Tuesday, June 24, 2014

Randy Wray — MODERN MONEY THEORY: THE BASICS

The post you were waiting for.
Modern Money Theory (MMT) seems to confuse two groups of otherwise sympathetic economists. First there are those like Paul Krugman who are generally of the Keynesian persuasion and who like MMT’s “deficit owl” approach. I think Krugman would really like to stop worrying about the deficit so that he could advocate an “as much as it takes” approach to government spending. The problem is that he just cannot quite get a handle on the monetary operations that are required. Won’t government run out? What, is government going to create money “out of thin air”? Where will all the money come from?
He really doesn’t understand that “money” is key stroke records of debits and credits. He still thinks banks take in deposits and then lend them out. He starts to tear his hair out whenever someone tries to correct him on this. He’s wedded to the deposit multiplier idea he got from his Econ 101 textbook.
The other group that is otherwise sympathetic is the Post Keynesians. They understand banking. They know that “loans create deposits”. They know the “deposit multiplier” is actually a “divisor”, as “deposits create reserves”. (Not in any metaphysical sense but rather in the sense that an interest rate-targeting central bank always accommodates the demand for reserves.) However, they cannot understand how a sovereign government spends. Doesn’t it have to borrow the currency from private banks? Like Krugman, they argue that (given modern arrangements), government cannot spend by “keystrokes”.
So here’s an attempt to put the fears of Krugman and Post Keynesians to rest. There is a symmetry between bank lending and government spending.
Economonitor — Great Leap Forward
MODERN MONEY THEORY: THE BASICS
L. Randall Wray | Professor of Economics, University of Missouri at Kansas City

33 comments:

Dan Kervick said...

The one aspect of Randy Wray's account I would push back on a bit is this:

While this gets a bit technical, the operational purpose of such bond sales is to help the central bank hit its overnight interest rate target (called the fed funds rate in the US). Sales of treasury bonds reduce bank reserves and are used to remove excess reserves that would place downward pressure on overnight rates. Purchases of bonds (called an open market purchase) by the Fed add reserves to the banking system, prevent overnight rates from rising. Hence, the Fed and Treasury cooperate using bond sales/bond purchases to enable the Fed to keep the fed funds rate on target.

As Wray notes, when the Fed buys treasury securities from the private sector, it adds reserves to the system; and that either relieves some upward pressure on the fed funds rate or exerts additional downward pressure on the fed funds rates.

Now consider two ways of draining $10 billion in reserves: (i) the Treasury sells some securities for $20 billion dollars and the Fed then buys about half of them for $10 billion, or (ii) the Treasury sells some securities for $10 billion and the Fed buys nothing.

Now if the sole operational purpose of issuing treasury debt were just to help manage the federal funds rate, then it would make no sense at all for the Treasury and Fed to employ the convulted procedure (i) when it could just employ procedure (ii) with much less fuss.

But the fact is that the Treasury and the Fed each have their own distinct roles and responsibilities, and their purposes are not the same. The treasury does not conduct monetary policy - the Fed does. The main operational purpose of selling treasury securities is not to assist with monetary policy, but to supply the general fund with dollar balances. The Treasury is not permitted to issue its own dollar balances in order to carry out its authoried spending. What it is permitted to do is issue interest-bearing debt instruments and swap them for dollar balances alreay in existence.

Now there is nothing written in stone here. We could certainly have a system in which the Treasury issues its own non-interest bearing dollars - just as the Fed can do now - and then spends them without going through all of those convoluted operations involving of securites sales and partial Fed buy-backs of securities sold by the Treasury.

But we don't have that system. We have a system in which the Treasury can't issue the non-interest bearing liabilities we call "dollars" and that it needs to carry out its spending operations. They can only issue interest bearing debt which must be sold for dollars.

MMT seems to be bending over backwards here to suggest that everything is lovely just the way it is, that there is nothing constraining or wrong about the present system, and that all of those securities operations can just be regarded as equivalent to the treasury kystroking balances to accounts. But that is not true. The existing system plays a functional role that goes beyond issuing dollars for spending and managing the fed funds rate.

Dan Kervick said...

It would be more realistic to say that an important part of the operational purpose of the existing system (as opposed to a more direct system we could have instead) is to provide risk-free short, medium and long-term interest payments to the possessors of surplus dollars. Of course, the same purpose could be played by Fed alone without any intermediation by the Treasury. The Treasury could issue dollars by itself to generate spending balances in excess of tax revenues, and the Fed could just offer term deposit accounts like any other bank. That would be a functionally similar system, but would also be one in which Congress and the Treasury accord themselves more freedom of movement and a larger leadership role in setting monetary policy, and the Fed has to follow along.

Randy says "it's complicated". But it's not that complicated. Treasury securities don't serve the operational purpose of managing rates. The Fed is entirely capable of doing that on its own. Instead, those securities provide wealthy capitalists, who possess large dollar surpluses, with a risk-free vehicle for collecting rents on the day-to-day operations of the US government.

y said...

"The treasury does not conduct monetary policy - the Fed does"

Actually during the crisis the Fed explicitly asked the Treasury to help it conduct monetary policy.

"Understanding the relationship between Federal Reserve credit policy and Treasury cash management is important because the relationship illuminates an important but sometimes unappreciated interface between the Treasury and the Fed. It also underscores the symbiotic relation- ship between the two institutions, in which each assists the other in fulfilling its statutory responsibilities."

http://www.newyorkfed.org/research/current_issues/ci18-3.pdf

y said...

The first Treasury cash management change following the onset of the crisis involved the sale of Treasury bills by the U.S. Treasury and the deposit of the proceeds with the Federal Reserve—actions that drained reserves from the banking system and reduced the volume of excess reserves. On Wednesday, September 17, the Treasury announced the initiation of “a temporary Supplementary Financing Program [SFP] at the request of the Federal Reserve." The announcement stated that the program would “consist of a series of Treasury bills, apart from Treasury’s current borrowing program, which will provide cash for use in the Federal Reserve [lending and liquidity] initiatives.” The Treasury announced three SFP sales that day for a total of $100 billion. The proceeds from the sales were deposited in a newly created SFP account at the Fed, thereby draining approximately $100 billion of reserves from the banking system."

p.6

http://www.newyorkfed.org/research/current_issues/ci18-3.pdf

Tom Hickey said...

I think that Randy is looking at the Treasury and Fed as agents that carry out the fiscal policy of the government that originates in the legislature and is approved by the president or the president's veto is overridden. So it is not quite correct to say that the Treasury "spends" and the Fed cashes the checks as the government's bank. IAW the Constitution the government taxes and spends and its agents execute the process.

So Treasury doesn't choose among spending alternatives. The legislature appropriates expenditure and levies taxes and the executive branch handles the details through its agencies. The balance of expenditure and revenue is decided prior to Treasury involvement and Treasury simply pays the bills other agencies incur due to appropriations and receives the taxes that are collected through the IRS.

Treasury can choose various combinations of bills and bonds along the curve and set the interest rate, with the market determining yield based on the price of the securities arrived at in market.

The Fed sets the policy rate it chooses based on its mandate, the policy rule it is following, and its perception of the economy. The Fed and Treasury coordinate to make this works in the interbank market for overnight funds when the policy rate is not set to zero and the Fed is not paying IOR. If the Fed chooses to set the rate to zero permanently, or to set the rate above zero by paying IOR, security issuance by Treasury is not needed operationally, which reveals its true purpose, which is to provide an interest bearing "safe asset" for savers.

Congress has also granted the Fed discretionary power in emergencies that are quasi-fiscal in that they affect the amount of $NFA through the interest channel. So the Fed can "spend" in this way by way of prior blanket appropriation, usually with conditions.

y said...

Dan,

when Wray talks about the 'the operational purpose' of bond sales he means the purely practical purpose of bond sales. Given that the government creates the money it spends, the only practical reason (according to him) for issuing bonds is to control the overnight interest rate.

"MMT seems to be bending over backwards here to suggest that everything is lovely just the way it is, that there is nothing constraining or wrong about the present system"

They argue that the current system places no real constraint on deficit spending.. however they do argue that the Fed is a problematic institution that needs to be reformed at least. They also recognise that the Fed can choose to raise the base rate on its own, which could have negative effects. In his paper on interest rates Fullwiler argued that the Fed could pursue 'unsustainable' monetary policy in this way.

"and that all of those securities operations can just be regarded as equivalent to the treasury kystroking balances to accounts"

Wray says that the government keystrokes balances to accounts, so this is a combination of the Treasury and Fed.

y said...

"Given that the government creates the money it spends, the only practical reason (according to him) for issuing bonds is to control the overnight interest rate."

actually this isn't quite right. I've seen it argued by MMT that the government issues treasuries of different maturities to provide savings vehicles which match the market demand for such vehicles.. but this isn't a mechanical or 'operational' reason for issuing bonds.

I agree with your point that treasuries "provide wealthy capitalists, who possess large dollar surpluses, with a risk-free vehicle for collecting rents" and I have seen Bill Mitchell make this point explicitly. However you have to bear in mind that the risk-free return is nominal and the real return depends on the rate of inflation, so there is risk in that sense.

Matt Franko said...

Its technically a dealer market and sometimes the dealers dont have any/enough dollar balances to buy the issues, ie there is NOT enough previously issued dollars in "the system",

so anyway the dealers then have to borrow the balances from the Fed (repo) using previously issued Treasury securities that the Dealers own as collateral and then the Fed credits the accounts of the dealers that the dealers can then use to buy the Treasury securities...

eventually the dealers broker the securities to non-govt entities after the Treasury spends the newly created balances into the non-govt and the dealers can then terminate the short term loan from the Fed... a short term loan the interest rate of which sets the policy rate...

Why else would a dealer borrow dollar balances in the first place? as the only thing they are allowed to do with the repo proceeds is purchase govt securities... they cant fund real estate developments or something...

Here:

"Historically, the Federal Reserve used repos to adjust the aggregate quantity of reserves so as to keep the federal funds rate close to the target rate established by the FOMC."

http://www.newyorkfed.org/markets/omo_transaction_data.html#Repurchase and reverse repurchase agreements

ie they use the repo process with the dealers to hit the target... not buying and selling bonds directly "from the private sector" ...

Also: "For these transactions, eligible securities are U.S. Treasury instruments, federal agency debt and the mortgage-backed securities issued or fully guaranteed by federal agencies."

Without the govt securities there is no collateral for the repo loans and the Fed cant operate monetary policy...

so the issuance of the govt securities has a role to play in monetary policy as without them there is NO COLLATERAL for the repo which has historically been THE process the Fed has used to conduct monetary policy the Fed says so RIGHT HERE: "Historically, the Federal Reserve used repos to adjust the aggregate quantity of reserves so as to keep the federal funds rate close to the target rate established by the FOMC."

http://www.newyorkfed.org/markets/omo_transaction_data.html#Repurchase and reverse repurchase agreements

No collateral > no repo

No repo > no monetary policy

rsp,

y said...

Tom,

"Congress has also granted the Fed discretionary power in emergencies that are quasi-fiscal in that they affect the amount of $NFA through the interest channel"

which emergency power do you mean?

Tom Hickey said...

Wray says that the government keystrokes balances to accounts, so this is a combination of the Treasury and Fed.

The Treasury directs the Fed as the government bank to keystroke accounts through the Federal Reserve payments system using reserves in the Treasury's account. Treasury used to write checks and the Fed "cashed" (cleared) them through the payments system.

This is similar to any of us writing a check or making an electronic payment through our bank. The bank makes the payment through the payments system (after netting). The check or electronic payment is a direction to the bank to do so.

We pay our own bills, but in the case of the Treasury, different agencies are invoiced by suppliers for orders and the bills are sent to Treasury, which pays them through the Fed since it is the Treasury that handles the national accounts as a department of the executive branch that was created to do so. It's not the Treasury that incurs the expenses. It's just an agent in the process, like the Fed. The spending is done through other agencies like DOD, which contracts for military expenditures iaw appropriations.

Treasury also directs the Fed to make recurring payments automatically, like Social Security and principal and interest due on securities. Again this is iaw with prior appropriations. The Fed keystrokes accounts in the payments system for the Treasury to various banks, which then credit customers' deposit accounts with Treasury payments.

Congress taxes and spends and the IRS collects the taxes for Treasury as a sub-agency, and the Fed clears the Treasuries checks in the payments system.

Just about the only thing that isn't purely routine in the process is the Fed's setting the policy rate and conducting extraordinary operations iaw its emergency powers, or as directed by Congress.

Tom Hickey said...

y, the Fed bought up a bunch of dodgy MBS to relieve the banks' balance sheets of this dreck to preserve their solvency, thereby taking on the possible markdown or default risk. Under ordinary circumstances, the Fed can only purchase government securities. That exceeds the normal operations of setting the policy rate and maintaining an orderly payments system. This was part of a bailout operation in extremis that a lot of people questioned the propriety of.

On the other hand, the Fed went to Congress for apporval to pay IOR, which is a fiscal add. Usually it is the Treasury that is responsible for interest payments.

http://online.wsj.com/news/articles/SB121011673771072231

Dan Kervick said...

"... when Wray talks about the 'the operational purpose' of bond sales he means the purely practical purpose of bond sales. Given that the government creates the money it spends, the only practical reason (according to him) for issuing bonds is to control the overnight interest rate."

But there are clearly other practical purposes, right y? Like the practical purpose of giving rich people and bank shareholders free money as their reward for not spending or lending their money as quickly as they would otherwise spend or lend it; or maybe just the purpose of giving rich people free money because, you know, we're all buddies here and - wink, wink - 99 out of 100 people have no idea how this racket actually works.

Note that the laws that have actually been passed and the institutions that have actually been established always create practical purposes that would not exist if other laws and other institutions had been created instead. You could say that there is no practical purpose in scoring goals in the World Cup since FIFA controls the scoreboards and can put the points on them however it wants to. But given the fact that FIFA has established certain rules for getting those points on the scoreboard, teams like Team Argentina do have a practical purpose for scoring goals. Similarly, given that Congress has established certain rules for the Treasurer in both spending money and getting balances in the general fund to do the spending, the Treasurer has an urgent and eminently practical purpose in selling bonds that has bnothing to do with managing the fed funds rate. How those bond sales end up affecting, or not affecting, the fed funds rate is the Fed's business at the end of the day.

Note also that the purpose of managing the fed funds rate is not in any way more fundamental or less of an arbitrary by-product of legislative choices than the purpose of getting spending balances in the general fund. The fact that treasury bonds are useful in helping to set the Fed funds rate is a purely contingent, institutional fact about the current legal and operational setup of the US financial system. The Fed governs the banks in the Federal Reserve system and regulates the federal funds market. It could, if so empowered, simply establish the fed funds rate by direct regulatory fiat. It could, if so empowered, set the interest rate for every single entity that has access to the fed funds market. And as mentioned ealier, the Fed could also manage the fed funds rate and conduct monetary policy even if the treasury always had a balanced budget and never issued a single bond. It could use a term deposit system with variable interest rates - a functional equivalent to government bonds - to add and drain reserves as desired.

There doesn't even have to be a fed funds market. Congress and the central bank could proscribe interbank lending altogether, and conduct monetary operations entirely via the discount window, as I beleive Warren Mosler has proposed.

So it makes no sense to say that supplying the general fund with spending blances is not a practical purpose because the laws can be changed, but that managing the fed funds rate is a practical purpose. The latter operational details are just as much a by-product of contingent and reversible legislative choices as the former.

Dan Kervick said...

Why do we have a system that depends on treasury debt, and not on the direct treasury issuance of dollars? I think there are three main reasons: The first reason is simply institutional inertia and path dependence. The current "fiat" system evolved from a pre-fiat system in which the government's currency was a genuine liability for quantities of precious metals the market for which governments could dominate but not fully control. The second reason is that Congress does not trust itself to preserve price stability if it avails itself of its inherent authority to issue money directly. So it has accepted a more complex and convoluted system in which only the central bank is permitted to issue dollars, and in which the US Treasury is required to obtain dollar balances by issuing debt instruments and exchanging them for central-bank issued dollars. Of course, Congress could change this system at any time, but not without a lot of complex legislative rigamarole, and so with the present system Congress has placed a disciplining hurdle in its own path that gives the capital class a bit more confidence that it won't succumb to the allures of inflationary banana republic monetary populism willy-nilly, and without a lot of political heavy lifting.

The third reason is that, in the end, private capital owns the American republic - at least so long as latent, popular democratic power doesn't achieve the solidarity, awareness and politically organized intelligence to take over that ownership on behalf of the public. The treasury debt system serves capital well, since it is a method for them to invest in, and collect rents on, the republic and the operations of its government.

Dan Kervick said...

I've seen it argued by MMT that the government issues treasuries of different maturities to provide savings vehicles which match the market demand for such vehicles.

That's right I think. But note that there will always be an endless market demand for risk-free additions to one's wealth. And the mechanism the govenment provides - government bonds - makes one's ability to aquire these additions proportional to the amount of wealth one already possesses. Should it really be a government role to provide risk-free wealth compounding for the wealthy?

Dan Kervick said...

The Treasury directs the Fed as the government bank to keystroke accounts through the Federal Reserve payments system using reserves in the Treasury's account. Treasury used to write checks and the Fed "cashed" (cleared) them through the payments system.

Right. But as you note, Tom, this "direction" is the same kind of direction you and I can give to our banks - whether by check or electronic instructions - to pay money to the order of some designated payee. We can't direct our bank to pay more to that payee than we have in our account, and neither can the Treasury.

Matt Franko said...

Dan the subsidy is to the Dealers not grandma and grandpa trying to earn 5.5% in their 12 month CD...

rsp,

Dan Kervick said...

Matt, the primary dealers are just the intermediaries for everyone else with money. People with money invest it with the dealers, and the dealers invest money in treasuries. Also, at least 30% of treasuries, I believe, are purchased directly by purchasers other than the primary delaers. And of course the pimary dealers sell many of the securities they buy on the secondary market.

Government bonds are the main source of risk-free returns to the entire system of private capital.

y said...

Dan,

"Like the practical purpose of giving rich people and bank shareholders free money as their reward for not spending or lending their money as quickly as they would otherwise spend or lend it"

Perhaps, if you think that spending would create uncontrolled inflation, and that paying interest is therefore a way to control inflation. But that's not an 'operational' purpose for issuing bonds.

My use of the word 'practical' probably confuses things more, so probably best to stick to 'operational'.

"or maybe just the purpose of giving rich people free money because, you know, we're all buddies here and - wink, wink - 99 out of 100 people have no idea how this racket actually works"

That's not an 'operational' reason for doing it, but a corrupt reason for doing it.

"It could, if so empowered, simply establish the fed funds rate by direct regulatory fiat."

I'm not sure how it would do that without having bonds on its balance sheet. Perhaps it could do it by changing the required reserve ratio?

"It could use a term deposit system with variable interest rates - a functional equivalent to government bonds - to add and drain reserves as desired."

Right, but then it would just be replacing treasury bonds with fed bonds, and the operational reason to sell the bonds would be to control the base interest rate.

"Congress and the central bank could proscribe interbank lending altogether, and conduct monetary operations entirely via the discount window, as I beleive Warren Mosler has proposed."

But if the Treasury were to just spend via money issuance and run deficits, the Fed would lose the ability to raise the rate at which it lent to banks, even if interbank lending was banned.

Tom Hickey said...

Well, the simple answer is that under currency regimes without convertibility into an asset the the government does not control and a floating exchange rate, there is no operational reason for prohibiting the Treasury from issuing notes and coin in unlimited quantity, since fiscal policy is in the hands of the legislature (with the possibility of a presidential veto, which can be overridden).

This would make the process clear and end the confusion that now exists.

Then use functional finance as a fiscal policy rule for managing growth, employment and price stability.

Warren Mosler favors setting the overnight rate to zero and providing unlimited liquidity to solvent depository institutions that use the payments system. He recommends either not issuing Treasury securities or limiting issuance to 3 mo. maturity as the maximum. T-bills would essentially be cash substitutes, so the interest would reflect this.

Others recommend still using monetary policy. Of these some, recommend paying IOR and not issuing bonds, while others would continue bond issuance as a public utility, like E/EE bonds, even though it is not needed operationally, but they would disconnect securities issuance from a deficit offset, since this is irrelevant for funding.

Tom Hickey said...

Government bonds are the main source of risk-free returns to the entire system of private capital.

The argument of those who realize that securities issuance is unnecessary operationally and still want to continue to issue "safe assets" is that this reduces systemic risk substantially, so it is in the public purpose to do so.

Dan Kervick said...

My use of the word 'practical' probably confuses things more, so probably best to stick to 'operational'.

I have no objection to that, as long as we then recognize that getting spending balances in the general fund to carry out authorized spending is just as much an operational necessity for the treasurer as manging the fed funds rate is for the central banker.

That's not an 'operational' reason for doing it, but a corrupt reason for doing it.

But it's one reason why they do do it, and one reason why the financial sector wants to keep doing it and one reason why you won't get any Washington or Wall Street bigshots or many professional economists proposing a system based on the direct issue of dollars by the treasury. If such a system existed, the rentiers wouldn't get their slice of the action.

"It could, if so empowered, simply establish the fed funds rate by direct regulatory fiat."

I'm not sure how it would do that without having bonds on its balance sheet. Perhaps it could do it by changing the required reserve ratio?

No, just by directly mandating the price, no matter what the required reserve ratio is, and no matter whether there even is a required reserve ratio. The interbank market in the Federal Reserve system is, in principle, entirely subject to Fed control. Why not just have the Fed dictate what the permitted lending rate is, and impose hefty penalties and fines if anybody lends at some rate other than that declared rate? Why all of this sloshing back and forth of reserves to create the illusion that market forces of supply and demand are doing the job?


Right, but then it would just be replacing treasury bonds with fed bonds, and the operational reason to sell the bonds would be to control the base interest rate.

Exactly. Which means there is no fundamental practical purpose related to interest rate management in having the treasury issue debt, an operational practice which needlessly entangles the fiscal operations of government with extraneous banking-side operations.

But if the Treasury were to just spend via money issuance and run deficits, the Fed would lose the ability to raise the rate at which it lent to banks, even if interbank lending was banned.

Why? I suppose it depends on the size of the deficit the treasury is permitted to run. Under most conditions, there would still be a demand for borrowing by the banks, and if the banks were not permitted to borrow from anyone but the Fed, the Fed would be the monopoly rate-setter.

There are lots of different systems we could have other than the one we have.

Tom Hickey said...

But it's one reason why they do do it, and one reason why the financial sector wants to keep doing it and one reason why you won't get any Washington or Wall Street bigshots or many professional economists proposing a system based on the direct issue of dollars by the treasury. If such a system existed, the rentiers wouldn't get their slice of the action.

Not necessarily. The currency and security issuance are separate issues and could easily be separated since there is no operational connection between them other than as a reserve drain that facilitates a type of monetary operation, which is a choice rather than being necessary.

There is no contradiction between the direct issuance of currency and securities in unlimited amounts. While direct issuance would require some fiscal policy rule in terms of functional finance, securities issuance could expand and contract based on demand for a default risk-free safe asset, if it could be justified by public purpose. Otherwise the interest constitutes a special interest subsidy.

Dan Kervick said...

Not necessarily. The currency and security issuance are separate issues and could easily be separated since there is no operational connection between them other than as a reserve drain that facilitates a type of monetary operation, which is a choice rather than being necessary.

Yes, Tom, but if the securities were sold by the central bank and not the treasury, it would be more difficult to obscure their function from the public: safe, interest-bearing assets provided by the public monetary authority to people and institutions with enough money to be fortunate enough to afford to buy them. We could then rationally discuss the policy for issuing these assets on their own terms.

The way it works now, decisions about the issuance of interest-bearing government assets are entangled with government fiscal operations, and the issuance is forced as a by-product of spending decisions.

Tom Hickey said...

"The way it works now, decisions about the issuance of interest-bearing government assets are entangled with government fiscal operations, and the issuance is forced as a by-product of spending decisions."

MMT economists have maintained that this is a voluntary political choice that is not necessary operationally as the funding operation is it represented as being.

Regardless of the contrivance, the US government funds itself through the Treasury using security issuance with the Fed providing the reserves for currency issuance through government spending. This provides the reserves to purchase the Treasuries, which can only come from government spending or lending since the sole issuer of $ currency and securities is the US government, iaw fiscal policy decided by law and with the executive acting through its agencies, the Dept. of Treasury and Federal Reserve System.

The reserves added by deficit spending are drained from the payment system into securities. The deficit offset requirement ensures that deficit expenditure and security issuance match "to the penny." It's the law.

It's a needless contrivance that is not only operationally unnecessary but also involves the subsidy of interest to securities holders, which may or may not be justified by public purpose. There needs to be a public debate about this so that an informed choice can be made.

Neil Wilson said...

"We can't direct our bank to pay more to that payee than we have in our account, and neither can the Treasury."

Yes they can. Name the person who will actually bounce a Treasury check and I'll show you a person looking for a new job in the morning.

For all the bluster, the Federal Reserve, or any other central bank, is unable to override the elected will of the legislature.

To try and do that would cause a constitutional crisis.

The key point, one which all others depend, is whether the central bank has the constitutional authority to say 'no' when the Treasury tries to implement the will of Congress.

And it doesn't. And nor does any other central bank. It's all an elaborate conjuring illusion of which David Copperfield would be proud.

Now the Krugmans of the world, and particularly the Market Monetarists *want* to give the central bank dictatorial powers over the economy such that it *can* override the will of the legislature.

And that's because they believe that an autocratic state with them in charge is better than a democratic one.

Unfortunately at that point they finally come up against reality.

Dan Kervick said...

For all the bluster, the Federal Reserve, or any other central bank, is unable to override the elected will of the legislature.

To try and do that would cause a constitutional crisis.

The key point, one which all others depend, is whether the central bank has the constitutional authority to say 'no' when the Treasury tries to implement the will of Congress.

Well, we just had a couple of standoffs that might have tested these issues, Neil, but they were both ended before crucnch time was reached.

The problem is that if the the elected will of Congress issues mutually contradictory directives, then the Fed will be in a position where no matter what it does, it violates one of those directives. If previous Congresses and the present Congress have together issued the directives: (i) spend $X and (ii) don't issue total debt in excess of $Y without furthur authorization; and then the present Congress declines to issue that furthur athorization, then what shall we say is the will of the Congress?

With the present House of Representatives, obviously the Congress's will was for the Treasurer to stop spending once the debt limit was reached. The best way for the Fed chair to get impeached by Congress would have been to cash the checks anyway.

That's what would have caused a constitutional crisis.

Now maybe this is a constitutional crisis we should have had. I would have likes to see it. But that's no way to run a government.

What would actually happen probably depends on which political camp the Fed Chair happens to sympathize with at the time. We already know that the previous Fed chair said he wouldn't accept the Trillion Dollar Coin for deposit.

Roger Erickson said...

This was all summed up pretty well by a retired Senator with Defense & Appropriations committee experience, at a off-the-record DC nat'l defense conference I attended.

"I think this whole deficit debate is a cop out. When the time comes, we'll do what we've always done. Congress will decide what the country needs, and then we'll just appropriate the money."

No mention of taxes, nor inflation, nor bonds ... nada.

Not a word was said to contradict this authority statement. You could have heard a pin drop in the room. Then they all went back to discussing MICC opportunities.

You see, this all comes down to stages of politics and political campaigning. In the end, serious people have always stepped in ... so far.

Dan Kervick said...

Roger, it sounds like he was confused. During the debt ceiling debates the money had already been appropriated. That's not what the debate was about. Apprpriations bills just allocate money from the treasury to programs and agencies, but they doen't say anything about how the treasury obtains the money that has been appropriated.

Calgacus said...

Dan Kervick: But we don't have that system. We have a system in which the Treasury can't issue the non-interest bearing liabilities we call "dollars" and that it needs to carry out its spending operations. They can only issue interest bearing debt which must be sold for dollars.

MMT seems to be bending over backwards here to suggest that everything is lovely just the way it is, that there is nothing constraining or wrong about the present system, and that all of those securities operations can just be regarded as equivalent to the treasury keystroking balances to accounts. But that is not true. The existing system plays a functional role that goes beyond issuing dollars for spending and managing the fed funds rate.


what is the constraint? It doesn't exist. It hasn't happened in hundreds of years, anywhere. People just say it exists, but never say what it is. There is nothing so wrong with the current system. Just lower the adjustable parameter of whatever interest rates are paid if you think they are too high. .1% or .001% or whatever is close enough to zero for all practical purposes. If the stupid securities operations are not equivalent to "keystroking" what on earth are they? What financial operation is not "keystroking"? Any operation involving money & credit, more generally, any conceivable economic transaction at all, is at least half "keystroking".

The current "fiat" system evolved from a pre-fiat system in which the government's currency was a genuine liability for quantities of precious metals the market for which governments could dominate but not fully control. No, it did not "evolve". All money is "fiat money" and always was. There is no "pre-fiat money". Pleonastic "Fiat Money" is and always was a "genuine liability". Which means it is a "liability to" (and from) - "just" a social relationship - a relationship recorded on two balance-sheets- and is not and never was a "liability for". That usage is a conceptual confusion here, the category mistake at the heart of the commodity theory. Retaining it has caused you to misunderstand or progressively reject the correct MMT concepts and propositions. In the "pre-fiat system" the US government used to run a buy & sell gold shoppe. It doesn't any more. But it still buys stuff (=spends) and sells stuff (=taxes). The example I used a couple years ago, that you unfortunately did not understand, was teddy bears in the Smithsonian Gift Shoppe. Which is exactly the same thing as gold, (or taxation). The US government has a store of Teddy Bears. It could dominate but not fully control TB production. It sells quantities of TBs for specific quantities of its purely immaterial liabilities, debts called "dollars". The relation between the TB quantity & the quantity of "dollars" the TBs sell for is called a "price". The value of the dollar is ultimately based on how many TBs & other nice things one can get from Uncle Sam in the future, and how easy it is or has been to get "dollars" from Uncle Sam. It always was fiat underneath. It's just a little more obvious now.

Calgacus said...

The second reason is that Congress does not trust itself to preserve price stability if it avails itself of its inherent authority to issue money directly. So it has accepted a more complex and convoluted system in which only the central bank is permitted to issue dollars, and in which the US Treasury is required to obtain dollar balances by issuing debt instruments and exchanging them for central-bank issued dollars. That is not how it works. Not that it matters, but most state money, reserves is or was issued by the Treasury, not the Fed. There's some old MMT paper that says 60% or so IIRC. The "money" in the Treasury's account is not money at all, but the result of a delusion - the delusion of the nonexistent "constraint" that is only said to exist. This "money" is just "one pocket owing another pocket" in Abba Lerner's words. Nothing would change if a trillion were added to it. The meaningful constraint is the informal upper one on the Treasury account - sopmething like $5B, not the lower one.

The general drift of some further comments is based on this too-usual unconscious construction of money as a thing, rather than a relationship. This results, as usual, in ascribing magical power to the Fed, the supposed magical maker of this magical "thing" - one sort of the nation's money/debt - the less important sort - reserves. There is even the suggestion that the Fed could win in a showdown with the US Treasury, who makes the more important sort of money - bond debt - or even the Congress, which created and empowered the Fed. What is done here, the common logical error is dissociating the Fed from the Treasury - the left pocket and the right pocket - in one place, but not another. Consolidate or deconsolidate, but decide on which, and then do the accounting. Of course if you change your decision in the middle you can arrive at nonsensical conclusions.

So the Treasury needs to get "money" - "reserves" from the Fed. Fine, we have deconsolidated them. But why is the Fed's money worth anything at all to anyone? Answer - because the Treasury makes it so. The Treasury exchanges the ready money it invisibly issues for this and only this purpose - and exchanges it at par for the Fed's reserves. That is one way of thinking of what is going on when the Treasury accepts dollars in its FR account as tax payments terminating debts owed it. That is where the Treasury gets its otherwise worthless reserve balances at the Fed, which are only valuable because they are so backed by the Treasury. Remember, we have deconsolidated. The Fed might as well be the FR Bank of Weimar Zimbabwe, issuing WZFR notes/ reserves. The Fed acts only as a fiscal agent for taxes owed to the Treasury, not it, and when a bank puts tax money in a Fed account, extinguishes its liability to the state by giving money to / drawing down its account at the government's bank, the Fed, then the bank's liability to the Treasury is terminated, but the Fed's liability to the Treasury remains. It needs to be terminated by issuance of Treasury dollars, Treasury credits, the truer money, which the Fed- fiscal-agent can only obtain by putting some Fed funny money in the TGA. In the real world, Treasury debt, US Treasury checks, Treasury money back Fed reserves, NOT vice versa. Fine, if the Fed refuses to cash gubmint checks - then the gubmint sez - I don't accept FR notes/reserves (at par) for taxes, only direct Treasury debt. Again, consolidate or separate, but do it consistently. Money is a relationship - and who would you like to be in a good odor with, have a positive relationship with, be a creditor, rather than a debtor of - Uncle Sam in DC with his legion of revenooers & henchpeople - or a bunch of snobs educated into ignorance sitting in the Eccles building?

Matt Franko said...

The word "money" is a metonym and therefore not qualified for use in professional terminology or be included in a professional lexicon...

It is a metonym that is associated with the temple of the goddess Juno-Moneta in Rome where the metal currencies were struck...

http://en.wikipedia.org/wiki/Moneta

No other disciplines use metonyms like this... we should avoid the use of this word...

Other disciplines typically use the names of actual human beings for their units and specific terms... Volts/Amperes/Pascals/Newtons, etc...

rsp,

y said...

Dan,

"The current "fiat" system evolved from a pre-fiat system in which the government's currency was a genuine liability for quantities of precious metals the market for which governments could dominate but not fully control."

In this interesting paper by John Cochrane, he argues that the gold standard was always a fiscal commitment:

http://media.hoover.org/sites/default/files/documents/2014CochraneMonetaryPolicywithInterestonReserves.pdf

y said...

Calgacus,

"The "money" in the Treasury's account is not money at all, but the result of a delusion"

I agree that the Treasury's balance at the Fed is not really "money", but I'd say its a fabrication of internal governmental accounting, rather than a 'delusion'.