At some point during this health crisis the financial class will likely begin its campaign against further Federal fiscal expansion, at least that portion directed towards the working class. They will wrap this argument in the language that heavy federal debt loads will burden future generations with heavy tax burdens and that the large new money creation associated with the fiscal expansion will cause inflationary pressures. There are problems with these arguments.
Borrowing at the federal level in order to match deficit spending is optional; it is a policy choice, accordingly, we need not burden future generations with debt repayments. The Federal Government has the ability to create its own money so it certainly does not need to borrow to fund its expenses. This is merely a matter of convention.
In 1913 the Nation established the Federal Reserve system which enabled a network of twelve Federal Reserve Banks to create money within their various districts. The U.S. Treasury Department has a general account at the Federal Reserve Bank of New York. This account receives tax revenues and other receipts, and from this account the Treasury spends as it needs to spend. The account, under current regulatory practice, must remain in balance so expenditures in excess of receipts, i.e., deficit, is funded through federal borrowing. This is simply our current approach but it need not be this way.
We could simply write new law which states that the FED would credit the Treasury for any shortfalls between revenues and expenses. The FED creates its own money so why not put this power to use in a manner which serves the public purpose. Why not? For two reasons: first, it is difficult for us to get our heads around the idea that spending need not match the combination of income, borrowing, and depletion of savings. In other words, we believe, what goes out must first come in. Household budgets must balance, so we project this perception of the budget process on to the federal government. But there is a difference between the household budget and the Federal Government. The Federal Government has the authority and ability to create its own money. We do not.
The Federal Government has delegated a large portion of money creation to the Federal Reserve (FED), but that is all it is: it is a delegation of sovereign power and the Sovereign authority can always take this power back. Sovereign means ultimate authority. The Federal Government, the sovereign authority, can also delegate that the Federal Reserve cover Treasury shortfalls in the Treasury account. The Federal Government can do pretty much anything it wants within political limitations. But political limitations are what they face.
These political limitations stem from orthodox economic thinkers who believe the above practice would be highly inflationary. The spending of money without a corresponding equal intake of money, through taxation and borrowing, inflates the money supply and to their way of thinking will create inflation in the goods, services, and asset markets. Federal spending pumps money into the economy while taxation and borrowing takes money out of the economy. The acts of spending money into the economy and taking money out of the economy through taxation and borrowing are acts of money creation and destruction. If the two processes remain in balance, there is less chance for inflationary pressure. If money creation, i.e., Federal Spending, exceeds money destruction, i.e. taxation and borrowing, greater inflationary pressure, according to their thinking, will result.
There are a couple problems with this view. The view itself has historically generally been correct, but times have changed. Since the 2007-2008 financial crisis, national governments globally have been fighting deflationary pressures. Japan has been fighting deflationary pressures since the 1990’s. How have the Japanese reacted? They borrow and spend a lot. The Japanese national debt level at the end of 2019, depending on the source, was over 230% its national income, while the U.S. debt at the end of 2019 was roughly 107% of national income and the Federal debt was 79% of U.S. national income if you exclude Federal debt held by other Federal agencies. In other words, the Japanese government has engaged in massive money creation relative to the U.S. and in Japan there is still no inflation in sight. Intuitively it seems, that the deflationary forces of globalization and technology, and an aging society, have had such a powerful deflationary impact, that this enables significant money creation without inflationary pressure, although there may have existed inflationary pressure within the asset markets.
These deflationary forces can actually be a good thing. It enables the federal government to engage in expansionary fiscal policy which can support incomes and jobs programs without inflationary results. The limits of this expansionary fiscal policy, i.e., greater money creation, are unknown but the expansion can likely go on quite a while so long as there are no significant supply constraints. It is possible, maybe even likely, however, the coronavirus will undermine much of this argument because COVID-19 is creating supply constraints as businesses shut down and as worker resistance against a physical presence in the workplace, which puts them and their families at risk, possibly grows. Expansive money creation in light of these supply constraints may create inflationary pressure. But the argument may still be correct given countervailing deflationary forces in current economic context. As the world hopefully moves away from the current crisis and as supply systems grow, increasing money supplies through expansive federal spending should be matched by an increase in the supply of goods and services and it is this balance between money and goods and services which can maintain a stable 2% or less inflation rate. Stated differently: all of this globalization and technology which has slammed working people has created such powerful deflationary pressure that these working people which have suffered real income losses may now get paid for these losses in the form of a guaranteed income check just in order to keep deflation at bay. Pretty cool.
But there will be resistance. In addition to the inflation hawks, there are those who are just philosophically opposed to greater government involvement in the economy. You know, the neoliberal establishment which over the past 40 years or so have brought us to our current sad state of being. They will also harness the inflation hawk argument and claim a fiscal scaleback will be needed to prevent inflationary pressures which destabilizes the system. You will hear arguments that inflation hurts the working class so we really must avoid it. One must really question this latter statement.
This leads us to the second problem of the inflation argument; it is not clear that inflation hurts the working class. If it is a choice between money within one’s pocket which has been slightly inflated away or less money that has not been inflated away, depending on the math, it might well be the better choice to accept the slightly inflated money, particularly if this reasonably inflated money is evenly distributed throughout the working class so that we don’t have large pockets of people sleeping on the streets. Unreasonable inflation, however, will destabilize the financial markets and ultimately result in less investment and fewer jobs. Which is basically why the capitalist system to date has not worked well for the working classes. Wage gains without corresponding productivity gains have, in the past, created inflationary pressures which slowed investment, reduced employment and put downward pressure on wages, so that previous wage gains, were then lost. There was no way around this paradox, it was the thing which made the system work. The financial system as currently laid-out was structured in a manner which automatically broke wage gains. It is this structure which enabled our class based society.
But now things may be different. Strong deflationary forces in the form of technology, globalization, and perhaps altered consumption patterns going forward, may enable significant fiscal expansion in the form of a Basic Income Guarantee and perhaps even a Federal jobs program. If this proves to be incorrect, and continued fiscal expansion does create inflationary pressures so that amount of income support granted to workers, whether through private or public sector jobs or through other Federal programs remains modest, then the system will have proven itself incapable of meeting the needs of all workers and the entire system will need to be scrapped in favor of a model which meets the needs of all people.