Progressive Money

Topic 2 of 8

Government spending

How the Australian Government's spending, taxing and borrowing actually work, and the debate over how far a currency-issuing government can spend before inflation and other real limits bite.

5 lessons · about 2 h 15 min with activities · beginner first

Before the videos

Key ideas for this topic

You start with Stephanie Kelton's TED talk and a written lesson on what limits spending: demand, capacity, inflation and jobs. Brett Scott then separates MMT as description from MMT as prescription, a senior Treasury official sets out how Treasury itself describes fiscal policy, and Bill Mitchell gives the MMT case in his own words.

Builds on: Topic 1 showed that modern money is a set of IOUs and introduced the idea that taxes create demand for a currency; this topic applies that to the Australian Government's budget.

Ideas you'll need

1Who does what: Australia's actual arrangements

Several institutions share the work of Australian government finance, and keeping them apart helps with every video in this topic.

  • Cabinet and Parliament. The government makes spending and tax decisions through Cabinet and its Expenditure Review Committee, and Parliament passes the laws.
  • Treasury advises the government on the economy, the budget and tax. The Department of Finance manages the government's main bank accounts.
  • The Reserve Bank (RBA) is the government's banker. Government payments are made from the Official Public Account (OPA) Group, a set of accounts at the RBA. The OPA has only a strictly limited overdraft.
  • The Australian Office of Financial Management (AOFM) keeps enough cash in those accounts to meet each day's payments, and issues Treasury Bonds and Treasury Notes by competitive tender to registered bidders. The Treasurer sets a legal maximum on the securities that can be on issue, currently $1.2 trillion, and can raise it by direction; gross debt is forecast to pass it during 2029–30.
  • The RBA does not normally buy bonds directly from the government. Its 2020–22 bond purchases were made in the secondary market, from existing holders.

The plumbing: when the government pays a $1,000 pension, the recipient's bank gains $1,000 in its settlement account at the RBA and credits the pensioner's deposit. Tax payments reverse this. When investors buy new bonds, their banks' settlement balances fall and the government's account rises. The RBA no longer tries to offset these daily swings. Since the pandemic, banks have held plentiful settlement balances, and a bank that wants more can borrow them from the RBA at its weekly market operations, at an interest rate slightly above the cash rate target.

2The simplified model and the real one

MMT economists often explain government finance with a simplified model that merges Treasury and the central bank into one "consolidated government". In that model, spending simply credits bank accounts, taxes debit them, and selling a bond swaps one government liability (settlement balances) for another (a bond that pays more interest). Nothing has to be collected before spending can happen.

The model is useful for one point: a government that issues its own currency cannot run out of it. But it is a model, not a description of Australian procedure. In practice the government spends from accounts that must hold funds, those accounts are topped up by tax receipts and by AOFM bond sales, and the RBA is kept out of financing the budget directly.

Treasury and the RBA see that separation as a deliberate safeguard for inflation control. MMT economists see it as a set of self-imposed rules that hide the underlying logic. Both pictures track the same flows of money; they disagree about which constraints are fundamental. A step-by-step worked example with balance sheets, elsewhere in this topic, follows the money through each step.

3Sectoral balances in plain words

Divide the economy into three groups: the government, the domestic private sector (households and businesses), and the rest of the world. Every dollar one group spends is a dollar another group receives.

So over any year, if one group spends more than its income, the others together must spend less than theirs by exactly the same amount. If the government runs a $30 billion deficit, households, businesses and overseas sellers together end up $30 billion better off in financial assets. If Australia also pays the rest of the world $10 billion more than it earns from it, $10 billion of that goes overseas and the private sector keeps $20 billion.

This is accounting, true by definition. Australia's typical pattern, as the RBA describes it, has been households saving more than they invest, businesses borrowing, government usually borrowing, and a current account deficit financed by overseas investors.

What the identity cannot tell you is cause, or what should happen. A deficit may follow a spending decision, or a recession in which tax receipts fall and households cut back. The identity says the balances must add up; it does not say how big the deficit should be.

4Deficits, debt and interest

Three numbers dominate budget news, and they are easy to mix up.

  • The deficit is a flow: how much more the government spends than it receives in a year. The May 2026 Budget forecast an underlying cash deficit of $31.5 billion, 1.0 per cent of GDP, for 2026–27.
  • The debt is a stock: the total value of government bonds outstanding, built up mainly from past deficits. The Budget expects gross debt of $1,051 billion, 34.0 per cent of GDP, at 30 June 2027. The bonds are financial assets held by investors in Australia and overseas, and some by the RBA from its 2020–22 purchases.
  • Interest is what the government pays bondholders each year. Net of the interest it earns, the Budget forecasts $19.9 billion in 2026–27, about 0.6 per cent of GDP. The Parliamentary Budget Office projects interest costs rising over the following decade.

Why measure against GDP, the total value of what Australia produces in a year? Because a dollar figure on its own means little: $1 trillion is a lot for an economy of $1 trillion and much less for one several times bigger.

Treasury and the PBO watch whether debt is stable or falling as a share of GDP. MMT economists watch inflation and unused capacity instead. Keep both lenses in mind.

✎Worked example: one day in the Government's bank account

A simplified day in Canberra, in billions of dollars, showing what the Government's payments, tax receipts and a bond tender do to the accounts at the RBA. The tables show only what changes. The full seven-step version is on The Money System in Five Minutes.

  1. 1Pension day: the Government pays $3 billion

    Services Australia pays $3 billion of pensions from the Government's accounts at the RBA (the Official Public Account group). The RBA credits the settlement accounts of the pensioners' banks, and the banks credit the pensioners' deposits. Pensioners have $3 billion more in their accounts and owe nothing for it.

    Government (accounts at the RBA) · changes
    AssetsLiabilities
    Deposits at the RBA −$3 No change
    RBA · changes
    AssetsLiabilities
    No change Government's accounts −$3
    Banks' settlement balances +$3
    Banks · changes
    AssetsLiabilities
    Settlement balances at the RBA +$3 Pensioners' deposits +$3

  2. 2Companies pay $2 billion in tax

    Company tax payments run the other way: firms' deposits fall, their banks' settlement balances fall, and the Government's accounts at the RBA rise. Over the day the Government has spent $1 billion more than it collected: a deficit of $1 billion, and $1 billion more in private hands.

    Government (accounts at the RBA) · changes
    AssetsLiabilities
    Deposits at the RBA +$2 No change
    RBA · changes
    AssetsLiabilities
    No change Government's accounts +$2
    Banks' settlement balances −$2
    Banks · changes
    AssetsLiabilities
    Settlement balances at the RBA −$2 Companies' deposits −$2

  3. 3The AOFM sells $1 billion of Treasury bonds

    To keep the Government's accounts topped up, the AOFM holds a bond tender. A superannuation fund wins $1 billion of bonds and pays from its bank deposit. The fund swaps one asset (a deposit) for another (a bond). The Government's accounts are back where they started, and the day's $1 billion deficit is now matched by $1 billion of new government debt, held as a private sector asset.

    Government (accounts at the RBA) · changes
    AssetsLiabilities
    Deposits at the RBA +$1 Treasury bonds +$1
    RBA · changes
    AssetsLiabilities
    No change Government's accounts +$1
    Banks' settlement balances −$1
    Banks · changes
    AssetsLiabilities
    Settlement balances at the RBA −$1 Super fund's deposit −$1
    Super fund · changes
    AssetsLiabilities
    Bank deposit −$1 No change
    Treasury bonds +$1

What the example shows, and what it doesn't. Deficit spending added $1 billion of financial assets to the private sector, first as deposits and settlement balances and then, after the tender, as a bond. That is the sectoral balances identity at work. In reality the AOFM issues bonds on a schedule set well in advance, banks hold plentiful settlement balances and any bank that runs short can borrow more from the RBA at its weekly operations, and the Government's accounts must stay in credit. Whether a deficit of this size is wise depends on something the accounts can't show: whether the economy had the spare workers and resources to absorb the extra spending.

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Lesson 2.1 Beginner14 min video Core about 20 min with questions

Stephanie Kelton: The big myth of government deficits | TED

Stephanie Kelton · TED

Also step 4 of Start here. If you've done it there, it counts here too.

Before you watch

After watching this video, you should be able to explain why Kelton calls 'how will we pay for it?' the wrong question, and say which questions she would ask instead.

Why this matters. Australian budget debates are framed around how to 'pay for' things. Kelton's alternative, asking whether the people, materials and equipment exist, is the starting point for everything else in this topic.

Stephanie Kelton: The big myth of government deficits | TED
Play: Stephanie Kelton: The big myth of government deficits | TED (14 minutes, opens YouTube)

Fourteen minutes from TEDMonterey in 2021, and the best first look at government finance for someone who has never studied it. Kelton argues that a government that issues its own currency is not like a household, that its deficit shows up as a surplus for the rest of us, and that inflation, not money, is the real limit. Her examples are American, and the timing matters: US inflation surged soon after, which became the test of how much room there really was.

Three things to remember

  1. Established When a government spends more than it collects in tax, the difference adds to the financial assets of households, businesses and the rest of the world. Its red ink is, to the dollar, someone else's black ink.
  2. Established Australia's federal government issues the currency its spending and debts are in. Unlike a household it cannot run out of Australian dollars, but it can still face inflation, resource, legal and political limits.
  3. Argument Kelton argues inflation is the real limit, and that a deficit should be judged by what it achieves and who gets the surplus, not by its size. In 2021 she judged the US far from full employment.

Can you explain it?

Optional. Try as often as you like; nothing is scored or sent anywhere.

The federal government proposes adding dental care to Medicare. Using Kelton's framework, which question matters most?

Show the answer

Are there enough dentists, clinics and equipment to deliver it without bidding up prices?

Yes. Kelton's 'how will we resource it?' question: paying the bills is easy for a currency issuer; the challenge is having the dentists, and not pulling them away from other work so fast that prices rise.

In one year the Australian Government runs a $30 billion deficit, and Australia runs a $10 billion current account deficit with the rest of the world. What is the domestic private sector's surplus?

Show the working

Answer: $20 billion

The government's $30 billion deficit is a $30 billion surplus for everyone else. But Australia is paying the rest of the world $10 billion more than it earns from it, so $10 billion of that surplus goes overseas. Households and businesses keep $20 billion. The three balances sum to zero.

Sources for this lesson

Lesson 2.2 Beginner7 min read Core about 13 min with questions

What limits government spending? Demand, capacity, inflation and jobs

A written lesson from Progressive Money

Also step 6 of Start here. If you've done it there, it counts here too.

Before you read

After reading this, you should be able to explain why the same amount of government spending can create jobs in one year and mostly push up prices in another.

Why this matters. Almost every argument on this site comes back to one question: is there spare capacity? Kelton, the RBA and Treasury all agree it matters. They disagree about how much there usually is, and who should manage it.

Spending is demand. Every dollar spent in the economy is a dollar of someone's income. Households, businesses, governments and overseas buyers all spend, and economists call the total aggregate demand. When it rises, firms sell more. They can respond in two ways: produce more, which usually means hiring, or raise their prices.

Capacity decides which happens. What the economy can actually produce depends on real things: people with the right skills, machines, buildings, land, materials and energy. Economists call this productive capacity, or potential output. When there are unemployed workers and idle equipment, firms can meet extra demand by producing more, so extra spending mostly turns into output and jobs. When the economy is already near capacity, firms cannot easily produce more. They compete for scarce workers and materials, bid up wages and costs, and raise prices. Extra spending then mostly turns into inflation.

The RBA puts it plainly in its explainer on the causes of inflation: when aggregate demand exceeds the economy's potential output, prices come under upward pressure. Government spending is part of aggregate demand, so it is subject to the same rule as everyone else's spending.

A simple picture. Imagine a state government that wants to build three hospitals. If thousands of qualified construction workers are out of work, it can hire them, and the hospitals add to output and employment. If the building industry is already flat out, the government has to lure workers and cranes away from other projects by paying more. The hospitals still get built, but something else does not, and construction costs rise for everyone.

Not all inflation is too much spending. Capacity can also fall. A drought, a war that pushes up oil prices, or a pandemic that snarls shipping can all reduce what the economy can supply. Prices then rise even if spending has not grown. The RBA calls this cost-push inflation, and it is why economists argue about how much of any particular burst of inflation came from demand and how much from supply.

Capacity is not fixed. Training, infrastructure, research and migration can expand it over time, though rarely quickly. That is why the type of spending matters, not only its size.

Where economists agree, and where they don't. Mainstream and MMT economists agree that spending beyond the economy's capacity pushes up prices, and that inflation is the sign the limit is being hit. Mainstream economists also stress the government's budget constraint over time: interest has to be paid, and debt that grows faster than the economy eventually needs higher taxes, lower spending or inflation. MMT economists see that as a matter of policy choices rather than a separate financial limit. The RBA aims for full employment, which it describes as as many people in jobs as possible while keeping inflation low and stable, and it admits that capacity cannot be observed directly, only estimated. The disagreements are about:

  • How close the limit usually is. MMT economists argue Australia has usually run with more spare capacity, including underemployed and discouraged workers, than official estimates assume. Mainstream economists worry that by the time inflation shows the limit has been reached, it is already hard to reverse.
  • Who should manage demand. In Australia today the RBA does it, with interest rates. MMT economists would lean more on fiscal tools: targeted spending, taxes and a Job Guarantee.
  • What to do about inflation from supply shocks. Raising interest rates reduces demand, but it does not fix a broken supply chain.

None of this says how big a deficit should be. It says the right question is not "can we pay for it?" but "do we have the people and materials to do it, and what else will they stop doing?"

Three things to remember

  1. Established Extra spending, from anyone, raises output and jobs when there are idle workers and equipment, and mostly raises prices when the economy is already near its productive capacity.
  2. Official view The RBA describes full employment as as many people in jobs as possible while keeping inflation low and stable, and says the economy's capacity can only be estimated, not observed.
  3. Argument MMT economists argue Australia usually has more spare capacity than official estimates suggest; mainstream economists stress the risk of finding the limit only after inflation has taken hold.

Can you explain it?

Optional. Try as often as you like; nothing is scored or sent anywhere.

The federal government announces the same $10 billion building program in two different years. In which year is it most likely to push up prices rather than add jobs?

Show the answer

A year when construction firms report severe labour shortages and unemployment is near record lows

Right. With little spare capacity, the program has to pull workers and materials away from other projects, which bids up wages and costs.

A state plans hospitals that need 3,000 extra construction workers. Only 1,200 suitably skilled workers are unemployed. How many workers would have to be drawn away from other projects?

Show the working

Answer: 1,800 workers

3,000 needed minus 1,200 available leaves 1,800 who must come from somewhere else. That is where the real cost appears: those 1,800 stop working on other projects, or have to be trained, recruited from overseas, or lured with higher pay. The money is the easy part; the people are the constraint.

Sources for this lesson

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Next, Brett Scott separates MMT as a description of how money works from MMT as a set of policy proposals, which is the most useful distinction to carry through the rest of the course.

Next: Modern Monetary Theory - A Primer

Lesson 2.3 Beginner20 min video Go deeper about 28 min with questions

Modern Monetary Theory - A Primer

Brett Scott

Before you watch

After watching this video, you should be able to explain the difference between MMT as a description and MMT as a prescription, and give one example of each.

Why this matters. Debates about MMT often run two kinds of claim together. Separating 'this is how the system works' from 'this is what governments should do' lets you accept one and still question the other.

Modern Monetary Theory - A Primer
Play: Modern Monetary Theory - A Primer (20 minutes, opens YouTube)

Brett Scott, who comes from economic anthropology rather than economics, gives a free-form, twenty-minute introduction to MMT. His most useful move is to separate MMT as a description of how a currency-issuing state's money works from MMT as a set of policy prescriptions. He is sympathetic and mostly answers MMT's critics rather than weighing them, so treat this as a clear statement of the case, not a neutral review.

Three things to remember

  1. Official view The RBA says government payments add to banks' accounts at the Reserve Bank, while tax receipts and new bond issues drain them. That part of Scott's description matches the central bank's own account.
  2. Argument Scott argues MMT is mainly descriptive: every government, left or right, spends money into existence and pulls some back through taxes and bonds, so even conservative governments are 'doing MMT'.
  3. Argument Scott says taxes have two jobs in MMT: creating demand for the currency and holding down inflation. His account treats government and central bank as one, which Australia's institutions deliberately keep separate.

Can you explain it?

Optional. Try as often as you like; nothing is scored or sent anywhere.

Which of these is a prescription (what should happen) rather than a description (what does happen)?

Show the answer

The government should offer a job to anyone who wants one

Yes. This is the Job Guarantee, an MMT policy proposal. You could accept every MMT description of how money works and still reject this, or support it for other reasons.

Scott calls MMT's view of taxes 'Copernican'. What does he mean, and why might the change of perspective matter even if your tax bill stays exactly the same?

Show a model answer

Copernicus did not change what people saw in the sky, only the explanation: the Earth goes round the Sun, not the reverse. Scott says MMT does the same with taxes. From the taxpayer's seat it feels as if our money funds the government, but MMT says the government spends first and taxes later to create demand for its money and limit inflation. Your tax bill is unchanged, but the question you ask about a policy changes, from 'where will the money come from?' to 'is there the capacity to deliver it without inflation?'

A strong answer

  • Explains the analogy: same experience, different explanation
  • States MMT's reversal: spending first, taxes afterwards
  • Explains how this changes the policy question, not the bill

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Scott gives MMT's description. Next, a senior Treasury official explains how Treasury itself sees fiscal policy and builds the budget, in the language Australian governments actually use.

Next: Fiscal Policy

Lesson 2.4 Beginner30 min video Go deeper about 36 min with questions

Fiscal Policy

Damien White · Reserve Bank of Australia

Before you watch

After watching this video, you should be able to name the three jobs Treasury says fiscal policy does, and explain the difference between discretionary and non-discretionary changes to the budget.

Why this matters. Almost every Australian news story about the budget uses Treasury's framing. Knowing it precisely, including what Treasury says about deficits over the economic cycle, lets you compare it fairly with the MMT account.

Fiscal Policy
Play: Fiscal Policy (30 minutes, opens YouTube)

A thirty-minute talk by Damien White, Treasury's Deputy Secretary for the Fiscal Group, at the RBA's Teacher Immersion Event on 18 July 2025. He explains what fiscal policy is for, how the Expenditure Review Committee builds a budget, and what Treasury's charts show about deficits, debt and the size of government. It is the clearest statement on this site of how Treasury itself describes fiscal policy, the framing most Australians absorb, and worth hearing in its own terms.

Three things to remember

  1. Official view Treasury says fiscal policy has three jobs: allocating resources where markets fall short, redistributing to people who need support, and stabilising the economy. It sees fiscal policy as better suited to longer-term goals.
  2. Established Much of the budget moves without new decisions. When unemployment rises, more people receive payments and less tax comes in, cushioning the downturn. Australian deficits and surpluses have broadly followed the economic cycle.
  3. Official view In this July 2025 talk, Treasury put gross debt at about 35.5 per cent of GDP for 2025–26, around $1 trillion. White says debt matters because bond investors need confidence it will be repaid.

Can you explain it?

Optional. Try as often as you like; nothing is scored or sent anywhere.

Treasury's 2025–26 estimates in White's talk put Commonwealth revenue at about $750 billion, with personal income tax about 48 per cent of it. Roughly how much is that?

Show the working

Answer: $360 billion

48 per cent of $750 billion is 0.48 × 750 = $360 billion. That heavy reliance on personal income tax, with company tax next at about 19 per cent, is why White mentions the debate about the role of the GST.

Unemployment rises from 4.1 to 4.3 per cent and the government makes no new decisions. According to White, what happens to the budget?

Show the answer

It worsens a little as more people receive payments, which helps cushion the downturn

Yes. Unemployment benefits are paid under existing law to everyone eligible, so spending rises automatically. These automatic stabilisers lean against a downturn without anyone deciding anything.

Sources for this lesson

Lesson 2.5 Intermediate23 min video Go deeper about 31 min with questions

Bill Mitchell: Demystifying Modern Monetary Theory

Bill Mitchell · New Economic Thinking

Before you watch

After watching this video, you should be able to list Mitchell's three conditions for a government that 'can never go broke' (and the fourth they assume, a floating exchange rate), and explain why Eurozone governments do not meet them.

Why this matters. Mitchell is Australian and his work shapes much of this site. This interview links currency sovereignty to the Eurozone, to inflation and to the Job Guarantee, themes that return in later topics.

Bill Mitchell: Demystifying Modern Monetary Theory
Play: Bill Mitchell: Demystifying Modern Monetary Theory (23 minutes, opens YouTube)

A 23-minute interview from 2014 for the Institute for New Economic Thinking with Bill Mitchell of the University of Newcastle, often credited with coining the name Modern Monetary Theory. He sets out when a government cannot run out of its own money, why he thinks the Weimar and Zimbabwe hyperinflations were about collapsing supply, why he sees bond issuance as unnecessary, and how an Australian wool scheme inspired his Job Guarantee. The interviewer is openly a friend, so expect a clear statement rather than a challenge.

Three things to remember

  1. Established A government that issues its own floating currency, has its own central bank and borrows only in that currency cannot be forced to default on those debts. Eurozone governments use a currency they do not issue, so they can. Mitchell's three conditions in the interview leave the floating exchange rate unstated; Russia, while defending a currency band, defaulted on debt in its own currency in 1998.
  2. Argument Mitchell argues that issuing bonds is unnecessary for such a government and amounts to corporate welfare: a risk-free, interest-paying asset for investors, who then lobby for cuts to income support.
  3. Argument Mitchell argues the limit on spending is what is available to buy. All spending, private or public, risks inflation once idle workers and capacity are used up; a Job Guarantee would set how far a deficit rises in a downturn.

Can you explain it?

Optional. Try as often as you like; nothing is scored or sent anywhere.

Which government best fits Mitchell's description of one that can never run out of its own money?

Show the answer

Australia's federal government

Yes. It issues the Australian dollar, has its own central bank, and its bonds are in Australian dollars. That does not remove inflation or resource limits, which Mitchell stresses too.

Mitchell explains the Weimar and Zimbabwe hyperinflations through collapsing supply. Summarise his argument, and one point a mainstream economic historian would add.

Show a model answer

Mitchell argues hyperinflation happens when a government keeps spending after the economy's capacity to produce has collapsed. In Zimbabwe he points to the destruction of much farm production; in Germany to the war's aftermath, the occupation of the Ruhr and reparations owed in gold and foreign currency. So these cases tell us nothing about a country with idle workers and spare capacity. A mainstream historian would add that in these cases large deficits were financed by the central bank printing notes, and that hyperinflations of the 1920s ended abruptly when that financing stopped and public confidence returned.

A strong answer

  • Mitchell: spending outran collapsed productive capacity
  • At least one of his examples (land seizures, Ruhr, reparations)
  • Mainstream addition: central bank financing of deficits, and the role of confidence or fiscal reform in ending it

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Topic 3 turns from government to private banks, starting with the Bank of England's short explanation of how bank lending creates new deposits.

Next: where this topic is contested

The big debate in this topic

Does government debt matter for a country like Australia?

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Where this leads. Topic 3 turns to the other big creator of money, private banks, and to why private debt can matter as much as public debt.

Go further (optional, more advanced)

Sources for the key ideas