Some Useful Tools to Help You Rethink How Government Spending Works
How You'll Learn to Stop Worrying and Love the Self-Financing State
The old saying is that if it aint broke, don’t fix it. The way we think about government spending is beyond broken. So, today we take apart how government spending works and put it back together again.
You’ll get some ideas and frames - tools - of how to frame your own thoughts and conversations about how government spending actually works.
While the mechanics of government expenditure are all very complicated, there are concrete, simple to understand facts we can point to which show that the state is self-financing.
The facts are that:
every dollar the government spends is a new dollar (government spending increases the settlement cash level - Callaghan et al, 2023, p. 4)
all New Zealand Government spending comes from the Crown Settlement Account. The Crown Settlement Account is the government’s disbursement account, the source of all government expenditure, and all spending between the government and non-government sector flows through this account (Frazer, 2004)
the government settles its payments (i.e., makes and receives payments) with settlement cash (Huxley and Riddell, 1996, p. 309)
the Reserve Bank has infinite control in determining the settlement cash level (Knowles et al, 2023, p. 3; Callaghan et al, 2023, p. 3)
the New Zealand government issues its own currency and floats it freely on international foreign exchange markets
the costs to government are represented through the availability of resources, not money
By understanding these facts, we can appreciate that it doesn’t matter whether you are Nicola Willis or Barbara Edmonds, the Taxpayer’s Union or the Council of Trade Unions, a martian or a fish, the structure and mechanics of government spending are the same for everyone.
Taking It Apart
For many people, it is quite difficult to grasp the concept that the government faces no financial constraints. I don’t blame them. It isn’t helped by the simple (and entirely incorrect) frame that the government ‘is like a household’. This view is prevalent in all elements of society.
This masks a rather simple reality.
The government is not like a household.
All government expenditure comes from the Crown Settlement Account. The government spends settlement cash, the amount of which is determined by the Reserve Bank. The government creates its own money when it spends. In other words, every dollar it spends is a new dollar.
That’s it.
The government does not fund its expenditure through income (taxes, asset sales etc) and anything over its ‘income’ is not funded through issuing ‘debt’.
Here’s something to help solidify the idea of money creation from nothing (ex nihlo).
The Reserve Bank pays interest on positive overnight balances in the Crown Settlement Account. The Reserve Bank paid $1.297 billion NZD in interest to the New Zealand Government on government deposits held at the Reserve Bank for the 2024 Financial Year.
Where did this money come from?
The same place all other government money comes from – it was created on a keyboard.
For another example, have a look at the overdraft example from this post.
Putting It Together
Understanding these realities fundamentally alters our view of public policy. The headlines and news articles we are accustomed to reading on ‘widening deficits’, the Government ‘running out of money’ and ‘fiscal cliffs’ are shown to be ideological constructs. These frames are quite distant from economic fact. For example, the ‘widening deficit’ demonstrates that the government is spending more into the economy than what it is taking out in taxes.
In recognising the self-financing state, the public’s obsession with financial cost to the government is replaced by the availability of resources able to be used by the New Zealand Government. We can call this the resource cost. For instance, the cost of a good health system is represented through the availability of nurses, doctors, equipment and facilities. It is not determined by the amount of money in Health New Zealand’s bank account.
Moreover, the financial cost of a better health system is not ‘a burden on future generations’ or ‘running up debt on the national credit card’.
All government expenditure comes from the Crown Settlement Account. The government spends settlement cash, the amount of which is determined by the Reserve Bank.
This isn’t to say that all spending is good spending. Far from it. Fiscal responsibility is reframed to mean that the government makes responsible use of resources for present and future generations. Crowding out of resources could (likely would) lead to price increases in the short to medium term (i.e., inflation).
This also doesn’t mean that the desire to limit the size of government is evil. The desire to limit the size of government is an entirely legitimate action from an ideological position. It could even be an empirical position depending on what the economic context of the time is (i.e., if non-government sector spending is ‘running hot’).
If it is ‘the will of the people’ for the Government to limit its spending, then that is the way that it is. However, this must be understood in the context of the self-financing state – that the government cannot run out of money.
Nicola Willis could (and should) accept that the state is self-financing. In doing so however, she would have to justify her political decisions without saying that the government is running out of money.
Government bonds and taxes don’t ‘fund’ government expenditure either.
Government bonds (debt) are assets for investors in the non-government sector. In Tender No. 935, the New Zealand Debt Management Office (NZDMO) auctioned $500 million NZD worth of bonds at three varying maturities.
The NZDMO received $2.348 billion NZD in bids for these bonds.
This doesn’t reflect investor desire to fund government spending. Rather, this indicates a strong demand to hold bonds.
Why?
Because government bonds are default risk free assets. The government can’t run out of money as it creates new money when it spends. Buying these bonds ensures that investors will receive income from their investment.
Taxes are the destruction of money. Tax payments are settled into the Crown Settlement Account at the end of every day they are received thereby decreasing the overall settlement cash level. They are never used again after the end of day settlement.
However, taxes are still very important in our economic system. They enforce the Government’s use of the New Zealand Dollar. They are also a highly effective policy tool, influencing where money should, or shouldn’t be spent.
From Bill Mitchell:
Taxation reduces the disposable income of the non-government sector and thus reduces the capacity of that sector to make claims [purchases] on the productive resources available. The taxation creates unemployed productive resources, which can then be brought into productive use by the government spending within the inflation ceiling. (Mitchell, 2024)
Out With the Old…
The ideas here represent a marked departure from the way we’ve thought about government spending. These old ways of thinking hold us back from achieving political and social objectives and do not reflect reality at all.
The ideas and concepts here don’t advocate for a new system, but advocate for understanding the system as it exists currently. Understanding how it actually works presents huge implications for how we engage with politics and public policy.
By understanding how the government expenditure actually operates, we can put our knowledge to good use in ensuring that government contributes to a better society for all.
It is up to us to become familiar with how the system actually works and bring a dose of reality to how we think about government spending.
As Max Planck once put it:
A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it. (Planck 1949, pp. 22-24).
Bullseye! But the right has pedalled the household budget meme and deficit = debt for decades. Unfortunately all major political parties in NZ do not seem to understand how things actually work. I suspect the neo classical economists in Treasury play a part.
Important stuff. Thanks bud, nicely put!