Reader’s Question: Another visit to CentralBankopia

We received an e-mail from David this week.

I really love your blog, and “get” nearly all the concepts on there now, but the one that I’ve never been able to grasp is your fiat currency “just print money” centralbankopia…

You seem to be suggesting that the Federal Reserve should just “print money” as/when required, as opposed to “running a balanced budget”. Please correct me if I’m wrong here.

However, aren’t both of these just different forms of theft/tax? Printing money taxes cash holdings (capital) through dilution/inflation whereas balanced budgets tax income. Can you explain why one is more preferable than the other.

Perhaps it has to do with the interest that the government pays on “loans” used to created a balanced budget. This just seems like wasteage. But perhaps, by “loaning” the money into existence, they have a mechanism to remove it from existence, thus reducing the inflation.

I’m not sure. I’d love it if you could have another go at explaining it (to us laypeople) …

A good question David, and you are certainly not the first person to ask this question or challenge us on this. So it looks like it is time to travel back to Centralbankopia. But firstly let us re-state what CentralBankopia is about.

We created the concept of CentralBankopia to explain the potential of the economic system that exists in Australia today, and how that system could be used to provide better economic outcomes for all Australians. It is however obvious that neither the current government nor the opposition understand how their economy actually works, so we are currently bound by the constraints of “household” budgetting. We created centralbankopia to attempt to explain how and why a FIAT currency issuing government’s budget is not a budget like the one “laypeople” would be used to.

CentralBankopia is a concept we use on this blog to help explain what “money” actually means in a modern FIAT currency economy with a floating exchange rate ( Australia’s economy ) from a unique perspective, that of the monopolistic issuer.

You need to be clear, this is not from the perspective of the private budgets of the people who work for the Central Bank, Treasury and/or other government institutions that set fiscal and monetary policy. It is from the functional perspective of the institutions themselves and the economy of Australia. From this perspective money is seen completely differently and has a very different use than it does to people, households, companies and other government entities.

So remember when we talk about “CentralBankopia” we mean these institutions. When we say “CentralBankopians” we mean the functional community of people who set fiscal, monetary and other economic policy that steers the macro-economy in the context of setting that policy.

CentralBankopian finance has a couple of concepts that are completely foreign to most people, but once you understand them you can appreciate a very different perspective on economic topics.

  1. Money has no real value; it can be created or destroyed at any time.
  2. The real currency is GPEC , which is made up of sustainable Growth, Productivity, Employment and social Calm.
  3. GPEC is gained by using policy to manipulate the supply of money to and from the private sector ( via the banks ) to ensure that resources are mobilised in such a way to create sustainable growth , productive gains, employment and social well-being.

If you had this perspective on “money” then you would have a very different view of deficits, national debts and the supply of money. As a CentralBankopian can issue their own currency at anytime they can obviously spend money at will. Likewise, they can do the opposite, that is, raise taxes and simply destroy the money knowing full well they can create more next time it is required.

With that in mind let us address David’s questions.

I’ve never been able to grasp is your fiat currency “just print money” centralbankopia.

You seem to be suggesting that the Federal Reserve should just “print money” as/when required, as opposed to “running a balanced budget”. Please correct me if I’m wrong here.

David is not wrong, but he is not right either. The question as it is phrased relates to money from a private sector perspective, David is asking whether the Federal Government should be running a balanced budget, which means attempting to equal out the amount that it spends and saves (taxes). In terms of a private household budget this makes sense, but in terms of a FIAT currency issuing sovereign government it is meaningless, and in some circumstances very dangerous.

However the concept of “just print money” is also something that needs to be addressed, because if the government “just” did continually print money then the economy would be destroyed.

The thing to remember at all times when thinking about economic policy in the context of CentralBankopia is that the aim is GPEC, money is simply a tool to get it. If you are mindlessly issuing money at a time when the economy does not require it to utilise resources then you will cause damage to the economy, by inflation , and most probably by creating speculative bubbles; in the same way that you will cause damage if mindlessly tax people (de-issue currency) when it is not required.

So the answer is No. The government should never “just” print money. But there are times when there is a need to utilise resources and/or change the way resources are used and in some cases this may require the FIAT currency issuing government to add additional money to the system, knowing full well that it can remove it at a later date via taxation or other methods if required.

But let us re-iterate once again. The aim is GPEC, if you issuing new money into the economy which cannot absorb it productively or without the policy frameworks in place to ensure that that money will in some way increase productivity, productive capacity, employment or social calm then it is going to cause problems. Stimulus for stimulus sake is an utter disaster, and in most cases simply leads to non-productive asset speculation, and inflation.

So with that in mind let us address the other part of David’s question.

However, aren’t both of these just different forms of theft/tax? Printing money taxes cash holdings (capital) through dilution/inflation whereas balanced budgets tax income. Can you explain why one is more preferable than the other.

There are two points to make about this question, so we will break it into 2 parts. But for simplicities sake we will be skipping over some concepts, if you anyone has further questions or needs clarification of a point then please ask, we have already addressed some in a previous post.

1. What causes inflation.

The first point that is always raised whenever you talk about the issuance of FIAT currency is the spectre of inflation. But it is important to understand what inflation is actually caused by. There are two main reasons. The lack of availability of a particular demanded resource; or the oversupply of money, directly or indirectly, in the economy that cannot be absorbed productively.

In the case of David’s question he is referring to the later. But the important point to note is the end of that sentence, “that cannot be absorbed productively”. If the national unemployment rate is running at 25% then the supply of additional 1% to the money supply into the economy is, in broad terms, not going to be an inflationary issue.

2. GPEC versus money.

The main part of the question is the difference in outcomes when money is the focus versus GPEC. A money centric government sees government debt as the primary issue, believing it is bound by its money; a GPEC centric government sees resource underutilisation as the primary issue, believing it is bound by the available resources.

Let us give you an example to explain the difference. Let us imagine we have a country that has just had some form of economic shock; unemployment is rising and the economic output is falling, due to this the taxation intake is falling and the social security bill is rising. Like all countries in the world we can assume they have an array of businesses and companies that produce goods of some kind, and have barriers and costs of/to production. For simplicities sake let us assume they had balanced terms of trade and political and social stability at the time of the shock.

The “money” centric approach.

A “money” centric government would have the budget as the primary focus, they would see the rising budget deficit due to falling taxation, and assume that the only thing to do is cut government spending and raise taxes. This in turn causes greater unemployment as the cut in spending and raising of taxes slowly steals private wealth and forces people to take on debt in an attempt to maintain the same standard of living. In this case unemployment is used as the countermeasure to attempt to “rebalance” the budget, and the fail safe is falling wage demands.

In the long term this would work to re-adjust the economy, but in the meantime many people would have lost their livelihood, been de-moralised and overall the only thing that has been fixed in terms of barriers to production is costs of wages ( i.e the standard of living of the populace fell ) and given this and the length of time that the economy floundered you would most likely be left with a deficit anyway. But note, most importantly, after all of this work to “fix” the economy the overall state of the country is in a worse position than it began.

The “GPEC” centric approach

A “GPEC” centric government would have the resource utilisation as the primary focus, they would see the rising unemployment and view it as an opportunity to reutilise those resources in a way to lower the current barriers to production. Their fiscal position is meanlingless.

Given that they are Centralbankopias, they would have already been holding public economic forums with business leaders and would have an agreed prioritised list of barriers to production, which could be addressed when resources were available to do this work. The government would initiate a number of these programs, including adjustments in taxation policy to support private investment in these programs.

These programs provide employment to the newly unemployed, with the end game to lower the current production barriers the economy faces, and therefore lower production costs and improve economy efficiency.

In this case “money” is used as the countermeasure to attempt to “rebalance” unemployment, and the fail safe being increased production.

In the long term this would work to re-adjust the economy, as the higher productive capacity flows through the economy then the government would lessened its input to these programs and jobs would start to move back into the private sector, increasing the tax intake.

Conclusion

As you can see from a “money” perspective the outcomes are the same, in both cases you would expect the budgets to eventually be re-balanced (although in the case of a GPEC government it is irrelevent) but the outcomes for the populace and the future of economy are very different.

We hope this provides another piece to the puzzle, and is also a catalyst for more thought on the issue.


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Comments

  1. Good potted description of Modern Monetary Theory.Bill Mitchell would be pleased.

    A pity that the powers that be are bogged down in pre fiat currency dogma.Their current thinking on a flood damage levy is a classic instance.

  2. I second Thirra's comments. Good description not only of MMT but of its advantages, with a brief nod to where it could go wrong (ie the government spending on things that do not advance GPEC).

  3. I'm confused, isn't this just Keynesian pump priming in the end? Has it ever really worked? After all, the interest, if not the principal, must be repaid. Running deficits is a fiscal road to nowhere, as the EU and the US are finding out, when you are not growing, just borrowing or printing, to cover last years interest payment and fund your budget.

  4. My thoughts:

    Of course, the GIGANTIC flaw in this whole process is that governments and the voting public a) love the methods that money is put into the system ie government spending and b) despise the methods of appropriating money ie taxation.

    Hence there will always be pressure on governments to spend and print, which you admit is destructive, as well as to not increase or even decrease taxes (often by middle class welfare). Which you acknowledge has clear destructive effects on the economy.

    Lastly, like unemployment, GDP, CPI and other publicly reported outcomes, GPEC is vulnerable to obfuscation by governments and private interest. Optimists might say the measures have been refined, realists would say distorted.

  5. @Mercury4

    The key to understanding MMT lies in the caveat in your last sentence, "when you are not growing". MMT does not espouse non-productive government deficit spending. The need for a deficit will depend on whether the economy is at full capacity or not, and whether the government can spend in ways that utilize idle capacity productively. If the economy is not at full capacity and the government can spend in the right areas, deficit spending will not be inflationary. If the economy is at full capacity, deficit spending will be inflationary. If it is not at full capacity, but government spending cannot be directed to the idle capacity, additional deficit spending might or might not be inflationary depending on flow on effects.

  6. @heyworth

    Thanks for your reply. However the government can be trusted not to do these things and trusted to help, protect and encourage existing industries with substantial sunk costs, whether productive or not.

  7. @Mercury4

    Yes, I agree that governments' track records in these areas leave a lot to be desired. However, they can (and do) stuff things up like this whether or not they run a deficit.

  8. Economic Delusion

    Yes,

    Good discussion. A couple of points.

    Firstly Mercury, I think you are still holding onto your "money ideas".

    > After all, the interest, if not the principal, must be repaid. Running deficits is a fiscal road to nowhere, as the EU and the US are finding out, when you are not growing, just borrowing or printing, to cover last years interest payment and fund your budget

    The US are in trouble due to a massive asset shock, brought about by ridiculous lending into housing, (as did/does Australia)

    CentralBankopians would never let this occur because it is very obviously monetary support for something that returns very little GPEC.

    I also think you need to be very careful about your EU argument. Germany the country with the most close-to-sovereign control of the Euro is doing very well , while ireland, a country with the most "money" focused economy, has been going backwards for nearly 3 years of trying to "balance its budget".

    It is very easy to run an economy when you are "lucky" enough to have everything going well, it is when things turn poorly that the weaknesses in the system show through.

    In regards to the "human behavour" issue, You will notice that I call this CentralBankopia a mixture of "central bank" and "Utopia". The Utopia refers to what CAN be done in a perfect system, I am not sure any system could compensate for vested interest, greed and stupidity. My inclusion of "economic democracy" is a small attempt to get around this issue, but even then we are all aware of corrupted democracies.

    Glad to see this has stirred a bit of educated debate.

  9. Mercury4: "After all, the interest, if not the principal, must be repaid."

    The point is that a sovereign government doesn't have to borrow in order to spend (logically anyway). Government borrowing from the banks is just a scam to give the banksters more profit.

  10. David: “You seem to be suggesting that the Federal Reserve should just “print money” as/when required, as opposed to “running a balanced budget”. Please correct me if I’m wrong here.”

    I think you also need to point out that in AU thanks to the floods in the North and the lack of water in the South, there has been a tremendous loss of money. It simply went down the drain/up in smoke. In this situation when the government adds money to the economy it can not be inflationary. Only when things get better and pumping money into an economy that doesn’t need it — then you may have “too much money chasing too few goods” e.g. inflation. In this latter situation the currency might be diluted, but these days that is not going to happen. Government spending on infrastructure rebuilding, even though it is not covered by the issuance of Government bonds, can not cause inflation.