The Deficit Myth: a review

12 Jul, 2020 at 12:21 | Posted in Economics | 11 Comments

One common objection to neoclassical economics is that it underweights the importance of history and class. It is therefore paradoxical that Stephanie Kelton’s The Deficit Myth, which claims to challenge orthodox economics, should be guilty of just these vices.

Modern-Monetary-Theory-Let’s start by saying that I wholly agree with the main claims she makes — that a government which enjoys monetary sovereignty can always finance its borrowing. Asking how we will pay for public spending is therefore daft. Instead, the question, as Dr Kelton says, is: can the extra spending be resourced? The constraint on raising health spending for example — if there is one — is a lack of doctors and nurses, not a lack of finance. Where there are resources lying idle, governments should raise spending to employ them. Dr Kelton explain these ideas wonderfully clearly, so I recommend this book to all non-economists interested in government finances.

For this economist, though, it poses a problem. I remember writing a research note for Nomura back in the early 90s arguing that increased government borrowing would not increase gilt yields because the same increased private saving that was the counterpart of government borrowing would easily finance that borrowing. Nominal gilt yields, I said, were determined much more by inflation than by government borrowing. But nobody accused me of originality. And rightly so. I was simply channelling Kalecki, Beveridge, Lerner and Keynes, who famously said back in 1933:

“Look after the unemployment, and the Budget will look after itself.”

For me, Kelton is – albeit very lucidly – reinventing the wheel …

At one stage she claims that MMT “didn’t exist” before the late 90s. But whilst the phrase did not exist, the ideas certainly did. Randall Wray is right to say that “the main principles of functional finance were relatively widely held in the immediate postwar period.”

Chris Dillow

Yours truly thinks that Dillow gets it right here on the question of the originality of MMT.

As has become abundantly clear during the last couple of years, it is obvious that most mainstream economists seem to think that Modern Monetary Theory is something new that some wild heterodox economic cranks have come up with. That is actually very telling about the total lack of knowledge of their own discipline’s history these modern mainstream guys like Summers, Mankiw, and Krugman has.

New? Cranks? Reading one of the founders of neoclassical economics, Knut Wicksell, and what he writes in 1898 on ‘pure credit systems’ in Interest and Prices (Geldzins und Güterpreise) soon makes the delusion go away:

It is possible to go even further. There is no real need for any money at all if a payment between two customers can be accomplished by simply transferring the appropriate sum of money in the books of the bank

A pure credit system has not yet … been completely developed in this form. But here and there it is to be found in the somewhat different guise of the banknote system

We intend therefore​, as a basis for the following discussion, to imagine a state of affairs in which money does not actually circulate at all, neither in the form of coin … nor in the form of notes, but where all domestic payments are effected by means of the Giro system and bookkeeping transfers.

What Modern Monetary Theory (MMT) basically does is exactly what Wicksell tried to do more than a hundred years ago. The difference is that today the ‘pure credit economy’ is a reality and not just a theoretical curiosity — MMT describes a fiat currency system that almost every country in the world is operating under.

In modern times legal currencies are totally based on fiat. Currencies no longer have intrinsic value (as gold and silver). What gives them value is basically the simple fact that you have to pay your taxes with them. That also enables governments to run a kind of monopoly business where it never can run out of money. A fortiori, spending becomes the prime mover, and taxing and borrowing are degraded to following acts. If we have a depression, the solution, then, is not austerity. It is spending. Budget deficits are not a major problem since fiat money means that governments can always make more of them.​

In the mainstream economist’s world, we don’t need fiscal policy other than when interest rates hit their lower bound (ZLB). In normal times monetary policy suffices. The central banks simply adjust the interest rate to achieve full employment without inflation. If governments in that situation take on larger budget deficits, these tend to crowd out private spending and the interest rates get higher.

What mainstream economists have in mind when they argue this way, is nothing but a version of Say’s law, basically saying that savings have to equal investments and that if the state increases investments, then private investments have to come down (‘crowding out’). As an accounting identity, there is, of course, nothing to say about the law, but as such, it is also totally uninteresting from an economic point of view. What happens when ex-ante savings and investments differ, is that we basically get output adjustments. GDP changes and so makes saving and investments equal ex-post. And this, nota bene, says nothing at all about the success or failure of fiscal policies!

It is true that MMT rejects the traditional Phillips curve inflation-unemployment trade-off and has a less positive evaluation of traditional policy measures to reach full employment. Instead of a general increase in aggregate demand, it usually prefers more ‘structural’ and directed demand measures with less risk of producing increased inflation. At full employment deficit spendings will often be inflationary, but that is not what should decide the fiscal position of the government. The size of public debt and deficits is not — as already Abba Lerner argued with his ‘functional finance’ theory in the 1940s — a policy objective. The size of public debt and deficits are what they are when we try to fulfill our basic economic objectives — full employment and price stability.

Governments can spend whatever amount of money they want. That does not mean that MMT says they ought to — that’s something our politicians have to decide. No MMTer denies that too much government spendings can be inflationary. What is questioned is that government deficits necessarily is inflationary.


  1. Dillow says more: [quoting Kalecki:]

    The social function of the doctrine of “sound finance” is to make the level of employment dependent on the “state of confidence…[Capitalists’] class instinct tells them that lasting full employment is unsound from their point of view and that unemployment is an integral part of the “normal” capitalist system.

    The politics of macroeconomic policy centers on an endless struggle over the distribution of income. If your economics cannot admit that and make explicit sense of that political struggle, it is going to remain pretty useless.

    • So capitalists are more confident when unemployment is relatively high and capitallists’ turnover is relatively low?? I doubt it.

      Re Bruce Wilder’s claim that economists are obliged to come up with some inspiring insight into the tussel over the distribution of income, else their subject remains “pretty useless”, do we take it that historians and sociologists are likewise obliged to produce insights into the distribution of income tussel else their subjects are also “pretty useless”?

  2. The point about history is interesting. In Canada during WWII the first governor of the fledgling Bank of Canada (created in 1935 and nationalized in 1938), Graham Towers, was asked by parliament about the growing debt. He said it was not a problem nor concern because it was a private sector asset. The finance minister of the day, J. L. Ilsley, then mused in parliament about how to make the debt an asset of the people. And that debate should be what continues to the present times but often is ignored.

    MMTers also talk about the government debt being a private sector asset and the government deficit being a private sector surplus. That is what balance sheets are about.

    They, MMTers, also talk about using the budget — fiscal measures — to balance the economy and I would add again “for the people.” Too often the fiscal measures are NOT for the people but the 1% or 10%. And the focus of politicians becomes on using the people and the economy to balance the budget. Seems they have put the cart before the horse.

    Recently I have been thinking about how budgets and government debts and deficits have been weaponized — to use a popular phrase — to terrorize voters into opting for austerity. Again an idea with a terrible history. But also one derived from fallacious thinking and analysis.

    But returning to the point about making government debts assets for the people. It has occurred to me as a senior citizen of Canada that it has been done to a modest extent. When universal healthcare is funded by government debt that is precisely what has been done.

    I receive a generous Canada Pension transfer every month suggesting that the Canada Pension Investment Board has invested both my and my previous employers’ contributions wisely — albeit not always beneficially to the environment or climate but that is another discussion. And part of that investment has been their purchase of government debt thereby making it an asset on behalf of myself, other pensioners and those who are still in the workforce.

    I also receive a generous pension from a provincially-started pension fund that also invests in government bonds as a bridge to more lucrative, and hopefully, investments that are beneficial to the environment and climate.

    However when that debt is created to manufacture arms for war instead of arms for persons who have lost their upper limbs — or other body parts — then we have violated that principle of making government debts assets for the people.

    And what is interesting to me about that is the moral and ethical accountability ignored by most economists in their calculations and policy recommendations. It is part of why I am excited about MMT because it fits in well with Doughnut Economics from Kate Raworth and dumping the GDP in favour of the GPI — Genuine Progress Indicator — as a measure of economic progress.

    Historically, money was part of the life cycle with feedback loops as has been pointed out by Professor John McMurtry in his various books. Now the life cycle feeds the money markets with no feedback loops. But this may be a topic for another day. We call that financialization of the economy and Michael Hudson amongst others has described it well.

    • Yes, history matters. The problem with economists are they tend to forget history. In the old days, history of economic thought and economic history were pre-requisite or compulsory subjects in most of the Ph.D. programs, at least until early 1980s. These have been casualties of the neoclassical counter revolution against Keynesian and development economics.
      Countries, as members of the United Nations, should be reminded of their obligations to the UN Charter. Article 55 of the Charter clearly states that the pursuit of “higher standards of living” and “full employment” is its aim, and hence by default the goals of its member States. The countries as members of the International Monetary Fund, too, are obliged to pursue full employment. The preamble of Article IV of the IMF says, “each member shall: (i) endeavor to direct its economic and financial policies toward the
      objective of fostering orderly economic growth with reasonable price stability,
      with due regard to its circumstances”. Notice, no mention of a sacrosanct “inflation target” regardless of circumstances or any hints to “one-size-fits-all” prescription as the law of gravity.
      I also would to draw attention to the first expert UN report, “National and International Measures for Full Employment”, authored by John Maurice Clark, Professor of Economics, Columbia University; Arthur Smithies, Professor of Economics, Harvard University; Nicholas Kaldor, Fellow of King’s College, Cambridge; Pierre Uri, Economic and Financial Adviser to the Commissariat general du Plan, Paris; Ronald Walker, Economic
      Adviser to the Australian Department of External Affairs.
      Aggregate demand was the focus of the report and how to face the international propagation of reductions in aggregate demand—responding, in this regard, to the problems generated by the United States’ first post-war recession. The report started by recalling the pledge to achieve full employment that was included in Article 55 of the UN Charter, as well as the right to work incorporated in the 1948 Universal Declaration of Human Rights. Its key policy recommendation was, therefore, that governments “should adopt and announce a full employment target” (para. 141.i) in conformity with these principles. The primacy of full employment was further reflected in the recommendation that a government “should announce the nature of the policies which it will adopt in order to maintain the stability of the price level and to combat inflationary tendencies in a manner consistent with the maintenance of its full-employment target” (para 141.iv). The Report included a complex set of domestic measures to achieve this objective, such as active fiscal policies, but also mechanisms to encourage private investment, plan public investment, stimulate consumption, and stabilize commodity prices. Automatic compensatory measures (automatic stabilizers, as they would come to be called), particularly progressive income taxes and social security provisions, were seen as particularly important. According to the Report, the object of a full employment policy in its international aspects is “to create conditions under which any particular country will so behave in its international economic relations as not to prevent other countries from maintaining the stability and prosperity of their economies”. To the extent that national action alone cannot ensure this, it was recommended that concerted international measures should be taken. The report suggested measures for bringing about a new equilibrium in world trade, and for the stabilization of the flow of international trade as well as of international investment for economic development.
      In any case, the Report emphasized country-specific circumstances instead of a ‘one-size-fits-all’ approach in determining national policies. It also proposed a set of international measures: an ECOSOC program to eliminate structural disequilibrium in international trade; stable flows of international investment from industrialized to underdeveloped areas of the world, particularly through a new International Bank for Reconstruction and Development (World Bank) credit line for general development purposes; and a new automatic IMF facility to finance current account deficits.

      We don’t have to re-invent the wheel. You can download the report from
      A follow-up report, “Measures for International Stability” (1951) can be downloaded from

  3. An economy with essential sectors where productivity gains are high (agriculture, telecommunications, computing),and others are low ( health care, govt services, education), will come to be dominated by the low productivity sectors. So concentrate on productivity growth.

    Capitalist economies are susceptible to a instability where banks lend to financiers against collateral they deem low risk compared to productive enterprise. The assumption of low risk is true only so long as bank lending per se drives this speculative asset price ever higher in price. This will recur as a sequence of asset price bubbles which are highly destructive. So focus on Minsky who described this.

    MMT is true but it’s a side show.

  4. “The size of public debt and deficits is not — as already Abba Lerner argued with his ‘functional finance’ theory in the 1940s — a policy objective. ”
    The interesting thing about Lerner is that in the 1970s he repudiated his previous position on fiscal policy and adopted monetarist sentiments. He felt that monetary policy was more effective in controlling inflation.
    The flip was more than likely due to the emergence of stagflation in the 1970s which the New Synthesis Keynesians couldn’t explain. (This permitted the rise of ratex.)
    In my view the stagflation was easily explainable.
    Everyone focused on the supply side oil price shock and ignored the demand side shock of a significant transfer of income to the oil producing countries.
    The supply side shock explains the inflation, the demand side shock explains the stagnation.

  5. Haven’t read the book but I did see an interview with Dr. Kelton about a year ago where she explained MMT is a misnomer, that these ideas have been around for a while but have been ‘crowded out’ for the past fifty years by neoliberalism, neoclassicism and anti-Keynesianism within the vested interest narrative (i.e. financial press, academia). So in many ways it is new. If it catches on because of its ‘new’ name, we’ll all be better off. Just wish MMTers would write a book about good vs bad debt, earned vs unearned income.

  6. Oh, the things that we will NOW “learn”, now that neoliberalism is no longer the pragmatic economic ideology for the U.S. to pursue (because of the end of its hegemony and the benefits it enjoyed as a result of being the writer of the rules of globalization for the last 40 years),

    And these benefits trickled down to all the developed-world countries to a certain extent.

    With the end of U.S. hegemony and their exorbitant privilege of being the printer of the world’s reserve currency (the privilege ends when the world needs no MORE U.S. dollars, not when everyone is trying to get rid of their U.S. dollars at any cost), manufacturing the consent needed to move America towards a more progressive future becomes the pragmatic thing to do, political-economy wise.

    • Just as the Reagan Revolution’s neoliberalism was the pragmatic political-economy ideology to manufacture at the beginning of globalization (China’s entry into the global economy with the commitment to succeed at all costs, be they virtual slave-labor wages or massive environmental degradation).

  7. Congratulations Lars your review is both compelling and a useful set of reflections.

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