Can economists work in quantitative finance

How do we finance the corona debt? Attempt to find a “right” answer to a “wrong” question from the perspective of Modern Monetary Theory

The year 2020 was marked by the COVID-19 pandemic and its economic consequences. In Germany, the government deficit and the debt ratio rose to an estimated 5% and 75% of GDP, respectively, as a result of the decline in economic output. In order not to jeopardize the economic recovery from the pandemic by returning to a rigid austerity course, it is now of particular importance to say goodbye to misconceptions about the financing and sustainability of government spending surpluses. This is the only way to set the right course for an economic policy for the 21st century.

The question of financing the national debt is aimed at whether the increase in debt could become a problem in the long term if the debt cannot be repaid in the future or replaced with new debt. This thinking is essentially based on the theory according to which a state can finance itself by 1. collecting taxes, 2. issuing government bonds or 3. having the central bank pay for its expenses. However, only case 1 in the classical theory ensures (long-term) sustainable public financing. Case 2, if spending is too high, can lead to an explosive path in the government debt ratio. If the debt ratio rose, private investors would demand higher and higher interest rates, which would have to be covered by further borrowing. If insolvency is feared, the state will no longer receive any money and bankruptcy would be inevitable. Funding through the central bank (case 3) would supposedly lead to certain hyperinflation.

Today we know that the tripling of the US government deficit from about $ 1 trillion in 2019 to $ 3 trillion in 2020 went perfectly smoothly. The US government deficit in the second quarter of 2020 was 27.5%. The yield on government bonds fell, inflation remained low and the external value of the US dollar increased. Apparently, the rise in national debt has not led to any of the feared problems.

This development is in line with the ideas of the Modern Monetary Theory (MMT) .1 It regards the government deficit as a purely statistical variable that is the result of economic activities and should therefore not be made a target variable. This also applies because the state cannot directly control the tax revenues it receives anyway. In the corona pandemic, these were significantly lower than expected.

Modern monetary theory

The MMT was launched almost exactly 25 years ago by the US investor and racing car designer Warren Mosler. His main insight was that a modern currency is a state monopoly. Today this is mostly transferred to (state) central banks, which act as the state's bank. They pay the government's bills by increasing banks' balances with the central bank and, in return, depositing deposits with the payees. Since central banks act as the creators of the currency, they cannot “finance” their expenditures at all - new money (both deposits and central bank balances) is always created when they spend on government orders. This also applies to Germany within the euro zone: the Bundesbank carries out all expenditure by the federal government on their behalf

Only at the level of the political rules can a “financing” of government expenditure be constructed. The federal central account (at the Bundesbank), which is debited for government spending, must be balanced at the end of the day. This account is filled through tax receipts and sales of government bonds. However, it is not a question of “money” in the physical sense, but merely a balance of points to offset income and expenses. Only if the number of points is not negative can the Bundesbank spend the federal government on its behalf by increasing the central bank account of a bank and reducing that of the federal government. From a purely technical point of view, this is not necessary - if you want to increase an entry in a balance sheet, you obviously do not have to "save" the numbers that are entered there in advance.

The state (including its central bank) creates its currency according to its own political rules. Since it promises nothing more than to accept the currency for the settlement of tax debts and for all other payments to the state, these are ultimately tax credits (Ehnts and Paetz, 2019). The state spends money at the federal level and subsequently withdraws it from the cycle through tax payments. Since a state can always make its payments with its own currency, deficits should therefore not form the basis of economic policy rules (Kelton, 2020). Government spending surpluses inevitably go hand in hand with equally high revenue surpluses in the private sector.3 Instead of a government deficit, one could therefore also speak of a surplus in the private sector. An alternative definition of government debt would then be: "Private sector tax credits."

The efficiency of an economy is limited only by the available resources - not by the existing means of payment. Of course, this does not mean that all usable resources should be used up. For what and to what extent the available options should be used, depends on the economic policy goals. According to Mosler (1997), these are full employment and price stability and should be supplemented by sustainable use of resources.

The inflation rate is essentially determined by the development of unit labor costs. As the economy approaches full employment, it can be expected that wages will rise faster and unit labor costs will increase. In the event of underutilization, however, an acceleration in price development is not to be expected. The inflation rate can in principle be reduced by higher unemployment, but ultimately depends on the wage negotiations between employees and employers. The level of employment is in turn determined by the actual demand.

Private spending largely depends on long-term expectations. Since the influence of interest rates on the demand for capital goods is rather subordinate, the central bank is overwhelmed with the stabilization of an economy and needs the support of fiscal policy. This is especially true in crises in which long-term expectations are naturally clouded.

The state can also influence the development of the general price level through the state prices, among other things, in local public transport, in the health system and in other areas as well as through the minimum wage and the wages in the public service. Furthermore, the legal framework for binding collective bargaining through the trade unions influences the development of unit labor costs and prices.

Monetary, fiscal and wage policies should all be geared towards achieving the goals of full employment and price stability. In contrast, it is not expedient to transfer the goal of stable prices to the central bank alone and to cause a rise in unemployment with a regular austerity policy, which leads to a trend towards falling inflation rates. Since the question of financing does not arise for a government with its own currency, austerity policies are not necessary as long as the economy is underutilized.

Current developments confirm the MMT perspective

The fact that a government cannot default in its own currency if the central bank cooperates is particularly evident in Great Britain at the moment. The Bank of England (2020) gives the British government the opportunity to overdraw the so-called Ways-and-Means account during the pandemic. Additional government spending is then not tied to the sale of interest-bearing government bonds to the private sector. This makes it clear that, thanks to the currency monopoly, a state does not need any income to spend. The issuance of government bonds is merely optional and can be used to reduce the central bank balances of the banks if this is desired.

In Canada, this “direct public finance” has existed for decades. The fear of a rising inflation rate outlined above did not materialize. According to Becklumb and Frigon (2015, 1-2), the Canadian central bank typically withholds around 20% of all government bonds. In return, she credits the government with the equivalent value on her account. The authors classify this transaction as “internal”, since bonds that the state holds with itself are no more a liability than a promissory note that one issues against oneself. Andolfatto (2020) of the St. Louis Federal Reserve Bank argues similarly for the USA. For a long time now, there has been a growing number of voices in central banks that question the traditional view of public finance.

The development in the euro zone also confirms the theoretical considerations of MMT. Economists such as Randall Wray or Wynne Godley have criticized from the start that the strict deficit rules of the euro area stand in the way of an appropriate economic policy (e.g. Godley, 1992). In fact, the unemployment rate has never fallen below 7% since the eurozone was founded. The inflation target has also been reached sporadically at best over the past ten years. Full employment and price stability are much more dependent on government spending than most economists would like to believe.

In the meantime, the European Commission has probably also recognized this and quickly overruled the euro zone rules based on government deficits after the outbreak of the pandemic. The general exit clause was activated as early as March 2020, so that deficits are no longer sanctioned. Also in March 2020, the European Central Bank (ECB) assumed the role of “lender of last resort” by launching the Pandemic Emergency Purchase Program (PEPP). This allows her to purchase government bonds almost indefinitely, reducing the risk of default to virtually zero. In this way, a renewed euro crisis with rising interest rates on government bonds from the periphery could be avoided.

Debt, Interest and Growth

In the Handelsblatt, Tom Krebs (2020) calls for a European fiscal rule that limits the level of debt. The English Economist (2020), on the other hand, calls for an editorial to make the deficit limits dependent on the unemployment rate and to suspend them in the event of increased unemployment. Blanchard et al. (2020) advocate a modification of the European fiscal rules because the dynamics of debt ratios are too complex to be assessed using a single key figure (the debt ratio). They are calling for qualitative standards to prevent the government debt ratio from exploding, as well as more country-specific analyzes and greater fiscal leeway.

This analysis too - although it takes a clear step in the right direction - falls short. From our point of view, an explosive debt path is ruled out, provided the central bank cooperates. It is commonly argued that for long-term stability of the debt ratio, the growth rate of GDP must be higher than the interest rate on bonds. Figure 1 shows that this was the rule until the 1970s. After the oil price crises caused inflation rates to rise significantly in most industrialized nations, the central banks decided to combat even the smallest sign of inflation with soaring interest rates. Combined with the decline in government spending to stabilize employment, this led to decades of rising unemployment and falling growth rates.

illustration 1
Difference between interest on 10-year government bonds and GDP growth rate for selected countries
Moving three-year averages in percentage points

After the financial crises of 2001 and 2007/2008, however, interest rates fell back below the growth rate in most nations. The central banks pushed down long-term interest rates by buying bonds, as this was the only way to fight the great recession. Since fiscal policy in the euro area followed the austerity course again in the following years and falling interest rates in an environment characterized by recession did not result in a significant increase in the demand for capital goods, the euro area was unable to recover from the financial crisis even with negative interest rates (Ehnts and Paetz, 2021 ).

Proponents of low debt ratios fear that as debt-to-GDP increases, interest rates on government bonds will rise. Figure 2 shows that there has not been such an increase in the past despite rising debt ratios. The reasons for this are, on the one hand, the lower inflation rates, which have led to falling interest rates, and the (implicit) signal from the central banks to buy up government bonds indefinitely, if necessary. The latter has assured buyers of government bonds that their money is safely invested, thus eliminating risk premiums due to possible default. Nevertheless, there is in principle the risk that if interest rates rise again, the debt ratios will follow an explosive path. However, interest rates will only rise again after the crisis has been overcome and therefore growth and inflation rates will rise again.

Figure 2
Interest on 10-year government bonds and debt ratios for selected countries

Sources: Ameco and FRED; own calculations.

Rethinking fiscal sustainability

Commentators such as This is money (2020) also argue that bonds owned by the state central bank should no longer be included in government debt. After all, the government pays the interest and the repayment installments to its own central bank.4 If this point is taken into account, the stability condition must also be reconsidered. When buying government bonds, the central bank increases the reserves of the commercial banks. Since the (long-term) interest rates on government bonds are usually higher than the interest that the central bank pays for the banks' reserves, this increases their profit, which in turn is paid back to the government. A stable debt ratio can therefore also be achieved if the interest on government bonds is above the growth rate, because part of the interest payments flow back to the government anyway. Furthermore, the debt-to-GDP ratio, which only takes into account private-sector bonds, represents only the share of bonds not held by the central bank in the total debt-to-GDP ratio

Regardless of the level of the debt ratio, the solvency of a government depends exclusively on the political rules that are drawn up at the European level on the basis of the concept of “fiscal sustainability” (Fullwiler, 2016, 14). For this purpose, reference values ​​for deficits (3% of GDP) and debt levels (60% of GDP) are given. A robust negative relationship between the level of national debt and the real growth rate of an economy has not yet been proven (Breuer and Colombier, 2020). Since insolvency is also ruled out as long as the central bank fulfills its role as lender of last resort, the European requirements for deficits and debt ratios are both arbitrary and unnecessary. Since economic development is also influenced by government spending, the reference values ​​de facto limit economic growth.

The ECB is currently making purchases on the secondary market to ensure that government bonds are viewed as risk-free. In combination with the suspension of the Stability and Growth Pact (SGP), there are currently de facto no spending limits for the governments of the euro zone. However, a reduction in debt to the EU benchmarks is already being considered. The Stability Council (2020, 2) predicts: "In the years 2022 and 2023, with the expected reduction in the general government structural financing deficit by more than ½% of GDP, the benchmark of European budgetary surveillance for reducing the structural deficit will be met." With a given trade balance, surpluses have to go hand in hand with private deficits, this strategy cannot work if the private sector should also want to reduce its expenditure after the pandemic due to higher debt (or lower savings). In this case, another lost euro decade threatens if the state and the private sector try to cut their spending at the same time.

The future of the euro area

In order to allow the governments of the eurozone to spend the necessary expenditures so that the eurozone can prevent further self-inflicted waning, the ECB must permanently assume the role of the lender of last resort. This could, for. B.the PEPP program should be consolidated. A return of the interest rate differentials and the corresponding dynamics with the end of a partial default as in Greece would, on the other hand, create a downward spiral that could induce some member states to exit the euro area.6 If the role of the lender of last resort becomes official and permanent belongs to the ECB, a state insolvency of the member states of the euro zone - and thus also the question of liability - would be ruled out once and for all. This would also mean that the interest rate premiums and the “Bank-Sovereign Doom Loop” would have disappeared forever.

However, if the SGP were to be deployed before GDP and unemployment rates had returned to pre-crisis levels in all member states, this would show that the EU Commission and Council continue to follow the old thought patterns. This also applies to the many national debt brakes that stand in the way of an expansive fiscal policy and should be abolished. Furthermore, the stipulation of “structural reforms” should be refrained from, as demanded by the Spanish government, among others, within the framework of the Next Generation Program (El Pais, 2020). The EU Commission has gambled away a lot of trust with similar requirements in recent years. As part of its austerity policy in the 2010s, the Italian government was z. B. recommended a dozen times to reduce spending in the health sector.

This crisis should therefore not be used to shift further powers to Brussels in order to force a renewed austerity policy and to increase the loss of confidence in the European institutions. As part of the fight against the corona pandemic, it would instead make sense to use national expenditure to develop vaccines and to distribute them to the population via the health system. Since the ECB can generate unlimited euros free of charge, the limits are in real resources, but not in the supposedly scarce money. The indicator that should be used instead in the future is the unemployment rate.

New monetary and fiscal policy

Since the oil price crises, the central banks have immediately stifled an economic upturn by raising interest rates whenever there was any suspicion of rising inflation rates. While the "interest rate hammer" was effective and inflation rates fell, this cannot be said of the rate cuts. They fueled asset prices, but did not lead to a sufficient recovery in the labor market. The unemployment rate continued to rise with each business cycle.

On the other hand, a “soft” control would make more sense as long as no steady rise in the inflation rate can be seen. Instead of reacting immediately to every upswing with drastic interest rate hikes by the central bank, the state can reduce demand by deferring investments or reduce wage increases for state employees. The automatic stabilizers also dampen inflation, as more purchasing power is siphoned off in the upswing through higher tax revenues.7 In the euro zone, it would currently be necessary to transfer the stabilization of economic development more to national fiscal policy, although coordination of economic policy would also be desirable. We can only achieve the inflation target of 2% if unit labor costs grow faster. Here, too, higher government spending can make a significant contribution if it strengthens the bargaining power of employees over bottlenecks in the labor market.

Effects on foreign trade and exchange rates

Higher demand could lead to a fall in net exports from the eurozone through additional imports. If a trade deficit arises, however, with a flexible exchange rate, this would not be a cause for concern. In the worst case, an increase in liabilities in foreign currencies could lead to a depreciation of the euro, which would tend to counteract the deficit. Since these foreign currency liabilities arise in the private sector, the debt sustainability of governments is not affected. Since the euro has so far fluctuated without any problems against the currencies of its trading partners without inducing seriously disruptive imported inflation, a more expansive economic policy will have no significant effects on inflation.

Dullien and Tober (2019), on the other hand, argue that "[if, however, the state continuously covers its debt servicing with newly created money, [...] a continuous expansion of the money supply ... through exchange rate effects would theoretically mean a continuous devaluation". Four arguments speak against this view. Firstly, as already shown, the central bank can prevent the debt ratio from taking an explosive path at any time. The debt servicing cover for the bonds held by the central bank is just an internal accounting process that does not affect the private sector money supply. Second, developments in the money supply and exchange rates do not correlate as claimed. Thirdly, two countries always belong to an exchange rate. If the government deficits in other countries rise equally (which is by no means unrealistic), no effect would be expected anyway. Fourth, the development of the money supply depends on a large number of factors. If, after the pandemic, the private sector were to generate revenue from an increase in government spending, e.g. B. used to repay loans that had to be taken out during the crisis, money would be destroyed and an increase in the money supply counteracted. The currencies of Norway, Sweden and Denmark exemplarily show that high government spending does not necessarily have to go hand in hand with a devaluation of the currency. A “continuous devaluation” would therefore not be expected if the euro zone were to negotiate a Green New Deal. However, should a government continue to increase its spending even at full capacity, inflation must inevitably be expected, which can lead to a devaluation. However, this is not a policy advocated by MMT advocates.

Shaping socio-ecological transformation democratically

With regard to climate change and its consequences, it does not seem advisable to further intensify the use of raw materials and energy. The state should therefore act in a guiding and coordinating manner and must not be guided by looking at deficits and the amount of debt. Without higher government spending, we will not be able to cope with the necessary ecological transformation. The ideologies of the 20th century must be overcome. Neither the state nor the market alone will be able to solve our problems. In addition, it is important to reunite society, which is currently threatened to break down due to increasing inequality. The social exclusion associated with the economic difficulties leads to more aggression and violence (Bauer, 2011).

As in 2009/2010, the Overton Window seems to be open again. Reinstatement of the Maastricht rules in conjunction with debt repayment on the basis of national debt brakes would plunge Germany and the eurozone into a recession or even depression within a few years. The latter is particularly to be feared if the ECB's PEPP is ended and interest rates on the government bonds of southern European countries would rise again. Against this background, it is important to establish adequate macroeconomic control instead of blocking oneself with the pointless question of financing state expenditure. As a description of our monetary system, the MMT can help to find such a path. Just as environmentalists and engineers should understand how a gasoline engine works, so should politicians understand the monetary system. Only in this way can the desired path be selected democratically from all the possibilities for shaping the future.

  • 1 Elements of the MMT can be found in post-Keynesian publications such as Helmedag (2018, 54-90).
  • 2 This has nothing to do with the independence of the central bank. The Bundesbank is the main bank of the Federal Republic of Germany and always makes all payments to the federal government.
  • 3 In an open economy, a national deficit can also lead to surpluses abroad.
  • 4 This is in line with post-Keynesian stock-flow-consistent models, in which the financial relationships of an economy are consistently mapped using double-entry bookkeeping (Godley and Lavoie, 2007).
  • 5 In order to keep interest rates low, it is usually sufficient to give a credible assurance that one is fulfilling the function of the lender of last resort, such as This can be seen, for example, in the falling interest rate differentials on government bonds in the euro area after Mario Draghi's announcement that he would do everything to stabilize the euro area and the implementation of the ECB's OMT program after 2012.
  • 6 In addition, interest rate differentials are hardly compatible with fair competition between euro member states (Kaczmarczyk, 2021).
  • 7 The MMT does not advocate the idea that the state increases tax rates or tax revenue during an upswing. Nevertheless, undesirable developments can also be slowed down by targeted tax increases.


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Title: How Do We Finance the Corona Debt? Attempting a "Right" Answer to the "Wrong" Question from the Perspective of Modern Monetary Theory

Abstract: The year 2020 was marked by the COVID-19 pandemic and its economic consequences. In Germany, government deficits as well as the debt ratio rose to an estimated 5% and 75% of GDP respectively as a result of the decline in economic output. In order not to jeopardize the post-pandemic economic recovery by returning to a rigid austerity policy, it is now of particular importance to abandon misconceptions regarding the financing as well as the sustainability of government expenditure surpluses. This is the only way to set the right course for an economic policy of the 21st century.

JEL Classification: B52, E12, E6

© The author: in 2021

Open Access: This article is published under the Creative Commons Attribution 4.0 International License (

Open Access is funded by the ZBW - Leibniz Information Center for Economics.