In The Deficit Myth, economist Stephanie Kelton—a former Senate Budget Committee staffer and 2016 campaign adviser to Bernie Sanders—writes that nearly all of the public discourse about national debts and deficits gets the facts entirely wrong.
A leading proponent of the heterodox economic school of thought known as Modern Monetary Theory (MMT), Kelton argues that it is incorrect to think of the U.S. federal government as “needing” money to pay for its spending. Because the government is the sole supplier of U.S. dollars, it can simply create them anytime it needs more dollars to pay for something.
This idea of the federal government as a currency issuer instead of a currency user is central to The Deficit Myth, in which Kelton champions more aggressive deficit spending by arguing that the U.S. government could finance any program it wishes to create. Kelton advocates a more holistic view of the economy—arguing that we ought to focus on poverty reduction, combating climate change, and building a more just and equitable society as the true measures of economic success, rather than focusing solely on the narrow budgetary impacts of legislation.
Kelton’s argument rests on these key principles:
In this guide, we’ve consolidated some of Kelton’s logical structure and omitted some anecdotal details (many of them related to her experiences working on the Senate Budget Committee) to focus on the main arguments. In particular, we streamlined and eliminated some sections (related to debunking myths about federal borrowing “crowding out” private borrowing and about the need to tackle non-fiscal deficits our society faces) because these were tangential to the main thrust of the book. We’ve also added perspective from other economic experts—including some voices from outside the MMT community who question Kelton’s theories—in order to present a more nuanced and balanced view of the economic ideas in the book.
Criticism and Praise for The Deficit Myth
The Deficit Myth is a controversial book in the economics world and has drawn a fair number of critics and detractors since its publication in 2020.
A Wall Street Journal review claimed that Kelton offers little evidence for her view that there is always slack—in other words, unemployed labor or idle capital—in the economy, and that therefore new federal spending will almost never lead to inflation. The Journal review also observed that Kelton offered no hard numbers for just how much the robust spending programs she champions (including a federal job guarantee, nationwide infrastructure package, and free college tuition) would actually cost—leading the reviewer to doubt that the country has enough untapped capacity to finance these programs without sparking runaway inflation. Finally, the review noted that Kelton cites no works of serious scholarship to support her ideas and ignores historical examples in which economic doctrines similar to hers were tried and did indeed result in inflation, depression, and unemployment.
However, The Deficit Myth also received its share of praise. The London School of Economics Review of Books celebrated Kelton’s work as a paradigmatic shift in economics thinking—shattering the idea that fiscal deficits are inherently irresponsible and moving the conversation toward an acceptance of deficits as a necessary (and possibly even morally righteous) tool for creating a better society.
About Modern Monetary Theory
Most of Kelton’s arguments in The Deficit Myth are derived from the emerging economic school of thought known as modern monetary theory (MMT). Since MMT is the intellectual framework for Kelton’s work, it’s worth exploring in a bit more detail just what MMT is.
MMT is a controversial and iconoclastic economic theory holding that nations like the United States, Canada, the United Kingdom, and Japan (to name just a few) are almost entirely unconstrained in their power to spend—regardless of how much revenue they receive in taxes. This is because these nations are what MMT proponents call monetary sovereigns: They are monetary sovereigns because their currencies satisfy the following criteria:
They are fiat currencies that are not tied to the value of some finite physical commodity like gold or silver.
They are issued solely by the government’s monetary authority—that is, they are not controlled by some external entity over which the government has no control (as in the case of the euro, which is issued by the European Central Bank, not by the governments that use it), nor are they pegged in a fixed ratio to a foreign currency over which the government has no control (as is the case with Caribbean countries like Aruba, the Bahamas, Barbados, and Bermuda, which stabilize their currencies by maintaining fixed exchange rates with the U.S. dollar).
Monetary sovereigns, according to MMT, have the ability to create their own currency and issue it in almost-unlimited quantities. Functionally, this means that they cannot “run out” of money, nor can they ever lack the necessary funds to finance whatever the government wishes to do—whether that’s establishing a universal health care system, a jobs guarantee, or increased military spending.
MMT takes this argument a step further, arguing that taxes levied on private individuals and businesses don’t exist to provide “revenue” that “pays for” government spending—instead, all money in private circulation is really just the money that the government chose not to tax. Taxes instead exist to create an incentive for the population to demand dollars—and, in the process of earning those dollars, to engage in socially beneficial activities (like creating jobs, providing health care, and educating children).
Besides Kelton herself, intellectual leaders of the MMT school include the economist and hedge fund manager Warren Mosler; economist and academic L. Randall Wray; and economist and activist Bill Mitchell. The theory has been criticized by mainstream economists such as Nobel winner Paul Krugman, who argues that MMT overstates the usefulness of fiscal policy (government taxing and spending) and ignores the power of monetary policy (managing the money supply through controlling interest rates). In particular, MMT critics argue that when interest rates are above zero (meaning the monetary authority has room to maneuver to bring them lower), full employment can be achieved by lowering interest rates without the need for high deficits. They also argue that high deficits will, over time, lead to high interest rates, which will have the effect of damping private sector investment.
Kelton objects to the way politicians often compare the federal government’s finances to that of a household.
These politicians claim that just as a family must be careful of how much it earns in income and how much it spends, so must the government keep careful watch over how much money it takes in in taxes against how much money it spends on social programs, military expenditures, and other programs.
According to this line of reasoning, the government can’t consistently spend more than it earns in taxes, or else it will wind up in the same financial straits as a household would—an endless cycle of debt, escalating borrowing costs, cash shortages, and ultimate financial ruin.
Kelton writes that while this argument sounds intuitive, practical, and reasonable, it is based on an entirely false premise. In reality, the federal government’s finances are nothing like those of a household and operate under an entirely different set of rules.
Some commentators go a step further and note that the “government as a household” metaphor fails even on its own terms because having a negative net worth isn’t necessarily bad even for most households.
For example, most households that have a home mortgage are technically underwater, financially speaking—their net debt outweighs their net assets. Yet, few would think of having a mortgage as an irresponsible or reckless thing to do, because owning a home is, in the long run, a net gain for your financial position—it is an asset that you can leverage and it builds wealth for you and your family. Similarly, some argue that public debt should be looked at as an investment or down payment on things that will ultimately make our society richer and happier, like health care, education, energy, and infrastructure.
Why doesn’t the U.S. federal government have to balance its budget like a private household? Why doesn’t it have to worry about its debt load and spending decisions the way an individual or business does?
According to Kelton and other proponents of MMT, this is because the United States is a monetary sovereign. A monetary sovereign is a country that is the sole issuer of its own currency and that does not borrow excessively in foreign currency or peg the value of its currency to something that it doesn’t directly control—like gold or another country’s currency.
Because these countries can just create money whenever they need it, they are generally unconstrained in their spending decisions, and they don’t need to balance their budgets and keep debts and deficits low—they can simply create more money and wipe the debt clean or balance the budget anytime they choose to. Thus, anytime the federal government needs more dollars to meet some obligation—like to finance a new spending bill passed by Congress or to pay the interest on the national debt—it can simply create the money at will.
Monetary sovereignty is a power that no private business, household, or individual has (nor do state or local governments). Therefore, according to Kelton, the “government as a household” analogy has no grounding in reality. Any purely fiscal constraints the federal government faces are entirely political and self-imposed.
Hyperinflation: The Danger of Money Printing
Kelton’s arguments are contested by other economists. They point to the historical examples of Zimbabwe during the 2000s and Germany during the 1920s to demonstrate that governments creating too much money with no actual economic activity to support it leads to hyperinflation—unsustainable rises in prices caused by too much money chasing too few goods. Eventually, the hyperinflation problem can spiral out of control, with prices rising astronomically within days or even hours—such that money ceases to lose all value and becomes entirely unreliable, with people reduced to bartering for basic goods. If a currency becomes too undervalued, foreign investors will refuse to deal in it, causing its value to fall even further and making it impossible for people to exchange it for other currencies—in effect, making it impossible for people to purchase goods and services from abroad.
(Shortform note: Some argue that cryptocurrencies like Bitcoin and Ethereum could potentially undermine monetary sovereignty. Without proper oversight and regulation, the free flow of non-state-issued digital currencies would put Bitcoin miners in the currency-creation role that central bankers currently occupy. As the ratio of cryptocurrency to traditional currencies grows, state actors like central bankers and treasuries would lose the ability to exert control over the total volume of money in circulation. The problem is compounded when one considers the fact that cryptocurrencies are uniquely vulnerable to wild value fluctuations, cyber attacks, and speculative bubbles, all of which could spill over into the non-crypto, “real” economy—with central banks having little ability to exert control.)
Kelton writes that the government doesn’t “earn” money from taxation and doesn’t need the revenue from taxes to finance its spending (because, as a monetary sovereign, it can simply create that money anytime it wishes).
Rather, the government, as the sole source of money, spends first, then taxes and borrows. The government puts money into circulation and then collects some of it back in taxes because money is a useful instrument for spurring the population into doing socially beneficial things.
(Shortform note: Right-libertarian economists would certainly disagree with Kelton’s ideas on the role of taxation in a modern society. According to economic theorists like Murray Rothbard, the entire concept of taxation represents nothing more than an infringement upon individual liberty and private property. These economists argue that taxation is legalized theft, because if you refuse to pay your taxes, the full force of the state will be brought to bear upon you, with the resultant loss of property and freedom (because you’ll go to jail). They argue that we only accept this forcible confiscation of property because we have been conditioned by society that the government is entitled to claims on the things we own.)
Kelton argues that the government wants a productive, high-value economy that encourages people to earn and invest. So it creates taxes to spur the demand for dollars (because you need to earn the dollars to be able to pay the tax), which gives people and businesses an incentive to do things that create value for the economy and society.
In addition to spurring economic activity, Kelton writes that a progressive, well-designed tax system can help reduce inequality and steer social policy in a progressive direction that leads to better and healthier outcomes for society. For example, taxing industrial pollution makes it more expensive for companies to damage the environment by dumping waste into the community’s air and water—creating an incentive for them to use more efficient and sustainable production processes that create less waste.
Is Progressive Taxation Counterproductive?
Some economists have argued that progressive taxation of the sort championed by Kelton is actually not effective at reducing income inequality—and may actually make it worse. According to the Federal Reserve Bank of St. Louis, progressive taxes do increase the disposable income of lower-income people. But it’s what happens after that that undermines their effectiveness. Lower-income individuals and households are much more likely to work for fixed wages. But higher-income individuals and households derive a larger share of their income from ownership of capital—such as businesses, stocks, bonds, and real estate. This means that, when the progressive tax is implemented, low-income individuals and households will go and spend their extra money at the businesses owned by the wealthy, which increases the latter’s earnings, dividends, and stock prices.
On top of that, those wealthy households, businesses, and individuals would then take their extra earnings and spend them at businesses owned by other wealthy parties. The overall effect is that the redistributed income from the progressive tax ends up being earned, spent, and re-spent by high earners.
Kelton writes that politicians, the media, and the general public take it for granted that large federal budget deficits are clear evidence that the government is spending too much on a yearly basis and living beyond its means.
But, as we’ve seen, any government that has monetary sovereignty (like the United States) has near-unlimited spending power and can sustain large deficits for long periods of time, because they can always create the money they need to meet any spending demands.
However, Kelton does acknowledge that there is a real limitation on how much the government can spend—inflation. Inflation is the constraint on our economy that limits how many goods and services we can produce without generating unsustainable price increases.
Kelton writes that inflation can occur “naturally” in the economy. Often, it doesn’t result from any policy decisions at all, but rather, from external supply shocks that boost prices—like a drought or hurricane that makes certain agricultural products scarce. But it can also come on the demand side, if consumers begin to demand goods and services faster than the economy can produce them.
Baby Boomers, Demographics, and the Great Inflation of the 1970s
Other economists agree with Kelton’s point that inflationary and deflationary pressures can occur in the economy entirely independent from the decisions of policymakers—even from large-scale demographic changes. Some economics commentators have argued that this is precisely what happened during the Great Inflation of the 1970s, which saw interest rates rise to nearly 20%. This famous period of rising prices has been attributed to a variety of factors, including oil supply shocks, a glut in the money supply due to high government spending on the Vietnam War and Great Society programs, and Richard Nixon’s ending of wage and price controls.
However, some economists believe that the massive rise in inflation during the 1970s was caused by the Baby Boomers—the demographic cohort generally defined as those born between 1946 and 1964, at the time the largest age group—all entering the workforce and their prime consumption years at the same time. According to this argument, the economy at the time simply lacked the productive capacity to accommodate this sudden new influx of workers and consumers, leading to a situation in which more people were chasing a fixed supply of goods and services—a classic recipe for inflation.
Kelton argues that inflation can happen to an economy regardless of the size of the fiscal deficit. But she notes that traditional economics does not accept this view.
According to the conservative economist Milton Friedman (1912-2006), inflation is caused by excesses in the money supply. When the government (or, more specifically, the Federal Reserve, the central bank of the United States) adds too much money to the economy (usually in an attempt to boost employment), it drops unemployment below its “natural” rate—the minimum amount of unemployment that monetarists like Friedman believe an economy requires to avoid tipping over into inflation.
Friedman taught that any employment gains achieved through aggressive fiscal policy would ultimately prove self-defeating, because inflation would simply eat away people’s wages. His solution was to have the Federal Reserve limit the money supply to keep prices stable.
Do Large Deficits and a Loose Money Supply Really Lead to Inflation?
In Capitalism and Freedom, Milton Friedman argued that the Federal Reserve should in fact focus solely on controlling the money supply as its core responsibility (since that is the one thing it can directly control) and pay less attention to full employment and price stability, over which it has a far more indirect effect. According to Friedman, the Federal Reserve should operate strictly according to rules about governing the money supply and set reasonable targets for its growth. He recommends a rate of growth between 3% and 5% per month. Friedman argues that this would make the central bank’s actions more stable and predictable.
It’s worth noting that Friedman’s warnings about the self-defeating effects of deficit spending have not necessarily aligned with subsequent events. Since the surpluses of the 1990s, the U.S. federal budget has been marked by large and persistent deficits as the nation has grappled with two recessions, two wars, and the Covid-19 pandemic. In fact, the nation went from a $236 billion surplus in fiscal year 2000 to a $779 billion deficit in 2018, a net swing of over $1 trillion. And yet, throughout this period, inflation has been persistently low, consistently falling well below the Fed’s 2% inflation target.
The Federal Reserve (usually abbreviated as the “Fed”) is the central bank of the United States, tasked with setting monetary policy. The primary way the Fed does this is through controlling interest rates.
Kelton writes that the Fed has been too conservative in its management of U.S. monetary policy, resulting in needless human suffering and the stifling of the nation’s full economic capacity.
The Fed has consistently overreacted to even the slightest possibility of inflation and has been far too willing to raise interest rates, she says. Because this makes it more difficult to borrow or for people and businesses to pay off debts, these tight-money policies impose a real cost on the economy and on people—imposing unemployment and all the resultant suffering on people who want to find jobs.
Further, Kelton writes that the Fed’s hyper-aggressiveness on inflation is based less on objective facts than on faith. The central bankers there believe there is a “natural” rate of unemployment, and dropping below it will result in uncontrollable inflation. Thus, one of the key aims of Fed policy has been to prevent unemployment from dropping below this level. According to Kelton, this confidence on the part of the Fed isn’t really backed up by recent history—the relationship between employment, inflation, and deficits is far murkier than they believe. She argues that their methods impose needless suffering by deliberately maintaining higher-than-necessary unemployment to stave off inflation.
(Shortform note: Many economists argue that 0% unemployment is an impossible and undesirable policy goal, and that some level of unemployment is necessary in an economy to stave off inflation. In a world in which all workers who were willing and able to work had jobs, employers would be forced to compete for labor by raising wages continually in order to lure workers away from other firms. The increased cost of labor would be passed on to customers in the form of higher prices for the goods and services produced by those workers—while those same workers would in turn demand more goods and services because of their higher wages. This sets off an inflationary dynamic known as the wage-price spiral, in which higher wages lead to higher prices, leading to higher wages, and so on.)
Early Unemployment Theory
The natural rate of unemployment replaced an earlier theory known as the Phillips curve. Created by British economist Williams Phillips, the Phillips curve drew on historical analysis that tracked inflation vs. unemployment in the UK for nearly a century between 1861 and 1957.
The data showed that there was a clear inverse relationship between inflation and unemployment: When inflation was high, unemployment was low, and vice versa. In other words, there was a clear trade-off between inflation and unemployment.
Critics argued that the Phillips curve created an excuse for politicians during the 1960s and 1970s to engage in inflationary policies—if they ever wanted to reduce unemployment (especially right before an election—all they would need to do was boost inflation. These critics championed the natural rate of unemployment theory as a superior alternative, one that properly accounted for the damaging effects of inflation.
Kelton contends that MMT offers a better alternative to the harsh and punitive policies of the Fed. MMT proponents argue that fiscal and monetary policy should work in tandem—using a combination of deficit spending and low interest rates to boost demand and create full employment.
Kelton writes that the Fed’s practice of tolerating—and even engineering—mass unemployment through high interest rates is both inhumane and extraordinarily wasteful. Unemployment obviously robs people of their livelihoods, imposes deep psychological wounds, contributes to the impoverishment of children, and decimates communities. But it also keeps the economy from reaching its full productive capacity, contributing to what economists call the output gap—the difference between what the economy could produce given its endowments of land, capital, human talent, and technology; and what it actually is producing.
MMT teaches that deficits are not inherently good or bad—fiscal policy is simply a tool for adding or subtracting dollars from the private-sector economy. The goal of economic policy ought to be the creation of a prosperous, equitable society that maximizes human happiness and broadly distributes its gains on an equitable basis—not simply for the government’s books to balance.
Accordingly, the federal government should use its nearly unlimited fiscal power to keep the output gap as close to zero as possible—regardless of the budgetary impact.
Inflation and the Biden Covid Relief Package
A disagreement over the output gap led to a well-documented debate between center-left economists during the passage of President Joe Biden’s $1.9 trillion Covid-19 relief bill in February 2021.
Lawrence Summers, former U.S. Treasury Secretary under Bill Clinton, argued that the Biden package was three times larger than the output gap and would put the economy at much higher risk of inflation. New York Times columnist and Nobel Prize winner Paul Krugman, however, argued that, despite its price tag, the bill would be unlikely to lead to inflation and an overheated economy because much of the money—especially the stimulus checks given to individuals—would be saved rather than spent. Krugman further argued that much of the aid to states and local governments would likely end up being saved in reserve funds rather than directly spent, because there would be less need for emergency spending as the virus abated—and that this would further blunt the bill’s inflationary impacts. It is worth noting, however, that following the bill’s passage, U.S. inflation in October 2021 was 5.4% over the previous year—the highest inflation rate in over a decade.)
However, some economists argued that the rise in prices had little to do with the Biden administration’s spending choices and was instead driven by the resurgence in pent-up demand as people began to travel, eat at restaurants, and resume other economic activity following the end of pandemic lockdowns. They argued that these inflationary impacts would ultimately prove short-lived as the economy adjusted to the post-pandemic world and supply aligned better with demand.
Kelton writes that fearmongering about the U.S. national debt has long been a staple of political discourse. Politicians from both major parties seem to be constantly hyping the danger from the debt—that it threatens to eat us alive with escalating borrowing costs, that it constitutes a mortgaging of the country’s future, and that we’ll never be able to pay it back without either significant tax increases (Democrats’ preferred solution) or massive budget cuts (Republicans’ preferred solution).
But Kelton argues that this debt hysteria is both factually wrong and counterproductive for the nation’s economic health. In reality, the national debt poses no threat.
Is the Debt-to-GDP Ratio a Threat to the Economy?
Many economists have argued that the threat from the national debt is very real, and can even be precisely quantified. In a famous 2010 paper, Harvard economists Carmen Reinhart and Kenneth Rogoff argued that there was a specific threshold of debt-to-GDP above which a nation’s economy would begin to stagnate. They were particularly focused on the portion of the national debt owed to foreign creditors. Reinhart and Rogoff argued that once a nation’s debt-to-GDP ratio reach 60%, it could expect to see annual growth decline by 2%. Once it reached 90%, that country’s expected GDP growth would be cut in half—although it’s worth noting that the U.S. debt-to-GDP ratio in 2021 stood at 125% and has consistently been over 90% for over a decade, and nothing like what Reinhart and Rogoff predict has come to pass.
The Reinhart-Rogoff theory exerted significant influence over the policy views and actions of center-right governments during the 2010s, who claimed that social spending needed to be slashed in order to bring the debt ratio under control and avoid economic stagnation.
Kelton notes that American national debt is created through the sale of U.S. Treasury bonds. Because the federal government can never default on these bonds (because it has monetary sovereignty that enables it to always create the dollars it needs to make the interest payments), they are considered risk-free securities.
As such, Treasuries are the backbone of the global financial system, used as a hedge against riskier investments by banks, insurance companies, states, foreign governments, pension funds, and private individuals. Thus, every dollar of U.S. debt represents a corresponding asset held by someone else. To put it another way, measures of the national debt are really just measures of national savings held by the private sector.
Moreover, Kelton argues that if the U.S. government were to actually retire the debt in full (which it could do at any time by simply creating new reserves of dollars), it would in effect eliminate the global market for U.S. securities. This would likely have the effect of destabilizing the entire global financial system by eliminating all those interest payments, having a net effect of taking money out of the economy. Worse, without marketable debt securities, the Fed would have no tool to set interest rates—it would not have them to buy or sell to banks to create or subtract new reserves.
The Threat of Life After Debt
Back in the 1990s, when the U.S. federal government was experiencing fiscal surpluses, policymakers did indeed worry about precisely what Kelton warned about—that the government would eliminate the outstanding national debt by 2012, leading to a world in which international investors had no place to make low-risk investments. In 2000, the government actually drafted a report called “Life After Debt,” in which it warned of the potentially destabilizing financial consequences of a global economy without a market for U.S. Treasuries. The authors of this report noted in particular that there would be no place for surpluses from the Social Security Trust Fund to be safely invested (potentially diminishing future benefits), nor would there be any way to determine home mortgage rates, since these are also tied to long-term federal debt.
Of course, these fears of a debt-free America did not come to pass—by 2012, the country would experience two overseas wars, large tax cuts, new social spending, and two recessions that would put the federal government’s books solidly back in the red.
Kelton disputes those who worry about the national debt and highlight what they see as a particularly grave threat—the share of U.S. debt held by foreign countries like China. They often paint the picture of the U.S. being held hostage by foreign countries, the way a debtor might be if they borrowed from a loan shark.
But, Kelton writes, this narrative is also misleading. The U.S. doesn’t go to foreign countries on bended knee to beg for foreign loans. Instead, foreign governments and investors purchase U.S. treasury bonds using the dollars they acquired when American businesses and individuals purchased goods and services from their countries.
Kelton argues that the purchase of U.S. debt by foreigners is nothing more than an accounting adjustment at the Federal Reserve. When a foreign country (say France) purchases U.S. Treasury bonds, it’s effectively just converting its foreign dollar reserves into interest-bearing Treasury bonds, exchanging one type of U.S. financial instrument for another.
The Federal Reserve just debits France’s dollar reserves and credits its Treasury bonds account (because it’s depleting its supply of dollars to purchase Treasuries). Similarly, to pay the interest on those bonds, all the Fed does is debit France’s Treasuries and credit their dollar reserves (because they’re now receiving cash in exchange for the bonds they hold). All it takes is for someone at the Fed to strike a keyboard to adjust the accounts.
Some debt worriers argue that countries that own large quantities of U.S. Treasuries—like China—have leverage over the U.S. because they could theoretically decide to stop buying American debt and drive up borrowing costs.
Kelton writes that this argument also rings hollow. China’s economic policy is predicated on running large trade surpluses with countries like the United States (meaning it sells more to the U.S. than it purchases). In order to run those trade surpluses, it’s going to be holding onto large stocks of U.S. dollars. And if it holds large quantities of dollars, it’s going to need to find a safe investment to park those dollars. And there’s no safer place to invest dollars than in U.S. Treasuries, since, as we’ve explored, the federal government can always create the necessary dollars to pay the interest.
Therefore, China has no reason to sell off or stop buying U.S. debt. Doing so would inflict economic pain on them.
China’s Debt Problem—and What It Means for the World
In fact, it may be China that has the real debt crisis, not the U.S. In 2021, multiple property developers and real estate holding companies like Evergrande and Sunshine 100 China Holdings Ltd. began defaulting on their notes (denominated in U.S. dollars), sparking a downgrade of Chinese corporate debt by the major credit rating agencies. The concern among Chinese central bankers was that the slowing of China’s property boom, which began in the 1990s, would leave Chinese banks with unsustainable levels of debt that could cause an investor panic that would, in turn, spill over into the country’s nonfinancial sector. This could cause the Chinese economy to crash, which would have significant ramifications for global trade.
Some critics note that China's economic woes should be seen as the bill coming due for an aggressive growth strategy based on an abundant supply of cheap labor and state-backed debt that enabled the country to massively boost its exports; urbanize much of the rural population; and rapidly build its industrial and residential infrastructure at lightning speed. Yet despite the rapid development in China over the past few decades, too much of the population is still too poor to transition away from the old state-supported economy to an economy based on consumer spending—leaving China with an investment landscape saddled by unsustainable debt because there are not enough people to actually use and pay for everything that’s been built. Worryingly, the Chinese government has responded to these developments by reverting back to socialism and state control, which could cause international investors to lose confidence in the Chinese economy and massively disrupt the global supply chain, which is now inextricably linked to China.
Trade deficits occur when a country buys more in goods and services from one country than it sells to that same country. If the U.S. buys $500 billion from Japan and sells $250 billion in turn, the U.S. would run a $250 billion dollar trade deficit with Japan ($250 billion - $500 billion = -$250 billion). In that same scenario, Japan would be running a $250 billion surplus with the United States.
Indeed, every trade deficit run by one country must be matched by a corresponding trade surplus run by another country as a simple matter of logic and accounting. By that same logic, it’s impossible for every country to run a trade surplus (or deficit for that matter).
Kelton notes that politicians on both sides of the aisle—in recent years Donald Trump most notably—have promoted the idea that trade deficits represent some kind of “loss” or fleecing of the U.S. at the hands of foreigners. But she notes that this idea betrays a fundamental misunderstanding of macroeconomics.
(Shortform note: Although Trump emphasized economic nationalist themes during his 2016 candidacy and his presidency (including the imposition of tariffs on China), his administration made little headway in the reduction of the U.S. trade deficit. As he was set to leave the White House in 2020, the trade deficit stood at $600 billion, its highest figure since 2008. Experts note that the large fiscal stimulus measures his administration implemented in response to the Covid-19 pandemic played a role, by enabling imports to recover more quickly than exports. They also noted that attempts to adjust trade deficits through one-off policy measures are generally exercises in futility—because trade deficits mostly result from larger structural macroeconomic factors, such as the fact that Americans tend to spend more than they save, which means that they must borrow from abroad in order to make up the difference.)
Kelton argues that globalization—the freer flow of goods, services, and capital across national borders—has contributed to trade deficits in the U.S. and in other advanced economies because globalization makes it easier for companies and individuals to purchase cheap labor, finished goods, and production inputs from the global market.
She also notes that globalization has undoubtedly inflicted pain on millions of Americans since the 1990s, when the U.S. signed high-profile free-trade agreements like the 1994 North American Free Trade Agreement (NAFTA). Because of free trade, low-skill manufacturing jobs have undergone a major decline in the United States. On net, 2.7 million American jobs have been lost due to outsourcing and offshoring.
(Shortform note: The loss of jobs due to trade imbalances has effects that go far beyond what the raw economics statistics will tell you. According to the National Institutes of Health, opioid-related deaths began their sharp increase in the U.S. in 1999, precisely when the country began experiencing significant job losses due to globalization. The NIH further found that the opioid-related deaths were most heavily concentrated in those former manufacturing communities that had been most heavily affected by losses from international trade. In a 2019 paper, they found that every 1,000 trade-related job losses was associated with a 2.7% increase in opiate deaths.)
Kelton concedes that this economic pain is real and does indeed merit a federal response. But she argues that doing this does not require eliminating the trade deficit—and that doing so may cause even more economic pain.
The trade deficit does not inherently mean that the U.S. must lose jobs and investment. All it means is that some of the money being transferred from the public sector to the private domestic sector is “leaking out” into the foreign private sector.
In other words, it’s just a deficit. And, as we’ve seen, the federal government has near-unlimited fiscal power to turn those private deficits into private surpluses by running deficits of its own. The government must simply run fiscal deficits in excess of the trade deficit, in order to keep the domestic private sector out of debt—remember, the private sector can’t sustain persistent deficits because private firms and households can’t issue their own currency.
Thus, according to MMT, the U.S. government can make the choice to commit to full employment through fiscal policy—regardless of the state of the trade deficit.
(Shortform note: The U.S. government does currently offer assistance to workers who have experienced job loss due to trade policies. The Trade Adjustment Assistance (TAA) program has been in effect since the early 1980s, and it provides affected workers with a range of benefits and services, including job retraining, income supports (called Trade Readjustment Allowances), support for relocation to another part of the country, wage supplements for workers over the age of 50, and a health insurance tax credit.)
Kelton argues that the U.S. trade deficit is a source of great national strength—not weakness. In fact, the U.S. has even greater monetary sovereignty than other countries that control their own currencies.
This is because the U.S. dollar is the world's reserve currency. A full 90% of foreign exchange transactions involve dollars, and international business contracts are still largely denominated in dollars. This means that there is a great demand for dollars—countries need dollars to do business and purchase high value-added U.S. products and services.
Thus, U.S. trade deficits underpin the global trading system by supplying the world with the dollars it needs. This puts the U.S. in a position of strength because it is the sole supplier of a commodity that the world desperately needs. Kelton argues that the U.S. can and should use this leverage to create international trade deals that force trading partners to take action on worker protections, green energy, poverty reduction, and global health.
(Shortform note: Some economists argue that trade deficits can harm countries because they are often the result of large capital inflows from other countries. While foreign direct investment (FDI) can lead to job creation and new economic opportunities, excessive foreign ownership of assets can put a domestic economy at the mercy of foreign investors if they suddenly decide to disinvest and leave the country. Moreover, large foreign firms may displace smaller domestic businesses and end up delivering little in the way of benefits to domestic workers and governments, since many of the profits are ultimately repatriated.)
Does U.S. Political Dysfunction Threaten the Dollar’s Reserve Status?
Although the U.S. dollar is currently the world’s reserve currency, the nation’s political dysfunction could jeopardize that status.
The U.S. federal government has a statutory limit on how much it is allowed to borrow in order to meet existing financial obligations. When the Treasury Department informs the president that the government is approaching this limit, Congress is supposed to pass new legislation that raises this figure and allows the government to pay its creditors. To not raise the debt ceiling, therefore, is to force the United States to default on its debt, even though, as Kelton argues, the U.S. has unlimited power to create the dollars it needs to meet its debt obligations.
Unfortunately, the debt ceiling has become a political football in recent years, with Congressional Republicans threatening to withhold the votes to raise the debt ceiling to force spending cuts and other policy concessions from Democratic presidents—as happened in 2011 under Barack Obama and may happen again in 2021 under President Joe Biden. Analysts warn that these brinksmanship exercises hurt confidence in the U.S. dollar and U.S. Treasury debt as safe assets—and could cause them to cede some reserve status to other currencies like the euro.
Claims that entitlement programs like Social Security, Medicare, and Medicaid are verging on insolvency or about to “go broke” are common in American political discourse. But Kelton argues that these claims are also false and designed to provide cover for a political agenda. The truth, she writes, is that these programs' finances are perfectly healthy, and the federal government will always be able to fund them.
These programs are crucial, as they provide much-needed financial security to society’s most vulnerable members—the poor, children, the elderly, the sick and disabled, widows and widowers, and veterans. Kelton writes that our society’s willingness to provide and care for its most at-risk people is a test of our humanity, compassion, and values that is far more important than these programs’ budgetary effect.
The Moral Case Against Entitlement Programs
Some conservative economists make the opposite moral argument from Kelton—that it is immoral to use the tax code to establish anti-poverty programs that confiscate property from some members of society to compensate others, even if those in the latter group believe themselves to be disadvantaged in some way. This is the argument that Milton Friedman makes in Capitalism and Freedom. Friedman writes that your compensation is a direct result of the value you create in the economy through your labor (the work you perform for which you are paid in wages and tips) and your capital (the productive assets you own, like land or machinery).
According to Friedman, economic outcomes are unequal because human beings all have different endowments of energy, talent, and capital. Some jobs are more unpleasant, entail more risk, or require longer hours than others—because fewer people will wish to do such jobs, they tend to be more highly compensated. Those who avoid such jobs tend to receive alternative compensation in the form of greater job security or more leisure time. Presumably, these individuals place greater value on such non-monetary rewards.
A system that mandated equal compensation would therefore produce unequal outcomes, because individuals doing unpleasant work would receive the same money as those doing more leisurely work. But because one group values money more than the other, the total compensation would be more unequal than it was before.
Kelton writes that politicians (usually, although again not exclusively, on the political right) argue that these programs rest on a financial house of sand owing to a combination of factors—an aging population as the massive Baby Boomer cohort continues to retire, a payroll tax financing system that is too meager to support the growing benefit obligations, and an unfavorable ratio of active workers to dependents that threatens to collapse the whole system.
They typically recommend a program of harsh austerity to stem the tide of red ink—such as direct cuts to benefits, decreases in cost-of-living adjustments, raising the retirement age, and slowing inflation-adjustment increases.
Kelton says these arguments and policy proposals are purely political in nature. They are wielded by powerful interest groups that wish to create the perception of out-of-control social insurance programs because they don’t want to pay the taxes to finance them; have an ideological opposition to wealth redistribution; and believe that social insurance is an illegitimate function of government that robs from the deserving and productive to reward the undeserving and unproductive.
Entitlement Reform and the Threat to The Poor
It’s been argued that some of these proposals to make entitlement benefits less generous really could have disastrous effects for the poor. Take the proposal to raise the Social Security retirement age. Many politicians argue that it’s simple common sense to do this because Americans on average live significantly longer than they did when the program was established in the 1930s.
But this ignores the inequities in lifespans between rich and poor Americans. Retirees who earned above-average incomes during their working years do indeed live on average six years longer than they did in the 1970s. But for retirees earning below-average incomes, the average increased life expectancy is only 1.3 years above what it was in the 1970s. Thus, raising the retirement age constitutes a highly regressive measure that penalizes poorer Americans by denying them years worth of earned benefits they would otherwise enjoy.
Kelton explores the financing mechanism of Social Security to demonstrate that the program and others like it are not constrained by a lack of financial resources required to pay the benefits. Rather, they are only constrained by legal and political obstacles that prevent lawmakers from fully safeguarding them.
Social Security benefits are paid out of the Social Security Trust Fund, which collects the dedicated payroll tax (jointly paid by both employers and employees) from people during their working lives and pays out benefits when they reach retirement age. Kelton argues that this financing mechanism was deliberately created by the Franklin Delano Roosevelt administration when the program was signed into law in 1936.
There was a political rationale behind this—FDR and his allies wanted it to appear to voters that the then-new program was financed with “real” money from payroll taxes. The theory was that this would give people a political stake in the program's survival—if people believed they had “paid into” it, they would be more committed to defending the benefits they had “earned” from politicians who might try to take them away.
(Shortform note: It could be argued that FDR’s political calculation proved to be correct. When, in 2005, a newly re-elected George W. Bush proposed a plan to allow Americans to invest some of their payroll tax contributions in private accounts—a move that Democratic critics labeled a “privatization” of Social Security—it faced enormous political backlash. An overwhelming majority of Americans opposed the plan and Bush was forced to retreat from what he had made his signature issue for his second term.)
But, Kelton argues, this structure also created a Board of Trustees that is required to submit periodic reports to the public—and those reports in recent years have warned that the program would become “insolvent” at some point during the 21st century as benefit payouts outstrip payroll tax receipts.
These reports are technically true in a limited sense, because the payroll tax receipts by themselves will not be sufficient to finance the program long term. But, Kelton writes, this shouldn’t matter—Social Security does not need to be funded through the payroll tax system. As we’ve seen, the U.S. Treasury can use its monetary sovereignty to just add new dollars to fully fund the system anytime. There are no real material or economic constraints preventing the federal government from doing this.
Instead, Kelton argues, it is legally and politically constrained from doing so—specifically, by laws that bar it from paying out any more than what the Trust Fund has accrued. But this is an entirely self-imposed constraint. According to Kelton, Congress could simply change the law to commit to paying in full the benefits to which recipients are legally entitled, regardless of the balance in the Trust Fund.
(Shortform note: If Congress does not change the law, however, then the Social Security Trust Fund is indeed expected to experience significant shortfalls in the coming decades—after 2034, it is projected to only be able to pay 79 cents on the dollar to beneficiaries. One proposed solution to this problem is more generous immigration policies. Immigrants—whether legal or undocumented—help to shore up the Social Security system by paying in additional billions in payroll taxes. Because immigrants tend to be younger, they also pay into the system for longer, infusing it with much-needed funding. And undocumented immigrants represented an even bigger boon to the retirement system, according to this analysis, because while they do pay payroll taxes, they do not receive benefits.)
To use the federal government’s extraordinary fiscal power to create a society that is more equitable, sustainable, and prosperous, Kelton proposes a federal job guarantee.
She positions this as a crucial remaking of the economic order—having the federal government serve as an employer of last resort, guaranteeing the fundamental right to a job for anyone who wants one. As we’ve explored, the federal government can always create the dollars needed to finance the program. She writes that a federal job guarantee would reap important benefits for the economy and society as a whole.
During regular slumps in the business cycle, people who would normally be laid off and remain without jobs for months or even years would instead have the option to be immediately rehired by the federal government. Participation in the program would be counter-cyclical—rising during recessions, shrinking during booms.
It would also help to shore up state and local tax revenues during recessions because participants would now be earning paychecks and paying these taxes. This helps the economy avoid the typical cascading job losses that occur during a recession, when state and local governments are forced to lay off civil servants, firefighters, teachers, police officers, and other workers when tax revenues plummet.
The federal jobs guarantee would benefit everyone, even those who don’t directly participate—because more jobs means more income and more consumers for businesses, which means more jobs and investment throughout the economy. The federal job guarantee would break the cycle of mass unemployment that spreads and causes business failures throughout the economy.
A federal job guarantee would also improve the bargaining power of labor (because it would be easier for people in the private sector to leave bad or exploitative jobs), while setting a minimum federal standard for wages and benefits, as private-sector firms would have to compete for talent with the federal program.
Perhaps best of all, the work done by participants in the program would help to address society’s most pressing needs. The federal job guarantee program could help redirect much-needed talent toward addressing shortages in nursing and eldercare; moving our energy grid toward a zero-emissions future; and repairing and modernizing the nation’s outdated infrastructure.
The Federal Job Guarantee: History and Criticism
With the rising specter of mass unemployment due to automation and concerns about the future of work, lawmakers in Washington, D.C. have reignited the debate around a federal job guarantee. However, the fight over such a program actually dates back to the 1970s, when Congress passed the Humphrey-Hawkins Full Employment and Balanced Growth Act of 1978.
The original version of this bill would have set explicit national employment goals—and, if they weren’t met, had the federal government make up the difference by directly supplying jobs to meet the target. In fact, unemployed workers would have had the right to sue the federal government if they didn’t receive a job. However, the bill was significantly watered down before it was signed into law by President Jimmy Carter. Although the nominal employment targets remained in the legislation, there would be no legal obligation for the federal government to take action to meet them, nor would there be any codified right to a job.
Today’s proponents argue that a federal job guarantee is a better alternative to other proposed solutions to automation, such as universal basic income, because creating useful private- and public-sector jobs would enable Americans to reap the dignity of doing real and meaningful work—while avoiding the social stigma of welfare or direct cash transfers.
On the other hand, critics of the federal job guarantee cite not only the program’s extraordinary cost, but also what they see as opportunities for corruption. They argue that the program would have the potential to become rapidly politicized, as politicians would scheme to have jobs projects of dubious economic value located in their home states or districts to enhance their election prospects. Moreover, critics worry that the fact that it’s a guarantee (by definition, someone can’t be fired from the program) would have the effect of degrading labor standards in the workforce.
Explore your understanding of deficits and debt.
Do you think the U.S. can sustain long-term deficits without sparking an economic crisis? Explain why or why not.
Do you think it’s more important to avoid saddling future generations with a large public debt burden or to use the federal government’s fiscal power to address today’s social problems? Explain your answer.
Rethink your assumptions about inflation.
How do you think inflation harms the economy? What corrective measures do you think the government ought to take to reduce or prevent inflation?
Do you think it’s more important for the government to maintain price stability or to provide citizens with adequate access to food, housing, health care, and other social services? Explain your answer.