“Where is the money going to come from?” This is often the supposed killer argument used in political debate to halt a policy or infrastructure project. The argument seems responsible. Political parties vie for the credibility of being “fiscally responsible”. Any suggestion of increasing the budget deficit is depicted as a sign of being feckless. It is as if money dominates society rather than money being used for what society wants.

Paul Sheard has stark words for those who speak of fiscal responsibility in an almost Pavlovian manner. In the second chapter of his book describing the role of money in society, he discusses government debt. Under the sub-heading of “The “Government as a Household” Fallacy” he writes:

“We shouldn’t be worrying about the government racking up too much debt because it might overwhelm the ability of the government to repay it or because future generations will inherit too large a debt burden. Rather, we should be worried about, or debating, other things. What is the right size and role of government? Is it too big or not big enough? How actively should it seek to manage the macroeconomy and how? How proactive a role should the government play in steering economic activity and seeking to redistribute income? Is it creating too much money relative to the capacity of the economy now and in the future to absorb the associated purchasing power without causing excess inflation? Is the right institutional framework in place to ensure that inflation is neither too high nor too low? Is the productive potential of the economy on track to grow fast enough to sustain the viability of the promises society makes to itself?” (Kindle page 41).

Soon after he provides further clarity writing: “The relevant question from a macroeconomic policy perspective is not “Has the government borrowed too much?” but rather “Has the government created too much purchasing power?” The first is a non sequitur, because the government does not really borrow money  – it just looks as if it does. The answer to the second question hinges on how much of that purchasing power is being released into the economy at any point in time relative to the capacity of the economy to absorb it without causing inflation to take off.” (Kindle pages 41 and 42).

The key element in this second quote is “the government does not really borrow money - it just looks like it does.” That this needs to be said explains why this book is relevant now and will remain so. Many people commenting on economic matters, including those from financial institutions, appear not to understand what money is and how it is created. Comments such as “the public finances will be placed under strain” or “the public purse cannot afford this” are facile. One commentator on UK macroeconomics calls this “media macro”. Government programmes should be assessed against the criteria outlined in the two quotes above. The money can - and should - be made available if it is deemed desirable to society.

The approach taken in this book is methodical and easily understood. The reader is taken through illustrative commercial and central bank balance sheets in a step by step manner that explains how money is created and flows through the financial system.

According to this approach, money can be created in one of three ways. A bank creates it when it makes a loan, the government creates it when it spends and does not withdraw that spending by taxation (i.e. the government runs a budget deficit), or the central bank buys a government debt security (or another asset) from the public. Because money can be created or destroyed either by government activity (i.e. fiscal policy) or by the central bank (i.e. monetary policy), the two are closely linked. The two are so closely linked that, in a primitive and idealised society playfully named a “monetary garden of Eden”, a central bank need not exist. Central banks are part of the institutional arrangement designed to guard against excessive money creation. Of course, the activities of central banks are more complicated than this but, for the topic of this book, this is their key reason for being.

The institutional structures that separate monetary and fiscal policy create difficulties in the language used to describe government activities. Common parlance talks of governments needing to fund budget deficits by issuing bonds. Going back to the three ways money is created suggests that is wrong. Bonds exist only as part of the institutional framework of the monetary system. The government could simply run a budget deficit and create money.

The narrative of the book is heavily influenced by modern monetary theory (MMT). The traditional reserves and money multiplier approach is considered limited because it concentrates on the third way of money creation. The role of banks as active creators of money is subsumed. That said, Sheard has mentioned elsewhere that he is not a complete convert to MMT. It is also fair to say that mainstream economists can accept some aspects of MMT without endorsing the approach Gregory Mankiw gives a flavour of some of those opinions in his “A Skeptic’s Guide to Modern Monetary Theory” in the May 2020 edition of the American Economic Review.

That Sheard should favour this approach is likely influenced by his experience. He spent many years in Japan working both as an academic and in finance. He speaks and has authored books in Japanese. In later years he spent time in the US, both at Lehman Brothers before and during its collapse, and later at S&P Global. Given this experience in Japan and during a crisis that saw monetary and budgetary systems placed under great strain, it should not be surprising that he appears less worried about high public debt levels than some other writers. I should, at this juncture, disclose a conflict of interest. Paul and I both worked at Baring Asset Management together many years ago. We have kept in casual contact.

There are several parts of the book that could be improved. At the risk of setting up straw arguments, the chapter on inequality is curious. For example, high executive pay is explained as a reward for rare talent. The literature on this and other aspects of inequality is more nuanced. The chapter on monetary policy in the Eurozone has been covered often (countries having a single currency but separate fiscal policies). However, it is harsh to dismiss the way the Eurozone is organised as a folly. If it is such a folly, one needs to explain why so many countries seem intent on joining. The idea of alternative international payment systems to the US dollar dominated system that currently exists could be covered more extensively.

One topic that could have been drawn out more fully is the relationship between monetary and fiscal policy. The book argues that there should be more coordination between the two. That may require rethinking the mandates of central banks. Paul Tucker’s 2018 “Unelected Power” goes into this in detail.

A further area of concern is that the book could say more about how changes in asset prices affect economic conditions and society. Changes in asset prices can destabilise financial systems. Chapter six covers financial crises from a monetary and lender of last resort perspective. This is fine but the issue of whether stability in asset prices should also be considered along with price and budgetary stability is worth considering further. Andrew Smithers’ writings on this are well worth thinking about.

This is a useful and topical book. When, for example, a politician may claim that a policy – for example, extending welfare payments to cover beyond the second child in a family – cannot be afforded, think back to the quotes at the beginning of this review. Take account of the constraints in those quotes Then consider whether such a policy can be afforded if that is the choice society wishes to make.