A Response to Monetarist Misconceptions About Taxes, Deficits, and Inflation
The Original Statement Posed to Me:
This statement deserves a thorough answer because it embeds assumptions that most people don’t realize are contested. The reader assumes taxes fund spending, that money creation automatically causes inflation, that 2021-2022 inflation resulted from government “printing money,” and that economic insecurity stems from currency devaluation. These aren’t facts but theoretical claims from one particular school of economics. To answer properly requires examining what we actually know about how monetary systems work and which theories best predict real-world outcomes.
I don't understand your point that our taxes don't pay for anything. Without them we would have to 'print' all the money we spend/waste which would inflate our deficit even higher. What they are describing is actually the problem with the current system and the Fed caused by printing money that wasn't created through production of actual value. Where does the value then comes from in these dollars? It comes from devaluing all the remaining dollars and stealing wealth from those who have earned and built it which is why everyone feels so poor all the time. It forces inflation and weakens our dollar globally. Imagine you spend your life saving $2 million for your retirement then inflation hits 9% in one year and the government effectively stole $180k from your retirement.
Direct Responses to the Claims
Claim 1: “Taxes pay for government spending; without them we’d have to print all the money”
Response: The government already creates all money when it spends. The operational sequence: Congress authorizes spending → Treasury instructs the Fed to credit bank accounts → money is created → later, taxes destroy some money. Spending happens first. The government creates dollars; it cannot run out of something it creates.
Evidence: Former Fed Chairman Beardsley Ruml stated explicitly in 1946 that “taxes for revenue are obsolete” for sovereign currency issuers. The Federal Reserve Bank of St. Louis confirms: “As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent.” This challenges Assumption #7 (Government Budget Constraint) from mainstream theory.
Claim 2: “Printing money would inflate our deficit even higher”
Response: This confuses several distinct concepts. Let’s clarify the terminology and operations:
Deficit versus debt: The deficit is the annual difference between government spending and tax revenue. The national debt is the cumulative total of past deficits. Creating money doesn’t change the deficit size; the deficit is determined by Congressional appropriations (spending) minus tax receipts (revenue), not by the mechanism of money creation.
Order of operations: Money creation comes first, always. When Congress appropriates $100 billion for infrastructure:
- Congress authorizes spending (fiscal policy decision)
- Treasury instructs Fed to credit accounts
- Money is created through keystroke entries
- The deficit increases by $100 billion (if taxes don’t cover it)
- Congress never reviews tax receipts before making appropriations
The narrative versus operational relationship: Public discourse presents federal tax receipts and budget appropriations as if they’re operationally connected, like a household checking its bank balance before writing checks. This is narrative, not operations. Congress appropriates based on political priorities, not available tax revenue. The government cannot be operationally constrained by tax revenue because it creates the money it spends.
Fiscal policy versus monetary policy confusion: This confusion deepens because of how Treasury bills work. Fiscal policy (Congressional domain) involves decisions about taxing and spending. When spending exceeds taxes, Congress runs a deficit. Monetary policy (Federal Reserve domain) involves managing interest rates, money supply, and financial conditions. Treasury bills exist at the intersection, creating confusion.
When the government runs a deficit, the Treasury issues bonds (T-bills). This happens because of a legal requirement, not operational necessity. The law requires the Treasury to issue bonds matching the deficit. But operationally, the government could simply create the money needed and not issue bonds at all. Many economists argue the bond issuance is a vestige of gold standard thinking, when governments actually did need to borrow real resources.
Treasury bills serve these purposes: providing a risk-free savings vehicle for the private sector, supporting monetary policy operations (the Fed uses them for interest rate management), and creating political constraint (making deficits “visible” and subject to debt ceiling debates). Treasury bills are created due to fiscal policy (Congressional deficits) but are used for monetary policy operations (Fed interest rate management), creating confusion about whether the government is “borrowing” to “finance” deficits. Operationally, the government doesn’t need to borrow its own currency. The bond issuance is a policy choice, not an operational necessity.
This challenges Assumption #7 (Government Budget Constraint) and Assumption #22 (“Budget Deficits Create Unsustainable Debt Burdens”).
Claim 3: “Printing money not created through production of actual value devalues all dollars”
Response: This assumes the Quantity Theory of Money (more money equals proportional inflation). Evidence across multiple countries contradicts this:
United States (2008-2019): Fed expanded its balance sheet from $870 billion to $4.5 trillion. Result: inflation stayed below 2% target, averaging 1.5% annually.
Japan (1990-present): Ran massive deficits for three decades, debt exceeding 250% of GDP. Result: persistent deflation, near-zero interest rates, strong currency.
United Kingdom (2009-2016): Bank of England created £375 billion (20% of GDP). Result: inflation near target, no spiral.
Switzerland (2009-2015): SNB massively expanded balance sheet. Result: franc strengthened so much they needed negative interest rates to prevent excessive appreciation.
Money doesn’t automatically devalue. Inflation happens when demand for real goods exceeds production capacity. That’s a real resource constraint, not a money constraint. This contradicts Assumption #9 (Money Neutrality).
Claim 4: “Where does the value then come from in these dollars?”
Response: This reveals a fundamental misunderstanding about what gives fiat currency value. The value doesn’t come from being “backed” by commodities or “created through production.” Fiat currency value comes from multiple sources:
Tax obligations create demand: The government requires taxes be paid in its currency. This creates fundamental demand for dollars. If you must pay taxes in dollars, you need dollars. This is called the “chartalist” or “tax-driven” theory of money. As long as the government can enforce tax obligations, there will be demand for its currency.
Legal tender laws: The government declares its currency must be accepted for debts, public charges, taxes, and dues. This creates broad acceptance.
Network effects: Once a currency is widely used, it becomes more valuable simply because everyone else uses it. Businesses price goods in dollars, workers expect wages in dollars, contracts are denominated in dollars. Switching away becomes increasingly difficult and costly.
Productive capacity of the economy: The dollar represents a claim on the real goods and services the US economy can produce. If the US economy can produce cars, computers, healthcare, food, and housing, then dollars represent claims on those real resources. The stronger and more diverse the productive capacity, the more valuable the currency.
Institutional stability and rule of law: Trust that contracts will be enforced, property rights protected, and government functions maintained. Countries with weak institutions often have weak currencies regardless of money supply, because people don’t trust the system.
Historical momentum: The dollar has been the world’s primary reserve currency since Bretton Woods (1944). This creates self-reinforcing demand as other countries hold dollar reserves and price commodities (especially oil) in dollars.
The commodity-backing view (“money created through production of actual value”) confuses money with the real resources it can purchase. Money is not itself valuable; it’s a claim on real resources. What matters is whether the economy can produce valuable goods and services, not whether paper currency is backed by gold or “production.”
Countries with weak currencies typically have weak productive economies, institutional instability, or both. They don’t have weak currencies simply because they “printed too much money.” Venezuela’s currency crisis stemmed from collapsed oil production, political instability, and institutional breakdown, not primarily from money printing. Zimbabwe’s crisis stemmed from collapsed agricultural production after land seizures, not merely from money creation.
The value of dollars comes from the combination of tax-driven demand, legal framework, network effects, productive capacity backing those dollars, and institutional trust. This is why the US can create trillions in 2020 without the dollar collapsing, while other countries face currency crises with far less money creation: the underlying real economy and institutions matter.
Claim 5: “Stealing wealth from those who have earned and built it / why everyone feels so poor all the time”
Response: The feeling of economic insecurity and declining living standards is real, but it’s not caused by money creation devaluing currency. The actual causes are distributional and structural:
Wage stagnation despite productivity growth: From 1979 to 2020, productivity grew 61.8% while median worker compensation grew only 17.5% (Economic Policy Institute data). Workers produce more value but capture less of it. This isn’t caused by money creation; it’s caused by policy choices about labor rights, corporate governance, and tax structure.
Rising costs of essentials: Housing, healthcare, and education costs have far outpaced general inflation. Median home prices relative to median income have roughly doubled since 1970. Healthcare costs as a percentage of GDP have more than doubled. College costs have increased 8x faster than wages. These aren’t caused by “too much money” but by specific factors: restrictive zoning (housing), insurance/pharmaceutical pricing power (healthcare), declining public funding (education).
Financialization of the economy: An increasing share of economic activity and profits goes to the financial sector rather than productive enterprise. Corporate profits increasingly come from financial engineering (stock buybacks, debt-funded dividends) rather than productive investment. This reshapes the economy toward asset owners and away from workers.
Concentration of wealth and income: The top 1% wealth share has grown from roughly 23% (1979) to over 32% (2020s). The top 0.1% captured a massively disproportionate share of post-2008 recovery gains. This concentration means economic growth increasingly accrues to asset owners rather than workers.
Declining labor power: Union membership fell from 27% of workers (1979) to 10% (2020s). This reduced workers’ bargaining power for wages and benefits. Simultaneously, corporate concentration increased market power, giving large employers monopsony power (few buyers of labor, driving down wages).
Insecure employment: Growth of gig economy, contract work, and precarious employment. Health insurance tied to employment creates insecurity. Pension replacement with 401(k)s shifted risk from employers to workers.
These are policy choices, not monetary phenomena. Other countries create money through sovereign currency systems yet maintain stronger wage growth, lower healthcare costs, more affordable education, and greater economic security through different policy choices: stronger labor protections, universal healthcare, public education funding, progressive taxation, competition policy.
The feeling of being economically insecure stems from real distributional problems and policy choices about who captures economic gains, not from the operational reality of how government creates and spends money. Blaming money creation for economic insecurity obscures the actual causes and prevents addressing them effectively.
Claim 6: “Government stole $180k from retirement through inflation”
Response: The 2021-2022 inflation stemmed from real disruptions, not money creation.
Evidence: Economic Policy Institute found corporate profits accounted for over 50% of price increases in 2021 (historical average: 11%). Federal Reserve Bank of Kansas City documented supply chain bottlenecks as primary drivers: semiconductor shortages crippling production, port congestion (dozens of ships waiting vs. typical zero), labor force participation dropping by 3-4 million workers, oil prices doubling due to supply constraints and Ukraine invasion.
These are real economy constraints. Creating less money wouldn’t have fixed broken supply chains or increased oil production. It would have added unemployment to inflation.
Claim 7: “This weakens our dollar globally”
Response: Dollar strength depends on productive capacity, institutional stability, financial market depth, and network effects, not money supply. The euro strengthened during ECB quantitative easing. China expanded money supply faster than the US for decades; the renminbi generally appreciated. The 2020-2021 money creation didn’t weaken the dollar because currency value reflects real economic factors, not nominal money supply.
How to Evaluate Competing Economic Explanations
Before examining why these responses are correct in detail, we must establish how to judge between competing theories, because the statement embeds one particular framework while my responses use another.
Facts, Beliefs, and Opinions: A Critical Distinction
Economic debates conflate three different types of claims:
Operational facts describe how systems mechanically function: When Congress authorizes spending, Treasury instructs the Fed to credit accounts. The Fed expanded its balance sheet from $870 billion to $4.5 trillion (2008-2014). Japan ran continuous deficits for three decades while experiencing deflation. These are verifiable observations about how monetary systems work.
Theoretical beliefs are interpretations we construct to explain facts: “Money supply increases cause proportional inflation” (Quantity Theory). “Government deficits crowd out private investment” (loanable funds theory). “Markets automatically clear” (equilibrium theory). These are frameworks for understanding observations, not observations themselves.
Normative opinions are value judgments: “We should prioritize price stability over full employment.” “Inequality is acceptable if it promotes growth.” These are political positions, not scientific claims.
The most common confusion: presenting theoretical beliefs as if they were operational facts.
When someone says “we can’t afford universal healthcare,” they’re stating a theoretical belief (that government faces household-like budget constraints) as if it were an operational fact. The actual facts: government creates dollars when it spends, cannot run out of dollars, and we have doctors, hospitals, and medical supplies. The theoretical belief smuggled in is Assumption #7 (Government Budget Constraint). The actual constraint is: can we organize real resources without causing problematic inflation?
This distinction matters because you can’t resolve ontological questions (what actually exists, how systems actually work) through theoretical debate. You must examine operations. And you can’t resolve epistemological questions (which theory better explains reality) through assertion. You must test predictions against outcomes.
Why Definitions Matter: The Case of Inflation
How we define inflation determines what we think causes it and therefore what policies we implement.
Inflation as monetary phenomenon (quantity theory): Inflation measures money supply growth relative to output. Policy response: always restrict money supply, raise interest rates, reduce credit.
Problem: This makes inflation a proxy for money supply rather than measuring what’s actually happening in the real economy. It assumes the causation rather than testing it.
Inflation as supply/demand phenomenon (real economy): Inflation measures mismatch between demand for goods and capacity to supply them. Policy response depends on diagnosis: excess demand (reduce spending), supply constraints (increase capacity), bottlenecks (address specific sectors), monopoly pricing (address market structure).
Why the real economy definition is superior: It corresponds to what inflation operationally measures. When prices rise, buyers compete for scarce goods. The scarcity reflects real factors: too much demand, too little supply, sectoral bottlenecks, or market power. Defining inflation monetarily obscures these distinctions, treating all inflation as identical when different types require different responses.
This explains the 2021-2022 misdiagnosis. Using the monetary definition, policymakers saw price increases and assumed “too much money.” Solution: raise rates, create unemployment. But the reality was supply chain breakdowns, energy shocks, corporate pricing power. Raising rates didn’t fix broken supply chains or increase semiconductor production. It risked creating both inflation (from supply constraints) and recession (from demand destruction).
The Three Major Schools of Macroeconomic Thought
Understanding the original statement requires recognizing it embeds assumptions from one particular school of economic thought. Most people don’t realize that what they learned as “economics” represents contested territory where fundamental disagreements remain unresolved. To evaluate competing claims, we must understand what these different frameworks actually say and why some have better empirical track records than others.
The Austrian and Monetarist Tradition: Centuries-Old Theory Contradicted by Modern Evidence
The framework embedded in the original statement comes from a tradition stretching from Austrian economics through monetarism. At its core sits the Quantity Theory of Money (MV=PY), which holds that money supply times velocity equals price level times real output. According to this framework, increases in money supply lead proportionally to increases in prices when velocity and output are relatively stable. This logic dates to at least the 16th century, articulated by thinkers like Jean Bodin and John Locke. Milton Friedman’s modern monetarism in the 1960s-1970s merely formalized ideas developed before the Industrial Revolution.
The fundamental empirical problem: This theory’s key prediction fails systematically across multiple countries and time periods. The Fed expanded its balance sheet roughly 5x (2008-2014) through quantitative easing. Quantity theory predicts substantial inflation if velocity remained stable. What happened: inflation stayed below 2% target for a decade, averaging 1.5% annually. Velocity collapsed by 35% from its 2007 peak. This isn’t minor deviation; it’s complete failure of the theory’s key assumption that velocity is stable or predictable.
Japan provides even more dramatic contradiction. Government debt grew from 60% to over 250% of GDP across three decades. The Bank of Japan expanded its balance sheet to over 130% of GDP. According to this theory, Japan should have faced runaway inflation, currency collapse, and funding crisis. What happened: persistent deflation, near-zero bond yields, strong currency, no difficulty funding operations. This is the opposite outcome from predictions across multiple dimensions simultaneously, sustained over thirty years.
Switzerland massively expanded its balance sheet attempting to prevent franc appreciation. The theory predicts: more money means weaker currency. What happened: franc strengthened so much they needed negative interest rates and exchange rate controls. The theory gets causation backward.
Why it persists despite failure: As I document extensively, economics maintains theories through institutional power rather than evidence. This tradition treats government as analogous to households (governments must earn before they spend, just as households must). The gold standard era shaped this thinking: when currencies were backed by gold, governments genuinely faced resource constraints on money creation. The framework assumes these constraints persist even after the gold standard ended in 1971. The analogy is demonstrably false (governments create money; households cannot), yet it dominates public discourse because it serves political purposes, making government spending appear inherently constrained.
This tradition also embodies Assumption #1 (Rational Choice Theory) and Assumption #5 (Automatic Market Clearing). It assumes people make perfectly rational decisions and markets naturally find equilibrium. Decades of behavioral economics research has systematically disproven these assumptions, yet they remain foundational to the framework.
The persistence of monetarism reveals how economics functions. We’re applying pre-Industrial Revolution monetary theory to modern economies with instantaneous global financial flows, complex derivatives, real-time economic data from billions of transactions, and supercomputers capable of simulating scenarios with millions of agents. Yet public discourse remains trapped in centuries-old frameworks not because they represent our best modern understanding but because, as I document, economics functions as a gatekept knowledge discipline where corporate-funded departments teach orthodox theory, mainstream media consults orthodox economists, and heterodox economists with better predictive records are systematically marginalized.
The New Keynesian Mainstream: Modest Improvements but Fundamental Failures Remain
The current academic and policy orthodoxy blends neoclassical foundations with Keynesian insights. This mainstream view dominates graduate economics training, central bank thinking, and international institutions. It accepts that markets can fail and that government intervention can improve outcomes, but maintains many problematic assumptions from neoclassical theory.
Where it improves on Austrian/monetarist thinking: New Keynesian economics recognizes that markets don’t always clear smoothly and that monetary policy affects real output in the short run. It accepts a role for government stabilization during recessions. It acknowledges market failures (monopolies, externalities, public goods) that justify intervention. These are genuine advances over rigid market fundamentalism.
Where it still fails critically: Despite sophistication, this framework shares core problems with Austrian thinking. It still treats people as having rational expectations (using all available information optimally to predict the future). It still assumes markets clear eventually, though prices may adjust slowly. Most critically, it excludes or minimizes banks, private debt, and how money is actually created through bank lending.
The 2008 financial crisis exposed this fundamental failure catastrophically. In 2003, Nobel laureate Robert Lucas declared: “The central problem of depression prevention has been solved.” In 2007, Fed Chairman Bernanke stated subprime problems would be “contained.” The profession’s dominant DSGE (Dynamic Stochastic General Equilibrium) models, used by the Fed, ECB, and central banks worldwide, couldn’t accommodate major financial crises. These models assumed markets clear automatically and financial markets are efficient.
As economist Steve Keen observes: “If you look at mainstream economics there are three things you will not find in a mainstream economic model: Banks, Debt, and Money. How anybody can think they can analyze capital while leaving out Banks, Debt, and Money is a bit to me like an ornithologist trying to work out how a bird flies whilst ignoring that the bird has wings.”
Who did predict the crisis: Heterodox economists working outside mainstream frameworks: Steve Keen (Post-Keynesian) warned from 2005 that private debt levels were unsustainable. Wynne Godley (Post-Keynesian) published warnings in 2004-2007 about unsustainable sectoral imbalances. Michael Hudson and Dean Baker warned about the housing bubble. They succeeded because their models included actual mechanisms (banks, debt, financial fragility) through which crises unfold.
When the crisis happened, mainstream economists didn’t abandon failed theories. They added “financial frictions” while preserving core assumptions about rational expectations and market clearing. This is precisely the behavior that characterizes ideology rather than science: protecting core beliefs by adding auxiliary assumptions rather than questioning foundations.
The crowding out failure: Mainstream models predict government deficits drive up interest rates and reduce private investment. The 2020-2021 test: US deficit reached $3.1 trillion (14.9% of GDP). Result: 10-year Treasury yields remained below 1.5%, corporate bond issuance reached records, private investment grew 5.6%. The prediction failed completely, yet the theory persists in textbooks and policy debates.
The European austerity disaster: In 2010-2015, European policymakers used mainstream models predicting deficit reduction would restore confidence and growth. Theory embodied Assumption #21 (“We Have to Be Fiscally Responsible”) and Assumption #22 (“Budget Deficits Create Unsustainable Debt Burdens”). What happened: Greece GDP contracted 26.8%, unemployment 27.5%. Spain GDP contracted 9%, unemployment 26.1%. Portugal GDP contracted 7%. Italy GDP declined 9%. In 2012, IMF chief economist Olivier Blanchard acknowledged fiscal multipliers were much larger than predicted. The austerity did more damage than anticipated because the models were wrong. This wasn’t academic error; millions of lives were damaged based on demonstrably false theory.
As I argue, this reveals how economics functions. The “national debt narrative” that governments must operate like households is demonstrably false. Mainstream economists know this. Unlike households, governments controlling their currency create money and cannot “run out.” Yet this framework dominates discourse because framing spending as constrained by debt removes entire categories of social investment from democratic consideration, serving those who prefer limited government while avoiding political debate about values.
Why it maintains dominance: Beginning in the 1940s, corporations funded “endowed chairs” in economics departments, positions costing millions that grant donors influence over hiring and research priorities. Over decades, this shifted faculty composition toward market-friendly approaches. The revolving door between academia, Federal Reserve/Treasury positions, and corporate consulting creates additional incentive alignment. Heterodox economists challenging orthodox assumptions are systematically marginalized: concentrated in lower-tier institutions, excluded from top journals, rarely invited to major conferences. A genuine science would test alternatives rigorously. Economics maintains competing schools through institutional power rather than evidence.
The Operational/Post-Keynesian Framework: Starting From How Systems Actually Work
The framework I present draws from Post-Keynesian economics and Modern Monetary Theory (MMT). Rather than starting from abstract assumptions about rational optimization, this approach starts from operational reality: how do monetary and fiscal systems actually function mechanically? What can we observe about how money is created, how government spending works, what actually causes inflation in different contexts?
Operational grounding rather than assumptions: When Congress appropriates funds and Treasury instructs the Federal Reserve to credit accounts, new money comes into existence through keystroke entries. This isn’t metaphorical or theoretical; it’s the documented operational sequence confirmed by the Federal Reserve Bank of St. Louis, the Bank of England’s 2014 paper “Money Creation in the Modern Economy,” and treasury operations globally. Former Fed Chairman Beardsley Ruml’s 1946 paper “Taxes for Revenue Are Obsolete” explicitly stated sovereign currency issuers don’t need tax revenue to spend. This is operational fact, not belief.
Taxes serve other purposes: creating demand for the currency (if you must pay taxes in dollars, you need dollars), redistributing income and wealth, influencing behavior, managing aggregate demand. But taxes don’t “fund” spending operationally because spending happens first. The government cannot run out of something it creates.
Better predictive track record: This framework predicted quantitative easing wouldn’t cause runaway inflation (2008-2019) while mainstream models predicted significant inflation. It correctly identifies when inflation is likely (when resource constraints bind) versus when money creation is benign (when substantial slack exists). It explains why Japan and the US can sustain large debts without funding crises while mainstream models predicted crises that never materialized.
The heterodox economists who predicted the 2008 crisis (Keen, Godley, Hudson, Baker) worked from frameworks emphasizing banks, private debt dynamics, and financial fragility. This attention to actual financial mechanisms rather than abstract optimization explains their success where mainstream models failed catastrophically.
On inflation: Rather than assuming all inflation is monetary, this framework distinguishes types. Demand-pull inflation occurs when spending exceeds productive capacity. Cost-push inflation occurs when input costs rise (oil shocks). Bottleneck inflation occurs when specific sectors cannot keep up. Profit-driven inflation occurs when corporations with pricing power raise margins. Each requires different responses. The 2021-2022 case demonstrates this: Economic Policy Institute found corporate profits accounted for over 50% of price increases versus 11% historically. Federal Reserve Bank of Kansas City documented supply chain bottlenecks as primary drivers. Cross-country comparison showed similar inflation across developed economies regardless of monetary policy differences, suggesting common supply-side causes. This was supply-side inflation requiring targeted responses, not monetary inflation requiring blanket interest rate increases.
The Federal Reserve’s implicit evolution: Even the Fed has quietly evolved beyond simple monetarism because practitioners managing real economies discover centuries-old theory doesn’t work. If inflation were simply monetary and controllable through interest rates, the Fed would need one tool. Instead they’ve developed: interest rate policy, quantitative easing/tightening, forward guidance, targeted lending facilities for specific sectors, reserve requirements, regulatory and macroprudential tools. Former Fed Chairs Yellen and Bernanke explicitly acknowledged this complexity, noting policy works through multiple channels and relationships are “neither simple nor mechanical.”
This proliferation of tools reveals practical recognition that different situations require different responses, that supply chain inflation needs different treatment than demand-pull inflation, that the economy is complex rather than reducible to MV=PY. Yet this practical institutional knowledge rarely filters to public discourse, which remains dominated by frameworks serving political purposes rather than describing reality.
Why it’s more scientific: This framework requires fewer auxiliary assumptions. You don’t need to assume stable velocity, rational expectations, or market clearing. You describe operational sequences and test predictions. When quantitative easing didn’t produce predicted inflation, the response isn’t “velocity must have changed mysteriously” but recognition that the quantity theory doesn’t capture how modern monetary systems work. When crises occur, models including banks and debt predict them while models excluding these mechanisms fail.
The operational approach follows scientific method: observe how systems actually work, build theory consistent with operations, test predictions against outcomes, abandon theories when they fail. This is why heterodox economists often predict crises mainstream economists miss, why operational predictions about quantitative easing proved correct while quantity theory predictions failed, why understanding that government creates money explains outcomes that household-budget analogies cannot.
The real constraints: This doesn’t mean government can spend unlimited amounts. Real constraints exist: inflation and availability of real resources. If government tries to purchase more than the economy can produce, it bids up prices. This is genuine limit, fundamentally different from “running out of money” or “unsustainable debt burden” concerns dominating conventional discourse. The question isn’t “can we afford it?” but “do we have sufficient real resources (labor, materials, capacity) to do this without causing problematic inflation?” This reframes political economy: debates about “fiscal responsibility” are revealed as misleading when applied to sovereign currency issuers. Real debates are about resource allocation, project priority, benefit distribution. These are political and ethical questions obscured when economic constraints are misunderstood.
Why better empirical grounding matters: Using the wrong model has catastrophic consequences measured in human suffering. European austerity imposed based on flawed mainstream models. Failure to predict 2008 meant no preventive action. Potential misdiagnosis of 2021-2022 inflation as monetary risked creating unemployment without addressing supply constraints. The stakes are too high for models chosen by institutional power rather than empirical success.
The operational/Post-Keynesian framework consistently outperforms Austrian and mainstream models not because it’s ideologically appealing but because it corresponds to how systems actually function and makes more accurate predictions. When theory and evidence conflict, science follows evidence. Economics, as currently practiced, follows theory and explains away evidence. That is why economics is not a science, and why understanding the operational reality of monetary systems matters for preventing policy disasters.
Testing Predictions: Which Model Actually Works?
How Money and Taxes Actually Operate
The documented operational sequence contradicts the “taxes fund spending” claim:
When government spends: Congress authorizes → Treasury instructs Fed to credit accounts → bank reserves credited → money created
When taxes are collected: Treasury debits accounts → bank reserves debited → money destroyed
Former Fed Chairman Beardsley Ruml’s 1946 paper “Taxes for Revenue Are Obsolete” explicitly stated sovereign currency issuers don’t need tax revenue to spend. Economist Abba Lerner formalized this as “functional finance” in the 1940s. Former Fed Vice Chairman Alan Blinder confirmed government doesn’t need to collect taxes before spending.
The Bank of England’s 2014 paper “Money Creation in the Modern Economy” confirmed: “Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.” This operational reality holds for any sovereign currency issuer.
The Quantity Theory: Systematic Failure Across Countries
The Austrian/quantity theory framework predicts money supply increases cause proportional inflation when velocity and output are stable. Evidence systematically contradicts this across multiple countries and time periods.
United States (2008-2019): The Fed expanded its balance sheet roughly 5x through quantitative easing. According to Quantity Theory (MV=PY), this should have produced substantial inflation if velocity remained stable. What happened: inflation stayed below 2% target, averaging 1.5% annually. Velocity collapsed by approximately 35% from its 2007 peak. This isn’t minor deviation; it’s complete failure of the theory’s key assumption that velocity is stable.
Japan (1990-present): Perhaps the most dramatic counterexample. Government debt grew from 60% of GDP to over 250%. The Bank of Japan expanded its balance sheet to over 130% of GDP. Fiscal deficits averaged 5-7% annually for three decades. According to quantity theory and Assumption #22 (“Budget Deficits Create Unsustainable Debt Burdens”), Japan should have faced runaway inflation, funding crisis, currency collapse, interest rate spikes. What happened: persistent deflation, near-zero or negative bond yields, yen remained strong, no difficulty funding operations. This is the opposite outcome from predictions across multiple dimensions simultaneously, sustained over three decades.
United Kingdom (2009-2016): Bank of England purchased £375 billion through quantitative easing (20% of GDP). Result: CPI inflation averaged 2.3%, close to target. No inflationary spiral.
Switzerland (2009-2015): SNB dramatically expanded its balance sheet attempting to prevent franc appreciation. Despite massive money creation: franc strengthened so much they implemented negative interest rates and set an exchange rate floor. When they removed the floor (2015), franc appreciated 30% instantly. This is opposite of quantity theory predictions: more money should mean weaker currency, but Switzerland created money and the franc strengthened.
The 2021-2022 Inflation: Evidence of Supply-Side Causes
The 2021-2022 episode initially appears to support quantity theory: M2 increased in 2020-2021, inflation followed. But examining mechanisms and cross-country evidence reveals primarily supply-side inflation.
Profit concentration evidence: Economic Policy Institute found corporate profits accounted for over 50% of price increases in 2021 versus 11% historically. This is inconsistent with general monetary inflation, which should affect all sectors proportionally. Concentration in corporate profits suggests pricing power, not monetary pressure.
Supply chain documentation: Federal Reserve Bank of Kansas City documented specific bottlenecks: semiconductor production fell significantly below demand, crippling automotive and electronics production. Los Angeles/Long Beach ports (40% of US container imports) had dozens of ships waiting versus typical zero, wait times exceeding two weeks versus less than one day. Labor force participation dropped 2 percentage points, representing 3-4 million fewer workers. Oil prices more than doubled from pandemic lows due to supply constraints and Ukraine invasion.
Cross-country comparison: If inflation were primarily monetary (caused by US money creation), we’d expect higher US inflation than countries with less money creation, and correlation between countries’ money supply growth and inflation rates. What happened: similar inflation across developed economies regardless of monetary policy differences. Euro area inflation reached 10.6% without similar ECB money creation. UK inflation reached 11.1% without comparable expansion. This suggests common supply-side causes rather than country-specific monetary causes.
Timing evidence: If 2020-2021 money creation caused 2021-2022 inflation, why the 12-18 month lag? Why no inflation in 2020 when money was created? Supply-side explanation fits timing: COVID disruptions cascaded through supply chains, Ukraine invasion (February 2022) caused immediate energy spikes.
The Federal Reserve’s Evolution Beyond Simple Monetarism
The Fed’s own evolution reveals simple monetarism’s limitations. If inflation were simply a monetary phenomenon controllable through interest rates, the Fed would need one tool. Instead, they’ve developed sophisticated approaches implicitly recognizing complexity.
Traditional monetarist playbook: Inflation appears → raise interest rates. One tool, one target, simple transmission.
The Fed’s actual modern toolkit:
- Interest rate policy (federal funds rate)
- Quantitative easing/tightening (asset purchases/sales)
- Forward guidance (managing expectations)
- Targeted lending facilities (addressing specific sectors: 2020 facilities for municipalities, medium businesses, commercial paper)
- Reserve requirements (rarely adjusted)
- Regulatory and macroprudential tools (stress tests, capital requirements)
This proliferation suggests the Fed understands different situations require different responses. Supply chain inflation needs different treatment than demand-pull inflation. Financial stability requires different tools than inflation control.
Former Fed Chairs Janet Yellen and Ben Bernanke explicitly acknowledged this complexity in speeches, noting monetary policy works through multiple transmission channels and the relationship between actions and outcomes is “neither simple nor mechanical.” Bernanke emphasized the Fed must examine a “dashboard” of indicators rather than single measures, calibrating policy to specific conditions rather than following simple rules.
The Fed’s creation of targeted 2020 crisis facilities demonstrates recognition that different sectors require specific interventions. Simple “print money and inflation rises” frameworks wouldn’t require such targeted approaches.
Why Centuries-Old Theory Still Dominates Public Discourse
The Fed’s toolkit evolution raises a critical question: if simple monetarism worked, why this proliferation of sophisticated tools?
Monetarism embodied in Quantity Theory (MV=PY) is not modern insight. Its core logic dates to at least the 16th century, articulated by Jean Bodin and John Locke. Milton Friedman’s modern monetarism in the 1960s-1970s merely formalized ideas developed before the Industrial Revolution, before electricity, before computers, before any capability to observe economies in real-time or model their complexity.
We’re applying pre-Industrial Revolution monetary theory to modern economies characterized by: instantaneous global financial flows, complex financial instruments and derivatives, real-time economic data from billions of transactions, supercomputers capable of simulating scenarios with millions of agents, sophisticated modeling techniques capturing complex system dynamics.
With modern computing and data availability, we have capabilities 16th century thinkers (or even 1960s economists) couldn’t imagine. We can run agent-based simulations with millions of actors, test how different policy tools affect different sectors in real-time, model supply chain dynamics and financial contagion, observe actual policy outcomes instantaneously and compare predictions to reality.
Yet public discourse about inflation and government spending remains trapped in centuries-old frameworks. Why?
As I document in “Economics is Not a Science,” economics functions as a gatekept knowledge discipline rather than open science. Unlike physics, biology, or chemistry where failed theories get abandoned and practitioners adopt frameworks with better predictive power, economics maintains orthodox theories through institutional power regardless of empirical failure.
The public encounters monetarist frameworks not because they represent our best modern understanding, but because: economics departments funded by corporate donors teach orthodox theory, mainstream media consults orthodox economists who learned this framework, heterodox economists with more sophisticated approaches are systematically marginalized, politicians find simple narratives (“printing money causes inflation”) politically useful even when empirically wrong.
Actual practitioners managing real economies (like the Federal Reserve) have quietly evolved beyond simple monetarism because they must. When your job is actually managing a modern economy, you discover centuries-old theory doesn’t work. Hence the proliferation of tools, attention to sectoral dynamics, recognition that different situations require different responses.
But this practical knowledge rarely filters to public discourse, which remains dominated by frameworks serving political purposes rather than describing economic reality. The persistence of monetarism in public debate despite institutional evolution beyond it reveals how economics functions: not as science updating based on evidence, but as ideology maintaining politically useful narratives through gatekeeping.
Additional Predictive Failures
Crowding out theory (Assumption #8): Predicts government deficits drive up interest rates and reduce private investment. The 2020-2021 test: US deficit reached $3.1 trillion (14.9% of GDP). Result: 10-year Treasury yields remained below 1.5%, corporate bond issuance reached records ($2.4 trillion in 2020), private investment grew 5.6% in 2021. Australia implemented 15% of GDP stimulus. Result: government bond yields fell during deficit expansion. No crowding out materialized.
The 2008 financial crisis: Most mainstream economists failed to predict it. In 2003, Nobel laureate Robert Lucas declared: “The central problem of depression prevention has been solved.” In 2007, Fed Chairman Bernanke stated subprime problems would be “contained.” Dominant DSGE models used by the Fed, ECB, and central banks worldwide couldn’t accommodate major financial crises, assuming markets clear automatically and financial markets are efficient. When the crisis happened anyway, mainstream economists didn’t abandon failed theories but added complications preserving core assumptions.
Who did predict the crisis? Heterodox economists: Steve Keen (Australia, Post-Keynesian) warned from 2005 that private debt levels were unsustainable. Wynne Godley (UK, Post-Keynesian) published warnings in 2004-2007 about unsustainable sectoral imbalances. Michael Hudson and Dean Baker warned about the housing bubble. They succeeded not through superior crystal balls but because their models included actual mechanisms (banks, debt, financial fragility) through which crises unfold.
Stagflation (1970s): Orthodox theory maintained high inflation and high unemployment couldn’t coexist. The Phillips Curve suggested inverse relationship. When stagflation occurred (US inflation reaching 13.5% with unemployment 10.8%, UK inflation 24.2% with unemployment 5.5%), orthodox economists were baffled. Explanation came from heterodox economists understanding inflation could be driven by supply shocks (OPEC embargoes) and institutional factors, not merely demand. In genuine science, such fundamental failure would trigger assumption reconsideration. In economics, the Phillips Curve was adjusted with new variables preserving the framework.
Why Model Choice Matters: Policy Consequences
These aren’t academic debates. Models determine policies, and wrong models create suffering.
If you believe inflation is always monetary, you respond to supply disruptions by restricting money and raising rates, creating unemployment. If you understand inflation can stem from supply constraints, you address constraints directly while using monetary policy judiciously.
If you believe deficits crowd out investment, you impose austerity during recessions, deepening crises. If you understand deficits create private sector income, you use fiscal policy to stabilize demand.
If you believe government spending must be “paid for” with taxes (Assumption #7 and Assumption #18: “We Can’t Afford It”), you artificially constrain public investment. If you understand the real constraint is inflation and real resources, you ask: do we have labor, materials, and capacity to do this without causing inflation?
The European Austerity Disaster
European austerity (2010-2015) provides perhaps the clearest natural experiment showing consequences of flawed models.
Following 2008, European countries faced rising deficits as revenues fell and automatic stabilizers increased spending. Based on theory embodied in Assumption #21 (“We Have to Be Fiscally Responsible”) and Assumption #22 (“Budget Deficits Create Unsustainable Debt Burdens”), European policymakers and institutions (Commission, ECB, IMF) imposed fiscal contraction. Theory predicted deficit reduction would restore confidence, leading to private expansion and growth.
What happened: Greece: GDP contracted 26.8%, unemployment reached 27.5%, youth unemployment 58.3%, public health crisis. Spain: GDP contracted 9%, unemployment 26.1%, youth unemployment 55.5%, over 400,000 families evicted. Portugal: GDP contracted 7%, unemployment 17.5%, emigration surged. Italy: GDP declined 9%, youth unemployment 42.7%.
IMF admission: In October 2012, IMF chief economist Olivier Blanchard acknowledged fiscal multipliers were much larger than predicted. The austerity did more damage than anticipated because models were wrong. IMF estimated multipliers between 0.9 and 1.7 (each dollar cut reduced GDP by 90 cents to $1.70). Models assumed 0.5. This wasn’t academic error; it was direct result of using models misunderstanding how government spending affects economies. Millions of lives were damaged based on demonstrably false theory.
As I argue, this reveals how economics functions. The “national debt narrative” that governments must operate like households (Assumption #7) is demonstrably false. Mainstream economists know this. Unlike households, governments controlling their currency create money and cannot “run out.” Yet this framework dominates discourse.
The political utility is enormous. Framing spending as constrained by debt removes entire categories of social investment from democratic consideration. Universal healthcare, free education, infrastructure, job guarantees become “unaffordable” (Assumption #18) not because of real resource constraints but because of artificially imposed fiscal constraints presented as natural laws. This serves those preferring limited government perfectly. Rather than arguing politically against popular programs, they claim economic impossibility (Assumption #19: “Government Intervention Distorts Markets”). Economics provides intellectual cover for limiting democratic control over economic resources.
Conclusion: Preventing Future Inflation Crises
The original challenge assumes one “economics” where describing government spending without taxation as inflationary is factual. But this represents one theoretical framework (Austrian/quantity theory) making specific assumptions about how money works, how inflation is generated, and what constraints governments face.
When we compare this framework’s predictions against empirical record, we find systematic failures: quantity theory predicted massive inflation from quantitative easing; we got a decade of below-target inflation. It predicted Japan would face crisis from deficits; Japan faced deflation for three decades. It predicted crowding out from 2020 deficits; we got record private investment and low rates. Mainstream models said 2008 crisis was impossible; heterodox economists using operational frameworks predicted it years ahead.
The operational/MMT framework describing how sovereign currency systems actually function has better track record precisely because it starts from operational reality rather than idealized assumptions borrowed from physics.
Understanding why mainstream economics persists despite failures requires recognizing the discipline has been shaped by physics envy and corporate capture rather than scientific progress. Models dominating policy discourse serve political purposes, constraining what democratic societies consider possible through claims of technical necessity rather than political choice.
Directly Addressing the Reader’s Concern
The reader’s concern about retirement savings eroded by inflation is legitimate and real. But preventing such scenarios requires economics to give us detailed, comprehensive, accurate understanding of what causes inflation and what tools effectively manage it.
The Austrian/quantity theory framework would tell policymakers: “Inflation is always caused by money creation, so restrict money supply whenever inflation appears.” This would have made 2021-2022 worse, creating mass unemployment without fixing actual problems (broken supply chains, energy disruptions, corporate pricing power) causing inflation.
The operational framework provides better tools:
For diagnosis: Is this demand-pull inflation (too much spending chasing limited goods)? Supply-side inflation (production disrupted)? Bottleneck inflation (specific sectors can’t keep up)? Profit-driven inflation (pricing power)? Each requires different responses.
For prevention: Build resilient supply chains, maintain productive capacity, address monopoly power, ensure energy security, keep strategic reserves. These address real economy factors causing inflation.
For management: When inflation appears, use targeted responses. If supply chains are broken, invest in logistics and domestic capacity. If energy is scarce, increase production or accelerate alternatives. If corporations price-gouge, enhance competition. Reserve broad monetary tightening for genuine demand-pull inflation when economy is at full capacity.
The reader’s scenario (savings losing purchasing power to 9% inflation) happened not because economics gave us good tools that were misused, but because mainstream economics gave wrong diagnosis and therefore wrong tools. Policymakers initially treated supply-side inflation as monetary inflation, risking recession alongside inflation without addressing root causes.
To genuinely address “I don’t want my savings destroyed by inflation,” we need:
- Accurate understanding of causes (real resource constraints, supply disruptions, market power, not money supply itself)
- Effective prevention tools (productive capacity, resilient supply chains, competitive markets, strategic reserves)
- Proper diagnosis when inflation occurs (identifying whether demand-driven, supply-constrained, bottleneck-related, or market power-driven)
- Targeted responses addressing root causes rather than blanket monetary restriction creating unemployment without fixing problems
This requires economics to function as actual science: testing theories against evidence, abandoning failed models, building better frameworks corresponding to operational reality. The fact that economics currently fails these standards is precisely why we get poor policy responses failing to prevent scenarios like the reader experienced.
The stakes are too high for anything less than rigorous, empirically grounded economic understanding. When theory and evidence conflict, science follows evidence. Economics, as currently practiced, follows theory and explains away evidence. That is why economics is not a science, and why we must demand better if we want to prevent inflation scenarios that genuinely harm people’s savings and security.
For those seeking to identify and challenge constraining assumptions making effective economic management appear impossible in everyday policy debates, I encourage consulting the full decoder ring, which provides systematic reference for recognizing and responding to specific claims embedded in economic arguments.