Can Uncle Sam Afford Any Amount of Spending?

In 2019, Congresswoman Alexandria Ocasio-Cortez introduced the Green New Deal, with a price tag estimated at trillions to possibly tens of trillions of dollars. When asked whether Washington could afford the Green New Deal, Ms. Ocasio-Cortez said Modern Monetary Theory (MMT) showed that we could.

In recent years MMT has received considerable attention. The theory was first expounded by investor Warren Mosler and expanded by academic economists. Stephanie Kelton of Stony Brook University offers an accessible presentation in The Deficit Myth. Does MMT really overturn how we think an economy works?

MMT begins with the observation that, in Professor Kelton words, “Uncle Sam will never go broke.” Because of monetary sovereignty, the Federal government does not face the financial constraints of a household or business. Consequently, Kelton claims that Congress could “advance legislation – today – aimed at raising living standards and delivering the public investments in education, health care, and resilient infrastructure that are critical for our long-term prosperity.”

Evaluating this claim requires unpacking the three components of monetary sovereignty. First, a nation must issue its own currency, so countries using the Euro do not qualify. Second, the currency must not be tied to gold, silver, or anything the government might run out of. The U.S. has met this since President Nixon ended international convertibility of the dollar in 1971. Finally, a government must borrow in its own currency. Latin American nations, which can only borrow in U.S. dollars fail here.

Yes, a nation with monetary sovereignty can always pay its debts by creating more currency. This observation, however, is not new. James Buchanan and Richard Wagner observed in Democracy in Deficit in 1977 that such monetization was the likely consequence of excessive borrowing by Washington, not default.

Professor Kelton rightly observes then that “For evidence of overspending, look to inflation.” But I think she ignores that a government’s ability to borrow depends on whether they intend to use money creation. Investors only lend to Venezuela in dollars because they fear being repaid with newly minted stacks of Venezuelan Bolivars. No immutable economic law requires that investors willingly purchase Treasury securities.

Money creation by government also has a moral dimension. You or I can only get dollars by giving up something of value: either our time working for someone, or some possession with market value. Uncle Sam as a currency issuer can create money out of paper and ink, or by changing account balances. Proponents of the gold standard view government money creation as the moral equivalent of counterfeiting.

When does government spending produce inflation? Macroeconomics textbooks say when an economy is at full employment. Government spending can increase output when an economy is in a recession but primarily increases prices at full employment.

MMT defines full employment differently from the mainstream. The conventional economic definition allows for some churn in the job market and measured unemployment of perhaps 5 percent while taking the labor force participation rate (currently 62 percent) as given. MMT sees millions of idle workers at “full employment,” so only prodigious government spending is likely to produce inflation.

Should inflation become a problem, MMT proposes checking it through taxation. Again, there’s some truth here. Inflation is too many dollars chasing the available goods and services. Taxes can take dollars out of circulation, reducing inflationary pressure.

Professor Kelton further claims that government does not need to tax or borrow before it can spend, which makes spending seem like it is free. Yet she acknowledges that Uncle Sam must get control of resources to provide things like free college and free health care. The use of government coercion to take control of resources out of the private sector is still “paying” for spending.

For thirty-five years, some politicians have simply said, “we cannot afford that” instead of arguing against increased spending on healthcare, childcare, or education. Yet Uncle Sam has never been as broke as fiscal conservatives imply. Predictions of imminent national bankruptcy have primed people to accept MMT’s claim that we can afford any spending program Congress wants.