Monday, June 25, 2012

Why can't the Treasury borrow directly from the Fed

Hat tip to Scott Fullwiler.

Marriner Eccles, Chairman of the Board of Governors of the Federal Reserve System 1947:

There was a feeling that this [Fed overdrafts to the Treasury's General Account] left the door wide open to the Government to borrow directly from the Federal Reserve bank all that was necessary to finance the Government deficit, and that took off any restraint toward getting a balanced budget. Of course, in my opinion, that really had no relationship to budgetary deficits, for the reason that it is the Congress which decides on the deficits or the surpluses, and not the Treasury. If Congress appropriates more money than Congress levies taxes to pay, then, there is naturally a deficit, and the Treasury is obligated to borrow. The fact that they cannot go directly to the Federal Reserve bank to borrow does not mean that they cannot go indirectly to the Federal Reserve bank, for the very reason that there is no limit to the amount that the Federal Reserve System can buy in the market. That is the way the war was financed.

Therefore, if the Treasury has to finance a heavy deficit, the Reserve System creates the condition in the money market to enable the borrowing to be done, so that, in effect, the Reserve System indirectly finances the Treasury through the money market, and that is how the interest rates were stabilized as they were during the war, and as they will have to continue to be in the future. So it is an illusion to think that to eliminate or to restrict the direct borrowing privilege reduces the amount of deficit financing. Or that the market controls the interest rate. Neither is true.


It boggles the mind to see yet another reminder of how thoroughly this was understood 60 years ago. It's not feasible to imagine that later Fed staff, economists and financiers didn't know this. Most had to consciously choose to not believe it, and therefore to not teach the truth to later students.

Four score years ago, our forefathers set up a workable fiat currency system, with much trivia modified unchanged from the shambles of the failed gold-std. It is our job to see that monetary policy of the people, by the people and for the people does not vanish from the face of the earth?


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Tom Hickey said...

vimothy, at one time the Fed thought that the control stick ever was quantity. Then they thought it was price. Now they are finding that it is neither.

The lever is effective demand and employment, just as JMK had said in the General Theory.

MMT shows why in terms of a macro theory built on operational description of the monetary system, general and specific.

Rather than relying on gratuitous assumptions descriptive of an imaginary world that doesn't approximate the real one we live in.

vimothy said...

Like operations, here's a time and place for polemics, but there's only so far that approach can take you.

You talk now about a macro theory, but that doesn't seem much in evidence here.

Why not read some mainstream economics sometime? You might discover that not everyone is as badly informed as you've been lead to believe.

Tom Hickey said...

vimothy, what do you think is happening wrt Fed ops and monetary policy that is different from what I said, or what MMT economists say?

y said...
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y said...


"No one is disputing the ability of the Fed to peg a rate above the equilibrium rate."

If the fed pays interest on reserves that interest rate is not "above" the equilibrium rate, it IS the equilibrium rate.

In this situation banks will "demand" whatever quantity of reserves the government/central bank supplies, and the interest rate will not change (unless the fed decides to change it).

So, in the model mentioned above, the demand curve shifts to the right as reserves are added (net) and shifts to the left as reserves are subtracted (net). The interest rate will not change (unless the fed decides to change it).

y said...
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y said...


"If the government finances its deficit by creating reserves, which it then pays the banking system to hold, then it is only financing by money creation in a very narrow, semantic sense."

The government does not need to pay the banking system to "hold" the reserves.

The reserves will simply sit in the banking system unless they are withdrawn as cash, or taxed or borrowed away by the government (or as loan repayments to the fed).

Why would the banks want to withdraw the reserves as cash?

The banking system will hold those reserves whether the central bank pays interest on them or not.

Interest is a bonus.

Again, my understanding. Please correct if wrong, Cheers.

y said...


"It is still financing its deficit by issuing interest bearing liabilities. The difference is that these liabilities are at a much shorter average maturity and the nominal interest payments on them move one-to-one with the target rate."

There's a difference between a government debt and a government liability in the form of reserves or cash.

If the government takes on a debt (issues a bond) it is making a promise to pay the creditor a certain quantity of money by a certain date.

If the government issues a liability in the form of reserves or cash, it is making a promise to subsequently accept that same liability in the payment of taxes, fees or loans owed to the government.

That's quite a difference.

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