56 pages • 1 hour read
Stephanie KeltonThe Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy
Nonfiction | Book | Adult | Published in 2020A modern alternative to SparkNotes and CliffsNotes, SuperSummary offers high-quality Study Guides with detailed chapter summaries and analysis of major themes, characters, and more.
Chapters 3-4Chapter Summaries & Analyses
Chapter 3 Summary: “The National Debt (That Isn’t)”
Kelton opens with an account of her arrival at the US Senate Budget Committee in 2015, where she alone saw the government’s role as a currency issuer rather than a currency user. Her colleagues divided into two camps: deficit hawks (primarily Republicans) who demanded balanced budgets, and deficit doves (mainly Democrats) who worried less about immediate deficit reduction but still saw long-term debt as problematic.
To illustrate the contradictory thinking about government debt, Kelton describes an exercise she conducted with committee members. When asked if they would use a magic wand to eliminate the national debt, they enthusiastically agreed. However, when asked if they would eliminate US Treasury securities, they declined, not realizing these were the same thing. This contradiction revealed a fundamental misunderstanding: People viewed government securities positively as financial assets but negatively as government obligations.
The author systematically dismantles several common fears about government debt. First, she addresses concerns about borrowing from China, explaining that when China holds US Treasury securities, this simply represents a conversion of dollar reserves into interest-bearing assets. The process involves nothing more than accounting entries at the Federal Reserve.
Kelton then tackles comparisons between the United States and Greece, explaining why such analogies fail. Greece, as part of the Eurozone, borrows in a currency it does not control. In contrast, the US government can never involuntarily default on dollar-denominated debt because it issues the currency.
Kelton uses Japan’s experience with government debt to demonstrate that high debt-to-GDP ratios need not lead to crisis. Despite having the highest debt-to-GDP ratio among developed nations, Japan maintains low interest rates and stable finances because its central bank controls the interest rate on government bonds.
Kelton challenges the notion that government debt places a burden on future generations. Treasury securities represent private wealth, and their existence does not inherently create financial obligations for future taxpayers. The government can maintain any desired interest rate on its debt and could theoretically eliminate the entire debt through central bank operations.
The author concludes by examining historical attempts to eliminate US government debt, including President Andrew Jackson’s 1835 success in paying off the entire national debt and the Clinton administration’s late 1990s surpluses. Both episodes preceded economic downturns, demonstrating the potential dangers of debt reduction through fiscal surpluses. Rather than viewing government debt as a problem to solve, society should recognize it as a form of private wealth and possibly rename it to avoid confusion with household debt.
Through these arguments and examples, Kelton builds a case that the national debt represents a policy tool rather than a financial burden. She maintains that public discussion should focus on managing inflation and solving real problems rather than the size of the national debt. She suggests that government debt might better be understood as part of the money supply rather than as debt in the conventional sense.
Chapter 4 Summary: “Their Red Ink is Our Black Ink”
Kelton challenges what economists term the “crowding out” theory by examining the relationship between government deficits and private investment. She presents this concept as one of the more complex myths about federal deficits, noting that while it may not appear in mainstream media as frequently as other deficit myths, it significantly influences policy decisions in Washington, DC.
The crowding out theory holds that when the government runs deficits, it must borrow money, leading to competition with private borrowers for limited savings. According to this theory, this competition drives up interest rates, making it harder for businesses to secure funding for their projects. However, Kelton demonstrates why this understanding is flawed by introducing British economist Wynne Godley’s sector balance framework.
Godley’s model divides the economy into two parts: the government sector and the non-government sector. In this framework, government deficits automatically create surpluses in the non-government sector. Kelton illustrates this concept with a metaphor of two buckets: When the government spends more than it taxes (running a deficit), the excess money flows into and accumulates in the non-government bucket. This process increases rather than decreases the total savings available in the private sector.
Kelton then addresses the common argument that government borrowing depletes savings. She explains that when the government sells US Treasury bonds to finance deficits, it does not reduce the pool of savings, but rather transforms the type of savings from bank reserves to interest-bearing securities. The government’s deficit spending creates the very dollars that investors later use to purchase Treasury bonds.
The author draws on historical examples to support her argument. During World War II, despite massive government deficits exceeding 25% of GDP, interest rates remained low because the Federal Reserve actively managed borrowing costs. Similarly, after the 2008 financial crisis, the Federal Reserve maintained near-zero interest rates for seven years despite significant budget deficits. Kelton argues that these examples demonstrate that interest rates are policy choices rather than market-determined outcomes for nations with monetary sovereignty.
To illustrate the importance of monetary sovereignty, Kelton contrasts countries like the United States and Japan with eurozone nations. Countries with monetary sovereignty can control their interest rates regardless of deficit levels. In contrast, eurozone countries, which gave up their sovereign currencies to use the euro, became vulnerable to market pressures when running deficits. She cites Greece’s experience during the European debt crisis, when interest rates on government bonds rose dramatically because the country lacked control over its currency.
Kelton concludes by inverting the traditional narrative about government deficits. Rather than hindering private investment, she argues that deficits can stimulate economic activity by increasing private sector savings and spending power. However, she emphasizes that not all deficits serve the broader public good. While deficits inherently create private sector surpluses, their benefits can be distributed inequitably, potentially enriching a small segment of the population while leaving others behind.
The chapter ends by acknowledging that well-designed fiscal policies, including deficit spending, can enhance economic growth by generating additional disposable income and increasing demand for private sector products and services.
Chapters 3-4 Analysis
The theme of The Government’s Unique Power as a Currency Issuer emerges prominently throughout both these chapters. Kelton draws a crucial distinction between currency users (households, businesses, and state governments) and currency issuers (the federal government). The author emphasizes this point through her analysis of the Federal Reserve’s operations, noting that “paying interest on government bonds is no more difficult than processing any other payment” (111). This distinction becomes particularly significant when examining historical examples, such as the Clinton surpluses of the late 1990s, which Kelton argues were actually detrimental to the economy precisely because they failed to leverage the government’s unique position as currency issuer.
The theme of Real Resource Constraints versus Financial Constraints receives extensive treatment, particularly in Chapter 4. Kelton challenges the traditional “crowding out” theory, which suggests that government borrowing reduces private investment by competing for scarce financial resources. She explains that “MMT rejects the loanable funds story, which is rooted in the idea that borrowing is limited by access to scarce financial resources” (139). Instead, the author argues that the true constraints on government spending relate to real resources—labor, raw materials, and productive capacity—rather than arbitrary financial limits. This argument is supported through detailed examination of how government bond markets actually operate, with Kelton noting that “there is always more demand for Treasuries than can be allocated from a limited supply of new issues in each auction” (146).
The text’s analytical framework centers on economist Wynne Godley’s sectoral balances approach, which Kelton uses to demonstrate how government deficits necessarily correspond to private sector surpluses. She recounts her interactions with Godley, describing him as someone who “built macro models and used them to analyze the US economy” (130). His insight that “every payment has to come from somewhere, and then it has to go somewhere” becomes a foundational principle for understanding the relationship between government spending and private sector wealth (130). Illustrating Godley’s ideas via the “two buckets” metaphor, Kelton demonstrates how government deficits invariably result in private sector surpluses, challenging conventional narratives about government debt.
The author grounds her arguments in historical evidence, citing specific examples such as the 1835 elimination of the national debt under US President Andrew Jackson, the financing of World War II, and more recent experiences with quantitative easing. She notes that “the historical record is clear. Each and every time the government substantially reduced the national debt, the economy fell into depression” (121). This observation serves to demonstrate both the validity of MMT principles and the potential dangers of conventional approaches to government finance. Kelton’s examination of Japan’s experience with government debt, where the Bank of Japan “now holds roughly 50 percent of all Japanese government bonds” (117), provides evidence for her arguments about sovereign currency issuers’ capacity to manage their debt loads.
The implications of Kelton’s analysis reach beyond academic theory into practical policy considerations. By demonstrating that “the interest rate on the national debt is a policy variable” rather than a market-determined constraint (151), she challenges fundamental assumptions about government spending limitations. This insight opens new possibilities for addressing pressing social needs through government spending, suggesting that political rather than financial constraints have limited government’s ability to address social problems. As Kelton argues, what matters is not the size of the debt but “whether we can look back with pride knowing our stockpile of Treasuries exists because of the many mostly positive interventions that were taken on behalf of our democracy” (125).
