The Tax Research glossary seeks to explain the terms used on this blog that refer to more technical aspects of economics, accounting and tax. It recognises that understanding these terms is critical to understanding the economic issues that affect us all the time.
Like the rest of the Tax Research blog, this glossary is written by Richard Murphy unless there is a note to the contrary. It is normative approach and reflects post-Keynesian, heterodox economic opinion with a bias towards modern monetary theory. The fact that many items in that sentence are hyperlinked shows that they are explained in the glossary.
The copyright notices pertaining to the Tax Research blog apply to this glossary.
The glossary is designed to achieve three goals:
- It seeks to provide a short, hopefully straightforward, definition of what a term might mean.
- It then seeks, when appropriate, to explain what the term means within the context in which it is used. This is meant to elaborate the definition to add to understanding.
- It then critiques the term, explaining, if appropriate, what the weaknesses inherent in the term or the situation it describes are. The aim here is to empower the reader to understand the issues behind the nonsense that most professions create around their activity to provide them with a mystique that they rarely deserve and which often hides what they are really up to.
The glossary is not complete. It will grow over time. If you think there are entries that need adding please let me know by emailing firstname.lastname@example.org. Please also feel free to suggest edits. The best way to do this is to copy an entry into Word and then send me a track-changed document indicating the changes that you suggest.
Because of the way in which it is coded this glossary automatically cross refers entries within itself and to the blog that it supports and within the glossary itself but if you think a link is missing please let me know.
Finally, if you like this glossary then you might like to buy me a coffee. It has required the support of a fair few to write it. You can do so here.
- Maxed-out credit card
- Memorandum of association
- Modern Monetary Theory
- Monetary policy committee
- Money creation
- Money in the bank
- Money laundering
- Multinational corporations
- Multiplier effect
Maxed-out credit card
References to a 'maxed-out credit card' are a part of the ‘household analogy' beloved of many politicians who like to claim that the affairs of a state must be run in a fashion akin to the way in which a household might be managed.
In this case the reference to the ‘maxed-out credit card' is supposed to imply that the state has run out of credit from its lenders and can borrow nothing more. The implication, which is heavily emphasised by those making use of the claim, is that the state must as a result cut its spending whether it likes it or not as its creditors will supply it with no more money. The claim is used to justify austerity requiring spending cuts by a government.
The claim, like all aspects of the household analogy, makes no sense.
A country cannot, for a start have a credit card.
In addition, a country with its own central bank and currency never needs to borrow: it can (and as a matter of fact, does) create all the money that is required to fund its spending by asking its central bank to create all the money required to fund that spending at the time that the spending in question takes place (see money creation).
The decision by a government to provide savers with the facility to save with it is an option, but not one that they need provide since the end of the gold standard era. During that era a government was supposedly only allowed to issue money if it had gold to back it. Without that gold to back new money creation a government supposedly had, if it wished to spend more than its receipts in the form of tax, to borrow to withdraw money from use elsewhere in the economy so that it might use that money instead to fund its own activities. With the artificial constraint of the gold standard having been removed, there is now no theoretical limit on the amount of money that a government can create. Nor need it borrow to fund its activities if its spending exceeds it tax revenues: it can simply instead run an overdraft at its central bank (called the Ways and Means Account in the UK).
As a result, the concept of government borrowing now makes no sense: instead the government now provides savers with a place of safe deposit for the funds that the government has already created by spending in excess of its tax revenues.
By definition, in that case government spending creates the funds available for those deposits (that some people still erroneously call government borrowing) to take place. Government spending can never be constrained by them as a result.
Nor is it possible in that case that those wishing to save with the government might constrain its spending plans: the government can either run an overdraft with its central bank to fund that spending or use quantitative easing (see separate entry, with all the caveats noted there).
The ‘maxed-out credit card' is mythology wholly unrelated to any economic reality in that case.
Memorandum of association
The memorandum of association sets out the purpose of the company and the powers it has to fulfil that purpose.
In recent decades companies have been allowed to adopt an all encompassing purpose stating that they will undertake a generic activity as a trading entity. This has reduced the significance of the memorandum of association but not eliminated it.
Modern Monetary Theory
MMT suggests that a government spends the currency that it wants to be used to make settlement of the taxes owing to it into the economy with the active assistance and support of its central bank when undertaking its routine spending, for the purposes of which expenditure the central bank provides all the money required by way of loans meaning that neither tax revenues or third party government borrowing are required to fund that spending although they might be for other purposes.
In more detail it is suggested that the core assumptions of MMT are:
- That a government that has its own central bank and currency, which currency is internationally acceptable, need neither tax nor borrow before spending because its entire government expenditure can be funded by new money creation by its central bank acting on its behalf, with the government then being indebted to its central bank for the sum expended.
- A government that borrows in this way from its own central bank need never repay the debt it owes to its central bank because that debt represents the money supply of the jurisdiction for which it is responsible and that money supply must, therefore, be maintained if the level of economic activity in that jurisdiction is to be sustained.
- The primary role of taxation in the funding cycle of such a government is to control the inflation that might be caused by the excessive creation of new money by that government when fulfilling its expenditure plans.
- The secondary role of tax in the government's funding cycle is to provide the government-created currency of a jurisdiction with value in exchange. That happens because if the tax owing to a government can only be settled using the currency that government creates those transacting in that economy who are likely to have tax liabilities arising as a result will not be able to afford the exchange risk arising from trading in any other currency.
- Once these roles of taxation have been fulfilled the additional role of taxation for a government is as a tool for the delivery of its economic, social, regulatory and inequality agendas. The design of taxes for this purpose is, however, never intended to have a revenue-raising function to enable government expenditure to take place, that expenditure having already been funded by the central bank of the jurisdiction on the government's behalf.
- A government in the situation described need not balance its expenditure and taxation income. In most situations that balance would, in fact, be undesirable. If the government has a growing economy and modest but controlled inflation within that economy, then the expansion of its money supply is essential, and that expansion of the money supply is best delivered by the running of government deficits. Such deficits represent a shortfall of tax receipts compared to government expenditure. This policy should be preferred to increasing the scale of private sector borrowing within the economy, which is the alternative source of new money creation.
- A government in the situation described need never borrow from financial markets. That is because the government can always borrow instead from its own central bank. It has no dependency on financial markets as a consequence.
- A government in the situation described may, however, wish to offer a savings banking facility to those in the jurisdiction for which it is responsible who wish to save in the currency that the government in question has created. It does so in its capacity as a borrower of last resort. This deposit-taking does not represent government borrowing: it is a banking arrangement. Even if the funds deposited with the government are then used to clear the apparent overdraft advanced by the central bank to the government the status of these deposits as a third-party bank or savings facility is not changed: the central bank can always guarantee the repayment of the deposits in question by the creation of new money, which is precisely why the government is able to offer this borrower of last resort facility.
- A government in this position does not need to use interest rates to control inflation. It can instead use the following mechanisms to control:
- Varying tax rates over one or more taxes to tackle the cause of the inflation being suffered. New taxes may be required to assist this process.
- Varying the scale of the deficit.
- Credit controls to limit commercial bank lending.
- A government in this position could seek to run a low effective interest rate policy within its economy to firstly minimise interest obligations to those to whom it provides banking facilities; secondly to provide the best possible environment for investment by lowering the cost of capital; and thirdly to minimise the upward reallocation of resources within the society for which it is responsible as a result of interest paid, thereby reducing inequality, which goals in combination have the best chance of delivering overall economic prosperity.
- A government in this position can have a policy of full employment, knowing that until that point is reached, there will be under-used resources within that economy for which they are responsible, meaning that inflation will not be stimulated as a result so long as the resources put to use are those currently unemployed, whether they be people, physical assets, or intellectual property. This policy could include the provision of a job guarantee for all those seeking work within the economy who are unable to secure it, but any such policy must reflect the individual circumstances of the job seeker and be consistent with the overall delivery of social security within the jurisdiction for which the government is responsible, and cannot as such be a critical component within the economic policy of the government in question.
Monetary policy committee
The Bank of England monetary policy committee (MPC) has nine members, five from the Bank and four external members who are usually academics or representatives of the financial services community. The committee has a very narrow focus of expertise as a result.
The notional independence of the MPC is controversial. See central bank independence.
All money represents a promise to pay denominated in the fiat currency of a particular jurisdiction. The UK pound sterling is a fiat currency, as is the US dollar, the euro, the Japanese yen, and all other major currencies in the world.
In a fiat currency system there is no asset backing for the money that a jurisdiction creates. This has been true in almost all jurisdictions, and all major ones, since the final abandonment of the gold standard by the USA in August 1971.
It is commonplace for people to think that money has a tangible existence, mostly because of the existence of notes and coins. This is not true. Notes and coins are simply tangible and transferable representations of the government's promise to pay which it redeems by accepting them in payment of tax.
As a result, the idea that there is ‘money in the bank', as many people commonly state, is not true. No one has ‘money in the bank'. The only thing that a bank has is a general ledger (see double entry book-keeping) that records the money owed to it and the people to whom it owes money.
Banks are as a result just giant exercises in book-keeping, whatever mystique they like to create around the process.
In a fiat currency system , which system is now used by almost all money-creating jurisdictions in the world (including the UK, USA and eurozone) all that money represents is a promise to pay, which is otherwise called debt. All money creation must, as a result, recognise the creation of new debt between the parties who give rise to that new money creation.
This process is not as complicated as it sounds. Only two types of organisation can be involved in transactions that create money.
One is the government of a jurisdiction that creates a fiat currency. A government can create new money at will by demanding that its central bank make a loan to it to finance its expenditure. This is the source of all new government-created money, otherwise known as base money, which is used to enable the banking system of a jurisdiction to function by providing the liquidity required so that the jurisdiction's commercial banks can settle their liabilities to each other.
Government-created money is injected into the economy via the central bank reserve accounts that commercial banks maintain with a jurisdiction's central bank.
Government-created money is destroyed through the payment of tax. This is important. It explains why tax does not fund government spending. Money creation by the government funds government spending. Taxation takes the money the government creates to fund its spending out of circulation as a mechanism to control inflation. That money is then destroyed. Tax as a result never funds government spending: it cancels money creation.
Government-created money can also be effectively neutered by the issue of government bonds: these effectively lock away government-created money from use in the economy for significant periods of time. They do not have the same impact of destroying money as taxation does, but the impact is not far short of that: the money, or debt, is locked out of use.
Commercial banks also take part in the money-creation process. They do so by lending, The money that they create is destroyed by loan repayment. This was acknowledged as a fact by the Bank of England in 2014.
There is no fixed stock of money. The amount of money in circulation depends on the amount of money created by both the government and the commercial banks of a jurisdiction, and the amount of money destroyed by taxation and loan repayment. In that case, the control of inflation necessarily requires the integration of tax policy and monetary policy. The fact that this rarely happens is a major weakness within modern macroeconomics.
Money creation by banks is pro-cyclical. That means when the economy is booming the banks lend more and so create more money. When an economy is sluggish borrowing is reduced and loan repayments tend to increase. The result is that if money supply is to be maintained across an economic cycle a government has to spend more money into existence during economic downturns. This is a major reason why austerity economics has been so counter-productive because it reinforces the pro-cyclical swings created by commercial bank lending policies and exaggerates the economic cycle as a result.
Money in the bank
It is commonplace for people to say that they have ‘money in the bank'. This is not true.
No one has ‘money in the bank'. The only thing that a bank has is a general ledger (see double entry bookkeeping) that records the money owed to it and the people to whom it owes money. Banks are just giant exercises in bookkeeping, whatever mystique they like to create around the process.
There is no tangible asset that backs up this process of debt management.
All money is debt: there is nothing more to it than that. As such all that a bank does is acknowledge the debts owed to it and by it. As a result, the only approximation to the tangible existence of money that actually exists is a bank statement.
The term originated from the use of laundromats or launderettes for this purpose since they always took payment in cash.
Money laundering frequently involves a process described as layering which means money moves through a number of processes or stages to distance it from its illicit or illegal origins.
A multiplier effect is a measure of the amount by which national income is increased or decreased as a result of additional spending within an economy. If a multiplier effect is greater than one then the additional spending produced an increase in income of greater than its own amount, and vice versa.
The largest multiplier effects are usually associated with healthcare spending and capital investment, where returns that are several times the size of the sum initially expended can result. In contrast, defence spending has very low multiplier effects.
Some multiplier effects e.g. those resulting from spending on education are hard to measure because of the extended time periods involved.