One of the primary concerns that people have about Modern Monetary Theory is that if the government
is not limited in it’s spending by the amount of revenue it can raise from taxes, in the common
“household budget” myth, then the government will increase spending, and when the government
increases spending, this leads to hyperinflation. Common examples of this are Weimar Germany,
Zimbabwe or Venezuela. All three of those had other factors that contributed to hyperinflation.
Let’s break down the process of why government spending would lead to hyperinflation
so you can understand how that could happen and what the government can do to halt inflation,
all within the framework of our understanding of MMT.
We have established in a previous video that a federal government that has its own currency
creates that currency, and so can never run out of its own money.
The method of currency creation is via government spending. When the government
pays its employees or purchases goods or services from companies or citizens then it electronically
creates the money required to cover the cost and money is created into the economy.
The risk is that if this happens too much there will be an oversupply of money in the economy
and an individual unit will lower in value because the money is so abundant. While this can,
and has happened, there’s a specific constraint that is being left out of the equation.
Let’s use an example to illustrate this. The government wants to build a new road.
They do not have financial constraints now that they understand MMT, but they do want to get it
done quickly. In order to do this they purchase every single unit of concrete in the country.
Having depleted the entire supply of concrete, the private, or n on-government sector
will realise there’s nothing left for them to use. Private companies who are able to will go back
to the concrete suppliers and offer to pay more than the government is offering for the concrete.
Of course, as we mentioned, the government does not have financial constraints
and so will have no problem raising their bid above the private sector again. This process
will continue until the private sector can no longer compete with the government’s price,
but by this time the price of concrete has soared to never before seen levels.
This is inflation. Now imagine this scenario, but it’s happening across the entire economy in all
sorts of different sectors. This is how we can see that hyperinflation can get out of control
if the government is not limited in its ability to create money.
Government spending is limited only by the full employment of resources, so when
there’s nothing left to buy, then any further government spending could lead to inflation.
Fortunately, as we have also learned previously, where government spending is the creation of
money, taxation is the removal of money from the economy. So the government has a tool available to
counter inflation. Let’s see that scenario again. The government tries to buy all of the concrete
in the country, then the private sector tries to outbid the government for use of that resource.
Only this time, instead of entering a bidding war until the price of concrete gets out of control,
the government can simply impose a tax on the private companies,
removing their ability to compete with the government in a bidding war.
Again, we could apply this tactic for almost any resource across the entire economy and
see that the inflation that could occur through government spending can be hindered by taxation.
So let’s hope the government never needs to buy all of the concrete in the country,
but at least if it does then we can be confident that they’ll have the resources available
to build a road quickly without having to worry about hyperinflation.