Wednesday, May 8, 2013

Jonathan Larson — Debt-free money—of course we can rebuild our infrastructure

Thomas Edison on Henry Ford's proposal to fund public infrastructure with issuance of bills rather than bonds in order to avoid the economic rent that interest payments involve.

Real Economics
Debt-free money—of course we can rebuild our infrastructure
Jonathan Larson
(h/t Paul via email)

From the MMT perspective the story is incomplete in that the interest paid is also an increase in consolidated non-government net financial assets in aggregate and the interest doesn't cost a self-funding government anything anyway. The real issue is whether this is the most appropriate way to inject funds for public purpose, based on criteria such as fairness, effectiveness and efficiency.

Since interest is not necessary operationally, as Edison and Ford point out, it is a subsidy. Who gets that subsidy and why should they get it rather than using that amount of funding for other purposes, like more infrastructure that benefits the everyone as a public good?

It might be argued that not issuing bonds is inflationary. But as Thomas Edison points out, anticipating the MMT economists on this, the interest-bearing government securities are also negotiable and are used for temporary safe storage as well as using large sums around conveniently. The MMT economists also point out that they are the best form of collateral and therefore function as near money, especially short terms bills. Therefore, issuance of government securities has little bearing on inflation.

The other argument is that a large economy needs safe assets and it is a public purpose to provide them. But, as Chris Cook points out, this could be done with consols rather than bonds, consols acting in the same fashion as stock, i.e., equity rather than debt.


Dan Kervick said...

If the central bank is paying interest on reserve balances, then money that is spent into the economy earns government interest anyway.

If people want to get over all of their various USG debt servicing fears, then why not pass a law requiring the Fed to work with the Treasury to maintain a specified interest rate ceiling on government debt. Then get rid of the debt ceiling.

F. Beard said...

The other argument is that a large economy needs safe assets and it is a public purpose to provide them. Tom Hickey

That's "welfare for the rich" and is hypocritical besides in that it fosters the illusion that the rich are benefiting the government instead of vice-versa.

Welfare should, of course, be limited to only those who need it and that would include people whose purely private investments have proven to be inadequate for a decent retirement.

And btw, since the rich would no longer be guaranteed a safe retirement at the expense of the rest of us then they would no longer be so keen to cut Social Security and Medicare, now would they?

And shouldn't a diversified stock portfolio be all the safety an investor needs? And would be without the instability caused by the government-backed credit cartel?

Matt Franko said...

"purely private investments "

F., I dont think these in fact exist under a system of state currency...

Where does the "money" ultimately come from?


F. Beard said...

"Purely private investments" could exist even with a state money monopoly IF the government simply spent its fiat into existence and taxed some of it out of existence again without borrowing, lending or showing any other partiality, especially to the rich.

Tom Hickey said...

How about going to direct issues of Treasury notes instead of Federal Reserve notes, ending bonds, and issuing consols paying a dividend instead of interest. Consols could be made available as demanded in exchange for Treasury notes instead of as a deficit offset. Treasury could set the dividend in the same way that the cb pays IOR, maybe targeting a real interest rate of 1%.

F. Beard said...

Consols could be made available as demanded in exchange for Treasury notes ... Tom Hickey

That's still welfare for the rich.

paul said...

Financing investment with credit and financing consumption with credit are two completely different animals. It's dangerous to fund conumption with private debt, especially when ones employment and income future isn't secure.

Financing of investment can't come from government spending because the funds have to pass thru household first before businesses can earn it through sales.

Financing of investment has to come first or we don't have products to buy…investors earn their capital…and pay off their debt…from sales.

Investment has to come first but there has to be confidence that there will be demand for the products and services produced.

You can't assume that the capital for investment is already in the system. How would it get there?

That's where government spending comes in…it's a coordinated effort that creates the "virtuous cycle" so many seem enamored with…except the "cycle" is powered by government spending not credit and not by the economy itself, which would be a nearly-dead machine without government spending.

Consumer credit is a boost to demand not a primary source…but the "boost" comes with a "vacuum" attached.

Eventually that "vacuum" become too much to overcome and debt can't be expanded any further without some kind of income support.

The "banking cartel" should be stopped from gambling I agree, but credit (for investment) is part of the foundation of a capitalist system.

Private banking isn't up to the task of providing this function.

Dan Kervick said...

Consols are just a workaround for a debt ceiling situation, since they don't count against the debt subject to limit. If we are asking Congress to change the way the government does its financial business, including by allowing Treasury to issue and spend its own currency notes, then we might as well ask them to ditch the debt ceiling.

Absent the debt ceiling, there is no reason at all to provide rich people with an eternal annuity.

F. Beard said...

but credit (for investment) is part of the foundation of a capitalist system. paul

1) A one-time massive and equal bailout of the entire population, besides being just, would provide plenty of new reserves for 100% reserve lending or whatever small leverage purely private banks could get away with.

2) Continual deficits by the monetary sovereign would provide the required interest.

3) Banks could use their own common stock as money even if 100% reserves were required by law since common stock is non-redeemable. But since borrowing common stock is risky (short-squeeze risk) few would be willing to do so. Instead, the "banks" would spend their common stock into existence and become holding companies.

y said...

I think the full-reserve-banking argument is that the government can maintain a positive base interest rate without having to pay the interest itself. i.e. the interest payment gets shifted onto banks and the rest of the private sector.

y said...

whereas under fractional-reserve banking system the government has to pay interest on its liabilities (money) if it runs a deficit, or else the base interest rate ends up going to zero.

Jonathan Larson said...

Thanks for the link guys. I happen to find the subject of monetary theory utterly fascinating, but I don't discuss it too often start out in a perfectly reasonable discussion about the flaws of the Federal Reserve and suddenly you have been sucked into a ridiculous conversation about the wonders of the gold standard. Perhaps that has happened to some of you.

My real interest in money these days is driven by the fact that we need $trillions in absolutely necessary investment and the moneychangers tell us we are too broke to build anything. We must change that story!

Dan Kervick said...

Good post Jonathan.

I think the fundamental reason the country can afford massive investment in infrastructure is that we have the material resources we need to build the infrastructure and we have the labor power we need, and that the value that would be generated for the nation by building the infrastructure would be greater than the value of the resources consumed in the building process. That's always the reason why anyone can afford anything: value-out is greater than value-in.

The value of infrastructure is the kind of value that has to be created by the public working in an organized fashion as a community, and can't be reliably left up to private entrepreneurs each seeking their own narrow interests. Nor would we want the kinds of results that private profit-seekers are likely to deliver.

To carry out these infrastructure improvements, the public has to shift control of the needed resources from private hands to public hands. This is somewhat easier for a country that runs its own currency system, but it can always be accomplished one way or another for a resource rich country, and no monetary innovations or special monetary cleverness are needed for the task. Even if the United States were dependent on an external monetary system that it did not control (for example, if we Americans used the Euro), we would still not be "out of money". We would just have to harness the resources we need the old-fashioned way via the tax system, rather than by relying also on the government's ability to add nominal financial assets to the system by issuing dollars. Compared to other developed nations, US taxes are rather low - especially in the upper income brackets.

Unfortunately, a lot of the economic blogosphere is joined at the hip to the financial blogosphere - the world of online money managers and wealth managers and traders whose perspective on the economy tends to be restricted to the buying and selling of money and financial assets. As a result, discussions of important economic and public choice questions frequently veer off from economic fundamentals into various kinds of money-mania and monetary crankery.

The reason we can "afford" to build infrastructure has nothing to do with the monetary system at bottom. It's because we haven't run out of material resources and human resources, and we haven't run out out the capacity to invest our nation's resources intelligently in developing our country and building a better future. People don't have to grasp or accept the insights of MMT to grasp these other basic facts, and our capacity in this area doesn't depend in any fundamental way on carrying out monetary system overhauls.

However, once we run out of intelligence, or run out of the willingness to cooperate, then it doesn't matter how resource-rich we are, how people-rich we are, or what kind of monetary system we have. Social isolation, ignorance, foolishness, lack of community spirit, and the prevalence of radically individualistic laissez faire outlooks are a form of national poverty.

paul said...


Your solution seems much too complicated to me…but I'm willing to listen if you can provide more detail.

I agree we need a private debt write-off for various reasons. That is functionally equivalent to a fiscal intervention. The debt (private) isn't going away anytime soon otherwise and people are suffering needlessly.

The system we have works if banks operate as prudent underwriters as they are required and as they agreed to as agents of the Federal government in creating credit.

The problem isn't the system…it's the lack of regulation…there's no reason to believe that your ideal system wouldn't be subject to the same co-opting or worse.

A government hamstrung by politics not delivering the liquidity we need is not going to be supportive of your ideas. Multiple currencies are not the answer to national economies either. Fiscal transfers are a Federal function and that requires a national currency.

I'm open to your argument but it's too vague to be useful to me…you are dropping bread crumbs and expecting us to fill in the blanks. The devil is in the details.

F. Beard said...

That is functionally equivalent to a fiscal intervention. paul

No, because non-debtors would receive nothing (directly) and the banks have cheated them too (of honest interest rates).

Also, a universal bailout would fix everyone from the ground up, including state and local governments and the banks. And once the banks were fixed, they could be reduced to insignificance by abolishing government deposit insurance (and the lender of last resort) and by having the monetary sovereign itself provide a risk-free storage and transaction service for its fiat available to all citizens and for free up to normal household limits.

As for "complicated", it is only as complicated as it need be to be ethical and would probably be far more simple in practice than our current unethical, philosophically inconsistent system.

F. Beard said...

“When these bills have answered the purpose of building and completing Muscle Shoals, they will be retired by the earnings of the power dam. That is, the people of the United States will have all that they put into Muscle Shoals and all that they can take out for centuries—the endless wealth-making water power of that great Tennessee River—with no tax and no increase of the national debt.” Thomas Edison [bold added]

Yep, that's how common stock as private money would work too. People with capital, including their own labor, would consolidate it for economies of scale in exchange for shares (common stock) which would be redeemable for the goods and services their joint endeavor produced.

Dan Kervick said...

Sounds like a path to a world entirely controlled by private capital, where public choice plays no role.

F. Beard said...

No, because:

1) Fiat would and should remain the only means to pay taxes.

2) The abolition of government support for the banks would include a massive and equal bailout of the entire population with new fiat at least until all deposits are 100% covered by reserves.

3) The use of common stock as private money "shares" wealth and power whereas the current government-backed credit cartel unjustly concentrates it.

Dan Kervick said...

As usual F. Beard, I can barely understand what you are arguing for. But it seems like a schizophrenic and ungainly forced fusion of a radical libertarian world of private capital fiefdoms running private monetary systems with an inert state-run tax-driven money system sitting alongside it. It's like you swallowed some Ron Paul books and some MMT papers and coughed up a Frankenstein's monster system that few people would actually want to live in but you.

Dan Kervick said...

Also, we already have common stock in our world. Would you say that the wealth of our society is thereby fairly "shared"?

F. Beard said...

Would you say that the wealth of our society is thereby fairly "shared"? Dan Kervick

Of course not. The corporations, if not banks themselves, are some of the banks most so-called "creditworthy" customers. So why "share" profits and power with your workers when your so-called "creditworthiness" allows you to steal their purchasing power instead? And if you don't, your competition will.

As for fiat, natural monopolies like the roads, hydro-electric power, perhaps nuclear power (so safety won't be underfunded), harbors, national parks, utilities, etc. should be government monopolies to make tax avoidance impossible or difficult.

I'm not arguing for a Frankenstein monster but for a clean division between the public and private sectors. Caesar should indeed be rendered to (cf. Romans 13:1-7) but only what is properly his.

Matt Franko said...


Check out the current read out on the "credit cartel":

They only have 7.3T out and it is mostly for property and autos... "big deal"...

Here is where they were now 5 years ago:

Already then at 6.9T...

So only 400B in 5 years... or 6.6B per month.... Exxon Mobil alone makes 10B per quarter... S&P 500 annual earnings this year alone are on target for $1T....

The banks are a broke dick industry that has run themselves into the ground...

I believe you over estimate their relevance in general...

What really is running things is Dan's "Public Enterprise".... the banks play a minor role financing mostly property and autos for citizens to live in and drive to work in...


Matt Franko said...


Caesar represented the true GOVERNMENT sector... he didnt borrow anything.


Dan Kervick said...

You can't have a clean division between public and private sectors, F. Beard. It's all one society. Some of the enterprises that keep the society running are organized by private firms and individuals and some are organized by state, local or national governments. But all of these enterprises and the transactions within and among them interpenetrate and are part of an economically organic whole. It makes little sense for the society to divide up it's media of exchange into two separate sub-systems. People will constantly need to convert their monetary holdings back and forth from one system into another anyway. So two systems just creates pointless transaction costs.

Also, I can never understand why you are so hostile to the idea of differences in credit-worthiness. Is it really wrong to think that a person who manages his life thriftily, prudently and responsibly is worthy of more credit than a person who pisses away everything that comes into his hands at the bar or gambling table? It is both rational and morally defensible to refrain from offering credit to people who have a track record of failing to meet the obligations they have made.

It is indeed unfair that some people are in need of more credit than others. That's an artifact of inequality. If inequality is a moral issue for you then think about ways to lessen or eliminate it. I doubt we're going to get a more equal society from a world of private corporations running their own monetary system.

Your arguments are never very persuasive. You never bother to try to assemble arguments to show why we would all be better off under your preferred system. You just seem to rely on repetitive, kneejerk moralism and empty epithets based on biblical literalism.

F. Beard said...

Is it really wrong to think that a person who manages his life thriftily, prudently and responsibly is worthy of more credit than a person who pisses away everything that comes into his hands at the bar or gambling table? Dan Kervick

Yes it is since credit creation steals by dilution from the less or non-creditworthy including from the prudent and thrifty.

But hey, if a business wants to extend credit then let it but NOT with support from the government. And when its first check bounces then it gets ruthlessly liquidated.

Roger Erickson said...

In changing contexts requiring constant evolution, F. Beard, the prudent and thrifty ALWAYS lose out to the prodigal investors.

Yesterday's fiat is soon obsolete, if not dynamically invested in things that pay off (most don't).

Your mind too becomes worthless if not used for 10 years. No one calls you prudent and thrifty for that.

F. Beard said...

Oh, I believe in investment and even usury* is preferable to hoarding. But theft by dilution is still theft even if the victims were all irresponsible drunks.

Our money system forces us to be either thieves or the victims of thieves. I'd rather be neither.

*Usury from foreigners is permitted in Deuteronomy 23:19-20.

Ralph Musgrave said...


Don’t agree with your claim that “safe assets” equals “welfare for the rich”.

“Safe assets” are the same as what MMTers call “private sector net financial assets” (PSNFA) aren’t they? Of course the majority of PSNFA are in the hands of the rich, but if you don’t supply enough PSNFA, then you get paradox of thrift unemployment. And it’s silly to deal with inequalities by raising unemployment.

There are other and more appropriate ways of dealing with inequality: raising taxes on the rich, attacking the Wall Street / Capitol hill nexus or merry go round, etc.

y said...

It doesn't matter how many times and in how many ways people explain to F. Beard the flaws in his "common stock as money" argument, he'll still come back the next day and just repeat the same things all over again.

Matt Franko said...

Here from the article:

"Now suppose instead that the Fed divided its $85 billion monthly money production into 300 million checks of $283 each and sent these to every man, woman and child in America. "

Without the interest income from the portfolio of usg bonds, the Fed cannot operate, that is why this is not an option.

If the Fed sent out this "money", there would still be reserve balances in the system which the Fed has to pay ior on, where will the Fed get the balances to pay the ior and other Fed/banking system expenses? How will the Treasury's fiscal agents get paid?

The Fed does not operate via appropriation.

The Fed "factors" govt securities.

"The three parties directly involved are: the one who sells the receivable, the debtor (the account debtor, or customer of the seller), and the factor. The receivable is essentially a financial asset associated with the debtor's liability to pay money owed to the seller (usually for work performed or goods sold)."

"There are three principal parts to "advance" factoring transaction; (a) the advance, a percentage of the invoice face value that is paid to the seller at the time of sale, (b) the reserve, the remainder of the purchase price held until the payment by the account debtor is made and (c) the discount fee, the cost associated with the transaction which is deducted from the reserve, along with other expenses, upon collection, before the reserve is disbursed to the factor's client."

Without the portfolio income the Fed cannot operate.

The Fed can only "credit a bank account" for the purchase of a factor.

The Fed cannot just "credit a bank account".

Here is a read out on the securities the Fed is currently factoring:

This approach that the article proposes via the Carney article is simply not possible under the current arrangements.


Matt Franko said...

Here is Bill Still on the Ford/Edison hook up:


Dan Kervick said...

A few remarks about the Fed:

The Fed's $85 billion in monthly money creation via QE is offset over the long run by the money it is draining from the economy in the form of the assets it purchases. If the Fed purchases $85 billion worth of financial assets held by the private sector, assets of various maturities with various associated interest payments, then the private sector gets $85 billion now. But as the principle and interest payments on those assets come due, the money that would have gone from one private sector bond-issuer to another private sector bondholder, remaining in the private sector, goes to the Fed instead and is thus drained from the private sector. So QE is best viewed as a kind of "loan" to the private sector in the aggregate. The private sector gets some money now which it then "pays back" over the months years to come.

The Fed is not really permitted by law to do a helicopter drop. The Fed is only permitted to purchase assets. Matt Yglesias once tweeted to me, only half in jest I think, that he thought the Fed should just buy old socks and call them assets, and do a helicopter drop that way. Whether this is legal or not by letter of the law is an interesting question. But the obvious barrier is political. Congress would rightly view the announcement of any such step by the Fed as a declaration by the Fed of its right to conduct its own fiscal policy, and would almost certainly move to shut the operation down. As it should! It would be an obvious violation of the intent of the current laws, a Rubicon-crossing encroachment on Congressional authority.

When the Fed does spend - to buy financial assets or pay interest on reserves - the Fed does not have to get that money from anywhere. That it chooses to operate in such a state of positive equity making an annual "profit" is a monetary policy choice, not an operational necessity. The Fed can't go bankrupt. It can never need a bailout. It is the issuer of our most fundamental forms of money. It was designed that way: it is supposed to provide the country with "an elastic currency" - a currency for which the quantity in circulation changes in response to economic need.

Without Fed participation, Treasury spending would not add a single cent to the private sector economy. Suppose the Fed completely ceased conducting open market operations and never bought another Treasury security, and that it decided to manage the Fed Funds rate purely through the payment of interest on reserves. Then - without changes in the existing laws - the Treasury would always have to fund its deficits and debts by a combination of taxes and more debt. It would have to drain as much from the private sector by these latter means as it injects via spending, with no net change in private sector dollars. Treasury spending only results in a net addition of dollars to the economy because the Fed decides to buy some of the debt the Treasury issues.

y said...

Dan, you're assuming the Treasury's account starts empty.

The fact is, when the Fed was created, the Treasury deposited its pre-existing funds into its new account there.

From that day on, Treasury spending has added to reserve balances, and bond sales have removed reserve balances thus added.

I don't think the account has ever reached zero.

Also when the Fed buys gold, this is equivalent to government deficit spending as the gold then belongs to the Treasury.

Matt Franko said...

"Treasury spending only results in a net addition of dollars to the economy because the Fed decides to buy some of the debt the Treasury issues."

Right I think they call this "factoring"... it is the Treasury/Fed's modus operandi...

But I still submit that the Fed pays the ior out of their portfolio income and not by "crediting a bank account"... the Fed NEEDS an upward sloping yield curve to operate...


Dan Kervick said...

y, I don't think I get your point.

Dan Kervick said...

Matt, isn't "factor" just being used herein its most common sense as a causal contributor? For example, if someone at a corporation presented a report on "factors contributing to decreased sales in Q1", they might cite such factors as "bad weather", "production delays", "reduced customer demand" etc. The report you cite is just a report on reserve balances and the various factors that determine them.

An upward-sloping yield curve might be something the Fed wants to maintain for the sake of pursuing financial stability and other monetary policy objectives, but I don't think the shape of the yield curve has anything to do with the Fed's operational necessities. If every single asset the Fed owned defaulted, that would just mean that the Treasury and the Fed's stockholders would get no profit distribution for a long, long time.

Of course that would only happen if the economy were in shambles, so Fed operations would be the least of our worries.

Tom Hickey said...

Matt, that's just the rules under which the Fed operates now. There is no operational necessity to do it that way. For example, the Fed could just as easily be permitted to run negative equity. After all, it's revenue gains from earnings on operations is not retained on its balance sheet but rather transferred to Treasury at the period's end. So some similar rule could be adopted to keep the Fed "solvent" if that would be an issue, which it is not really.

Tom Hickey said...

BTW, the money that is taken out of the economy by Fed operations goes to the Treasury, from which it is spent back into the economy. So it is a redistribution from tsy holders to recipients of Treasury spending, although not immediately, since Fed doesn't settle up with Treasury until the end of the period. That could be changed of course, too.

Tom Hickey said...

beowulf has previously gone through the law on emergency powers, and IIRC it seems that the law is broad enough to permit the Treasury secretary to direct the Fed to do just about anything that the President wishes, including a helicopter drop.

The Fed chairman probably could not do this on his own without authorization from either the executive under emergency powers or Congress changing the rules.

Matt Franko said...

I think that word 'factor' is a term of art in finance Dan... there is a history there:


local architectural renovation:

So this term in the title of the Fed H41 report probably goes back a long way... and is perhaps revealing.

Agree that policy can change but I'm still trying to understand what these people are actually currently doing from their own perspective a bit...

What I'm currently thinking is that they for instance (hypothetical) could not come in tomorrow and raise the policy rate to 5% because their portfolio income (which is fixed) would then be insufficient to both pay ior and pay Fed expenses...

this is perhaps how THEY see it...


Matt Franko said...

I'm trying to better understand the method to their madness ... rsp,

y said...


"I don't think I get your point".

The point is, you appear to see debt sales by the Treasury as taking money out of the economy, which the Treasury then spends.

My point is it's the other way around.

Treasury spends, and then sells bonds to withdraw or "drain" money (reserve balances).

Dan Kervick said...

The way I see it, when the Fed purchases a Treasury security and holds it to maturity, it is basically monetizing the interest component of the government's obligation to the security holder. It buys the asset at more or less face value, and then effectively cancels the Treasury's interest obligation, only collecting the principle. (In practice it does collect the interest from the treasury, but then refunds it.)

But without the Fed's participation via open market operations, and without changes is current operational rules, the Treasury would be just like any other financially constrained agent.

I think the Fed can already run is a state of negative equity under current operational rules - no rules changes are necessary. This was studied by Willem Buiter in a series of papers over the past few years. The only risk is that if the money going out of the Fed exceed the money going in by too great an amount, then serious inflationary pressure could result. The Fed can always use seigniorage to pay its own employees, maintain its buildings and buy the equipment it needs. But it could, in theory, get into a situation in which "running the printing presses" to fund itself causes so much inflation that it can't acquire the real assets it needs without triggering a hyperinflationary spiral.

Running a "profit" is a monetary policy choice by the Fed, not an operational necessity.

Remember the MMT framework is only valid if you consolidate the government accounts, and include the Fed in the government sector.

Dan Kervick said...

y, what's the difference? With a government that is in continuous operation, it doesn't matter which operations come "first" and which come "later". Spending is happening all the time, taxing is happening all the time and securities sales are happening all the time. When the government spends, dollars move into the non-government sector, and when the government taxes or borrows, dollars move out of the non-government sector. For these operations to result in a long-run change in the number of dollars in the non-government sector, the central bank has to be involved, since the central bank is currently the operational locus of of the federal government's monetary authority.

Unless the Treasury employs novel tricks like PCS, the Treasury doesn't control the "printing press". The Fed does. When Ben Bernanke said, "The government has a printing press", he was speaking of his own part of the government, and was explaining how the Fed could do QE without having to collect taxes.

paul said...

"Spending is happening all the time,"

All "spending" is not equal...the Fed doesn't buy anything that helps increase the level of money available to buy stuff.

Buying and selling securities just shifts money around among the wealthy.

In order for spending to be meaningful it must have a labor component or at least lead to spending on things having a labor component.

Tom Hickey said...

Y The point is, you appear to see debt sales by the Treasury as taking money out of the economy, which the Treasury then spends.

My point is it's the other way around.

Treasury spends, and then sells bonds to withdraw or "drain" money (reserve balances).

Both are correct. One is micro and the other macro. MMT deals with macro, and a lot of circuitism with micro. So it looks like a zero-sum argument when it is both/and. One focuses on the temporal and transactional and the other on the systems logic and aggregates.

Tom Hickey said...

Dan, if one creates rules and then let them hang one by the toes when one has the power to change them, that is pretty stupid. Just look at the EZ for an example of such.

MMT shows now a non-convertible floating rate system operates from a general POV. Of course, special cases alter the general, usually in order to constrain policy space politically, which is likely due to ignorance, special interest pleading, or seeing monsters under the bed.

Dan Kervick said...

Paul, by buying government securities the Fed makes it possible for the Treasury to spend more without taxing or borrowing as much as it would otherwise have to. The purchases reduce the Treasury's net liabilities. Without Fed participation, the only means available to the Treasury for meeting its liabilities + spending commitments would be taxing and borrowing the full amounts needed.

When the Fed purchases Treasury securities from the private sector, the Treasury's liabilities are reduced by roughly the amount of the interest component of the purchased securities. (It can also make profits for the Treasury by buying longer-term securities from private sector sellers who are willing to part with long-term profits for the sake of immediate liquidity.)

Because the Fed has gobbled up massive amounts of securities and turned over many tens of billions profits to the Treasury, Treasury has been able to borrow less and still meet its obligations.

Dan Kervick said...

Tom, yes, we could certainly do with some rule-changes so that the full power of functional finance would be liberated from the policy decisions of central bankers. I'm just describing the system as it presently exists and is established by law. Congress writes the laws, so it can change any of the laws it wants to change within the bounds set by the constitution.

Tom Hickey said...

The only affect of the Fed's use of OMO and POMO is on liquidity, the interest rate and yield curve.

If Warren's proposal of setting the interest rate to zero and automatically providing rb to clear were to be adopted, the Fed would be superflous and there would still be just as much $NFA in the system. Fed ops don't affect amount of $NFA, only composition, and that relatives to interes rate setting when not paying IOR or setting the rate to zero.

Dan Kervick said...

Paying interest on reserves does affect the quantity of NFA's. Those interest payments are free money that is simply credited to bank reserve accounts. No asset swapping involved.

Matt Franko said...

"Those interest payments are free money that is simply credited to bank reserve accounts. No asset swapping involved."

How and where are these new RBs accounted for in the Fed's H.4.1?

I would think that if these are new system reserves, the other side of the dual accounting entry has to appear in the H.4.1 Factors.... (to maintain double entry accounting discipline, etc..)

This is what I am trying to discern...


Tom Hickey said...

Because the Fed has gobbled up massive amounts of securities and turned over many tens of billions profits to the Treasury, Treasury has been able to borrow less and still meet its obligations.

Right, the foregone interest is actually a tax on non-govt imposed by the Fed and paying IOR is a quasi-fiscal injection that counters that tax. Since banks hold a lot of tsys and have greater need of liquidity, it's essentially a wash for them.

Matt Franko said...

this is how it appears (to me, could be wrong):

1. Fed has to pay interest on RBs...

2. Fed receives balances from the TGA for interest on USTs that it is factoring..

3.Fed takes some of those balances and transfers this to Depository Institutions Reserve accounts as IOR..

4. Fed holds on to the rest of the UST interest and pays it;s expenses with some of these balances from a internal Fed account until the end of the quarter when it transfers any remaining excess balances received on portfolio back to the TGA...

ie Fed needs the UST coupon payment to use the balances to pay ior and pay Fed expenses...

Could be wrong...


Tom Hickey said...

Sounds right to me, Matt. I would say however, that the Fed "uses" ... instead of "needs" ... to keep the description operational.

The Fed never "needs" to get reserves operationally, since it is the issuer of reserves. However, due to political restraints it may "need" to get rb, e.g, to avoid negative equity if that is off the table politically.

paul said...

"Paying interest on reserves does affect the quantity of NFA's" - Dan

True, but the $NFA 's go to the wealthy mainly....and they are going to accumulate more wealth, not spend the $ on consumption.

In the net, the flow is always towards the top. Because that is true, there can be no significant effect on increase demand discretionary income has to increase among households...the 99% part mainly.

...and in the net the Fed can't make that happen.

Dan Kervick said...

Matt, perhaps the IOR is included on the line labelled "Other Federal Reserve Assets". That line has a footnote (13) which says it "includes accrued interest, which represents the daily accumulation of interest earned, and other accounts receivable."

Dan Kervick said...

Yes, I agree with you Paul. I think that's the main reason that fiscal policy is so important, and would be even if the consolidated government were budget constrained. Fiscal policy transfers dollar balances from savers to spenders and investors. And if the government itself acts as a customer for consumption or investment goods, that spending contributes directly to aggregate demand.

Matt Franko said...


I'm not sure if it is the IOR but I think that is probably the account in which the Fed accrues the interest it receives on the portfolio at least..

And makes sense as the Fed probably just lets the interest that the Treasury pays on the securities the Fed is factoring just go into an account that the Fed itself maintains at a Depository Institution(s) so that would be RBs if the balances are in a bank account even if the "owner" of the account at the Depository Institution is the Fed itself...

Then I suppose the Fed probably just distributes these balances from that account to the other banks to pay IOR ... then sweeps the leftovers back to the TGA at quarter end or something...


What I would like to know is if the Fed can issue reserves (or "create" reserve balances") by any other method than "factoring"... I am assuming they cannot...


Tom Hickey said...

As I understand it, national governments issue currency either through the Treasury or central bank, or both without operational constraint. The US issues reserves and FRN through the Fed and coin and tsys through the Treasury Dept (as well as Treasury notes previously).

There is no operational limit on currency creation in that the govt is the currency issuer. The government may place restrictions on itself, of course, e.g., by adopting a convertible or fixed rate standard. That's no longer the case for the US. but I am not up on the law in the US that regulates Fed and Treasury ops.

paul said...


The way I look at it, if we modeled consolidated Treasury/Fed ops as part of an electrical circuit...

...Ops would be modeled as a wire...a resistance...the wire between the plug and the machine.

Self-limiting laws/behavior the government places on the system is analogous to the size of main circuit-breaker in the electrical service panel.

Modern houses need a 200-amp service, but we can limit capability by replacing the 200 with a 100 or a 60-amp breaker.

Congress serves that restricts the amount of "current" when it reduces spending...smaller main breaker.

Ops are the "how" of producing money, nothing else.

Tom Hickey said...

Right, the general case is the power house. How that power gets distributed in national economies as policy space defines the special cases. A special case could be to use all the power available for policy space — or not.

The later is like thinking, Oh, that much power is just too dangerous, and it needs to be stepped down so no one gets burned by drawing too much.

The former is like thinking, What's the best use of available power to accomplish our goals and serve our needs.