Thursday, March 23, 2017

Philip Arestis and Malcolm Sawyer — Quantitative Easing vs. Fiscal Policy

… when people pay taxes their bank accounts are debited and correspondingly the government account at the central bank is replenished. During an accounting period, government expenditure will have been funded by tax revenues received, sale of bonds to the private sector, plus the increase in central bank money....
I am not sure from reading this whether the authors hold that taxes fund spending and debt issuance finances deficits in the accounting sense of "fund" and "finance," or that such funding/financing is operationally necessary before spending can take place. The former is consistent with the MMT view, but not the latter.

From the MMT point of view, the central bank creates government liabilities by crediting accounts with bank reserves, which increases the monetary base. Funds in the Treasury's general account (TGA) do not count toward either the monetary base or the money supply. 

In the US, when the Treasury spends in accordance with appropriations, it directs the Fed to credit bank's account in the payments system with settlement balances aka "bank reserves." This increases base money. When taxes are paid, base money is reduced by that amount and taxpayers deposit accounts at banks are reduced. The spending and taxation are reflected in the government fiscal balance.

Similarly, when government securities are issues, the auction is paid for with settlement balances, the monetary base is reduced by that amount, and purchasers's deposit accounts at banks are reduced.

This simply involves crediting and debiting various accounts on the government's books (Treasury and central bank), banks' books, and bank customers books. There is no operational need for funding for the government to spend prior to spending than for banks to secure funding before extending credit by making loans and crediting deposit accounts. 

In the process, the LHS and RHS balance, which is what "funding" means in an accounting sense. For banks, the corresponding entry in a deposit account "funds" the loan. For government, the entries in accounts recording tax payments and debt issuance "fund" spending. 

With respect to government, the ratio between money creation that adds to the monetary base and money withdrawal through taxation and securities issuance that reduces the money base determines the fiscal balance. 

The difference between taxation and securities issuance is that taxation "destroys" money in the sense  that the monetary based and M1 are reduced, decreasing non-government net financial wealth in aggregate, while securities issuance shifts funds from the monetary base and deposit accounts to government securities without changing non-government net financial wealth in aggregate. Only the term changes and not the amount. 

MMT calls the issuance of government securities "draining the monetary base." It is a monetary operation that is not necessary operationally, but rather it is an optional tool operationally that is convenient for conducting monetary policy when the central bank chooses to set the interest rate above zero and is not paying interest on excess reserves. Draining the monetary base with securities issuance reduces the needs to open market operations (OMO) using repurchase agreements (repo).

However, instead of the Treasury issuing securities, the central bank could simply book loans to the Treasury directly. This is permitted in some jurisdiction, but it is prohibited politically in the US. This is a voluntary political choice that doesn't involve the US government needing to obtain funding from nongovernment in order to spend. In actuality, spending funds both tax payments in aggregate and securities purchases in aggregate, since the funds that government spends are offset on the governments' books by taxes and sale of government securities, both of which reduce the monetary base. The monetary base consists of government liabilities that only the central bank can create and that must already be available for tax payment and securities purchases. 

In this sense, government spends first which creates the funding for it similar to the way that the extension of a loan as an account receivable that is bank asset creates the corresponding funding in the form of a credit to a customer deposit account, which is a bank liability. Similarly, when government spends, the money base as a liability of the central bank increases and the TGA is debited. Debiting the TGA doesn't affect any of the measures of money.  When taxes are paid, monetary based decreases, which is the same as saying that the central banks' liabilities decrease. The TGA is credited but this credit doesn't count toward any measure of money. Thus tax payments "destroy money." The Treasury does not have money to spend. It simply has a credit that is used in determining the fiscal balance.

Based on spending appropriations and tax policy determined by the fiscal authority, generally the legislative branch, the Treasury and central bank coordinate operations to accommodate both the fiscal operations of the Treasury conducted by the central bank as the government's fiscal agent with the monetary operations of the central bank. This is coordinated so that all accounts stay in balance, which means that spending is always funded using government liabilities as the spending occurs.

The key to understanding this is that "the government neither has not does not have money." The government as monetary and fiscal authority issues the currency, determines monetary and fiscal policy, using its agents, the Treasury and central banks to carry it out in accordance with law and regulation.

Central banks are usually delegated as the fiscal agent of government having the authority and responsibility for issuing the currency. This means that the central bank is not limited in the amount it can credit to its liabilities. That is, as the currency issuer the central bank does not have to get money elsewhere. 

The Treasury does not have money either since credits to its account at the central bank do not count toward any measure of money. Moreover, the doesn't have to get money from the central bank to spend. The Treasury directs the central bank to credit non-government accounts in accordance with the government appropriations. Like the liabilities of the central bank that constitute bank reserves, the numbers in the TGA are simply accounting entries used to compute the fiscal balance from the income statement and balance sheet and show sources and uses of funding. 

The Treasury and central bank coordinate operations to ensure that accounts balance as operations are conducted. From the logical point of view, spending must precede taxation and securities purchases, since government only accepts its own liabilities in the payments system operated by the central bank. Currency users have to get these liabilities, whereas government is the currency issuer. From the temporal point of view, accounts are debited and credited simultaneously so that they are always in balance. There is some intra-day leeway but all accounts must balance at the close. 

Another key point is that government liabilities held by non-government are non-government financial assets. Since the liability is on the side of government, these financial assets held by non-government constitute non-government net financial assets in aggregate, that is to say, non-government financial wealth the funding of which is government liabilities.

Triple Crisis
Quantitative Easing vs. Fiscal Policy
Philip Arestis and Malcolm Sawyer


Jose Guilherme said...

From the logical point of view, spending must precede taxation and securities purchases, since government only accepts its own liabilities in the payments system operated by the central bank. Currency users have to get these liabilities, whereas government is the currency issuer

It's true that newly-issued government securities have to be bought by base money - but isn't it the case that this base money could also be created "on purpose" by the Fed via advances to the primary dealers who then proceed to buy the securities?

In such a case, the sale of said securities didn't require previous spending by government, only previous advances (credit) by the central bank.

Tom Hickey said...

isn't it the case that this base money could also be created "on purpose" by the Fed via advances to the primary dealers who then proceed to buy the securities?

Yes, but the Fed says it doesn't do that directly.

However, the Fed as lender of last resort always ensures that there is sufficient liquidity available to clear all transactions in the payments system by members in

Jose Guilherme said...

Could we perhaps put it this way, then?

"Spending by the government or lending by the central bank must precede taxation and securities purchases".

Tom Hickey said...


But in the US, the Fed lends against acceptable collateral which is tsys and tsys are purchased with rb. So banks have to have rb to purchase tsys for collateral to borrow from the Fed.

But if the bank comes up short required rb at the end of a period, the Fed will lend automatically at the penalty rate so that all transactions always clear.

So I think that the Fed would say that it doesn't lend directly to purchase tsys.

The Fed says that the PDs don't purchase tsys at auction directly from the Fed but by using a "correspondent bank." It seems that the Fed can ensure indirectly that the correspondent bank has the rb to clear.

Jose Guilherme said...

Since the crisis, U.S. commercial banks have also been holding billions in accounts at the Fed as a result of the Fed purchasing non-government securities such as MBS.

In Europe, it's even more straighforward now: the ECB has been purchasing bonds issued by private sector corporations directly at issuance, it does not even go to the secondary market for purchases.

So on both sides of the Atlantic hundreds of billions of dollars and euros (that is, reserves - base money standing at the top of the monetary pyramid) have been created by central banks making advances to private entities.

Under such circumstances, it's unlikely that the central bank will need to advance reserves for banks to be able to buy newly-issued government securities.