the Reserve Bank of Australia, Sydney. Hilder’s sculpture integrates the design of the Bank’s corporate emblem by Gordon Andrews, and shows it in a number of variations, reflecting the Bank’s influence in different spheres.