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Home > Money and Credit Conversion > About Money > Government fiat: how much is too much?

Government fiat: how much is too much? A practical solution


A monetary system in which government money and bank money are clearly separated, with the market deciding their relative value, is a practical solution to gauging reasonable levels of government indebtedness.

The question

We start with the observation that a government can issue significant amounts of fiat money with legal tender status in anticipation of tax revenues, without necessarily having a negative impact on commerce and the money system. But we also know that excessive issuance has, at various times in history, led to bouts of inflation and even hyperinflation.

So the question is: how much is too much?

If a government proposes to issue fiat money in the amount of a year's expected tax receipts, even fiscal conservatives will probably agree with that. After all, if we postulate a system in which the only issuer of legal tender money is the government, then in order to provide the private sector with enough legal tender to pay its taxes, the government would indeed have to issue at least one year's worth of tax receipts every year. But if the issuance of a year's worth of tax receipts is prudent, would twice that amount not also be reasonable? And how about three times, four times, or even ten times?

Some proponents of Modern Monetary Theory (MMT) insist that the government can issue whatever volume is needed, and speak of an "unlimited capacity to pay" 1 without ill effects. How could such statements be justified? Let's assume we agree that (as I believe to be true) a government can also set the interest rate on the money it issues. Now if the government sets its interest rate to 0% or below2, then the net present value (NPV) of its future tax receipts is virtually unlimited, which would then offset the "unlimited capacity" cited above.

That being said, the taxing capacity of a government is always limited by the actual amount of goods and services available in the economy. No monetary accounting ledgerdemain can overcome this limitation. And let's also not forget that any money issued by the government must some day be redeemed by taxation.

So common sense and historical precendent suggest that the government should limit the volume of issuance. However, different schools of monetary theory are likely to provide widely diverging ranges as to what that volume might be.

A possible solution: decoupling government money from bank money

A simple and practical solution to this dilemma is to clearly separate government money and bank money1, and to let the market decide their relative value.

Under normal circumstances, with both monies expressed in the same unit of account, government money and bank money would be more or less equivalent. With sound public finances, government money might be at a slight premium, from which the government could profit by setting negative interest rates. With a moderate budget deficit, the premium might become a small discount.

But in times of excessive government spending, the discount would be likely to widen, therefore providing a strong signal to the government that a change of policy is necessary. This would also provide a clear and direct feedback to all citizens.

Note that if there is a central bank, the government money would have to be completely distinct and dissociated from central bank money3.

  1. Tymoigne and Wray, quoted in the wikipedia entry on MMT 

  2. in the late Middle Ages, governments often issued coins and then "cried them down" - a kind of indirect taxation whcih was had the same effect as a (sometimes quite high) negative interest rate. Today, governments achieve this effect indirectly. 

  3. incidentally, I agree with Mitchell-Innes that central banks are not necessary for a stable monetary system, and would not be necessary for the solution proposed here