“The Deficit Myth” by Stephanie Kelton: A Review

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If there is a “deficit myth”, Stephanie Kelton is bent on exposing it. There is a puritanical shame that accompanies talk of a country’s deficit, the putrid stench of moral decay wafts through the air, driving governments to violent self-lacerations by way of swingeing spending cuts. Kelton’s book, The Deficit Myth, is a work of popular economics whose mission is to introduce the public to modern monetary theory (MMT) and lift the shame around the deficit myth through a paradigm shift in the way the public thinks about it, while offering up a promise of a Prometheus unbound: a government whose fiscal space and consequently, scope for action, is much, much wider than is commonly held and capable of tackling the very big problems of our age -climate change, poverty and inequality-. Responsible citizens and public officials educated to associate reining in the deficit with public-spiritedness are asked to dare to imagine that our notions of the deficit are wrong, that we have, in fact, been believing in a deficit myth. Like all myths, many will cherish this one and The Deficit Myth, whatever its merits, will find many detractors. Myths are difficult things to get rid off, but there is a whiff of revolt in the air and one is wise to attempt to understand a school of economics that may well be influential in public policy in the coming years. Some myths are worth preserving, the reader must decide if the deficit myth is useful or as dangerous as Kelton argues they are.

Kelton, in line with MMT, identifies six main myths that make up the broader deficit myth:

1. Governments should budget like households.
2. Deficits are evidence of overspending.
3. One way or another, we’re all on the hook.
4. Government deficits crowd out private investment, making us poorer.
5. The trade deficit means America is losing.
6. Entitlement programs are financially unsustainable. We can’t afford them anymore.

I will focus on what I think is the key insight of the book: there is a fundamental difference between the government of a country that issues its own currency and a household and that is, the government is an issuer of a currency and the household a user. Like the bank in Monopoly, the government can never run out of money. Government does not need to tax and borrow to spend, what Kelton refers to as a “TABS” paradigm, it lives under a “STAB” reality: it spends currency into existence and only then taxes and borrows. Kelton quotes in explanation, the then-Federal Reserve chairman Ben Bernanke, who, when responding to the claim that taxpayer dollars rescued Wall Street during the Great Recession, said, “The banks have accounts with the Fed. We just use the computer to mark up the size of the accounts.” Money is created at will by the government. This of course does not apply to countries who use a currency board, such as Hong Kong, or whose currency is otherwise pegged to a commodity such as gold, or the currency of another country, for example, Jordan’s dinar is pegged to the dollar, or those countries that have dollarized, such as Panama, or who are under a currency union such as the nations of the Eurozone. So long as a country’s currency is produced by itself, there are no limits to how much money it can create and so talk of government needing to tax and borrow before it can spend is part of the deficit myth. If that country takes on debt denominated in a foreign currency, it reduces its “monetary sovereignty”. A country like Argentina which has its own currency, the peso, but has debt denominated in dollars and euros, must earn revenue in dollars and euros to pay off its debts.

This point goes back to the origins of money, a subject that interests me, esoteric as it is, and on which I have published. Economics is a largely ahistoric discipline, at least neoclassical economics is, but there is an abundance of evidence from historians, anthropologists, and sociologists that money was spent into existence and the role of taxes was to oblige people to find means of earning the currency, which had the twin result of making the state’s currency the money of the land and creating markets. Kelton does not go into detail on this but does suggest further reading for those few brave souls willing to do the work. David Graeber’s Debt is a good place to start.

When told that the government can issue money at will, people usually respond, “Well what’s the point of taxes?”. Kelton, and MMT argue that taxes exist not only to oblige people to work, create businesses, etc, to get money, they also exist to control inflation, redistribute wealth and income, and to alter behaviors, for example, with sin taxes like the cigarette tax. As for borrowing, the government borrows so people exchange non-interest bearing money for interest-bearing money, dollars for Treasuries. Kelton gives the example that the US government has, for over a century, spent more than it taxes, i.e. ran a fiscal deficit and matched that deficit with with borrowing. Kelton’s working paper, “Can Taxes and Bonds Finance Government Spending”, goes into greater detail on the question of whether or not governments need taxes and borrowings to spend. A distinction in the literature is made between “inside”, and “outside” money: outside money is money that is not a liability for anyone “inside” the economy, in that frame, public sector liabilities are private sector assets in a closed, two-sector model of the economy and the only way for the inside to get outside money is if the outside runs a deficit, the question being how big or small the deficit should be.

At this point the reader is surely asking, “Well what about inflation?”, but Kelton is explicit in stating that MMT is “not a free lunch”. The Deficit Myth is not a manifesto for the Venezualization of an economy but a carefully thrown grenade at the myth of the government’s budget constraint. What Kelton asks us to do is to substitute a false constraint for a real one, to move from, “Where will the money come from?”, to, “Will spending the money here increase inflation?”. The government of a monetarily sovereign state does not have a “budget constraint” but an “inflation constraint” and the answer to whether spending will push inflation up is related to how much “slack”, as she puts it, exists in the economy. So, for example, the real question when arguing over Alexandria Ocasio-Cortez’ Green New Deal is not, “Can we afford it?”, but, “Will the Green New Deal take productive resources away from existing jobs and bid up the price of those resources or will it absorb unused resources?” Kelton points out that in the aftermath of the Second World War, the United States had a deficit that was 125% of its GDP and went into a golden era of capitalism and at present, Japan has a deficit that is 240% of its GDP with persistent low inflation and long-term interest rates near-zero.

Tackling the notion that the national debts should be treated similarly to household debts, leads Kelton and MMT toward a functional view of finance first proposed by Abba P. Lerner. Functional finance holds that given that the budget is not a constraint on spending, the finances of a monetarily sovereign state should be judged on explicit goals such as full employment, growth, and low inflation. So, in the example of the Green New Deal, the question for the White House and Congress is one of ascertaining whether it would trigger inflation or not, the deficit implications beings entirely unimportant. If inflation were to rise, Congress would simply raise taxes and borrow more to push inflation down. The widespread interest in MMT arises, I imagine, because over the last decade, one could even go back to the Bush years, the US deficit has soared amidst very low inflation. From Iraq to Covid-19, Congress has deployed trillions of dollars to work without any impact on inflation, which raises interesting questions and possibilities. The question then is, is changing the budget constraint for an inflation constraint tantamount to nothing, or are there real gains?

The book, ultimately, is a provocation, in the good sense of the word, to abandon a deficit myth, to demand that our governments remain on a permanent war-footing in order to build a “care economy” and the book suggests that governments of monetarily sovereign states have the tools to ramp up their spending to tackle some of the great challenges of our era when a crash of what Michele Wucker, in her book on high impact, high probability and largely ignored threats calls, “gray rhinos” are charging at us, a subject I discussed in an earlier post on extreme events and uncertainty. Kelton argues that rather than deem these challenges and threats too-expensive-to-fix, we should re-organize our economies to meet the threats, safe in the knowledge that insolvency is not a risk and that the real risk is inflation. After a decade of stagnant growth and trillions spent without impact to inflation, whatever the merits of the book it has surely found an audience because it posits an alternative universe where big problems are solved with bold actions rather than waived away while we plead poverty. The story of the origins of money which Graeber tackles in his book, Debt, shows that there is a close relationship between the power that the immense power that the state holds, inequality, the creation of markets and the evolution of society. Kelton is wise to the fact that there is no straight line between acknowledging this power and her proposals, indeed, the central tenets of MMT could easily be called upon by the right as well as the left, but that is not an argument against the book.

The big policy proposal Kelton makes, in line with MMT and which Pavlina R. Tcherneva writes about in her book, The Case for a Job Guarantee, has a long history and has recently come back into mainstream policy discussions. In his 1944 State of the Union Address, Franklin D. Roosevelt called for a “second Bill of Rights” because “true individual freedom cannot exist without economic security and independence.” The first of these right being “the right to a useful and remunerative job” and “the right to earn enough to provide adequate food and clothing and recreation.” In 1967, President Lyndon Johnson’s National Advisory Commission on Rural Poverty recommended the “government stand ready to provide jobs at the national minimum wage, or better, to every unemployed person willing and able to work.” The job guarantee is not a cure all, for one thing, as Kelton shows, there is a deficit of care workers. It does not solve the declines in productivity in the economy or a host of other problems but it is certainly a revolutionary idea.

It succeeds in its main goal, which is to shake up the conversation and make us take a look at the immense power that the government of a monetarily sovereign state has. Is MMT “right”? There is a saying in statistics that “all models are wrong but some are useful” and my position is not about the truthfulness of MMT but its usefulness in understanding the economy and making it work better for the common man. That is a question we must answer with open-minds and more than a cursory glance and rapid acceptance or condemnation of the core program. Given the state of economics today, we are more than ever in need of a more “anarchic”, experimental, open approach to economics, a willingness to listen to many ideas and to test rather than accept on faith and a heroic readiness to sacrifice even the most cherished notions if they prove to be less than useful or less useful than others.

I must state again that this is a work of popular economics, and in that capacity, I think it is a gem worth reading even if one has heard all the arguments before. When one reads a book, one enters into a pact with the writer to engage the text on its terms. One does not pick a book on biophysical chemistry and fume at the absence of a single mention of pricing of pharmaceutical stocks. When one reads Mansfield Park, Jane Austen assumes one will treat her fictional world as if it were real. When Warren Buffett says he buys a stock for “forever” or calls derivatives “weapons of mass destruction”, he does not expect to be called a hypocrite for selling Southwestern Airlines or for using derivatives, because he speaks with the tacit understanding that the audience knows he is speaking metaphorically. One does not storm out of a Somali restaurant because they do not serve pizza. Often critics exercise bad faith and ask of a book what it never promised to give. The Austrian economist who reads Frédéric Bastiat’s Economic Sophisms or Henry Hazlitt’s Economics in One Lesson, would be flabbergasted to hear you ask for “specifics”, more “in-depth explanations” and the like. Their purpose and the purpose of The Deficit Myth, is to introduce the reader to a way of thinking and a set of ideas through the use of metaphors, analogies and a stripped-down explanation of the core idea. Kelton supplies many end-notes and references for anyone who wants “more explanations” and “details”. Sadly, there are enough reviews out there that make one despair for the state of reading and many a critic who, claiming his or her “open-mindedness” has walked away condemning MMT as a school on the basis of a book that at no point signals that it gives an in-depth, under-the-hood review of what MMT is all about. Indeed, I can across no review not written by a believer in MMT which showed even a smidgen of awareness of the literature. That is bad faith. This book is a provocation and an invitation to rethink central ideas around deficits and a vision of what is possible and I think in that it succeeds superbly. Whether it is “true”, or useful is a question the reader must do the work to come to an honest conclusion. I repeat: Kelton supplies numerous end-notes and references. For details and further explanations, check there to learn more about what MMT thinks on what it “the deficit myth”.

Of course, there will be resistance to the main ideas of MMT no matter how clearly they are given. Even in physics, the hardest of sciences, or mathematics, the queen of sciences, arguments are not always won with persuasion. The great Albert Einstein spent half his life a revolutionary genius and the other half a reactionary denying widespread evidence for quantum physics, supplying his own metaphor: “God does not play dice with the world”. Did Einstein convince the physics world of relativity? No: Einstein won converts among the new physicists entering the field who eventually replaced the old guard. In Thomas Kuhn’s classic work, The Structure of Scientific Revolutions, Kuhn offers two radical ideas most scientists -and I consider economics to be a “complex science”- downplay: (1) politics and personalities play a large role in science and (2) scientists can never really understand the world and each other. I say “downplay” because though the first idea is widely understood at a conceptual level, but deep in his heart the typical scientist likes to think that scientific consensus is rationally arrived at and that we are always making progress towards the truth or at least that he or she gives an idea a fair shake. For example, in one op-ed many years ago, one moderately famous economist attacked a much more famous economist for saying that much of what has been done since the 1960s has been bad economics. Why? He claimed that the idea was absurd, which hid an assumption: that science cannot be retrogressive for extended periods of time. Why not? It just can’t! Yet it can and often, ideas are accepted and become part of the mainstream consensus not because they are right but because they agree with the dominant politics and personalities. This becomes particularly pernicious when the mainstream goes wildly astray and yet other ideas and personalities are suppressed or held at an absurdly high standard before the grandees of the mainstream deem it worthy of acceptance. Kuhn’s second point explains why, despite a wealth of explanations marshaled up by MMT, MMT remains misunderstood. There are almost wilful misreadings of MMT out there. There is a churchiness to economics: read an Austrian blogger and he invariably cites only Austrian sources and calls up Ludwig von Mises, Carl Menger and F.A. Hayek with religious fervor. Read a Keynesian and John Maynard Keynes is the all-too-wise king. Read a neoclassical economist and there are pious incantations of Adam Smith, Paul Samuelson, John Hicks, etc. I could go on. This Babylonian madness can only lead to misunderstandings and a failure to advance knowledge and to learn from each other. Kuhn indeed lamented the misunderstanding his own book triggered. Scientific American initially called his book, “much ado about very little”.

I encourage you to read this book, with the openness it demands and treat it as an invitation to do the work to understand MMT and its ideas on the deficit myth and the role of the state in the economy and then decide on its usefulness.