A currency-issuing government is not revenue constrained. It is always able to purchase whatever is available for sale in its own currency. This simple reality is partially concealed by a variety of contrived hoops through which modern day governments require themselves to jump. There are at least two different ways in which we can see past the confusion. The easiest way is to stand back and look at the big picture, both from the standpoint of logic and by considering the monetary and fiscal authorities as two parts of the same entity, the consolidated government sector. For the eagle eyed, this approach may appear to overlook potentially consequential details in the way governments actually spend. In practice, the monetary authority plays one set of roles, the fiscal authority plays another, and many governments have introduced various restrictions on the way in which the two can interact. The present post begins with a bird’s eye view of government spending, and then turns to a more detailed consideration of the way in which self-imposed constraints and convoluted operational procedures complicate but do not undermine the sovereignty of a currency-issuing government. The case of the US government is taken throughout as an example, but much of the discussion is also broadly applicable to other currency-issuing governments.heteconomist
Exercising Currency Sovereignty Under Self-Imposed Constraints
Peter Cooper
21 comments:
"1. Repurchase agreement. The Fed purchases second-hand treasuries from primary dealers with primary dealers promising to buy back at a later date. The effect of this step is to add reserves in exchange for second-hand treasuries in order to facilitate the non-government’s subsequent purchase of newly issued treasuries."
My point is not many people can understand this statement... or perhaps the "mathematical relevance" of this statement.... or at least this absence of comprehension is applicable to 99.999% of our current policy makers and popular macro economists...
You can ask them: "Do you understand this?"
And they will say: "Sure...."
BUT
I assert, in FACT they do not really understand this...
rsp,
Peter's statement here is VERY abstract....you need a somewhat rare ability to truly understand it imo....
And btw for members of the academe : giving them a failing grade is not a option for success in this situation....
If this is the same Peter Cooper who ran for President flying the Greenback flag, (and there is little doubt it is) then you have some insights into the sort of monetary debates of the late 19th century.
Franko's right—damn few people could understand this argument anymore. Especially academic economists. Shows what you get for your $60k / year educations these days.
Matt, you may be right. I tried to prepare the reader for it in the earlier, lighter half of the post. In relation to an example in which the Treasury plans to spend but its account balance is zero (and balances in the tax and loan accounts are also zero):
"This gives us the following situation. The Treasury is only allowed to spend by drawing down its account, but the account is empty. Its tax and loan accounts are also empty. The Treasury is not permitted to borrow directly from the Fed. Evidently, the Treasury will have to auction off debt to primary dealers in the open market. And it will have to do this before it can spend.
We might wonder, then, where the reserves will come from that are required to settle the treasury auction? The answer is that they will come from the Fed. The Fed will have to do a reserve add, by lending to the non-government, specifically to primary dealers."
@Jonathan: I wish. :)
@peterc
I wish too.
Just remember, if you go around discussing monetary policy with that name, you have a powerful legacy to uphold.
Peter just to be clear I am not "blaming you" type of thing....
I am trying to make the point that these concepts, the insight into which people like us take for granted, are extremely challenging to "transfer" the understanding of to many (perhaps most?) others...
An interesting "test" might be to ask someone who would say to you "oh, yes I understand what you are saying here Peter!"... to explain your use of the metaphor "second-hand" here... iow ask someone who reads it WHY it is appropriate for you to use the metaphor "second-hand" here...
This might be revealing.... rsp,
Jonathan,
would you play along here and humor me and perhaps offer a short reason why it is appropriate for Peter to use the "second-hand" figure of speech here?
Just post a short comment why this is so if you have a moment...
rsp,
If you dont know just say so and no worries... rsp,
I assert that AT BEST 75% of even "MMT people" can correctly explain Peter's use of 'second hand' here.... rsp
Email your answers to matt_franko at hotmail dot com......
I would describe the operation as lending against Treasury collateral. Anyone who understands how margin debt works would be able to understand the concept. For others, it would depend upon whether they understand what collateral is.
The fact that it is structured as a purchase that will be reversed is not that important for most purposes.
As an aside, I have never seen "second hand" used in that fashion. The usual formulation is "in the secondary market", as opposed to the "primary market", which is issuance (auctions, for Treasurys). However, market slang varies in different regions.
Peter's description is great.
However it doesn't take into account the difference between the intra day system and the inter day system
*All* clearing systems operate on effectively an infinite overdraft intra-day because they have no idea what the time differences on clearing will be. It has to operate asynchronously, with a time at which everything has to be zero at the central bank.
What that means, as a mental model, is that Treasury spends at 11am and issues debt/borrows inter-bank at 2pm recovering the increased reserves in circulation from the 11am spending. That means it is square by the end of the day.
So it can always operate at zero if it wishes. Although in reality there is a small positive buffer maintained and the cash management arm targets that positive number as the 'new zero'.
Once you realise the same $10 can be spent and recovered several times in a day, you can easily see how Treasury can spend as much as it likes as long as it is authorised to issue its 'real' money - Treasury bonds.
In the scenario Peter describes cant the "purchase of second hand treasuries" by the Fed be likened to QE on a much smaller scale?
Neil,
"*All* clearing systems operate on effectively an infinite overdraft intra-day because they have no idea what the time differences on clearing will be."
I'm not sure what you mean by this. Surely the central bank can tell whether the Treasury has 'funds' in its account or not. In the US the Fed is not supposed to make payments from the Treasury's account if it is 'empty' - i.e. it's not supposed to give overdrafts to the Treasury. You're suggesting that in reality it does? Do you have any evidence that this is the case?
I assert Jamie Dimon could NOT explain the use of Peter's 'second hand' here.... Dimon would have no idea what Peter is even talking about..
"Do you have any evidence that this is the case?"
It's how the Sterling framework works. All entities in clearing have an infinite intra day overdraft against lodged collateral - which are .... Treasury bonds (Gilts in the UK).
HM Treasury is no exception.
Within Fedwire in the US they are called 'daylight overdrafts'.
I doubt the US framework is much different because that is how clearing has to work across such a large network of operators. There will be timing differences. There has to be liquidity to deal with that.
The limit is usually that there is a zero balance *at the end of the day*.
Plus as I've alluded the inter-bank system works during the day as well.
So if Treasury makes a payment to some bank or other, it simply borrows the reserves back on the inter bank from the same bank.
So you can spend the same $10 lots and lots of time with a day by spending it, causing a deposit creation and then borrowing the reserves back.
The way it works in the US is that there is a huge buffer in the Treasury General Account (billions of dollars), which is the result of draining some of the excess reserves issued by the Fed with QE.
There's a nice run down of the prior to crisis and after crisis system here
Prior to the crisis the Fed and Treasury targeted $5bn in the TGA as the 'zero' point - which was sufficient to handle the timing difference between payments are receipts.
Matt, I think I should have just used a different term rather than "second hand". This was not the choice of a finance wiz using his local lingo. It was the choice of a "know little about the nuts and bolts of finance" economic theory person trying to distinguish between the newly-issued and already-existing treasuries. :) (I was relying on the previous analyses of Scott and Randy for the 6 steps, etc. And, no, they are not to blame for the "second hand" lingo. That was my own unfortunate "innovation".)
(A commenter, Jeff, had asked a question about the topic of the post a few days ago on billy blog. The post was an extension of my attempt to respond in that earlier thread.)
BTW, I didn't take your comments as blaming, etc.
Also, really enjoyed your recent podcast with Mike.
Peter I think it was fine.... for me ;)
and Neil and Brian (quants) had no problem with it too but Jon (who is steeped in economic "history" to the point where he knows names of obscure 1800s monetary economists...) hasnt responded here.... hmmmm.
So this is like making my point wrt what I was talking about on the podcast, ie that there are "mathematical" type economists and "historical" type economists, and the "historic" types should not be put into operational/policy making positions imo....
I think Bill M was an undergrad math major down there... he went on to make a MATHEMATICAL (this is important to distinguish imo...) connection between what he was investigating in the wool industry on commodity "buffers" and human unemployment... this mathematical insight he had to make the analogy is perhaps exceptional... we take it for granted...
So imo we should investigate strategies to overcome these cognitive limits that others among us may have in this regard (I'm SURE they have other cognitive strengths in other areas that exceed mine ;) ... no answers yet but we need the correct diagnosis first...
Roger has done research into how neural pathways are formed...
It looks like these people's neural pathways are not configured the same as ours...he explains this on the podcast he did with Mike the other day if you havent listened to that suggest you take that in Roger has some good info on how those pathways can be formed/modified... seems like it takes iterative repetitions to change the "wiring"....
So I think we have to somehow go into this direction.... we have more than enough technocratic understanding (we do..) but seems like we are hitting a cognitive road block with the masses to me.... so we may have to branch out into this direction and increase our knowledge on how the cognition works to be able to gain on this thing big time....
rsp, matt
Thanks, Matt. Interesting stuff. I guess my background is relatively math and stat based as well, even though I don't tend to think of it that way. My postgrad dissertation was not mathematical at all, but my undergrad degree after the first year was pretty much all economics, mathematical economics and econometrics units.
I enjoyed Roger's podcast, too. Just listened to it now.
One thing I find can work in casual conversation (if the topic comes up and the person expresses concern about the deficit, public debt or affordability of social policies) is just to ask the person "who creates money?' If they say govt, then ask how it could run out of money. Often the person can see that. They might then worry about inflation. I give an example like a newsagency or a supermarket. If pensions were increased and retirees go to the supermarket with a bit more money, what will happen? Will the price of the newspaper change? Milk? It might, but then it might just mean there are less newspapers or milk cartons left over at the end of the day. Or it might mean they order more from suppliers in future. So prices might rise or it might be mainly quantity that rises. This is not necessarily to convince the person one way or the other, but just to make them aware that there is more than one impact of the policy change. Sometimes, they haven't really thought about quantity adjustment as a possibility. A newspaper is quite a good example for this, because it is quite obvious that the price is administered -- set at a price that lasts quite a while before changing. Menu prices at McDonalds, say, are similar. Burger flipping is not a bad example, because most people can see that there will be busy and slack periods. More customers can mean more or fewer burgers get flipped and sold by the same staff. Etc.
It might just be selective memory on my part, or my limited social circles, but it often seems harder to convince people on the internet, and a bit easier in person. However, it is hard to reach many people in person compared with on the internet. Sometimes I suspect astroturfing is a bigger factor on the internet than we might realize. There is also the problem of lack of reach in addition to difficulty in conveying the ideas. We are well and truly drowned out by the mainstream media and anything outside the established views are easy to marginalize. At the same time, I think people not wanting to understand can be a problem as well. I guess that ties in to what Roger was saying about habit formation and brain wiring.
Anyway, we definitely have a lot to think about in terms of packaging the ideas, disseminating them, etc. Intriguing, but daunting also.
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