Question 1:
Issuing government debt reduces the risk of inflation arising from deficit spending because the private sector has less money to spend.
The answer is False.Bill explains why this is so.
This objection keeps coming up, it seems. This is nice short explanation to save for the occasion.
Bill Mitchell – billy blog
Saturday Quiz – January 2, 2015 – answers and discussion
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia
14 comments:
https://longandvariable.wordpress.com/2015/12/18/more-on-the-germans/
"The limitations are there to create the expectation that there will be fiscal discipline not to use the printing presses, and thus that inflation will be whatever it is promised to be. And the benefit of that is that the economy is not exposed to high and volatile inflation, and the fiscal authority can raise money at lower cost."
I have left a comment. Could you leave a short comment Tom please? :)
I used to comment rather profusely on blogs like that. Got tired of it. Time for others to take a turn.
OK. I still do :)
Someone has to do it.
BTW, I found MMT through a comment that Ramanan left somewhere that I can no longer recall. Now I wish I had saved it as a souvenir.
I know I found it somewhere in December 2014 but I can't remember where. Think Mosler Economics was first site to look at.
"Got tired of it. Time for others to take a turn."
It's largely pointless of course. Tony has a religious belief that is part of his core values as an ex-central banker. And like all those with deep religious convictions he will go to his grave believing it and will quite literally not be able to see anything that contradicts it.
Of all the scientists I've dealt with over the years economists are the most closed and the most cliquey. It is a behaviour I've only seen elsewhere in those belonging to political parties or lobby groups. And of course it is explained by that. The economists are the legitimisers for the political regime that pays them.
That's true, Neil, but others who read the blog may read the comments and if it influences even one person, it's worth it. As I said, it's how I discovered MMT. I may not have otherwise.
In addition, the power of suggestion is amazing. Putting ideas out there has an effect, which is why the saying in PR, "There is no such thing a bad publicity." Trump is proving that adage, for example.
I was just thinking about this and have got confused.
I have always understood debt issuance as just an asset swap between two types of government financial assets,reserves/cash vis a vis bonds.So the net wealth stays on banks balance sheets is the same.
So the deficit spending creates net new demand
But it occurred to me that QE created huge asset price inflation,so debt issuance is actually a counter-inflationary mechanism.
Also what does this mean:
"So M1 (deposits in the non-government sector) rise as a result of the deficit without a corresponding increase in liabilities. It is this result that leads to the conclusion that that deficits increase net financial assets in the non-government sector."
Because Earlier Bill writes:
"The transactions are clear: The commercial bank’s assets rise and its liabilities also increase because a new deposit has been made. Further, the target of the fiscal initiative enjoys increased assets (bank deposit) and net worth (a liability/equity entry on their balance sheet)."
Aren't the bank deposits liabilities of the bank?so how can defict spending create deposits without corresponding liabilites on the banks' balance sheet?
Also I Had a vague understanding that the excess reserve created by deficit spending (spending greater than tax) were used by the banks to buy bonds.so the 'money' for the debt issuance is financed by the deficit spendings resulting excess reserves.However the target of the governemnt spending still recieved the cash,its just that the bank rearragned it's portfolio.(my understanding gets fuzzy here),but essentially it pays for itself.and it doesnt affect/limit banks' cappacity to lend in the private sector
But what about the fact that banks don't buy all the the bonds on issues.other entities do aswell.
any help would be appreciated
"Also I Had a vague understanding that the excess reserve created by deficit spending (spending greater than tax) were used by the banks to buy bonds.so the 'money' for the debt issuance is financed by the deficit spendings resulting excess reserves.However the target of the governemnt spending still recieved the cash,its just that the bank rearragned it's portfolio.(my understanding gets fuzzy here),but essentially it pays for itself.and it doesnt affect/limit banks' cappacity to lend in the private sector"
Please read:
http://www.3spoken.co.uk/2013/06/the-sterling-hierarchy-of-money.html
and
http://www.3spoken.co.uk/2012/04/fixed-exchange-rate-system-at-heart-of.html
"Let's run through a use case - the payment of benefits to an individual with an account at a Credit Union. Let's say the Partner's Credit Union which happens to have a clearing account at the Co-op bank in Liverpool.
The first thing that happens is that the Department of Work and Pensions (DWP) uses the Government Banking Service to instruct either Citibank or Royal Bank of Scotland (RBS) to make a payment to the Credit union account. Let's say Citibank. So in the DWP accounts of Citibank are debited with the payment, and so is Citibank's reserve account at the Bank of England (BoE). That reduces the size of Citibank's balance sheet.
The payment ends up at the Co-op bank which receives a credit to its reserve account at BoE. It then credits the account of the Credit union at the local branch. This increases the size of the Co-op balance sheet.
The credit union notes the payment into its clearing account. It increases the amount in the bank in its accounts and also increases the amount in the credit union deposit account of the particular customer. Again the balance sheet of the credit union expands.
HM Treasury clears with Citibank via the 'Exchequer Pyramid' which sweeps money backwards and forwards between the operational transaction accounts at Citibank and the Consolidated Loan account held at the Bank of England. So in this case Citibank will receive a credit to its reserve account at BOE, and it then credits that to the DWP accounts - expanding Citibank balance sheet once more.
At the Bank of England side there is a debit to the Consolidated Loan account to offset the outgoing payment. The Debt Management Office of HM Treasury records the outgoing payments in its accounts and uses that data as part of its swap management operation to decide which Treasury Bills and Gilts to issue into the market. Importantly though the two flows are not directly connected. Payment and swap flows happen separately (along with the receipt flow from taxation) and the Consolidated Loan account acts as a stock buffer between those flows.
So in summary the accounting transactions are:
Debt Management Office: DR Government Expenditure, CR Consolidated Loan
Bank of England: DR Consolidated Loan, CR Citibank Reserve
Citibank: DR Citibank Reserve, CR DWP Account
Citibank: DR DWP Account, CR Citibank Reserve
Bank of England: DR Citibank Reserve, CR Co-op Bank Reserve
Co-op: DR Co-op Reserve, CR Partners Credit Union Clearing Account
Partners Credit Union: DR Co-op bank account, CR: Customer's deposit account
The net effect of all that is that Co-op bank and the Credit Union both get an increase in the size of their assets and liabilities. And that's because the Credit Union is a secondary financial institution. "
Essentially when the government spends it is expanding the internal assets and liabilities of the bank. The bank gets some central bank liabilities (reserves/vault cash) and a deposit. When taxes are paid it is the opposite.
"it doesnt affect/limit banks' cappacity to lend in the private sector"
Correct. When banks make a loan they create a deposit and a loan. No prior cash needed. Banks have access to reserves when needed via the central bank.
Firstly a bank creates a loan. So the loan is to person A, and firstly the deposit is to person A as well. At that point the bank is still fine and still fully funded.
What happens then though is that person A wants to pay person B.
If person B is at the same bank, then there is NO problem. The deposit is switched to person B and the bank is still fully funded.
The fun starts when person B is at another bank.
What has to happen that is that bank 2 has to take over the deposit in bank 1 from person A. That increases the assets of bank 2 which then creates a new deposit for person B.
That’s how payment works. Somebody has to take the place of the original depositor in the source bank before you can create anything in the target bank.
Of course at that point bank 2 is taking a risk on bank 1 and will expect to be paid by bank 1 an interest rate to compensate for that risk.
And it also means that if bank 2 isn’t prepared to take a risk on bank 1, that nobody in bank 1 can pay anybody in bank 2.
It’s this latter point that caused the creation of central banks – to make sure that the payment system clears. The theory being that all the banks trust the central bank ‘in the last resort’ and therefore the central bank can ensure payments always clear.
So the cost of funding is really the payments bank make so they can be part of a payment clearing system.
It is the same with cash. Reserves are debited and a deposit no longer exists.
When the CB credits a non-govertnment account at the direction of the Treasury, banks account as the CB are credited with reserves balances (aka settlement balances). The reserve balances are liabilities of the CB and assets of the banks. The banks then credit customer accounts as directed. Notice that two sets of books are involved, that of the CB, the only place where reserves balances exist, and the banks. When the appropriate entires are made the books are in balance and government has increased its liabilities while non-government has increased its assets.
Taxes and other obligations to government must be paid using settlement balances. That drains some of the settlement balances created by spending. When government spending is in excess of payment of obligations to the government, excess reserves remain in the hands of nongovernment, increasing nongovernment net financial assets in aggregate.
When governments issue government securities in the amount of the fiscal deficit, then the reserve add in excess of withdrawals is drained into government securities, since government securities are purchased with reserve balances. The amount that the reserve balances increased from Treasury spending in excess of withdrawals is drained into government securities through this operation.
Since the government securities purchased are assets of non-government, non-government net financial assets have increased in that amount, which corresponds to the Treasury spending in excess of taxes.
Of course, if government didn't issue securities corresponding to the deficit, then the increase in nongovernment net financial assets in aggregate would remains in the form of reserves balances.
The degree that the CB expands its balance sheet by purchasing government securities from nongovernment the amount of nongovernment net financial assets remains the same but the composition changes. This goes both ways in the course of monetary operations conducted by a CB. The Cb can also shrink its balance sheet by selling securities to nongovernment, which decreases the amount of reserve balance held as bank assets and increases the amount of government securities held by nongovernment.
Where most people get confused is in not understanding nongovernment net financial assets in aggregate and also reversing causality based on the so-called money multiplier, which is actually an accounting residual, ex post instead of ex ante.
People also fail to understand that obligations to government and purchase of government securities only takes place through the central bank through exchange of CB liabilities. That means that government must supply those liabilities for those transactions to take place. Thus, the MMT dictum that a reserve drain into government securities requires a prior add of government liabilities, either as cash or reserve balances.
The other difficulty comes from failure to realize that there are two sets of books involved, those of the consolidated government and those of consolidated nongovernment, or else mixing them up. This is the reason it is necessary to follow the accounting trail in thinking about this.
I believe bond issuance by the Treasury does neutralize federal-govt-deficit-spending's creation of newly created dollars going into the money supply (I use the word neutralize for the Treasury because the Fed has their own definition for Fed sterilization of newly created reserves that do not). I think Bill is just saying that the neutralization is not because of the so-called, out-dated, 'crowding out' effect).
Bill and other MMT economists recommend ending issuance of tsys and going to "overt money financing," in which increases in banks reserve balances from government spending are not drained. This would mean that the policy rate would correspond to the "natural rate" of zero, since reserve balances would be in excess of those demanded.
Warren recommends issuing tsy bill of no greater maturity than 3 mo to facilitate private sector financial operations, but with a natural rate of zero they would be essentially cash-equivalents. Their value would be a safe asset at the CB instead of large amounts having to be held in uninsured private accounts.
There would not necessarily even be a one-off rise in asset values since the existing tsys would be available until expiration and reserve balances would not increase until redemption unless the CB decided for whatever reason to expand its balance sheet. There could be a one-off rise owing to ignorance as with QE, but lacking substance that would correct of itself.
What would go is the free lunch of getting paid for a default risk free parking place instead of paying for the service.
Agreed...This may be wishful thinking, but perhaps the Fed might be moving towards what you write above, to what Bill and Warren have recommended. Under the guise of conducting monetary policy, the newly created Term Deposit Facility could be the beginning of a phase-out of Treasury bond 'debt' to Term Deposits (that are "analogous to certificates of deposits" as per Bernanke in The Courage To Act).
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