I have written a new glossary entry that covers both deficits and the national debt.
This is it. Comments are welcome.
A government deficit arises when a government spends more into an economy during a period than it extracts from that economy via taxation or other forms of income.
When this happens, the government creates additional money to meet its spending commitments, doing so via its central bank, which it both owns and controls in the case of a country like the United Kingdom.
The new money in question can be left outstanding as owed by the government to its central bank, or the government can issue bonds or gilts (as they are called in the case of the UK) to clear that balance it notionally owes to its central bank, which is the Bank of England in the case of the UK.
In either case, the cumulative deficit incurred is described as the national debt, although it does not, as such, represent borrowing.
That is because the sum owed by the government to its central bank is a balance that disappears if the activities of the two are consolidated, as is always technically possible in accounting terms (and accounting is what is being discussed here). Consolidation is what happens if a single set of accounts for the government as a whole is created. The asset of the central bank that the government owes to it is, in that case, matched by the liability the government owes to the central bank: there is, in net terms, no overall liability as a result.
In that case, the sums paid to the government for bonds that it issues do not clear the government's liabilities, because in net terms, it has none. Instead, they represent sums placed on deposit with it as if it were a bank.
As importantly, the sums placed on deposit can only exist because the government created them by spending more than it raised in revenue: the sums deposited represent the sums created by the government not as yet taxed back by it, but which it might claim back through additional tax, at its own discretion.
This arrangement is particularly advantageous to the wealthy of a jurisdiction that offers bonds to those who want to subscribe for them. Since to be able to subscribe for bonds a person must be possessed of private wealth, or represent those who do, and those with private wealth are invariably those most likely to be under-taxed in a jurisdiction simply because they have most income and wealth on which tax might be paid, the offer of bond deposit facilities means that the wealthy are compensated with the payment of interest on balances they deposit with a government that it could otherwise have demanded from them by way of payment of tax instead.
The result is that the value of bonds in issue can be seen as representing the value of the money supply the government has injected into an economy to permit it to function. This injection of money into an economy is a crucial role that a government must undertake. The supply of fiat currency is a fundamental task of modern governments. It is not a weakness of that system of government, but a strength. Withdrawing these funds from use by eliminating this supposed debt would mean that government-created money was no longer available for use in the economy of the jurisdiction in question, which most likely could not function without it. Those suggesting that national debt is a problem have, in that case, failed to understand what that debt is and why it is so important.
The real issues of concern with regard to the national debt are, in fact:
- Whether more tax should be charged to reduce inequality.
- Whether interest should be paid, and at what rate, to bondholders given that they crave the security of depositing funds with the government, which is the only institution in any jurisdiction able to guarantee repayment, come what may, since it alone has the power to create fiat money.
- Whether excess funds fuelling inflation are being created.
By itself, the quantum of the debt is not an issue.
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Hi Richard….with regards to “Withdrawing these funds from use by eliminating this supposed debt would mean that government-created money was no longer available for use in the economy”… my understanding is that funds held in government bonds have no utility as such? They do not contribute overall to the productive economy? Although, as a source of funds, they could be diverted into something more useful?
I am saying withdrawing government created debt from the economy ends the money supply.
I was thinking that government debt includes savings such is pensions and money in my bank account. This being the case I would be very angry if the government taxed my savings to reduce a number on a spread sheet,
I think you are trying to over simplify things.
All very clear. My only comment is re the bullet point ‘Whether more tax should be charged to reduce inequality’. We know what you mean but will everyone? I think perhaps this could be slightly adjusted to read something like ‘Whether more progress taxes should levied to reduce inequality’
Noted
I think it would help understanding if this whole process was described using a worked example with figures in debit/credit style showing entries in all institutions with the equivalent other side to all entries for each part of the process. Many years ago I worked in manufacturing for a very large company and I did this in order to get a better understanding in my own head. Some people prefer words but some like an alternative approach.
I think 99.9% of people would be lost.
Steve Keen tries to do this and I very much doubnt it helps his raeders
Sorry – but most people (most accountants now) can’t do double entry. I can, but know others can’t. It would be more incomprehensible that writing the entry in German.
I found this a useful resource. I don’t now what Richard makes of it but I found it illuminating
https://gimms.org.uk/2021/02/21/an-accounting-model-of-the-uk-exchequer/
I have read it.
Not suggesting you change your ‘formal’ entry to the glossary, but I know that not everyone would understand it. So for those that would struggle this could be an alternative simplified explanation to help undertsanding:
Government Deficit and National Debt Made Simple
What is a Government Deficit?
A deficit happens when the government spends more money than it collects in taxes.
To cover the extra spending, the government “creates” new money (through its central bank, like the Bank of England in the UK).
What is National Debt?
The total of all past deficits is called the “national debt.”
But this isn’t like personal debt—it’s more like money the government owes to itself (since the central bank is part of the government).
If you combine the government and central bank accounts, the debt cancels out—it’s just an accounting record, not real borrowing.
Why Does the Government Issue Bonds?
Instead of leaving the money it created as an internal record, the government can issue bonds (or “gilts” in the UK).
These bonds are like savings accounts for rich people and big investors—they lend money to the government and earn interest.
But since the government created the money in the first place, it’s not really “borrowing”—it’s just letting wealthy people park their cash safely.
Is National Debt a Problem?
No, the size of the debt isn’t the real issue. The government can always create more money if needed.
The real questions are:
Should taxes be higher on the rich to reduce inequality?
Should bondholders earn so much interest when they’re already getting a safe place to store wealth?
Is the government creating too much money, causing inflation?
Why Does This System Exist?
Governments must spend money into the economy—otherwise, there wouldn’t be enough cash for people and businesses to use.
The “debt” is just a record of money the government put into the economy but hasn’t taxed back yet.
Bottom Line:
National debt isn’t like household debt—it’s just a way to track money the government has spent into the economy. The real debate should be about fair taxes, interest payments to the wealthy, and controlling inflation—not the debt itself.
Those who say “national debt is bad” don’t understand how money really works.
I have revised this morning.
@Martin Crompton
For me the key “problem” is answered in that last sentence of yours because it captures that rock solid assumption drilled into us since the 1980s, “national debt is bad”.
“Everyone” knows what debt is, and the less money one has, the more terrified one is of debt. But nowadays, even if you are terrified of debt and were told, “always live within your means – be prudent – pay off your debts” – you have to borrow to survive, which reinforces your fear and hatred of debt.
The better off know that debt is a very handy tool to get more wealth. They can manipulate it, especially in corporate entities – as illustrated with water. Loading them with debt has helped greedy criminal thugs extract wealth and then hide behind corporate limited liability.
In more inflationary times (my young adult housebuying days) debt plus inflation helped clear our mortgages as inflation gifted us equity in our houses. But that isnt the “experience” now, with a dramatically different situation on mortgages, cf wages and house prices. The financial advice my dad gave me, is useless now, 50 years later.
Then along comes the Thatcher household analogy constantly recycled by Reeves today, and loads all this learned experience about debt onto macro-economics. It’s incredibly powerful, and it is so rarely challenged. “Debt is bad, surplus is good”. “Everyone knows that.”
Except of course, it isn’t true, and effectively challenging it is like trying to make water run uphill.
But slowly, the tide is beginning to turn.(to stick the water analogy)
My understanding of what you’re saying is that when a government is in deficit, it has two choices. Tax its citizens, or sell bonds/gilts on which it pays interest. Either way, the deficit is reduced. However, the government has an opportunity to tackle wealth inequality by increasing taxes on its more wealthy citizens, rather than pay them interest on their loans which serves to compound the inequality problem. Have I understood this correctly?
Not really.
Running a deficit is a choice.
It has the option of doing nothing. It can leave the balance owing to the Bank of England.
To the extent that it needs to control inflation it must tax.
That rarely requires that books be balanced.
The deficit can be let owing to the Bank of England.
Or bonds can be issued, but that is not necessary.
If the deficit is desired more tax is not required.
Howeeer, if tax to tackle inequality is required then taxes on others need to be cut or the deficit would be reduced – and deficits are run deliberately as part of fiscal policy.
When Stephanie Kelton talks about this (I think its in her film “Finding the Money” ) she has some charts showing how gov’t surpluses lead to recession (particularly Bill
Clinton’s presidency). Would this glossary entry benefit from something similar? As a financial ignoramus, I found the UK surplus=recession historical data hard to find, and even harder to talk about on the omnibus, so that might be helpful. Eg: I found a chart showing surpluses here in an OBR article that might make you quite angry, as it is kcouched in all sorts of neoliberal assumptions.
https://obr.uk/forecasts-in-depth/brief-guides-and-explainers/public-finances/#deficit
Did the 1989 and 2001 UK surpluses result in recession/contraction in as clear a way as Bill Clinton’s surpluses did over in Kelton’s USA??
My problem is correlation does not equal causation.
I am not convinced it did then.
You cannot ignoe the dot.com crash.
Thx. So would it be safer to say that a consistent pattern of surplus government budgets over several years as an economic policy, would lead to contraction, as “money” disappeared from the economy? (Rather than “that surplus budget led to that recession”?)
Devil’s advocate question – could commercial bank lending then “create money” to keep things going?
I’m still trying to climb my learning curve on “surplus budgets”. Thx for ropes and pitons available here, otherwise I’d have fallen on my head long ago.
1) Yes
2) Yes – but at high cost and instability – see this morning’s post on debt
Will do more on this
This entry has now been updated in the light of comments received.
Richard,
On a slightly different tack re glossary on our national accounts for this I mean imports, exports etc.
How much do we depend on trade with other countries? Is the balance of trade important?
Years ago the press/tv used to report on monthly figures but today they don’t. But should we be focusing on trade?
Could you please do a video on this topic?
I could, but it would take some thinking about how to do it.
I agree with your explanation. You never really talk about the difference between the nominal value of money and the real value(purchasing power). I always assumed that interest payable on bonds or any form of savings or investment was there to protect the real value of money invested in them.
I remember when I taught basic accounting many years ago, emphasising that this year’s pounds were not the same as last year’s, hence the need for using discounted cash flow methods when looking at investments. Maybe it’s so obvious that it’s assumed that everyone instinctively knows it. I know national statistics are invariably adjusted to reflect this.
They are adjusted
I will think about how to tackle that
Coming in a bit late on this, sorry.
I’ve read your latest version, and I’m not sure you are quite making clear that the government of a floating currency issuing government doesn’t actually has to issue bonds at all.
The so-called National debt only happens to be a measure of past fiscal deficits because governments always issue bonds to match their deficits in any given period. In fact, I’m not convinced that they really do anyway, because the Treasury issues bonds in advance of anticipated deficit expenditure as set out in the budget and spending reviews. So the actuality may not be in lock-step. It all harps back to the bad old days of the Gold Standard and Bretton-Woods, but has not been the case since 1971.
BTW there’s a typo in para 3, line 5. “binds”, though I’m sure it is getting the government into a bind.
Typo corrected
And an emphasis added that bonds are not a necessity but a choice.
Your updated glossary explains the concept really well. However, I’m wondering if managing the national debt is PRIMARILY about inflation control, with who should be taxed and by how much, and the sale of interest bearing bonds being a secondary issue, should the government choose to manage inflation via the management of the national debt. Therefore, is the mention of taxation policy a conflation brought about by your beliefs about wealth inequality, and jumping a few steps ahead, as it were!
No, I think it’s reality.
This is obviously more complex than would first appear. Detailed explanations would be helpful for those of us with a lay persons understanding of economics and accounting. I appreciate that this would be time consuming, but perhaps it’s something to be integrated into your plans for the future.
OK….let’s see how things develop
I am not going anywhere any time soon.
I think omnibus passengers (and political campaigners) would benefit from an awareness of a point Richard often makes in answers here, which is that MMT is not political.
There are FACTS about “money” that MMT describes – what goes on that list?
The facts that go on that list are then indisputable, but pundits, economists and politicians lie about them all the time, decade after decade (water flows uphill, the world is flat, Covid never happened, water boils at 200 degrees centigrade).
There are massive political implications once the public grasps such things. No Chancellor could “sell” austerity or water privatisation to an MMT-aware public.
Take electricity – my mum didnt understand it at all, when she extended a cable for the first time, she trimmed both cables and wrapped all 3 strands, (red, black, green, it was a long time ago) in insulating tape. Switched on, the laws of physics did their stuff (BANG!).
It’s REALLY important that the public “get it” about electricity, but also about “money”.
What you choose to connect to the socket? A slot machine or a dialysis unit? That’s politics!
This brings us to the political stuff. If these are the MMT facts about tax, spending, inflation and central interest – what decisions shall we make?
Do we want sh*t in the rivers?
What about health and social care? Whose responsibility is that? The state or the individual?
Shall we tax to reduce or increase inequality?
Shall we control inflation or let it rip?
Knowing that water flows downhill really helps save money because you put the reservoirs on land that is higher than the consumers homes and save millions on pumping stations. (You still need some but not as many)
Knowing that governments create money, makes some political decisions much easier and others much harder.
So SOMEHOW I’d like that distinction between MMT “facts” and the separate issue of political “choices” like austerity or regressive taxation, to be even clearer so that the public eventually GET it. Rachel Reeves and Dan Neidle DON’T want that happen, I can’t imagine why….
I acknowledge that this blog already tries hard to maintain that distinction.
Theer is an MMT video coming…
It’s in the can, as they say…