Money creation and Public Expenditure

It has been shown that the creation of inflation subsequent to the issue of new money can, in theory, always be prevented by trying to maintain true the equation  (G)oods[1] =  (M)oney.

Indeed, where, subsequent to the creation of new money, new goods or public services are created and always have the essential characteristic of carrying[2] utility (in both social and individual terms), which is the basis for its actual value, inflation cannot be generated thanks to this very reason only[3].

It is a unifying model that prevents extreme positions and dangers, which have occurred in this first part of the 21st century; this model also features an effective action to the detriment of country-systems resulting from financial and monetary capitalism, which has often caused the effects mentioned above, beyond any physiological rule (either written or unwritten) of social well-being.

The hoped-for unification is based on the implementation of fiscal policies that are closely coordinated with monetary policies. The breathlessness caused by their separation is shown by the present European situation, where the monetary policy is implemented with quite some delay to try and make up for the damage caused by non-coordinated economic (fiscal) policies implemented by the single Member States[4]. This is the ultimate reason why the implementation of unified fiscal policies at EU level is a "must have"[5].

As stated at the beginning of this paper, this would lead to the “solution of the dilemma”[6] consisting in the “circular relationship” between public expenditure[7], debt and tax revenue.

Therefore, as stated in the premises, conceiving the use of the monetary lever in a “new way”, other than the present one, can amount to a third way that is a must to be able to get out of the “vicious circle” given below: lessening tax revenue = increase in public debt, on the one hand, and decrease in public debt = increase in tax revenue, on the other.

However, it is wise and prudent not to ignore the fact that, where even only one fiscal policy, based on debt and taxation, today proves not to be adequate, also a public expenditure policy that, in theory, can be financed only by issuing money, up to the extreme of full use of all productive factors, would, inevitably and quite soon, show all its limits.

See the works by Warren Mosler on Modern Monetary Theory (MMT), which is defined also as “neochartalism”, where taxation is considered a simple tool, not to finance public expenditure but as a counterbalance to a monetary policy on which decisions concerning public budgets, always in deficit, are based. Moreover, a theoretical absence of taxation would give raise to social and economic scenarios featuring distortions and unfair redistribution of the wealth produced. All the more so in a scenario like the present one, which leads to expect capital accumulation rather than any increase in income. Indeed, the latest calculations show that, in these first decades of the 21st century, the annual return on capital is expected to come to 4-5%, vs. income from work that is expected to increase, in the best scenario, by 1-1.5%, thus, with a nearly mechanical increase in the gap between these two entities and their “owners and producers”, with a nearly inevitable increase in social inequalities[8], unless a wealth tax is introduced, which is difficult in political terms, at least in Italy (even though this phenomenon is global).

Important reasons, both theoretical and practical ones, prevent drastic and hasty conclusions (or theories), which would entail traditional fiscal policies to be fully discontinued.

In practice, it is not advisable to have the monetary policy reins held by the political power only, since, in this case, the risk of abuse would be very high indeed, especially, as well known and proven, during election campaigns[9].

In designing new food for thought, on specific matters concerning living in a community, such as economic ones, extreme positions must be avoided, since they cause different hypotheses to be ruled out if they seem antithetical to the proposed ones.

For instance, it would not make sense giving up the monetary and lending function that only a banking system, duly regulated (in order to prevent any excesses), would be able to manage efficiently, in symbiosis with a monetary policy public governance. The private-law criteria for lending, as implemented by banks and regulated based on international agreements (for instance the Basel Accords I, II and III), in the majority of cases (non-turbulent economic scenarios) are very likely to prove much more efficient than public-law ones.

In theory, it can once again be observed that the equation G = M necessarily requires making decisions concerning the issue of money linked to specific and efficient public expenditure plans[10].

As regard the latter point, it is still necessary to further think over what type of public expenditure is to be made subsequent to the issue of new money.

Indeed, both current expenses for services and non-current ones for investment seem, in theory, to have the same rank: both, if effectively managed, can increase the GDP and, thus, global income, but it is obvious, in practice, that current expenses are more at risk of waste and inefficiencies[11].

Conversely, for investment expenses, which are carefully planned and highly required[12], this risk is mitigated, while they increase the specific infrastructure assets that are required to increase the country-system competitiveness.

Fiscal and monetary policies, unified and coordinated with one another, would then need to be implemented, exploiting essentially and expediently their specific and important counter-cyclical function[13] against economic fluctuations: specifically, it can be proven logically but also in a formal mathematical way, that, in stagnation and recession scenarios, for the State it is “economically advisable” to finance a deficit generated by public investments that were required for an economic recovery, with no need to create other debt, but using only and exclusively, money issue.

A logical/formal demonstration (thus, a mathematical one) should prove that the increase in income resulting from the creation of new goods and services can absorb the increase in money supply required to generate it, without, exclusively for this very reason, generating inflation. Demonstrating also that the alternative, based on the increase in government debt, would at least generate a constraint in terms of resources (which would impact on the State's future budget). These tied resources are obviously to be used for servicing the debt itself (payment of interest due by the State to the subscribers of government securities). It can be formally demonstrated that the financial resources to be used to pay interest would be used by the relevant payees (and in different timeframes) in a non-functional way (with a subsequent loss in terms of efficiency and effectiveness) with respect to the stringent economic requirements that have caused the State to implement, here and now, a specific fiscal policy for investments supporting the economy.

Finally and for the sake of completeness, it can be easily realized that the other possible, in theory, alternatives, concerning the implementation of tax measures, are not easy to implement in economic crisis scenarios, for a number of reasons. Indeed, they seem to be affected by a high “stiffness factor”, caused by the uncertainty and long times for their implementation (such as in the fight against tax evasion), the already high existing overall taxation (which is a decelerator of the economy) and the ever-existing political conditioning concerning the relevant decision-making. The rationalization of the tax system is certainly an essential objective to be pursued, but it is not the main tool to rely on[14] in scenarios of recession and economic crisis, where fast decision-making is a key requirement.

[1] Keeping in mind that Goods include also Services.

[2] It goes without saying that this is possible only with an administration action that is, both in terms of decision-making and in terms of implementation, sound and free from any private conditioning or even offences. In other words, it requires a political and administrative action that is, on average, sound, where waste, inefficiencies, corruption, etc., which probably cannot be fully eliminated, are reduced to a physiological size.

[3] As already pointed out in the previous Note, inflationary tendency could well be generated by induced demand but, however, could be controlled.

[4] Whose politicians seem to gear their actions based on immediate election success rather than on wide medium- and long-term perspective.

[5] The considerations made herein are intended to prove why coordination between fiscal and monetary policies is a "must-have". It seems logic to conclude that such unification must take place on the same political and institutional level; therefore, if, for Euro area Member States, monetary policies are dealt with at a EU level, also the fiscal policies of such Member States, or at least a significant part thereof, must be subject to supranational unified coordination. The transfer of monetary authority and powers to the EU entails the transfer of a considerable portion of authority and powers regarding fiscal policies. Transferring powers and responsibilities for fiscal policies to the EU without setting down mechanisms and principles for their coordination with monetary policies would be a mistake that must be prevented. In short, the present governance standards must be redesigned at a EU level not only concerning fiscal policies but also monetary ones.

[6] Economists, especially classical ones, define the situation in which a difficult choice has to be made between two alternatives as a dilemma, where neither alternative ensures an outcome deemed optimal.

[7] It goes without saying that sound management of public expenditure is given for granted, which means that waste is reduced to a physiological size.

[8] It is worth mentioning the “cycle of poverty”, which is typical of Latin America Countries (but obviously not limited to) and based on which the farmers that own small plots of land are, by hook (i.e. receiving a very low consideration) or by crook, “dispossessed ” of their land, the title on which is acquired (requisitioned) by the large “green multinationals”; the dispossessed farmers then add to the crowd of the hopeless living in the favelas of the now apocalyptical big cities in the South America.

[9] In this regard, reference is made to the fundamental works by James M. Buchanan, one of the founders of the public choice school, whose analyses have well shown the relationships existing between economic and social objectives, personal interest and aspirations, errors of judgement, institutional constraints and external conditioning factors.

[10] There is a logical and practical need to make unitary and synergic decisions, concerning both public expenditure and monetary policy. They are the “two sides of the same coin”.

[11] In this regard an old Italian saying comes to mind, which goes “Expenses pile up more quickly using a tea spoon that a shovel”, conveying the same meaning as Benjamin Franklin’s “Beware of little expenses. A small leak will sink a great ship”. These considerations are far from the formalization given by a mathematical model, but are empirical and based on sensible observation, which ranks exactly the same in terms of its contribution to the design of a reference theoretical model.

[12] Thus, meeting the utility requirement, which gives them (economic) value.

[13] In this regard, reference is made to the considerations previously made criticizing the procyclical policies implemented in Europe during the latest financial crisis. It is a fact that neoliberalistic policies only (as progressively implemented since the 70s), after 40 years of harsh implementation, at least in the “economic system of the West” (keeping in mind that globalization is one of their “adverse” side effects) are proving to be breathless, despite their very wide cultural background, both political and academic, seems not ready to admit it or even to detect it.

[14] Except for a decrease in tax rates (with the already-mentioned stabilizing effects on the economy), which, however, does not seem likely to be implemented in the short time, since there are no significant margins given the stiffness of public expenditure, whose rationalization would require a long time.