A federal government with a sovereign currency has a unique responsibility/capability – A Balanced Economy.
Unlike the federal government, you and I, our local governments, our county governments, and our state governments all have to live within a balanced budget, which may include borrowing and paying back the debt, using dollars from the federal government. We all need dollars, coming and going, to balance our budget.
Not so for the federal government. Their job is to maintain a balance economy where they must balance inflation against unemployment. They use the creation and deletion of dollars to manage this balancing act and that can only happen using a federal deficit (good or bad).
The unique capability of the federal government to create every dollar of America’s currency out of thin air is what allows the rest of us to function within the economy and balance our budgets.
This unique capability of the federal government means that, unlike you or I or lower level governments, the federal government doesn’t technically need to borrow. It just uses a computer keyboard to pump dollars into the economy. It also means it doesn’t need to tax anyone to pay its bills. It will just create dollars as needed to make payments. More on this below.
This unique Federal ability to create money to inflate a deflated economy, means the federal government can pay for wars without increasing taxes like GWB. It also means the federal government can increase the the largest defense budget in the world while providing enormous tax cuts for billionaires and corporations as DJT has done. The government just adds dollars to the defense bank accounts and leaves more dollars in the economy through less taxation to keep the economy growing, sort of. And all without inflation because the economy is not balanced.
Unfortunately, these GWB and DJT deficita are bad for the economy because it doesn’t cause widespread, democratic, economic growth. The money from this bad deficit is focused on just a few citizens who work for defense contractors and an even smaller number of billionaires like DJT and his owners. These few citizens can’t buy a lot of stuff with those trillions and everyone else suffers because they got nothing from this national deficit spending spree.
On the other hand, a good deficit would make sure the money pumped into the economy is more democratically distributed. For example, rebuilding our aging national infrastructure, funding a green new deal, raising the minimum wage to a living wage, wiping out student debt, and providing medicare for all. This will affect hundreds of millions of citizens who will buy stuff and pay taxes.
Yes, both the bad and good deficits increase the number of dollars in the economy and inflation can be a consequence. However, when the current economy isn’t at full capacity this won’t happen. Currently, inflation isn’t happening and interest rates have been historically low and sometimes negative to try and stimulate the economy.
So at the federal level, more dollars can be pumped into the economy without inflation as long as the economy is operating at less than full capacity and full employment. And as we have experienced, an inflationary economy and full employment aren’t likely with the bad deficits we are currently suffering from.
Now imagine a good deficit like the one described above. It would lead to full employment at a living wage and eventual inflationary pressures. At some point after this stimulation kicks in, the federal government must put on the economic breaks by removing dollars from the economy and/or slowing their creation for buying stuff.
Since the federal government controls the dollar pump to fuel the economy, it can also slow down the dollar pump and consider consuming/disappearing dollars when inflation becomes a problem.
To slow down the pump, they will raise interest rates to discourage the need to create dollars. On the other end, they will, as needed, increase income taxes and promote ‘government borrowing’ – a misnomer.
To be effective at slowing down the economy, tax revenues represent dollars that must be removed not only from your bank account but also from the economy. Just like these dollars were created from thin air on a computer balance sheet, they will disappear from that same balance sheet and are no longer part of the economy. They can no longer be used to buy stuff and thus cut inflationary pressures.
‘Government borrowing’ is another tool to remove dollars from the economy. When we buy stuff, many of those dollars end up leaving the country and are now held by others, like China. To get those dollars back from others and disappeare them from the economy like tax revenues, the federal government makes an agreement with those dollar hoarders to take them back with a promise of small, periodic, periodic income until they need those dollars again at some later time. Hopefully, that will be when the economy has slowed down and needs a boost. In the mean time, there are fewer dollars in the economy and less inflationary pressure.
If you’d like to know more, this all comes under the heading of Modern Monetary Theory/Practice.