Government Finance and Money Creation in China: An MMT Perspective

Abstract

The traditional theory of money creation and supply has been widely questioned and criticized after the Global Financial Crisis in 2008. The existing empirical research on China’s money supply has been basically based on this traditional theoretical framework of “monetary base-money multiplier,” and ignored the important role of government finance in money creation. From the perspective of MMT, this paper investigates the evolution of the role of fiscal policy in China’s money creation, and analyzes the macroeconomic impact of the fiscal creation of money. In the past 70 years, China has experienced a planned economy regime, a fiscal dominance regime and a monetary dominance regime. And during this time the dominant mode of money creation has gradually shifted from fiscal creation to credit creation, to the extent that the old fiscal creation mode has been ignored or even disdained. However, the fiscal creation of money is still of great importance. Compared with credit creation, it helps to promote the development of real economy, reduce systemic financial risks and narrow the wealth gap. This article argues that China should increase the contribution of fiscal expansion to money creation and reduce the dependence of money growth on credit, so as to better achieve the three goals of stable growth, risk prevention and structural adjustment.

Keywords:

• Government finance
• money creation
• modern money theory

Notes

1 Zhong Xu, the director of the Research Bureau of the PBOC, argued in an article in 2018 that the fiscal policy is not active enough, and is responsible for preventing financial risks. Later, a staff of the Ministry of Finance responded with a signed “green ruler”, proclaiming that the fiscal policy has been sufficiently active and should not act arbitrarily, and that the PBOC should attach importance to the independence of the central bank. For more information, see https://baijiahao.baidu.com/s?id=1605871453603674563&wfr=spider&for=pc; http://www.sohu.com/a/241561969_742508.

2 “Report on the implementation of the national final accounts for 1980 and the national budget for 1981”. See http://www.npc.gov.cn/wxzl/gongbao/2000-12/26/content_5328403.htm.

3 “Report on the implementation of the national budget for 1984 and the national budget draft for 1985”. See http://www.npc.gov.cn/wxzl/gongbao/2000-12/26/content_5001623.htm.

4 This equation is a modified form of Li and Wu (2014, p.38), for they mistakenly included the fiscal deposit into M2. We separate it to investigate the role of fiscal policy. It is worth noting that we consider the finance-cash in bank only, and leave the deposits of non-profit institutions, the other category of fiscal deposit, in “the others”, for the concern that most of the movement of the deposits of non-profit institutions is unrelated with fiscal policy, even though it plays a considerable role in M2 fluctuations.

5 For simplicity, we do not consider the issuance of government bonds and central bank’s purchase of bonds, which would also affect the size of net money creation by government.

6 For simplicity, we do not consider other asset purchases of commercial banks, which would also create money.

7 Therefore, in theory, it cannot be asserted that the government’s fiscal creation of money would inevitably produce inflationary pressure whereas bank credit creation would not, or mistakenly claim that fiscal creation is nonproductive whereas bank creation is productive.

8 In this period, as most commodity prices were uniformly formulated and controlled by the state according to the plan, and money and credit were strictly regulated, China did not experience significant inflation. The average inflation rate in 1952-1978 was 1.7% per year (Maddison, 2007, p. 89).

9 Minsky refers to the two kinds of effects of government deficits as “cash flow effect” (or Kalecki effect) and “balance sheet effect” (or Tobin effect) respectively. These two effects are often overlooked by mainstream economics (Li, 2018, p. 266).

10 For example, a recent study by the Southwestern University of Finance and Economics found an increase of Gini coefficient from 0.61 in 2012 to 0.62 in 2016. For data availability, we do not demonstrate the other sources of Gini coefficient apart from that of National Bureau of Statistics.

11 China’s fiscal policy has been neutral or moderately expansive for most of the time since the 1990s. The government adheres to the principle of “calculating how much revenues received before deciding how much to spend”, that is sound finance. Over the past decades, China’s budget deficit-to-GDP ratio and public debt-to-GDP ratio have been kept at a relatively low levels, with below 3 percent and about 20 percent. Therefore, at present, there are still great room for China’s expansionary fiscal policy, and China should gradually shift to functional finance from sound finance.