Perhaps the most interesting thing about economics is how things at the personal level are often at direct odds with what works at the group level and vice versa.
Quoting Milton Freedman from his 1977 Money and Inflation talk:
The great mistake that many make is confusing what's true for the individual with what's true for the society as a whole
Something I hear from time to time is people talking about how the government budget is balanced or not.
In your personal life a balanced budget is important, specifically if you spend more than you make you likely will find yourself facing issues.
But what about at a government level? What about for any organization that can issue currency?
You'll notice that a balanced budget just isn't the same for any entity that can issue currency. Such an entity can attempt to pay its liabilities with freshly printed currency. In essence what they are doing is creating inflation in the broader system to pay their liabilities. We have seen this sort of situation lately with the LUNA crypto currency, which shows that if too currency issuance is made eventually the currency itself hyperinflates and becomes entirely worthless. So there is a cap on how much new currency creation can be done before a currency ceases to be useful. Cryptocurrencies with their technology and lack of regulation provide for a good example since things can happen in far quicker calendar time frames than in other areas.
Many governments (but not all) have the ability to issue new currency 1. Some organizations with banking privileges also have the ability to issue new currency. For these organizations a balanced budget starts to look very different to anything that anyone in their day to day life deals with. So stark is the difference that if any ordinary citizen were to create new currency to pay their liabilities they would literally be jailed for counterfeiting. I think there's a genuine question to be asked if at the organizational level this should also be considered counterfeiting, whatever the answer is best there just isn't being discussed much. Again many of these discussions don't happen because the idea that the group level and the individual level operate in completely different ways is not something that people tend to think about much.
Put simply if a government spends more than it takes in tax revenue the ability to make this spending has to come from either loans or currency creation. If the spending is funded by the creation of new currency the result will be inflation because the government spending will find its way into the broader economy and will increase the aggregate amount of currency in circulation.
Loans are slightly more complex but similar dynamics apply. If for example you have loans as an individual the interest payments or loan servicing payments take away from the rest of your budget which means you have less monet to spend on other things. This personal perspective is often extrapolated to look at the systems level as though the increased debt levels mean it's more expensive to service the debts and hence creates deflationary pressures as the currency that was created in the process of the loans starts to get destroyed as the loans are repaid while less economic activity occurs hence reducing velocity. This intuition is solid as long as the loans are not paid off by issuing more currency, if more currency is issued to service debts then higher debt levels mean more inflation. If the government takes in money as loans then that currency ends up getting distributed to the rest of the economy, this will increase monetary velocity at least initially.
The Modern Monetary Theory crowd goes one step further by directly building on the concept that a government budget, in reality, is always balanced. They do this by outright rejecting any attempts to keep a stable supply of money when creating a government budget. The idea they have is that the government can fund itself partially through inflation and can also control inflation by creating surpluses or deficits since those will drive changes in the overall quantity of currency in circulation. The reason many people find it hard to understand inflation and related concepts like MMT is because they assume based on their personal experiences that a budget must balance. Perhaps a difficulty from the personal level that does carry over to the broader level is that of psychology. If you find some way in which you can magically just pay for everything without being the one who directly foots the consequences this can dramatically change your behavior. This psychological shift can fool people into thinking that no scarcity exists and the results of such a misconception can be quite bad in the long term.
Monetary policy is a huge issue in the Euro zone, this is because there's a central monetary authority but the individual member states have different governments with different policy goals. There's a sizeable mismatch here that has led to many crisis situations, particularly notable was the Cypriot and Greek financial crises. Greece was facing a financial crisis but was also a member of the euro zone, this meant that there were conflicting interests with monetary policy, the Greeks needed one thing while the Eurozone and in particular Germany wanted something else. ↩
This post is part 14 of the "MonetaryPolicy" series:
- Finally getting around to publishing some monetary policy articles
- Fast things happen slowly then quickly
- Politics of unproductive debt
- Futures markets lower prices, both in good and bad ways
- Why do stable coins matter
- Why is so much financial advice bullshit
- Bank bail ins
- Where is money created
- Bastiat on legal systems and morality
- Transitory inflation means permanent purchasing power reduction
- Problems with Celsius
- Crypto's Lehman moment
- Crypto crash update May 2022
- The myth of the unbalanced government budget *
- The 2006 debasement of NZ coinage
- Demand destruction anecdotes