The Deficit Myth: Modern Monetary Theory and the Birth of the People's Economy

The Deficit Myth: Modern Monetary Theory and the Birth of the People's Economy (Stephanie Kelton, 2020)

Introduction: Bumper Sticker Shock

Mark Twain's quote, "It ain’t what you know that gets you into trouble. It’s what you know for sure that just ain’t so," serves as a foundational premise for understanding the misconceptions surrounding government deficits. In 2008, the author observed a bumper sticker symbolizing a widespread belief that the government is financially destitute, incapable of funding critical public services such as healthcare, infrastructure, education, or climate change. This belief is rooted in the erroneous comparison of the federal budget to a household budget, implying that imprudent government spending leads to bankruptcy similar to an individual's financial collapse.

Modern Monetary Theory (MMT), of which Stephanie Kelton is a leading proponent, offers a "Copernican shift" in understanding the deficit's relationship to the economy. MMT applies to monetarily sovereign countries like the US, UK, Japan, Australia, and Canada, which are monopoly issuers of their own fiat currencies. A central tenet of MMT is that federal deficits are often beneficial and necessary for a healthy economy. Instead of aiming for a balanced budget, the goal should be to utilize sovereign currency to balance the economy, ensuring broadly shared prosperity rather than concentrated wealth.

The Role of the Taxpayer and Government Finance

The conventional view places the taxpayer at the center of the monetary universe, assuming the government relies on taxpayer money for funding. MMT fundamentally challenges this by recognizing that the federal government, as the currency issuer, directly finances all its expenditures. Taxes, while important for other reasons (explained later in the book), do not "pay for" government spending; this notion is considered a "pure fantasy."

Kelton's personal journey involved initial skepticism towards MMT, which led her to rigorous research into government fiscal and monetary operations. Her findings proved MMT's descriptive accuracy, revealing that it offers a nonpartisan lens into the monetary system's actual workings. MMT's explanatory power is independent of ideology, aiming to clarify economic possibilities and reframe policy debates hindered by concerns over financial feasibility. It advocates for judging policy by its functional impact—such as controlling inflation, sustaining full employment, and promoting equitable wealth distribution—rather than its narrow budgetary outcome, a concept Abba P. Lerner dubbed "functional finance."

Limits to Government Spending

While MMT posits no financial constraints on the federal budget, it acknowledges real limits. Every economy has an "internal speed limit" determined by its productive resources (land, labor, capital, technology, materials). Excessive government spending into an economy already operating at full capacity will accelerate inflation. Therefore, the true limits are inflationary pressures and resource availability within the real economy, not the government's ability to create money or the size of the deficit.

MMT's insights were apparent during Kelton's time in the US Senate. Debates around Social Security, education, or healthcare invariably raised the "how to pay for it" question. However, this concern rarely arose for defense budgets, bank bailouts, or tax breaks for the wealthy, even when these measures significantly increased the deficit. This disparity highlights that government spending is ultimately a political decision. Historical examples, such as Roosevelt's New Deal, Kennedy's moon landing initiative, and wartime expenditures, demonstrate that Congress can always fund its priorities if the political will exists. Spending decisions should be based on economic ramifications, not arbitrary budget targets or allegiance to "sound finance."

The 2008 Financial Crisis and Policy Response

The economic downturn of 2008, the worst since the Great Depression, amplified outdated beliefs about government insolvency. The crisis, originating in the subprime mortgage market, led to millions of job losses, foreclosures, and increased reliance on public assistance. Consequently, tax receipts plummeted, and spending on unemployment benefits surged, pushing the deficit to a record $779 billion. MMT proponents advocated for a robust stimulus, including a payroll tax holiday, state and local aid, and a federal job guarantee.

President Obama, despite calls from some advisors like Christina Romer for a substantially larger stimulus (up to $1.8$ trillion), opted for a more modest $787$ billion package, largely due to fiscal conservatism and fears of "sticker shock" in Congress and among the public. This intervention, though helpful, was insufficient, leading to a prolonged and weak recovery. The economy shrank, and the deficit climbed to over $1.4$ trillion. Obama's statement, "Well, we are out of money now," reinforced the "deficit myth."

Consequences of Insufficient Policy Response

The Great Recession (December 2007 to June 2009) left lasting socioeconomic scars. The US labor market took over six years to recover the $8.7$ million jobs lost. Millions faced long-term unemployment or settled for lower-paying, part-time work. Housing wealth declined by $8$ trillion, and $6.3$ million people (including $2.1$ million children) were pushed into poverty. The Federal Reserve Bank of San Francisco estimated that the inadequate policy response cost the US economy up to $7$ percent of its output potential from 2008 to 2018, equating to $70,000$ per American citizen in foregone prosperity.

Political divisions, exemplified by Mitch McConnell's stated goal of making Obama a one-term president, contributed to the policy shortfall. However, the pervasive "deficit hysteria," embraced by both parties, was an even greater impediment. The belief that larger deficits were inherently problematic prevented policymakers from advocating for the necessary fiscal stimulus. This book aims to dismantle the deficit myth, which continues to influence nearly half of Americans' belief that deficit reduction should be a top priority.

Overview of the Book's Structure

The book systematically dispels six key deficit myths:

• Myth #1: The federal government should budget like a household. The federal government, unlike a household or private business, issues its own currency and thus cannot go broke. Its spending is not constrained by tax revenues or borrowing; the primary constraint is inflation.

• Myth #2: Deficits are evidence of overspending. While a deficit occurs when spending exceeds taxation, it also creates a surplus in the non-government sector. Overspending is actually evidenced by inflation, and often, deficits are too small, leading to underemployment.

• Myth #3: Deficits will burden the next generation. Historical data contradict this. Government deficits do not impose financial burdens on future populations. The national debt, which is a record of dollars added to the economy in the form of US Treasuries, does not make future generations poorer.

• Myth #4: Deficits crowd out private investment and undermine long-term growth. This myth assumes government borrowing competes for a limited supply of savings. In reality, fiscal deficits increase private savings and can "crowd-in" private investment.

• Myth #5: Deficits make the United States dependent on foreigners. The US is not truly borrowing from countries like China; rather, it is providing them with dollars, which they then invest in safe, interest-bearing US Treasuries. The US, as a currency issuer, could extinguish this "debt" with a keystroke.

• Myth #6: Entitlements are propelling us toward a long-term fiscal crisis. Programs like Social Security, Medicare, and Medicaid are financially sustainable because the government, as a currency issuer, can always meet future obligations. The real challenges relate to managing real resources and demographic shifts, not monetary cost.

The book will then explore "the deficits that matter," such as child poverty ($21$ percent of US children), deteriorating infrastructure (graded D+), extreme inequality (Gilded Age levels), stagnant real wage growth since the 1970s, student loan debt ($44$ million Americans with $1.7$ trillion in debt), and climate change. The 2017 Trump tax bill, for instance, exacerbated inequality by funneling help to the wealthy under the guise of deficit spending. MMT argues for taxing the rich to rebalance wealth and protect democracy, not to fund government spending. It advocates for redefining fiscal responsibility, focusing on harnessing the economy's untapped potential and pursuing policies that prioritize human and public interests. The COVID-19 pandemic vividly demonstrated MMT's principles, as Congress committed trillions to crisis response, with projected deficits skyrocketing, highlighting that financial capacity is rarely the limiting factor in national crises.

1 Don't Think of a Household

President Obama's 2010 State of the Union address, comparing the federal government's budget to a household's, embodies Myth #1: "The federal government should budget like a household." This perspective, the "household myth," is widely adopted by politicians for its simplistic appeal, resonating with common understanding of personal finance: spend within your means, save for the future, and avoid excessive debt to prevent bankruptcy. While families, businesses (e.g., RadioShack, Toys "R" Us), cities (e.g., Detroit), and states (e.g., Kansas) can indeed face financial insolvency, the federal government operates under fundamentally different principles.

Issuers Versus Users of Currency

The core of MMT lies in a simple, incontrovertible fact: the US dollar originates solely from the US government, legally. Both the US Treasury (minting coins) and the Federal Reserve (printing bills, creating digital reserves) have the authority to issue the currency. This grants the federal government a monopoly over the dollar. Unlike individuals, businesses, or state/local governments, which are mere "currency users" who must earn dollars before spending them, the federal government is the "currency issuer." Counterfeiting laws underscore this exclusive power granted by the US Constitution.

This distinction is crucial for understanding policy debates concerning healthcare, climate change, Social Security, international trade, and inequality. To fully leverage this power, countries must issue their own nonconvertible (fiat) currency and borrow only in their own currency, thereby achieving "monetary sovereignty." Such countries, including the US, Japan, UK, Australia, and Canada, are not constrained like households and can pursue policies aimed at full employment. MMT also offers insights for countries with limited or no monetary sovereignty (e.g., Panama, Greece, Venezuela), explaining how fixed exchange rates or foreign-denominated debt undermine their policy flexibility and expose them to household-like financial constraints.

Thatcher's Backward Dictum: (TAB)S

Margaret Thatcher's 1983 assertion that "the state has no source of money, other than the money people earn themselves…There is only taxpayer money" represents the conventional, "TABS" (taxing and borrowing precede spending) view. This dictum, whether an innocent mistake or a deliberate political strategy, conceals the state's currency-issuing power. Contemporary leaders, including Theresa May, continue to propagate the "magic money tree" myth, implying that government spending must be financed by taxes or borrowing from citizens' savings.

This conventional understanding is deeply ingrained: we relate it to our personal experience of needing funds before making purchases. Consequently, policymakers face intense pressure to justify new spending with equivalent tax increases or spending cuts to maintain "deficit neutrality." This is exemplified by proposals from figures like Donald Trump (Mexico paying for a border wall) or Bernie Sanders (financial transactions tax to fund college tuition). MMT reveals this understanding to be backward.

How the Currency Issuer Spends: S(TAB)

MMT introduces the "S(TAB)" (spending before taxing and borrowing) model. This radical reordering posits that the government spends its currency into existence first, and then taxes or borrows. As Warren Mosler, a key figure in MMT, explained, the government, as the sole issuer of dollars, doesn't "want dollars"; it wants to "provision itself" with real resources (e.g., military, infrastructure, public services). Taxes are imposed to create demand for its currency, motivating people to work to earn dollars required to settle tax obligations. Mosler's anecdote of using business cards to incentivize his children to do chores illustrates this: the tax (the need for his cards) gave value to his otherwise worthless paper, prompting labor.

This chartalist (state theory of money) perspective, found in historical texts predating modern economics, rejects the barter narrative of money's origin. Money's value is derived from the state's imposition of taxes payable in that currency. The government spends currency into existence, providing the tokens needed to pay taxes. Therefore, taxpayers do not fund the government; the government funds the taxpayers.

Playing the board game Monopoly further clarifies this: the "Bank" (currency issuer) can never run out of money, creating it by "writing on any ordinary paper." The US Bureau of Engraving and Printing and the Federal Reserve similarly manufacture physical and digital dollars. Government payments, like for fighter jets, are typically executed via keystrokes at the Federal Reserve, crediting the recipient's bank account. This makes the Fed a "scorekeeper" that cannot run out of "points."

Former Fed Chairman Ben Bernanke confirmed this during the 2008 financial crisis, stating that the Fed bailed out banks by "us[ing] the computer to mark up the size of the accounts," not taxpayer money. While the government's "points" (dollars) matter for citizens to pay taxes and conduct transactions, Uncle Sam does not "lose" dollars when spending or "get" dollars when taxing. This is the first "Copernican moment" of MMT: understanding that government spending isn't tethered to taxpayer dollars shifts the entire fiscal paradigm.

Why Bother Taxing and Borrowing?

Recognizing the government's ability to create money raises the question: why tax or borrow at all? MMT identifies at least four critical reasons for taxation:

1. Provisioning: Taxes create demand for the government's currency, incentivizing people to work and produce goods/services for the state instead of requiring explicit force.

2. Inflation Management: Unfettered spending without taxation would lead to inflation. Taxes remove spending power from the economy, balancing government outlays and mitigating inflationary pressures on real productive capacity.

3. Wealth and Income Distribution: Taxes are a powerful tool to alter wealth distribution. Progressive taxation can counter inequality, which otherwise harms economic stability (as the wealthy tend to save rather than spend) and democracy.

4. Behavioral Incentives/Disincentives: Taxes can encourage (e.g., tax rebates for energy-efficient appliances) or discourage (e.g., sin taxes on cigarettes or carbon taxes) specific behaviors. The purpose here is not revenue generation but achieving policy objectives.

Most governments, including the US, routinely run deficits without causing inflation, often due to under-inflation. The concept of borrowing (selling US Treasuries) also requires re-evaluation. For MMT, the purpose of auctioning Treasuries is not to raise dollars for the government (which it can create) but to offer interest-bearing government money, effectively, a different form of dollars, and importantly, to support interest rates. When the government runs a deficit, it increases the supply of "green dollars" (non-interest-bearing currency). Selling Treasuries allows people to convert these "green dollars" into "yellow dollars" (interest-bearing government bonds).

Staying Within the Limits

Internalizing the currency issuer/user distinction reveals the flaws in current political discourse. Monetary sovereignty frees the US to manage its budget in service of its people, unconstrained by a gold-standard mindset. However, this doesn't mean infinite spending. MMT is not a "free lunch" or a "blank check"; very real limits exist, primarily inflation. MMT distinguishes these "real limits" from "delusional and unnecessary self-imposed constraints."

In the US, Congress has adopted technical procedures and budgetary conventions to impede federal spending, such as PAYGO (requiring spending offsets), the Byrd rule (limiting deficit growth beyond a ten-year window), mandatory budget scores from the CBO, and the debt ceiling. However, these are self-imposed and can be waived or suspended, and frequently are (e.g., suspending PAYGO for the 2017 Tax Cuts and Jobs Act; repeatedly raising the debt ceiling).

These nonbinding constraints are politically useful, providing lawmakers with cover to deny funding for social programs by blaming the deficit. They also offer opportunities (e.g., progressive Democrats proposing taxes on the rich to fund new programs, akin to Robin Hood). Real limits are determined by the availability of the economy's productive resources (technology, workforce, factories, materials). The US, rich in these resources, can build an economy for all, provided it budgets its real resources effectively and respects inflationary limits.

2 Think of Inflation

Stephanie Kelton's experience as Chief Economist for the Democrats on the US Senate Budget Committee in 2015 revealed a profound misunderstanding of federal finance among policymakers. Myth #2, "Deficits are evidence of overspending," was a common refrain, notably from Senator Mike Enzi, who viewed the federal budget through the lens of his shoe-sale business. Kelton, as an MMT economist, understood that excessive spending manifests as inflation, not simply a deficit. Since prices were not accelerating at the time, deficits could not be too large. Policymakers, whether deficit hawks (Republicans blaming entitlements) or deficit doves (Democrats blaming tax cuts/wars), generally agreed the deficit was too big, differing only on whether to cut spending or raise taxes.

What Policymakers Were Missing:

1. Monetary Sovereignty: Post-1971 (Nixon's suspension of dollar convertibility), the US, operating with a purely fiat currency, can issue dollars without fear of depleting gold reserves, making it impossible for Uncle Sam to run out of money. The senators' bankruptcy fears were outdated.

2. Balancing the Economy, Not the Budget: The government's budget is a tool to manage the economy's balance. Fiscal deficits add dollars to the economy; surpluses subtract them. Neither is inherently good or bad; the goal is a "broadly balanced economy" with shared prosperity.

3. Deficits Often Too Small: Evidence of deficits being "too small" is unemployment. MMT recognizes that deficits can be too big (leading to inflation), but Enzi's claim that deficits are evidence of overspending was fundamentally incorrect.

Inflation: Common Ways of Thinking

Inflation, a continuous rise in the price level, erodes purchasing power and living standards. A moderate level is considered healthy; hyperinflation is disastrous. Various indices (CPI-U, CPI-W, PPI, PCE) measure price changes, focusing on a "typical household's" consumption basket. Worry arises when prices outpace incomes, leading to a real loss in goods and services.

Paradoxically, many major economies (US, Japan, Europe) have struggled with "underinflation" (below a 2% target) for over a decade, a sign of economic weakness. Economists attribute this to technology, demographics, globalization, insufficient central bank stimulus, or inequality/wage stagnation. "Cost-push inflation" stems from supply shocks (e.g., droughts, storms impacting oil) or increased worker bargaining power (wage-price spirals) or market power (pharmaceutical price hikes). "Demand-pull inflation" occurs when spending outpaces the economy's productive capacity, leading to bottlenecks and rising prices, especially as it approaches full employment.

"Monetarism," spearheaded by Milton Friedman, asserted that "inflation is always and everywhere a monetary phenomenon" caused by an excessive money supply. Friedman challenged Keynesian views that expanding the money supply could reduce unemployment. He argued that attempts to push unemployment below its "natural rate" would lead to accelerating inflation and lower real wages. Monetarism advocated for strict rules on money supply growth rather than central bank discretion, aiming to stabilize inflation by accepting a certain level of unemployment.

How We Fight Inflation Today

Since 1977, the Federal Reserve has a "dual-mandate" from Congress: maximum employment and stable prices. The Fed, independent in setting its inflation target (2%) and defining "maximum employment," typically aims to maintain the "right" amount of unemployment to prevent overshooting its inflation target. Lacking direct spending or taxing powers, the Fed influences inflation by targeting a key interest rate. Lowering rates (easing credit) encourages borrowing and spending, stimulating job growth. However, this risks a "hot" labor market and wage-price inflation.

The Fed operates on the concept of the "natural rate of unemployment" (NAIRU), an unobservable ideal where any further unemployment decline causes inflation. This is discovered through trial and error. The Fed preemptively raises interest rates to curb potential inflation before it escalates, leading to "overtightening" and unnecessarily keeping millions out of employment. Former Fed Governor Daniel Tarullo admitted the Fed lacks a reliable theory of inflation, relying on conjectures and faith that excessive inflation is a greater threat than unemployment.

The Fed's NAIRU estimates have been consistently too high. For instance, despite the unemployment rate falling significantly post-2014, inflation remained low. Chairman Jerome Powell admitted this error but still affirmed the necessity of the NAIRU concept, effectively redefining "full employment" to a level that ensures price stability, even if it means persistent unemployment. This approach is criticized for relying on human suffering (forced idleness) to control inflation and for systematic underestimation of the economy's employment potential.

Inflation and Unemployment: The MMT Approach

MMT recognizes real spending limits (inflation) but seeks better, more equitable management strategies that do not necessitate perpetual unemployment. It proposes leveraging "true full employment" to stabilize prices, rejecting the NAIRU concept. MMT views unemployment as a sign of "slack" or "unused capacity," meaning the economy is operating below its potential, akin to "leaving money on the table." Eliminating involuntary unemployment, a long-standing Keynesian concern, is central.

Abba P. Lerner's "functional finance" advocated for adjusting fiscal policy (taxes and government spending) to maintain a balanced economy at full potential, with budget outcomes being secondary. MMT agrees that fiscal policy, not monetary policy, should steer the economy. It asserts that fiscal deficits are not inherently bad; their value lies in achieving good economic outcomes. Well-targeted tax cuts or government spending (especially those with high fiscal multipliers benefiting low- and middle-income households) can stimulate demand. Lerner also argued against raising taxes simply for "fiscal responsibility" when not needed to fight inflation.

MMT enhances Lerner's framework with a "powerful new shock absorber": a federal job guarantee. This is a nondiscretionary automatic stabilizer that would establish a universal right to a good job with decent pay and benefits for anyone unable to find suitable employment in the private sector. The government would set a living wage (e.g., 15$per hour) and hire all who seek work, eliminating involuntary unemployment. This effectively creates a "public option" in the labor market.</p><p>The job guarantee would be federally funded (as the federal government cannot run out of money), but locally administered to meet community needs (e.g., care economy jobs: caring for people, communities, and the planet). Unlike state/local governments, the federal government can sustain such a program, especially during recessions when tax revenues fall. The program offsets the tax liability created by the government, ensuring there's always a way to earn the currency needed to pay taxes. This makes the job guarantee a countercyclical force, expanding when the economy softens and shrinking during private sector recovery, thereby cushioning downturns, supporting wages, and preserving skills.</p><p>Furthermore, the job guarantee stabilizes inflation by anchoring a key price: the minimum wage rate (e.g.,$15$per hour) for public service jobs. This effectively becomes the de facto minimum wage for the entire economy, providing a stable reference point for other wages and prices, similar to how the Federal Reserve sets overnight interest rates. It also provides a ready pool of employed workers for businesses, mitigating inflationary wage bidding for scarce labor. This avoids the "musical chairs" scenario where employed workers constantly shift to better-paying jobs while others remain jobless.</p><p>MMT advocates for integrating inflation risk into the federal budgeting process, replacing the "artificial (revenue) constraint" with a "real (inflation) constraint." Agencies like the CBO should evaluate legislation for inflation risk <em>before</em> approval, not just budgetary impact. If new spending risks inflation, lawmakers should identify effective offsets. This means working backward from desired economic outcomes, not from the presumption that every new dollar must be fully offset. This approach safeguards against both unwarranted tax increases and undesired inflation, ensuring political decisions responsibly align with real resource availability.</p><h4 id="67c0d7ee-28a1-4f77-8d27-70c7f37e1a93" data-toc-id="67c0d7ee-28a1-4f77-8d27-70c7f37e1a93" collapsed="false" seolevelmigrated="true">3 The National Debt (That Isn't)</h4><p>Upon arriving in Washington, DC, in 2015, Kelton found herself unique on the US Senate Budget Committee as the sole MMT economist. The committee was broadly divided into "deficit hawks" and "deficit doves," both of whom perceived the national debt as a looming crisis requiring cuts to spending or tax increases. Kelton challenged this bipartisan consensus, coining the term "deficit owl" to represent MMT economists who view deficits from a fundamentally different, and supposedly wiser, perspective. Her views, initially met with reticence, focused on dispelling the common "deficit myths."</p><p>Kelton's "magic wand" thought experiment with staffers revealed a love-hate relationship with the national debt: they wanted to eliminate the "debt" but not the "US Treasuries" (which are the same thing). This highlighted the confusion: the so-called national debt comprises US Treasuries, which are simply interest-bearing financial assets held by the private sector. For their holders, they represent wealth. The "debt clock" on West 43rd Street, therefore, is more accurately a "US dollar savings clock."</p><p>Politicians often weaponize fear of the national debt (meganumaphobia—fear of large numbers) to advocate for cuts to popular programs like Social Security and Medicare. This fear is exacerbated by misleading rhetoric, such as President Obama's claim of borrowing from China via a "credit card from the Bank of China," and Congressman Paul Ryan's warnings of a "crushing burden" on future generations. MMT aims to "fix our thinking" about debt, not the debt itself, to enable more enlightened public policy debates.</p><h5 id="17b2ef09-7d9c-458d-ae0c-332f4bed776b" data-toc-id="17b2ef09-7d9c-458d-ae0c-332f4bed776b" collapsed="false" seolevelmigrated="true">China, Greece, and Bernie Madoff</h5><p>The notion that the US is dependent on foreign lenders like China is false. China (and other trade-surplus nations) accumulates US dollars from its exports to the US. These dollars are then typically converted into interest-bearing US Treasuries, essentially moving from a checking account (reserves) to a savings account (Treasuries) at the Federal Reserve. The dollars originate from the US, not China. Therefore, the US is not "borrowing from China" in the household sense; it is merely facilitating the conversion of dollars it has already supplied.</p><p>China's substantial holdings of US Treasuries (less than 7$13.9$trillion US debt divided by the population) is a misapplication of household budgeting to a currency-issuing government. The entire national debt <em>could</em> be paid off instantly without taxing citizens, as the government can credit bank accounts. While some economists advocate for faster growth to reduce the debt-to-GDP ratio, MMT economists like Scott Fullwiler argue that the interest rate on national debt is a policy variable, not solely determined by markets. A monetarily sovereign government can always maintain debt sustainability (interest rate$<$economic growth rate,$r < g$) because its central bank can control interest rates.</p><p>Japan serves as a case study: despite a debt-to-GDP ratio exceeding$240$$50Government\ financial\ balance + Nongovernment\ financial\ balance = Zero$<br>This means for every deficit in one sector, there is an equal and opposite surplus in another. Or, simply: <br>$Government\ deficit = Nongovernment\ surplus$</p><p>To illustrate, consider two "buckets": one for the US government and one for the "nongovernment sector" (all US households, businesses, and foreign entities). If the government spends$100$dollars into the economy and taxes$90$away, it runs a fiscal deficit of$10$. Crucially, this$10$deficit for the government is a$10$surplus for the nongovernment sector. The government's "red ink" directly creates or adds to the "black ink" (financial savings) of the rest of us. Therefore, fiscal deficits do not <code>eat up</code> our savings; they <code>enlarge</code> them. Similarly, the Clinton-era fiscal surpluses (where the government taxed more than it spent) resulted in deficits for the private sector, diminishing private savings.</p><p>This accounting identity is a foundational MMT insight. It demonstrates that the CBO's reports, focusing only on the government's financial balance, provide an incomplete picture. The public is often terrorized by "big scary deficit numbers" without understanding their matching surpluses in other sectors. A "deficit owl" perspective, capable of seeing both sides, is necessary for a complete understanding of fiscal dynamics and their impact on financial balances.</p><h5 id="15671e8b-8c98-4462-b36e-39eb77169e68" data-toc-id="15671e8b-8c98-4462-b36e-39eb77169e68" collapsed="false" seolevelmigrated="true">The Interest Rate Is a Policy Variable</h5><p>The crowding-out story's central flaw is its reliance on the "loanable funds" theory, which assumes a fixed supply of savings that limits borrowing. MMT rejects this. As a currency issuer, the US government is not revenue-constrained and spends first, supplying the dollars that can then be used to purchase government bonds (S(TAB) model). These bond sales, termed "borrowing," are better understood as converting non-interest-bearing "green dollars" (bank reserves, notes/coins) into interest-bearing "yellow dollars" (US Treasuries).</p><p>Fiscal deficits, even with bond sales, do not reduce the supply of dollar savings; they increase the <code>net supply</code> of financial assets held by the nongovernment sector. Therefore, deficits cannot be responsible for driving interest rates higher by reducing the supply of savings.</p><p>MMT posits that interest rates are a <em>policy choice</em>, not dictated by private markets for monetarily sovereign nations. When the US government runs a fiscal deficit, it credits private bank reserve balances, increasing the aggregate supply of reserves. Without intervention, this excess supply would drive the overnight interest rate to zero. To maintain a positive interest rate, the Federal Reserve (central bank) either sells bonds (historically, draining reserves) or, as it does today, pays interest on reserves. This means deficits inherently push short-term interest rates down, unless the central bank acts to raise them.</p><p>In the primary market for US Treasuries, primary dealers bid for newly issued government securities. While they express desired rates of return, the Fed ultimately influences the rates. Historically, during World War II, the Fed pegged short-term interest rates at 0.375$500$billion$ to China) and saw the exchange of US wheat for Japanese cars as a loss. However, this perspective could be construed as winning, as America receives more "stuff" (imports) than it sends (exports). This chapter explores the complexities of trade, arguing that it's more nuanced than a simple win-lose scenario.

The Human Cost of Trade

The anxiety surrounding trade deficits often stems from job displacement and community devastation. Trade deals since 1994, such as NAFTA and China's WTO accession in 2001, led to millions of lost US manufacturing jobs and lower wages for those who found new employment. This economic disruption, exacerbated by the Great Recession, created fertile ground for Trump's protectionist message. The Democratic Party's failure to offer a compelling alternative plan alienated many working-class voters.

While Senator Bernie Sanders also advocates for fixing trade policy, MMT argues that a trade deficit is not inherently something to fear, provided the federal government uses its fiscal capacity to maintain full employment domestically. MMT envisions a new world trade order that prioritizes worker standards and environmental sustainability, rather than corporate exploitation. The focus should be on fair trade, not merely eliminating trade deficits.

Three Buckets: The Global Sectoral Balance

To understand trade imbalances, MMT expands the two-bucket model to three: the US government, the US domestic private sector, and the foreign sector. As an accounting identity, the balances of all three must sum to zero. If the US government runs a fiscal deficit (e.g., spending $100$, taxing $90$, leaving $10$ in the private sector), and the US runs a trade deficit (e.g., Americans import $5$, foreigners import $3$, transferring $2$ to the foreign sector), the US government's fiscal deficit ($-10$) is balanced by the sum of surpluses in the domestic private sector ($8$) and the foreign sector ($2$). As long as the US economy is at full employment, this outcome is not problematic.

Since the US private sector typically seeks to accumulate dollar surpluses, and chronic US trade deficits cause dollars to flow out of the private sector to the foreign sector, Uncle Sam must run domestic budget deficits that exceed the trade deficit to prevent the US private sector from falling into deficit. If the government deficit is smaller than the trade deficit, the US private sector will run a deficit, which is often unsustainable for currency users. Ways to address a private sector deficit include increasing government spending/reducing taxes or shrinking the trade deficit. The latter can involve currency devaluation (e.g., Trump's accusations against China, Brazil, Argentina) or "internal devaluation" (structural reforms to reduce labor costs, exemplified by Germany).

Trump's tariffs, aimed at reducing the trade deficit, are largely counterproductive from an MMT perspective. They are a "tax on US benefits" (imports) and fail to address the core issue of job loss. A federal job guarantee, creating good jobs domestically, can mitigate the unemployment caused by trade shocks, making "free trade" less threatening and "trade wars" unnecessary. This allows trade negotiations to focus on global labor and environmental standards.

The Special Position of the US Dollar and Monetary Sovereignty

Since Nixon ended dollar convertibility in the 1970s, the monetary system fundamentally shifted from the gold standard, giving monetarily sovereign countries greater policy space. Under the gold standard, trade deficits led to gold outflows, forcing governments to raise interest rates (often causing domestic recessions) to protect reserves. The post-Bretton Woods system, with floating exchange rates, removed this constraint, allowing governments to prioritize full employment. However, "gold standard thinking" persists in trade policy.

The US dollar's role as the dominant global reserve currency gives the United States unparalleled monetary sovereignty. A vast portion of international contracts are written in USD, even by countries not using it domestically. Japan, the UK, Canada, and Australia also enjoy high monetary sovereignty through nonconvertible fiat currencies and borrowing in their own currency. Countries that peg their currencies (e.g., Venezuela, Niger), abandon national currencies (e.g., eurozone members, Ecuador), or borrow heavily in foreign currencies (e.g., Ukraine, Argentina) compromise their monetary sovereignty and policy flexibility.

Developing economies are typically at the weaker end of the sovereignty spectrum due to reliance on imports (food, oil, medicine, technology) and the need for foreign currency (USD) to pay for them. They often borrow in US dollars and struggle with repayment. American trade deficits, in this context, are not optional for much of the world that must run surpluses with the US. These dollar surpluses accumulate as US Treasuries, which some interpret as US dependence, but MMT clarifies these are simply safe, interest-bearing options for foreign holders of US dollars. The US is not dependent on foreign lenders.

Decisions by the Federal Reserve, particularly regarding interest rates, have profound consequences for developing countries, often without recourse. Volcker's interest rate hikes in the late 1970s, for example, drove Latin American and sub-Saharan African countries into debt crises due to higher borrowing costs and currency depreciations. Post-Bretton Woods international organizations (IMF, WTO, World Bank) shifted to promoting "free trade" and austerity, often recommending policies that reduce rather than enhance developing countries' monetary sovereignty, leading to currency peg collapses, hyperinflation, and increased poverty. This framework, based on extreme interpretations of "comparative advantage," often traps developing countries in low-value-added production, hindering diversified economic development.

Good-bye, Trade War—Hello, Trade Peace?

MMT offers tools to reform global trade, moving beyond the "win-lose" mentality. It recognizes that trade is about power relationships, not just competition. Trump's tariffs, rooted in the trade deficit myth, demonstrate counterproductive outcomes. Instead, the US government, as a currency hegemon, can supply the dollars needed for domestic full employment and global reserves, leveraging its position for a global Green New Deal. It can promote low and stable interest rates for global economic tranquility.

Monetarily sovereign countries can implement job guarantees. Even seemingly financially troubled nations like Argentina successfully implemented the Plan Jefes y Jefas de Hogar Desocupados in 2001, a direct job creation program modeled after MMT principles. This program employed two million people (13% of the labor force) in community projects, reducing extreme poverty and decreasing reliance on foreign capital. Such initiatives, and potentially a global job guarantee, uphold the human right to employment and address the nearly 200 million involuntarily unemployed worldwide.

Reimagining trade policy requires rethinking "free-trade agreements" which current favor wealthy investors over workers and the environment (e.g., investor-state dispute settlement, intellectual property enforcement). The US can lead reforms by demanding strict ecological and labor standards, promoting green technology sharing, and ensuring trade enhances living standards for all. South-South trade partnerships and regulating international capital flows can further strengthen developing countries' monetary sovereignty, reducing their dependence on unstable foreign currency inflows and enabling local, sustainable development, particularly in food and energy.

Ultimately, a global all-hands-on-deck effort is needed to address global poverty, joblessness, and climate change. Trade peace, facilitated by MMT insights, is not merely achievable but necessary for a sustainable and equitable planet.

6 You're Entitled!

For decades, "entitlement" programs like Social Security, Medicare, and Medicaid have been depicted as financially unsustainable, growing too quickly, eating up the federal budget, and on the verge of bankruptcy unless drastic cuts or revenue increases are implemented. Myth #6 states: "Entitlement programs…are financially unsustainable. We can't afford them anymore." MMT argues this is fundamentally incorrect: as federally funded programs, the federal government can always afford to make payments, provided it commits to doing so. The real concern is our economy's long-run capacity to produce the real goods and services people will need, not monetary cost.

Who Are You Calling Entitled?

"Entitlement" programs guarantee benefits to eligible groups (elderly, disabled, poor) by law. These benefits are legally binding obligations for the federal government. Most Americans will benefit from Social Security and Medicare in retirement, or from disability insurance and child assistance. Antipoverty programs also aid millions, as nearly six out of ten Americans will experience poverty between ages 20 and 65. Receiving these benefits is not a moral failing; basic financial security is a right.

Attacks on these programs by self-interested wealthy individuals/corporations (fearing higher taxes) or by ideological opponents (viewing them as wealth redistribution) are frequent. Critics like Senator Alan Simpson have used derogatory terms ("greedy geezers," "milk cow with 310 million tits") to stir resentment and divide generations. Historical caricatures (e.g., "The Insatiable Glutton" for veterans) demonstrate the long-standing nature of such attacks. The "Entitlements" moniker itself has become stigmatized, with the word evolving from "earned entitlements" to an association with "narcissistic personality disorder."

MMT argues that such fear-mongering is unnecessary. It shows why the debate over program sustainability should focus on values and real productive capacity, not a fabricated financial crisis.

The Great Social Security Mistake

Social Security, a monumental success in poverty reduction and economic security, faces constant political attack due to its original funding structure. In 1935, Franklin D. Roosevelt, to protect the program from opponents and instill a sense of earned entitlement, tied benefits to a payroll tax and created trust funds. This led to the misconception that payroll taxes fund benefits and that the federal government needs this money to keep Social Security solvent.

The Board of Trustees evaluates the program's solvency by projecting receipts and expenditures 75 years into the future. Their 2019 report projected that the main trust fund would be exhausted by 2035, legally mandating a 22% cut in benefits. This is a fundamental mistake: Congress, which created this legal constraint, could simply change the law with a single vote, and the financial "crisis" would disappear. MMT highlights that a currency-issuing government is never financially constrained in its own unit of account.

Perpetrators of the debt myth, like Marc Goldwein of the Committee for a Responsible Federal Budget, leverage these projections to claim Social Security is in "crisis" or headed for "catastrophe." Economists like Laurence Kotlikoff even extend these projections to an "indefinite future," arriving at astronomical "unfunded obligations" of $43$ trillion, claiming the program is "bankrupt 'to infinity and beyond!'"

Past projections have led to benefit cuts, such as in the 1980s (delayed cost-of-living increases, taxed benefits for high-income earners, and a gradual raising of the retirement age from 65 to 67, effectively cutting total benefits by 30% for early retirees). Even Democrats, like President Bill Clinton (who reportedly sought a compromise to cut Social Security/Medicare with Newt Gingrich) and Al Gore (who proposed a "lockbox" for surplus dollars), have fallen prey to the funding myth. Gore's lockbox was mocked by George W. Bush as a "cabinet full of IOUs," who then attempted privatization. President Obama also proposed benefit cuts via the "chained CPI."

Means-testing benefits is another proposed cut, but it would undermine Social Security's universal support and conflates an accounting problem with a financing problem. The fact that Medicare Parts B and D are deemed "adequately financed into the indefinite future" solely because "current law provides financing" demonstrates that the issue is legal authority, not financial ability. MMT shows that Congress could extend this same legal authority to Social Security and Medicare's Hospital Insurance fund, resolving their "crisis."

Fearmongering about Social Security's insolvency is taking a toll on younger generations, despite the program's increasing importance amid a growing retirement crisis. The disappearance of reliable defined-benefit pensions and stagnant wages have left millions with insufficient savings. Women and racial minorities are disproportionately affected by this "savings deficit." Social Security, which lifts 15 million older Americans and 1 million children out of poverty, is crucial. The constraints are political, not economic.

Other Entitlements Are Also in Danger

Similar misguided arguments plague other entitlement programs. Historically, entitlements (e.g., Civil War pensions) have constituted a significant portion of federal spending. Opponents, from Senator Daniel Hastings (fearing "socialism") to Ronald Reagan (resisting Medicare), have consistently attacked these programs. More recently, critics cite rising healthcare costs and "aging baby-boomers" as reasons for program unsustainability, calling for cuts or tax increases based on the "dependency ratio" (workers vs. beneficiaries).

MMT refutes these claims. The concern should be the economy's real productive capacity to deliver healthcare services and goods, not monetary affordability. The claim that Americans are living longer is also inaccurate overall, with life expectancy declining due to "deaths of despair" and other factors. Significant disparities in life expectancy are tied to income and race, highlighting issues of social justice.

The ongoing demonization of entitlement beneficiaries (e.g., Reagan's "welfare queen" stereotype, exaggerated claims of disability fraud) aims to sow shame and resentment. Peter G. Peterson, a billionaire budget hawk, funded a massive public relations campaign to undermine support for these programs, advocating for cuts and privatization. Obama's Deficit Commission, while bipartisan, also had ties to Peterson's funding and agenda.

How We Should Talk About Entitlements

The key is to distinguish among three issues when discussing entitlements:

1. Government's financial ability to pay: For monetarily sovereign countries, this is never in doubt; they can always afford payments in their own currency.

2. Legal authority to pay benefits: This is a man-made constraint. Congress can modify laws to ensure payment, as it does with Medicare Parts B and D. This is a political choice, not an economic one.

3. Economy's productive capacity to deliver real program benefits: This is the true limit. An aging society requires ensuring enough doctors, nurses, hospital beds, and consumption goods can be produced to meet demand without causing inflation.

Economists like Alan Greenspan (in testimony to Paul Ryan) and Robert Eisner acknowledged that the federal government can always create money to pay for Social Security. Eisner specifically pointed out that trust funds are "merely accounting entities" and that Congress can ensure their solvency (and thus legal authority) by simply committing to payments or even adjusting interest rates on government bonds held by the funds. The current focus on cutting benefits or raising taxes to "shore up" the system is misplaced.

To prepare for an aging population, the US needs to invest in training more medical professionals, building assisted living facilities, and improving infrastructure and education. This boosts productive capacity and mitigates inflation risks arising from increased demand for scarce resources. The debate should shift from "How will we pay for it?" to "How will we resource it?" Social Security and Medicare are crucial for financial security and dignified retirement, and are affordable if we prioritize them and manage our real resources effectively. The "war on entitlements" is rooted in outdated monetary thinking, hindering a deeper discussion about societal values and available resources.

7 The Deficits That Matter

Stephanie Kelton's arrival in Washington in 2015, during the slow recovery from the Great Recession, underscored the pervasive "deficit myth." Both Democrats and Republicans, despite their political differences, operated under the false premise that the federal government was cash-constrained, leading to endless debates about tax cuts versus spending cuts to address a perceived fiscal crisis. Kelton, as Chief Economist for the Senate Budget Committee Democrats, felt frustrated by this "pointless exercise."

She realized that a "deficit is merely a gap between what we have and what we need." While the government's fiscal deficit was not a concern for a currency issuer, America faced immense deficits in genuine human needs: good jobs, healthcare access, quality infrastructure, a clean environment, and a sustainable climate. This led to a pivotal moment where Senator Bernie Sanders adopted Kelton's reframing of the discussion, focusing his remarks during a CBO hearing on "the deficits that really matter," rather than projected fiscal shortfalls. This shift, highlighted by a headline in The Hill, challenged the prevailing narrative that prioritized abstract ledger entries over the needs of people.

The Good Jobs Deficit

America faces a severe "good jobs deficit." The closure of manufacturing plants (like GM in Lordstown, Ohio) due to trade deals (NAFTA, WTO) and the 2008 financial crisis led to millions of lost well-paying jobs. Public sector jobs also declined. While unemployment rates have recovered (e.g., 3.7% in early 2020), job growth is heavily concentrated in low-skill, low-paid occupations (e.g., food service, retail). Millions struggle to survive on meager wages (e.g., $8.25$/hour in Illinois, $7.25$/hour federal minimum), with 40% unable to cover a $400$ emergency. Real wages for average workers have only grown 3% since the 1970s, and fallen for the bottom fifth.

This decline in job quality is linked to weakened unions and employers using tactics like outsourcing and franchising to keep wages low. Geographic disparities also exist, with job growth concentrated in urban areas, leaving rural communities devastated. "Underemployment," where skilled individuals must take lower-paying jobs, is rampant, affecting mental and physical health. The US lags behind European countries in employment and lacks mandated paid leave. MMT argues that since the federal government controls the money supply, there's no reason why every job cannot be a good one, with dignified pay and benefits. A federal job guarantee (discussed in the next chapter) could set a minimum standard, eliminate unemployment, raise incomes, and improve quality of life.

The Savings Deficit

The "good jobs deficit" creates a "savings deficit." Many Americans, burdened by student debt and rising costs of healthcare and education, are unable to save for retirement. Studies show a significant portion (21-45%) of working-age Americans have zero retirement savings, with median balances being very low for those who do. Low incomes and high bills are the primary culprits. Nearly two-thirds of Americans fear outliving their savings, and many over 65 are still working.

This contrasts with earlier generations who enjoyed defined-benefit pension plans and greater economic security. The shift from defined-benefit to defined-contribution plans (e.g., 401(k)s) in the 1980s, coupled with wage stagnation and rising costs, has eroded retirement security, particularly for lower-income workers, women, and racial/ethnic minorities. Many families are caught in a "two-income trap," with both parents working to cover basic costs while accumulating debt (student loans, auto loans, credit card debt). This exacerbates existing inequalities.

MMT provides solutions: eliminating the deficit myth around Social Security allows for expanded benefits. A federal job guarantee, student debt cancellation, and free/affordable childcare can free up income for savings and homeownership. The focus is on building an economy where families can save, not just encouraging them to save when they lack the means.

The Health-Care Deficit

America's "health-care deficit" costs lives. US life expectancy, once highest among developed nations in 1970, now lags behind most OECD members, with higher infant mortality rates. Longevity varies significantly by socioeconomic status and race (e.g., the wealthiest men live 15 years longer than the poorest). Despite spending more per capita ($10,586$) than any other developed country (e.g., Canada: $4,974$), $28.5$ million Americans lack health insurance, and $87$ million are uninsured or underinsured, a number that is declining due to weakening of the Affordable Care Act.

High deductibles (e.g., over $6,000$ for an individual bronze plan) and copayments force many insured to forgo necessary care. Medical debt pushed 8 million people into poverty in 2018, and 137 million faced tough choices due to it. Medical debt is also a top reason for cashing out retirement accounts, linking health and savings deficits. Many skip doctor visits or prescribed medications due to cost. The fragmented system of private insurers, employer plans, and patchwork government programs creates bottlenecks, prioritizing profits over accessible care.

MMT recognizes that financial affordability is not the constraint. The real challenge is ensuring sufficient real resources (doctors, nurses, facilities, equipment) to meet demand. Closing the health-care deficit requires investments in training, infrastructure, and research, and an economy that makes medical professions affordable (e.g., debt-free education). This would involve a shift from simply providing monetary coverage to ensuring the material capacity for care.

The Education Deficit

The "education deficit" starts early and persists. Disparities in K-12 funding, heavily reliant on local property taxes, create unequal opportunities (e.g., wealthy suburban schools outperforming urban ones). The credentialing system pressures students into endless pursuit of college degrees for increasingly common jobs, exacerbating student debt and contributing to the good jobs deficit. Spiraling college costs mean the average borrower from the class of 2017 owes $28,650$, with higher figures for private and for-profit institutions. Students of color are disproportionately affected by increased debt and dropout rates, often citing high costs.

This leads to $45$ million Americans burdened with $1.6$ trillion in student loan debt, limiting their financial freedom (e.g., delaying homeownership, family formation). Federal Reserve Bank of New York estimates suggest as much as $333$ billion in delinquent student loans. The promise of college as a path to higher lifetime earnings is increasingly broken, with wages for 60% of college graduates lower than in 2000. Incomes for college graduates have stagnated while costs have soared, forcing people to pile on debt merely to maintain their economic standing.