An economics, investment, trading and policy blog with a focus on Modern Monetary Theory (MMT). We seek the truth, avoid the mainstream and are virulently anti-neoliberalism.
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Friday, July 6, 2012
Jobs, the Fed and a real simple way to eliminate our debt
The Fed can't do anything to stimulate demand or create jobs, however, there is one very simple thing it can do to eliminate our supposed debt.
Let's see if I understand this correctly -- if the Fed shreds the T-bills it holds, that eliminates the government obligation.
But if the Fed holds the T-bills to maturity, don't the proceeds get swept back to the Treasury ? Seems like the net effect on the Treasury would be the same ?
I believe there is a legal limit to how much debt the Fed is allowed to purchase, otherwise they could "finance" the debt as was done in WWI ?
A visualization of how loans create deposits attached. There's a better visual out there somewhere, but this was the best I could find on short notice.
Correct. Absent any new issuance by the Treasury, the entire "debt" would eventually be replaced with cash balances. The so-called debt would disappear. So you see, Treasury "debt" is nothing more than "term" dollars. It's not really debt in the first place.
I think the main supposed channel for QE is not actually increased lending, but portfolio rebalancing. The effect of investors moving out of bonds and cash and into other assets, like corporate bonds and equities is supposed to have a stimulatory effect, whilst also bringing down the cost of corporate borrowing.
This bank of englan paper covers it in quite a lot of detail, including BoE estimates of the effects of QE. It's worth a read.
Joe, Banks loan to creditworthy customers. There are reserve requirements that must be met so when those customers spend those loans, the checks will clear. After the loan is made, if the bank is short reserves, it must obtain them either from other banks or from the Fed. In the current environment, banks are sitting on reserves, but a few years ago, when credit was booming, the Fed would provide the reserves necessary to make sure all the checks would clear. The important point is that banks do not lend reserves. They lend to worthy customers and meet reserve requirements after the fact.
OK, I think I get it completely now. Thanks Mike. But I'll play bust-nuts with verbage here, it's not the loan that creates the reserves, the loan creates a shortage of reserves which puts upward pressure on interest rates forcing the fed to supply more reserves to hit their target. All correct?
Dan, I get that loans create deposits, but deposits are a bank's liability and reserves are an asset, so it was specifically the link to reserves I was wondering about.
"Loans create deposits" on a bank's ledge simply through the entries. Most loans are drawn for immediate use, so a check is written on the deposit account. If it is not netted by being made to another account holder at the same bank, it has to clear in the interbank settlement system operated by the Fed and settlement takes place there in reserves. So a deposit creates the need for reserves and if the bank doesn't have excess reserves or doesn't obtain them during the accounting period by borrowing in the overnight market, then the Fed as lender of last resort loans them at the penalty rate to the bank.
So deposits only create reserves in the sense of generating accounting entries in the Fed spreadsheet wrt member banks' accounts at the Fed.
The Fed sets the interest rate. It adds and drains reserves to keep the rate where they set it. Hence, treasuries going back and forth between the books of the Fed and the banks.
The only significant effect that QE can produce is by lowering borrowing rate out on the yield curve, stabilizing housing, encouraging corp borrowing for investment in capital goods in the absence of demand for consumer goods, forcing saving in riskier assets by withdrawing tsys, thereby driving up asset prices higher than they would be otherwise through leverage, supposedly resulting in a wealth effect that encourages more consumer spending. The Fed is manage to prop up housing somewhat and drive equity prices higher than they would have been otherwise.
On the other hand, the mainstream idea is that QE would stimulate the economy through increasing inflation expectations by adding to the monetary base and increasing money supply through the money multiplier. See how well that worked.
"it's not the loan that creates the reserves, the loan creates a shortage of reserves which puts upward pressure on interest rates forcing the fed to supply more reserves to hit their target. All correct?"
Yes, though apparently when banks make loans and end up short on reserves, they effectively become overdrawn on their reserve account at the fed. This means that reserves are added automatically as needed by banks and then paid for in retrospect, as with any overdraft.
So in a sense, banking lending creates reserves automatically too, in the form of an automatic loan (overdraft) from the fed.
This is how Warren Mosler described it in reply to a question at his site:
"Bank deposits are the accounting record of the liability associated with loans. So when a bank lends you $100 they might at the same time enter the number ’100′ into your checking account. But the loan didn’t do the entering of the 100 into your account per se. The 100 liability is the accounting record of the loan. Liabilities are accounting records of assets, etc.
When you account for something you don’t exactly ‘create’ it the way the word ‘create’ is generally understood - making something out of something else, etc. What I mean by allowing banks to create reserves is that regulation allows banks to make loans and corresponding deposits that it will accept for payment of taxes, recognizing that they are allowing that bank to incur a reserve deficiency in the case of reserve requirements. Additionally, when the Fed ‘clears a check’ it’s allowing the possibility of the account debited to be overdrawn which is also the possibility of a loan from the Fed."
Tom, And Twist was taking higher yielding longer term notes out of the economy as well. Even more "profit" for the Fed to turn over. Not very stimulating. The confidence fairy is thoroughly bored.
But if the Fed holds the T-bills to maturity, don't the proceeds get swept back to the Treasury ? Seems like the net effect on the Treasury would be the same ?
In principle, Dan, only the interest gets swept back to the Fed. So, if the Fed doesn't shred the debt, then principle payments must be made from Treasury to the Fed, and these balances are not replenished absent tax revenues unless the Fed chooses to replenish them.
Of course, the Fed always can can replenish them, because it can buy as much government debt as it wants to, so the Treasury can continually roll over this intergovernmental debt indefinitely.
By law, the Fed has to buy this debt on the open market, and so Treasury has to find a private buyer first. But the Fed can guarantee that Treasury always can find these buyers. Think of it this way: If you have $1000, no matter what state the dollar is in internationally, you will always prefer $1001 to $1000. So if Treasury issues a security of any kind with a price of $1000, and the Fed lets it be known that for anybody who buys that security for $1000 on Monday, the Fed will pay $1001 on Tuesday, then the Treasury will always be able to sell that security.
The yield doesn't even really matter here. But just to reassure people, the Fed can make sure that Treasury can offer as low a yield as it wants on the instruments the Fed is willing to buy.
Mike, I agree that the Fed could buy up all the debt out there and then shred it, and that such a move would get rid of the debt. However, the debt it holds is an asset of the Fed and a liability of the Treasury, so if the Fed does that it destroys some of its own assets. Would Bernanke feel free to do that? He has the rest of the Board to answer to and that Board is composed of a good many private sector bankers. Will they agree to allow the Fed to destroy its own assets? I don't think so.
So, I think this variant of Ron Paul's solution won't work, because the Board of Governors will think that financial responsibility demands that they safeguard the value of Fed assets.
OTOH, if the President minted the $60 T coin and had the Mint deposit it in its PEF account, then, since its legal tender the Fed would be forced to generate $60 T in electronic credits and mark up the PEF account. The Treasury could then seep the seigniorage profits into the Treasury general Account, and Treasury could pay off the $6.7 of intragovernment debt including the debt held by the Fed in days. The rest of the debt could then be paid off as the debt comes due, leaving about $44 T in the TGA to be used for deficit sending.
The PPCS scheme requires the decision of only one man, the President of the US. That's why it's the most practical of the current alternatives for getting rid of the debt.
When the Fed's balance sheet shrinks, the monetary base shrinks.
Imagine that the Fed's portfolio consists entirely of t-bills, maturing next week. Then, next week, it hands back the principle payments to the treasury.
That action necessarily requires that the Fed withdraw the entire base from the economy.
Joe, I think the idea of Treasury securities as Fed assets is a bit of an accounting fiction. Think about it: each Treasury security is a promise to pay a certain number of dollars. And each dollar in circulation is officially a liability of the Fed. And the fed can create these so-called liabilities at will, and at no cost. So each Treasury security held by the Fed is a promise for another arm of the government to deliver back to the Fed a think which the Fed can create at will.
For the arm of the government that is entitled to create money, it doesn't matter how many promises of money receipts they hold. Central banks view their balance sheets and so-called positive or negative equity as an accounting tool for managing price stability.
The only reason the Fed might not want to destroy government debt is that by destroying that debt and destroying all those Treasury liabilities, the rest of the government is then in a position to cancel muchos tax obligations. That means people spend a lot more. The Fed might not like that because they might judge it to be inflationary. And the financial system the Fed oversees and feeds might not like that because that means the real value of their loans drops in value.
Dan K"the idea of Treasury securities as Fed assets is a bit of an accounting fiction
It is an accounting fiction necessitated by the separation of the cb and Tsy functions,which is operationally unnecessary and the function could just be formally consolidated under Tsy, eliminating the independent cb command system for micro-managing the economy from on high.
Tom, I don't think that particular accounting fiction is necessitated by the division of Treasury and the Fed. I think the fiction is mainly due to a political decision to misleadingly present the Fed - which is a branch of government which runs the Federal Reserve system - to the public as just another private "bank" with its own capital requirements, assets and liabilities. This keeps the public, accustomed to the free market mythologies of America, from recognizing that the banking system is run by the government. It also keeps them from recognizing the true nature of their own monetary system.
That is true too. Because the Fed and Tsy are separate institutions they have to maintain separates sets of books, even for intera-governmental transactions. But the institutional arrangements are determined by Congress with the approval of the president unless the president's veto is over-riden. So it is the case the present rather convoluted arrangements are politically imposed, and we can assume there is a political agenda behind it since it doesn't conform to the operational reality of a non-convertible floating rate system in general. I assume it is to mimic the gold standard.
This keeps the public, accustomed to the free market mythologies of America, from recognizing that the banking system is run by the government. It also keeps them from recognizing the true nature of their own monetary system.
Not sure that is the case. I would question whether the public has much of a clue about these things, and if you ask people were the money comes from, most say "the government" rather than the Fed or the banks.
Dan and Tom I certainly agree with what you've said, but that doesn't change the accounting rules. When the Fed buys Tsys from whatever source, those Tsys become assets. To rip them up, you have to get the consent of the Board of Governors. I don't believe that consent will ever be forthcoming. I know as well as anyone that it's all a ridiculous fiction; but the fiction is the way it is, and I don't think there is legal way around it in spite of all of our fine analysis showing that it is a fiction.
So, the alternatives remain to get rid of the debt subject to the limit, if that's what we want to do. They are:
1. The Fed destroying the debt instruments it buys with its money from thin air. This alternative isn't feasible so long as private interests are on the Board of Governors of the Fed, and as long as the Fed Regional Banks are private organizations owned by banking interests, even if they are also federal instrumentalities.
2. Moving the Fed into the Treasury Department. This would move the reserve creation function into Treasury, and is the elegant solution to the debt problem. But to get this done Congress must legislate. They will never do this in the short run.
3. There's PPCS. Its use is up to the President alone. This President may not do it; but it is still the easiest and quickest way to the political problem posed by the debt-subject-the-limit.
4. There is beowulf's consols idea, issuing securities without a date for repayment of principal. Of course, consols would be debt. But as a matter of Fed accounting rules, they would not represent debt-subject-to-the-limit. This is a practical alternative to PPCS, because Treasury can issue consols on its authority; so it comes down to only the President.
I don't think, however, that this alternative is as good as the PPCS alternative. the reason is that consols cannot be issued to replace all the debt in the short run. That means Congress will see the process of raising money using consols unfold and they will have time to close the loophole that allows consols. On the other hand, with PPCS, once the President uses the a really big coin like the $60 T coin, the filling of the public purse with enough credits to pay down all the debt and cover deficit spending for perhaps 20 years is a fait accompli, and Congress would only be able to close the barn door, after the cow has left.
It wouldn't do any good Vimothy; but it wouldn't do any harm either. A central bank doesn't really need financial assets to do anything it does. In the conduct of monetary policy, the only reason the central bank cares about the money that is owed to it is because those promise represent money that is scheduled to be extracted from the private sector. If you pay the central bank a billion dollars and the bank credits the billion to its own account, the monetary policy impact would be just the same if the Fed deleted a billion dollars from your account but did nothing to its own account.
What would it matter if the central bank has a millionty-trillion dollars of negative equity? Its ability to make payments and create or destroy money is not dependent on the condition of its balance sheet. It can't go bankrupt.
Not sure that is the case. I would question whether the public has much of a clue about these things, and if you ask people were the money comes from, most say "the government" rather than the Fed or the banks.
I don't know if that is true. If you ask the Austrians, they seem to say that "true" money comes from holes in the ground, and that the money the government makes is "counterfeit".
I don't know if it is accurate to say that the regional Fed banks are owned by private interests. This is from the Fed's own web site:
The Federal Reserve System fulfills its public mission as an independent entity within government. It is not "owned" by anyone and is not a private, profit-making institution.
As the nation's central bank, the Federal Reserve derives its authority from the Congress of the United States. It is considered an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.
However, the Federal Reserve is subject to oversight by the Congress, which often reviews the Federal Reserve's activities and can alter its responsibilities by statute. Therefore, the Federal Reserve can be more accurately described as "independent within the government" rather than "independent of government."
The 12 regional Federal Reserve Banks, which were established by the Congress as the operating arms of the nation's central banking system, are organized similarly to private corporations--possibly leading to some confusion about "ownership." For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.
It seems to me that the so-called stock is not really an ownership stake, but a kind of pay-to-play fee. In effect, the member banks are licensed to operate by the Fed regional banks, which are the regional arms of a government agency. The "stock" gives few of the usual rights over the the regional banks, but is a kind of licensing fee. The "dividends" are certain amounts of dollars the Fed creates each year and provides to these licensed entities.
The Fed is sometimes said to be "private" because does not require public funding. But that is only because Congress has delegated its constitutionally provided money-creation authority to the Fed. But every dollar the Fed creates is officially a liability of the US Government, so that is public funding.
Again, I think that's right, Dan, and I don't want to over-emphasize the significance of the stock ownership. It doesn't mean that the regional banks are controlled by the members. However, I do think there is a financial interest involved in the ownership and that the regional banks cannot just destroy balance sheet assets without facing Court challenges by their stockholders, because that asset destruction must have some impact on the balance sheets of the member banks.
It seems strange to propose something on the basis of it not making any difference.
One reason that it might matter is that people might value the Fed's liabilities according to the value of its assets. (This is sometimes known as backing theory.)
There are no monies, a far as I know, whether private or public, that are not backed by assets. To me this suggests that backing assets provide some useful function, and that the bar that needs to be cleared if one wants to do away with them must be set higher than, "I can't think of any reason why not".
Debt that is held by the Fed against base money is effectively government debt financed at the nominal interest rate on money, which is zero (ignoring the current ROIR). As such the government is already doing as well as it possibly can in nominal terms. This debt can be rolled over indefinitely--for as long as there is demand for base money. So the government's fiscal position is not improved if the Fed destroys the t-bills etc in its portfolio.
There is also the issue of how the Fed could perform its operations without the use of assets with which to make trades. If the Fed wants to contract the base, today it instructs the manager of the System Open Market Account to sell some bills. If it has no assets to sell, how does it contract the base?
You may be able to see it, but no one in leadership at the Fed can see that they are out of Schlitz, their intelligence is being darkened.
QE is all that these monetarists have left now that they are at zero %, and above Ralph has a good link to an article by M Friedman where he was recommending QE for Japan back in 1997 based on the moron belief that "banks lend out the reserves".
I guess they could go to negative rates, but Bernanke I believe has said he is against that because it would shut down the Fed Funds market....
The monetarists are being made hard core morons... I believe many if not all are closet lovers of gold and perhaps refuse to jettison their false paradigm because their "quantity theory" framework would make it easier to slip gold back in as the basis for the USD a la Ron Paul.
Warren has often commented that all of this falseness is based on a gold standard paradigm, and now I may finally see what he means in this regard....
Tom linked up an obituary for Anna Schwartz (M Freidman's spouse) the other day, posted by the "Mexican Hat Dancer" Chris Whelan over at zerohedge (lots of gold love over their btw) that extolled the virtues of Anna's appointment to a panel back in the 80's that was recommending a return to the gold standard.
Looks like there is a direct connection between monetarism and gold...
Whelan has been a person you have had a hard time convincing and based on the fact that he would choose to promote Schwartz's gold advocacy in her obit, I would have to assume that Whelan himself probablysupports a move back to gold.
This gold issue is the only thing I can currently come up with wrt the causation of this insanity... if they admit to themselves that all of this monetarism is false and that fiscal policy under a FFNC regime is the only way out of this, then kiss their hopes for a return to gold goodbye for quite a long time...
One reason that it might matter is that people might value the Fed's liabilities according to the value of its assets. (This is sometimes known as backing theory.)
Really, Vimothy? Where are these people? Do you value the Fed liabilities in your wallet according to the value of its assets?
The Fed's assets are securities promising payment of the very same dollars which are it's so-called liabilities. Those dollars aren't redeemable for anything but other dollars. So can it possibly be the case that the value of the liabilities is backed by the assets?
The role of the assets in the system is a price stability management role. The value of dollars in exchange depends in part on how many of them are in circulation, and the Fed buys and sells financial assets to regulate flows of dollars into and out of the private sector, including via the public treasury. The Fed cares about obligations others have to pay the Fed, not because it needs the money and is financially constrained by its assets, but because it has a monetary policy, and the monetary obligations people have to the Fed are part of the way it executes that policy.
That's not to say that it makes no difference to the person who has promised payment whether the Fed cancels that obligation. Since all of the rest of us have real financing constraints, it makes a big difference to us what we owe, and what we are owed. So if the Fed tears up some asset, the Fed is no worse off or better off than it was before. But the person whose liability that asset is? That person is relived from a real financial constraint.
If the owner of the liability is the public treasury, then in principle it shouldn't matter much. Public debts are the obligations of the government to itself, which a real constraint on public spending only to the extent that the government decides to make them so. If the central bank acts independently within the government, then those public debts only become constraints on future spending to the extent the central bank decides to employ them as such, rather than rolling them over automatically and indefinitely. And the independence of the central bank is only a relative independence, since it is established and maintained by the legislative branch.
But cancelling government debt to its own central bank might be useful from time to time both as an act of monetary policy, and as a way of granting psychological relief to the public, since many people do not understand the nature of their own monetary system.
You pose the question as if its absurdity were self-evident. But in fact, if the Fed were to buy worthless assets, or (somehow) hold no assets against its liabilities, I think it would be quite reasonable to revise their value downwards. I’m not a finance person, but shouldn’t the value of an entity’s liabilities be related to the value of its assets?
If this is not the case, by implication it must be that base money is a pure bubble—it is a liability that people value only because it is a liability that people value.
When considering this alternative explanation, I am struck by the following: one, that it is not obviously less ridiculous from a common sense point of view than backing theory, and two, that as soon as one assume its truth, some observed facts of central banking practice immediately seem weird and inexplicable.
In practice, what backs Fed money? Government debt. And what is government debt? It is a promise of future income generated by the government’s assets, the main component of which its (net) fiscal asset, i.e., its ability to tax the population. This seems close to an MMT understanding of the value of money (and also to a mainstream approach known as the Fiscal Theory of the Price Level).
Incidentally, Thomas Sargent wrote a famous paper about this topic that is quite germane: “The Ends of Four Big Inflations”.
http://www.nber.org/chapters/c11452.pdf
It’s hard to see what the upsides might be, though. Debt that is carried by the Fed is already effectively money financed, so the benefit to the government’s fiscal position would be nil.
One of the reasons for double entry accounting is accuracy in keeping track. Another huge one is making sure that money doesn't "just disappear" by "ledgerdemain" aka cooking the books. And everything is traceable to the journal entries that get posted to the general ledger. So even within government where the accounting is "fictitious" in the sense that government issues the money, there are tight controls on where everything comes from and where it goes.
Where does the Fed get is capital? Who would recapitalize the Fed if it hits negative equity? Treasury.
Where does Treasury get the reserves to cover its expenditure from its Fed account? The Fed
vimothy, Of course it makes a difference. But that difference is political. Paying off the debt without using government "surpluses" removes the debt issue from the political table without constricting the private sector And that difference is critical in increasing the political leverage progressives have to push Medicare for All, Federal Job Guarantees, State Revenue Sharing, elimination of FICA while still expanding the Social Safety Net, funding a massive expansion in alternative energy supplies, reconstructing our failing educational system, and all the other things we need to do to make the United States the land of equality of opportunity, rather than the land of plutocracy again.
Sort of like "what if there's a dollar crises and the US has to go to the IMF." Where do you think the the IMF gets most of its funding? Right. The US.
Central bank and treasury liabilities can both be seen as ultimate liabilities of the sovereign on a consolidated sovereign balance sheet. Then, sovereign financing is obtained from a mixture of money and debt instruments.
This does not equate to the sovereign financing itself, as Tom seems to suggest. Typically, the sovereign will finance some portion of its total debt with money creation—in the US in normal times, this is about 1/15th of the whole.
Matt, Rose Friedman is rolling in her grave. Such a thing you say. Oy, no wonder Anna had that funny look when she and her husband were over for dinner. Feh, her Milton would never sleep with that nafka.
In a non-convertible system floating rate system "sovereign financing" is petty meaningless since the unit of account a govt liability ("IOU") that the govts issues without operational constraint — although institutional rules may be imposed politically that limit this inherent capacity as long as the rule is in effect. Typically, the rules are bent as needed ini order to increase policy space.
Banks have a govt franchise for money creation, and to the degree that govt doesn't guarantee the banks' liabilities incurred in the process of doing so, these firms put their own capital at risk in making loans and in the event of defaults they either have to obtain more capital or else they become insolvent and are put into resolution.
I'd say from an MMT perspective Fed liabilities are backed by the government's ability to tax, i.e. by its ability to impose a 'debt' (tax liability) on people and organisations within its jurisdiction.
Fed liabilities are also government obligations.
When a commercial bank makes a loan, the deposit it creates (the bank's liability) is 'backed' by the borrower's debt (the bank's asset). It's the same thing with Fed liabilities (which are government obligations, i.e. government liabilities) - except that the debt is imposed unilaterally as a tax liability by the government.
"If the Fed wants to contract the base, today it instructs the manager of the System Open Market Account to sell some bills. If it has no assets to sell, how does it contract the base?"
It doesn't have to contract the base to change interest rates.
If it wanted to contract the base and didn't have any treasury bonds on hand, it could possibly offer term (saving) accounts to member banks, which would earn higher interest than the base (reserves).
I find the idea that sovereign financing is meaningless a bit bewildering. It seems to me that it has a fairly straightforward meaning.
As can be seen from a comparison between net money creation and government expenditure in any given period, it's clear that governments generally obtain funds from sources other than the issuance of base money.
"When the Fed's balance sheet shrinks, the monetary base shrinks."
Isn't that simply because when it sells bonds in an open market operation it withdraws reserves from the banking system (i.e. swaps bonds for reserves)?
If however the fed hands the principal payments on government debt back to the treasury, this has no effect on the quantity of reserves in the banking system (the monetary base).
Y: "I'd say from an MMT perspective Fed liabilities are backed by the government's ability to tax, i.e. by its ability to impose a 'debt' (tax liability) on people and organisations within its jurisdiction."
Currency ("state money") is govt liability and a non-govt tax credit. Warren Mosler.
In a no-bond system, if the govt wished to set the rate above zero, then it would use IOR, which is the straight forward way to do it, instead of the present convoluted system.
I was making the point that for commercial banks, a borrower's debt is the bank's asset. This asset can be said to 'back' the bank's liabilities (deposits).
The government's asset is the tax 'debt' it imposes on the population (or rather its ability to do so). This can be said to 'back' its liabilities (currency).
"As can be seen from a comparison between net money creation and government expenditure in any given period, it's clear that governments generally obtain funds from sources other than the issuance of base money."
The government includes the treasury and the fed.
The treasury obtains funds either by taxing or borrowing. But the funds it taxes or borrows originally come from (are issued by) by the fed.
So one part of the government essentially gets it funds from another part of the government.
The banks are backed by their capital. A fiat currency is defined as without backing other than "the full faith and credit of the country," which means exactly what legally in terms of backing. the US government doesn't need to tax to get USD because it is the currency issuer. The tax simply gives value to the currency by creating a need for it to meet non-govt obligations imposed by the US govt — taxes, fines, tariffs and fees.
y: "So one part of the government essentially gets it funds from another part of the government."
Right. This is the sleight of hand that confuses people. It's just shifting from one hand to the other and back repetitively, with the third hand of the PD's in there as the third shell in the shell game.
Here’s a simple example. Say we have three balance sheets: private sector, government and central bank. The private sector has $1 assets and $1 tax obligation due at the end of the period. The central bank has $1 zero coupon government bond maturing at the end of the period as assets and $1 as liabilities. The government has $1 tax asset and the $1 bond as liabilities.
The private sector pays its $1 tax. Its assets and liabilities go to zero. The government pays the central bank the $1 for the bond. Its assets go to zero. But the central bank now has no assets and no liabilities outstanding either. So its assets and liabilities are also zero.
The central bank could then if it chose to, issue more liabilities, and credit them to the treasury. Then the treasury acquires another liability and the Fed acquires another asset. Let’s say that it does this to the tune of $1. The Fed’s balance sheet is back to its original size and so is the monetary base.
If the fed were to hand back the bond principal to the treasury (in the way that it hands back interest payments on bonds to the treasury), why would this lead the treasury to incur an additional liability?
You’ve added an additional step! It was the treasury’s liability. The Fed does not owe the treasury $1.
The treasury obtains funds either by taxing or borrowing. But the funds it taxes or borrows originally come from (are issued by) by the fed.
So one part of the government essentially gets it funds from another part of the government.
Although it’s easy to see why you might think this, it’s not actually true.
At any point in time in the economy, there are flows of income and expenditure. Very broadly, the income in these flows is consumed, taken in taxes or saved. Taxed income finances government expenditure directly. Saved income is then allocated across different types of assets, one of which is government debt. And so saved income also finances government spending.
You are being misled by the fact that the central bank issues the particular type of financial asset used for final settlement with the government. This is only a financing flow with respect to the actual stock of government debt held by the central bank (and not at all with respect to taxes or other sources of funds). The rest of the debt is not financed by central bank money issuance.
Thanks for your comments--always appreciate the way you tear the veil from the governmental masquerade.
De facto the Fed serves the interests of Wall St., as does the entire government. Our government is "privatized" or "corporatized." and thus it is also a plutocracy, an oligarchy, a kakocracy, and a "lobbocracy," depending on the angle of vision. It is also what has been termed "friendly fascism"--now morphing into "less friendly fascism," soon to become "unfriendly fascism," judging by the wholesale slaughter of the Constitution, the rise of surveillance and the security state, monstrous Pentagon and armaments industry ,and militarization of police, rampant corruption--above all the financial octopus everywhere-- corrupt, spineless Congress, bought President, Supreme Court rubber stamp circus, etc. Buena suerte, Americanos!
vimothy, "Bank capital is basically the difference between the value of its assets and its liabilities, correct? loans, esp. mortagages form part of a bank's capital, as does equity. other assets that form part of bank capital: govt debt and cash/ reserves.
Yes, assets minus liabilities equals equity. And bank regs don't rate all capital at nominal value but risk weighted. Mark to market is also different from mark to model.
The credit a bank extends puts a bank at risk of losses, both actual through default and non-performing loans, and nominal losses in terms of mark to market if that rule is in force. The mark to market rule was suspended to save many banks that would otherwise have been technically insolvent.
There are also issues with shadow banking that is not on the books of banks and therefore not regulated but which do have an effect on bank solvency.
Noe of the his applies to any govt agency, all of which are funded by appropriations and then Treasury and the Fed handle the details of money creation.
Looks like Friedman was not for gold but Schwartz tho not adamant, does look like she favored use of gold in some way...
Apologies for wrong marriage assignment again but the issue remains monetary vs fiscal policy and the related broad public/govt/academic ignorance of the true nature of public "debt", which none of these people gets right...
"You are being misled by the fact that the central bank issues the particular type of financial asset used for final settlement with the government. This is only a financing flow with respect to the actual stock of government debt held by the central bank (and not at all with respect to taxes or other sources of funds). The rest of the debt is not financed by central bank money issuance."
I understand that reserves are only used in settlement.
If depositors at bank A owe the treasury a total of $100 in taxes and the treasury owes the depositors at bank A a total of $99(wages, benefits etc), then when they settle bank A will transfer $1 in reserves to the treasury.
If however the depositors owe the treasury $100 and the treasury owes them $0, then when they settle bank A will transfer $100 in reserves to the treasury.
The reason such small quantities of reserves are needed in settlement in general is that all the transfers cancel each other out and only the difference needs to actually be transferred.
If the government were running a large budget surplus, then the banks would presumably have to sell more of their government bonds to acquire the additional reserves with which to settle tax payments with the treasury.
The funds for government spending aren't created by the non-government sector, however the fact that payments between govt and non-govt cancel each other out means that only small quatities of reserves are usually needed.
"You’ve added an additional step! It was the treasury’s liability. The Fed does not owe the treasury $1"
Ok, but under current arrangements the fed hands the interest it receives on govt bonds back to the treasury, even though it doesn't 'owe' this to the treasury.
"under current arrangements the fed hands the interest it receives on govt bonds back to the treasury, even though it doesn't 'owe' this to the treasury."
This alone should put to rest forever how the system actually works. This was not always the case and then Congress decided to change the rules. The accounting follows the rule that Congress prescribes.
(1) The public pays its taxes and buys government securities using money issued by the central bank. (2) This central bank money is created when the government spends. Therefore, (3), all the funds used to pay taxes and buy government bonds come from government spending.
the agency was funded by a federal grant: finance, pay for, back, capitalize, sponsor, put up the money for, subsidize, underwrite, endow, support, maintain; informal foot the bill for, pick up the tab for, bankroll, stake.
funding for the central bank comes from the realm of numbers in the universe - an infinite resource.
The fact that the government chooses to pay interest on the "funds" obtained from that same realm of numbers does not add any "cost" or burden to the operation. Interest paid is a net add to the stock of NFA's in the non-government.
If the government chooses to tax funds back out of the non-government to "pay" for that which costs nothing it is simply choosing to cripple the economic engine that runs on those funds.
The reasoning behind, "The funds to pay taxes and buy government securities come from government spending," is pretty simple. Consider that govt didn't, and that all money in an economy is created by banks hence nets to zero. Then govt takes money out of the economy to provision itself. This is govt creating demand leakage that would result in not all products capable of being produced at FE being sold, so UE results.
Thus the argument is that govt must add at least as much NFA to non-govt as it withdraws in taxes to avoid creating UE.
In an open economy, the govt fiscal balance is determined by the effect that shifting saving desire has on the sector balances. The objective is to run a full employment budget without generating inflation. MMT shows how to achieve this through monetary operational understanding (Mosler), SFC modeling of sectoral balances (Godley), functional finance (Lerner), and the MMT JG (Minsky).
"…This is govt creating demand leakage that would result in not all products capable of being produced at FE being sold, so UE results…"
It would also create liabilities in the banking system that couldn't be satisfied without creating more debt. This has a functional limit, leading to a banking crisis where losses (debt that can't be paid) must be written off, monetized - a back-door currency-creation operation.
vimothy: "So the funding for the central bank's portfolio comes from money issuance, not government expenditure."
The that the cb can do is increase and decrease numbers on its spread sheet, doesn't change the amount of non-govt financial assets only the composition of those assets. Changing the amount is by definition fiscal and the cb doesn't do fiscal other than marginally, like paying IOR if it chooses.
paul:"It would also create liabilities in the banking system that couldn't be satisfied without creating more debt. This has a functional limit, leading to a banking crisis where losses (debt that can't be paid) must be written off, monetized - a back-door currency-creation operation."
Right. This is the reason that govt "must" fund at least the amount it withdraw through the taxes it collects. Otherwise, UE become endemic since there are only nine bones for ten dogs and private debt is unsustainable under such as arrangement too. Both of which WM mentions as reasons.
Tom, it's not necessarily about unemployment, just the simple fact that in this system transfers and payments between the treasury and banks have to be settled in 'government-issued' money. So the government has to spend or lend that money for that to be able to happen.
"So the funding for the central bank's portfolio comes from money issuance, not government expenditure."
Money has to be issued in one way or another by one or other branch of the government before the government can collect taxes or borrow in its own currency, which is what it does in the current system.
Tom’s comment at July 10, 2012 2:22 PM is a non sequitur.
His argument is that if the funds weren’t created by the government, taxes and government borrowing would drain money from the economy, causing unemployment. There is no such thing as unemployment; hence, the government funds itself.
Firstly, it’s obvious that we do see unemployment, so the contradiction fails.
It’s also the case that taxes and borrowing don’t drain money from the economy. This is something that MMTers should understand well. The government taxes and spends. The government borrows and spends. In both cases, the private sector ends up with the same amount of money it started with.
Critically, though, Tom is confusing flows of funds with money. Money is created by a process of (in the modern world, bank and non-bank) intermediation. Private sector financial institutions intermediate against illiquid assets to create liquidity. If the government changes its tax rates, it doesn’t affect their ability to do this in any immediate sense.
If the government borrows, then it has to borrow from the saved income of the private sector. The funds that it borrows come from the income generated by the economy. Money is just another asset that is useful in the course of this activity. When the government taxes it is taking income from the private sector. When the government borrows it is taking saved income from the private sector. That is what funding represents: income. Income is denominated in money, but it is not the same thing.
Money has to be issued in one way or another by one or other branch of the government before the government can collect taxes or borrow in its own currency, which is what it does in the current system.
You’re running a bunch of stuff together here and so coming up with something that seems to make sense but is actually misguided.
The private sector needs outside money. The central bank supplies this elastically, leaving demand to determine the actual stock at its target rate.
Government spending has no first order effect on this process, which is undertaken by the central bank. (Specifically, the CB issues outside money against high grade short term notes in repo operations known as open market operations, or OMO.)
The private sector also needs inside money. This is created by private financial intermediaries. In the course of financial intermediation, private financial intermediaries need outside money to settle obligations between themselves, so that you can imagine a Perry Mehrling style hierarchy of money, with outside money at the top.
When the government taxes or borrows “in its own currency”, it doesn’t literally borrow its own currency! That would be weird and absurd. It borrows savings and taxes income denominated in its own currency (and often in foreign currencies as well).
When I buy a bond, I pay using a liquid bank liability, which is denominated in dollars or pounds or euros (or whatever). I don’t literally stuff an envelope full of cash and post it to the treasury department.
This represents a capital flow: the government borrows my saved income.
"In the course of financial intermediation, private financial intermediaries need outside money to settle obligations between themselves"
Ok, so if bank A owes bank bank B $100 and bank B owes bank A $99, then when they settle, bank A transfers $1 reserves to bank B.(?)
But if A owes B $100 and B owes A $0, then when they settle A transfers $100 reserves to B. (?)
It's the same thing with the government.
Only small quantities of reserves are needed for settlement purposes because in general all the payments 'cancel each other out'.
(I apologise for being really simplistic and using imprecise terms) If you want a proper explanation of the MMT view then you should read their work. My explanations are just my own mangled thoughts, no one elses :)
Tom, I read both those years ago, and (FWIW) I would be very surprised if we have different views on money creation.
Money creation is not the issue here. The issue as I see it, ironically enough, is rather that you haven't read Godley-Lavoie (or similar), and so do not have a good grasp on aggregate flows and the way they all fit together in the macroeconomy.
vimothy, if you are correct about this, I apologize for being dense. But I think it is about money creation and will continue to do so until someone from the MMT side confirms that you are right.
Tom, It's only possible for money creation to fund the quantity of government debt that is the held by the central bank. That's straightforward.
Have a look at Godley's transactions flow matrix some time. It's impossible to understand this stuff without some reference to a model of the actual flow of funds in the economy.
Total NFA held by non-govt = total govt liabilities held by non-govt, that is, tys and reserves associated with deposit accts and cash currency.
Individuals and firms can and do borrow from banks to pay taxes, but that private borrowing reduces non-govt NFA since taxes are paid by banks creating a Tsy acct.
Govt creates the amount of NFA it issues in Tsy when it deficit spends, increasing govt liabilities in deposit accounts and while also putting tsys of equal value in the possession of non-govt.
When the Fed acquires tys for its book, it simply changes the composition of non-govt NFA by crediting reserves to non-govt accts in payment for the asset swap.
Total NFA held by non-govt = total govt liabilities held by non-govt, that is, tys and reserves associated with deposit accts and cash currency.
Tom, you're forgetting the main component of NFA--treasury liabilities.
NFA = net outstanding treasury liabilities + CB liabilities held by private sector
When the CB issues liabilities, the total stock of NFA doesn't change. Rather, the private sector holds a different mix of NFA. It holds less treasuries and more base money. That's what an OMO does--it swaps CB liabilities for treasury liabilities (or vice versa).
Say that the stock of government debt is $100 in t-bills. Now say that the Fed swaps that for reserves in an OMO. The government is now financing the same stock of debt at 0% nominal interest rate instead of whatever the t-bill rate was. It doesn't increase its borrowing. total borrowing is exactly the same: $100.
The cb liabilities held by non-govt are of two kinds, those that result from Tsy disbursements that credit non-govt accounts with reserves that the Tsy obtains from the cb, and cb lending to non-govt (FRS member banks) The first increases non-govt NFA when the govt balance is in deficit. Cb lending does not increases non-govt NFA in that that a non-govt liability (loan obligation) is created.
The tsys that the Tsy issues that are held by non-govt are also non-govt NFA. If the Fed purchases (POMO) or borrows (OMO) from banks are just an assest swap of a Tay liability (tys) for a cb liability (reserves). Both are govt liabilities with no corresponding liability in non-govt. That is, they are non-govt assets.
The CB holds the level of reserves wherever it wants them to be, subject to its interest rate target.
Say that the government spends $100. If the spending was funded by taxes, NFA does not increase. If the spending was funded by CB or treasury note issuance (for e.g.), NFA increase to the tune of $100.
Treasury has an account at the Fed, though. Doesn't this mean that when the treasury spends, the private sector ends up with more CB liabilities, regardless of treasury's method of financing?
No. It's obvious that this isn't the case, because otherwise the Fed's balance sheet would grow pari passu with government expenditure. CB liabilities are settlement balances. Banks receive reserves from the Fed as their account holders are paid by the treasury.
What happens to all the reserves? The Fed determines the outstanding stock, subject to its IR target. The only way that the stock of reserves can increase is if the CB expands its balance sheet to accomodate them.
In other words, why doesn't the stock of reserves disappear every month when everyone pays their taxes? Because the Fed is there managing the system. That's its job.
vimothy: The CB holds the level of reserves wherever it wants them to be, subject to its interest rate target.
Right and the cb does this using assets swaps (OMO) that change the composition and maturity but not the amount of non-govt NFA to set price within the desired corridor. As Warren says, its just shifting bank reserves between deposit (reserve) accounts held at the cb and savings (tsy) accounts held at the Fed. Non-govt assets remain the same (other than interest payments, which increase non-govt NFA) after the shift as before.
The interbank system is about liquidity and price. The cb maintains the needed liquidity for settlement at the price it chooses. Tsy is about injecting financial assets into non-govt by disbursements using its liabilties (tsys) in conjunction with cb liablities it obtains from sale of tsys, and also withdrawing them through taxes, fines and fees (although the db can withdraw NFA also through its charges, such Fedwire rent and interest banks pay on loans and injects NFA if it pays IOR. The difference between aggregate injection and withdraw of govt financial assets into non-govt is the "net" in NFA.
This is the difference between monetary and fiscal.
vimothy, In other words, why doesn't the stock of reserves disappear every month when everyone pays their taxes? Because the Fed is there managing the system. That's its job.
Right. According to people who know the operational aspect, the cb and Tsy coordinate closely on a daily basis to ensure that the quantity of reserves in the interbank system is sufficient provides sufficient liquidity for settlement, while keeping price within the desired corridor.
Looks like there's some substantial agreement WRT this sort of stuff. So how do we relate this back to our earlier argument about the government "funding itself"?
“as a point of logic, the dollars we need to pay taxes must, directly or indirectly, from the inception of the currency, come from government spending (or government lending, which I’ll discuss later). Now let’s build a national currency from scratch. Imagine a new country with a newly announced currency. No one has any. Then the government proclaims, for example, that there will be a property tax. Well, how can it be paid? It can’t, until after the government starts spending. Only after the government spends its new currency does the population have the funds to pay the tax. To repeat: the funds to pay taxes, from inception, come from government spending (or lending). Where else can they come from?”
And here’s some more: “For those of you who understand reserve accounting, note that the Fed can’t do what’s called a reserve drain without doing a reserve add. So what does the Fed do on settlement day when Treasury balances increase? It does repos - to add the funds to the banking system that banks then have to buy the Treasury Securities. Otherwise, the funds wouldn’t be there to buy the Treasury securities, and the banks would have overdrafts in their reserve accounts. And what are overdrafts at the Fed? Functionally, an overdraft is a loan from the government. Ergo, one way or another, the funds used to buy the Treasury securities come from the government itself. Because the funds to pay taxes or buy government securities come from government spending, the government is best thought of as spending first, and then collecting taxes or borrowing later.
Note on how this works inside the banking system: When you pay taxes by writing a check to the federal government, they debit your bank’s reserve account at the Federal Reserve Bank. Reserves can only come from the Fed; the private sector can’t generate them. If your bank doesn’t have any, the check you write results in an overdraft in that bank’s reserve account. An overdraft is a loan from the Fed. So in any case, the funds to make payments to the federal government can only come from the federal government.”
As a point of logic, the dollars we need to pay taxes must, directly or indirectly, from the inception of the currency, come from government spending (or government lending, which I’ll discuss later).
There’s something of an equivocation here: we do not generally pay taxes in “dollars”, but in liquid bank liabilities denominated in dollars. In other words, Mosler is jumping between dollars as the medium of exchange and dollars as the unit of account.
I don’t need any “dollars” to pay my taxes.
With that said, it’s true that the banking system relies on a tiny quantity of these dollars as settlement balances—pre-crisis, electronic reserves at the Fed amounted to about $10 billion, or one one-hundredth of the total monetary base. Without these balances, the banks could not settle and the banking system would not function properly.
It’s this tiny quantity of electronic reserves that’s doing all the work in Warren Mosler’s argument, and causing all the confusion here.
Even if Mosler is correct, the amount of dollars needed to pay taxes is quantitatively insignificant: $10 billion out of a total base of $1 trillion and a gross public debt of $15 trillion. The government could never spend again, and the “dollars we need to pay taxes” (i.e., the electronic reserves used for settlement between banks) would still be there, all 10 billion of them, sitting on the Fed’s balance sheet.
It’s not the case, though, that base money originates from government spending. It’s certainly possible to imagine a situation in which it did, but it’s not how most modern governments operate. Base money (of which electronic reserves is a proper subset) is issued by the central bank. The central bank doesn’t spend. (Strictly speaking, spending refers to consumption expenditure.) It’s a bank—it intermediates. It issues liquid liabilities in exchange for assets.
vimothy: "There’s something of an equivocation here: we do not generally pay taxes in “dollars”, but in liquid bank liabilities denominated in dollars. In other words, Mosler is jumping between dollars as the medium of exchange and dollars as the unit of account. I don’t need any “dollars” to pay my taxes.
Taxes are billed the unit of account, and paid in the medium of exchange. You can settle your tax obligation in cash at the govt's payment office, or you can pay by check, in which case your demand account is debited by the bank and the bank settles for you in reserves at the cb as your agent and the cb credits the Tsy account. This may not happen immediately because the Tsy may choose to hold the funds in TTL acct at a private bank to assist the Fed in managing the quantity of reserves. Both cash currency and reserves are govt liabilities that function as tax credits for taxpayers and they are denominated in the govt's unit of account, which in the US is the USD. So, yes, taxpayers pay in "dollars" (US govt currency), which alone is accepted by the Tsy in payment of obligations to the state.
"Note on how this works inside the banking system: When you pay taxes by writing a check to the federal government, they debit your bank’s reserve account at the Federal Reserve Bank. Reserves can only come from the Fed; the private sector can’t generate them."
"It’s this tiny quantity of electronic reserves that’s doing all the work in Warren Mosler’s argument"
Because most payments "cancel each other out" I suppose. Also, the central bank mitigates any changes to the quantity of reserves in the system as the result of taxes/spending etc with OMOs, so as to maintain its target interest rate.
"The government could never spend again, and the “dollars we need to pay taxes” (i.e., the electronic reserves used for settlement between banks) would still be there, all 10 billion of them, sitting on the Fed’s balance sheet."
The federal government collected approx $2.5 trillion in taxes in 2011.
What would happen if it just kept that and didn't spend (i.e. ran a massive budget surplus)? And then did that year after year?
"Base money (of which electronic reserves is a proper subset) is issued by the central bank. The central bank doesn’t spend. (Strictly speaking, spending refers to consumption expenditure.) It’s a bank—it intermediates. It issues liquid liabilities in exchange for assets."
The central bank may be a bank but it is still part of the government.
It issues central bank liabilities in exchange for treasury liabilities (usually). Treasury liabilities are created when the government deficit spends.
Central bank liabilities are government liabilities (in the US they call them government 'obligations), and treasury liabilities are government liabilities. So the cb issues one type of government liability in exchange for another.
Though the CB 'buys' treasuries with reserves, as you say this is technically an asset swap rather than 'spending' by the CB (though it is buying an asset created by government deficit spending).
If the CB buys a non-government created asset, such as gold, then I would have thought that would technically be 'spending'. NFAs are added to the non-govt sector by the central bank directly in this case.
Neil Wilson gave me the following reply regarding this subject:
"The central bank *is* government. That’s the MMT analysis – a consolidated central bank and Treasury balance sheet. That way you don’t get confused with irrelevant excess accounting journals. You get to see the Wood rather than the Trees.
The beneficial owner of the central bank is the treasury, and in many jurisdictions the legal owner is the treasury as well. Therefore a consolidated balance sheet is and entirely appropriate analysis tool.
The government sector has to first buy something from the non-government sector so that the non-government sector has the central bank reserves to settle the tax bill.
That can be a mortgage asset if policy in the government sector deems that suitable.
To clear the repo the non-government sector entity would have to get central bank reserves from somewhere to buy the mortgage asset back. To do that it, or some other entity with a central bank account, would have to sell something else to the government sector.
So you see it is always prior government sector spending that funds the tax bill – one way or another.
Calling the mechanism collateralised loans, Repos, OMOs, operational standing facilities, asset purchase schemes or whatever doesn’t alter the underlying fact. Government sector bought something from the non-government sector in return for government sector money.
y: "Though the CB 'buys' treasuries with reserves, as you say this is technically an asset swap rather than 'spending' by the CB (though it is buying an asset created by government deficit spending).
It's like family members making change, swapping notes for coins. That's not spending.
Suppose a non-family proxy is included to intermediate. Does it become spending? I don't thing soo
Look at what actually happens and don't get confused with words. Govt (Tys) "spending" def= "fiscal" and cb/Tsy asset swap def= monetary. Fiscal changes NFA amount, monetary changes NFA composition/term but not amount.
I think the issue stems from seeing the central bank as an entity somehow divorced from government, operating not according to 'government policy' but to some inherent natural market logic.
I noticed this when reading Lavoie's criticism of MMT. He kept referring to the "central bank" and "government" as totally separate things, not once acknowledging that the central bank is actually part of the government!
I think MMTers often insist on thinking about the treasury and central bank as consolidated because they don't see the separation as 'natural', just as they don't see typical CB monetary policy as 'natural' or bond issuance as 'natural' or believe in a 'natural rate of interest' or 'natural rates of unemployment', etc.
Plus, from their perspective it clears up the understanding of operational stuff.
Taxes are billed the unit of account, and paid in the medium of exchange.
IOW, Tom, you are equivocating. As we all know from experience, nobody pays their taxes in cash. Final settlement between banks takes place in electronic reserves. So from that point of view all purchases are paid for with the medium of exchange—and Warren ought to also write things like “the funds you need to pay for your chicken dinner come from government spending”. In fact, by your argument here, the government "funds" your chicken dinner. And if you follow this argument to its logical conclusion, you are led to believe that neither private wealth in general, nor inside money in particular, exists, and that the government “funds” all activity in the economy, which is prima facie absurd.
By the way, I have to say that it’s hard to see how this slogan will appeal to anyone with knowledge of economics. It’s seems aimed squarely at those for whom the argument: all goods are paid for with money, the government issues money, therefore the government pays for all goods, makes a weird kind of intuitive sense.
He doesn’t really address my criticism, though. Warren Mosler is basically saying that banks need reserve balances with the Fed to settle intra-system debts, which is obviously true and not controversial, and then using equivocation to turn this into a much larger and highly dubious claim about public finance and the role of the government in the economy.
Because most payments "cancel each other out" I suppose. Also, the central bank mitigates any changes to the quantity of reserves in the system as the result of taxes/spending etc with OMOs, so as to maintain its target interest rate.
But the point is that amount of “funds” that are “required to pay taxes” is tiny relative to any fixed point you’d care to choose, and the same as the amount of funds that are required to pay for any item for sale in the economy, since these are final settlement balances for the banking system. If government debt is $15 trillion, then as a simple matter of arithmetic, the $10 billion in electronic reserves held at the Fed will not suffice.
The federal government collected approx $2.5 trillion in taxes in 2011.
What would happen if it just kept that and didn't spend (i.e. ran a massive budget surplus)? And then did that year after year?
A good question: the “funds” that are “required to pay taxes” would still exist, because the Fed controls the level of electronic reserves held by the banks, and this has nothing to do with government taxation and spending programmes.
The central bank may be a bank but it is still part of the government.
I don’t want to get into an argument about semantics. Government spending has a clear and commonly understood meaning. If you wish to redefine “government spending”, to include OMP by the central bank, you make rational discussion of these issues impossible, and concede the substantive point from the outset.
Incidentally, there is nothing wrong with consolidating balance sheets to create a sovereign balance sheet that incorporates the different arms of the sovereign (the most important being that of the central bank and the budgetary government). I do this myself (I even devote a blog to it). It is essential to get a good picture of sovereign risk. But it is beside the point.
If the CB buys a non-government created asset, such as gold, then I would have thought that would technically be 'spending'.
If the CB purchases an asset, it changes the size and/or composition of its balance sheet. It isn’t “spending” and it isn’t “government spending”.
Think of a great circuit going through the economy. Call this circuit “current income and expenditure”. Every time anyone earns or spends, it goes through this circuit. Now think of another circuit navigating a plane orthogonal to the income-expenditure circuit. Call this circuit “funding flows”. Every time anyone undertakes a purely balance sheet operation, acquiring assets or issuing liabilities, it goes through this circuit. (Net assets acquired are equal to the flow of saving, which resolves the two circuits I have described here).
Neil Wilson gave me the following reply regarding this subject
Something that I’ve noticed over the years is that MMTers will often say that MMT is based on a superior understanding of accounting definitions and the operational realities of the monetary system. But then, when people point out some basic flaw in their understanding, the argument shifts immediately to the irrelevance of a pedantic commitment to accuracy in accounting and operational matters.
As I said above, it’s perfectly legitimate to consolidate the balance sheets of the government and the central bank. (The fact that they can be consolidated tells you that they must be distinct entities in some context—i.e., if they were not distinct, there would be nothing to consolidate, since they would share the same balance sheet already, and it would be impossible to distinguish between them.)
Consolidating the CB and the government does not make the proposition: “government spending creates the funds needed to pay taxes” true, nor can it prove that the government funds the national debt by issuing currency.
If you’re going to redefine terms, then you can prove anything: if we call up down, it follows that up is down. And so on. But that’s a programme that deliberately avoids the substantive issues in exchange for semantic point scoring. Why bother with such things?
"IOW, Tom, you are equivocating. As we all know from experience, nobody pays their taxes in cash. Final settlement between banks takes place in electronic reserves. So from that point of view all purchases are paid for with the medium of exchange—and Warren ought to also write things like “the funds you need to pay for your chicken dinner come from government spending”. In fact, by your argument here, the government "funds" your chicken dinner. And if you follow this argument to its logical conclusion, you are led to believe that neither private wealth in general, nor inside money in particular, exists, and that the government “funds” all activity in the economy, which is prima facie absurd."
Asa matter of fact, all financial transactions using the currency as unit of account and medium of exchange are settled either spot in cash or else using reserves after netting.
First, transactions are netted intra-bank and then interbank. The residual is handled by reserve via Fedwire.
The very large banks use a clearing house to save on Fedwire fees, and the residual is settled through Fedwire.
Clearing is not cost-effective for smaller banks, so they settle via Fedwire.
So, yes, it is in general true to say that all final settlement (after netting) takes place in currency (reserves or cash).
I noticed this when reading Lavoie's criticism of MMT. He kept referring to the "central bank" and "government" as totally separate things, not once acknowledging that the central bank is actually part of the government!
Yes, this is a fairly widespread criticism of MMT analysis. Some people hold that the cb is private unless nationalized and the Tsy is public. Others hold that consolidating the functions misrepresents actual operations.
Tom, Actually, I believe most settlement in a large value transaction context is undertaken on a gross real time basis (hence the name).
But the equivocation comes in after the true thing, which we all agree on--that banks use reserves to settle (and consumers sometimes use cash, etc). The point is that settlement balances do not "fund" all economic activity everywhere, which is what your argument implies.
y: "If the CB buys a non-government created asset, such as gold, then I would have thought that would technically be 'spending'."
vimothy: "If the CB purchases an asset, it changes the size and/or composition of its balance sheet. It isn’t “spending” and it isn’t “government spending”."
My understanding is that when the cb buys net gold then it is increasing non-govt NFA, one of the the few things that the cb is permitted to do fiscally in terms of its monetary operations. Paying IOR is another.
vimothy: "But the equivocation comes in after the true thing, which we all agree on--that banks use reserves to settle (and consumers sometimes use cash, etc). The point is that settlement balances do not "fund" all economic activity everywhere, which is what your argument implies."
I don't regard netting for settlement as "funding."
You have claimed that, since tax payments are utlimately settled using electronic reserve balances issued by the Fed, the Fed actually "funds" all government expenditure. But reserves (and cash) are the instrument of ultimate settlement for everything. Hence, if the Fed funds government expenditure, it must fund all expenditure of any type.
The MMT claim is that taxation creates the basic 'need' for the currency.
It's possible that banks could opt to settle their transactions through other means than government currency. (Scott Fullwiler mentions this in his 'interest-on-reserves' paper).
So for example, you could imagine a society in which the government neither spends nor taxes nor borrows, and is not directly involved in the monetary system or economy in any way. So the economy/monetary system operates without government currency, using some other means of settlement.
Then one day the government decides to get involved and starts by imposing a tax on the population, to get some 'funds'. And it states that the tax has to be paid in 'dollars', a new paper/electronic currency it just made up.
But no one has any of these 'dollars' as yet. So how do they get hold of some, with which to pay the tax?
Either: the government has to buy something from the private sector with 'dollars', or it has to lend 'dollars' to the private sector.
Once the private sector has these new 'dollars', it can pay the tax.
vimothy: "You have claimed that, since tax payments are utlimately settled using electronic reserve balances issued by the Fed, the Fed actually "funds" all government expenditure. But reserves (and cash) are the instrument of ultimate settlement for everything. Hence, if the Fed funds government expenditure, it must fund all expenditure of any type."
Yes, all transactions not netted out are funded in the currency since all final settlement is in either cash currency or reserve currency, both govt liabilities. The only reason that one can spend bank money created by credit extension is that banks have access to the cb and can get cash and reserves from the cb for settlement extra-netting.
I'd be interested in getting a better understanding of where you're coming from - have you got any links/papers you can recommend that I can get online?
"The only reason that one can spend bank money created by credit extension is that banks have access to the cb and can get cash and reserves from the cb for settlement extra-netting"
Is that correct?
Scott Fullwiler mentions in his interest-on-reserves paper that other forms of interbank settlement can develop that have no need for cb reserves. But he makes the point that so long as banks have to settle their tax obligations in the currency, they will have a need and demand for it. (As far as I can remember).
Yes, banks can and have developed other means of settlement, such as a clearing house that may less costly than Fedwire. But is not less expensive for most of smaller and medium size banks so they use Fedwire as a matter of convenience. Settlement is a matter of liquidity and convenience. The cb provides both. Only a cb (govt) can provide because it has virtually unlimited resources and a great deal of policy space under a non-convertible floating rate regime.
While banks could provide their own settlement solution, it comes down to transaction cost, and also liquidity risks. Without an LLR a banking system can freeze due to lack of liquidity when there is nowhere else to go to obtain funds. Banks also get a guarantee that they likely would not have under different, more private arrangements. One of the reasons that govts rein in free banking is to gain more control over systemic risk. Electorates really don't like panics, depressions and recessions, and politicians know it.
I hope vimothy keeps going with this discussion as I really want to get to the bottom of this. He's made some really fascinating but perplexing comments so I want to know exactly what the argument is here. Is it about use of language, or something deeper? I was a bit disapointed when vimothy broke off the last discussion regarding excess reserves and interest on reserves, as I felt personally that no conclusion was reached (though he may think differently of course!)
Sorry, I seem to have got a bit over excited there. That’s usually a good sign that it’s time to move on to other things. As Sun Tzu once wrote, “Before you can be trolled, first you must troll yourself”. Wise words. But I can tell that Y wants to get to the bottom of whatever this is, so I’ll have another stab at laying it all out as plainly as I can.
It seems to me Tom’s argument is more or less that: funds are money; money is from the government; therefore, all funding is from the government.
I think that, with respect, this is pretty silly.
Let’s go back and think a bit more about the aggregate accounts and economic flows. The most basic and fundamental flows as far as macroeconomics is concerned are production, income and expenditure. The nature of these flows is more or less self-explanatory (though perhaps it is worth mentioning that expenditure is outlays on final consumption and new capital goods).
These flows are linked together by budget constraints, which, are really sets of accounting tautologies or “identities” that describe the activities of different types of agent in the economy with respect to production, income and expenditure. In other words, even though they’re customarily referred to as “budget constraints”, they don’t actually describe behavioural relationships, but instead tell you how to calculate the value of some particular flow for some particular agent, sector, or aggregate, so that you can track how resources are shifted, combined, multiplied and consumed across the economy.
Whatever happens, the identities must be satisfied—otherwise, the implication is that resources are appearing out of the aethyr, or disappearing into it. This property is sometimes known as “stock-flow consistency”, or just “consistency”.
The budget constraints faced by agents in the economy imply the following pivotal relationships: 1. The value of aggregate production equals the value of aggregate income generated domestically; 2. Income earned equals spending plus saving, which can be positive or negative; 3. Saving plus borrowing equals asset acquisition. As MMTers like to say, this isn’t theoretical—it just happens to be the way things are on Planet 3.
The second and third identities are worth thinking about in greater detail. The third says that asset acquisition can be financed in one of two ways: through borrowings and through savings. Those are the only two options. The second says that spending equals income minus saving. So if income is zero, say, then spending equals “dissaving”, or borrowing. This holds for the government, just like everyone else—if the government’s tax revenue is zero, then its dissaving equals its expenditure. If it issues no bonds, and has no savings to run down, it must finance instead by issuing money, which is just borrowing at a nominal rate of zero (assuming no IOR).
When Mosler says that, “As a point of logic, the dollars we need to pay taxes must, directly or indirectly, from the inception of the currency, come from government spending”, he’s running a bunch of things together, and through equivocation making something that is actually nonsensical seem like a plausible explanation for how the government and the economy works.
Imagine that you want a new laptop. I agree to lend you $500 to buy it. Where does the funding for this purchase come from: me or the government? Obviously, it’s from me. I lent you some of my savings. That’s true regardless of whether I give you cash, lend you my credit card, write you a cheque for a bank we both use, or write you cheque for a different bank.
All “money” might, under one definition (i.e., “money” = base money) originate from the government. But it’s clearly wrong to say that all funding in the economy is from the government. That simply confuses “funds”, noun, with “fund”, verb. In order for the government to finance its expenditure, it requires income from taxes, which in turn requires private income to tax, which in turn requires private production to generate income; or it requires some form of borrowing from the private sector, which requires private saving; which requires private income; which again requires private production. Or, more probably, it requires some mix of the two. So the funds come from current income and saved income from previous periods. They don’t come from the government. If I hold some portion of my savings in a particular financial asset, like a bond, my savings weren’t generated by whoever originally issued the instrument, but by me, who then assigned those savings to a particular vehicle.
BTW, Tom, Fedwire is not a netting system. It is a real time gross settlement (RTGS) system—settlement occurs in real time on a gross basis. So, ignoring things like CHIPS, according to Mosler, anything that requires interbank settlement is “funded” by government spending. But this is a silly argument.
vimothy:"Fedwire is not a netting system. It is a real time gross settlement (RTGS) system"
IIRC, I said intermediated settlement after netting intra-bank and inter-bank is handled through Fedwire, for which banks pay a fee. Spot settlement takes place in cash.
Regarding your other points, if "funding" means transacting through state money + credit money + other credit, then OK. If the meaning of "funding" is qualified as involving final settlement, that takes place in state money as rb for intermediated settlement in the FRS, or cash in circulation for spot.
What I was trying to get at there was that if everything that involves settlement with cash or reserves is funded by government spending, this implies that almost all economic activity is funded by government spending. But this is absurd on its face. Hence, everything that is settled with cash or reserves is not funded by the government. What you are doing here is confusing some basic economic concepts.
If I have an income I can either spend it or save it. Income: source of funds; spending or saving: uses of funds. If I want to purchase an asset, I can either finance that purchase with savings or borrowings. Savings and borrowings: sources of funds; asset acquisition: use of funds.
It doesn’t matter if money is defined as M2, base money, gold bullion or 4 metre high disks of carved stone. Those relationships still hold. Now, fiat money is an asset and liability, so it is a source of funds for the entity that issues it and a use of funds for the entity that acquires it. If the government is the only entity that issues money, that doesn’t mean that all “funding” comes from the government. That’s just silly. It means that the asset side of the central bank’s balance sheet was funded by issuing the money stock. The money stock is not a source of funds for me. If the central bank holds government bonds, then the money stock ultimately finances whatever proportion of the national debt that is. It doesn’t finance all government expenditure in total. That’s silly as well.
Warren Mosler made a comment over at his site, saying "it’s just that in general I don’t call anything ‘money’ particularly around academics"
Money is such a malleable term that it just leads to people talking past each other. It would probably improve communication considerably to pause whenever we find ourselves about to type the word money, think about what the more specific thing is we really have mind and type that instead.
geerussell said... "Warren Mosler made a comment over at his site, saying "it’s just that in general I don’t call anything ‘money’ particularly around academics" Money is such a malleable term that it just leads to people talking past each other. It would probably improve communication considerably to pause whenever we find ourselves about to type the word money, think about what the more specific thing is we really have mind and type that instead."
Exactly. This is basic to MMT, since the analysis rests on distinguishing net financial assets from financial assets that neet to zero. This is the distinction that MMT calls "vertical" or "exogenous," meaning that the level of govt, versus "horizontal: or "endogenous." which means at the level of non-govt.
Non-govt NFA is vertical and exogenous, i.e., originates from the side of govt and these non-govt financial assets are govt liabilities.
Horizontal and endogenous financial assets originate with non-govt, and these non-govt financial assets have corresponding non-govt liabilities and therefore net to zero.
Only govt can change the amount of non-govt net financial assets and this is through fiscal policy, which the US Constitution enumerates as a federal legislative power.
The Fed can alter the composition and term of non-govt net financial assets and does so in conducting monetary policy. The Fed has limited fiscal powers, e.g., purchasing gold and paying IOR.
vimothy: "What does that have to do with what we've been discussing?
I don't know. I wasn't thinking of you when I wrote it. It's simply a general statement about the MMT view of talking about "money," and it is generally the frame in terms of which Warren works.
Fair enough, Tom. While what geerussell wrote is a good point in general, what we have been discussing does not turn on confusion over particular definitions of money.
Both you and Warren Mosler have claimed that, because the government issues base money by spending, and the private sector requires base money to pay its taxes or buy government bonds, the government can be said to "fund itself" by spending.
I think it's clear that this isn’t true. The amount of government expenditure financed by issuance of base money is equal to the amount of government debt held as assets by the Federal Reserve. Government expenditure over and above this must find other sources of finance.
It's not true either that base money enters the economy through government spending. The central bank regulates the supply of base money using a process that doesn't require any government spending. What it requires instead is that the central bank buys government debt from the private sector.
Right--that's a useful link. It shows a very basic "current transactions matrix" from Godley & Lavoie's textbook.
In the matrix, entries that are positive in sign constitute sources of funds for the sector in question, and entries that are negative in sign constitute uses of funds.
So if you read down the column marked "Govt", you can see that taxes and saving constitute sources of funds for the government, and government spending and debt service constitute uses of funds.
if a bank and its customers owe $100 (in total) in tax to the government, and the government owes $0 to the bank and its customers, then when they settle the bank will transfer $100 in reserves to the treasury.
The bank and its customers owed $100 in tax, and paid $100 tax in reserves.
Correct?
We know that reserves are issued by the government in one way or another.
So would you agree that in the simple example given above, the funds to pay the tax originally came from the government?
vimothy: "In the matrix, entries that are positive in sign constitute sources of funds for the sector in question, and entries that are negative in sign constitute uses of funds. So if you read down the column marked "Govt", you can see that taxes and saving constitute sources of funds for the government, and government spending and debt service constitute uses of funds."
Yes, and so people incorrectly conclude that in the present monetary system this indicates that govt is not self-funding. The MMT pros have explained how this is not the case. If you disagree with the argument, so be it.
This stuff is quite confusing at first. One of the problems when you try to understand it is figuring out what people mean when they refer to something and then trying to fit that into whatever framework you’ve managed to build up on your own.
When you write, “the funds to pay the tax originally came from the government”, you’re describing a process where, somehow or other, the government has given the private sector some quantity of money, and then taken it back in taxes. Thus, the funds—i.e., money—to pay the taxes came from the government.
But how did the private sector get that money in the first place? Money is a type of financial asset. This means that it’s a use of funds for the entity that acquires it and a source of funds for the entity that issues it. So, in order for there to be any money to pay the government’s tax, there must have been some process that generated the funds in the first place.
You can imagine, if you like, that the government literally gives the private sector $100 and then demands it back in taxes. It’s clear that this would be a pointless exercise. Why would the government give the private sector money and then demand it back? It might as well simplify the process by not giving them the money in the first place. The net result is the same.
"Yes, and so people incorrectly conclude that in the present monetary system this indicates that govt is not self-funding. The MMT pros have explained how this is not the case. If you disagree with the argument, so be it."
I think you’re committed to believing whatever you think the MMT consensus is on this issue and I’m not looking to convert you from that belief into something different.
I don’t think the argument makes any sense though. The idea that the government “funds itself” violates stock-flow consistency, making a nonsense out of Godley & Lavoie’s current transactions matrix and out of basic national accounting relationships.
If the government is “self-funding” then it can conjure resources out of thin air. If that is so, then macroeconomics is pretty much solved and we should all find some other way to amuse ourselves.
But of course, it is not so, since that would violate the laws of physics as well as accounting. “Self-funding” is oxymoronic. Instead, the government does all the usual stuff—taxing, selling bonds, issuing money—that governments have always done to raise funds. There’s no secret semantic trick that allows them to circumvent this process and dance off into utopia.
"If the government is “self-funding” then it can conjure resources out of thin air. If that is so, then macroeconomics is pretty much solved and we should all find some other way to amuse ourselves."
Yup. Pretty much the definition of fiat currency. Resources conjured up out of thin air.
Macroeconomics is pretty much solved by adhering to the principles found in the MMT framework. It is reduced to flows in simple circuits that are not very difficult to understand.
"The idea that the government “funds itself” violates stock-flow consistency, making a nonsense out of Godley & Lavoie’s current transactions matrix"
An unverified claim and an appeal to authority. You're embarrasing yourself.
"But of course, it is not so, since that would violate the laws of physics as well as accounting"
This comment is so full of hubris it defies ridicule.
The person that wrote it must have a poor understanding of math and physics, but especially systems, and is unequipped to comment on any argument that would rely on them.
As I've said, we've worked through this and come to different conclusions. I agree with the views of the MMT pros who have presented what I see as cogent argument. Of course, I am no authority since this is not my field. But they are experts in the field and they seem to be to have it right. You don't see it that way. So be it.
"in order for there to be any money to pay the government’s tax, there must have been some process that generated the funds in the first place"
I think the MMT argument might be that the government imposes a debt on the taxpayer, and thereby creates an asset for itself.
Against this asset the government can then issue liabilities, with which it can acquire real goods and services from the private sector. This process of imposing a debt by fiat creates the 'funds'.
Central bank liabilities are, essentially, backed by the government's ability to tax, rather than it's portfolio of government debt.
In the macrofinance literature, the present value of the government’s future tax revenue, net of future social insurance payouts, is known as its “net fiscal asset”. We could call the PV of future taxes simply its “fiscal asset”.
The fiscal asset represents the present value of future revenue generated by levying taxes against the populace, so it’s clear from a conventional point of view that it should be accounted for as an (implicit) asset in any comprehensive balance sheet setting. The government can use this revenue to fund current expenditure, pay current liabilities and so on. The government can also borrow against it (assuming that it has positive net present value), by issuing liabilities such as bills and bonds.
All of this is consistent with the idea that tax revenue is a source of funds for the government. Otherwise, in what sense is its fiscal asset really an asset? In no sense, as far as I can see.
But can we still say that the government funds itself, since it creates the tax obligation that generates the stream of revenue? If you like, following Humpty Dumpty, you can say anything you wish. Nevertheless, the government needs funds to cover its expenditure. It acquires these funds by raising taxes and by borrowing.
So where are the funds created? The economy constantly produces goods and services, adding to the stock of resources available for use. The government gains access to these resources by taxing (for example, taxing private income and expenditure) and by borrowing (for example, issuing bonds and money).
MMTers seem to think that, because when the government taxes or borrows, it ends up with some money in an account, and the government actually prints money, it doesn’t need to bother with either of these activities. But this is specious. What the government gains from this process is not some of your money, but some of your income, or some of your wealth. That is, it gains access to the stock of resources generated by the economy.
Look again at Mitchell’s transactions matrix. Taxes are a source of funds for the government. Where do they come from? They are a use of funds for households. But where do households get them from? They are paid wages by firms. And where do firms acquire the funds to pay households? They sell output—to households; but also to the government. Where does the government get the funds to pay for the output? And round and round it goes.
The principle of consistency says that everything comes from somewhere and everything goes to somewhere, that it should all be tracked and accounted for. People who claim that funds don’t actually have to come from somewhere when where they are going to is the government are in violation of this simple principle.
"The principle of consistency says that everything comes from somewhere and everything goes to somewhere, that it should all be tracked and accounted for."
What causes the Earth system to be viable? Obviously nothing within the system can do it.
It's clear that you're trying to make a particular point, Paul. Why not take the time to explain it in a bit more detail? As is, it's very hard to know what to make of statements like the above.
"Why not take the time to explain it in a bit more detail?"
It was offered as an example of a closed system. The Earth is a closed system that, without the energy input from the Sun would be a dead planet. The Earth cannot create it's own energy input.
Aside from the discussion of the mechanics of money creation, which doesn't interest me and is for the most part irrelevant from a system perspective, We don't worry about how the Sun creates it's energy except as a knowledge quest.
I'm making the argument that net spending by the government is what ultimately drives economic activity in the non-government.
It appears that you believe that money can't be created from nothing, which is where the Sun comes in. The energy from the Sun is effectively created from nothing as far as the Earth is concerned.
Net financial assets are created from nothing as far as the non-government is concerned. No NFA's, no economy (following the passage of some time). Natural frictions (the acts of saving) force decay of system flows. There is no natural mechanism to reverse this process.
It appears that you believe that the money creation requirement can be and is satisfied by credit issued through the banking system.
I say that this cannot be viable because the expansion of credit is constrained - there is a functional limit imposed by the ability (or lack of) of agents to service their debt with their income.
My own perspective on economics is entirely from a systems math point of view, a view that I believe is ignored in Neoclassical economics.
Once the limitations on flows is understood from a systems perspective, then we can move on to the social sciences and studies of human behavior to tweak the performance of the system in terms of how the needs of society are served .
"The government gains access to these resources by taxing (for example, taxing private income and expenditure) and by borrowing (for example, issuing bonds and money)."
I'm going to try and put your argument to Warren Mosler.
There are quite a number of models and techniques in use in economics that have been adapted from physics and engineering. The most famous of these is probably the Black-Scholes equation for option pricing.
One of the problems with this approach generally, as we have seen during the crisis, is that it’s very hard to describe the full range of potential human behaviour with relatively simple mathematical models. Humans don’t obey physical laws that can be easily uncovered in the usual naturalistic, empirical way.
What this means is that the models are more like analogies and tools to aid thought. To take a concrete example, stock prices are not really a Brownian motion, but rather, they might behave in this fashion in some, even many, situations and so it can be useful to model them as such.
Here you are doing the same sort of thing. The government is to the economy as the sun is to the earth. But it’s only an analogy—the true underlying relationship, which the analogy aims to approximate, will be different.
And so, it’s natural to ask, how good is the analogy?
It’s true that the government is a monopoly supplier of NFA. But that’s what NFA means. Net financial assets are a synonym for outside assets. Any agent or group of agents is potentially a monopoly supplier of NFA to the rest of the economy, since the liability lies within the set of issuers and outside the set of holders of the asset (by construction, the two set are disjoint). The government isn’t the only actor or sector who can be a net borrower or user of funds from the rest of the economy. Anyone can do it. (Of course, though, only the government can be the government and be a net borrower.)
You suggest that, without the supply of new NFA from the government, the economy will become “inert”. There are two things to say about this. The first is theoretical. Why would the economy become inert simply because the government stopped borrowing? I can’t see any reason why that would be the case, and I’ve never seen anyone suggest it seriously before. It looks more like the sort of straw man accusation that Austrians often make of Keynesians: “You think that if the government stopped borrowing the entire economy would shut down!”
The second is empirical. No economies have ever stopped functioning and died because the government stopped borrowing. And that’s not because governments never stop borrowing. There are lots of examples of governments running surpluses and no examples of inert economies. What’s more, as you go back in time, you find smaller and smaller governments, and yet there are still functioning, not-inert economies.
Finally, I want to say something about money “being created from nothing” because there seems to be a bit of confusion. Money is a liability of banks (and maybe some other bank-like institutions, depending on how we’re defining it). Any entity can issue liabilities. After all, a liability is only a kind of promise. What I referred to above was not liabilities being “created from nothing”, but liabilities coming from somewhere. That is, money is issued by one entity and acquired by another. It comes from somewhere and goes to somewhere else. Funds flow around the economy. They don’t just appear out of the void, or disappear into it.
Why would the economy become inert simply because the government stopped borrowing? I can’t see any reason why that would be the case, and I’ve never seen anyone suggest it seriously before.
It's not the borrowing it's the spending. Absent net fiscal injections from the government do you see a path that doesn't terminate in either straight deflation or private debt boom followed by debt deflation?
Money has no real economic value until it's spent.
Spending is what creates economic activity.
If the government stops issuing new currency, eventually existing dollar assets will accumulate amongst a relatively few and the liabilities created by private-sector borrowing will end up being held by the worker class, with no means to obtain the funds it would take to satisfy the liabilities.
I would have thought if the govt were to stop spending then it would also stop taxing. Without taxation, after a while people might start to wonder why it actually has any value?
"no means to obtain the funds it would take to satisfy the liabilities."
You're more likely to end up with a repetitive boom-bust cycle, with deflationary periods, occasional depressions, wages forced downwards, vast inequalities in wealth...etc.
"Money is a liability of banks... money is issued by one entity and acquired by another. It comes from somewhere and goes to somewhere else. Funds flow around the economy. They don’t just appear out of the void, or disappear into it."
Banks issue money when they make loans. The money is created "out of thin air" through the process of making a loan. The deposit is the bank's liability and the loan contract is the bank's asset.
The borrower agrees to take on a debt, against which the bank issues a liability (deposit money). The funds to repay loans (and to pay the interest on loans) come from previous bank loans, or base money issued by the cb.
It's basically the same logic with the government, except that the debt (tax) is originally imposed on the population. Against this debt the govt (cb) issues a liability (currency). This is then used to repay the debt (tax) by the population.
In both cases (banks, government), money is created "out of thin air" through the process of someone going into debt, either voluntarily or involuntarily. And the funds to repay that debt come from the creditor, or from a creditor higher up in the "money hierarchy" (govt currency repays debt owed to the govt, bank money or govt currency repays debt owed to banks).
"You're more likely to end up with a repetitive boom-bust cycle, with deflationary periods, occasional depressions, wages forced downwards, vast inequalities in wealth...etc."
y: As financial assets pile up in few hands, as they must, the only result I see as possible is general deflation.
There will not be waves of spending towards the worker, every business cycle depletes their spending further and the amount of money the workers hold will become vanishingly small.
Don't see any way for that process to end well.
Saving is the natural friction of a capitalist economy that causes the system to decay if it isn't replenished, and towards the right cohort.
I like to think of this model as the sand in an hourglass, which represents the net flow of spending.
Adding to the coffers of the already-rich (bottom of the hourglass) doesn't maintain the flow. It takes a reset or adding sand to the top to do that.
Paul, if the govt budget is balanced the economy can grow and the domestic private sector can still be in surplus if there is also an external (current account) surplus. However, if the government never runs counter-cyclical budget deficits then recessions are likely to be far worse, with unemployment much higher and wages probably being forced down over time.
But, even with an external surplus, the external sector will effectively be increasingly leveraged, presumably leading to a bust at some point. I think.
"if the govt budget is balanced the economy can grow and the domestic private sector can still be in surplus if there is also an external (current account) surplus."
I know this - it follows from the sectoral balances.
It's called succeeding at the expense of another.
If the external countries don't create new funds to finance their spending on imports then the economic death will happen to them.
When it happens to them it is visited on us - we are all inter-connected.
In a closed system there is always feedback.
It's a decaying system setup. No way to escape the tyranny of the arithmetic.
Any entity can issue liabilities: me, you, the government, the bank. A liability is just a kind of promise to do something in the future. (The definition in my accounting textbook is rather strained, but is as follows: “A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits”.) You can, in principle, make as many promises as you like, but you make them, i.e., the promises have a source: you.
In the same way, when an entity issues liabilities, those liabilities can be traced from source to destination. They are represented as flows in the system of national accounts and they result in stock adjustments. Everything comes from somewhere and goes somewhere else. That’s what the principle of stock-flow consistency, to which MMTers often appeal, means.
Let’s say that a firm issues a $100 bond, which is bought by the household sector. Both you and Paul would presumably say that the bond was “created out of thin air”, and of course in one sense you would be quite right. Obviously, the bond didn’t exist before the firm issued it. The firm created it—but “it” is not a tangible product but rather a promise to supply $100 at some point in the future. There’s no way that “it” could be created out of anything but thin air.
The important thing from the point of stock-flow consistency is that the bond purchase is represented as a flow of funding from households to firms, which firms use to finance something or other; new fixed capital, for example. So the flow results in stock adjustments to firms and to households. Households lent surplus funds to firms: they acquired a financial asset (use), financed with their savings (source). Firms borrowed surplus funds from households: they acquired a tangible asset (use), financed by issuing liabilities (source).
When the government issues liabilities, like bonds, or levies taxes, it does so to acquire funds. (Like the firm in my example, it creates these liabilities “out of thin air”.) The private sector uses the funds it generates to pay its taxes and buy bonds, and the government uses the funds it acquire in this way to finance government consumption, investment in social overhead capital , and so on. So we see a flow of funds from the private sector (“comes from somewhere”) to the government (“goes somewhere else”). The government then uses these funds for whatever particular purpose it is pursuing.
"that's why I said you'd get a boom-bust cycle, with depressions and wages getting forced down through periods of high unemployment."
This may be true over the short term but the overall trend will be a downward spiral.
However, I should have been more clear that I was focusing on a closed economy with no external leakages/injections to avoid these side issues, which are a distraction from the main point I'm trying to make.
basically it would look a bit like the 19th century, altough it might be worse as the supply of base money wouldn't grow (no new gold discoveries) and there wouldn't be whole continents to settle with only small populations to eradicate (!).
ok, but you should make that clear if that's your argument, as we don't live in a closed economy at all.
I'm not sure there would necessarily be an overall downward spiral, as the busts would eliminate debts, liquidate businesses and wipe slates clean, ready for the next expansion.
Actually I'm wondering whether redistibution might not actually counteract the situation, rendering it more sustainable and less divisive.
A government can enact huge redistribution of wealth whilst running a balanced budget.
Taxing hoards and recycling the money in the hands of poorer spenders would generate growth.
"There's no law that says if the government runs a surplus the economy can't grow."
I agree. But an external surplus will be needed or the domestic private sector will have to go into deficit
"Also, the supply of base money is independent of government spending or net spending."
You're right, you have lending by the central bank and central bank purchases of assets. Doh!
However, if the cb is buying real assets from the private sector, like gold for example, wouldn't you say that is spending? It's adding net financial assets to the private sector.
If the cb is lending to the private sector then no net financial assets are being added, private sector indebtedness increases in accordance with the increase in base money through the loan..
"When the government issues liabilities, like bonds, or levies taxes, it does so to acquire funds."
The government does so because of legislation in place that requires it to do so.
"So we see a flow of funds from the private sector (“comes from somewhere”) to the government (“goes somewhere else”). The government then uses these funds for whatever particular purpose it is pursuing."
What you call funding I call money creation. Essentially at the beginning of every budget cycle the government issues new currency by net spending and converts an equivalent amount of previous spending to bonds.
The government thus "borrows" the "same money" over and over again ad infinitum, each iteration increasing the financial wealth of the non-government. I call that creation as in there is financial wealth in existence after the operation that didn't exist previously. See Arrow of Time.
There is no real-world process that exhibits the characteristics of this operation. Such a process would be termed a perpetual-motion machine and by current knowledge can't exist.
Since it is impossible for the non-government to create new net financial assets, one has to conclude that the government had to create them although It is more accurate to say that the government enters or introduces new nfa's into the system rather than creates.
Since the government didn't have the asset previously, they must have been introduced out of thin air. This is a view from an engineering/ science perspective not financial, but math is math.
No state-backed financial asset can enter a non-government balance sheet, increasing the financial wealth of the non-government in the aggregate until the government enters it (enters a number) on a balance sheet.
Further, it is not possible to "create" anything new from elemental particles in a closed system. All that is possible is to change the form or composition of that which already exists. Resources are already in existence.
The effort of labor (energy) changes the state, composition or form of existing resources into something useful for humanity, more an idea than a thing.
Spending drives that effort in a capitalist economy.
Even if the private sector is in deficit, the economy can still grow.
(In fact, it's possible for the government & private sector to save at the same time, even if the CA is in balance.)
if the cb is buying real assets from the private sector, like gold for example, wouldn't you say that is spending? It's adding net financial assets to the private sector.
I wouldn't call that spending. The CB is taking one asset off the private sector's hands (gold) and giving it another (cash).
"Even if the private sector is in deficit, the economy can still grow"
sure, but a continuous private sector deficit is unsustainable in the long run isn't it? I mean, it's end point is a 'bust', given that the private sector desire to save enails a demand 'leakage' which has to be patched over by more and more debt?
"it's possible for the government & private sector to save at the same time, even if the CA is in balance"
what affect would that have on growth, and unemployment?
"The CB is taking one asset off the private sector's hands (gold) and giving it another (cash)."
If I swap a cash or credit for a real asset (a car, some gold), isn't that spending?
I think that private deficits might or might not be unsustainable, depending on the situation, but that there's no hard & fast law that applies to all cases.
I'm also not a big fan of the idea of saving as a "demand leakage". Aggregate saving is equal to aggregate investment, hence aggregate saving contributes to aggregate demand.
what affect would that have on growth, and unemployment?
It depends on lots of other stuff.
If I swap a cash or credit for a real asset (a car, some gold), isn't that spending?
If you think about consumers buying cars and stuff, then it gets into grey areas, but if we limit the case to an economic entity buying gold, then it doesn't constitute spending for that entity. Think of spending as something that lowers you net worth. If you buy gold, your net worth should stay the same.
(although you say that but if I buy gold today and the price falls tomorrow then my net worth goes down. Do you think the price of gold could crash at some point?
I would say that the bank purchased an asset, or the bank acquired an asset. People normally refer to expenditure as outlays on consumption and investment. Spending normally refers to consumption expenditure alone. For e.g., when you put money in the bank, you've purchased or acquired an asset (a bank liability).
If you want to describe these sort of operations as spending, then you end up defining saving as spending and it's all a bit messy. I think that Paul's idea of an asset swap is also helpful.
I'm not a financial accountant, though. The important thing is just to understand the differences between what's going on in the current accounts and capital accounts, and income-expenditure flows and saving-borrowing flows.
It's still possible--that was just a typo. Just have a look at the identities and think them through for yourself.
Here, I'll redo the example with that mistake corrected and add a few more notes. Remember, all we're doing is manipulating identities.
National saving, which is the sum of private and public saving is equal to total investment. We derive the identity for national saving (here, "S") as follows:
Y = C + I + G S = Y - C - G = I
Including a term for taxes allows us to decompose national savings into private saving and public saving:
Y - C - G + T - T = I
Collect terms and rewrite that as,
(Y - C - T) + (T - G) = I
What we have above says that the two terms in brackets must equal total investment.
What are the two terms in brackets? The first is,
(Y - C - T)
This says that private saving is equal to total income, Y, less consumption, C, and taxes, T. In other words, private saving equals disposable income, Y - T, minus consumption.
The second term is,
(T - G)
This says that government saving is equal to tax revenue minus government consumption expenditure.
If you can't see how this works, just add in some numbers. E.g., let,
Y = 100 C = 70 T = 20 I = 20 G = 10
Y = 70 + 20 + 10 = 100
S = 100 - 70 - 10 = 20 = I
(100 - 70 - 20) + (20 - 10) = 10
I.e.,
Private saving + government saving = 10 + 10 = Total investment = 20
So private saving and public saving are both positive, and equal to total investment.
If I issue a liability I'm promising the receiver (creditor?)that either:
a)they can use that liability to repay debts owed to me, b)they can return it to me in return for goods and services, c) I will exchange it for the liability of someone higher up the "pyramid of liabilities" (i.e. If I give them an IOU I'm promising to redeem it in cash).
But if the central bank issues a liability (currency) to purchase an asset from the private sector (let's say gold), all it really promising to the receiver of that liability (the seller of the gold), is that he will be able to use it to repay debts owed to itself or to the treasury.
It's not promising anything else, explicitly.
However we might also say that the cb is making an implicit promise that the value of its liability (in the wider economy) won't depreciate too rapidly over time.
if the treasury issues a liablility in the form of a bond, then it's promising
a)to accept it in payment of debts to the government (including taxes and fees). b) to pay interest (in cb liabilities) on the bond, and redeem it in cb liabilities.
Which makes it look as if the treasury is below the cb in the hierarchy of liabilities. However, whilst the cb's job is to help the treasury always keep its promises, then functionally they're on the same level. ?
The argument is simply that the private sector and public sector can both save. It's easy to see that this is possible from the identity I derived for public and private saving:
(Y - T - C) + (T - G) = I
It's also easy to see that all of the numbers I gave in my example add up.
You said it wasn't possible for both the government and the private sector to save. That's a universal statement. I showed the existence of a contradiction. That's all that's needed to prove that the universal isn't true.
The question is whose liability. All accounting entries are in the same unit of account, customarily the currency. Some of those entries have both asset and liability on the side of non-government and net to zero. Other entries have the asset on the side of non-government and the liabilities on the side of govt. There are the net financial assets saved in the currency. When govt saves it reduces the NFA of non-govt, and when govt dissaves then it increases the NFA of non-govt. When govt neither saves nor dissaves, then there is no change in non-govt NFA.
if I issue a $1 paper IOU (liability) in return for a $1 Fed reserve note, then I'm borrowing that $1 at zero interest for an indeterminate period of time.
If however I agree to pay interest on that IOU and give it a fixed maturity date, then my IOU becomes what people call a 'bond'.
If the Fed issues a liability (reserves) in exchange for gold, it's not promising to return that gold at some point in the future. Also, it isn't promising to exchange that liability for anything other than its own liability.
If we assume it isn't paying interest on reserves, then all it is explicitly promising is that its liability can be used to pay debts owed to itself or to the treasury (i.e. to repay loans, pay taxes, fines etc).
So, unlike me, it isn't 'borrowing' at zero interest. It's simply crediting an account - it's a creditor not a debtor.
It's the same if it pays interest on reserves, except that its policy is then to add additional interest credits to reserve accounts. It is not promising to pay interest when it issues its liabilities, it simply does it, or not.
I'm sure this has been answered before, but how does a bank loan actually create reserves?
ReplyDeleteGreat video, Mike !
ReplyDeleteLet's see if I understand this correctly -- if the Fed shreds the T-bills it holds, that eliminates the government obligation.
But if the Fed holds the T-bills to maturity, don't the proceeds get swept back to the Treasury ? Seems like the net effect on the Treasury would be the same ?
I believe there is a legal limit to how much debt the Fed is allowed to purchase, otherwise they could "finance" the debt as was done in WWI ?
A visualization of how loans create deposits attached. There's a better visual out there somewhere, but this was the best I could find on short notice.
ReplyDeletehttp://econviz.org/macroeconomic-balance-sheet-visualizer/
Also, your question answered at MMTWIKI
http://mmtwiki.org/forums-topic/loans-create-deposits-question/
Joe:
ReplyDeleteThe Fed supplies reserves to the system to maintain its target rate.
Here's a good visual on how loans create money.
ReplyDeletehttp://econviz.org/how-loans-create-money/
Dan,
ReplyDeleteCorrect. Absent any new issuance by the Treasury, the entire "debt" would eventually be replaced with cash balances. The so-called debt would disappear. So you see, Treasury "debt" is nothing more than "term" dollars. It's not really debt in the first place.
I've been telling "educated" people for ages QE proves Government doesn't need to borrow for spendIng. They look at me like I'm a cretin or something.
DeleteMaybe they just like to think they are the ones paying for Government services. It will take a miracle to disabuse them of that notion.
good video,
ReplyDeleteI think the main supposed channel for QE is not actually increased lending, but portfolio rebalancing. The effect of investors moving out of bonds and cash and into other assets, like corporate bonds and equities is supposed to have a stimulatory effect, whilst also bringing down the cost of corporate borrowing.
This bank of englan paper covers it in quite a lot of detail, including BoE estimates of the effects of QE. It's worth a read.
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb110301.pdf
Joe,
ReplyDeleteBanks loan to creditworthy customers. There are reserve requirements that must be met so when those customers spend those loans, the checks will clear. After the loan is made, if the bank is short reserves, it must obtain them either from other banks or from the Fed.
In the current environment, banks are sitting on reserves, but a few years ago, when credit was booming, the Fed would provide the reserves necessary to make sure all the checks would clear.
The important point is that banks do not lend reserves. They lend to worthy customers and meet reserve requirements after the fact.
OK, I think I get it completely now. Thanks Mike. But I'll play bust-nuts with verbage here, it's not the loan that creates the reserves, the loan creates a shortage of reserves which puts upward pressure on interest rates forcing the fed to supply more reserves to hit their target. All correct?
ReplyDeleteDan, I get that loans create deposits, but deposits are a bank's liability and reserves are an asset, so it was specifically the link to reserves I was wondering about.
"Loans create deposits" on a bank's ledge simply through the entries. Most loans are drawn for immediate use, so a check is written on the deposit account. If it is not netted by being made to another account holder at the same bank, it has to clear in the interbank settlement system operated by the Fed and settlement takes place there in reserves. So a deposit creates the need for reserves and if the bank doesn't have excess reserves or doesn't obtain them during the accounting period by borrowing in the overnight market, then the Fed as lender of last resort loans them at the penalty rate to the bank.
ReplyDeleteSo deposits only create reserves in the sense of generating accounting entries in the Fed spreadsheet wrt member banks' accounts at the Fed.
The Fed sets the interest rate. It adds and drains reserves to keep the rate where they set it. Hence, treasuries going back and forth between the books of the Fed and the banks.
ReplyDeleteThe only significant effect that QE can produce is by lowering borrowing rate out on the yield curve, stabilizing housing, encouraging corp borrowing for investment in capital goods in the absence of demand for consumer goods, forcing saving in riskier assets by withdrawing tsys, thereby driving up asset prices higher than they would be otherwise through leverage, supposedly resulting in a wealth effect that encourages more consumer spending. The Fed is manage to prop up housing somewhat and drive equity prices higher than they would have been otherwise.
ReplyDeleteOn the other hand, the mainstream idea is that QE would stimulate the economy through increasing inflation expectations by adding to the monetary base and increasing money supply through the money multiplier. See how well that worked.
"it's not the loan that creates the reserves, the loan creates a shortage of reserves which puts upward pressure on interest rates forcing the fed to supply more reserves to hit their target. All correct?"
ReplyDeleteYes, though apparently when banks make loans and end up short on reserves, they effectively become overdrawn on their reserve account at the fed. This means that reserves are added automatically as needed by banks and then paid for in retrospect, as with any overdraft.
So in a sense, banking lending creates reserves automatically too, in the form of an automatic loan (overdraft) from the fed.
This is how Warren Mosler described it in reply to a question at his site:
ReplyDelete"Bank deposits are the accounting record of the liability associated with loans. So when a bank lends you $100 they might at the same time enter the number ’100′ into your checking account. But the loan didn’t do the entering of the 100 into your account per se. The 100 liability is the accounting record of the loan. Liabilities are accounting records of assets, etc.
When you account for something you don’t exactly ‘create’ it the way the word ‘create’ is generally understood - making something out of something else, etc. What I mean by allowing banks to create reserves is that regulation allows banks to make loans and corresponding deposits that it will accept for payment of taxes, recognizing that they are allowing that bank to incur a reserve deficiency in the case of reserve requirements. Additionally, when the Fed ‘clears a check’ it’s allowing the possibility of the account debited to be overdrawn which is also the possibility of a loan from the Fed."
Mike, does the Fed only hand back the interest it receives on govt bonds to the treasury, or the whole amount (minus costs)?
ReplyDeleteTom,
ReplyDeleteAnd Twist was taking higher yielding longer term notes out of the economy as well. Even more "profit" for the Fed to turn over. Not very stimulating. The confidence fairy is thoroughly bored.
But if the Fed holds the T-bills to maturity, don't the proceeds get swept back to the Treasury ? Seems like the net effect on the Treasury would be the same ?
ReplyDeleteIn principle, Dan, only the interest gets swept back to the Fed. So, if the Fed doesn't shred the debt, then principle payments must be made from Treasury to the Fed, and these balances are not replenished absent tax revenues unless the Fed chooses to replenish them.
Of course, the Fed always can can replenish them, because it can buy as much government debt as it wants to, so the Treasury can continually roll over this intergovernmental debt indefinitely.
By law, the Fed has to buy this debt on the open market, and so Treasury has to find a private buyer first. But the Fed can guarantee that Treasury always can find these buyers. Think of it this way: If you have $1000, no matter what state the dollar is in internationally, you will always prefer $1001 to $1000. So if Treasury issues a security of any kind with a price of $1000, and the Fed lets it be known that for anybody who buys that security for $1000 on Monday, the Fed will pay $1001 on Tuesday, then the Treasury will always be able to sell that security.
The yield doesn't even really matter here. But just to reassure people, the Fed can make sure that Treasury can offer as low a yield as it wants on the instruments the Fed is willing to buy.
Mike, I agree that the Fed could buy up all the debt out there and then shred it, and that such a move would get rid of the debt. However, the debt it holds is an asset of the Fed and a liability of the Treasury, so if the Fed does that it destroys some of its own assets. Would Bernanke feel free to do that? He has the rest of the Board to answer to and that Board is composed of a good many private sector bankers. Will they agree to allow the Fed to destroy its own assets? I don't think so.
ReplyDeleteSo, I think this variant of Ron Paul's solution won't work, because the Board of Governors will think that financial responsibility demands that they safeguard the value of Fed assets.
OTOH, if the President minted the $60 T coin and had the Mint deposit it in its PEF account, then, since its legal tender the Fed would be forced to generate $60 T in electronic credits and mark up the PEF account. The Treasury could then seep the seigniorage profits into the Treasury general Account, and Treasury could pay off the $6.7 of intragovernment debt including the debt held by the Fed in days. The rest of the debt could then be paid off as the debt comes due, leaving about $44 T in the TGA to be used for deficit sending.
The PPCS scheme requires the decision of only one man, the President of the US. That's why it's the most practical of the current alternatives for getting rid of the debt.
Y,
ReplyDeleteWhen the Fed's balance sheet shrinks, the monetary base shrinks.
Imagine that the Fed's portfolio consists entirely of t-bills, maturing next week. Then, next week, it hands back the principle payments to the treasury.
That action necessarily requires that the Fed withdraw the entire base from the economy.
Joe, I think the idea of Treasury securities as Fed assets is a bit of an accounting fiction. Think about it: each Treasury security is a promise to pay a certain number of dollars. And each dollar in circulation is officially a liability of the Fed. And the fed can create these so-called liabilities at will, and at no cost. So each Treasury security held by the Fed is a promise for another arm of the government to deliver back to the Fed a think which the Fed can create at will.
ReplyDeleteFor the arm of the government that is entitled to create money, it doesn't matter how many promises of money receipts they hold. Central banks view their balance sheets and so-called positive or negative equity as an accounting tool for managing price stability.
The only reason the Fed might not want to destroy government debt is that by destroying that debt and destroying all those Treasury liabilities, the rest of the government is then in a position to cancel muchos tax obligations. That means people spend a lot more. The Fed might not like that because they might judge it to be inflationary. And the financial system the Fed oversees and feeds might not like that because that means the real value of their loans drops in value.
Dan K"the idea of Treasury securities as Fed assets is a bit of an accounting fiction
ReplyDeleteIt is an accounting fiction necessitated by the separation of the cb and Tsy functions,which is operationally unnecessary and the function could just be formally consolidated under Tsy, eliminating the independent cb command system for micro-managing the economy from on high.
Tom, I don't think that particular accounting fiction is necessitated by the division of Treasury and the Fed. I think the fiction is mainly due to a political decision to misleadingly present the Fed - which is a branch of government which runs the Federal Reserve system - to the public as just another private "bank" with its own capital requirements, assets and liabilities. This keeps the public, accustomed to the free market mythologies of America, from recognizing that the banking system is run by the government. It also keeps them from recognizing the true nature of their own monetary system.
ReplyDeleteDan,
ReplyDeleteWhat good would it do if the Fed destroyed its assets?
That is true too. Because the Fed and Tsy are separate institutions they have to maintain separates sets of books, even for intera-governmental transactions. But the institutional arrangements are determined by Congress with the approval of the president unless the president's veto is over-riden. So it is the case the present rather convoluted arrangements are politically imposed, and we can assume there is a political agenda behind it since it doesn't conform to the operational reality of a non-convertible floating rate system in general. I assume it is to mimic the gold standard.
ReplyDeleteThis keeps the public, accustomed to the free market mythologies of America, from recognizing that the banking system is run by the government. It also keeps them from recognizing the true nature of their own monetary system.
Not sure that is the case. I would question whether the public has much of a clue about these things, and if you ask people were the money comes from, most say "the government" rather than the Fed or the banks.
Dan and Tom I certainly agree with what you've said, but that doesn't change the accounting rules. When the Fed buys Tsys from whatever source, those Tsys become assets. To rip them up, you have to get the consent of the Board of Governors. I don't believe that consent will ever be forthcoming. I know as well as anyone that it's all a ridiculous fiction; but the fiction is the way it is, and I don't think there is legal way around it in spite of all of our fine analysis showing that it is a fiction.
ReplyDeleteSo, the alternatives remain to get rid of the debt subject to the limit, if that's what we want to do. They are:
1. The Fed destroying the debt instruments it buys with its money from thin air. This alternative isn't feasible so long as private interests are on the Board of Governors of the Fed, and as long as the Fed Regional Banks are private organizations owned by banking interests, even if they are also federal instrumentalities.
2. Moving the Fed into the Treasury Department. This would move the reserve creation function into Treasury, and is the elegant solution to the debt problem. But to get this done Congress must legislate. They will never do this in the short run.
3. There's PPCS. Its use is up to the President alone. This President may not do it; but it is still the easiest and quickest way to the political problem posed by the debt-subject-the-limit.
4. There is beowulf's consols idea, issuing securities without a date for repayment of principal. Of course, consols would be debt. But as a matter of Fed accounting rules, they would not represent debt-subject-to-the-limit. This is a practical alternative to PPCS, because Treasury can issue consols on its authority; so it comes down to only the President.
I don't think, however, that this alternative is as good as the PPCS alternative. the reason is that consols cannot be issued to replace all the debt in the short run. That means Congress will see the process of raising money using consols unfold and they will have time to close the loophole that allows consols. On the other hand, with PPCS, once the President uses the a really big coin like the $60 T coin, the filling of the public purse with enough credits to pay down all the debt and cover deficit spending for perhaps 20 years is a fait accompli, and Congress would only be able to close the barn door, after the cow has left.
It wouldn't do any good Vimothy; but it wouldn't do any harm either. A central bank doesn't really need financial assets to do anything it does. In the conduct of monetary policy, the only reason the central bank cares about the money that is owed to it is because those promise represent money that is scheduled to be extracted from the private sector. If you pay the central bank a billion dollars and the bank credits the billion to its own account, the monetary policy impact would be just the same if the Fed deleted a billion dollars from your account but did nothing to its own account.
ReplyDeleteWhat would it matter if the central bank has a millionty-trillion dollars of negative equity? Its ability to make payments and create or destroy money is not dependent on the condition of its balance sheet. It can't go bankrupt.
Not sure that is the case. I would question whether the public has much of a clue about these things, and if you ask people were the money comes from, most say "the government" rather than the Fed or the banks.
ReplyDeleteI don't know if that is true. If you ask the Austrians, they seem to say that "true" money comes from holes in the ground, and that the money the government makes is "counterfeit".
Good points, Joe.
ReplyDeleteI don't know if it is accurate to say that the regional Fed banks are owned by private interests. This is from the Fed's own web site:
ReplyDeleteThe Federal Reserve System fulfills its public mission as an independent entity within government. It is not "owned" by anyone and is not a private, profit-making institution.
As the nation's central bank, the Federal Reserve derives its authority from the Congress of the United States. It is considered an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.
However, the Federal Reserve is subject to oversight by the Congress, which often reviews the Federal Reserve's activities and can alter its responsibilities by statute. Therefore, the Federal Reserve can be more accurately described as "independent within the government" rather than "independent of government."
The 12 regional Federal Reserve Banks, which were established by the Congress as the operating arms of the nation's central banking system, are organized similarly to private corporations--possibly leading to some confusion about "ownership." For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.
It seems to me that the so-called stock is not really an ownership stake, but a kind of pay-to-play fee. In effect, the member banks are licensed to operate by the Fed regional banks, which are the regional arms of a government agency. The "stock" gives few of the usual rights over the the regional banks, but is a kind of licensing fee. The "dividends" are certain amounts of dollars the Fed creates each year and provides to these licensed entities.
The Fed is sometimes said to be "private" because does not require public funding. But that is only because Congress has delegated its constitutionally provided money-creation authority to the Fed. But every dollar the Fed creates is officially a liability of the US Government, so that is public funding.
Again, I think that's right, Dan, and I don't want to over-emphasize the significance of the stock ownership. It doesn't mean that the regional banks are controlled by the members. However, I do think there is a financial interest involved in the ownership and that the regional banks cannot just destroy balance sheet assets without facing Court challenges by their stockholders, because that asset destruction must have some impact on the balance sheets of the member banks.
ReplyDeleteAccording to John Taylor, 77% of the “debt” issued by the U.S. government in 2011 was bought by the Fed. See:
ReplyDeletehttp://johnbtaylorsblog.blogspot.co.uk/2012/06/fed-bought-77-of-federal-debt-increase.html
Plus it could be Milton Friedman who started this QE nonsense. See under the heading “Increase the Money Supply” here:
http://www.hoover.org/publications/hoover-digest/article/6549
Dan,
ReplyDeleteIt seems strange to propose something on the basis of it not making any difference.
One reason that it might matter is that people might value the Fed's liabilities according to the value of its assets. (This is sometimes known as backing theory.)
There are no monies, a far as I know, whether private or public, that are not backed by assets. To me this suggests that backing assets provide some useful function, and that the bar that needs to be cleared if one wants to do away with them must be set higher than, "I can't think of any reason why not".
Debt that is held by the Fed against base money is effectively government debt financed at the nominal interest rate on money, which is zero (ignoring the current ROIR). As such the government is already doing as well as it possibly can in nominal terms. This debt can be rolled over indefinitely--for as long as there is demand for base money. So the government's fiscal position is not improved if the Fed destroys the t-bills etc in its portfolio.
There is also the issue of how the Fed could perform its operations without the use of assets with which to make trades. If the Fed wants to contract the base, today it instructs the manager of the System Open Market Account to sell some bills. If it has no assets to sell, how does it contract the base?
Mike,
ReplyDeleteYou may be able to see it, but no one in leadership at the Fed can see that they are out of Schlitz, their intelligence is being darkened.
QE is all that these monetarists have left now that they are at zero %, and above Ralph has a good link to an article by M Friedman where he was recommending QE for Japan back in 1997 based on the moron belief that "banks lend out the reserves".
I guess they could go to negative rates, but Bernanke I believe has said he is against that because it would shut down the Fed Funds market....
The monetarists are being made hard core morons... I believe many if not all are closet lovers of gold and perhaps refuse to jettison their false paradigm because their "quantity theory" framework would make it easier to slip gold back in as the basis for the USD a la Ron Paul.
Warren has often commented that all of this falseness is based on a gold standard paradigm, and now I may finally see what he means in this regard....
Tom linked up an obituary for Anna Schwartz (M Freidman's spouse) the other day, posted by the "Mexican Hat Dancer" Chris Whelan over at zerohedge (lots of gold love over their btw) that extolled the virtues of Anna's appointment to a panel back in the 80's that was recommending a return to the gold standard.
Looks like there is a direct connection between monetarism and gold...
Whelan has been a person you have had a hard time convincing and based on the fact that he would choose to promote Schwartz's gold advocacy in her obit, I would have to assume that Whelan himself probablysupports a move back to gold.
MNE history wrt to Whelan (not pretty):
http://mikenormaneconomics.blogspot.com/2009/04/chris-walen-of-institutional-risk.html
This gold issue is the only thing I can currently come up with wrt the causation of this insanity... if they admit to themselves that all of this monetarism is false and that fiscal policy under a FFNC regime is the only way out of this, then kiss their hopes for a return to gold goodbye for quite a long time...
rsp,
One reason that it might matter is that people might value the Fed's liabilities according to the value of its assets. (This is sometimes known as backing theory.)
ReplyDeleteReally, Vimothy? Where are these people? Do you value the Fed liabilities in your wallet according to the value of its assets?
The Fed's assets are securities promising payment of the very same dollars which are it's so-called liabilities. Those dollars aren't redeemable for anything but other dollars. So can it possibly be the case that the value of the liabilities is backed by the assets?
The role of the assets in the system is a price stability management role. The value of dollars in exchange depends in part on how many of them are in circulation, and the Fed buys and sells financial assets to regulate flows of dollars into and out of the private sector, including via the public treasury. The Fed cares about obligations others have to pay the Fed, not because it needs the money and is financially constrained by its assets, but because it has a monetary policy, and the monetary obligations people have to the Fed are part of the way it executes that policy.
That's not to say that it makes no difference to the person who has promised payment whether the Fed cancels that obligation. Since all of the rest of us have real financing constraints, it makes a big difference to us what we owe, and what we are owed. So if the Fed tears up some asset, the Fed is no worse off or better off than it was before. But the person whose liability that asset is? That person is relived from a real financial constraint.
If the owner of the liability is the public treasury, then in principle it shouldn't matter much. Public debts are the obligations of the government to itself, which a real constraint on public spending only to the extent that the government decides to make them so. If the central bank acts independently within the government, then those public debts only become constraints on future spending to the extent the central bank decides to employ them as such, rather than rolling them over automatically and indefinitely. And the independence of the central bank is only a relative independence, since it is established and maintained by the legislative branch.
But cancelling government debt to its own central bank might be useful from time to time both as an act of monetary policy, and as a way of granting psychological relief to the public, since many people do not understand the nature of their own monetary system.
Dan,
ReplyDeleteYou pose the question as if its absurdity were self-evident. But in fact, if the Fed were to buy worthless assets, or (somehow) hold no assets against its liabilities, I think it would be quite reasonable to revise their value downwards. I’m not a finance person, but shouldn’t the value of an entity’s liabilities be related to the value of its assets?
If this is not the case, by implication it must be that base money is a pure bubble—it is a liability that people value only because it is a liability that people value.
When considering this alternative explanation, I am struck by the following: one, that it is not obviously less ridiculous from a common sense point of view than backing theory, and two, that as soon as one assume its truth, some observed facts of central banking practice immediately seem weird and inexplicable.
In practice, what backs Fed money? Government debt. And what is government debt? It is a promise of future income generated by the government’s assets, the main component of which its (net) fiscal asset, i.e., its ability to tax the population. This seems close to an MMT understanding of the value of money (and also to a mainstream approach known as the Fiscal Theory of the Price Level).
Incidentally, Thomas Sargent wrote a famous paper about this topic that is quite germane: “The Ends of Four Big Inflations”.
http://www.nber.org/chapters/c11452.pdf
It’s hard to see what the upsides might be, though. Debt that is carried by the Fed is already effectively money financed, so the benefit to the government’s fiscal position would be nil.
One of the reasons for double entry accounting is accuracy in keeping track. Another huge one is making sure that money doesn't "just disappear" by "ledgerdemain" aka cooking the books. And everything is traceable to the journal entries that get posted to the general ledger. So even within government where the accounting is "fictitious" in the sense that government issues the money, there are tight controls on where everything comes from and where it goes.
ReplyDeleteWhere does the Fed get is capital? Who would recapitalize the Fed if it hits negative equity? Treasury.
Where does Treasury get the reserves to cover its expenditure from its Fed account? The Fed
vimothy, Of course it makes a difference. But that difference is political. Paying off the debt without using government "surpluses" removes the debt issue from the political table without constricting the private sector And that difference is critical in increasing the political leverage progressives have to push Medicare for All, Federal Job Guarantees, State Revenue Sharing, elimination of FICA while still expanding the Social Safety Net, funding a massive expansion in alternative energy supplies, reconstructing our failing educational system, and all the other things we need to do to make the United States the land of equality of opportunity, rather than the land of plutocracy again.
ReplyDeleteWhere does the Fed get is capital? Who would recapitalize the Fed if it hits negative equity? Treasury.
ReplyDeleteWhere does Treasury get the reserves to cover its expenditure from its Fed account? The Fed
Tom, this basic Q&A should be automatically attached to the bottom of every comment you write.
Sort of like "what if there's a dollar crises and the US has to go to the IMF." Where do you think the the IMF gets most of its funding? Right. The US.
ReplyDeleteDoh.
Central bank and treasury liabilities can both be seen as ultimate liabilities of the sovereign on a consolidated sovereign balance sheet. Then, sovereign financing is obtained from a mixture of money and debt instruments.
ReplyDeleteThis does not equate to the sovereign financing itself, as Tom seems to suggest. Typically, the sovereign will finance some portion of its total debt with money creation—in the US in normal times, this is about 1/15th of the whole.
Matt,
ReplyDeleteRose Friedman is rolling in her grave. Such a thing you say. Oy, no wonder Anna had that funny look when she and her husband were over for dinner. Feh, her Milton would never sleep with that nafka.
In a non-convertible system floating rate system "sovereign financing" is petty meaningless since the unit of account a govt liability ("IOU") that the govts issues without operational constraint — although institutional rules may be imposed politically that limit this inherent capacity as long as the rule is in effect. Typically, the rules are bent as needed ini order to increase policy space.
ReplyDeleteBanks have a govt franchise for money creation, and to the degree that govt doesn't guarantee the banks' liabilities incurred in the process of doing so, these firms put their own capital at risk in making loans and in the event of defaults they either have to obtain more capital or else they become insolvent and are put into resolution.
Vimothy,
ReplyDeleteI'd say from an MMT perspective Fed liabilities are backed by the government's ability to tax, i.e. by its ability to impose a 'debt' (tax liability) on people and organisations within its jurisdiction.
Fed liabilities are also government obligations.
When a commercial bank makes a loan, the deposit it creates (the bank's liability) is 'backed' by the borrower's debt (the bank's asset). It's the same thing with Fed liabilities (which are government obligations, i.e. government liabilities) - except that the debt is imposed unilaterally as a tax liability by the government.
(I think.)
"If the Fed wants to contract the base, today it instructs the manager of the System Open Market Account to sell some bills. If it has no assets to sell, how does it contract the base?"
ReplyDeleteIt doesn't have to contract the base to change interest rates.
If it wanted to contract the base and didn't have any treasury bonds on hand, it could possibly offer term (saving) accounts to member banks, which would earn higher interest than the base (reserves).
Or the fed could issue fed bonds perhaps?
I find the idea that sovereign financing is meaningless a bit bewildering. It seems to me that it has a fairly straightforward meaning.
ReplyDeleteAs can be seen from a comparison between net money creation and government expenditure in any given period, it's clear that governments generally obtain funds from sources other than the issuance of base money.
vimothy,
ReplyDelete"When the Fed's balance sheet shrinks, the monetary base shrinks."
Isn't that simply because when it sells bonds in an open market operation it withdraws reserves from the banking system (i.e. swaps bonds for reserves)?
If however the fed hands the principal payments on government debt back to the treasury, this has no effect on the quantity of reserves in the banking system (the monetary base).
Y: "I'd say from an MMT perspective Fed liabilities are backed by the government's ability to tax, i.e. by its ability to impose a 'debt' (tax liability) on people and organisations within its jurisdiction."
ReplyDeleteCurrency ("state money") is govt liability and a non-govt tax credit. Warren Mosler.
In a no-bond system, if the govt wished to set the rate above zero, then it would use IOR, which is the straight forward way to do it, instead of the present convoluted system.
ReplyDeleteunderstood Tom.
ReplyDeleteI was making the point that for commercial banks, a borrower's debt is the bank's asset. This asset can be said to 'back' the bank's liabilities (deposits).
The government's asset is the tax 'debt' it imposes on the population (or rather its ability to do so). This can be said to 'back' its liabilities (currency).
"As can be seen from a comparison between net money creation and government expenditure in any given period, it's clear that governments generally obtain funds from sources other than the issuance of base money."
ReplyDeleteThe government includes the treasury and the fed.
The treasury obtains funds either by taxing or borrowing. But the funds it taxes or borrows originally come from (are issued by) by the fed.
So one part of the government essentially gets it funds from another part of the government.
The banks are backed by their capital. A fiat currency is defined as without backing other than "the full faith and credit of the country," which means exactly what legally in terms of backing. the US government doesn't need to tax to get USD because it is the currency issuer. The tax simply gives value to the currency by creating a need for it to meet non-govt obligations imposed by the US govt — taxes, fines, tariffs and fees.
ReplyDeletey: "So one part of the government essentially gets it funds from another part of the government."
ReplyDeleteRight. This is the sleight of hand that confuses people. It's just shifting from one hand to the other and back repetitively, with the third hand of the PD's in there as the third shell in the shell game.
Bank capital is basically the difference between the value of its assets and its liabilities, correct?
ReplyDeleteloans, esp. mortagages form part of a bank's capital, as does equity.
other assets that form part of bank capital: govt debt and cash/ reserves.
Y,
ReplyDeleteHere’s a simple example. Say we have three balance sheets: private sector, government and central bank. The private sector has $1 assets and $1 tax obligation due at the end of the period. The central bank has $1 zero coupon government bond maturing at the end of the period as assets and $1 as liabilities. The government has $1 tax asset and the $1 bond as liabilities.
The private sector pays its $1 tax. Its assets and liabilities go to zero. The government pays the central bank the $1 for the bond. Its assets go to zero. But the central bank now has no assets and no liabilities outstanding either. So its assets and liabilities are also zero.
The central bank could then if it chose to, issue more liabilities, and credit them to the treasury. Then the treasury acquires another liability and the Fed acquires another asset. Let’s say that it does this to the tune of $1. The Fed’s balance sheet is back to its original size and so is the monetary base.
vimothy
ReplyDeleteIf the fed were to hand back the bond principal to the treasury (in the way that it hands back interest payments on bonds to the treasury), why would this lead the treasury to incur an additional liability?
might be a dumb question perhaps....?
ReplyDeleteY,
ReplyDeleteYou’ve added an additional step! It was the treasury’s liability. The Fed does not owe the treasury $1.
The treasury obtains funds either by taxing or borrowing. But the funds it taxes or borrows originally come from (are issued by) by the fed.
So one part of the government essentially gets it funds from another part of the government.
Although it’s easy to see why you might think this, it’s not actually true.
At any point in time in the economy, there are flows of income and expenditure. Very broadly, the income in these flows is consumed, taken in taxes or saved. Taxed income finances government expenditure directly. Saved income is then allocated across different types of assets, one of which is government debt. And so saved income also finances government spending.
You are being misled by the fact that the central bank issues the particular type of financial asset used for final settlement with the government. This is only a financing flow with respect to the actual stock of government debt held by the central bank (and not at all with respect to taxes or other sources of funds). The rest of the debt is not financed by central bank money issuance.
@Dan K
ReplyDeleteThanks for your comments--always appreciate the way you tear the veil from the governmental masquerade.
De facto the Fed serves the interests of Wall St., as does the entire government. Our government is "privatized" or "corporatized." and thus it is also a plutocracy, an oligarchy, a kakocracy, and a "lobbocracy," depending on the angle of vision. It is also what has been termed "friendly fascism"--now morphing into "less friendly fascism," soon to become "unfriendly fascism," judging by the wholesale slaughter of the Constitution, the rise of surveillance and the security state, monstrous Pentagon and armaments industry ,and militarization of police, rampant corruption--above all the financial octopus everywhere-- corrupt, spineless Congress, bought President, Supreme Court rubber stamp circus, etc. Buena suerte, Americanos!
vimothy, "Bank capital is basically the difference between the value of its assets and its liabilities, correct?
ReplyDeleteloans, esp. mortagages form part of a bank's capital, as does equity. other assets that form part of bank capital: govt debt and cash/ reserves.
Yes, assets minus liabilities equals equity. And bank regs don't rate all capital at nominal value but risk weighted. Mark to market is also different from mark to model.
The credit a bank extends puts a bank at risk of losses, both actual through default and non-performing loans, and nominal losses in terms of mark to market if that rule is in force. The mark to market rule was suspended to save many banks that would otherwise have been technically insolvent.
There are also issues with shadow banking that is not on the books of banks and therefore not regulated but which do have an effect on bank solvency.
Noe of the his applies to any govt agency, all of which are funded by appropriations and then Treasury and the Fed handle the details of money creation.
Chewie,
ReplyDeleteI thought M Freidman was married to A Schwartz?? No??
I'll look into it, if not mea culpa...
Forbes: "Anna J. Schwartz died today at age 96–the less-heralded partner of Milton Friedman in his celebrated work on monetary history."
I guess they mean research "partner"... (I thought wrongly that they were married)
wiki says that M Friedman was married to Rose Friedman (also at U of Chicago at Law School).
Apologies for this mistake.
AEIR interview of Schwartz on gold commission:
http://www.aier.org/sites/default/files/images/stories/news/documents/anna-schwartz/GC-1.pdf
Rothbard on Friedman including gold:
http://www.lewrockwell.com/rothbard/rothbard43.html
Looks like Friedman was not for gold but Schwartz tho not adamant, does look like she favored use of gold in some way...
Apologies for wrong marriage assignment again but the issue remains monetary vs fiscal policy and the related broad public/govt/academic ignorance of the true nature of public "debt", which none of these people gets right...
rsp
"You are being misled by the fact that the central bank issues the particular type of financial asset used for final settlement with the government. This is only a financing flow with respect to the actual stock of government debt held by the central bank (and not at all with respect to taxes or other sources of funds). The rest of the debt is not financed by central bank money issuance."
ReplyDeleteI understand that reserves are only used in settlement.
If depositors at bank A owe the treasury a total of $100 in taxes and the treasury owes the depositors at bank A a total of $99(wages, benefits etc), then when they settle bank A will transfer $1 in reserves to the treasury.
If however the depositors owe the treasury $100 and the treasury owes them $0, then when they settle bank A will transfer $100 in reserves to the treasury.
The reason such small quantities of reserves are needed in settlement in general is that all the transfers cancel each other out and only the difference needs to actually be transferred.
If the government were running a large budget surplus, then the banks would presumably have to sell more of their government bonds to acquire the additional reserves with which to settle tax payments with the treasury.
The funds for government spending aren't created by the non-government sector, however the fact that payments between govt and non-govt cancel each other out means that only small quatities of reserves are usually needed.
Vimothy
ReplyDelete"You’ve added an additional step! It was the treasury’s liability. The Fed does not owe the treasury $1"
Ok, but under current arrangements the fed hands the interest it receives on govt bonds back to the treasury, even though it doesn't 'owe' this to the treasury.
"under current arrangements the fed hands the interest it receives on govt bonds back to the treasury, even though it doesn't 'owe' this to the treasury."
ReplyDeleteThis alone should put to rest forever how the system actually works. This was not always the case and then Congress decided to change the rules. The accounting follows the rule that Congress prescribes.
Y makes an interesting observation there about why the Fed has to put their surplus USD balances back into the Treasury Account.
ReplyDeleteIt is NOT a tax.
If the Fed were truly "independent" then this would have to be a tax.
But it is NOT a tax.. probably mandated in the FRA somewhere, ie NOT covered under tax laws...
Agree with Tom here: "This alone should put to rest forever how the system actually works."
Of course for morons being the exception...
rsp,
I'm not sure Jesus would approve of you calling people morons left right and centre :)
ReplyDeleteBy definition, the funds come from private savings.
ReplyDeleteMoney is not income, even though it is common in every day speech to conflate the two.
Great vid Mike!
ReplyDelete"By definition, the funds come from private savings.
ReplyDeleteMoney is not income, even though it is common in every day speech to conflate the two."
Could you please explain in more detail what you mean so there's no confusion?
Why exactly do you think Mosler's claim that "The funds to pay taxes and buy government securities come from government spending" is wrong?
I'd like to quiz him on this if you can explin you position to me in more detail. Thanks.
Why exactly do you think Mosler's claim that "The funds to pay taxes and buy government securities come from government spending" is wrong?
ReplyDeleteIs this something that Mosler alone claims or do the other MMT economists also sign up for it? It looks like total nonsense to me.
That makes it hard to say something about without seeing more of the argument. What's the logic there? Can you explain?
Here's an attempt:
ReplyDelete(1) The public pays its taxes and buys government securities using money issued by the central bank. (2) This central bank money is created when the government spends. Therefore, (3), all the funds used to pay taxes and buy government bonds come from government spending.
???
All payments between banks and the treasury are settled in reserves (central bank money).
ReplyDeleteThose reserves are created by the central bank, (which is part of the government).
Either they are spent "into existence" (my term) or lent "into existence" by the central bank...
So the funding for the central bank's portfolio comes from money issuance, not government expenditure.
ReplyDeletefund: verb
ReplyDeletethe agency was funded by a federal grant: finance, pay for, back, capitalize, sponsor, put up the money for, subsidize, underwrite, endow, support, maintain; informal foot the bill for, pick up the tab for, bankroll, stake.
funding for the central bank comes from the realm of numbers in the universe - an infinite resource.
The fact that the government chooses to pay interest on the "funds" obtained from that same realm of numbers does not add any "cost" or burden to the operation. Interest paid is a net add to the stock of NFA's in the non-government.
If the government chooses to tax funds back out of the non-government to "pay" for that which costs nothing it is simply choosing to cripple the economic engine that runs on those funds.
The reasoning behind, "The funds to pay taxes and buy government securities come from government spending," is pretty simple. Consider that govt didn't, and that all money in an economy is created by banks hence nets to zero. Then govt takes money out of the economy to provision itself. This is govt creating demand leakage that would result in not all products capable of being produced at FE being sold, so UE results.
ReplyDeleteThus the argument is that govt must add at least as much NFA to non-govt as it withdraws in taxes to avoid creating UE.
In an open economy, the govt fiscal balance is determined by the effect that shifting saving desire has on the sector balances. The objective is to run a full employment budget without generating inflation. MMT shows how to achieve this through monetary operational understanding (Mosler), SFC modeling of sectoral balances (Godley), functional finance (Lerner), and the MMT JG (Minsky).
"…This is govt creating demand leakage that would result in not all products capable of being produced at FE being sold, so UE results…"
ReplyDeleteIt would also create liabilities in the banking system that couldn't be satisfied without creating more debt. This has a functional limit, leading to a banking crisis where losses (debt that can't be paid) must be written off, monetized - a back-door currency-creation operation.
You can pay me now or you can pay me later.
vimothy: "So the funding for the central bank's portfolio comes from money issuance, not government expenditure."
ReplyDeleteThe that the cb can do is increase and decrease numbers on its spread sheet, doesn't change the amount of non-govt financial assets only the composition of those assets. Changing the amount is by definition fiscal and the cb doesn't do fiscal other than marginally, like paying IOR if it chooses.
paul:"It would also create liabilities in the banking system that couldn't be satisfied without creating more debt. This has a functional limit, leading to a banking crisis where losses (debt that can't be paid) must be written off, monetized - a back-door currency-creation operation."
ReplyDeleteRight. This is the reason that govt "must" fund at least the amount it withdraw through the taxes it collects. Otherwise, UE become endemic since there are only nine bones for ten dogs and private debt is unsustainable under such as arrangement too. Both of which WM mentions as reasons.
Tom, it's not necessarily about unemployment, just the simple fact that in this system transfers and payments between the treasury and banks have to be settled in 'government-issued' money. So the government has to spend or lend that money for that to be able to happen.
ReplyDelete"So the funding for the central bank's portfolio comes from money issuance, not government expenditure."
Money has to be issued in one way or another by one or other branch of the government before the government can collect taxes or borrow in its own currency, which is what it does in the current system.
Tom’s comment at July 10, 2012 2:22 PM is a non sequitur.
ReplyDeleteHis argument is that if the funds weren’t created by the government, taxes and government borrowing would drain money from the economy, causing unemployment. There is no such thing as unemployment; hence, the government funds itself.
Firstly, it’s obvious that we do see unemployment, so the contradiction fails.
It’s also the case that taxes and borrowing don’t drain money from the economy. This is something that MMTers should understand well. The government taxes and spends. The government borrows and spends. In both cases, the private sector ends up with the same amount of money it started with.
Critically, though, Tom is confusing flows of funds with money. Money is created by a process of (in the modern world, bank and non-bank) intermediation. Private sector financial institutions intermediate against illiquid assets to create liquidity. If the government changes its tax rates, it doesn’t affect their ability to do this in any immediate sense.
If the government borrows, then it has to borrow from the saved income of the private sector. The funds that it borrows come from the income generated by the economy. Money is just another asset that is useful in the course of this activity. When the government taxes it is taking income from the private sector. When the government borrows it is taking saved income from the private sector. That is what funding represents: income. Income is denominated in money, but it is not the same thing.
Money has to be issued in one way or another by one or other branch of the government before the government can collect taxes or borrow in its own currency, which is what it does in the current system.
ReplyDeleteYou’re running a bunch of stuff together here and so coming up with something that seems to make sense but is actually misguided.
The private sector needs outside money. The central bank supplies this elastically, leaving demand to determine the actual stock at its target rate.
Government spending has no first order effect on this process, which is undertaken by the central bank. (Specifically, the CB issues outside money against high grade short term notes in repo operations known as open market operations, or OMO.)
The private sector also needs inside money. This is created by private financial intermediaries. In the course of financial intermediation, private financial intermediaries need outside money to settle obligations between themselves, so that you can imagine a Perry Mehrling style hierarchy of money, with outside money at the top.
When the government taxes or borrows “in its own currency”, it doesn’t literally borrow its own currency! That would be weird and absurd. It borrows savings and taxes income denominated in its own currency (and often in foreign currencies as well).
When I buy a bond, I pay using a liquid bank liability, which is denominated in dollars or pounds or euros (or whatever). I don’t literally stuff an envelope full of cash and post it to the treasury department.
This represents a capital flow: the government borrows my saved income.
vimothy, as Warren would say, read "Soft Currency Economics" and Seven Deadly Innocent Frauds of Economic Policy.
ReplyDeleteLet's just say we have different views of money creation.
vimothy,
ReplyDelete"In the course of financial intermediation, private financial intermediaries need outside money to settle obligations between themselves"
Ok, so if bank A owes bank bank B $100 and bank B owes bank A $99, then when they settle, bank A transfers $1 reserves to bank B.(?)
But if A owes B $100 and B owes A $0, then when they settle A transfers $100 reserves to B. (?)
It's the same thing with the government.
Only small quantities of reserves are needed for settlement purposes because in general all the payments 'cancel each other out'.
(I apologise for being really simplistic and using imprecise terms) If you want a proper explanation of the MMT view then you should read their work. My explanations are just my own mangled thoughts, no one elses :)
*wrote 'bank' twice in a row for some strange reason.
ReplyDeleteVimothy,
ReplyDelete"The government taxes and spends."
When it runs a budget surplus it taxes more than it spends.
Tom, I read both those years ago, and (FWIW) I would be very surprised if we have different views on money creation.
ReplyDeleteMoney creation is not the issue here. The issue as I see it, ironically enough, is rather that you haven't read Godley-Lavoie (or similar), and so do not have a good grasp on aggregate flows and the way they all fit together in the macroeconomy.
Y,
ReplyDeleteYes, that's correct. (In normal pre-crisis times, reserve balances at the Fed are quantitatively insignificant.)
In order for your argument to stick, you need to explain why that fact implies that the government "funds itself".
"…and so do not have a good grasp on aggregate flows and the way they all fit together in the macroeconomy…"
ReplyDeletePot.Kettle.Black.
vimothy, if you are correct about this, I apologize for being dense. But I think it is about money creation and will continue to do so until someone from the MMT side confirms that you are right.
ReplyDeleteTom, It's only possible for money creation to fund the quantity of government debt that is the held by the central bank. That's straightforward.
ReplyDeleteHave a look at Godley's transactions flow matrix some time. It's impossible to understand this stuff without some reference to a model of the actual flow of funds in the economy.
Total NFA held by non-govt = total govt liabilities held by non-govt, that is, tys and reserves associated with deposit accts and cash currency.
ReplyDeleteIndividuals and firms can and do borrow from banks to pay taxes, but that private borrowing reduces non-govt NFA since taxes are paid by banks creating a Tsy acct.
Govt creates the amount of NFA it issues in Tsy when it deficit spends, increasing govt liabilities in deposit accounts and while also putting tsys of equal value in the possession of non-govt.
When the Fed acquires tys for its book, it simply changes the composition of non-govt NFA by crediting reserves to non-govt accts in payment for the asset swap.
Total NFA held by non-govt = total govt liabilities held by non-govt, that is, tys and reserves associated with deposit accts and cash currency.
ReplyDeleteTom, you're forgetting the main component of NFA--treasury liabilities.
NFA = net outstanding treasury liabilities + CB liabilities held by private sector
When the CB issues liabilities, the total stock of NFA doesn't change. Rather, the private sector holds a different mix of NFA. It holds less treasuries and more base money. That's what an OMO does--it swaps CB liabilities for treasury liabilities (or vice versa).
Say that the stock of government debt is $100 in t-bills. Now say that the Fed swaps that for reserves in an OMO. The government is now financing the same stock of debt at 0% nominal interest rate instead of whatever the t-bill rate was. It doesn't increase its borrowing. total borrowing is exactly the same: $100.
Sorry, Tom, my mistake--I'm trying to reply quickly and I misread you. You do mention treasuries. Rest of the post stands, I think.
ReplyDeleteThe cb liabilities held by non-govt are of two kinds, those that result from Tsy disbursements that credit non-govt accounts with reserves that the Tsy obtains from the cb, and cb lending to non-govt (FRS member banks) The first increases non-govt NFA when the govt balance is in deficit. Cb lending does not increases non-govt NFA in that that a non-govt liability (loan obligation) is created.
ReplyDeleteThe tsys that the Tsy issues that are held by non-govt are also non-govt NFA. If the Fed purchases (POMO) or borrows (OMO) from banks are just an assest swap of a Tay liability (tys) for a cb liability (reserves). Both are govt liabilities with no corresponding liability in non-govt. That is, they are non-govt assets.
The CB holds the level of reserves wherever it wants them to be, subject to its interest rate target.
ReplyDeleteSay that the government spends $100. If the spending was funded by taxes, NFA does not increase. If the spending was funded by CB or treasury note issuance (for e.g.), NFA increase to the tune of $100.
Treasury has an account at the Fed, though. Doesn't this mean that when the treasury spends, the private sector ends up with more CB liabilities, regardless of treasury's method of financing?
No. It's obvious that this isn't the case, because otherwise the Fed's balance sheet would grow pari passu with government expenditure. CB liabilities are settlement balances. Banks receive reserves from the Fed as their account holders are paid by the treasury.
What happens to all the reserves? The Fed determines the outstanding stock, subject to its IR target. The only way that the stock of reserves can increase is if the CB expands its balance sheet to accomodate them.
In other words, why doesn't the stock of reserves disappear every month when everyone pays their taxes? Because the Fed is there managing the system. That's its job.
ReplyDeletevimothy: The CB holds the level of reserves wherever it wants them to be, subject to its interest rate target.
ReplyDeleteRight and the cb does this using assets swaps (OMO) that change the composition and maturity but not the amount of non-govt NFA to set price within the desired corridor. As Warren says, its just shifting bank reserves between deposit (reserve) accounts held at the cb and savings (tsy) accounts held at the Fed. Non-govt assets remain the same (other than interest payments, which increase non-govt NFA) after the shift as before.
The interbank system is about liquidity and price. The cb maintains the needed liquidity for settlement at the price it chooses. Tsy is about injecting financial assets into non-govt by disbursements using its liabilties (tsys) in conjunction with cb liablities it obtains from sale of tsys, and also withdrawing them through taxes, fines and fees (although the db can withdraw NFA also through its charges, such Fedwire rent and interest banks pay on loans and injects NFA if it pays IOR. The difference between aggregate injection and withdraw of govt financial assets into non-govt is the "net" in NFA.
This is the difference between monetary and fiscal.
vimothy, In other words, why doesn't the stock of reserves disappear every month when everyone pays their taxes? Because the Fed is there managing the system. That's its job.
ReplyDeleteRight. According to people who know the operational aspect, the cb and Tsy coordinate closely on a daily basis to ensure that the quantity of reserves in the interbank system is sufficient provides sufficient liquidity for settlement, while keeping price within the desired corridor.
Looks like there's some substantial agreement WRT this sort of stuff. So how do we relate this back to our earlier argument about the government "funding itself"?
ReplyDeleteVimothy,
ReplyDeleteHere’s Mosler’s argument:
“as a point of logic, the dollars we need to pay taxes must, directly or indirectly, from the inception of the currency, come from government spending (or government lending, which I’ll discuss later).
Now let’s build a national currency from scratch. Imagine a new country with a newly announced currency. No one has any. Then the government proclaims, for example, that there will be a property tax. Well, how can it be paid? It can’t, until after the government starts spending. Only after the government spends its new currency does the population have the funds to pay the tax. To repeat: the funds to pay taxes, from inception, come from government spending (or lending). Where else can they come from?”
And here’s some more:
“For those of you who understand reserve accounting, note that the Fed can’t do what’s called a reserve drain without doing a reserve add. So what does the Fed do on settlement day when Treasury balances increase? It does repos - to add the funds to the banking system that banks then have to buy the Treasury Securities. Otherwise, the funds wouldn’t be there to buy the Treasury securities, and the banks would have overdrafts in their reserve accounts. And what are overdrafts at the Fed? Functionally, an overdraft is a loan from the government. Ergo, one way or another, the funds used to buy the Treasury securities come from the government itself. Because the funds to pay taxes or buy government securities come from government spending, the government is best thought of as spending first, and then collecting taxes or borrowing later.
Note on how this works inside the banking system: When you pay taxes by writing a check to the federal government, they debit your bank’s reserve account at the Federal Reserve Bank. Reserves can only come from the Fed; the private sector can’t generate them. If your bank doesn’t have any, the check you write results in an overdraft in that bank’s reserve account. An overdraft is a loan from the Fed. So in any case, the funds to make payments to the federal government can only come from the federal government.”
http://moslereconomics.com/wp-content/powerpoints/7DIF.pdf
Thanks for posting that quote, Y.
ReplyDeleteLet’s look at the opening sentence:
As a point of logic, the dollars we need to pay taxes must, directly or indirectly, from the inception of the currency, come from government spending (or government lending, which I’ll discuss later).
There’s something of an equivocation here: we do not generally pay taxes in “dollars”, but in liquid bank liabilities denominated in dollars. In other words, Mosler is jumping between dollars as the medium of exchange and dollars as the unit of account.
I don’t need any “dollars” to pay my taxes.
With that said, it’s true that the banking system relies on a tiny quantity of these dollars as settlement balances—pre-crisis, electronic reserves at the Fed amounted to about $10 billion, or one one-hundredth of the total monetary base. Without these balances, the banks could not settle and the banking system would not function properly.
It’s this tiny quantity of electronic reserves that’s doing all the work in Warren Mosler’s argument, and causing all the confusion here.
Even if Mosler is correct, the amount of dollars needed to pay taxes is quantitatively insignificant: $10 billion out of a total base of $1 trillion and a gross public debt of $15 trillion. The government could never spend again, and the “dollars we need to pay taxes” (i.e., the electronic reserves used for settlement between banks) would still be there, all 10 billion of them, sitting on the Fed’s balance sheet.
It’s not the case, though, that base money originates from government spending. It’s certainly possible to imagine a situation in which it did, but it’s not how most modern governments operate. Base money (of which electronic reserves is a proper subset) is issued by the central bank. The central bank doesn’t spend. (Strictly speaking, spending refers to consumption expenditure.) It’s a bank—it intermediates. It issues liquid liabilities in exchange for assets.
vimothy: "There’s something of an equivocation here: we do not generally pay taxes in “dollars”, but in liquid bank liabilities denominated in dollars. In other words, Mosler is jumping between dollars as the medium of exchange and dollars as the unit of account. I don’t need any “dollars” to pay my taxes.
ReplyDeleteTaxes are billed the unit of account, and paid in the medium of exchange. You can settle your tax obligation in cash at the govt's payment office, or you can pay by check, in which case your demand account is debited by the bank and the bank settles for you in reserves at the cb as your agent and the cb credits the Tsy account. This may not happen immediately because the Tsy may choose to hold the funds in TTL acct at a private bank to assist the Fed in managing the quantity of reserves. Both cash currency and reserves are govt liabilities that function as tax credits for taxpayers and they are denominated in the govt's unit of account, which in the US is the USD. So, yes, taxpayers pay in "dollars" (US govt currency), which alone is accepted by the Tsy in payment of obligations to the state.
vimothy,
ReplyDelete"I don’t need any “dollars” to pay my taxes."
Mosler addresses this in the quote above:
"Note on how this works inside the banking system: When you pay taxes by writing a check to the federal government, they debit your bank’s reserve account at the Federal Reserve Bank. Reserves can only come from the Fed; the private sector can’t generate them."
"It’s this tiny quantity of electronic reserves that’s doing all the work in Warren Mosler’s argument"
Because most payments "cancel each other out" I suppose. Also, the central bank mitigates any changes to the quantity of reserves in the system as the result of taxes/spending etc with OMOs, so as to maintain its target interest rate.
"The government could never spend again, and the “dollars we need to pay taxes” (i.e., the electronic reserves used for settlement between banks) would still be there, all 10 billion of them, sitting on the Fed’s balance sheet."
The federal government collected approx $2.5 trillion in taxes in 2011.
What would happen if it just kept that and didn't spend (i.e. ran a massive budget surplus)? And then did that year after year?
"Base money (of which electronic reserves is a proper subset) is issued by the central bank. The central bank doesn’t spend. (Strictly speaking, spending refers to consumption expenditure.) It’s a bank—it intermediates. It issues liquid liabilities in exchange for assets."
ReplyDeleteThe central bank may be a bank but it is still part of the government.
It issues central bank liabilities in exchange for treasury liabilities (usually). Treasury liabilities are created when the government deficit spends.
Central bank liabilities are government liabilities (in the US they call them government 'obligations), and treasury liabilities are government liabilities. So the cb issues one type of government liability in exchange for another.
Though the CB 'buys' treasuries with reserves, as you say this is technically an asset swap rather than 'spending' by the CB (though it is buying an asset created by government deficit spending).
If the CB buys a non-government created asset, such as gold, then I would have thought that would technically be 'spending'. NFAs are added to the non-govt sector by the central bank directly in this case.
Neil Wilson gave me the following reply regarding this subject:
"The central bank *is* government. That’s the MMT analysis – a consolidated central bank and Treasury balance sheet. That way you don’t get confused with irrelevant excess accounting journals. You get to see the Wood rather than the Trees.
The beneficial owner of the central bank is the treasury, and in many jurisdictions the legal owner is the treasury as well. Therefore a consolidated balance sheet is and entirely appropriate analysis tool.
The government sector has to first buy something from the non-government sector so that the non-government sector has the central bank reserves to settle the tax bill.
That can be a mortgage asset if policy in the government sector deems that suitable.
To clear the repo the non-government sector entity would have to get central bank reserves from somewhere to buy the mortgage asset back. To do that it, or some other entity with a central bank account, would have to sell something else to the government sector.
So you see it is always prior government sector spending that funds the tax bill – one way or another.
Calling the mechanism collateralised loans, Repos, OMOs, operational standing facilities, asset purchase schemes or whatever doesn’t alter the underlying fact. Government sector bought something from the non-government sector in return for government sector money.
‘Spending’ in normal language."
y: "Though the CB 'buys' treasuries with reserves, as you say this is technically an asset swap rather than 'spending' by the CB (though it is buying an asset created by government deficit spending).
ReplyDeleteIt's like family members making change, swapping notes for coins. That's not spending.
Suppose a non-family proxy is included to intermediate. Does it become spending? I don't thing soo
Look at what actually happens and don't get confused with words. Govt (Tys) "spending" def= "fiscal" and cb/Tsy asset swap def= monetary. Fiscal changes NFA amount, monetary changes NFA composition/term but not amount.
I think the issue stems from seeing the central bank as an entity somehow divorced from government, operating not according to 'government policy' but to some inherent natural market logic.
ReplyDeleteI noticed this when reading Lavoie's criticism of MMT. He kept referring to the "central bank" and "government" as totally separate things, not once acknowledging that the central bank is actually part of the government!
I think MMTers often insist on thinking about the treasury and central bank as consolidated because they don't see the separation as 'natural', just as they don't see typical CB monetary policy as 'natural' or bond issuance as 'natural' or believe in a 'natural rate of interest' or 'natural rates of unemployment', etc.
Plus, from their perspective it clears up the understanding of operational stuff.
Taxes are billed the unit of account, and paid in the medium of exchange.
ReplyDeleteIOW, Tom, you are equivocating. As we all know from experience, nobody pays their taxes in cash. Final settlement between banks takes place in electronic reserves. So from that point of view all purchases are paid for with the medium of exchange—and Warren ought to also write things like “the funds you need to pay for your chicken dinner come from government spending”. In fact, by your argument here, the government "funds" your chicken dinner. And if you follow this argument to its logical conclusion, you are led to believe that neither private wealth in general, nor inside money in particular, exists, and that the government “funds” all activity in the economy, which is prima facie absurd.
By the way, I have to say that it’s hard to see how this slogan will appeal to anyone with knowledge of economics. It’s seems aimed squarely at those for whom the argument: all goods are paid for with money, the government issues money, therefore the government pays for all goods, makes a weird kind of intuitive sense.
Y,
ReplyDelete"I don’t need any “dollars” to pay my taxes."
Mosler addresses this in the quote above:
He doesn’t really address my criticism, though. Warren Mosler is basically saying that banks need reserve balances with the Fed to settle intra-system debts, which is obviously true and not controversial, and then using equivocation to turn this into a much larger and highly dubious claim about public finance and the role of the government in the economy.
Because most payments "cancel each other out" I suppose. Also, the central bank mitigates any changes to the quantity of reserves in the system as the result of taxes/spending etc with OMOs, so as to maintain its target interest rate.
But the point is that amount of “funds” that are “required to pay taxes” is tiny relative to any fixed point you’d care to choose, and the same as the amount of funds that are required to pay for any item for sale in the economy, since these are final settlement balances for the banking system. If government debt is $15 trillion, then as a simple matter of arithmetic, the $10 billion in electronic reserves held at the Fed will not suffice.
The federal government collected approx $2.5 trillion in taxes in 2011.
What would happen if it just kept that and didn't spend (i.e. ran a massive budget surplus)? And then did that year after year?
A good question: the “funds” that are “required to pay taxes” would still exist, because the Fed controls the level of electronic reserves held by the banks, and this has nothing to do with government taxation and spending programmes.
Y,
ReplyDeleteThe central bank may be a bank but it is still part of the government.
I don’t want to get into an argument about semantics. Government spending has a clear and commonly understood meaning. If you wish to redefine “government spending”, to include OMP by the central bank, you make rational discussion of these issues impossible, and concede the substantive point from the outset.
Incidentally, there is nothing wrong with consolidating balance sheets to create a sovereign balance sheet that incorporates the different arms of the sovereign (the most important being that of the central bank and the budgetary government). I do this myself (I even devote a blog to it). It is essential to get a good picture of sovereign risk. But it is beside the point.
If the CB buys a non-government created asset, such as gold, then I would have thought that would technically be 'spending'.
If the CB purchases an asset, it changes the size and/or composition of its balance sheet. It isn’t “spending” and it isn’t “government spending”.
Think of a great circuit going through the economy. Call this circuit “current income and expenditure”. Every time anyone earns or spends, it goes through this circuit. Now think of another circuit navigating a plane orthogonal to the income-expenditure circuit. Call this circuit “funding flows”. Every time anyone undertakes a purely balance sheet operation, acquiring assets or issuing liabilities, it goes through this circuit. (Net assets acquired are equal to the flow of saving, which resolves the two circuits I have described here).
Neil Wilson gave me the following reply regarding this subject
Something that I’ve noticed over the years is that MMTers will often say that MMT is based on a superior understanding of accounting definitions and the operational realities of the monetary system. But then, when people point out some basic flaw in their understanding, the argument shifts immediately to the irrelevance of a pedantic commitment to accuracy in accounting and operational matters.
As I said above, it’s perfectly legitimate to consolidate the balance sheets of the government and the central bank. (The fact that they can be consolidated tells you that they must be distinct entities in some context—i.e., if they were not distinct, there would be nothing to consolidate, since they would share the same balance sheet already, and it would be impossible to distinguish between them.)
Consolidating the CB and the government does not make the proposition: “government spending creates the funds needed to pay taxes” true, nor can it prove that the government funds the national debt by issuing currency.
If you’re going to redefine terms, then you can prove anything: if we call up down, it follows that up is down. And so on. But that’s a programme that deliberately avoids the substantive issues in exchange for semantic point scoring. Why bother with such things?
Net assets acquired are equal to the flow of saving...
ReplyDeleteWhich is defined as unconsumed income, I should probably add.
"IOW, Tom, you are equivocating. As we all know from experience, nobody pays their taxes in cash. Final settlement between banks takes place in electronic reserves. So from that point of view all purchases are paid for with the medium of exchange—and Warren ought to also write things like “the funds you need to pay for your chicken dinner come from government spending”. In fact, by your argument here, the government "funds" your chicken dinner. And if you follow this argument to its logical conclusion, you are led to believe that neither private wealth in general, nor inside money in particular, exists, and that the government “funds” all activity in the economy, which is prima facie absurd."
ReplyDeleteAsa matter of fact, all financial transactions using the currency as unit of account and medium of exchange are settled either spot in cash or else using reserves after netting.
First, transactions are netted intra-bank and then interbank. The residual is handled by reserve via Fedwire.
The very large banks use a clearing house to save on Fedwire fees, and the residual is settled through Fedwire.
Clearing is not cost-effective for smaller banks, so they settle via Fedwire.
So, yes, it is in general true to say that all final settlement (after netting) takes place in currency (reserves or cash).
I noticed this when reading Lavoie's criticism of MMT. He kept referring to the "central bank" and "government" as totally separate things, not once acknowledging that the central bank is actually part of the government!
ReplyDeleteYes, this is a fairly widespread criticism of MMT analysis. Some people hold that the cb is private unless nationalized and the Tsy is public. Others hold that consolidating the functions misrepresents actual operations.
Tom, Actually, I believe most settlement in a large value transaction context is undertaken on a gross real time basis (hence the name).
ReplyDeleteBut the equivocation comes in after the true thing, which we all agree on--that banks use reserves to settle (and consumers sometimes use cash, etc). The point is that settlement balances do not "fund" all economic activity everywhere, which is what your argument implies.
y: "If the CB buys a non-government created asset, such as gold, then I would have thought that would technically be 'spending'."
ReplyDeletevimothy: "If the CB purchases an asset, it changes the size and/or composition of its balance sheet. It isn’t “spending” and it isn’t “government spending”."
My understanding is that when the cb buys net gold then it is increasing non-govt NFA, one of the the few things that the cb is permitted to do fiscally in terms of its monetary operations. Paying IOR is another.
vimothy: "But the equivocation comes in after the true thing, which we all agree on--that banks use reserves to settle (and consumers sometimes use cash, etc). The point is that settlement balances do not "fund" all economic activity everywhere, which is what your argument implies."
ReplyDeleteI don't regard netting for settlement as "funding."
Why not?
ReplyDeleteYou have claimed that, since tax payments are utlimately settled using electronic reserve balances issued by the Fed, the Fed actually "funds" all government expenditure. But reserves (and cash) are the instrument of ultimate settlement for everything. Hence, if the Fed funds government expenditure, it must fund all expenditure of any type.
vimothy,
ReplyDeleteThe MMT claim is that taxation creates the basic 'need' for the currency.
It's possible that banks could opt to settle their transactions through other means than government currency. (Scott Fullwiler mentions this in his 'interest-on-reserves' paper).
So for example, you could imagine a society in which the government neither spends nor taxes nor borrows, and is not directly involved in the monetary system or economy in any way. So the economy/monetary system operates without government currency, using some other means of settlement.
Then one day the government decides to get involved and starts by imposing a tax on the population, to get some 'funds'. And it states that the tax has to be paid in 'dollars', a new paper/electronic currency it just made up.
But no one has any of these 'dollars' as yet. So how do they get hold of some, with which to pay the tax?
Either: the government has to buy something from the private sector with 'dollars', or it has to lend 'dollars' to the private sector.
Once the private sector has these new 'dollars', it can pay the tax.
where's your blog?
ReplyDeletevimothy: "You have claimed that, since tax payments are utlimately settled using electronic reserve balances issued by the Fed, the Fed actually "funds" all government expenditure. But reserves (and cash) are the instrument of ultimate settlement for everything. Hence, if the Fed funds government expenditure, it must fund all expenditure of any type."
ReplyDeleteYes, all transactions not netted out are funded in the currency since all final settlement is in either cash currency or reserve currency, both govt liabilities. The only reason that one can spend bank money created by credit extension is that banks have access to the cb and can get cash and reserves from the cb for settlement extra-netting.
Tom,
ReplyDeleteMany transactions occur intra-bank so entail no settlement in currency. It's only really the Fed member banks who settle in reserves isn't it?
Some transactions are also basically barter.
vimothy,
ReplyDeleteI'd be interested in getting a better understanding of where you're coming from - have you got any links/papers you can recommend that I can get online?
vimothy,
ReplyDeleteComing back to this settlement/ funding thing, wrt government spending, etc:
Say for example that the customers of Bank A owe $100 tax in total, and that Bank A also owes $100 in tax to the government.
In contrast, let's say, the government owes the customers $0, and also owes Bank A $0.
On settlement day therefore, Bank A will have to transfer $200 in reserves to the treasury, on behalf of itself and its customers.
So here we have a situation in which $200 is owed in taxes, and as such $200 is paid in reserves (currency) to the treasury.
Where did those reserves come from?
Originally they must come from the government in some way or other.
Would you agree with this, in this very simple hypothetical case or not?
y: "Many transactions occur intra-bank so entail no settlement in currency. It's only really the Fed member banks who settle in reserves isn't it?"
ReplyDeleteI said "after netting."
Barter is a non-financial transaction.
ok
ReplyDelete"The only reason that one can spend bank money created by credit extension is that banks have access to the cb and can get cash and reserves from the cb for settlement extra-netting"
Is that correct?
Scott Fullwiler mentions in his interest-on-reserves paper that other forms of interbank settlement can develop that have no need for cb reserves. But he makes the point that so long as banks have to settle their tax obligations in the currency, they will have a need and demand for it. (As far as I can remember).
Yes, banks can and have developed other means of settlement, such as a clearing house that may less costly than Fedwire. But is not less expensive for most of smaller and medium size banks so they use Fedwire as a matter of convenience. Settlement is a matter of liquidity and convenience. The cb provides both. Only a cb (govt) can provide because it has virtually unlimited resources and a great deal of policy space under a non-convertible floating rate regime.
ReplyDeleteWhile banks could provide their own settlement solution, it comes down to transaction cost, and also liquidity risks. Without an LLR a banking system can freeze due to lack of liquidity when there is nowhere else to go to obtain funds. Banks also get a guarantee that they likely would not have under different, more private arrangements. One of the reasons that govts rein in free banking is to gain more control over systemic risk. Electorates really don't like panics, depressions and recessions, and politicians know it.
ReplyDeleteI hope vimothy keeps going with this discussion as I really want to get to the bottom of this. He's made some really fascinating but perplexing comments so I want to know exactly what the argument is here. Is it about use of language, or something deeper? I was a bit disapointed when vimothy broke off the last discussion regarding excess reserves and interest on reserves, as I felt personally that no conclusion was reached (though he may think differently of course!)
ReplyDeleteSorry, I seem to have got a bit over excited there. That’s usually a good sign that it’s time to move on to other things. As Sun Tzu once wrote, “Before you can be trolled, first you must troll yourself”. Wise words. But I can tell that Y wants to get to the bottom of whatever this is, so I’ll have another stab at laying it all out as plainly as I can.
ReplyDeleteIt seems to me Tom’s argument is more or less that: funds are money; money is from the government; therefore, all funding is from the government.
I think that, with respect, this is pretty silly.
Let’s go back and think a bit more about the aggregate accounts and economic flows. The most basic and fundamental flows as far as macroeconomics is concerned are production, income and expenditure. The nature of these flows is more or less self-explanatory (though perhaps it is worth mentioning that expenditure is outlays on final consumption and new capital goods).
These flows are linked together by budget constraints, which, are really sets of accounting tautologies or “identities” that describe the activities of different types of agent in the economy with respect to production, income and expenditure. In other words, even though they’re customarily referred to as “budget constraints”, they don’t actually describe behavioural relationships, but instead tell you how to calculate the value of some particular flow for some particular agent, sector, or aggregate, so that you can track how resources are shifted, combined, multiplied and consumed across the economy.
Whatever happens, the identities must be satisfied—otherwise, the implication is that resources are appearing out of the aethyr, or disappearing into it. This property is sometimes known as “stock-flow consistency”, or just “consistency”.
The budget constraints faced by agents in the economy imply the following pivotal relationships:
1. The value of aggregate production equals the value of aggregate income generated domestically;
2. Income earned equals spending plus saving, which can be positive or negative;
3. Saving plus borrowing equals asset acquisition.
As MMTers like to say, this isn’t theoretical—it just happens to be the way things are on Planet 3.
The second and third identities are worth thinking about in greater detail. The third says that asset acquisition can be financed in one of two ways: through borrowings and through savings. Those are the only two options. The second says that spending equals income minus saving. So if income is zero, say, then spending equals “dissaving”, or borrowing. This holds for the government, just like everyone else—if the government’s tax revenue is zero, then its dissaving equals its expenditure. If it issues no bonds, and has no savings to run down, it must finance instead by issuing money, which is just borrowing at a nominal rate of zero (assuming no IOR).
When Mosler says that, “As a point of logic, the dollars we need to pay taxes must, directly or indirectly, from the inception of the currency, come from government spending”, he’s running a bunch of things together, and through equivocation making something that is actually nonsensical seem like a plausible explanation for how the government and the economy works.
[Cont.]
ReplyDeleteImagine that you want a new laptop. I agree to lend you $500 to buy it. Where does the funding for this purchase come from: me or the government? Obviously, it’s from me. I lent you some of my savings. That’s true regardless of whether I give you cash, lend you my credit card, write you a cheque for a bank we both use, or write you cheque for a different bank.
All “money” might, under one definition (i.e., “money” = base money) originate from the government. But it’s clearly wrong to say that all funding in the economy is from the government. That simply confuses “funds”, noun, with “fund”, verb. In order for the government to finance its expenditure, it requires income from taxes, which in turn requires private income to tax, which in turn requires private production to generate income; or it requires some form of borrowing from the private sector, which requires private saving; which requires private income; which again requires private production. Or, more probably, it requires some mix of the two. So the funds come from current income and saved income from previous periods. They don’t come from the government. If I hold some portion of my savings in a particular financial asset, like a bond, my savings weren’t generated by whoever originally issued the instrument, but by me, who then assigned those savings to a particular vehicle.
BTW, Tom, Fedwire is not a netting system. It is a real time gross settlement (RTGS) system—settlement occurs in real time on a gross basis. So, ignoring things like CHIPS, according to Mosler, anything that requires interbank settlement is “funded” by government spending. But this is a silly argument.
ReplyDeletevimothy:"Fedwire is not a netting system. It is a real time gross settlement (RTGS) system"
ReplyDeleteIIRC, I said intermediated settlement after netting intra-bank and inter-bank is handled through Fedwire, for which banks pay a fee. Spot settlement takes place in cash.
Regarding your other points, if "funding" means transacting through state money + credit money + other credit, then OK. If the meaning of "funding" is qualified as involving final settlement, that takes place in state money as rb for intermediated settlement in the FRS, or cash in circulation for spot.
What I was trying to get at there was that if everything that involves settlement with cash or reserves is funded by government spending, this implies that almost all economic activity is funded by government spending. But this is absurd on its face. Hence, everything that is settled with cash or reserves is not funded by the government. What you are doing here is confusing some basic economic concepts.
ReplyDeleteIf I have an income I can either spend it or save it. Income: source of funds; spending or saving: uses of funds. If I want to purchase an asset, I can either finance that purchase with savings or borrowings. Savings and borrowings: sources of funds; asset acquisition: use of funds.
It doesn’t matter if money is defined as M2, base money, gold bullion or 4 metre high disks of carved stone. Those relationships still hold. Now, fiat money is an asset and liability, so it is a source of funds for the entity that issues it and a use of funds for the entity that acquires it. If the government is the only entity that issues money, that doesn’t mean that all “funding” comes from the government. That’s just silly. It means that the asset side of the central bank’s balance sheet was funded by issuing the money stock. The money stock is not a source of funds for me. If the central bank holds government bonds, then the money stock ultimately finances whatever proportion of the national debt that is. It doesn’t finance all government expenditure in total. That’s silly as well.
Warren Mosler made a comment over at his site, saying "it’s just that in general I don’t call anything ‘money’ particularly around academics"
ReplyDeleteMoney is such a malleable term that it just leads to people talking past each other. It would probably improve communication considerably to pause whenever we find ourselves about to type the word money, think about what the more specific thing is we really have mind and type that instead.
geerussell said... "Warren Mosler made a comment over at his site, saying "it’s just that in general I don’t call anything ‘money’ particularly around academics" Money is such a malleable term that it just leads to people talking past each other. It would probably improve communication considerably to pause whenever we find ourselves about to type the word money, think about what the more specific thing is we really have mind and type that instead."
ReplyDeleteExactly. This is basic to MMT, since the analysis rests on distinguishing net financial assets from financial assets that neet to zero. This is the distinction that MMT calls "vertical" or "exogenous," meaning that the level of govt, versus "horizontal: or "endogenous." which means at the level of non-govt.
Non-govt NFA is vertical and exogenous, i.e., originates from the side of govt and these non-govt financial assets are govt liabilities.
Horizontal and endogenous financial assets originate with non-govt, and these non-govt financial assets have corresponding non-govt liabilities and therefore net to zero.
Only govt can change the amount of non-govt net financial assets and this is through fiscal policy, which the US Constitution enumerates as a federal legislative power.
The Fed can alter the composition and term of non-govt net financial assets and does so in conducting monetary policy. The Fed has limited fiscal powers, e.g., purchasing gold and paying IOR.
What does that have to do with what we've been discussing?
ReplyDeletevimothy: "What does that have to do with what we've been discussing?
ReplyDeleteI don't know. I wasn't thinking of you when I wrote it. It's simply a general statement about the MMT view of talking about "money," and it is generally the frame in terms of which Warren works.
vimothy,
ReplyDeletethis blog post by Bill Mitchell may be of interest:
"Stock-flow consistent macro models"
http://bilbo.economicoutlook.net/blog/?p=4870
Fair enough, Tom. While what geerussell wrote is a good point in general, what we have been discussing does not turn on confusion over particular definitions of money.
ReplyDeleteBoth you and Warren Mosler have claimed that, because the government issues base money by spending, and the private sector requires base money to pay its taxes or buy government bonds, the government can be said to "fund itself" by spending.
I think it's clear that this isn’t true. The amount of government expenditure financed by issuance of base money is equal to the amount of government debt held as assets by the Federal Reserve. Government expenditure over and above this must find other sources of finance.
It's not true either that base money enters the economy through government spending. The central bank regulates the supply of base money using a process that doesn't require any government spending. What it requires instead is that the central bank buys government debt from the private sector.
Y,
ReplyDeleteRight--that's a useful link. It shows a very basic "current transactions matrix" from Godley & Lavoie's textbook.
In the matrix, entries that are positive in sign constitute sources of funds for the sector in question, and entries that are negative in sign constitute uses of funds.
So if you read down the column marked "Govt", you can see that taxes and saving constitute sources of funds for the government, and government spending and debt service constitute uses of funds.
vimothy,
ReplyDeletecoming back to my simple example,
if a bank and its customers owe $100 (in total) in tax to the government, and the government owes $0 to the bank and its customers, then when they settle the bank will transfer $100 in reserves to the treasury.
The bank and its customers owed $100 in tax, and paid $100 tax in reserves.
Correct?
We know that reserves are issued by the government in one way or another.
So would you agree that in the simple example given above, the funds to pay the tax originally came from the government?
vimothy: "In the matrix, entries that are positive in sign constitute sources of funds for the sector in question, and entries that are negative in sign constitute uses of funds. So if you read down the column marked "Govt", you can see that taxes and saving constitute sources of funds for the government, and government spending and debt service constitute uses of funds."
ReplyDeleteYes, and so people incorrectly conclude that in the present monetary system this indicates that govt is not self-funding. The MMT pros have explained how this is not the case. If you disagree with the argument, so be it.
Y,
ReplyDeleteThis stuff is quite confusing at first. One of the problems when you try to understand it is figuring out what people mean when they refer to something and then trying to fit that into whatever framework you’ve managed to build up on your own.
When you write, “the funds to pay the tax originally came from the government”, you’re describing a process where, somehow or other, the government has given the private sector some quantity of money, and then taken it back in taxes. Thus, the funds—i.e., money—to pay the taxes came from the government.
But how did the private sector get that money in the first place? Money is a type of financial asset. This means that it’s a use of funds for the entity that acquires it and a source of funds for the entity that issues it. So, in order for there to be any money to pay the government’s tax, there must have been some process that generated the funds in the first place.
You can imagine, if you like, that the government literally gives the private sector $100 and then demands it back in taxes. It’s clear that this would be a pointless exercise. Why would the government give the private sector money and then demand it back? It might as well simplify the process by not giving them the money in the first place. The net result is the same.
ReplyDeleteTom,
ReplyDelete"Yes, and so people incorrectly conclude that in the present monetary system this indicates that govt is not self-funding. The MMT pros have explained how this is not the case. If you disagree with the argument, so be it."
I think you’re committed to believing whatever you think the MMT consensus is on this issue and I’m not looking to convert you from that belief into something different.
I don’t think the argument makes any sense though. The idea that the government “funds itself” violates stock-flow consistency, making a nonsense out of Godley & Lavoie’s current transactions matrix and out of basic national accounting relationships.
If the government is “self-funding” then it can conjure resources out of thin air. If that is so, then macroeconomics is pretty much solved and we should all find some other way to amuse ourselves.
But of course, it is not so, since that would violate the laws of physics as well as accounting. “Self-funding” is oxymoronic. Instead, the government does all the usual stuff—taxing, selling bonds, issuing money—that governments have always done to raise funds. There’s no secret semantic trick that allows them to circumvent this process and dance off into utopia.
"If the government is “self-funding” then it can conjure resources out of thin air. If that is so, then macroeconomics is pretty much solved and we should all find some other way to amuse ourselves."
ReplyDeleteYup. Pretty much the definition of fiat currency. Resources conjured up out of thin air.
Macroeconomics is pretty much solved by adhering to the principles found in the MMT framework. It is reduced to flows in simple circuits that are not very difficult to understand.
"The idea that the government “funds itself” violates stock-flow consistency, making a nonsense out of Godley & Lavoie’s current transactions matrix"
An unverified claim and an appeal to authority. You're embarrasing yourself.
"But of course, it is not so, since that would violate the laws of physics as well as accounting"
This comment is so full of hubris it defies ridicule.
The person that wrote it must have a poor understanding of math and physics, but especially systems, and is unequipped to comment on any argument that would rely on them.
I'd like to quote two sentences from Paul's post:
ReplyDeleteMacroeconomics is pretty much solved by adhering to the principles found in the MMT framework...
This comment is so full of hubris it defies ridicule.
Quite.
As I've said, we've worked through this and come to different conclusions. I agree with the views of the MMT pros who have presented what I see as cogent argument. Of course, I am no authority since this is not my field. But they are experts in the field and they seem to be to have it right. You don't see it that way. So be it.
ReplyDelete@Tom
ReplyDelete"I agree with the views of the MMT pros who have presented what I see as cogent argument."
In addition, you have the laws of arithmetic and the unrelenting tyranny of system dynamics behind you, which mainstream theory does not.
MMT sees the whole race track. Mainstream theory is focused on a few of the turns and all of the turns are assumed to be the same.
Neoclassical Economics is built upon a foundation of quicksand and finding anything of use in it is like trying to grab a puff of smoke in the wind.
How anyone can defend such an obviously flawed and failed school of thought is beyond me.
Economics is easier learned by people that have never been exposed to or corrupted by such defective thinking.
maybe a less aggressive stance would be better when responding to vimothy, Paul.
ReplyDeletevimothy,
ReplyDelete"in order for there to be any money to pay the government’s tax, there must have been some process that generated the funds in the first place"
I think the MMT argument might be that the government imposes a debt on the taxpayer, and thereby creates an asset for itself.
Against this asset the government can then issue liabilities, with which it can acquire real goods and services from the private sector. This process of imposing a debt by fiat creates the 'funds'.
Central bank liabilities are, essentially, backed by the government's ability to tax, rather than it's portfolio of government debt.
?
Y,
ReplyDeleteI actually agree with much of that.
In the macrofinance literature, the present value of the government’s future tax revenue, net of future social insurance payouts, is known as its “net fiscal asset”. We could call the PV of future taxes simply its “fiscal asset”.
The fiscal asset represents the present value of future revenue generated by levying taxes against the populace, so it’s clear from a conventional point of view that it should be accounted for as an (implicit) asset in any comprehensive balance sheet setting. The government can use this revenue to fund current expenditure, pay current liabilities and so on. The government can also borrow against it (assuming that it has positive net present value), by issuing liabilities such as bills and bonds.
All of this is consistent with the idea that tax revenue is a source of funds for the government. Otherwise, in what sense is its fiscal asset really an asset? In no sense, as far as I can see.
But can we still say that the government funds itself, since it creates the tax obligation that generates the stream of revenue? If you like, following Humpty Dumpty, you can say anything you wish. Nevertheless, the government needs funds to cover its expenditure. It acquires these funds by raising taxes and by borrowing.
So where are the funds created? The economy constantly produces goods and services, adding to the stock of resources available for use. The government gains access to these resources by taxing (for example, taxing private income and expenditure) and by borrowing (for example, issuing bonds and money).
MMTers seem to think that, because when the government taxes or borrows, it ends up with some money in an account, and the government actually prints money, it doesn’t need to bother with either of these activities. But this is specious. What the government gains from this process is not some of your money, but some of your income, or some of your wealth. That is, it gains access to the stock of resources generated by the economy.
Look again at Mitchell’s transactions matrix. Taxes are a source of funds for the government. Where do they come from? They are a use of funds for households. But where do households get them from? They are paid wages by firms. And where do firms acquire the funds to pay households? They sell output—to households; but also to the government. Where does the government get the funds to pay for the output? And round and round it goes.
The principle of consistency says that everything comes from somewhere and everything goes to somewhere, that it should all be tracked and accounted for. People who claim that funds don’t actually have to come from somewhere when where they are going to is the government are in violation of this simple principle.
"The principle of consistency says that everything comes from somewhere and everything goes to somewhere, that it should all be tracked and accounted for."
ReplyDeleteWhat causes the Earth system to be viable? Obviously nothing within the system can do it.
Must we account for the Sun's energy?
It's clear that you're trying to make a particular point, Paul. Why not take the time to explain it in a bit more detail? As is, it's very hard to know what to make of statements like the above.
ReplyDelete@vimothy
ReplyDelete"Why not take the time to explain it in a bit more detail?"
It was offered as an example of a closed system. The Earth is a closed system that, without the energy input from the Sun would be a dead planet. The Earth cannot create it's own energy input.
Aside from the discussion of the mechanics of money creation, which doesn't interest me and is for the most part irrelevant from a system perspective, We don't worry about how the Sun creates it's energy except as a knowledge quest.
I'm making the argument that net spending by the government is what ultimately drives economic activity in the non-government.
It appears that you believe that money can't be created from nothing, which is where the Sun comes in. The energy from the Sun is effectively created from nothing as far as the Earth is concerned.
Net financial assets are created from nothing as far as the non-government is concerned. No NFA's, no economy (following the passage of some time). Natural frictions (the acts of saving) force decay of system flows. There is no natural mechanism to reverse this process.
It appears that you believe that the money creation requirement can be and is satisfied by credit issued through the banking system.
I say that this cannot be viable because the expansion of credit is constrained - there is a functional limit imposed by the ability (or lack of) of agents to service their debt with their income.
My own perspective on economics is entirely from a systems math point of view, a view that I believe is ignored in Neoclassical economics.
Once the limitations on flows is understood from a systems perspective, then we can move on to the social sciences and studies of human behavior to tweak the performance of the system in terms of how the needs of society are served .
The 800 lb. gorilla is the system.
"The government gains access to these resources by taxing (for example, taxing private income and expenditure) and by borrowing (for example, issuing bonds and money)."
ReplyDeleteI'm going to try and put your argument to Warren Mosler.
Paul,
ReplyDeleteThere are quite a number of models and techniques in use in economics that have been adapted from physics and engineering. The most famous of these is probably the Black-Scholes equation for option pricing.
One of the problems with this approach generally, as we have seen during the crisis, is that it’s very hard to describe the full range of potential human behaviour with relatively simple mathematical models. Humans don’t obey physical laws that can be easily uncovered in the usual naturalistic, empirical way.
What this means is that the models are more like analogies and tools to aid thought. To take a concrete example, stock prices are not really a Brownian motion, but rather, they might behave in this fashion in some, even many, situations and so it can be useful to model them as such.
Here you are doing the same sort of thing. The government is to the economy as the sun is to the earth. But it’s only an analogy—the true underlying relationship, which the analogy aims to approximate, will be different.
And so, it’s natural to ask, how good is the analogy?
It’s true that the government is a monopoly supplier of NFA. But that’s what NFA means. Net financial assets are a synonym for outside assets. Any agent or group of agents is potentially a monopoly supplier of NFA to the rest of the economy, since the liability lies within the set of issuers and outside the set of holders of the asset (by construction, the two set are disjoint). The government isn’t the only actor or sector who can be a net borrower or user of funds from the rest of the economy. Anyone can do it. (Of course, though, only the government can be the government and be a net borrower.)
You suggest that, without the supply of new NFA from the government, the economy will become “inert”. There are two things to say about this. The first is theoretical. Why would the economy become inert simply because the government stopped borrowing? I can’t see any reason why that would be the case, and I’ve never seen anyone suggest it seriously before. It looks more like the sort of straw man accusation that Austrians often make of Keynesians: “You think that if the government stopped borrowing the entire economy would shut down!”
The second is empirical. No economies have ever stopped functioning and died because the government stopped borrowing. And that’s not because governments never stop borrowing. There are lots of examples of governments running surpluses and no examples of inert economies. What’s more, as you go back in time, you find smaller and smaller governments, and yet there are still functioning, not-inert economies.
Finally, I want to say something about money “being created from nothing” because there seems to be a bit of confusion. Money is a liability of banks (and maybe some other bank-like institutions, depending on how we’re defining it). Any entity can issue liabilities. After all, a liability is only a kind of promise. What I referred to above was not liabilities being “created from nothing”, but liabilities coming from somewhere. That is, money is issued by one entity and acquired by another. It comes from somewhere and goes to somewhere else. Funds flow around the economy. They don’t just appear out of the void, or disappear into it.
Why would the economy become inert simply because the government stopped borrowing? I can’t see any reason why that would be the case, and I’ve never seen anyone suggest it seriously before.
ReplyDeleteIt's not the borrowing it's the spending. Absent net fiscal injections from the government do you see a path that doesn't terminate in either straight deflation or private debt boom followed by debt deflation?
@geerussell
ReplyDelete"It's not the borrowing it's the spending"
That's the key and I wish I had said it first.
Money has no real economic value until it's spent.
Spending is what creates economic activity.
If the government stops issuing new currency, eventually existing dollar assets will accumulate amongst a relatively few and the liabilities created by private-sector borrowing will end up being held by the worker class, with no means to obtain the funds it would take to satisfy the liabilities.
Checkmate. We're close to that place now.
Paul,
ReplyDeleteI would have thought if the govt were to stop spending then it would also stop taxing. Without taxation, after a while people might start to wonder why it actually has any value?
"no means to obtain the funds it would take to satisfy the liabilities."
You're more likely to end up with a repetitive boom-bust cycle, with deflationary periods, occasional depressions, wages forced downwards, vast inequalities in wealth...etc.
people might start to wonder why *the currency* actually has any value
ReplyDeletevimothy,
ReplyDelete"Money is a liability of banks... money is issued by one entity and acquired by another. It comes from somewhere and goes to somewhere else. Funds flow around the economy. They don’t just appear out of the void, or disappear into it."
Banks issue money when they make loans. The money is created "out of thin air" through the process of making a loan. The deposit is the bank's liability and the loan contract is the bank's asset.
The borrower agrees to take on a debt, against which the bank issues a liability (deposit money). The funds to repay loans (and to pay the interest on loans) come from previous bank loans, or base money issued by the cb.
It's basically the same logic with the government, except that the debt (tax) is originally imposed on the population. Against this debt the govt (cb) issues a liability (currency). This is then used to repay the debt (tax) by the population.
In both cases (banks, government), money is created "out of thin air" through the process of someone going into debt, either voluntarily or involuntarily. And the funds to repay that debt come from the creditor, or from a creditor higher up in the "money hierarchy" (govt currency repays debt owed to the govt, bank money or govt currency repays debt owed to banks).
@y
ReplyDeleteMy argument relates to net spending not spending altogether. Balanced budgets. No net creation of state-backed financial assets.
Haven't thought much about what would happen if we didn't spend at all, and I think that's an absurd notion on it's face.
Somalia maybe?
"You're more likely to end up with a repetitive boom-bust cycle, with deflationary periods, occasional depressions, wages forced downwards, vast inequalities in wealth...etc."
ReplyDeletey: As financial assets pile up in few hands, as they must, the only result I see as possible is general deflation.
There will not be waves of spending towards the worker, every business cycle depletes their spending further and the amount of money the workers hold will become vanishingly small.
Don't see any way for that process to end well.
Saving is the natural friction of a capitalist economy that causes the system to decay if it isn't replenished, and towards the right cohort.
I like to think of this model as the sand in an hourglass, which represents the net flow of spending.
Adding to the coffers of the already-rich (bottom of the hourglass) doesn't maintain the flow. It takes a reset or adding sand to the top to do that.
Paul, if the govt budget is balanced the economy can grow and the domestic private sector can still be in surplus if there is also an external (current account) surplus. However, if the government never runs counter-cyclical budget deficits then recessions are likely to be far worse, with unemployment much higher and wages probably being forced down over time.
ReplyDeleteBut, even with an external surplus, the external sector will effectively be increasingly leveraged, presumably leading to a bust at some point. I think.
ReplyDelete"if the govt budget is balanced the economy can grow and the domestic private sector can still be in surplus if there is also an external (current account) surplus."
ReplyDeleteI know this - it follows from the sectoral balances.
It's called succeeding at the expense of another.
If the external countries don't create new funds to finance their spending on imports then the economic death will happen to them.
When it happens to them it is visited on us - we are all inter-connected.
In a closed system there is always feedback.
It's a decaying system setup. No way to escape the tyranny of the arithmetic.
@y
ReplyDeleteYou're answering your own questions before I have time to respond. :-)
Y,
ReplyDeleteAny entity can issue liabilities: me, you, the government, the bank. A liability is just a kind of promise to do something in the future. (The definition in my accounting textbook is rather strained, but is as follows: “A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits”.) You can, in principle, make as many promises as you like, but you make them, i.e., the promises have a source: you.
In the same way, when an entity issues liabilities, those liabilities can be traced from source to destination. They are represented as flows in the system of national accounts and they result in stock adjustments. Everything comes from somewhere and goes somewhere else. That’s what the principle of stock-flow consistency, to which MMTers often appeal, means.
Let’s say that a firm issues a $100 bond, which is bought by the household sector. Both you and Paul would presumably say that the bond was “created out of thin air”, and of course in one sense you would be quite right. Obviously, the bond didn’t exist before the firm issued it. The firm created it—but “it” is not a tangible product but rather a promise to supply $100 at some point in the future. There’s no way that “it” could be created out of anything but thin air.
The important thing from the point of stock-flow consistency is that the bond purchase is represented as a flow of funding from households to firms, which firms use to finance something or other; new fixed capital, for example. So the flow results in stock adjustments to firms and to households. Households lent surplus funds to firms: they acquired a financial asset (use), financed with their savings (source). Firms borrowed surplus funds from households: they acquired a tangible asset (use), financed by issuing liabilities (source).
When the government issues liabilities, like bonds, or levies taxes, it does so to acquire funds. (Like the firm in my example, it creates these liabilities “out of thin air”.) The private sector uses the funds it generates to pay its taxes and buy bonds, and the government uses the funds it acquire in this way to finance government consumption, investment in social overhead capital , and so on. So we see a flow of funds from the private sector (“comes from somewhere”) to the government (“goes somewhere else”). The government then uses these funds for whatever particular purpose it is pursuing.
paul,
ReplyDeletethat's why I said you'd get a boom-bust cycle, with depressions and wages getting forced down through periods of high unemployment.
"that's why I said you'd get a boom-bust cycle, with depressions and wages getting forced down through periods of high unemployment."
ReplyDeleteThis may be true over the short term but the overall trend will be a downward spiral.
However, I should have been more clear that I was focusing on a closed economy with no external leakages/injections to avoid these side issues, which are a distraction from the main point I'm trying to make.
basically it would look a bit like the 19th century, altough it might be worse as the supply of base money wouldn't grow (no new gold discoveries) and there wouldn't be whole continents to settle with only small populations to eradicate (!).
ReplyDeleteThere's no law that says if the government runs a surplus the economy can't grow.
ReplyDeleteAlso, the supply of base money is independent of government spending or net spending.
ReplyDeleteok, but you should make that clear if that's your argument, as we don't live in a closed economy at all.
ReplyDeleteI'm not sure there would necessarily be an overall downward spiral, as the busts would eliminate debts, liquidate businesses and wipe slates clean, ready for the next expansion.
Actually I'm wondering whether redistibution might not actually counteract the situation, rendering it more sustainable and less divisive.
A government can enact huge redistribution of wealth whilst running a balanced budget.
Taxing hoards and recycling the money in the hands of poorer spenders would generate growth.
"There's no law that says if the government runs a surplus the economy can't grow."
ReplyDeleteI agree. But an external surplus will be needed or the domestic private sector will have to go into deficit
"Also, the supply of base money is independent of government spending or net spending."
You're right, you have lending by the central bank and central bank purchases of assets. Doh!
However, if the cb is buying real assets from the private sector, like gold for example, wouldn't you say that is spending? It's adding net financial assets to the private sector.
If the cb is lending to the private sector then no net financial assets are being added, private sector indebtedness increases in accordance with the increase in base money through the loan..
sorry I'm stumbling and fumbling my way through this stuff. Not an economist.
ReplyDelete@vimothy
ReplyDelete"When the government issues liabilities, like bonds, or levies taxes, it does so to acquire funds."
The government does so because of legislation in place that requires it to do so.
"So we see a flow of funds from the private sector (“comes from somewhere”) to the government (“goes somewhere else”). The government then uses these funds for whatever particular purpose it is pursuing."
What you call funding I call money creation. Essentially at the beginning of every budget cycle the government issues new currency by net spending and converts an equivalent amount of previous spending to bonds.
The government thus "borrows" the "same money" over and over again ad infinitum, each iteration increasing the financial wealth of the non-government. I call that creation as in there is financial wealth in existence after the operation that didn't exist previously. See Arrow of Time.
There is no real-world process that exhibits the characteristics of this operation. Such a process would be termed a perpetual-motion machine and by current knowledge can't exist.
Since it is impossible for the non-government to create new net financial assets, one has to conclude that the government had to create them although It is more accurate to say that the government enters or introduces new nfa's into the system rather than creates.
Since the government didn't have the asset previously, they must have been introduced out of thin air. This is a view from an engineering/ science perspective not financial, but math is math.
No state-backed financial asset can enter a non-government balance sheet, increasing the financial wealth of the non-government in the aggregate until the government enters it (enters a number) on a balance sheet.
Further, it is not possible to "create" anything new from elemental particles in a closed system. All that is possible is to change the form or composition of that which already exists. Resources are already in existence.
The effort of labor (energy) changes the state, composition or form of existing resources into something useful for humanity, more an idea than a thing.
Spending drives that effort in a capitalist economy.
Y,
ReplyDeleteEven if the private sector is in deficit, the economy can still grow.
(In fact, it's possible for the government & private sector to save at the same time, even if the CA is in balance.)
if the cb is buying real assets from the private sector, like gold for example, wouldn't you say that is spending? It's adding net financial assets to the private sector.
I wouldn't call that spending. The CB is taking one asset off the private sector's hands (gold) and giving it another (cash).
"ok, but you should make that clear if that's your argument, as we don't live in a closed economy at all."
ReplyDeleteThis is a common point of confusion.
"Closed economies" and "closed systems" refer to entirely different things.
Open economies are still viewed as closed systems.
The World economy is an open economy but it is a closed system. We don't have interstellar trade.
The US economy is a closed system with leakages/injections.
The definition of a closed system is simple - the number of elemental particles (however defined) cannot be changed from within the system.
In this case I (and MMT) define the elemental particles as U.S. state-backed money "things".
Within the system these money "things" can exist only in the following forms:
• dollars
• dollar liabilities
• government bonds held by the public
NFA dollars = total dollars - total dollar liabilities.
Total NFA = NFA dollars + government bonds held by the public.
And before someone steps in and says "but what about demand deposits, etc." …
These are just dollars in different form.
vimothy:
ReplyDelete"(In fact, it's possible for the government & private sector to save at the same time, even if the CA is in balance.)"
No, it's not but I would like to see your argument. This would violate the sectoral balances relationship.
vimothy,
ReplyDelete"Even if the private sector is in deficit, the economy can still grow"
sure, but a continuous private sector deficit is unsustainable in the long run isn't it? I mean, it's end point is a 'bust', given that the private sector desire to save enails a demand 'leakage' which has to be patched over by more and more debt?
"it's possible for the government & private sector to save at the same time, even if the CA is in balance"
what affect would that have on growth, and unemployment?
"The CB is taking one asset off the private sector's hands (gold) and giving it another (cash)."
If I swap a cash or credit for a real asset (a car, some gold), isn't that spending?
Paul,
ReplyDeleteIt's a very straightforward application of basic accounting identities.
National saving, the sum of private and public saving, is defined as follows:
Y = C + I + G
S = Y - C - I - G
Including a term for taxes allows us to decompose national savings into public and private:
(Y - C - T) + (T - G) = I
Which is sufficient to show that it is possible.
If you can't see how this works, just add in some numbers. E.g., let,
Y = 100
C = 70
T = 20
I = 20
G = 10
Y = 70 + 20 + 10 = 100
S = 100 - 70 - 10 = 20 = I
(100 - 70 - 20) + (20 - 10) = 10
I.e.,
Private saving + government saving = 10 + 10 = Total investment = 20
Y,
ReplyDeleteI think that private deficits might or might not be unsustainable, depending on the situation, but that there's no hard & fast law that applies to all cases.
I'm also not a big fan of the idea of saving as a "demand leakage". Aggregate saving is equal to aggregate investment, hence aggregate saving contributes to aggregate demand.
what affect would that have on growth, and unemployment?
It depends on lots of other stuff.
If I swap a cash or credit for a real asset (a car, some gold), isn't that spending?
If you think about consumers buying cars and stuff, then it gets into grey areas, but if we limit the case to an economic entity buying gold, then it doesn't constitute spending for that entity. Think of spending as something that lowers you net worth. If you buy gold, your net worth should stay the same.
ok, so if not spending, what is the correct term?
ReplyDelete(although you say that but if I buy gold today and the price falls tomorrow then my net worth goes down. Do you think the price of gold could crash at some point?
ReplyDelete@vimothy
ReplyDeleteIf this is true…
Y = C + I + G
S = Y - C - I - G Then…
C + I + G = C + I + G + S
…which can't be true unless S = 0. ????
No point in going forward from here. There must be a mistake.
"ok, so if not spending, what is the correct term?"
ReplyDeleteSpending is defined as consumption or investment.
Buying gold isn't consumption. It also isn't investment by the economic definition which means spending on production of goods.
I suppose you might call it an asset swap.
Sorry, Paul, you're quite right. I added investment in there by mistake.
ReplyDeleteIt should read,
Y = C + I + G
S = Y - C - G = I
Y,
ReplyDeleteI would say that the bank purchased an asset, or the bank acquired an asset. People normally refer to expenditure as outlays on consumption and investment. Spending normally refers to consumption expenditure alone. For e.g., when you put money in the bank, you've purchased or acquired an asset (a bank liability).
If you want to describe these sort of operations as spending, then you end up defining saving as spending and it's all a bit messy. I think that Paul's idea of an asset swap is also helpful.
I'm not a financial accountant, though. The important thing is just to understand the differences between what's going on in the current accounts and capital accounts, and income-expenditure flows and saving-borrowing flows.
"Sorry, Paul, you're quite right. I added investment in there by mistake."
ReplyDeleteso what does that mean re the possibility for the government & private sector to save at the same time, even if the CA is in balance?
@vimothy
ReplyDeleteIf "S = Y - C - G = I"…
…then S = I and net saving is zero. There is no surplus.
Y,
ReplyDeleteIt's still possible--that was just a typo. Just have a look at the identities and think them through for yourself.
Here, I'll redo the example with that mistake corrected and add a few more notes. Remember, all we're doing is manipulating identities.
National saving, which is the sum of private and public saving is equal to total investment. We derive the identity for national saving (here, "S") as follows:
Y = C + I + G
S = Y - C - G = I
Including a term for taxes allows us to decompose national savings into private saving and public saving:
Y - C - G + T - T = I
Collect terms and rewrite that as,
(Y - C - T) + (T - G) = I
What we have above says that the two terms in brackets must equal total investment.
What are the two terms in brackets? The first is,
(Y - C - T)
This says that private saving is equal to total income, Y, less consumption, C, and taxes, T. In other words, private saving equals disposable income, Y - T, minus consumption.
The second term is,
(T - G)
This says that government saving is equal to tax revenue minus government consumption expenditure.
If you can't see how this works, just add in some numbers. E.g., let,
Y = 100
C = 70
T = 20
I = 20
G = 10
Y = 70 + 20 + 10 = 100
S = 100 - 70 - 10 = 20 = I
(100 - 70 - 20) + (20 - 10) = 10
I.e.,
Private saving + government saving = 10 + 10 = Total investment = 20
So private saving and public saving are both positive, and equal to total investment.
ok, agreed re 'spending'.
ReplyDeleteIf I issue a liability I'm promising the receiver (creditor?)that either:
a)they can use that liability to repay debts owed to me,
b)they can return it to me in return for goods and services,
c) I will exchange it for the liability of someone higher up the "pyramid of liabilities" (i.e. If I give them an IOU I'm promising to redeem it in cash).
...cont
ReplyDeleteBut if the central bank issues a liability (currency) to purchase an asset from the private sector (let's say gold), all it really promising to the receiver of that liability (the seller of the gold), is that he will be able to use it to repay debts owed to itself or to the treasury.
It's not promising anything else, explicitly.
However we might also say that the cb is making an implicit promise that the value of its liability (in the wider economy) won't depreciate too rapidly over time.
2@vimothy
ReplyDelete(G - T) + (I - S) = 0
(G-T) = (S - I)…or
(T-G) = (I - S) where…
(T - G) is net government saving, positive if in surplus and negative if in deficit…and
(I - S) is net private saving, positive if in deficit and negative if in surplus.
Applying your numbers…
(20 - 10) = (20 - 20)…which isn't true…
…and again you have I = S from the numbers you gave so net saving is still zero.
Still not seeing your argument.
...cont.
ReplyDeletesorry this is all a bit simplified but,
if the treasury issues a liablility in the form of a bond, then it's promising
a)to accept it in payment of debts to the government (including taxes and fees).
b) to pay interest (in cb liabilities) on the bond, and redeem it in cb liabilities.
Which makes it look as if the treasury is below the cb in the hierarchy of liabilities. However, whilst the cb's job is to help the treasury always keep its promises, then functionally they're on the same level. ?
The argument is simply that the private sector and public sector can both save. It's easy to see that this is possible from the identity I derived for public and private saving:
ReplyDelete(Y - T - C) + (T - G) = I
It's also easy to see that all of the numbers I gave in my example add up.
You said it wasn't possible for both the government and the private sector to save. That's a universal statement. I showed the existence of a contradiction. That's all that's needed to prove that the universal isn't true.
The question is whose liability. All accounting entries are in the same unit of account, customarily the currency. Some of those entries have both asset and liability on the side of non-government and net to zero. Other entries have the asset on the side of non-government and the liabilities on the side of govt. There are the net financial assets saved in the currency. When govt saves it reduces the NFA of non-govt, and when govt dissaves then it increases the NFA of non-govt. When govt neither saves nor dissaves, then there is no change in non-govt NFA.
ReplyDeleteif I issue a $1 paper IOU (liability) in return for a $1 Fed reserve note, then I'm borrowing that $1 at zero interest for an indeterminate period of time.
ReplyDeleteIf however I agree to pay interest on that IOU and give it a fixed maturity date, then my IOU becomes what people call a 'bond'.
If the Fed issues a liability (reserves) in exchange for gold, it's not promising to return that gold at some point in the future. Also, it isn't promising to exchange that liability for anything other than its own liability.
If we assume it isn't paying interest on reserves, then all it is explicitly promising is that its liability can be used to pay debts owed to itself or to the treasury (i.e. to repay loans, pay taxes, fines etc).
So, unlike me, it isn't 'borrowing' at zero interest. It's simply crediting an account - it's a creditor not a debtor.
It's the same if it pays interest on reserves, except that its policy is then to add additional interest credits to reserve accounts. It is not promising to pay interest when it issues its liabilities, it simply does it, or not.
@vimothy
ReplyDeletein the equation (Y-C-G) + (T - G) = I,
If (T-G) is in surplus (positive) then the expression (Y-C-G) must evaluate to a negative number for the private sector to be in surplus.
By definition private saving is opposite in sign to government saving.
Your numbers do not satisfy this requirement.
The equations you wrote distill down to…
Y= C + I + G
Y = C + S + T
which you have already stated indirectly. Then…
C + I + G = C + S + T; thus…
I + G = S + T; and
(I - S) = (T - G); where
(T - G) is defined as net government savings, positive if in surplus, negative if in deficit, and
(I - S) is defined as net private savings, positive if in deficit, negative if in surplus.
For both to be in surplus they would have opposite signs which is not possible.