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Policy Reponses to the Fluctuating “Fiscal Arm”


“If our Govt deliberately weakens a key component of the fiscal arm, policy responses could become weaker or create greater unintended consequences”

In my view MMT more accurately describes how free floating fiat currency systems work compared to other disciplines. The descriptive attributes of MMT are compelling in my view. MMT’s prescriptive policies are not the topic of this post. Several key points are issuers of currencies and fiscal authorities spend first and then tax later.

“Taxation is not to raise revenues but to limit total fiscal stimulus, create demand for the currency and to affect behaviors, spending or rearrange incomes”

While many may disagree I don’t think these points should be that controversial. If anyone had a the legal right to issue currency and levy taxes (to create demand for said currency) why would they need taxes to receive the currency they can create with a computer? How do currencies come into existence? They must be issued or spent first before they are taxed. I believe in 50 years these points will be assumed and we will look back and scratch our heads these were not consensus in 2022.

For whatever reasons, it seems defunding law enforcement for violent or property crime is pretty unpopular. But defunding law enforcement for tax or financial crime is more popular. I will leave the Sunday shows and cable “news”…I mean entertainment channels to debate that. However, lowering the ability for the tax authority to collect legal taxes is playing with fire especially when one of the US’ most valuable attribute is reserve currency status.

First, taxes create demand for the fiat. US taxes can only be settled in USDs. If more leakage occurs that can create a marginal decline in USD demand. Second, tax leakage is a regressive tax. For the vast majority of Americans their taxes are on auto pilot. I would venture a gutted IRS slows tax refunds and hurts marginal demand. Second, this leads to greater income inequality and the risk of higher corruption. Greater inequality leads to slower GDP growth as lower income populations have higher propensities to consume. Greater inequality leads to populism which typically is accompanied by higher fiscal and monetary stimulus thus placing more pressure on the FX.

We are told that inflation is always a monetary problem and it could lead to a currency crisis. I think it’s a contributing factor but does anyone really believe inflation and FX issues currently in Argentina, Turkey, Venezuela etc. are just a monetary problem? I think there are a host of problems including corruption and weak tax collection ability with many other issues.

What does this have to do with today’s markets? Not much. However as the Fed’s marginal strength declines (secular decline in Fed Funds Rate, more QE required to get similar results, expanding asset support into credit markets etc.), fiscal becomes the only game in town. If our Govt deliberately weakens a key component of the fiscal arm, policy responses could become weaker or create greater unintended consequences.

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