The weight of evidence for an extraordinary claim must be proportioned to its strangeness. – Pierre-Simon Laplace
A strange and extraordinary claim is currently doing the rounds in the halls of power and academia. The claim is part and parcel of the emerging school of Modern Monetary Theory (MMT) and is packed in the short meme “Taxes Don’t Fund Spending”. You read it well. It basically covers the idea that states with their own sovereign money system spend money created out of nothing (and can not go bankrupt) and when people pay their taxes, money gets destroyed.
A strange and extraordinary claim is currently doing the rounds in the halls of power and academia. The claim is part and parcel of the emerging school of Modern Monetary Theory (MMT) and is packed in the short meme “Taxes Don’t Fund Spending”. You read it well. It basically covers the idea that states with their own sovereign money system spend money created out of nothing (and can not go bankrupt) and when people pay their taxes, money gets destroyed.
What we should be looking for as proof for this MMT hypothesis and extraordinary claim is something similar to the overwhelming evidence developed for the other big, strange claim by Post-Keynesians, MMT-ers and Sovereign Monetary Reformers, that “Deposits Don’t Create Loans” or the credit creation theory of money and banking (Werner, 2014). Again, you read it well. The idea is that, when banks originate a loan, they create out of nothing the money by crediting the borrower’s account and destroy money when the principal is paid back.
Both are similar, strange, counter-intuitive claims which do not accord with folk economics, i.e. the average, popular understanding of money and banking based on the idea that a bank or a state just cannot loan out or spend money it doesn’t have. And it is not only ordinary folk who believe this, but also a majority of politicians and economists.
But the “Deposits Don’t Create Loans” claim has the advantage that it has been proven and / or admitted and / or adhered to now by a vast amount of specialists and financial institutions.
Below is a list of sources backing that claim. There are economists, social scientists, commercial and central banks, a rating agency and government commissioned research reports all backing the claim. As far as I can tell, the most important ones are Moore (1988), Wray (1990), Graziani (2003), McLeay (2014), ECB (2015) with Werner (2014) providing a dramatic, detailed, empirical proof following the steps in a specific bank when it originated a loan. Quite a weight of evidence, to say the least.
What I miss is a similar amount and strength of proof from diverse corners (national treasuries, budget administrators, tax experts, government economists, etc.) to back up the claim that “Taxes Don’t Fund Spending”. Most writers making the claim refer back to Stephanie Kelton’s 2000 paper, “Do Taxes and Bonds Finance Government Spending?”, in which she presents it as the product of an “intuitive analysis of Treasury operations” (613)*. For me, an ‘intuitive analysis’ is only a first step to evidence and not unlike the formation of a hypothesis, which still has to be tested.
I found only one bank-based economist who, while critiquing MMT, seems to admit that states do, in extraordinary circumstances like war, first spend without concern if the money is already available from taxation or bonds (Every, 2019)**.
* Bell [Kelton], Stephanie. 2000 “Do Taxes and Bonds Finance Government Spending?”. Journal of Economic Issues, 34/3: 603-620.
** Every, Michael. 2019. “Mmm…MMT“. Utrecht, Netherlands: Rabobank/RaboResearch, 15 April 2019.
A. Economists
Graziani, A. 2003. The Monetary Theory of Production. Cambridge, UK: Cambridge University Press.
McMillan, Jonathan. 2015. The End of Banking: Money, Credit, and the Digital Revolution. Zurich, Switzerland: Zero/One Economics .
Moore, B.J. 1988. Horizontalists and Verticalists: The Macroeconomics of Credit Money. Cambridge, UK: Cambridge University Press.
Rochon, Louis-Philippe & Rossi, Sergio (Eds.). 2015. The Encyclopedia of Central Banking. Cheltenham, UK & Northampton, MA: Edward Elgar Publishing.
Schumpeter, Joseph. 1954. History of Economic Analysis. London: Allen and Unwin.
Werner, Richard A. 2014. “Can banks individually create money out of nothing? The theories and the empirical evidence”. International Review of Financial Analysis, 36 (2014): 1–19.
Wray, L.Randall. 1990. Money and Credit in Capitalist Economies: The Endogenous Money Approach. Aldershot, UK and Brookfield, USA: Edward Elgar Publishing.
B. Commercial Banks
Rabobank (Netherlands): Boonstra, W.W. 2015. “Hoe werkt geldschepping?” Rabobank Special, 21 May 2015. Utrecht.
BNP Paribas (France): Quignon, Laurent. 2019. “Money Creation: How Does It Work?” BNP Paribas, 19 Feb 2019.
C. Central Banks
Federal Reserve Bank of New York: Holmes, Alan. 1969. “Operational constraints on the stabilization of money supply growth“. Controlling Monetary Aggregates (1969): 65-77.
Bank for international Settlements. Borio, Claudio and Piti Disyatat. 2009. “Unconventional monetary policies: an appraisal”. BIS Working Paper no. 292, November 2009.
European Central Bank: Constancio, Vitor. 2011. “Challenges to monetary policy in 2012.” Speech at 26th International Conference on Interest Rates, Frankfurt am Main. Vol. 8. 2011.
European Central Bank. 2015. “What is Money“. European Central Bank, 24 Nov 2015.
Bank of England: McLeay, Michael & Radia, Amar & Thomas, Ryland. 2014a. “Money Creation in the Modern Economy”. Monetary Analysis Directorate. Bank of England Quarterly Bulletin (Q1, 2014): 14-27.
Bank of England: McLeay, Michael & Radia, Amar & Thomas, Ryland. 2014b. “Money in the modern economy: an introduction”. Monetary Analysis Directorate. Bank of England Quarterly Bulletin (Q1 2014): 4-13.
Bank of England: Jakab, Zoltán & Kumhof, Michael. 2015. “Banks Are Not Intermediaries of Loanable Funds–And Why This Matters”. Bank of England Working Paper 529 (London).
Bank of England: Jakab, Zoltan, and Michael Kumhof. 2018. “Banks are not Intermediaries of Loanable Funds—Facts, Theory and Evidence“. Bank of England Working Paper No. 761, 26 Oct 2018.
Deutsche Bundesbank. “How Money is Created”. Topics. 4 Apr 2017.
International Monetary Fund: Jakab, Zoltan & Kumhof, Michael. 2014. “Models of Banking: Loanable Funds or Loans that Create Funds?“. International Monetary Fund.
International Monetary Fund: Kumhof, Michael & Jakab, Zoltán. 2016. “The Truth about Banks”. Finance and Development. IMF Publication (March 2016).
Dutch Central Bank: De Nederlandsche Bank. 2016: “Central Banks Keep Finger on Money Creation Pulse”. DNBulletin, 19 Aug 2016.
D. Social Scientists
Huber, Joseph. 2017a. Sovereign Money. Beyond Reserve Banking. London: Palgrave Macmillan.
Ingham, Geoffrey. 2004. “The Emergence of Capitalist Credit Money.” In L. Randall Wray (Ed.), Credit and State Theories of Money: The Contributions of A. Mitchell Innes. Edward Elgar. 173-223.
Yamaguchi, Kaoru. 2004. “Money Supply and Creation of Deposits: SD macroeconomic modeling (1)”. In Proceedings of the 22nd International Conference of the System Dynamics Society, Oxford, England, 2004. The System Dynamics Society.
E. Government Commissioned Research
Sigurjonsson, Frosti. 2015. “Monetary Reform: A Better Monetary System for Iceland“. A Report Commissioned by the Prime Minister of Iceland. March 2015. Foreword by Aidar Turner. Rekjavik, Iceland.
WRR. 2019. Money and Debt: The Public Role of Banks – Summary of WRR Report. The Hague: Netherlands Scientific Council for Government Policy.
F. Philosopher
Bjerg, Ole. 2014. Making Money: The Philosophy of Crisis Capitalism. London & New York: Verso.
G. Rating Agency
Sheard, Paul. 2013. “Repeat after Me: Banks Cannot and Do Not Lend Out Reserves”. Standard and Poor’s Rating Service, 2013: 1–15.
Updated on October 20, 2020
The MMT claim that taxes don’t fund federal government spending can be broken into parts. Part of the claim is that unlike lower levels of government and everyone else, the federal does not have to get dollars before it can spend them. I think this can be proved. When the government runs budget deficits, it appears to borrow dollars by selling securities. If, however, it just recycled the same number of dollars back into the economy that it appeared to take out with the sales, it would not add more and the spending could not be inflationary. But deficit spending may be inflationary, so new… Read more »
Thanks, Govert and AFJM for positing for consideration and discussion one of MMT’s more outrageous monetary-economic postulations – being the one that “TAXES DO NOT FUND SPENDING”. To begin, important that this is NOT anything to do with Post-Keynesian Economics, the bonafide safe harbor for most MMTrs. This is pure Moslerian Economics, and if you think about the history of P-K Economic leadership, the exact opposite of their Philosophy…. to wit, Government MUST spend more in times of downturns, and do so by EITHER deficit spending, OR by “printing the money” . EVERY noteworthy P-K Economist occupied that monetary-economic Fiscal… Read more »