How The Economic Machine Works: Part 5
[Music] All of this impacts the central government because lower incomes and less employment means the government collects fewer taxes. At the same time, it needs to increase its spending because unemployment has risen. Many of the unemployed have inadequate savings and need financial support from the government.
Additionally, governments create stimulus plans and increase their spending to make up for the decrease in the economy. Government budget deficits explode into leveraging because they spend more than they earn in taxes. This is what's happening when you hear about the budget deficit on the news. To fund their deficits, governments need to either raise taxes or borrow money.
But with incomes falling and so many unemployed, who is the money going to come from? The rich. Since governments need more money and since wealth is heavily concentrated in the hands of a small percentage of the people, governments naturally raise taxes on the wealthy, which facilitates a redistribution of wealth in the economy from the halves to the have-nots. The have-nots, who are suffering, begin to resent the wealthy halves.
The wealthy halves, being squeezed by the weak economy, falling asset prices, and higher taxes, begin to resent the have-nots. If the depression continues, social disorder can break out. Not only do tensions rise within countries, they can rise between countries, especially debtor and creditor countries. This situation can lead to political change that can sometimes be extreme. In the 1930s, this led to Hitler coming to power, war in Europe, and depression in the United States.
Pressure to do something to end the Depression increases. Remember, most of what people thought was money was actually credit. So when credit disappears, people don't have enough money. People are desperate for money, and you remember who can print money? The central bank can.
Having already lowered its interest rates to nearly zero, it's forced to print money. Unlike cutting spending, debt reduction, and wealth redistribution, printing money is inflationary and stimulative. Inevitably, the central bank prints new money out of thin air and uses it to buy financial assets and government bonds. It happened in the United States during the Great Depression and again in 2008 when the United States central bank, the Federal Reserve, printed over $2 trillion.
Other central banks around the world printed a lot of money too. By buying financial assets with this money, it helps drive up asset prices, which makes people more creditworthy. However, this only helps those who own financial assets. You see, the central bank can print money but it can only buy financial assets.
The central government, on the other hand, can buy goods and services and put money in the hands of the people, but it can't print money. So in order to stimulate the economy, the two must cooperate. By buying government bonds, the central bank essentially lends money to the government, allowing it to run a deficit and increase spending on goods and services through its stimulus programs and unemployment benefits.
This increases people's income as well as the government's debt. However, it will lower the economy's total debt burden. This is a very risky time; policymakers need to balance the four ways that debt burdens come down. The deflationary ways need to balance with the inflationary ways in order to maintain stability. If balanced correctly, there can be a beautiful deleveraging.