In these pages last week (25 November), Green Party leader Zack Polanski told George Eaton that “The fiscal rule we need to have is to make sure that inflation doesn’t go higher than the skills and resources that we have in our economy.” It sounded a lot like Modern Monetary Theory (MMT), which holds that for a currency-issuing government like the UK, inflation rather than debt is the real constraint.
Many mainstream economists and commentators have dismissed MMT as “voodoo economics”. Clips of Rory Stewart and Alastair Campbell challenging Polanski went viral. When Polanski argued the UK doesn’t need to service all of its debt – citing the Bank of England’s holdings where interest payments return to the Treasury – Campbell responded: “One of the reasons why [Labour] do have to be conscious of the market reaction to something like a Budget is because if they get it wrong, the markets lose confidence and the costs of borrowing then go further.”
Although Campbell is right to point out that markets do play a significant role in government spending, Polanski is on to something deeper that could help reframe the debate around the UK economy. While Rachel Reeves might be celebrated for scrapping the two-child benefit cap, the latest budget doesn’t go nearly far enough in delivering the change that Britain desperately needs. Austerity has scarred the UK for the last 14 years. If it wants to finally break free, then it’s time for a radical new approach. And that starts with rethinking how government finances work.
For most of history, austerity was a rational policy choice. Under the gold standard, accruing debt meant depleting finite gold reserves, putting the government at risk of insolvency. When debt levels would rise too high, austerity made sense: cutting government spending and raising taxes brought the debt back down. Everything changed, however, when the US abandoned gold in 1971. Money was no longer backed by a physical commodity but by government credibility alone. This shift to fiat money fundamentally changed the way government finances work, transforming countries like the UK from currency users into currency issuers, a much more powerful position.
You and I, along with businesses and local authorities, are currency users. We must earn or borrow pounds before we can spend. However, currency issuers play by a different set of rules. Most notably, they can’t run out of the money they create. Alan Greenspan, the former Chair of The Federal Reserve said it himself: “The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.” While the UK might not enjoy the reserve currency status that gives the US exceptional fiscal flexibility, the same principle still applies – Britain cannot be forced to default on debt denominated in pounds.
Whereas governments historically needed to raise revenue through taxation or borrowing, currency issuers must spend first to put money into circulation. To paraphrase MMT economist Stephanie Kelton, taxpayers don’t fund the government; the government funds the taxpayers. Taxes serve other purposes, such as controlling inflation (taking money out of the economy) and creating demand for the currency (requiring taxes to be paid in pounds). Rather than debt, the constraint for currency issuers is the economy’s productive capacity – the ability to convert money into real goods and services. Spend beyond what the economy can produce and you get inflation. Spend too little while resources sit idle (unemployed workers, empty factories) and you condemn the economy to stagnation.
This understanding significantly expands what’s politically possible. With full control over the money supply, currency issuers can more strategically deploy fiscal policy to mobilise idle resources, fund transformative public investments and actually expand productive capacity in ways that were limited under the gold standard. The question isn’t whether the UK can afford a brighter future, but whether it has the resources to build it. When the US abandoned gold, the nature of money changed but our mental models didn’t. The issue is that we’re still treating government finances like a household budget and subjecting everyone to artificial constraints that are no longer needed.
This outdated thinking has had devastating consequences for the UK. GDP is £10,000 less per person than if pre-2008 growth had continued. Infrastructure investment lags £700 bn behind what experts say is needed. And Britain is the only advanced economy where economic inactivity has increased since the pandemic. The fact the UK’s debt-to-GDP ratio is approaching 100 per cent is not because the government overspent, but because austerity stifled the very growth needed to address it.
What makes this failure even more damning is that the UK has complete monetary sovereignty: not only the ability to issue its own currency, but maintain a floating exchange rate, avoid borrowing in foreign currencies and have no external fiscal restrictions (foreign investors do own roughly 25 per cent of UK debt but that debt is denominated in pounds). This gives the UK a strategic advantage over its Eurozone neighbours. France may pay lower interest rates as part of a larger market, but it relegated itself to a mere currency user by adopting the Euro.
But the mental gymnastics persist. Although Reeves claims “there can be no return to austerity”, her fiscal rules of balancing the Budget and paying off the debt prevent her from leaving it behind for good. Despite welcome infrastructure investment, Reeves decided to freeze income tax thresholds for longer than expected, stealthily raising taxes for millions in the future. At the same time, the Resolution Foundation warns that public services outside of the NHS, education and defence will still face cuts toward the end of the decade close to those made during “peak austerity years”.
These policy decisions, which affect the lives of real people, are driven not by actual economic events but by the OBR’s imperfect forecasts. Ahead of the Budget, a projected 0.3 per cent downgrade in the OBR’s productivity forecast created a £20 bn shortfall that forced Reeves to consider raising the headline income tax rate for the first time since 1975. Even though last-minute projections ended up being more favourable than anticipated, this still demonstrates an obsession with satisfying arbitrary rules above all else.
Naturally, this brings us back to Campbell’s challenge to Polanski: even with monetary sovereignty, the UK is still exposed to the bond markets. While the UK must service its debt interest, the key to maintaining market confidence is not whether it achieves a balanced budget but whether that budget leads to real economic growth. As Cambridge economist Dimitri Zenghelis notes, “What unsettles the bond market is not the level of UK public debt… It is doubt about the UK’s ability to grow without requiring persistently high interest rates.” This is the doom loop in action. Decades of underinvestment have left the UK struggling to grow without triggering inflation – not because demand is too high, but because productive capacity is too low. The solution isn’t paying down the debt, but bold investment in productive capacity that breaks the cycle.
Reeves’s £120bn for infrastructure is a step in the right direction but her debt reduction targets constrain it far below what is needed. As a monetary sovereign free from solvency risk, the UK should set fiscal targets based not on abstract debt ratios but on real economic outcomes: increasing investment as a share of GDP, closing the infrastructure gap, reducing economic inactivity or lifting millions out of poverty. This means building transport links in underinvested regions, expanding childcare so parents can work, retraining workers in high-demand skills, modernising the energy grid and constructing affordable homes. This isn’t reckless borrowing; it’s investing in what matters.
What the UK needs now is brave leadership to chart a new course. Years of austerity have conditioned the UK to accept artificial constraints as if they were immutable economic laws. But like a horse with a rope around its neck that’s no longer tied to its post – the UK is constrained only by the belief that it cannot move. The resources are there. The needs are urgent. All it needs to do is go.
[Further reading: What would Zack Polanski do?]
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