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Money is created by government spending (or by bank loans, which create deposits). Taxes serve to make us want that money—we need it in order to pay the taxes. And they help regulate total spending, so that we don’t have more total spending than we have goods available at current prices—something that would force up prices and cause inflation. But taxes aren’t needed in advance of spending—and could hardly be, since before the government spends there is no money to tax.
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Public deficits increase financial private savings—as a matter of accounting, dollar for dollar. Imports are a benefit, exports a cost. We do not borrow from China to finance our consumption: the borrowing that finances an import from China is done by a U.S. consumer at a U.S. bank.
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The term “innocent fraud” was introduced by Professor John Kenneth Galbraith in his last book, The Economics of Innocent Fraud,
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The presumption of innocence, yet another example of Galbraith’s elegant and biting wit, implies those perpetuating the fraud are not only wrong, but also not clever enough to understand what they are actually doing. And
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Galbraith was largely a Keynesian who believed that only fiscal policy can restore “spending power.” Fiscal policy is what economists call tax cuts and spending increases, and spending in general is what they call aggregate demand. Galbraith’s academic antagonist, Milton Friedman, led another school of thought known as the “monetarists.” The monetarists believe the federal government should always keep the budget in balance and use what they called “monetary policy” to regulate the economy. Initially that meant keeping the “money supply” growing slowly and steadily to control inflation, and letting the economy do what it may. However they never could come up with a measure of money supply that did the trick nor could the Federal Reserve ever find a way to actually control the measures of money they experimented with.
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Paul Volcker was the last Fed Chairman to attempt to directly control the money supply. After a prolonged period of actions that merely demonstrated what most central bankers had known for a very long time— that there was no such thing as controlling the money supply—Volcker abandoned the effort. Monetary policy was quickly redefined as a policy of using interest rates as the instrument of monetary policy rather than any measures of the quantity of money. And “inflation expectations” moved to the top of the list as the cause of inflation, as the money supply no longer played an active role. Interestingly, “money” doesn’t appear anywhere in the latest monetarist mathematical models that advocate the use of interest rates to regulate the economy.
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Keynesian views lost out to the monetarists when the “Great Inflation” of the 1970s sent shock waves through the American psyche. Public policy turned to the Federal Reserve and its manipulation of interest rates as the most effective way to deal with what was coined “stagflation”—the combination of a stagnant economy and high inflation.