This quote comes from Prof Jamie Galbraith's March 2010 article 'In defence of deficits'. The original is here. I learned of it via William Thomson's Substack.
To put things crudely, there are two ways to get the increase in total spending that we call "economic growth." One way is for government to spend. The other is for banks to lend. Leaving aside short-term adjustments like increased net exports or financial innovation, that's basically all there is. Governments and banks are the two entities with the power to create something from nothing. If total spending power is to grow, one or the other of these two great financial motors--public deficits or private loans--has to be in action.
For ordinary people, public budget deficits, despite their bad reputation, are much better than private loans. Deficits put money in private pockets. Private households get more cash. They own that cash free and clear, and they can spend it as they like. If they wish, they can also convert it into interest-earning government bonds or they can repay their debts. This is called an increase in "net financial wealth." Ordinary people benefit, but there is nothing in it for banks.
And this, in the simplest terms, explains the deficit phobia of Wall Street, the corporate media and the right-wing economists. Bankers don't like budget deficits because they compete with bank loans as a source of growth. When a bank makes a loan, cash balances in private hands also go up. But now the cash is not owned free and clear. There is a contractual obligation to pay interest and to repay principal. If the enterprise defaults, there may be an asset left over - a house or factory or company - that will then become the property of the bank. It's easy to see why bankers love private credit but hate public deficits.
William credited Stephanie Kelton with linking Jame Galbraith.
She did so in response to a tweet by Steve Keen in which he said, on Wednesday:
Two types of money. One comes with a chain. One does not.
When a bank gives you a mortgage, it creates money. But every dollar comes with decades of repayment. That is money with a chain. You spend carefully. You save defensively. You slow down.
When the government runs a deficit, it also creates money. But that money lands in private bank accounts with no debt attached. That is money without a chain. You spend freely. Commerce picks up.
In the 1950s and 60s, private debt was low. Government spending put debt-free money into the economy. People spent. Growth was real.
Then economists told politicians to slash deficits and let the private sector fill the gap. The private sector filled it. With debt. Household borrowing exploded. The economy ran on money that people were terrified to spend.
That is how you build a subprime bubble.
That is how you get 2008.
The economy does not just need money. It needs money people are free to use. Economists spent 50 years trying to eliminate exactly that. So for a more comprehensive understanding, refer to the full video presentation.
A few of my friends, getting money right, just like that.
Thanks, everyone for pointing out we are in an economic mess by choice: banker's choice, backed by a captured economics profession.
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Shoot me down in flames if I have misunderstood “When the government runs a deficit… … money lands in private bank accounts with no debt attached” Surely any Government created money (or most of it) will eventually have to be taxed out of the economy to avoid inflation? So while there is no direct payment back to a lender needed there will be a requirement for more taxation. This is one of the things I struggle with trying to explain MMT to people. Me: “Tax doesn’t fund Government spending, spending comes first, creating money which the Government will tax out of the economy later” Them: “So the more the Government spends, the more money they create so the more money needs be taxed out of the economy. So the more the Government spends the more tax I will eventually have to pay?” Me; “Well err.. yes”
You have identified a common misunderstanding, but the answer is “not necessarily”.
The government does not spend with the intention of taxing back every pound it creates. If it did, there would be no net financial assets left in the private sector.
When the government runs a deficit, it leaves additional financial assets in private hands. That is what a deficit is: government spending exceeds taxation.
The question is not whether every pound must eventually be taxed away. The question is whether there is too much money chasing too few goods and services. If there is, taxation may be needed to reduce demand and control inflation. If there is not, there is no reason why all the money should be removed.
Equally, the burden does not necessarily fall on you. Taxation can be changed in many ways. It can fall more heavily on higher incomes, wealth, land, pollution or activities that society wishes to discourage. It is a policy choice, not a mechanical consequence of government spending.
So I would answer your friend like this:
“No. Government spends to achieve public purpose. It taxes to control inflation, influence behaviour, reduce inequality and create demand for the currency. The amount of tax required depends on the state of the economy, not on matching yesterday’s spending.”
That is a very different proposition from saying that government must always tax back everything it spends.
https://energyindemand.com/2026/07/08/clean-energy-means-security-the-european-commissions-energy-priorities/
This covers the EU and the costs for additional bits of power networks (my demolition of what is said is at the end). The key point (not mentioned in the interview) is that the European Commission sees most of the money coming from….. banks, not e.g. the ECB/EIB combo. The reality that it could come from the ECB/EIB combo (& thus cost less) is never discussed in the Bx village. Those that try are treated as lepers or regarded as demented, such is the grip of the neo-libtards on discussions.
For me, this is an excellent reason for the UK to NEVER rejoin the EU. It is a failing political project because of its adherence to neo-libtardism &, for my sins, I knew some of those that developed the libtard project (in fairness this was in “my salad days”).
Same problem in the UK and with housing: PM in waiting Burnham is touted as doing a lot to address housing shortages in Greater Manchester, but it’s done with Private developers and Private credit. In other words, mortgaging the future, not funding it.
Hello Richard.
Considering this excerpt from Richard Banner –
Them: “So the more the Government spends, the more money they create so the more money needs be taxed out of the economy. So the more the Government spends the more tax I will eventually have to pay?” Me; “Well err.. yes”
My thinking as I read this, is that it is describing a situation where nothing happens with the money within the economy. The government creates money. The money just sits there. There’s more money. The government taxes more. There’s now less money.
There’s nothing about the purpose to which the money has been used by the time it flows through the economy, and some of it is removed as taxation.
Society itself shall decide if the purpose to which the money was used was worthwhile, or not. If it was worthwhile, society has profited in a non-financial way, from the spending, and so the taxation isn’t a negative. If the spending wasn’t worthwhile, then it’s been a loss.
Life is full of situations, with or without money, where you feel you’ve benefited or where you just have to shrug, move on and chalk it up to experience.
Does this seem to make sense to anyone, or not, or does it just need some work…or binned?
This ties in with the money as lubrication analogy I have mentioned before. The government injects lubrication into parts of the economy that needs it. That flows through the machine, enabling the wheels to turn and useful work to be done. Even if all the new lube is then removed, the work has still been done, the benefits still exist. Exactly how much lube is removed and exactly where and when depends on decisions made by the government based on other objectives.
Thank you – that was a very neat and clear explanation. It hadn’t occurred to me that the banks were in competition with the government in this way but it makes perfect sense!
The sooner it becomes common knowledge that the government allows the wealthy to accumulate the free money while the rest of us have to use the expensive money the better.
Maybe then we could start to make some inroads into change.
Government money and bank money are like two partners in a marriage. Each has different strengths, different responsibilities and different motivations. Left to themselves they may pull in different directions. The task of good economic policy is not to favour one over the other, but to provide the relationship counselling that enables them to work together in pursuit of both public purpose and private prosperity.
You say that the task of good economic policy is not to favour government money or bank money.
Are you happy with the current situation where failing to favour government money over bank money means that plenty of money is available to those who already have enough and not enough to provide for those with unmet needs?
Do you think that those with unmet needs have only themselves to blame; they failed to choose the right parents, they failed to choose to be without disabilities or special needs; and so they don’t deserve to live in a caring society?
In a word, Roger, NO, to both your questions. The relationship between Government and bank money needs fixing. Currently, both of them are failing us. I am arguing that we need to build a new partnership between the two. Our economy is really founded on that principle, but very few seem to have actually noticed to the extent of recognising that the relationship needs to be proactively managed. There needs to be a new alignment between the two. If this isn’t done, then it becomes more likely that a new feudalism will return, with a name something like Liberland.
Well put.
Great blog, I really enjoyed this one. Many thanks Richard.
A couple of months back I read Doughnut Economics in which Kate Raworth states that around 97% of the money in the economy originates from private/commercial banks. To my surprise, I heard Yanis Varoufakis say the same in a recent video. It really puzzles me how such people can get it so wrong. Unless I’m misunderstanding them. Would love to hear some thoughts on this.
It’s great to see others explaining things as they actually are.
They are both wrong. The figure might have been right in 2007. It is maybe 60% now.
“Right in 2007” due to the massive amount of private money pre the collapse?
As for Raworth and Varoufakis…. I just can’t understand how progressive, intelligent leftist economists, with many years experience behind them – and whilst not MMTers as such, certainly aware of the lens it provides and on friendly terms with MMT advocates -can get it so wrong.
I’m relatively new to economics (a year or two). Prior to that I knew next to nothing. How can I see it and they not?
QE changed everything.
They are ignoring that. I don’t know why.
Perhaps I’m misunderstanding things… Reading the blog again, I see it refers more to the deficit rather than government money in general. When it comes to the 97% figure, as far as I can tell, they are talking about the total amount of money in circulation and claiming that 97% of that total money is from commercial/private banks. Seemingly that’s because they don’t consider the government/BoE as being able to create money from nothing.
Apologies that I’m not so much commenting as trying to get some help in understanding it all!
Don’t apologise. These are exactly the questions we should be discussing.
The 97% figure (which I now think is overstatd) refers to commercial bank money – that is, bank deposits created when commercial banks make loans. Most of the money we use every day is indeed created in this way.
However, that does not mean the state cannot create money. It plainly can. The Bank of England creates reserves, and government spending ultimately results in new money entering the economy.
The mistake is to assume that because commercial banks create most of the money in circulation, the government is somehow dependent upon them for money. It is not.
The government and the commercial banking system create different forms of money that work together within the same monetary system.
So the issue is not who creates “all” the money. It is understanding that there is more than one type of money and more than one mechanism by which it is created. That is where so much of the confusion arises.
Many thanks for your kind words and clear explanations.
I’ve had a look back at some of my notes and firstly thought it best to confirm that Raworth is seemingly talking about broad money, so the 97% figure applies to all the money in circulation. I’m not so much replying to the previous comment, more adding to the whole discussion.
Likewise for the benefit of the discussion and for anyone reading this now or in the future, I thought I’d add the relevant quotes from Raworth and Varoufakis. I hope it’s ok to quote directly but appreciate it might not be. Varoufakis to follow.
Raworth
“Who makes your money? We live in a monoculture of money…
“In the majority of countries, the privilege of creating money has been handed to commercial banks… As a result, more money is made available only by their issuing more interest bearing debt…
“In the UK… 97% of money is created by commercial banks, and its character takes the form of debt based interest bearing loans…
“When such debt increases, a growing share of a nation’s income is syphoned off as payments to those with interest earning investments and as profit for the banking sector, leaving less income available for spending on products and services made by people working in the productive economy…
“It becomes clear that there are many options for redesigning [money] involving the state and the commons, along with the market. What’s more, many different kinds of money can co-exist with the potential to turn a monetary monoculture into a financial ecosystem. Imagine, for starters, if central banks were to take back the power to create money and then issue it to commercial banks. Or simultaneously requiring them to hold 100% reserves for the loans that they make…”
I hater to say it, but I think she misunderstands money..,..
I am not alone. She is not alone.
Ne error is to think there can be many kinds of money.
There can only be one currency in a functioning macroeconomy.
And what she is proposing is the Positive Money approach – which is akin to the fold standard and would be disastrous.
[…continuation of previous reply…]
Varoufakis
“Yes, lest not forget, only 3% of the money in our advanced economies come from the Central Bank. The rest is conjured up by private banks.”
Source:
https://youtu.be/2PBQEFOtkkA?is=SbyAMCrPSzV4XDlG
As I said above, I’m quite new to economics and so might be misunderstanding or not seeing the whole picture. But from what I’ve learned to date, the ideas proposed in the video can’t hold without first premising the correct view of money creation. And as such, the ideas proposed in the video – or indeed in Doughnut Economics and a concept – can be hit and miss at the same time (?).