Dirk Ehnts suggests that Liz Truss’s downfall may have not been because she was wrong.

Shadow chancellor, Rachel Reeves, said in 2021 that delaying tackling climate breakdown would be at the “greatest cost to public finances, as well as to our planet”, and told those watching that Labour would not “shirk our responsibility to future generations”. Hence the pledge to spend £28bn a year on green investment. One might argue whether this will be enough, but at least the idea was that spending would be increased every year for five years. The UK would follow the policies of the Biden Administration (Inflation Reduction Act) and the European Union (European Green Deal), both of which recognise the size of the problem (big) and the fact that infrastructure investment by the public sector is important (very). Given Reeves’ pledge, the U-turn by Labour in early March was a surprise.

Labour’s Darren Jones said on TV that the Tories would have “spent all the money and maxed out the country’s credit card”. Sir Keir Starmer announced that less than £5bn a year would be spent, probably not even half of the original proposal – consider that the UK spends nearly £10bn on pet food each year. What caused Labour to walk back this important piece of economic and ecological policy?

The Treasury had sabotaged Truss by not intervening in the gilts market. A coincidence? Maybe.

What seems to have gotten in the way is the politics of money. Let us go back in time to the days when Liz Truss was prime minister. The idea that tax cuts funded an increase in public debt was central to Truss’ economic policy programme. In October 2022, Trussonomics was buried. The Treasury had sabotaged Truss by not intervening in the gilts market. A coincidence? Maybe.

Truss was attacked for her economic policies, which led to her ousting. It was said that her mini budget containing tax cuts for the rich would drive up the public deficit, which is the difference between spending and tax revenues. A higher deficit would supposedly translate into less trust in the government’s public finances, and that would translate into higher interest rates and, probably, a slippery path to state bankruptcy for the UK. None of this was true, almost every argument in this chain of possible events was false, but the media, the policymakers and, finally, the public bought into it.

Funny money
How does the government spend money and why would that be a bad thing? The first thing to understand is that the payments of the government are executed by the Bank of England, which is the monopoly supplier of Sterling. How do they make payments on behalf of the Treasury? They increase the balance of the receiving banks with the Bank of England. It is a purely digital operation in the payment system and has nothing to do with printing money.

So, if the government would pay you £100, they would increase the balance of your commercial bank by that amount with the help of the computer and then ask your bank to mark up your digital balance as well. If you do online banking, you would see the money is there. It is all digits in computer software run by your bank. To increase that balance, there is no need to reduce a number elsewhere in the system because the numbers are created by the computer.

Government spending therefore is “paid for” by the money creation of the Bank of England, acting on behalf of the government, which has an account there. While the actual mechanics of the spending process are relatively obscure, the whole system is set up to ensure that the government never runs out of pounds … ever. This means that there is no combination of interest rates, growth rates, public deficit and public debt that would lead the government to run out of money. Not executing any more payments would be a purely political decision, as the infrastructure to make payments is always in place. So, why all the fuss about Truss?

In reality, the government cannot run out of money and hence public deficits are no cause for concern. Only by framing the government’s budget as a household budget does a fear of bankruptcy result from higher public deficits. When private borrowers get into trouble, their bond price falls as investors are selling. The Bank of England watched as public bond prices fell during Truss tenure, without intervening in the market to support bond prices. It could always have bought government bonds (known as gilts) to stabilise prices. It could have explained that higher interest rates set by the Bank of England itself would be the cause of falling bond prices, as old government bonds with lower interest rates were less attractive than newer bonds with higher interest rates. Falling bond prices never reflected a risk of default by the government, as implied by some market commentators.

The public debates about money in the UK are informed by the ideas of Margaret Thatcher and her notion of “taxpayer money”. She famously quipped that there would be no public money, but only taxpayer money. The opposite is true (see box Funny money), but the general public was misled. Thatcher used her ideas about money, which have no roots in academic papers or books, to gather support for her ideas of privatising the UK. She wanted to sell off public assets, like the trains and the energy grid. This is why she came up with the taxpayer money myth. Suggesting that the government would need money just like anyone else!

Truss was defeated because of a clever ploy In financial reality, there was nothing interesting going on. In political reality, we watched a prime minister leave office because of “problems” with the public finances.

The idea stuck and since then taxpayer money is a myth that dominates the public debates about money and budgets. Truss was defeated because of a clever ploy. In financial reality, there was nothing interesting going on. In political reality, we watched a prime minister leave office because of “problems” with the public finances. That is why Labour is scared. They are scared that the Tories will play the taxpayer money game and attack the Green Prosperity Plan, trying to “prove” that it would lead to higher interest rates and bankruptcy for the country.

The Labour Party had two options. Number one, get some economists to explain to the public how public finances really work and trust that the results would convince voters. Number two, scrap the policy, keep their mouths shut and work within the taxpayer money frame, even if that meant that the Green Prosperity Plan would be sacrificed. Labour seems to have gone  for option two.

While this might be a clever choice for those in Labour who can expect to take over the government, it is a disastrous choice for all of us facing climate change and a deterioration of the environment, let alone future generations. It also creates problems for Britain’s economy as the industrial policies in the US, China, Japan and the European Union have gathered steam.

Not responding to the public investment of other countries with its own public investment means that the British economy will fall behind. South Korea will invest $470bn in semiconductors alone until 2047. Investing half the amount being spent on pet food pales in comparison and will not allow the UK to keep up with international innovation. It could make the UK overly dependent on imports, further de-industrialise the country and wreak havoc in the labour market.

In the US, many citizens do understand how the money system works. There is no government credit card, no magic money tree, no taxpayer money and definitely no involuntary government bankruptcy in its own currency. The Biden administration ignored the advice of some economists to fight inflation by cutting government spending and instead opted to ramp it up. The result: record employment, low and falling inflation, rising private investment, and an increase in manufacturing output and employment. Bidenomics, so it seems, is the best option.

While more money does not solve all problems, some, if not most, cannot be solved without spending more money to move resources in the right direction.

An understanding of the monetary system is essential for public policy-making. The Modern Money Theory that underpins it offers an accounting-based view of monetary operations that allows policymakers to grasp the main mechanisms of economic policy.

The next Labour government will be judged by the results of its policies, not by its degree of accordance with the ideas of Margaret Thatcher. While more money does not solve all problems, some, if not most, cannot be solved without spending more money to move resources in the right direction. Climate change is one such problem, as public green investment is badly needed. The social democrat-led government of Germany shows what happens when fiscal discipline is more important than solving real problems. The party is polling at around 15%, having gained 25.7% of the vote in the last election, but since then being buried under an avalanche of defeats in local and regional elections, largely at the hands of the extreme right.

Dirk Ehnts

Dirk is an economist based in Berlin. He is the author of Modern Monetary Theory: A Simple Guide to the Monetary System and an adjunct lecturer at Torrens University’s MA  program “The …

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