by
Robert Cauneau – MMT France
18 November 2024
Public debt has become a central topic of debate in government budget management. Many believe that the accumulation of debt by governments constitutes an economic risk factor, particularly due to the interest payments, which are said to weigh on public finances and justify austerity policies. This traditional approach deserves to be reassessed in the context of contemporary monetary systems.
This article highlights the necessity of public borrowing in a fixed exchange rate regime, but emphasizes that, in a floating exchange rate system, a government issuing its own currency does not need to borrow to finance it. It then proposes a rethinking of public debt in light of Modern Monetary Theory (MMT), which reveals the true nature of public debt and advocates the idea that the natural interest rate for a government that controls its currency is zero. Finally, the article asks whether the necessity of public borrowing is the result of a biased understanding of how the system works, or a political choice.
Public borrowing, a necessity in a fixed exchange rate regime
It is essential, in any economic analysis with a monetary dimension, to specify whether one is reasoning within a fixed or floating exchange rate framework. This clarification is often omitted by other economic approaches, but for MMT, it constitutes a fundamental element.
A fixed exchange rate regime is a situation in which the currency is anchored to a standard that requires a buffer stock to maintain it, either a commodity (usually a precious metal) or a foreign currency. The exchange rate must then be continuously manipulated (primarily through sales and acquisitions of the standard (gold, silver, or foreign currencies) and domestic currencies) by monetary policy in order to keep it fixed. Indeed, since the currency is fixed to a standard, the state must be constantly willing to sell this standard whenever a buyer is willing to buy it at that price and cannot find it on the private market, which therefore necessitates state intervention. This point, concerning the need to maintain the fixed exchange rate through state manipulation, is central to distinguishing it from a floating exchange rate. There is therefore a close relationship between the buffer stock constituted by the standard and the state’s ability to maintain the fixed rate, which makes this exchange rate regime fragile. As a result, the pressure the state must constantly exert limits its spending capacity. Under this regime, when it spends, the state must compensate with revenue in the form of taxes or borrowing. This regime is therefore one that entails financial restrictions.
Under a floating exchange rate regime, the government has no need to borrow.
Under a floating exchange rate regime, the relationship between maintaining a reserve buffer (gold standard or otherwise) and the ability to spend is abandoned. The government is then the monopoly creator of its currency, and its spending is financed neither by its taxes nor by the debt securities it issues. The government therefore has no nominal limit on its spending. It can spend as much as it wishes, without any financial restrictions, provided that real goods and services are available for sale. This government is never financially constrained in its currency. Its spending capacity is therefore unlimited in nominal terms, but nevertheless limited by the availability of real resources (technological resources, natural resources, and labor).
According to this logic, a government that has a monopoly on creating its currency under a floating exchange rate regime cannot go bankrupt unless it wants to. And the fact that a State sets limits on its spending is purely voluntary.
The True Nature of Public Debt
It therefore appears that understanding how the monetary system actually works is crucial to dispelling fears related to public debt. Under a floating exchange rate regime, government securities are not used to finance spending, but to support interest rates. This is why Warren Mosler, the leading thinker behind MMT, suggests no longer using the term « public debt » but rather « interest rate maintenance account. » And what we call public debt is nothing other than the national currency created by public spending and not yet withdrawn through taxation. It is the sum of cash + bank reserves + government securities. It is therefore, to the nearest cent, the net financial wealth of private sector agents. This means that when the government issues securities, it is not « borrowing, » in the sense of private debt, but simply changing the form of its currency, which goes from reserves to securities.
Indeed, the issuance of a government bond is in every way comparable to the transfer of a sum from an uninterest-bearing current account to an interest-bearing deposit account. It provides no additional means for spending for the government, which in reality creates its own currency by spending. And when the bonds mature, this is not a « repayment, » but rather a reverse change in the form of the domestic currency, from « securities » to « reserves, » just as it is from an interest-bearing deposit account to an uninterest-bearing current account.
The key interest rate should be kept at zero.
This understanding of monetary functioning, which reveals the issuance of government bonds as a relic of the gold standard and fixed exchange rates, allows us to overcome the all-too-common fixation on budgetary balance, as well as the concept of a quantitatively limited national currency. And, in any case, faced with the rising cost of interest1, MMT proposes a radical solution: keeping the central bank’s key interest rate at zero.
This proposal stems from the analysis of modern monetary mechanisms, which demonstrates that a zero risk-free nominal interest rate is normal for national currencies created by governments2. These systems are based on « fiat » currencies3 with floating exchange rates, with the government having a monopoly on the creation of the national currency.
In this context, as explained above, governments, as creators of their own currency, are not limited by their revenues to finance their spending. Taxes do not serve to directly finance spending, but to create demand for the national currency. Moreover, public deficits are « natural, » because government spending precedes revenues. The sale of government securities primarily serves to regulate bank reserves and stabilize interest rates, while deficits create surpluses of the national currency in the economy.
Japan is a concrete example: despite a very high public debt ratio, the country has maintained interest rates close to zero for years, demonstrating that public deficits and low interest rates can coexist without harming economic stability. In short, a zero interest rate is a functional feature of the modern monetary system, where government spending does not need to be financed by revenue4.
The Imperative of Public Borrowing : A Biased Understanding of How the System Works or a Political Choice ?
The preceding developments reveal a profound contradiction between the MMT analysis and current practices. This divergence raises the question of whether the persistence of public borrowing is due to a lack of understanding of monetary mechanisms or to political choices.
The example of the Eurozone, which itself operates under a floating exchange rate regime, particularly clearly illustrates this tension between the intrinsic functional characteristics of the monetary system and the way it is used. By renouncing control over their currencies, member states, including France, have submitted to restrictive rules dictated by the governance of the euro, such as the obligation to maintain a positive balance in their Treasury account with the ECB. These constraints, which have no economic basis, reflect an ideological vision favoring strict budgetary discipline.
Thus, reducing the explanation for dependence on financial markets to a mere ignorance of contemporary monetary principles would be overly simplistic. Indeed, recourse to financial markets can also be interpreted as an ideological choice aimed at strengthening their influence and serving the interests of investors. By issuing government securities, governments offer a safe asset to financial actors, which perpetuates the neoliberal idea of the state’s submission to market constraints, as well as austerity policies, thus favoring private interests over the public interest.
Conclusion
The persistence of public borrowing, despite the economic futility of this practice under a floating exchange rate regime, rests on foundations linked as much to a lack of understanding of the monetary system as to political choices. Far more than a simple financial option, by fostering the illusion of a budgetary constraint weighing on the state, the issuance of government securities embodies a form of submission to financial markets. It follows that, under the unfounded pretext of the « sustainability » of public debt, this outdated vision limits the scope for government public policies and thus prevents fiscal management geared toward the real needs of the population.
Yet, as Warren Mosler suggests, all issuance of government securities could be stopped.
« Instead [any issuance of Treasury securities], any deficit spending would accumulate in the form of excess reserve balances at the Fed. Issuing Treasury securities with a non-convertible currency and floating exchange rate policy serves no public purpose. » Mosler (2009)5
Such a change would break with the logic of dependence on financial markets and, by dispelling the illusion that public spending must be financed through borrowing, refocus fiscal policy on the public interest. However, for the Eurozone member states, such a development remains conditional on a review of the financial constraints imposed on them.
Notes
1. This point will be the subject of another article.
2. See : https://moslereconomics.com/wp-content/graphs/2009/07/natural-rate-is-zero.PDF
3. Fiat currency is a government-issued currency convertible only into itself, as opposed to a fixed-rate national currency such as a gold standard or other currency with convertibility into any other commodity or national currency fixed by the issuing state (such as currency boards, pegged national currencies, or currency unions). The United States, Japan, and most of the world’s industrial economies are examples of such monetary systems, including the Eurozone.
4. Stephanie Kelton, asking the question « To bond, or not to bond? », suggests in this video a choice of measures including that of the zero interest rate. : https://www.youtube.com/watch?v=ql0OFY7W3Qs
5. See this article : https://neweconomicperspectives.org/2010/02/warren-moslers-proposals-for-treasury.html
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