Printing money to fix problems ain’t the free lunch it seems

Inflation is caused when the demand for real (that is, tangible) resources runs ahead of the supply of real resources, thereby causing prices to rise.

So, even though people spending the money you’ve created will add to the demand for real resources, this won’t cause inflation provided you do it when demand is weak. Only when you reach the point where demand catches up and overtakes supply will you have a problem with inflation.

That’s the purely pragmatic reason most economists disapprove of MMT. Once politicians had the idea they could keep spending without worrying about debt and deficit, how would you get them to stop adding to inflation by continuing to create money rather switching back to borrowing and paying interest?

How would you get them to do what Chalmers is doing as we speak: looking at all the spending plans of his Liberal predecessors that aren’t sensible and stopping them, so as to make room for Labor’s own spending plans?

Even so, as the econocrats would prefer me not to point out, the MMT brigade has had a qualified win. As part of the Reserve Bank’s resort to “unconventional” monetary policy during the pandemic – aka “quantitative easing” – it has bought more than $350 billion-worth of second-hand government bonds.

Bonds it paid for merely by crediting the “exchange-settlement accounts” that each of the banks it bought the bonds from has with the central bank.

Why all this fuss about budget deficits? Who said the shortfall between what a government spends and what it raises in taxes must be covered by borrowing from the public? That’s just a rule someone made up.

So indirectly, the Reserve has done what the MMT people say it should have done: covered about $350 billion of budget deficits by creating money.

This means $350 billion of the government’s $1 trillion debt – and the related interest payments – is owed to the Reserve Bank, which just happens to be owned by the government. Roughly a third of the government’s debt is owed to, and must eventually be repaid to, itself.

So, the government’s liability is cancelled out by its subsidiary’s asset. That’s what I wrote a few weeks’ ago, and it’s true. But, as some fossilised central banker explained to me, it’s not the whole truth.

When you trace through all the double-entry bookkeeping, you see that the created money the Reserve paid into the banks’ exchange-settlement accounts in return for the bonds it bought is still sitting there. It’s still a liability on the Reserve’s balance sheet, and an asset on the banks’ balance sheets.

That money is part of what monetary economists call “base money”. Base money consists of all the “currency” – notes and coins – issued by the central bank, plus all the money the banks are holding in their exchange-settlement accounts at the central bank.

And the trick to base money is that its quantity can be changed only by a transaction with either the government or the central bank on the other end of it. That is, nothing anything any person or business or even a bank can do of their own volition can change the quantity of base money.

It’s true that bank A and bank B can do a deal that reduces the balance of bank A’s account – but only by increasing bank B’s balance by the same amount. That is, the banks can move base money around between themselves, but they can’t change the quantity of base money held by the banks as a whole.

OK, but why is this a problem? Because the banks have money they own stuck in bank accounts with the central bank, on which it pays little or no interest. They’d like to lend it to someone else at a much higher interest rate.

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So they’re tempted to enter highly contrived, highly risky arbitrage arrangements which involve borrowing short-term and lending long-term. The Yanks call this “picking up dimes in front of a steamroller”.

It’s fine until there’s a financial crisis, which brings down banks and does huge damage to the rest of the economy, as we saw with the global financial crisis of 2008. Yet another case of there being no free lunches.

Ross Gittins is the economics editor.