MMT, Deficits and Savings: The Babysitting Model

The way Modern Monetary Theory folks talk about the economy leads to a lot of confusion.


The best example is the assertion that the private sector cannot "net save" unless the government runs a budget deficit.

This annoys and confuses people because it seems to be an assertion that people cannot save money unless the government is running a deficit. If that was what MMT was claiming, it would be nonsense. You and I are perfectly capable of saving regardless of how the government’s spending and revenues balance out.

The MMT people aren’t actually referring to you and I saving. They aren’t even talking about the entire household sector saving financial assets. They are talking about the entire private sector spending less money than it earns.

You can easily see why this would be impossible without the government spending more than it collects. Every dollar someone is paid is a dollar someone else has spent. If we all—every single person and company—spend less than we are paid, very quickly we will find we have to be paid less. The aggregate effect of savings is to reduce the total amount people are being paid for things.

Imagine there are a bunch of us in a Park Slope babysitting co-op. We each earn an hour of babysitting time by providing an hour of babysitting time to our fellow co-op members. So long as everyone “spends” the hours they earn, everything works out fine.

But if we all try to spend more than we earn, there’s a problem: a shortage of babysitters. If we all try to save more than we earn, there’s another problem: a shortage of people needing babysitting. Everything would work out fine if one or more family just constantly needed babysitting—they’d accumulate a babysitting debt, we’d all accumulate a babysitting surplus or savings.

So this is what MMT people are talking about when they refer to a “private sector desire to net save.” They mean that if you add up all the earning, spending and savings of every person and company in the economy outside of the government, sometimes you find that the private sector is trying—nearly impossibly—to earn more than it spends.

The only thing that can make private-sector net savings possible is government spending. If the government spends more than it takes in taxes, the private sector can earn more than it spends. Remember, if everyone pays less than they earn, some outsider must be paying more than he earns. The government is basically filling in the role of the family who constantly needs babysitting—using up those saved hours and, therefore, providing a chance for the shut-in Park Slope parents to save even more hours.

Once you wrap your head around that, it seems easy to understand what those MMT people are talking about when they say the government must run a deficit in order for the private sector to net save. But it’s also easy to mistake this fact for a number of similar but false statements.

For instance, the government does not need to run a deficit for “people” to save. If by people, you mean households, there’s no need for a government deficit. People can save by putting their money into savings accounts that are then lent out and spent by others. They can buy corporate bonds or even stocks. They can put money into a 401(k).

Also, it’s simply not true that government deficits result from the private sector's desire to net-save. Deficits can “accommodate” an aggregate demand in the private sector to save more than it earns, but they don’t result from that demand. Deficits result from votes by politicians interacting with the real economy. There’s no “to the penny” causal relationship.

It’s worth keeping in mind that it is just as true to say that the entire world itself cannot “net-save financial assets” anymore than the private sector can. Everyone’s financial asset is someone else’s liability. Viewed on a planetary scale, net financial savings is completely impossible. Unless, you know, we start trading with Newt Gingrich’s moon colony.

This raises an interesting question: should we enable the private sector to net save? There’s a good argument that we shouldn’t use government for this purpose. A private sector that doesn’t have recourse to government savings accounts would likely invest more.

Providing government savings accounts—reserve balances at banks or Treasury bonds—simply allows leakage from the economy. It’s a version of “crowding out” private investment, although the phrase “crowding in” might be more appropriate.

On the other hand, in economic emergencies the effect of everyone—households and companies—attempting to save more than they spend can be devastating. The economy has to contract in that situation. If everyone in our babysitters club went from requiring 1 hour of sitting a week to requiring 1 hour of sitting a month, we’d all suddenly be earning 1 quarter of the babysitting credits we used to. In the real economy, where lots of prices are fixed in the short and medium term (think of your rent or your mortgage, your salary, your cable television bill), this can cause serious problems.

The deepest questions in economics is really about how permanent the emergencies are and whether attempting to address the emergencies makes the situation worse. Many MMTers assume that the private sector more or less always desires to net save, which means a public sector deficit is always necessary. Old-school Keynesians, from what I understand, think that deficits are necessary when the economy enters a contraction. Post-Keyensians think that deficits don’t work because they only encourage people to save more, undermining the whole purpose. A market-oriented anarcho-libertarian would argue that we shouldn’t have government providing an escape hatch for the economy.

This gets to the idea of “public purpose” that MMT people bat around a lot. They don’t usually address this directly, but it seems to me that the primary public purpose of deficits in MMT discourse is allowing “net savings.” That is, government exists, in part, to allow the private sector to accumulate financial assets. The deficit, in this sense, is simply the public way to achieve our cumulative but individual spending, earning, and savings plans. In this sense, the libertarian objection to deficits is anti-democratic and anti-market: it says that the government should not respond to the expressed desires of individuals acting in the economy.

Don’t get carried away with that idea, however. There can be a lot of things that the public may desire that the government should not provide. The public might agitate for unjust war. It may desire “net segregation.” History is unfortunately full of examples of people desiring bad outcomes that infringe on the dignity and pursuit of happiness of others.

The crucial question, then, is whether we infringe on anyone’s fundamental rights by having the government accommodate the aggregate desire to net-save by running a budget deficit. I think the answer to this is that we do not. But that’s not the end of inquiry.

The next question is whether the benefits of accommodating net savings are greater than the costs. This seems to me to be almost always a contingent question based on current circumstances. Does running a deficit encourage further economic leakage, diminishing investment for the future? Or would people be stuffing mattresses rather than investing? Are the effects of government spending worse than the effects of economic contraction? (Liberals hate that question, but it is very important because most government spending is destructive.)

It’s tautologically true that the private sector on its own cannot save more than it spends. The question we’re faced with is whether we should use the government to accommodate the otherwise impossible.

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