Money in a nation is not limited. False notions of fixed money supplies or limited gold reserves need to be put aside in order to properly understand how money works in an economy. When the government spends it does NOT use up money that would otherwise have existed in the economy. It is in fact injecting newly created money that we collectively save.
It is helpful when talking about a
nation’s money to separate the economy into three sectors:
- Government sector
- Private sector
- Foreign sector
When we want to assess how "the economy" is doing, we are usually talking about the Private sector. Viewing sectors independently helps us understand what is influencing the economy, and guides our understanding of how the monetary system can be used to benefit the economy (or more specifically, the nation's citizens).
These three sectors ALWAYS balance. If the Private sector has a deficit with one sector, at least one other sector has to make up the difference. So how does each one influence money flows and the other sectors?
- Government sector adds money through spending and removes money via taxation. Whatever is spent and not taxed remains in the Private (or Foreign) sector as savings (e.g. cash, deposits, bonds, bank reserves).
- Private sector's money is affected by the flows from the two other sectors. In addition, banks create bank money through loans to households & businesses but this is offset by an equal liability (debt) and so there is no "net savings" from bank money (see here for more on this).
- Foreign sector removes money when the Private sector imports (we buy goods; they get money), and adds money when the Private sector exports (they get goods; we get money).
We can see from this picture that the money left in the economy from net Government financial activity is actually a financial asset of the Private sector. Our nation's so-called "debt" is actually our savings.
If a country imports more than it exports as is the case with the US there is a drain of money from the economy that has to be made up somewhere. This can be via Private sector debt (borrowing to spend more than we earn), Private sector recession, and/or the Government spending more than it taxes (i.e. deficit spending). Recessions are evidence that some part of this equation has changed and the Private sector is contracting.
Unfortunately, we have been led to believe that there is no alternative but to suffer unemployment and "real economy" contraction during such times. Appropriate use of government money can be used to offset another sector loss during such times, along with debt write-offs that free up incomes.
[Scott Fullwiler and Stephanie Kelton provide more detailed explanations of this equation, demonstrating how Domestic Private Sector Net Saving = Government Sector Deficit + Current Account Balance. See here, here and here.
The chart below from Stephanie Kelton illustrates the net balance over time, highlighting the Clinton era surpluses which logically resulted in a recession once private debt creation reached a peak and could no longer compensate for the government removing money from the economy.]
