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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Monday, February 11, 2013
How MMT Will Save America & the World: Thom Hartmann interviews Michael Hudson
He was talking about this on and off for the rest of his three hour program today. He seems really interested in MMT, but isn't fully up to speed yet. But definitely potential to reach a wider audience, at least on the progressive side.
Thom Hartmann needs to read Warren's 7DIF and Randy's recently published Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems, and then have some of the MMT economists on his show.
Wasn't Hartmann correct when he asked if "banks came between the treasury and the fed?" Aren't the primary dealers basically just banks? I wonder if Hudson is hearing correctly; it's not the first time I've heard him answer a different question than the one asked. I hate to think he's slipping in other ways.
If they are, it means the process of deficit spending in the U.S. starts with a bank loan to the government (a PD asset) - and a corresponding government deposit as a PD (bank) liability.
And, considering that non depository institutions were holding about 80% of government debt outstanding as late as mid-2011, one must conclude that U.S. commercial banks end up selling most of their T-bond and T-bill holdings to the non bank private sector.
Whereas in Europe (euro zone) commercial banks generally keep huge amounts of govt. debt on their balance sheets. A fact that may be at least partially explained as a consequence of the ECB's policy of not engaging in OMOs - defined as "irregular and exceptional" in several of the bank's publications and statements.
However, this situation may well change in the near future if (when) OMTs are implemented to support periphery debt.
"If they are, it means the process of deficit spending in the U.S. starts with a bank loan to the government (a PD asset) - and a corresponding government deposit as a PD (bank) liability."
No. Let's say you built the system from zero, and designed it exactly as it is today. The Treasury would have to start by giving a bond to a PD. The PD would then have to borrow from the Fed (get an overdraft) to pay the Treasury for the bond, and the Fed would then credit the Treasury's account. Then the Treasury would spend.
However, the system didn't start off as it is today. For example, the Treasury used to be able to get overdrafts or issue notes directly. So it's actually difficult to say which came first: the chicken or the egg.
alternatively the Treasury could start by minting a coin and depositing it with the Fed. Or it could just send out cheques and the Fed would probably just clear them (ignoring the supposed no overdraft rule), as it does what Congress tells it to do.
The interview was not too clear. Thom hasn't yet got a good grip on MMT and Michael was pushing the point he wanted to make regardless of the question. He wanted to make the point that constitutionally and operationally under the existing system, the US is sovereign in its currency and capable of self-funding. However, due to political influence, banks have inserted themselves into the process, which involves an unnecessary extraction of rent when the nation could fund itself directly, as Lincoln did with the greenback.
The PD would then have to borrow from the Fed (get an overdraft) to pay the Treasury for the bond
That means the PD is not really a bank.
A bank should be able to create a government deposit out of thin air in order to "pay" for a govt. bond or, to put it in equivalent terms, in order to provide a loan to the government.
alternatively the Treasury could start by minting a coin
It could but it won't - at least as long as a certain Mr. Obama sits in the presidential chair.
It would likely require the election of a true revolutionary in order for the Treasury to exercise that right and prove private markets can be dispensed - for deficit spending, at any rate.
Let's say the Treasury gives a PD a bond, and the PD "pays" for it by creating a deposit in its accounts for the Treasury.
The point is that deposit is only a *promise to pay*, not *payment* itself.
The PD pays for the bond when it makes payment to the Treasury's account at the Fed. To do this it has to borrow money from the Fed, assuming it starts with $0 in its reserve account.
So the PD has to borrow money from the Fed to pay the Treasury. We can simplify this to: the PD has to borrow money from the government to pay the government.
The Treasury spends out of its account at the Fed. IN the current system this means it needs a positive balance in that account before it can spend. So the deficit spending can not occur, in my/your example, until the PD has borrowed money from the Fed to pay the Treasury.
Jose, the auction settles finally in rb, which the Fed cfredits to the Treasury account to clear its spending. It doesn't really make too much difference how the PD's finance, since auctions are subscribed and they sell the tsys on. Their only concern is with their own inventory they may choose to hold.
btw, in my comment above I was assuming the system is at "point zero" - i.e. starting from scratch.
If there are already reserves and bonds in the banking system then of course the PD wouldn't necessarily have to borrow directly from the Fed. Just thought I'd make that clear.
If the PD were a real bank it could simply provide the government with a bank deposit. Then the govt./Treasury would transfer that deposit to its account at the Fed (where the govt. usually keeps its funds). After this step. the deficit spending might start by crediting firm or household accounts at the commercial banks.
But the "the PD has to borrow (reserves) from the Fed in order to pay for the bond" looks suspiciously like the "banks are reserve constrained" mantra. A neoclassical dude might seize upon that as evidence that banks have to get reserves first in order to be able to provide loans (to the govt., in this case).
Why can't the PD's - if they are indeed banks - simply credit the govt. account? That's an interesting question for PK economists to answer (note that the T accounts for deficit spending by Lavoie, Kelton et alia do start with a commercial bank creating a government deposit on said bank's books - yet the real life process seems to be quite a bit different from this).
If the PD were a real bank it could simply provide the government with a bank deposit. Then the govt./Treasury would transfer that deposit to its account at the Fed (where the govt. usually keeps its funds).
The bank pays for the tsys with a depost. The Fed marks down the banks reserve account at the Fed, which the bank has to have from excess reserves or borrow them. (If there are insufficient rb in the period, the Fed lends the needed rb at the penalty rate.) The Fed transfers the rb to the Treasury account. The Treasury uses the reserves in its account to clear expenditure it directs the Fed to make on its behalf as its fiscal agent.
I'm still waiting for the MMT speech/book/essay on how MMT will save the world.
The global economy is a closed system with expanding availability of real resources overall. The management challenge is deploying those resources most effectively and most efficiently to meet objectives determined by potential and preferences. Since the global monetary system is running under a non-convertible floating rate regime, affordability is never the problem. The problem is management. The necessary liquidity can always be provided to fund deployment of available resources.
"If the PD were a real bank it could simply provide the government with a bank deposit. Then the govt./Treasury would transfer that deposit to its account at the Fed (where the govt. usually keeps its funds). After this step. the deficit spending might start by crediting firm or household accounts at the commercial banks."
Jose, it looks like you're getting things upside down and back to front.
Let's say the bank creates a deposit on its books to "pay" for the bond. What happens when the Treasury "transfers that deposit to its account at the Fed"?
Answer: the Fed debits the bank's reserve account and credits the Treasury's account at the Fed.
But in the example the bank doesn't have any reserves!
So it has to borrow the reserves from the Fed.
(it could also sell the bond to the Fed in exchange for reserves to pay the Treasury. But that's basically the same thing: the funds come from the Fed to pay the Treasury.)
"the PD has to borrow (reserves) from the Fed in order to pay for the bond" looks suspiciously like the "banks are reserve constrained" mantra. A neoclassical dude might seize upon that as evidence that banks have to get reserves first in order to be able to provide loans (to the govt., in this case)."
The banks don't need reserves to create deposits. But deposits are *promises to pay*. To make a payment to the Treasury's account at the Fed, the bank must get the necessary reserves, as payment is made with reserves!
Similarly, payment between banks is made with reserves.
If the Treasury wants to spend $100 it has to have $100 in its account at the Fed, under current arrangements. Otherwise the Fed might say "you don't have enough in your account to make the payment".
So if a bank owes $100 to the Treasury, it has to pay $100 in reserves.
"So if a bank owes $100 to the Treasury, it has to pay $100 in reserves."
*when it makes the payment to the Treasury's account at the Fed. There could be, and often are, intermediate steps before that final payment is made to the Treasury's account.
Of course, MMT will not and could not save the world or the US. US culture is decadent to an extreme; Americans, taken as a whole, is a rather despicable caricature. It is hard to imagine a more predatory, destructive, and yet mortally trivial and stupid culture. Vietnam, Abu Ghraib, drone bombing, millions homeless or jailed, and so on and on and on, are not accidents; they manifest something, something unrelievedly shallow, rotten, cowardly, and despicable.
Jose, it looks like you're getting things upside down and back to front
I think we´re telling exactly the same story, but your first version (not this last one) might - no doubt unintentionally - let some readers, such as myself, under the impression that bank lending is reserve constrained.
The chronological (and logical) sequence is very important in this regard and I think you've put it 100% didactically now.
First step is a commercial bank (a PD) lending to the govt. It debits a T bond and credits a govt. deposit.
At this moment there is no need for reserves. The bank is only looking at a profitable opportunity - a risk-free loan with an attractive coupon. It doesn't look at its books to see whether it has enough reserves to lend the money. If it did, the neoclassical story on money creation might consider itself vindicated, sort of.
Then there is the second step, when the govt. transfers the deposit to the Tsy account at the Fed. At that moment the commercial bank will have a negative position in reserves.
It may borrow the needed reserves from the Fed at the penalty rate (this is more like the eurozone method, where the central bank does not wish to carry govt. bonds on its books and thus makes systematic advances of funds to commercial banks as a matter of policy) or the Fed may buy the bond back via a OMO (in theory, this would be the "American way" to provide banks with reserves).
This "American" process, btw, is nicely explained in the following passage from L R Wray (note the chronological order) :
the Treasury sells the treasuries to the private banks, which create deposits for the Treasury that it can then move over to its deposits at the Fed. And then ‘Helicopter Ben’ buys treasuries from the private banks…. The Fed ends up with the treasuries, and the Treasury ends up with the demand deposits in its account at the Fed – which is what it wanted all along, but is prohibited from doing directly
And of course, if we replaced the word treasuries with "platinum coin" in the last sentence, we'd have a description of the books of the Fed after such an operation.
Right, the Treasury issues a tsy security (Treasury liability) and receives an equal amount of rb (Fed liability) in its spending account at the Fed. what happens in between is relatively insignificant other than for the politically imposed requirement that the Fed not deal directly with Treasury.
The significant thing is that after Treasury spends using the rb in its account to settle, $NFA increases in the amount of the sale of tsys (=deficit), whatever the disposition of tys and rb in different accounts at the Fed. In other words, govt has self-funded.
The current "indirect" method involves the creation of tsys as "safe assets" and interest, while the "direct" method just increases aggregate reserves held by non-govt.
All that is different between the two methods is composition of govt liabilities held in aggregate by the consolidated non-govt sector. Amount of $NFA is the same (other than the interest accruing on the tsys, which adds to $NFA over time).
Yes, the cost is only that of "losing one's soul." And yet, the Americans have been thus from the very beginning: Indian genocide, Black slavery, Civil War, Philippine invasion, etc., etc., etc. Essentially barbarians; technological advances changes nothing, they just "put lipstick on the pig." Plus ça change, plus c'est la même chose.
Very naive the author's idea that if only this would have come to light in time, perhaps Abu Ghraib would not have happened. But precisely, the shamelessness which is part of the pathological hubris and irremediable barbarism of the American ethos. There is no capacity for shame here, but only the reactions that one expects from conscienceless sociopaths. True, some soldiers have thrown away their medals and even committed suicide; they are the exception that proves the rule.
Not to condone American misbehavior but it is hardly unique in the history world. What makes it egregious is the hypocrisy involved in American exceptionalism and triumphalism. Not too much different from the Hebrew conquest of "the promised land," Alexander's conquests and Hellenism, the depredations of the Romans and the excesses of empire, the Christian crusades, European wars, the global colonialism of the supposedly Christian Europeans, etc. America is just the latest and greatest in the saga of "man's inhumanity to man." Of course this is not limited to the West, either. In many ways there was no huge jump in the evolutionary chain, and humans are animals after all.
"First step is a commercial bank (a PD) lending to the govt. It debits a T bond and credits a govt. deposit"
If the bank can't actually PAY the Treasury, then it's not lending the Treasury anything, it's simply PROMISING to pay the Treasury something, and then failing to do so.
In order to actually PAY the Treasury, the bank has to borrow the money from the Fed, or else sell the bond to the Fed.
* just to be clear: in the above comment I am talking about the hypothetical "point zero"example".
(Obviously, if there are already reserves in the banking system then the bank in question doesn't necessarily have to borrow the reserves from the Fed. But we are assuming a situation in which there are not already reserves in the banking system)
If the bank can't actually PAY the Treasury, then it's not lending the Treasury anything
Let's try to clarify this point, because it's really important IMO.
When the bank lends to a corporation no one mentions the word "paying".
The bank debits a loan and credits the corporation a deposit. The corporation is then ready to use said deposit for paying its bills, suppliers, whatever. ~
The bank does not look at its reserve position before making said loan. If it finds it to be a likely source of future profits it will lend the corporation the "money" (bank liability accepted for "payment" everywhere).
Once the corporation starts using its deposit, sending funds elsewhere in the system the bank may find the necessary reserves at the interbank market or at the Fed (at a penalty rate) if need be.
Why should the above process be different when the beneficiary of a bank loan is the Treasury of the U.S. instead of a corporation?
This is the question I've been asking since the beginning of this conversation.
not a good interview - fails the elevator test. again back to square ONE - someone needs to put together a factbook presentation outlining what MMT is.
But that would put the government at a disadvantage vis-Ã -vis the corporation.
It would be more difficult for the govt. to draw funds from the private banks than for a corporation or an individual. The bank would need to get "reserves" first from the independent central bank in order to lend to the govt - whereas it would need no such thing in order to provide private agents with potentially unlimited funds.
That is, it would be a travesty of the very notion of hierarchy - the govt. at the bottom, private parties on top.
I see it differently. The Treasury decides to transfer its deposit at the commercial bank to the bank it uses - the Fed. Just like a customer may choose to transfer its newly-created deposit at a commercail bank to another bank of his or her choice.
But, substantially, the mechanics of granting a loan should be the same, indepently of the private or public nature of the bank customer. Accounting rules don't change just because the government is involved.
"This seems to be a common failing of MMT'ers, getting bogged down in the nerdy details and failing to emphasize what it means for the average Joe."
True. Interview should be labeled "MMT COULD save the world, if actually used intelligently."
Of course, lots of things could, if anything were used intelligently. Which brings us down to the main issue. The easiest, most coherent system is most likely to be 1st to be used coherently.
So, we're just waiting for a threshold level of group intelligence to be achieved? If we're not smart enough as a nation to leverage even MMT ... then you may as well pray for the goddesses to save us.
Accounting rules don't change just because the government is involved.
When a commercial bank makes a loan, the deposit is the bank's liability. When the Fed makes a loan the deposit is a govt liability. Banks need a govt liability (rb) to settle after the tsy auction. They cannot create rb, which can only be created by the Fed. So the bank either has to have the excess reserves to cover, or else borrow them in the interbank market or from the Fed.
When banks make loans that create deposits, the deposit is a promise by the bank to clear, either with cash at the window or settling as the intermediary. Settlement takes place either by netting, which doesn't need rb, or in the interbank settlement system (FRS in the US) using rb, which the bank has to have or get.
BTW, paying tax also requires settlement in rb. For example, a depositor write a check payable to the Treasury against a demand account. The bank then acts as the depositor's intermediary and transfers rb from its account to the Treasury account through the agency of the Fed, which operates the settlement system. The bank has got to have the rb balance in its account at the Fed or else to borrow the rb in the interbank market or from the Fed. If the bank is short at the end of a period, the Fed automatically extends the loan of rb at the discount rate. T
When the rb corresponding to the taxpayer's payment are credited to the Treasury's account, the obligation is cancelled.
That is to say, at the governmental level, which includes the Fed, all transactions take place in the government's liabilities, Fed, Treasury, or agency.
When the rb corresponding to the taxpayer's payment are credited to the Treasury's account, the obligation is cancelled
Right - credited, and not destroyed (as per Mosler's colorful expression).
The Treasury will subsequently draw on its replenished account at the Fed to make payments to third parties. If it wants to spend above its tax receipts it will have to rely on proceeds from T bond or T bill sales. Or, one day perhaps, on the proceeds from a newly-minted Platinum coin.
No reason to claim that tax receipts are destroyed. That was one of the points in Fiebiger's criticism of the way MMT explained certain parts of its discourse.
Yes, I think that "destroy" has turned out to be misleading. What is destroyed in the $NFA corresponding to the rb credited to the Treasury account.
Treasury spending (together with bond issuance under the present rules) increases ("injects", "creates") net financial assets of consolidated non-government ($NFA) and taxation decreases ("withdraws," "destroys") $NFA.
Treasury doesn't need to tax to obtain the reserves to clear, since it can issue more Treasuries.
But the fact is that the rb from taxation don't just disappear from the Treasury account on payment of taxes, which cancels the tax liability.
Similarly, when a bank loan is paid off, the loan is cancelled, so we say that the bank money created by the loan was "destroyed" in repayment. But the funds are credited to the bank, although it is not the case that the bank turns around and "lends out" those funds.
I believe the destruction story was linked to an imaginary situation where a taxpayer decided to discharge his or her obligations in cash. The Federal official would supposedly not know what to do with the damned dollar bills and - these not being needed to pay the Treasury's expenses - would simply order their physical destruction by a shredding machine.
Maybe the story can make sense if the Treasury somehow never deposits cash in its account at the Fed; in that case it would simply inform the Fed that individual X has just paid Y dollars in taxes in physical cash - and the Fed would proceed to credit the Treasury's account by the announced amount.
Under said circumstances - supposing they're realistic - the puzzled IRS official would be right to destroy the dollar bills. They would be useless and should not be left to survive at the risk of falling in someone else's (wrong) hands. :)
Not to condone American misbehavior but it is hardly unique in the history world.
But that is precisely what you are doing. You have neatly integrated it in your the comfort you have created for yourself.
And as a so-called new ager, you should know better that humans, in principle are lower than animals or else imagio Dei. Probably you don't really understand what that means, since you are also an evolutionist.
"But that would put the government at a disadvantage vis-Ã -vis the corporation.
It would be more difficult for the govt. to draw funds from the private banks than for a corporation or an individual. The bank would need to get "reserves" first from the independent central bank in order to lend to the govt - whereas it would need no such thing in order to provide private agents with potentially unlimited funds.
That is, it would be a travesty of the very notion of hierarchy - the govt. at the bottom, private parties on top."
That makes no sense whatsoever.
Literally no sense.
Obviously it's not more difficult for the government to borrow - it's easier. Obviously banks need reserves to pay the Treasury. If they don't have any, they need to get them from somewhere. They are created by the central bank. That's how it works. You seem to be saying that maybe that's not how it works, but it is.
"it would need no such thing in order to provide private agents with potentially unlimited funds."
Yeah a bank can credit a trillion dollars to someone's account as if by magic. But when that person spends the trillion dollars and the person receiving it has an account at another bank, the bank will have to pay up. Or if the person tries to withdraw the money, the bank will have to pay up. Or if the government taxes the person, the bank will have to pay up. etc. It can promise as much as it wants but it also has to be able to pay up when the time comes or it goes bankrupt. To do that it needs reserves/cash. It's actually very simple.
Anyone can "create a deposit". I just wrote "I owe Jose $500 trillion" on piece of paper. There, you now have a $500 trillion dollar deposit at the bank of Me.
You seem to think banks have special magical super powers for some reason.
"I see it differently. The Treasury decides to transfer its deposit at the commercial bank to the bank it uses - the Fed. Just like a customer may choose to transfer its newly-created deposit at a commercail bank to another bank of his or her choice."
Federal Reserve deposits are known as "reserves" or "reserve balances". They are electronic versions of physical currency.
So if the Treasury "transfers a deposit" from a commercial bank to the Fed, the commercial bank has to pay in reserves. The Fed therefore debits the bank's reserve account and credits the Treasury's account. It's not complicated.
"But, substantially, the mechanics of granting a loan should be the same, indepently of the private or public nature of the bank customer. Accounting rules don't change just because the government is involved"
Nothing I said indicates that"the rules of accounting change". I simply described how the system works.
The Treasury spends from its account at the Fed. So it needs money in that account. If it wants to spend $100 it needs $100 in that account. How does money get into the Treasury's account?
Answer: the Fed debits bank reserve accounts and credits the Treasury's account.
If a bank doesn't have any reserves in its reserve account it can't pay the Treasury. It can't lend to the Treasury, as it doesn't have anything to lend.
The bank has to get the reserves from somewhere. If there are no reserves in the banking system it has to get them from the central bank, as that's where they come from. It has to borrow them from the central bank or else sell assets (bonds) to the central bank. This is how it works.
"No reason to claim that tax receipts are destroyed. That was one of the points in Fiebiger's criticism of the way MMT explained certain parts of its discourse."
Fiebiger never understood what he was talking about.
When taxes are paid to the government, the government gets back its own liabilities. It is paid with its own liabilities. This simply extinguishes those liabilities. It doesn't provide the government with additional assets.
Tax payment extinguishes government liabilities. It "destroys" government liabilities. It doesn't provide the government with additional funds.
Henry I understand that quiet well and in fact my master's thesis in social political philosophy was title, "Revolution or Evolution: Toward a Theory of Social Change," which explored this.
At every point in time, humanity stands at a particular point in its evolution, poised between the momentum of the past and the possibility of the future. That is captured as the level of collective consciousness, which is reflected in individual and group behaviors that are in turn mediated through culture and institutional arrangements.
Since we are inside the process, we cannot stand outside of it to examine it. We have to locate patterns as best we can iaw our present mode of knowing.
What we have discovered recently in our substantial history is the dynamics of complex adaptive systems and emergence. That gives hope for continuing evolution.
We are also coming to understand through the study of perennial wisdom that evolution is not merely biological but also spiritual, and the there is indeed a logic, so to speak, underlying the dynamic, which has been going on for millions and billions of years and will continue for millions and billions of years even when this planet is no longer a factor in it. See Meher Baba, God Speaks, for a summary.
This is symbolized in religion and the arts as the "battle between good and evil." The challenge is to integrate more primitive with newly emergent forces into a balanced and harmonious life as an individual in community, yoking passion and reason in order to progressively unfold excellence as persons and societies. This is a delicate balance and many, even those who strive for excellence, often miss the mark due to some bias.
The process was, is and will be messy due to the very nature of it. It is never going to be complete in the relative changing dimension of existence for the simple reason that time is cyclical.
The saying, if you want to change the world, change yourself, holds true. It's also a good idea to get with people who are committed to doing so, too. Then do what is possible to change things for the better more widely.
You seem to think banks have special magical super powers
Well, the power to create deposits out of thin air is maybe not "magic", but it comes pretty close.
That's why this simple truth is never spoken to the general public.
They still believe that power is "backed" by something else - the piggy bank, the savings, gold, whatever.
Recent polls in Britain show an overwhelming majority believing banks cannot create "money". Same majority claims it would be "unacceptable" if said power were to be conferred to the banks.
Well, it already is. A pity that the public never noticed, but I suppose that's how democracy works :)
If the Treasury has $100 in its account at the Fed
I'll suppose the $100 resulted from payment of taxes.
Before said payment, the net position of the (consolidated) government was also $0; with a slight difference, however - the government could not spend (I'm presuming overdrafts are not allowed)
Now, thanks to those Fed liabilities that resulted from payment of taxes, it can spend $100.
Let's try to put it in as neutral a form as possible so that we can all agree on such a basic element of reality.
When taxes are paid the Treasury account at the Fed is marked up.
The Treasury can then spend said funds into the economy again, by crediting bank accounts of households and/or firms.
Would you agree with this statement?
Yes, taxes are credited to the Treasury account, and the reserves can be used as credits for spending or retiring bonds by crediting bank accounts without the Treasury needing to obtain more reserves from the Fed via a bond auction. That is to say, taxes reduce the need for fiscal deficits and consequent bond issuance.
That's the idea behind a balanced budget amendment, for instance. Tax credits withdrawn from the private sector are then used as tax credits to spend into the private sector. The cb creates the tax credits in from of reserves, and without deficit spending, reserves in excess of the tax credits in the private sector not yet taxed have to be borrowed from the Fed by banks at the rate the Fed sets.
Under a fiscal balance, no new $NFA would be added to consolidated nongovt in aggregate. Under a fiscal surplus $NFA would decrease in the amount of the surplus. ONly with a fiscal deficit do $NFA increase.
Banks can only create credit/debt but not currency, so theirlending does not affect the amount of $NFA in that credit-debt nets to zero.
If settlement in currency is required, either the home currency or foreign currency, banks have to get that currency, ultimately from the sole creator of the currency, usually the central bank under present arrangements, at any rate from the agent that the govt as currency sovereign authorizes.
Banks may borrow currency from someone else, but ultimately the currency comes from a central bank, because under present rules that is (generally) the agency were currency originates. Of course, the Treasury could be the designated agent, but under the present system in general countries use the cb currency-Treasury bond model. But that is a political choice that doesn't alter the general case wrt to currency sovereign. Countries can and do delegate monetary sovereignty, but those are special cases.
Turning to commercial banks.
If I go to my bank and demand dollars at the window, the bank does not create those dollars as currency, it has to get them by exchanging rb at the Fed for vault cash or through customer deposit that can be traced by to this process. Both rb and vault cash count as reserves in figuring the reserve requirement.
Same if I am traveling and want to avoid the airport exchange window, which may be crowded on arrival, and ask for yen, pounds, euro, etc., at my US bank prior to departure. No one thinks that the bank can just print up these notes. It has to get them from someone else, like a customer deposit, but ultimately those notes come from a govt issuer as the monopoly provider of the currency. Same with home country.
It works the same way with reserves. Banks have to obtain reserves needed to clear and meet the reserves requirement if imposed. If they fall short in the period, the cb as LLR lends the required reserves and charges the penalty rate.
In summary, cash only gets into circulation by banks' ultimately exchanging rb for physical currency with the cb as the govt's agent. Ultimately, banks only get rb when either govt credits bank accounts in making disbursements (spending and transfers) or by borrowing from the Fed. Every other means is traceable to the originator, which is the agent designated by govt as currency issuer, in the US, per US Constitution, Art 1, Sec. 8.
"thanks to those Fed liabilities that resulted from payment of taxes, it can spend $100."
Let's imagine there was a strange rule which said the Fed could only lend out or spend as many Federal Reserve notes as it had previously collected from the public. Crazy, I know.
If you were to give the Fed some Federal Reserve notes, would it then have additional funds?
Let's look at the basic accounting:
In this example there is only $100 in existence and you have it.
Jose: $100 asset Fed: $100 liability
You then give the notes to the Fed.
Jose: $0 Fed: $0
However, the Fed has now collected $100 in notes, so it can issue $100. So let's say it pays you $100:
Jose, the only way that the rb from taxes is extinguished from the govts books is when the rb from taxation is used to retire govt debt. then a Treasury asset cancels a Tsy liability on the Treasury's books.
Payment of the tax, on the other hand, cancels a private tax liability using a tax credit, and that tax credit is credited to the Tsy account as an asset. That asset can be used alternatively to retire tsys, or to be returned to non-govt as NFA through fiscal expenditure or interest payment.
Otherwise, the credit to the Treasury account from taxation can be spent into non-govt, reversing the withdrawal of $NFA, without the need to issue more tsys to get more rb for the Treasury account.
Similarly, when a bank creates a deposit by extending a loan, the deposit then leaves the bank and gets spent, and the bank has the loan as an account receivable. When the deposit is returned in payment of the loan (principal and interest), the deposit extinguishes the loan. But the deposit is not extinguished. It becomes a bank asset. If the loan defaults, then bank assets get marked down and so does equity.
In other words, nothing is ever lost in double-entry, and nothing just disappears from the books. Records of one account cancelling another are maintained, so it is always possible to see what happened. (Of course, I know you know this, but I am setting it forth in some detail for those who may not.)
Recent polls in Britain show an overwhelming majority believing banks cannot create "money". Same majority claims it would be "unacceptable" if said power were to be conferred to the banks.
IIRC, same in the US. People think that money comes from the govt. But they also think that govt gets the money from taxes. A bit of cognitive dissonance there.
the government is only permitted to issue as many of its liabilities through spending as it has previously extinguished through taxes (and other forms of revenue).
The quantity of "extinguished government liabilities" is shown as a positive balance in the Treasury's account.
(imagine there's a strange rule which says the Fed can only lend out or spend as many Federal Reserve notes as it has previously collected from the public.)
Now let's imagine the Fed sets up two departments to keep track of the notes it collects and the notes it issues, to make sure it's sticking to the rule. One department is called the "collection department" and the other is called the "issuing department". Each department keeps its own accounts. The collection department counts the notes it receives as assets, and the issuing department counts the notes it issues as liabilities. To issue a note, the issuing department has to get one from the collection department, meaning that the collection department's account is depleted when the issuing department issues notes, i.e. when the Fed lends or spends.
As before, the question is: If you were to give the Fed some Federal Reserve notes, would it then have additional funds?
Let's look at the basic accounting in this extended example:
(In this example there is only $100 in existence, and Jose has it).
We can conclude that, obviously, the Fed does not get additional funds when it receives Federal Reserve notes from Jose. This is because those notes are simply Fed liabilities.
For people like Fiebiger, however, in this example the Fed does get additional funds from Jose. Fiebiger would point to the collection department's account and point out that its assets increase when notes are deposited, and diminish when the Fed lends or spends.
For people like Fiebiger, however, in this example the Fed does get additional funds from Jose
I can´t speak in Fiebiger's name (though I did read - and like - his paper) but I can tell you what I think.
When the Treasury's account at the Fed is at zero, it will have to be marked up before the Treasury can spend.
There are 2 possibilities (allowing for the no overdraft clause) in that case.
Either the Treasury raises funds via bond or bill sales.
Or it raises funds via taxes.
Otherwise, it will not be able to spend.
When Jose sends his $100 bill to the IRS to pay his taxes, the Fed will subsequently debit banknotes and credit the Treasury account.
The Fed's total liabilities remain at the same level as they were before the tax payment occurred - the $100 liability was merely reshuffled from banknotes to Treasury account.
The Treasury can now spend $100. Before the tax payment, it could not spend a single cent.
If the Federal Reserve were to run out of Federal Reserve notes, it wouldn't be able to redeem its deposits (reserve balances) for notes. As such the Fed would default on its promises to do so - it would default on its debts.
Banks would not be able to withdraw notes from the Fed, so bank customers would consequently not be able to withdraw notes from their banks. As such the banks would default on their promises to their customers - they too would default on their debts.
So if the Treasury were to stop supplying Federal Reserve notes to the Fed, the Fed would end up defaulting on its debts.
By your logic this must mean the Federal Reserve gets its funds from the Treasury.
Following on from the above, the Fed should therefore count Federal Reserve notes in its possession as 'assets' - which it needs to acquire in order to be able to lend to banks or purchase assets from banks without subsequently defaulting on its debts (i.e. defauting on its promise to redeem deposits for notes).
As such, when the Fed gets Federal Reserve notes from the Treasury, or when notes are deposited at the Fed by banks, the Fed should count this as an increase in its available funds.
So we should consistently talk about the Fed getting its funds from the Treasury and from banks, as this is how the system works.
Therefore anyone who says the Fed "creates money ex nihilo" is wrong, and the truth is that the Fed has to procure funds from the Treasury or from banks in order to be able to lend or spend.
I suppose the Treasury could, in theory, simply spend by issuing cheques, without ever having to pay in reserve balances or cash if the cheques were never returned to the Fed for clearing.
i.e. you could receive a cheque from the Treasury, take it to your bank, the bank would credit your account, and then simply keep the cheque as a reserve, paying other banks with Treasury cheques instead of Fed reserve balances. The cheques would then serve as currency, never being redeemed for reserve balances or Federal Reserve notes.
Of course this would never happen but its not impossible in theory.
However, it is the case that Treasury payments always clear, and Treasury cheques don't bounce. If they did, the monetary system would go into meltdown.
Similarly, the Fed spends and lends by creating deposits (reserve balances). In theory banks could use only these deposits, and no notes would ever need to be withdrawn, if everyone just accepted payment in electronic credits and never used cash. But that doesn't happen (at least not yet!).
When banks want to withdraw their deposits as notes, the Fed doesn't default. It supplies the notes.
When the Treasury prints Federal Reserve notes and supplies them to the Federal Reserve, does the Federal Reserve then have additional funds?
Federal Reserve notes are "issued at the discretion of" the Fed Board of governors.
They are liabilities of the Fed, issued to respond to commercial bank demand for bank notes (itself s result of the public wanting to hold a portion of its bank deposits as currency).
The banks must have deposits (reserves) at the Fed in order to get the needed banknotes. TIn that cae, the Fed debits commercial bank deposits (reserves) and credits banknotes.
and of course the total amount of Fed liabilities stays unchanged.
As you say, Federal Reserve notes are indeed liabilities of the Fed. As such, if you return a Federal Reserve note to the Fed, the Fed's assets don't increase, and it doesn't get any additional funds. Returning a note to the Fed simply extinguishes a Fed liability.
We can show this as follows.
1. Mr A has $100 in Fed notes:
Mr A: $100 asset Fed: $100 liability
2. Mr A returns the notes to the Fed:
Mr A: $0 Fed: $0
The Fed now has zero. It doesn't have any additional assets or funds. Its liability has simply been extinguished.
Ok, so now let's look at the US Code:
"Federal reserve notes, to be issued at the discretion of the Board of Governors of the Federal Reserve System for the purpose of making advances to Federal reserve banks through the Federal reserve agents as hereinafter set forth and for no other purpose, are authorized. The said notes shall be obligations of the United States and shall be receivable by all national and member banks and Federal reserve banks and for all taxes, customs, and other public dues."
http://www.law.cornell.edu/uscode/text/12/411
The Code states that Federal Reserve notes are "obligations of the US". "US" means the US government/ Federal government, and an "obligation" is a liability.
Here's another section of the Code:
"The term “obligation or other security of the United States” includes all bonds, certificates of indebtedness, national bank currency, Federal Reserve notes, Federal Reserve bank notes, coupons, United States notes, Treasury notes, gold certificates, silver certificates, fractional notes, certificates of deposit, bills, checks, or drafts for money, drawn by or upon authorized officers of the United States, stamps and other representatives of value, of whatever denomination, issued under any Act of Congress, and canceled United States stamps."
http://www.law.cornell.edu/uscode/text/18/8
Here we see that Federal Reserve notes are US government "securities", like Treasury bonds. Both are US government liabilities.
We saw before that when Federal Reserve notes are returned to the Fed, the Fed doesn't then have any additional assets or funds. The Fed's liability is simply extinguished - it ends up with $0 in my example above.
The same thing is NECESSARILY the case when Federal Reserve Notes are returned to the US government.
We can show this as follows.
1. Mr A has $100 in Fed notes:
Mr A: $100 asset US government: $100 liability
2. Mr A gives the notes to the US government:
Mr A: $0 US government: $0
Notice that the US government now has zero. It doesn't have any additional assets or funds. Its liability has simply been extinguished.
We know that when people make payments to the US government, such as taxes, the money is ultimately paid to the Treasury's account at the Fed. The Treasury, however, counts Federal Reserve notes as "assets". So if someone were to give $100 in Federal Reserve notes to the Treasury, the following would happen:
Treasury: $100 asset Federal Reserve: $100 liability US government: $0
Clearly, the US government has not received any additional assets or funds. Its liability has simply been extinguished.
This is odd, as the Treasury is part of the US government. Indeed, the Treasury and US government are usually regarded as the same thing when people talk about “government spending” and “paying taxes to the government”. So how can it be that, in the example above, the US government both has and doesn’t have an asset?
How can the Treasury have funds if the US government doesn’t have funds?
How can the Treasury have funds if the US government doesn’t have funds?
I assume your Mr. A is returning the banknote in the process of paying taxes.
In that case, commercial banks are out of the picture - an atypical case, since usually taxes are paid via deposits that taxpayers hold at commercial banks.
Anyway, I see the 3 balance sheets involved (Treasury, Fed and Mr. A) thus:
Phase 1 (starting point, before tax payment)
Tsy: zero assets and liabilities Fed: Liability: +$100 banknote Mr. A: Asset: +$100 banknote
Phase 2 (tax payment; Tsy receives payment and deposits the proceeds at the Fed)
Tsy: Asset - +$100 banknote Fed: Liability - +$100 tsy deposit Mr. A: zero assets and liabilities
Phase 3 (Tsy spends by paying a putative Mr. B with a note)
Tsy: zero assets and liabilities Fed: Liability - +$100 banknote Mr. B: Asset- +$100 banknote
In a sense, the process is a wash. The funds (banknote) used by Mr. A to pay taxes are returned to the economy (househols or firm sector) as a government payment to Mr. B.
The Fed starts and ends the process with the same $100 banknote liability. In the middle of the story the $100 liability was changed from the Fed's "banknote" account to the Fed's "Treasury" account. In the end, it returned to its original account.
"I assume your Mr. A is returning the banknote in the process of paying taxes."
To keep it simple, yes.
"usually taxes are paid via deposits that taxpayers hold at commercial banks."
That's not correct. Taxes are paid in reserves from bank reserve accounts to the Treasury's account at the Fed. The debiting of people's bank deposits is only the first step in a process which ends when payment is made to the Treasury's account by banks.
Your description of the process above (phase 1,2,3) is correct. However, you haven't really addressed my point, which is:
In Phase 2 the Tsy has a $100 asset.
But the US government has $0. No asset.
This is a strange state of affairs.
Because if the Tsy has an asset, and funds, then surely the government should have an asset and funds. But it doesn't, it has zero.
So the Tsy's asset is really a kind of intra-governmental accounting fiction.
If this is kept in mind, then it's fine to say "the Treasury has funds", if one keeps that context in mind.
However, Fiebiger, JKH and others all make the mistake of saying "the Treasury has funds therefore the government has funds". This leads to the nonsensical conclusion that the government gets funds from taxes and is a "currency user".
That's not correct. Taxes are paid in reserves from bank reserve accounts to the Treasury's account at the Fed
It's correct. I just mentioned the first phase of the process ("via deposits..."). There is a debit to taxpayers' deposits and a simultaneous credit to commercial banks' reserves. On the Fed's books a debit to reserves (Fed liability) and a credit to Tsy account (another Fed liability).
But the US government has $0. No asset. This is a strange state of affairs
I think that it's helpful to think "at the margin" here.
The consolidated govt (Tsy + Fed) started from a net liability position of $100 and went to a net position of zero. It has "gained" $100 as a result of the tax payment.
"There is a debit to taxpayers' deposits and a simultaneous credit to commercial banks' reserves"
Where does the "simultaneous credit to commercial banks' reserves" come from?
If a bank debits $100 from a customer's account, the bank's liabilities are reduced by $100. There is no simultaneous increase in its assets, no increase in its reserves.
You appear to have magicked additional reserves from nowhere. Please explain.
"The consolidated govt (Tsy + Fed) started from a net liability position of $100 and went to a net position of zero. It has "gained" $100 as a result of the tax payment."
I wasn't referring to the "consolidated government", i.e. Fed and Treasury combined, I was referring to the US government, i.e. basically Congress.
When the Treasury has $100 in its account at the Fed the US government - Congress - has $0. There is no need to consolidate Treasury and Fed to get that result. You can keep the Fed separate from the government for accounting purposes and still get that result.
In your example the US govt starts from a $100 liability position and goes to $0 when payment is made to the Tsy. As such the govt then has zero funds.
If you owe someone $100 and pay it back, you simply cancel your debt, you don't "gain" additional assets or funds.
I forgot to add a possible interpretation for y's puzzle.
We should keep in mind that the starting position with only a $100 liability on the Fed´s BS - while useful for understanding the issue, by breaking it into isolated pieces, so to speak - was also somewhat artificial.
The "real" initial Fed Balance Sheet, of course was balanced. Ditto for the consolidated govt. BS.
So the tax payment actually generated "equity" for the consolidated govt. An "equity" subsequently spent by said govt. by making a payment to the private sector.
"Tsy then spends by depleting its $100 account at the Fed. No need to get Congress in the picture here."
I said Congress so it was clear what I was referring to. I keep talking about the US government, and you keep inferring that I'm talking about a "consolidated government" in which Fed and Treasury are "consolidated". I'm not actually talking about that. We can keep Fed, Treasury, and US government completely separate and make no mention of a "consolidated government" and still say that when the Treasury has $100 in its account at the Fed the US government has $0.
The Treasury's account shows that the Treasury has received $100, and it counts this as an asset. But for the US government that cannot be an asset as the $100 is a liability of the US government.
Again, I'm not talking about a liabiltiy of the Fed or a liability of a "consolidated government" - it is a liability of the US government.
So when the Treasury has $100 in its account, the US government has $0. No asset, no funds. Yet it spends, despite the fact that it has no funds.
As I said before, if you pay Federal Reserve notes to the Fed, it doesn't then have additional assets or additional funds.
The same is the case with the US government. The government spends from zero, i.e. it creates its liabilities, creates money, when it spends.
If the Treasury shows $100 in its account, this means the US government is allowed by 'the rules' - i.e. by itself - to issue $100 of new liabilities, i.e. to create $100 worth of new money by spending.
When the Treasury "depletes its account" and the account hits $0, the US government is no longer allowed by 'the rules' - i.e. by itself - to create money by spending. It has to destroy more of its outstanding liabilities before it is allowed - by itself - to create new ones. So it has to collect taxes or sell bonds.
The Treasury's account shows how many US government liabilities have been extinguished through taxes and bond sales, and as such how many new liabilities the government is allowed to create. It shows this as a positive number.
"So the tax payment actually generated "equity" for the consolidated govt."
In a really simple scenario, say we have:
1. Before tax payment
Fed: $100 Tsy bond (asset) $100 reserves (liability)
Tsy: $100 bond (liability) $0 deposit
Bank: $100 reserves (asset)
2. After $100 tax payment:
Fed: $100 Tsy bond (asset) $100 Tsy deposit (liability)
Tsy: $100 bond (liability) $100 deposit (asset)
Bank: $0
The "consolidated government" now has net $0. No increase in equity.
Well, your initial example had a banknote at the start, now you're switching into bonds and bank deposits.
Let's try to stick to some rules, so we don't get all messed up in the process, ok?
Forget your "starting point". At the start, as you well know, all balance sheets have to be at balance. However, your starting point has two "unbalanced balance sheets", with positive assets and no accounting entries on the liability & equity side. These would have to be either liabilities or equity and you don't clear up that issue.
Think at the margin: what happens when Mr. A pays his taxes?
Here are the accounting entries:
Mr. A: Minus bank deposit (Asset) Minus Equity (L & E)
Bank: Minus reserves at Fed (Asset) Minus Mr. A deposit (L & E)
Fed: Minus bank deposit (L & E) Plus tsy deposit (L & E)
Tsy: Plus deposit at Fed (Asset) Plus Equity (L % E)
Net result for consolidated government (tsy AND Fed): Plus Tsy asset, plus Tsy equity. Note that on the Fed balance sheet there was simply a reshuffle among items on the liability side; these net out to zero.
Overall net result for government: more assets and more equity. The increase in equity is equal in amount to the tax payment.
To the penny.
Overall net result for the private sector (Mr. A): a loss of equity equal in amount to the tax payment. Again, to the penny.
This is as should be: the tax payment drained resources from the private sector and increased the resources at the disposal of the government.
The govt. is now ready to spend, injecting the resources back into the economy. Before the tax payment, it could not spend.
"Overall net result for government: more assets and more equity."
You seem to be saying that the Treasury is the 'government' - the 'government' being a different thing to the "consolidated government", which is the Treasury and Fed combined.
This is not the case. The Treasury is not the government, it is a part of the government, it is a government department.
If the Treasury has a deposit in its account at the Fed, that deposit a Treasury asset. However, that Treasury asset is also a government liability. Not a "consolidated government" (Treasury and Fed combined) liability - simply a government liability.
Treasury asset (+1) + government liability (-1) = 0
You seem to be saying that the Treasury is the government
No, I'm not saying that.
Remember we agreed that all the balance sheets started at balance.
What happened when Mr. A paid his $100 in taxes?
The Treasury gained an Asset (deposit at Fed) with no corresponding liability. Its equity thus increased by $100.
The Fed, however, had a change of zero in its overall balance sheet amounts. No change in assets (no accounting entries) and no net change in liabilities either (the only thing that changed was the composition of liabilities - it "owed" $100 to the banks, now it "owes" the same $100 to Tsy). Thus, the equity position of the Fed was unchanged.
And the total equity of the government? Well, it increased by $100. Plus $100 to Tsy + zero to Fed = Plus $100 to consolidated government.
That is, it increased by exactly the amount of the tax payment by Mr. A.
I think that y is arguing here that the consolidated government books net to zero, just as the consolidated private sector books net to zero, since RHS = LHS by identity?
Seems to me it comes down to borrowed v. non-borrowed reserves.
1. According to MMT (Warren's Soft Currency Economics) government as currency issuer must do a reserve add to do a reserves drain. Deficit expenditure is the add and bond issuance is the drain. Net zero, no borrowing from private sector.
2. Some argue that govt borrows using bank money rather than its own money. Since auctions don't settle in bank money but govt money (rb or cash), if the govt doesn't provide the funding, then private banks have to borrow the reserves from the central bank.
y is cancelling out the Fed's liability against the tsy's asset, but the Fed has its own asset, which backs the deposit, and its side of the equation nets to zero.
"y is cancelling out the Fed's liability against the tsy's asset, but the Fed has its own asset, which backs the deposit, and its side of the equation nets to zero."
But the Fed's asset (Treasury bond) is the Treasury's liability...?
government as currency issuer must do a reserve add to do a reserves drain
I think those arguments over what came first - the chicken or the eggs - inevitably lead to infinite regress (that is, a road to nowhere).
Anyway, bond issuance constitues a reserve drain only if the government gets financing from the private sector.
In Canada, where the central bank is authorized to buy bonds at primary market auctions, there need be no reserve drain. The accounting entry at the central bank will be in the form of an asset (tsy bond) and a liability (govt. deposit). Commercial bank deposits at the central bank (reserves) will not be touched in this case.
But a tax payment will necessarily involve a reserve drain. The subsequent government spending, however, will provide a reserve add, for a net change of zero.
Of course, we could say the same thing the other way around: govt. spending first provides a reserve add, and taxes will provide a reserve drain. From an accounting POV the statements are equivalent.
In a pure MMT-system, where the government gets funds directly from its central bank (and not from private markets as is the case of present-day US of A) there are two possible sources to fund govt. spending:
a) the government's own central bank "money"
b) payment of taxes
In practice, taxes will provide the overwhelming majority of funds. Otherwise, inflation would threaten the system.
Of course, many MMTers object to the expression "taxes financing government spending".
To accomodate said objections we might find an alternative expression, involving the word "rules". We could say, e. g., that there must be rules in place to dictate that govt. may spend only if its account at the central bank has a positive balance - resulting from either tax payments or bond sales.
"In a pure MMT-system, where the government gets funds directly from its central bank"
It's not possible for the government to get funds from its central bank in a "pure MMT system". You have things upside-down. Apparently because you think banks have mysterious special magical super powers, for some reason.
All books have to balance, including within within govt. The books we are concerned with are cb and Treasury. The cb's books balance, and so do the Treasury's.
The private sector can hold both cb and Treasury liabilities as assets, also although bank money nets to zero, consolidated non-got can net save using govt liabilities, which are tax credits.
It's first ying and then yang. But it could also be first yang and then ying. This kind of argument will lead us nowhere.
First the private sector loses equity (it pays taxes). Then the govt. spends - and the private sector regains said equity.
And yes, you may also state it the other way around. It won´t change anything to the fact that when the private sector pays taxes the govt. sees its "equity" increased. The opposite, when it spends.
You didn't answer the question but rather avoided it
1. Deficit expenditure is the add and bond issuance is the drain Correct, in the present U.S. system
2. if the govt doesn't provide the funding, then private banks have to borrow the reserves from the central bank In fact, the Fed buys back the bonds from the banks, thus providing an injection of reserves (and also preserving its interest rate target). So, it's also correct.
I'd also like leave a couple of questions of my own:
1. Do tax payments drain resources from the private sector and provide resources for the government to spend?
This was what was being discussed, after all.
And also another (related) question:
Can the government spend when its account at the Fed has a balance of zero?
Since we are in quotation mode (as per the warren Mosler passage above) let me also add a quote from L R Wray, describing the process of deficit spending as it really is, at present in the U.S.; if you don't mind, I'll add the corresponding accounting entries in balance sheet form:
the Treasury sells the treasuries to the private banks, which create deposits for the Treasury... Banks' BS: Asset: + tsy bonds liability: + govt deposit
...that it can then move over to its deposits at the Fed... Banks' BS: Asset: minus reserves Liabilities: minus govt deposit Fed BS: Liabilities: minus bank reserves, plus govt deposit
And then ‘Helicopter Ben’ buys treasuries from the private banks… Fed BS: Assets: plus govt bonds liabilities: plus bank deposits Banks' BS: Assets: minus govt bonds, plus reserves
And the conclusion naturally follows: The Fed ends up with the treasuries, and the Treasury ends up with the demand deposits in its account at the Fed – which is what it wanted all along, but is prohibited from doing directly"
It's not possible for the government to get funds from its central bank in a "pure MMT system"
Well, you'll have to explain that POV to Stephanie Kelton (then Bell).
In her paper "Functional Finance: What, How and Why" she starts the process of deficit spending with an accounting table under the title "Step A: The sale of a Government bond to the Central Bank", where one can read the following entry: Central Bank: Asset: + government security Liability: + balance owed to Treasury
That is, a perfect description of a "pure" MMT system - unfortunately, not (yet) the one we have in the U.S. of A.
If the govt has a $100 liability and zero assets it must have (accounting rules) negative equity of $100.
When the private sector pays $100 in taxes, govt assets increase by $100 (it received or "earned", if you prefer, $100). Consequently, govt equity must change from minus $100 to zero.
That equity thus increased (net change) by exactly $100.
Simple accounting arithmetic.
And also economic logic. A private sector deficit necessarily results in a govt surplus.
"A private sector deficit necessarily results in a govt surplus"
but they both end up with zero.
So next time the govt issues a liability, it's starting from zero - not drawing on existing assets or funds, or surplus, or equity. Just zero. What am I missing?
1. Deficit expenditure is the add and bond issuance is the drain Correct, in the present U.S. system
2. if the govt doesn't provide the funding, then private banks have to borrow the reserves from the central bank
In fact, the Fed buys back the bonds from the banks, thus providing an injection of reserves (and also preserving its interest rate target). So, it's also correct.
I'm talking about when the bonds are bought by non-govt entities that intend to hold them and not sell them. In aggregate, do they buy them to hold with reserves that are borrowed from the Fed or reserves are not borrowed from the Fed? If they are not borrowed from the Fed, then how does non-govt get them?
BTW, in using OMO, govt doesn't purchase bonds from the private sector but rather does repo agreements. Prrchase is only in POMO, when the cb pays IOR.
I'd also like leave a couple of questions of my own:
1. Do tax payments drain resources from the private sector and provide resources for the government to spend?
According to MMT,taxes draw down consolidated non-govt net financial assets previously provided by govt through deficit spending. Govt doesn't take what it did not previously give, in aggregate.
According to MMT, if govt runs a balanced budget or a deficit, it adds the financial assets it taxes in aggregate. If it runs a surplus, then it draws down consolidated non-govt saving of net financial assets provided previously by govt.
Some opponents of MMT hold that govt borrows credit money created by banks. If this is what is meant by draining resources from the private sector, the answer MMT gives is, no.
And also another (related) question:
Can the government spend when its account at the Fed has a balance of zero?
No, not with the existing Treasury no-overdraft rule.
In her paper "Functional Finance: What, How and Why" she starts the process of deficit spending with an accounting table under the title "Step A: The sale of a Government bond to the Central Bank", where one can read the following entry: Central Bank: Asset: + government security Liability: + balance owed to Treasury
That is, a perfect description of a "pure" MMT system - unfortunately, not (yet) the one we have in the U.S. of A.
I would not call it a "pure MMT system" in that no MMT economist does. Scott, for example, distinguishes between general and special case.
The above is a description of general case operations in a non-convertible floating rate system. Different countries modify the general case with politically chosen (voluntary) conditions that limit general case operations iaw special rules.
So, let's say the Tsy imposes $100 a tax on the non-govt in the above scenario. Where does the non-govt get the money to pay the tax from?
Answer: it has to borrow it from the Fed
Very well, then.
I understand what you mean, but unfortunately your accounting entries are incomplete.
Lat's recap.
The non govt (starting from a zero position in assets and L & E, in your exemple) must pay the $100 tax by determination of the govt.
Here are the entries required for the non-govt to pay: Asset: minus $100 deposit L & E: minus $100 equity
Note how equity is the plug. By definition equity equals (assets minus liabilities). Since assets went down by $100 without a corresponding reduction in liabilities, equity took the hit.
But, as you say, the non-govt does not really have any asset so it must borrow from the Fed.
Here are the entries for the Fed loan, from the non-govt perspective: Assets: + advance from Fed L & E: + funds owed to Fed
What's the overall situation now? Assets are again at $0. But liabilities are at $100 (owed to the Fed). Applying the identity (equity = assets - liabilities) we have, equity = zero minus $100.
Conclusion: after the Fed loan to pay the tax, the non-govt equity is still at a negative $100 position.
Whereas before the tax was imposed its equity stood at $0.
If it (the govt)runs a surplus, then it draws down consolidated non-govt saving of net financial assets provided previously by govt
Ok, I understand that; but the point in discussion was never about the primeval origin of financial assets. It was exclusively about what happens - in terms of changes to the balance sheets of the various parties involved - when Mr. A, a private sector agent, pays his taxes.
Can the government spend when its account at the Fed has a balance of zero?
No, not with the existing Treasury no-overdraft rule
Yes; and said account may be replenished via either tax payments or bond sale proceeds.
I would not call it a "pure MMT system" in that no MMT economist does
We can change "pure" to "general case", no problem at all. The intended meaning is the same.
Unfortunately, the only country that likely comes near to that general case is Canada. The U.S. still suffers from many "voluntary restrictions" that do very much put it in the "special case" category.
Ok, I understand that; but the point in discussion was never about the primeval origin of financial assets. It was exclusively about what happens - in terms of changes to the balance sheets of the various parties involved - when Mr. A, a private sector agent, pays his taxes.
I think that there are two separate things going on here. First, Jose and y debating certain accounting issues, which I have not been following closely.
What I am interested in is the objection to MMT that govt uses bank money when it taxes or borrows. That may be true in individual cases but it cannot be true in aggregate because taxes and bond auctions settle in reserves, which come only from the side of govt. So to settle, non-govt either has to get the reserves from govt by borrowing from the cb or through fiscal injection by the Treasury. The MMT position is that taxes and bonds sales are generally settled in aggregate with funds that govt provided through injection. However, if there were to be no govt debt and no reserves from injection due to persistent fiscal supluses, then non-govt would have to borrow from the cb for taxation and to purchase govt securities.
We can change "pure" to "general case", no problem at all. The intended meaning is the same.
Yes, better to stick with the terminology that MMT economists use.
What MMT economists claim is that limiting the general case limits govt policy space. The obvious question then is why?
Unfortunately, the only country that likely comes near to that general case is Canada. The U.S. still suffers from many "voluntary restrictions" that do very much put it in the "special case" category.
Yes. I would add that the current system of bond financing doesn't fit the general case either, since bonds are operationally unnecessary under a non-convertible floating rate regime, and the interest constitutes a subsidy since it too is unnecessary. That is to say, this method of departing from the general case stands in need of justification since it is not operationally unnecessary and introduces inefficiency. What is the trade-off for introducing inefficiency or it is a special interest insertion that creates privilege?
What I am interested in is the objection to MMT that govt uses bank money when it taxes or borrows
Actually, there is a much more important objection to what we might call the MMT world view (as far as it goes beyond MMT's plain description of government spending).
It's the objection that in the real world that we all live in, most of the money created does not derive from govt activity: it's commercial bank money (bank deposits that do not result from govt deficit spending).
According to estimates for the UK provided by Prof. Richard Werner, about 97% of money is created by banks, rather than by the govt.
That seems to me a much more important objection (or should we say, different perspective?)for dedicated MMTers to comment upon.
I would add that the current system of bond financing doesn't fit the general case either
No, it doesn't.
The purpose of this system is to create and maintain the fiction that the govt needs the private markets' funding in order to deficit (underline: deficit) spend.
When in fact it doesn't.
To place the govt in a subordinate role on the people's minds.
That's why I never thought the platinum coin idea stood a chance. It was too dangerous for TPTB.
Actually, there is a much more important objection to what we might call the MMT world view (as far as it goes beyond MMT's plain description of government spending).
It's the objection that in the real world that we all live in, most of the money created does not derive from govt activity: it's commercial bank money (bank deposits that do not result from govt deficit spending).
According to estimates for the UK provided by Prof. Richard Werner, about 97% of money is created by banks, rather than by the govt.
That seems to me a much more important objection (or should we say, different perspective?)for dedicated MMTers to comment upon.
MMT of course recognizes this, since it is a combination of Chartalism and the credit theory of money, and distinguishes bank created money that nets to zero from govt created money that doesn't. MMT also agrees that money creation is endogenous with the cb as the LLR.
The important thing that most people don't realize is that most of what they call "money" indiscriminately — and most people think that the money comes from the goverment — is actually credit that has a corresponding debt and that bank "money" is the debt created by lending. It has no backing and is subject to default.
What sustains bank money is the banks' promise to settle in govt money on demand, either through cash at the window or in bank reserves at the cb in the case of payment by other means. That is to say, the bank promises to obtain government money to settle on demand since banks cannot create the government's money currency. All they can do is issue credit denominated in the unit of account, which is generally the currency, along with the promise to deliver currency on demand either at the window or in the payments system.
Obviously, this is a very unstable system, when the overwhelming percentage of money is based on private promises, that is, the borrowers' promise to pay and the banks' promise to settle in govt money that banks cannot create but must obtain from equity or borrowing.
I suspect that if the public realized this, the system would change pretty quickly, since it is clearly a house of cards, other than the small fraction of government money.
Then and only then can govt spend that money into the economy.
But it is not required in the general case. Only if a special case requires it.
Of course, in the general case, when taxes are received they are created to the TGA and the Treasury has those reserves to credit to non-govt accounts. But it doesn't need them to spend since it can create currency as desired.
However, it is true that if a govt running the general case decided to spend only what it taxes, i.e., a balanced budget, then non-govt cannot net save in aggregate without a deficit to provide the net financial assets.
I suspect that if the public realized this, the system would change pretty quickly, since it is clearly a house of cards
That's precisely what the people from the "Positive Money" site and campaign are trying to achieve in the UK: explain how money really works so that people will realize the con job being played on them and start demanding profound changes to the system.
If that happens, the days of absolute rule by the banking cartel may well be numbered.
In practice, it cannot create currency "as desired" and forget about tax receipts. That would mean inflation, a very real constraint.
In modern societies (even if ruled by anti-welfare state ideologues), G-T is always much smaller than G.
Such societies will always have a large state sector, most of which will have to be financed by taxes, not by deficits (currency creation).
Agreed.
The size of the deficit is based on the saving desire of non-govt, so currency creation through deficits to meet non-govt saving desire results in the desired net financial assets in aggregate in a full employment budget. Increasing deficits beyond that limit will be inflationary. If govt wishes to spend more than non-govt wishes to net save, then it must tax more to prevent inflationary pressure. Govts generally wish to spend more than non-govt desires to save, so taxes are needed to manage the size of the deficit to keep it in line with non-govt saving desire.
That's precisely what the people from the "Positive Money" site and campaign are trying to achieve in the UK: explain how money really works so that people will realize the con job being played on them and start demanding profound changes to the system.
If that happens, the days of absolute rule by the banking cartel may well be numbered.
Agreed. Advocacy is needed in all countries. Positive money in the UK and AMI in the US have been able to get the most publicity so far.
Your example implies the govt going into negative equity when it spends. (An increase in liabilities without a corresponding increase in assets implies a negative equity entry).
That is correct.
And reverting to zero equity when the private sector pays taxes.
This is also correct.
You should notice, however, that when taxes were paid, the govt saw its equity increase by $100. Indeed, it went from a negative $100 to zero.
Zero minus a negative $100 equals a positive $100 change.
This has been my consistent point all along this debate: when taxes are paid the government sees an increase in its equity.
It can't be otherwise. And I'm glad to see you fully agree.
Consolidated govt books balance, and consolidated non-govt balance. I think there is agreement on that.
Govt can issue currency (Fed liabilty) and bonds (Treasury liability) that non-govt holds as assets. I think that is agreed.
Govt can then tax back assets (tax credits) that it created in non-govt through issuance, some of which (fiscal deficits) is saved in tsys. I think that there is agreement there, too.
The tax credits that are issued come from the Treasury account at the Fed, and tax credits are credited to the Treasury account when taxes are paid.
The Treasury can only spend by having reserves that it can neither issue directly,nor obtain directly from the Fed under current law. I think this is also agreed.
The Treasury spends by getting reserves from taxation, and it deficit spends by getting reserves from tsy issuance via auction. Agreed?
Taxation creates private sector liabilities that can only be satisfied with government liabilities (rb or cash). Agreed? (Some seem to object to this.)
So the accounting shows these "vertical transactions" between govt and non-govt that show up in the respective books and can be aggregated. I assume this is agreed, too.
Govt liabilities are only created when the Fed issues its liabilities and the Treasury its liabilities. I think this is agreed.
Treasury liabilities are cancelled when tsys are redeemed for reserves. Non-govt tax liabilties are cancelled when taxes are paid. Some Fed liabilities are created when the Fed loans rb to non-govt and cancelled when the loans is repaid. Agreed?
The Fed only creates rb without lending when it purchases tsys from non-govt, in what MMT calls an asset swap. Similarly the Fed exchanges bonds for rb as an asset swap when it sells tsys. Agreed?
There is one point, however, that I think deserves further discussion:
Taxation creates private sector liabilities that can only be satisfied with government liabilities (rb or cash). Agreed? (Some seem to object to this.)
There is no doubt, IMO, that tax payments are ultimately made with commercial bank deposits at the central bank ("reserves").
This is implied by the accounting entries of a tax payment on the Balance Sheets of the several actors concerned:
For private sector: minus bank deposit, minus equity
For commercial banks: minus reserves, minus private sector deposits
For the Fed: minus commercial bank deposits ("reserves"), plus Tsy deposits
For Tsy: plus deposit at Fed, plus equity
But the big question is the following: since the Fed is "condemned" to always provide commercial banks with the needed reserves - otherwise the payment and settlement system will collapse, a result that central banks want to prevent from occurring at all costs - we could say that (ultimately) it's the commercial banks who hold the keys to the supply of reserves (so-called "govt money" or "base money").
So we might interpret the present situation as: yes, the government sector creates reserves via its central bank - but it does so at the pleasure and discretion of the commercial banks.
In a sense, it's the commercial banks who hold the keys not only to the money supply (deposits) but also to the creation of base money ("reserves") by the government's own bank.
Yes, that is what endogenous money creation involves and both circuitists and chartalists agree on that point.
That is to say, the size of the M2 money stock is determined endogenously by credit extension chiefly (net zero) and partially by deficit spending ($NFA).
The fiscal balance is also largely determined endogenously, rather than exogenous by discretionary fiscal policy, due to the variability of tax receipts and automatic stabilization over the cycle.
What this analysis shows, btw, is the centrality of leverage and its use in the present institutional arrangements through which money is created.
Economic cycles involve expansion and contraction of leverage and leverage ratios. This is the basis of risk and risk management. The higher the gearing the greater the exposure of borrowers, lenders, and the system itself.
the size of the M2 money stock is determined endogenously by credit extension chiefly (net zero) and partially by deficit spending ($NFA)
I'd add the proviso that deficit spending only increases the money stock as far as government bonds/bills are bought by the commercial bank sector.
If it's non depository institutions or households that are buying the govt securities, there will be no net increase in bank deposits ("money").
There will be an increase in the amount of bonds outstanding, of course; but that would lead us back to the old discussion on whether Tsy secutities are "money" :)
There will be an increase in the amount of bonds outstanding, of course; but that would lead us back to the old discussion on whether Tsy secutities are "money" :)
So it is technically possible to have a situation where govt deficit spending does not involve any "money" creation.
That would be the case when commercial banks don't hold any Tsy securities on their balance sheets.
All increases in the "money" supply (as opposed to the monetary base) would result entirely from the commercial banks' deposit creation.
And since the monetary base, issued by the Fed, also responds to the whimsical behaviour of commercial banks we´d have - in practice - both "base money" and "money" creation under the spell of a small number of unaccountable private institutions: the commercial banks.
"There will be an increase in the amount of bonds outstanding, of course; but that would lead us back to the old discussion on whether Tsy secutities are "money" "
That's a pretty pointless discussion. If you have a bond and want to spend, you can sell it asap. The difference is pretty meaningless.
"since the monetary base, issued by the Fed, also responds to the whimsical behaviour of commercial banks we´d have - in practice - both "base money" and "money" creation under the spell of a small number of unaccountable private institutions: the commercial banks."
If its under their "spell" then why can they go bust?
And since the monetary base, issued by the Fed, also responds to the whimsical behaviour of commercial banks we´d have - in practice - both "base money" and "money" creation under the spell of a small number of unaccountable private institutions: the commercial banks.
Largely the case in most modern economies.
However, as MMT economists point out, the govt has control over this to the degree it chooses to exercise it. Central banks are creatures of law. The banking system is also a creature of law.
But the way things stand now, the role of government in money creation is secondary, acting through economic policy that is mostly based on partisan politics.
And although government does provide non-govt with net financial assets in aggregate through deficit spending and bond issuance, the size of the deficit is also determined endogenously.
This is the system that MMT describes and is mostly content to live with, other than Bill Mitchell, it seems. Warren has proposed banking reform but this would still leave the existing system largely in place.
I would say that most (all?) MMT economists would recommend removing political imposed restraints on govts using the full potential of the existing monetary system due to concerns that are not relevant economically and get in the way of public purpose.
Beyond that, MMT economists recommend fashioning economic policy based on applying a correct economic understanding, which MMT purports to deliver, to the use of available resources for public purpose based on choices arrived at democratically, and to do this in way that optimizes growth, employment, and price stability.
Nothing radical about this. Pretty much says, use what you got intelligently instead of not.
If its under their "spell" then why can they go bust?
Basically over-leveraging against dodgy collateral and other aspects of Ponzi finance. According to Warren, regulators have control over what counts as collateral and they failed to step in and regulate the asset side of banks' balance sheets. The loans were unrealistic based on value. For example, the run up in the housing bubble was not based on increasing value of the house, e.g., evaluated in terms of replacement value, but rather of gigantic increases in land value, which was assessed unreasonably, based on increasing marginal price alone, and not taking things like income into consideration.
Govt delegates money creation to the private sector since the private sector is considered better at risk management than govt. But left to itself that is not the case over time, as financial cycles that culminate in a Ponzi stage go to show. As Minski points out, financial instability goes with the territory.
Could govt improve on this record? Remains to be seen. In my view probably not under neoliberalism.
If its under their "spell" then why can they go bust?
Well, in practice they rarely if ever go bust.
The commercial banks can always rely on the helping hand of the central bank to provide the necessary funds to keep them alive.
This is so in both the U.S. and the eurozone. A very recent example can illustrate this attitude: the Dutch central bank, when it decided to rescue the bank SNS Reaal a couple of weeks ago, had the following explanation: "...as a ‘system bank’ (it is) an institution which should not be allowed to fail because of the damage it would cause to the Dutch financial system".
It could by changing the rules of the game for banks. No need to nationalize them - just regulate their activity in a different way, that severely dents their capacity for money creation.
This is the line being followed by the Positive Money campaign in the UK: propose specific, carefully studied reforms that may point a dagger at the heart of the financial system's current, immense power.
There were significant bank failures leading up to the Great Depression and as a result of the ensuing debt-deflation. Governments and central banks learned that lesson, excepting the case of Lehman Bros. When it was allowed to fail, it nearly brought the global financial system down. So, TBTF and TBTJ, and hope not TBTB (to big to bail).
The financial system provides finance capital necessary for a capitalistic system to function. Therefore, the financial system is a matter of national security, and therefore, it receives the highest priority.
It could by changing the rules of the game for banks. No need to nationalize them - just regulate their activity in a different way, that severely dents their capacity for money creation.
The skeptical view says:
1. The clout of the financial sector will smother that in the crib.
2. Even if the baby survives and grows, the financial sector will always be scheming about how to weaken it and eventually kill it.
"the Dutch central bank, when it decided to rescue the bank SNS Reaal a couple of weeks ago.."
It's strange that banks should have to be rescued by the government if it is banks that "control" the money system.
It might be more appropriate to say that the banks' influence over policy is a form of corruption, or that banks have a privileged position, or that their debts have been allowed to grow to such crazy levels that they pose a risk to the whole economoy, etc.
It's strange that banks should have to be rescued by the government if it is banks that "control" the money system.
Because modern banking ia a public-private partnership, banks are quasi-agents of the government and therefore, when they get the system banking itself into difficulty, government needs to step into rescue the system.
but if banks supposedly "control" the money system because they can create money by magic because they have super powers and "rule the roost" and other such nonsense, then why should they need the help of government?
Under neoliberalism, the powerful control the reins of power through wealth rather than land as under feudalism. In both, power equates with ownership. So welcome the new aristocracy — the super-class.
This is a big reason for opposing disproportionate per capita distribution
When I suggest banks "can't create money by magic", what I mean is that there's nothing magical about what banks do. Bank deposits are bank liabilities - i.e. bank debts. When they "create deposits" they simply increase their debts.
He was talking about this on and off for the rest of his three hour program today. He seems really interested in MMT, but isn't fully up to speed yet. But definitely potential to reach a wider audience, at least on the progressive side.
ReplyDeleteThom Hartmann needs to read Warren's 7DIF and Randy's recently published Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems, and then have some of the MMT economists on his show.
ReplyDeleteWasn't Hartmann correct when he asked if "banks came between the treasury and the fed?" Aren't the primary dealers basically just banks? I wonder if Hudson is hearing correctly; it's not the first time I've heard him answer a different question than the one asked. I hate to think he's slipping in other ways.
ReplyDeleteAren't the primary dealers basically just banks?
ReplyDeleteGood question!
If they are, it means the process of deficit spending in the U.S. starts with a bank loan to the government (a PD asset) - and a corresponding government deposit as a PD (bank) liability.
And, considering that non depository institutions were holding about 80% of government debt outstanding as late as mid-2011, one must conclude that U.S. commercial banks end up selling most of their T-bond and T-bill holdings to the non bank private sector.
Whereas in Europe (euro zone) commercial banks generally keep huge amounts of govt. debt on their balance sheets. A fact that may be at least partially explained as a consequence of the ECB's policy of not engaging in OMOs - defined as "irregular and exceptional" in several of the bank's publications and statements.
However, this situation may well change in the near future if (when) OMTs are implemented to support periphery debt.
Some are banks and some not. List is here:
ReplyDeletehttp://www.newyorkfed.org/markets/pridealers_current.html
The PDs are all banks.
ReplyDelete"If they are, it means the process of deficit spending in the U.S. starts with a bank loan to the government (a PD asset) - and a corresponding government deposit as a PD (bank) liability."
No. Let's say you built the system from zero, and designed it exactly as it is today. The Treasury would have to start by giving a bond to a PD. The PD would then have to borrow from the Fed (get an overdraft) to pay the Treasury for the bond, and the Fed would then credit the Treasury's account. Then the Treasury would spend.
However, the system didn't start off as it is today. For example, the Treasury used to be able to get overdrafts or issue notes directly. So it's actually difficult to say which came first: the chicken or the egg.
"The Treasury would have to start by..."
ReplyDeletealternatively the Treasury could start by minting a coin and depositing it with the Fed. Or it could just send out cheques and the Fed would probably just clear them (ignoring the supposed no overdraft rule), as it does what Congress tells it to do.
The interview was not too clear. Thom hasn't yet got a good grip on MMT and Michael was pushing the point he wanted to make regardless of the question. He wanted to make the point that constitutionally and operationally under the existing system, the US is sovereign in its currency and capable of self-funding. However, due to political influence, banks have inserted themselves into the process, which involves an unnecessary extraction of rent when the nation could fund itself directly, as Lincoln did with the greenback.
ReplyDeleteThe PD would then have to borrow from the Fed (get an overdraft) to pay the Treasury for the bond
ReplyDeleteThat means the PD is not really a bank.
A bank should be able to create a government deposit out of thin air in order to "pay" for a govt. bond or, to put it in equivalent terms, in order to provide a loan to the government.
alternatively the Treasury could start by minting a coin
ReplyDeleteIt could but it won't - at least as long as a certain Mr. Obama sits in the presidential chair.
It would likely require the election of a true revolutionary in order for the Treasury to exercise that right and prove private markets can be dispensed - for deficit spending, at any rate.
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ReplyDeleteJose, I think you're missing something here.
ReplyDeleteLet's say the Treasury gives a PD a bond, and the PD "pays" for it by creating a deposit in its accounts for the Treasury.
The point is that deposit is only a *promise to pay*, not *payment* itself.
The PD pays for the bond when it makes payment to the Treasury's account at the Fed. To do this it has to borrow money from the Fed, assuming it starts with $0 in its reserve account.
So the PD has to borrow money from the Fed to pay the Treasury. We can simplify this to: the PD has to borrow money from the government to pay the government.
The Treasury spends out of its account at the Fed. IN the current system this means it needs a positive balance in that account before it can spend. So the deficit spending can not occur, in my/your example, until the PD has borrowed money from the Fed to pay the Treasury.
Jose, the auction settles finally in rb, which the Fed cfredits to the Treasury account to clear its spending. It doesn't really make too much difference how the PD's finance, since auctions are subscribed and they sell the tsys on. Their only concern is with their own inventory they may choose to hold.
ReplyDeletebtw, in my comment above I was assuming the system is at "point zero" - i.e. starting from scratch.
ReplyDeleteIf there are already reserves and bonds in the banking system then of course the PD wouldn't necessarily have to borrow directly from the Fed. Just thought I'd make that clear.
I'll put in in a slightly different way.
ReplyDeleteIf the PD were a real bank it could simply provide the government with a bank deposit. Then the govt./Treasury would transfer that deposit to its account at the Fed (where the govt. usually keeps its funds). After this step. the deficit spending might start by crediting firm or household accounts at the commercial banks.
But the "the PD has to borrow (reserves) from the Fed in order to pay for the bond" looks suspiciously like the "banks are reserve constrained" mantra. A neoclassical dude might seize upon that as evidence that banks have to get reserves first in order to be able to provide loans (to the govt., in this case).
Why can't the PD's - if they are indeed banks - simply credit the govt. account? That's an interesting question for PK economists to answer (note that the T accounts for deficit spending by Lavoie, Kelton et alia do start with a commercial bank creating a government deposit on said bank's books - yet the real life process seems to be quite a bit different from this).
The interview failed to live up to it's claim, as both Hartman and Hudson rambled on about banking and failed to explain how MMT could save the world.
ReplyDeleteThis seems to be a common failing of MMT'ers, getting bogged down in the nerdy details and failing to emphasize what it means for the average Joe.
I'm still waiting for the MMT speech/book/essay on how MMT will save the world.
If the PD were a real bank it could simply provide the government with a bank deposit. Then the govt./Treasury would transfer that deposit to its account at the Fed (where the govt. usually keeps its funds).
ReplyDeleteThe bank pays for the tsys with a depost. The Fed marks down the banks reserve account at the Fed, which the bank has to have from excess reserves or borrow them. (If there are insufficient rb in the period, the Fed lends the needed rb at the penalty rate.) The Fed transfers the rb to the Treasury account. The Treasury uses the reserves in its account to clear expenditure it directs the Fed to make on its behalf as its fiscal agent.
I'm still waiting for the MMT speech/book/essay on how MMT will save the world.
ReplyDeleteThe global economy is a closed system with expanding availability of real resources overall. The management challenge is deploying those resources most effectively and most efficiently to meet objectives determined by potential and preferences. Since the global monetary system is running under a non-convertible floating rate regime, affordability is never the problem. The problem is management. The necessary liquidity can always be provided to fund deployment of available resources.
"If the PD were a real bank it could simply provide the government with a bank deposit. Then the govt./Treasury would transfer that deposit to its account at the Fed (where the govt. usually keeps its funds). After this step. the deficit spending might start by crediting firm or household accounts at the commercial banks."
ReplyDeleteJose, it looks like you're getting things upside down and back to front.
Let's say the bank creates a deposit on its books to "pay" for the bond. What happens when the Treasury "transfers that deposit to its account at the Fed"?
Answer: the Fed debits the bank's reserve account and credits the Treasury's account at the Fed.
But in the example the bank doesn't have any reserves!
So it has to borrow the reserves from the Fed.
(it could also sell the bond to the Fed in exchange for reserves to pay the Treasury. But that's basically the same thing: the funds come from the Fed to pay the Treasury.)
"the PD has to borrow (reserves) from the Fed in order to pay for the bond" looks suspiciously like the "banks are reserve constrained" mantra. A neoclassical dude might seize upon that as evidence that banks have to get reserves first in order to be able to provide loans (to the govt., in this case)."
The banks don't need reserves to create deposits. But deposits are *promises to pay*. To make a payment to the Treasury's account at the Fed, the bank must get the necessary reserves, as payment is made with reserves!
Similarly, payment between banks is made with reserves.
If the Treasury wants to spend $100 it has to have $100 in its account at the Fed, under current arrangements. Otherwise the Fed might say "you don't have enough in your account to make the payment".
So if a bank owes $100 to the Treasury, it has to pay $100 in reserves.
"So if a bank owes $100 to the Treasury, it has to pay $100 in reserves."
ReplyDelete*when it makes the payment to the Treasury's account at the Fed. There could be, and often are, intermediate steps before that final payment is made to the Treasury's account.
Of course, MMT will not and could not save the world or the US. US culture is decadent to an extreme; Americans, taken as a whole, is a rather despicable caricature. It is hard to imagine a more predatory, destructive, and yet mortally trivial and stupid culture. Vietnam, Abu Ghraib, drone bombing, millions homeless or jailed, and so on and on and on, are not accidents; they manifest something, something unrelievedly shallow, rotten, cowardly, and despicable.
ReplyDeleteJose, it looks like you're getting things upside down and back to front
ReplyDeleteI think we´re telling exactly the same story, but your first version (not this last one) might - no doubt unintentionally - let some readers, such as myself, under the impression that bank lending is reserve constrained.
The chronological (and logical) sequence is very important in this regard and I think you've put it 100% didactically now.
First step is a commercial bank (a PD) lending to the govt. It debits a T bond and credits a govt. deposit.
At this moment there is no need for reserves. The bank is only looking at a profitable opportunity - a risk-free loan with an attractive coupon. It doesn't look at its books to see whether it has enough reserves to lend the money. If it did, the neoclassical story on money creation might consider itself vindicated, sort of.
Then there is the second step, when the govt. transfers the deposit to the Tsy account at the Fed. At that moment the commercial bank will have a negative position in reserves.
It may borrow the needed reserves from the Fed at the penalty rate (this is more like the eurozone method, where the central bank does not wish to carry govt. bonds on its books and thus makes systematic advances of funds to commercial banks as a matter of policy) or the Fed may buy the bond back via a OMO (in theory, this would be the "American way" to provide banks with reserves).
This "American" process, btw, is nicely explained in the following passage from L R Wray (note the chronological order) :
the Treasury sells the treasuries to the private banks, which create deposits for the Treasury that it can then move over to its deposits at the Fed. And then ‘Helicopter Ben’ buys treasuries from the private banks…. The Fed ends up with the treasuries, and the Treasury ends up with the demand deposits in its account at the Fed – which is what it wanted all along, but is prohibited from doing directly
And of course, if we replaced the word treasuries with "platinum coin" in the last sentence, we'd have a description of the books of the Fed after such an operation.
@ Henry
ReplyDeleteThe cost of empire.
@ Jose
ReplyDeleteRight, the Treasury issues a tsy security (Treasury liability) and receives an equal amount of rb (Fed liability) in its spending account at the Fed. what happens in between is relatively insignificant other than for the politically imposed requirement that the Fed not deal directly with Treasury.
The significant thing is that after Treasury spends using the rb in its account to settle, $NFA increases in the amount of the sale of tsys (=deficit), whatever the disposition of tys and rb in different accounts at the Fed. In other words, govt has self-funded.
The current "indirect" method involves the creation of tsys as "safe assets" and interest, while the "direct" method just increases aggregate reserves held by non-govt.
All that is different between the two methods is composition of govt liabilities held in aggregate by the consolidated non-govt sector. Amount of $NFA is the same (other than the interest accruing on the tsys, which adds to $NFA over time).
Re: "The cost of empire."
ReplyDeleteYes, the cost is only that of "losing one's soul." And yet, the Americans have been thus from the very beginning: Indian genocide, Black slavery, Civil War, Philippine invasion, etc., etc., etc. Essentially barbarians; technological advances changes nothing, they just "put lipstick on the pig." Plus ça change, plus c'est la même chose.
For a glimpse into the sheer savagery, depravity, and barbarism that underlie the national "culture" and mentality of the average American, see:
ReplyDeleteKill Anything That Moves
Nick Turse Describes the Real Vietnam War
http://www.informationclearinghouse.info/article33915.htm
Very naive the author's idea that if only this would have come to light in time, perhaps Abu Ghraib would not have happened. But precisely, the shamelessness which is part of the pathological hubris and irremediable barbarism of the American ethos. There is no capacity for shame here, but only the reactions that one expects from conscienceless sociopaths. True, some soldiers have thrown away their medals and even committed suicide; they are the exception that proves the rule.
Not to condone American misbehavior but it is hardly unique in the history world. What makes it egregious is the hypocrisy involved in American exceptionalism and triumphalism. Not too much different from the Hebrew conquest of "the promised land," Alexander's conquests and Hellenism, the depredations of the Romans and the excesses of empire, the Christian crusades, European wars, the global colonialism of the supposedly Christian Europeans, etc. America is just the latest and greatest in the saga of "man's inhumanity to man." Of course this is not limited to the West, either. In many ways there was no huge jump in the evolutionary chain, and humans are animals after all.
ReplyDeleteJose,
ReplyDelete"First step is a commercial bank (a PD) lending to the govt. It debits a T bond and credits a govt. deposit"
If the bank can't actually PAY the Treasury, then it's not lending the Treasury anything, it's simply PROMISING to pay the Treasury something, and then failing to do so.
In order to actually PAY the Treasury, the bank has to borrow the money from the Fed, or else sell the bond to the Fed.
Otherwise the bank will DEFAULT on its PROMISE.
* just to be clear: in the above comment I am talking about the hypothetical "point zero"example".
ReplyDelete(Obviously, if there are already reserves in the banking system then the bank in question doesn't necessarily have to borrow the reserves from the Fed. But we are assuming a situation in which there are not already reserves in the banking system)
If the bank can't actually PAY the Treasury, then it's not lending the Treasury anything
ReplyDeleteLet's try to clarify this point, because it's really important IMO.
When the bank lends to a corporation no one mentions the word "paying".
The bank debits a loan and credits the corporation a deposit. The corporation is then ready to use said deposit for paying its bills, suppliers, whatever. ~
The bank does not look at its reserve position before making said loan. If it finds it to be a likely source of future profits it will lend the corporation the "money" (bank liability accepted for "payment" everywhere).
Once the corporation starts using its deposit, sending funds elsewhere in the system the bank may find the necessary reserves at the interbank market or at the Fed (at a penalty rate) if need be.
Why should the above process be different when the beneficiary of a bank loan is the Treasury of the U.S. instead of a corporation?
This is the question I've been asking since the beginning of this conversation.
not a good interview - fails the elevator test. again back to square ONE - someone needs to put together a factbook presentation outlining what MMT is.
ReplyDelete"Why should the above process be different when the beneficiary of a bank loan is the Treasury of the U.S. instead of a corporation?"
ReplyDeleteBecause the monetary system is hierarchical.
When the government spends, it makes payments drawn on its account at the Fed, not on accounts held at commercial banks.
i.e. it issues its own liabilities when it spends.
It asserts its sovereignty in this way, I suppose.
In turn, it demands that payments be made to its account at the Fed.
Because the monetary system is hierarchical
ReplyDeleteBut that would put the government at a disadvantage vis-Ã -vis the corporation.
It would be more difficult for the govt. to draw funds from the private banks than for a corporation or an individual. The bank would need to get "reserves" first from the independent central bank in order to lend to the govt - whereas it would need no such thing in order to provide private agents with potentially unlimited funds.
That is, it would be a travesty of the very notion of hierarchy - the govt. at the bottom, private parties on top.
I see it differently. The Treasury decides to transfer its deposit at the commercial bank to the bank it uses - the Fed. Just like a customer may choose to transfer its newly-created deposit at a commercail bank to another bank of his or her choice.
But, substantially, the mechanics of granting a loan should be the same, indepently of the private or public nature of the bank customer. Accounting rules don't change just because the government is involved.
"This seems to be a common failing of MMT'ers, getting bogged down in the nerdy details and failing to emphasize what it means for the average Joe."
ReplyDeleteTrue. Interview should be labeled "MMT COULD save the world, if actually used intelligently."
Of course, lots of things could, if anything were used intelligently. Which brings us down to the main issue. The easiest, most coherent system is most likely to be 1st to be used coherently.
So, we're just waiting for a threshold level of group intelligence to be achieved? If we're not smart enough as a nation to leverage even MMT ... then you may as well pray for the goddesses to save us.
Accounting rules don't change just because the government is involved.
ReplyDeleteWhen a commercial bank makes a loan, the deposit is the bank's liability. When the Fed makes a loan the deposit is a govt liability. Banks need a govt liability (rb) to settle after the tsy auction. They cannot create rb, which can only be created by the Fed. So the bank either has to have the excess reserves to cover, or else borrow them in the interbank market or from the Fed.
When banks make loans that create deposits, the deposit is a promise by the bank to clear, either with cash at the window or settling as the intermediary. Settlement takes place either by netting, which doesn't need rb, or in the interbank settlement system (FRS in the US) using rb, which the bank has to have or get.
BTW, paying tax also requires settlement in rb. For example, a depositor write a check payable to the Treasury against a demand account. The bank then acts as the depositor's intermediary and transfers rb from its account to the Treasury account through the agency of the Fed, which operates the settlement system. The bank has got to have the rb balance in its account at the Fed or else to borrow the rb in the interbank market or from the Fed. If the bank is short at the end of a period, the Fed automatically extends the loan of rb at the discount rate. T
ReplyDeleteWhen the rb corresponding to the taxpayer's payment are credited to the Treasury's account, the obligation is cancelled.
That is to say, at the governmental level, which includes the Fed, all transactions take place in the government's liabilities, Fed, Treasury, or agency.
When the rb corresponding to the taxpayer's payment are credited to the Treasury's account, the obligation is cancelled
ReplyDeleteRight - credited, and not destroyed (as per Mosler's colorful expression).
The Treasury will subsequently draw on its replenished account at the Fed to make payments to third parties. If it wants to spend above its tax receipts it will have to rely on proceeds from T bond or T bill sales. Or, one day perhaps, on the proceeds from a newly-minted Platinum coin.
No reason to claim that tax receipts are destroyed. That was one of the points in Fiebiger's criticism of the way MMT explained certain parts of its discourse.
Yes, I think that "destroy" has turned out to be misleading. What is destroyed in the $NFA corresponding to the rb credited to the Treasury account.
ReplyDeleteTreasury spending (together with bond issuance under the present rules) increases ("injects", "creates") net financial assets of consolidated non-government ($NFA) and taxation decreases ("withdraws," "destroys") $NFA.
Treasury doesn't need to tax to obtain the reserves to clear, since it can issue more Treasuries.
But the fact is that the rb from taxation don't just disappear from the Treasury account on payment of taxes, which cancels the tax liability.
Similarly, when a bank loan is paid off, the loan is cancelled, so we say that the bank money created by the loan was "destroyed" in repayment. But the funds are credited to the bank, although it is not the case that the bank turns around and "lends out" those funds.
I believe the destruction story was linked to an imaginary situation where a taxpayer decided to discharge his or her obligations in cash. The Federal official would supposedly not know what to do with the damned dollar bills and - these not being needed to pay the Treasury's expenses - would simply order their physical destruction by a shredding machine.
ReplyDeleteMaybe the story can make sense if the Treasury somehow never deposits cash in its account at the Fed; in that case it would simply inform the Fed that individual X has just paid Y dollars in taxes in physical cash - and the Fed would proceed to credit the Treasury's account by the announced amount.
Under said circumstances - supposing they're realistic - the puzzled IRS official would be right to destroy the dollar bills. They would be useless and should not be left to survive at the risk of falling in someone else's (wrong) hands. :)
Not to condone American misbehavior but it is hardly unique in the history world.
ReplyDeleteBut that is precisely what you are doing. You have neatly integrated it in your the comfort you have created for yourself.
And as a so-called new ager, you should know better that humans, in principle are lower than animals or else imagio Dei. Probably you don't really understand what that means, since you are also an evolutionist.
"But that would put the government at a disadvantage vis-Ã -vis the corporation.
ReplyDeleteIt would be more difficult for the govt. to draw funds from the private banks than for a corporation or an individual. The bank would need to get "reserves" first from the independent central bank in order to lend to the govt - whereas it would need no such thing in order to provide private agents with potentially unlimited funds.
That is, it would be a travesty of the very notion of hierarchy - the govt. at the bottom, private parties on top."
That makes no sense whatsoever.
Literally no sense.
Obviously it's not more difficult for the government to borrow - it's easier. Obviously banks need reserves to pay the Treasury. If they don't have any, they need to get them from somewhere. They are created by the central bank. That's how it works. You seem to be saying that maybe that's not how it works, but it is.
"it would need no such thing in order to provide private agents with potentially unlimited funds."
Yeah a bank can credit a trillion dollars to someone's account as if by magic. But when that person spends the trillion dollars and the person receiving it has an account at another bank, the bank will have to pay up. Or if the person tries to withdraw the money, the bank will have to pay up. Or if the government taxes the person, the bank will have to pay up. etc. It can promise as much as it wants but it also has to be able to pay up when the time comes or it goes bankrupt. To do that it needs reserves/cash. It's actually very simple.
Anyone can "create a deposit". I just wrote "I owe Jose $500 trillion" on piece of paper. There, you now have a $500 trillion dollar deposit at the bank of Me.
You seem to think banks have special magical super powers for some reason.
"I see it differently. The Treasury decides to transfer its deposit at the commercial bank to the bank it uses - the Fed. Just like a customer may choose to transfer its newly-created deposit at a commercail bank to another bank of his or her choice."
ReplyDeleteFederal Reserve deposits are known as "reserves" or "reserve balances". They are electronic versions of physical currency.
So if the Treasury "transfers a deposit" from a commercial bank to the Fed, the commercial bank has to pay in reserves. The Fed therefore debits the bank's reserve account and credits the Treasury's account. It's not complicated.
"But, substantially, the mechanics of granting a loan should be the same, indepently of the private or public nature of the bank customer. Accounting rules don't change just because the government is involved"
Nothing I said indicates that"the rules of accounting change". I simply described how the system works.
The Treasury spends from its account at the Fed. So it needs money in that account. If it wants to spend $100 it needs $100 in that account. How does money get into the Treasury's account?
Answer: the Fed debits bank reserve accounts and credits the Treasury's account.
If a bank doesn't have any reserves in its reserve account it can't pay the Treasury. It can't lend to the Treasury, as it doesn't have anything to lend.
The bank has to get the reserves from somewhere. If there are no reserves in the banking system it has to get them from the central bank, as that's where they come from. It has to borrow them from the central bank or else sell assets (bonds) to the central bank. This is how it works.
"No reason to claim that tax receipts are destroyed. That was one of the points in Fiebiger's criticism of the way MMT explained certain parts of its discourse."
ReplyDeleteFiebiger never understood what he was talking about.
When taxes are paid to the government, the government gets back its own liabilities. It is paid with its own liabilities. This simply extinguishes those liabilities. It doesn't provide the government with additional assets.
Tax payment extinguishes government liabilities. It "destroys" government liabilities. It doesn't provide the government with additional funds.
Simple, basic accounting.
Henry I understand that quiet well and in fact my master's thesis in social political philosophy was title, "Revolution or Evolution: Toward a Theory of Social Change," which explored this.
ReplyDeleteAt every point in time, humanity stands at a particular point in its evolution, poised between the momentum of the past and the possibility of the future. That is captured as the level of collective consciousness, which is reflected in individual and group behaviors that are in turn mediated through culture and institutional arrangements.
Since we are inside the process, we cannot stand outside of it to examine it. We have to locate patterns as best we can iaw our present mode of knowing.
What we have discovered recently in our substantial history is the dynamics of complex adaptive systems and emergence. That gives hope for continuing evolution.
We are also coming to understand through the study of perennial wisdom that evolution is not merely biological but also spiritual, and the there is indeed a logic, so to speak, underlying the dynamic, which has been going on for millions and billions of years and will continue for millions and billions of years even when this planet is no longer a factor in it. See Meher Baba, God Speaks, for a summary.
This is symbolized in religion and the arts as the "battle between good and evil." The challenge is to integrate more primitive with newly emergent forces into a balanced and harmonious life as an individual in community, yoking passion and reason in order to progressively unfold excellence as persons and societies. This is a delicate balance and many, even those who strive for excellence, often miss the mark due to some bias.
The process was, is and will be messy due to the very nature of it. It is never going to be complete in the relative changing dimension of existence for the simple reason that time is cyclical.
The saying, if you want to change the world, change yourself, holds true. It's also a good idea to get with people who are committed to doing so, too. Then do what is possible to change things for the better more widely.
It doesn't provide the government with additional funds
ReplyDeleteLet's try to put it in as neutral a form as possible so that we can all agree on such a basic element of reality.
When taxes are paid the Treasury account at the Fed is marked up.
The Treasury can then spend said funds into the economy again, by crediting bank accounts of households and/or firms.
Would you agree with this statement?
You seem to think banks have special magical super powers
ReplyDeleteWell, the power to create deposits out of thin air is maybe not "magic", but it comes pretty close.
That's why this simple truth is never spoken to the general public.
They still believe that power is "backed" by something else - the piggy bank, the savings, gold, whatever.
Recent polls in Britain show an overwhelming majority believing banks cannot create "money". Same majority claims it would be "unacceptable" if said power were to be conferred to the banks.
Well, it already is. A pity that the public never noticed, but I suppose that's how democracy works :)
I simply described how the system works
ReplyDeleteI agree.
The money in the Treasury's account is a government liability.
ReplyDeleteIf the Treasury has $100 in its account at the Fed the following is the case:
Treasury: $100 asset
Fed: $100 liability
US government: $0
"the power to create deposits out of thin air is maybe not "magic", but it comes pretty close"
ReplyDeleteNo, it's not magic.
I'm going to create another deposit for you at the bank of Me:
I owe Jose 700 quadrillion dollars and 52 cents.
There, you have a deposit. Spend it wisely.
Jose,
ReplyDeleteIf you give some Federal Reserve notes to the Fed, does the Fed then have additional funds?
Yes! Look!! It's got more money!! It's obvious!! More Federal Reserve notes = more money!! Duh!
If the Treasury has $100 in its account at the Fed
ReplyDeleteI'll suppose the $100 resulted from payment of taxes.
Before said payment, the net position of the (consolidated) government was also $0; with a slight difference, however - the government could not spend (I'm presuming overdrafts are not allowed)
Now, thanks to those Fed liabilities that resulted from payment of taxes, it can spend $100.
Do you agree?
"Before said payment, the net position of the (consolidated) government was also $0"
ReplyDeleteNo it wasn't.
Also, I'm talking about the US government - a specific legal entity - not a hypothetical "consolidated government".
Say there's only $100 in existence, and you have it.
Jose: $100 asset
Treasury: $0
Fed: $100 liability
US government: $100 liability.
The government then taxes you $100.
Jose: $0
Treasury: $100 asset
Fed: $100 liability
US government: $0
Let's try to put it in as neutral a form as possible so that we can all agree on such a basic element of reality.
ReplyDeleteWhen taxes are paid the Treasury account at the Fed is marked up.
The Treasury can then spend said funds into the economy again, by crediting bank accounts of households and/or firms.
Would you agree with this statement?
Yes, taxes are credited to the Treasury account, and the reserves can be used as credits for spending or retiring bonds by crediting bank accounts without the Treasury needing to obtain more reserves from the Fed via a bond auction. That is to say, taxes reduce the need for fiscal deficits and consequent bond issuance.
That's the idea behind a balanced budget amendment, for instance. Tax credits withdrawn from the private sector are then used as tax credits to spend into the private sector. The cb creates the tax credits in from of reserves, and without deficit spending, reserves in excess of the tax credits in the private sector not yet taxed have to be borrowed from the Fed by banks at the rate the Fed sets.
Under a fiscal balance, no new $NFA would be added to consolidated nongovt in aggregate. Under a fiscal surplus $NFA would decrease in the amount of the surplus. ONly with a fiscal deficit do $NFA increase.
Banks can only create credit/debt but not currency, so theirlending does not affect the amount of $NFA in that credit-debt nets to zero.
If settlement in currency is required, either the home currency or foreign currency, banks have to get that currency, ultimately from the sole creator of the currency, usually the central bank under present arrangements, at any rate from the agent that the govt as currency sovereign authorizes.
Banks may borrow currency from someone else, but ultimately the currency comes from a central bank, because under present rules that is (generally) the agency were currency originates. Of course, the Treasury could be the designated agent, but under the present system in general countries use the cb currency-Treasury bond model. But that is a political choice that doesn't alter the general case wrt to currency sovereign. Countries can and do delegate monetary sovereignty, but those are special cases.
Turning to commercial banks.
If I go to my bank and demand dollars at the window, the bank does not create those dollars as currency, it has to get them by exchanging rb at the Fed for vault cash or through customer deposit that can be traced by to this process. Both rb and vault cash count as reserves in figuring the reserve requirement.
Same if I am traveling and want to avoid the airport exchange window, which may be crowded on arrival, and ask for yen, pounds, euro, etc., at my US bank prior to departure. No one thinks that the bank can just print up these notes. It has to get them from someone else, like a customer deposit, but ultimately those notes come from a govt issuer as the monopoly provider of the currency. Same with home country.
It works the same way with reserves. Banks have to obtain reserves needed to clear and meet the reserves requirement if imposed. If they fall short in the period, the cb as LLR lends the required reserves and charges the penalty rate.
In summary, cash only gets into circulation by banks' ultimately exchanging rb for physical currency with the cb as the govt's agent. Ultimately, banks only get rb when either govt credits bank accounts in making disbursements (spending and transfers) or by borrowing from the Fed. Every other means is traceable to the originator, which is the agent designated by govt as currency issuer, in the US, per US Constitution, Art 1, Sec. 8.
"thanks to those Fed liabilities that resulted from payment of taxes, it can spend $100."
ReplyDeleteLet's imagine there was a strange rule which said the Fed could only lend out or spend as many Federal Reserve notes as it had previously collected from the public. Crazy, I know.
If you were to give the Fed some Federal Reserve notes, would it then have additional funds?
Let's look at the basic accounting:
In this example there is only $100 in existence and you have it.
Jose: $100 asset
Fed: $100 liability
You then give the notes to the Fed.
Jose: $0
Fed: $0
However, the Fed has now collected $100 in notes, so it can issue $100. So let's say it pays you $100:
Jose: $100 asset
Fed $100 liability
Hang on, how did that happen?
Let me start with y's example where the Fed had a $100 liability to Jose (a banknote).
ReplyDeleteThat liability was not the Treasury's to spend.
After Jose pays his taxes, the Fed will remain with a $100 liability on its books - but now said liability is to the Treasury, not Jose.
So, the Treasury can now spend. Before Jose paid his taxes, it could not (again, I'm assuming no overdrafts are allowed).
Correct?
Jose, the only way that the rb from taxes is extinguished from the govts books is when the rb from taxation is used to retire govt debt. then a Treasury asset cancels a Tsy liability on the Treasury's books.
ReplyDeletePayment of the tax, on the other hand, cancels a private tax liability using a tax credit, and that tax credit is credited to the Tsy account as an asset. That asset can be used alternatively to retire tsys, or to be returned to non-govt as NFA through fiscal expenditure or interest payment.
Otherwise, the credit to the Treasury account from taxation can be spent into non-govt, reversing the withdrawal of $NFA, without the need to issue more tsys to get more rb for the Treasury account.
Similarly, when a bank creates a deposit by extending a loan, the deposit then leaves the bank and gets spent, and the bank has the loan as an account receivable. When the deposit is returned in payment of the loan (principal and interest), the deposit extinguishes the loan. But the deposit is not extinguished. It becomes a bank asset. If the loan defaults, then bank assets get marked down and so does equity.
In other words, nothing is ever lost in double-entry, and nothing just disappears from the books. Records of one account cancelling another are maintained, so it is always possible to see what happened. (Of course, I know you know this, but I am setting it forth in some detail for those who may not.)
Recent polls in Britain show an overwhelming majority believing banks cannot create "money". Same majority claims it would be "unacceptable" if said power were to be conferred to the banks.
ReplyDeleteIIRC, same in the US. People think that money comes from the govt. But they also think that govt gets the money from taxes. A bit of cognitive dissonance there.
In other words, nothing is ever lost in double-entry, and nothing just disappears from the books
ReplyDeleteExactly, a perfectly clear and true statement.
(assuming no high-denomination coins, etc)
ReplyDeletethen yes, correct.
So the way we can describe this is to say:
the government is only permitted to issue as many of its liabilities through spending as it has previously extinguished through taxes (and other forms of revenue).
The quantity of "extinguished government liabilities" is shown as a positive balance in the Treasury's account.
Jose,
ReplyDeletecoming back to my second example:
(imagine there's a strange rule which says the Fed can only lend out or spend as many Federal Reserve notes as it has previously collected from the public.)
Now let's imagine the Fed sets up two departments to keep track of the notes it collects and the notes it issues, to make sure it's sticking to the rule. One department is called the "collection department" and the other is called the "issuing department". Each department keeps its own accounts. The collection department counts the notes it receives as assets, and the issuing department counts the notes it issues as liabilities. To issue a note, the issuing department has to get one from the collection department, meaning that the collection department's account is depleted when the issuing department issues notes, i.e. when the Fed lends or spends.
As before, the question is: If you were to give the Fed some Federal Reserve notes, would it then have additional funds?
Let's look at the basic accounting in this extended example:
(In this example there is only $100 in existence, and Jose has it).
Jose: $100 asset
collection department: $0
issuing department: $100 liability
Federal Reserve: $100 liability
Jose then gives the notes to the Fed.
Jose: $0
collection department: $100 asset
issuing department: $100 liability
Federal Reserve: $0
The Fed has now collected $100 in notes, so it is allowed by the rules to issue $100. So let's say it then pays Jose $100:
Jose: $100 asset
collection department: $0
issuing department: $100 liability
Federal Reserve: $100 liability
We can conclude that, obviously, the Fed does not get additional funds when it receives Federal Reserve notes from Jose. This is because those notes are simply Fed liabilities.
For people like Fiebiger, however, in this example the Fed does get additional funds from Jose. Fiebiger would point to the collection department's account and point out that its assets increase when notes are deposited, and diminish when the Fed lends or spends.
For people like Fiebiger, however, in this example the Fed does get additional funds from Jose
ReplyDeleteI can´t speak in Fiebiger's name (though I did read - and like - his paper) but I can tell you what I think.
When the Treasury's account at the Fed is at zero, it will have to be marked up before the Treasury can spend.
There are 2 possibilities (allowing for the no overdraft clause) in that case.
Either the Treasury raises funds via bond or bill sales.
Or it raises funds via taxes.
Otherwise, it will not be able to spend.
When Jose sends his $100 bill to the IRS to pay his taxes, the Fed will subsequently debit banknotes and credit the Treasury account.
The Fed's total liabilities remain at the same level as they were before the tax payment occurred - the $100 liability was merely reshuffled from banknotes to Treasury account.
The Treasury can now spend $100. Before the tax payment, it could not spend a single cent.
That's the way the system works.
When the Treasury prints Federal Reserve notes and supplies them to the Federal Reserve, does the Federal Reserve then have additional funds?
ReplyDeleteIf the Federal Reserve were to run out of Federal Reserve notes, it wouldn't be able to redeem its deposits (reserve balances) for notes. As such the Fed would default on its promises to do so - it would default on its debts.
ReplyDeleteBanks would not be able to withdraw notes from the Fed, so bank customers would consequently not be able to withdraw notes from their banks. As such the banks would default on their promises to their customers - they too would default on their debts.
So if the Treasury were to stop supplying Federal Reserve notes to the Fed, the Fed would end up defaulting on its debts.
By your logic this must mean the Federal Reserve gets its funds from the Treasury.
There are 2 possibilities (allowing for the no overdraft clause) in that case.
ReplyDeleteEither the Treasury raises funds via bond or bill sales.
Or it raises funds via taxes.
Otherwise, it will not be able to spend.
This is not disputed. It's part of the the US special case.
Following on from the above, the Fed should therefore count Federal Reserve notes in its possession as 'assets' - which it needs to acquire in order to be able to lend to banks or purchase assets from banks without subsequently defaulting on its debts (i.e. defauting on its promise to redeem deposits for notes).
ReplyDeleteAs such, when the Fed gets Federal Reserve notes from the Treasury, or when notes are deposited at the Fed by banks, the Fed should count this as an increase in its available funds.
So we should consistently talk about the Fed getting its funds from the Treasury and from banks, as this is how the system works.
Therefore anyone who says the Fed "creates money ex nihilo" is wrong, and the truth is that the Fed has to procure funds from the Treasury or from banks in order to be able to lend or spend.
Taking this to its logical conclusion, we should therefore describe the Federal Reserve as a "currency user".
ReplyDeleteI suppose the Treasury could, in theory, simply spend by issuing cheques, without ever having to pay in reserve balances or cash if the cheques were never returned to the Fed for clearing.
ReplyDeletei.e. you could receive a cheque from the Treasury, take it to your bank, the bank would credit your account, and then simply keep the cheque as a reserve, paying other banks with Treasury cheques instead of Fed reserve balances. The cheques would then serve as currency, never being redeemed for reserve balances or Federal Reserve notes.
Of course this would never happen but its not impossible in theory.
However, it is the case that Treasury payments always clear, and Treasury cheques don't bounce. If they did, the monetary system would go into meltdown.
Similarly, the Fed spends and lends by creating deposits (reserve balances). In theory banks could use only these deposits, and no notes would ever need to be withdrawn, if everyone just accepted payment in electronic credits and never used cash. But that doesn't happen (at least not yet!).
When banks want to withdraw their deposits as notes, the Fed doesn't default. It supplies the notes.
When the Treasury prints Federal Reserve notes and supplies them to the Federal Reserve, does the Federal Reserve then have additional funds?
ReplyDeleteFederal Reserve notes are "issued at the discretion of" the Fed Board of governors.
They are liabilities of the Fed, issued to respond to commercial bank demand for bank notes (itself s result of the public wanting to hold a portion of its bank deposits as currency).
The banks must have deposits (reserves) at the Fed in order to get the needed banknotes. TIn that cae, the Fed debits commercial bank deposits (reserves) and credits banknotes.
and of course the total amount of Fed liabilities stays unchanged.
Sorry for the typos :)
ReplyDeleteThis comment has been removed by the author.
ReplyDeleteAs you say, Federal Reserve notes are indeed liabilities of the Fed. As such, if you return a Federal Reserve note to the Fed, the Fed's assets don't increase, and it doesn't get any additional funds. Returning a note to the Fed simply extinguishes a Fed liability.
ReplyDeleteWe can show this as follows.
1. Mr A has $100 in Fed notes:
Mr A: $100 asset
Fed: $100 liability
2. Mr A returns the notes to the Fed:
Mr A: $0
Fed: $0
The Fed now has zero. It doesn't have any additional assets or funds. Its liability has simply been extinguished.
Ok, so now let's look at the US Code:
"Federal reserve notes, to be issued at the discretion of the Board of Governors of the Federal Reserve System for the purpose of making advances to Federal reserve banks through the Federal reserve agents as hereinafter set forth and for no other purpose, are authorized. The said notes shall be obligations of the United States and shall be receivable by all national and member banks and Federal reserve banks and for all taxes, customs, and other public dues."
http://www.law.cornell.edu/uscode/text/12/411
The Code states that Federal Reserve notes are "obligations of the US". "US" means the US government/ Federal government, and an "obligation" is a liability.
Here's another section of the Code:
"The term “obligation or other security of the United States” includes all bonds, certificates of indebtedness, national bank currency, Federal Reserve notes, Federal Reserve bank notes, coupons, United States notes, Treasury notes, gold certificates, silver certificates, fractional notes, certificates of deposit, bills, checks, or drafts for money, drawn by or upon authorized officers of the United States, stamps and other representatives of value, of whatever denomination, issued under any Act of Congress, and canceled United States stamps."
http://www.law.cornell.edu/uscode/text/18/8
Here we see that Federal Reserve notes are US government "securities", like Treasury bonds. Both are US government liabilities.
We saw before that when Federal Reserve notes are returned to the Fed, the Fed doesn't then have any additional assets or funds. The Fed's liability is simply extinguished - it ends up with $0 in my example above.
The same thing is NECESSARILY the case when Federal Reserve Notes are returned to the US government.
We can show this as follows.
1. Mr A has $100 in Fed notes:
Mr A: $100 asset
US government: $100 liability
2. Mr A gives the notes to the US government:
Mr A: $0
US government: $0
Notice that the US government now has zero. It doesn't have any additional assets or funds. Its liability has simply been extinguished.
We know that when people make payments to the US government, such as taxes, the money is ultimately paid to the Treasury's account at the Fed. The Treasury, however, counts Federal Reserve notes as "assets". So if someone were to give $100 in Federal Reserve notes to the Treasury, the following would happen:
Treasury: $100 asset
Federal Reserve: $100 liability
US government: $0
Clearly, the US government has not received any additional assets or funds. Its liability has simply been extinguished.
This is odd, as the Treasury is part of the US government. Indeed, the Treasury and US government are usually regarded as the same thing when people talk about “government spending” and “paying taxes to the government”. So how can it be that, in the example above, the US government both has and doesn’t have an asset?
How can the Treasury have funds if the US government doesn’t have funds?
How can the Treasury have funds if the US government doesn’t have funds?
ReplyDeleteI assume your Mr. A is returning the banknote in the process of paying taxes.
In that case, commercial banks are out of the picture - an atypical case, since usually taxes are paid via deposits that taxpayers hold at commercial banks.
Anyway, I see the 3 balance sheets involved (Treasury, Fed and Mr. A) thus:
Phase 1 (starting point, before tax payment)
Tsy: zero assets and liabilities
Fed: Liability: +$100 banknote
Mr. A: Asset: +$100 banknote
Phase 2 (tax payment; Tsy receives payment and deposits the proceeds at the Fed)
Tsy: Asset - +$100 banknote
Fed: Liability - +$100 tsy deposit
Mr. A: zero assets and liabilities
Phase 3 (Tsy spends by paying a putative Mr. B with a note)
Tsy: zero assets and liabilities
Fed: Liability - +$100 banknote
Mr. B: Asset- +$100 banknote
In a sense, the process is a wash. The funds (banknote) used by Mr. A to pay taxes are returned to the economy (househols or firm sector) as a government payment to Mr. B.
The Fed starts and ends the process with the same $100 banknote liability. In the middle of the story the $100 liability was changed from the Fed's "banknote" account to the Fed's "Treasury" account. In the end, it returned to its original account.
"I assume your Mr. A is returning the banknote in the process of paying taxes."
ReplyDeleteTo keep it simple, yes.
"usually taxes are paid via deposits that taxpayers hold at commercial banks."
That's not correct. Taxes are paid in reserves from bank reserve accounts to the Treasury's account at the Fed. The debiting of people's bank deposits is only the first step in a process which ends when payment is made to the Treasury's account by banks.
Your description of the process above (phase 1,2,3) is correct. However, you haven't really addressed my point, which is:
In Phase 2 the Tsy has a $100 asset.
But the US government has $0. No asset.
This is a strange state of affairs.
Because if the Tsy has an asset, and funds, then surely the government should have an asset and funds. But it doesn't, it has zero.
So the Tsy's asset is really a kind of intra-governmental accounting fiction.
If this is kept in mind, then it's fine to say "the Treasury has funds", if one keeps that context in mind.
However, Fiebiger, JKH and others all make the mistake of saying "the Treasury has funds therefore the government has funds". This leads to the nonsensical conclusion that the government gets funds from taxes and is a "currency user".
That's not correct. Taxes are paid in reserves from bank reserve accounts to the Treasury's account at the Fed
ReplyDeleteIt's correct. I just mentioned the first phase of the process ("via deposits..."). There is a debit to taxpayers' deposits and a simultaneous credit to commercial banks' reserves. On the Fed's books a debit to reserves (Fed liability) and a credit to Tsy account (another Fed liability).
But the US government has $0. No asset. This is a strange state of affairs
I think that it's helpful to think "at the margin" here.
The consolidated govt (Tsy + Fed) started from a net liability position of $100 and went to a net position of zero. It has "gained" $100 as a result of the tax payment.
"There is a debit to taxpayers' deposits and a simultaneous credit to commercial banks' reserves"
ReplyDeleteWhere does the "simultaneous credit to commercial banks' reserves" come from?
If a bank debits $100 from a customer's account, the bank's liabilities are reduced by $100. There is no simultaneous increase in its assets, no increase in its reserves.
You appear to have magicked additional reserves from nowhere. Please explain.
"The consolidated govt (Tsy + Fed) started from a net liability position of $100 and went to a net position of zero. It has "gained" $100 as a result of the tax payment."
I wasn't referring to the "consolidated government", i.e. Fed and Treasury combined, I was referring to the US government, i.e. basically Congress.
When the Treasury has $100 in its account at the Fed the US government - Congress - has $0. There is no need to consolidate Treasury and Fed to get that result. You can keep the Fed separate from the government for accounting purposes and still get that result.
In your example the US govt starts from a $100 liability position and goes to $0 when payment is made to the Tsy. As such the govt then has zero funds.
If you owe someone $100 and pay it back, you simply cancel your debt, you don't "gain" additional assets or funds.
Ok.
ReplyDeleteCommercial Bank BS:
Minus $100 reserves at Fed
Minus $100 customer deposit
Fed BS:
Minus $100 Deposits of commercial banks
Plus $100 Tsy deposits
Tsy then spends by depleting its $100 account at the Fed. No need to get Congress in the picture here.
I forgot to add a possible interpretation for y's puzzle.
ReplyDeleteWe should keep in mind that the starting position with only a $100 liability on the Fed´s BS - while useful for understanding the issue, by breaking it into isolated pieces, so to speak - was also somewhat artificial.
The "real" initial Fed Balance Sheet, of course was balanced. Ditto for the consolidated govt. BS.
So the tax payment actually generated "equity" for the consolidated govt. An "equity" subsequently spent by said govt. by making a payment to the private sector.
Hope that helps.
Well, I see y went silent - but it's not clear whether this is a result of agreement with my points or a sudden loss of interest in the subject. -:)
ReplyDelete"Tsy then spends by depleting its $100 account at the Fed. No need to get Congress in the picture here."
ReplyDeleteI said Congress so it was clear what I was referring to. I keep talking about the US government, and you keep inferring that I'm talking about a "consolidated government" in which Fed and Treasury are "consolidated". I'm not actually talking about that. We can keep Fed, Treasury, and US government completely separate and make no mention of a "consolidated government" and still say that when the Treasury has $100 in its account at the Fed the US government has $0.
The Treasury's account shows that the Treasury has received $100, and it counts this as an asset. But for the US government that cannot be an asset as the $100 is a liability of the US government.
Again, I'm not talking about a liabiltiy of the Fed or a liability of a "consolidated government" - it is a liability of the US government.
So when the Treasury has $100 in its account, the US government has $0. No asset, no funds. Yet it spends, despite the fact that it has no funds.
As I said before, if you pay Federal Reserve notes to the Fed, it doesn't then have additional assets or additional funds.
The same is the case with the US government. The government spends from zero, i.e. it creates its liabilities, creates money, when it spends.
If the Treasury shows $100 in its account, this means the US government is allowed by 'the rules' - i.e. by itself - to issue $100 of new liabilities, i.e. to create $100 worth of new money by spending.
When the Treasury "depletes its account" and the account hits $0, the US government is no longer allowed by 'the rules' - i.e. by itself - to create money by spending. It has to destroy more of its outstanding liabilities before it is allowed - by itself - to create new ones. So it has to collect taxes or sell bonds.
The Treasury's account shows how many US government liabilities have been extinguished through taxes and bond sales, and as such how many new liabilities the government is allowed to create. It shows this as a positive number.
"So the tax payment actually generated "equity" for the consolidated govt."
In a really simple scenario, say we have:
1. Before tax payment
Fed: $100 Tsy bond (asset)
$100 reserves (liability)
Tsy: $100 bond (liability)
$0 deposit
Bank: $100 reserves (asset)
2. After $100 tax payment:
Fed: $100 Tsy bond (asset)
$100 Tsy deposit (liability)
Tsy: $100 bond (liability)
$100 deposit (asset)
Bank: $0
The "consolidated government" now has net $0. No increase in equity.
Well, your initial example had a banknote at the start, now you're switching into bonds and bank deposits.
ReplyDeleteLet's try to stick to some rules, so we don't get all messed up in the process, ok?
Forget your "starting point". At the start, as you well know, all balance sheets have to be at balance. However, your starting point has two "unbalanced balance sheets", with positive assets and no accounting entries on the liability & equity side. These would have to be either liabilities or equity and you don't clear up that issue.
Think at the margin: what happens when Mr. A pays his taxes?
Here are the accounting entries:
Mr. A: Minus bank deposit (Asset)
Minus Equity (L & E)
Bank: Minus reserves at Fed (Asset)
Minus Mr. A deposit (L & E)
Fed: Minus bank deposit (L & E)
Plus tsy deposit (L & E)
Tsy: Plus deposit at Fed (Asset)
Plus Equity (L % E)
Net result for consolidated government (tsy AND Fed): Plus Tsy asset, plus Tsy equity. Note that on the Fed balance sheet there was simply a reshuffle among items on the liability side; these net out to zero.
Overall net result for government: more assets and more equity. The increase in equity is equal in amount to the tax payment.
To the penny.
Overall net result for the private sector (Mr. A): a loss of equity equal in amount to the tax payment. Again, to the penny.
This is as should be: the tax payment drained resources from the private sector and increased the resources at the disposal of the government.
The govt. is now ready to spend, injecting the resources back into the economy. Before the tax payment, it could not spend.
"Net result for consolidated government (tsy AND Fed): Plus Tsy asset, plus Tsy equity."
ReplyDeleteIf the Treasury has an asset, and the Fed has an equal liability, then the net result for the "consolidated government" is surely zero.
-1+1= 0
You appear to be saying that -1+1=1
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ReplyDeleteThis comment has been removed by the author.
ReplyDelete"Overall net result for government: more assets and more equity."
ReplyDeleteYou seem to be saying that the Treasury is the 'government' - the 'government' being a different thing to the "consolidated government", which is the Treasury and Fed combined.
This is not the case. The Treasury is not the government, it is a part of the government, it is a government department.
If the Treasury has a deposit in its account at the Fed, that deposit a Treasury asset. However, that Treasury asset is also a government liability. Not a "consolidated government" (Treasury and Fed combined) liability - simply a government liability.
Treasury asset (+1) + government liability (-1) = 0
You seem to be saying that the Treasury is the government
ReplyDeleteNo, I'm not saying that.
Remember we agreed that all the balance sheets started at balance.
What happened when Mr. A paid his $100 in taxes?
The Treasury gained an Asset (deposit at Fed) with no corresponding liability. Its equity thus increased by $100.
The Fed, however, had a change of zero in its overall balance sheet amounts. No change in assets (no accounting entries) and no net change in liabilities either (the only thing that changed was the composition of liabilities - it "owed" $100 to the banks, now it "owes" the same $100 to Tsy). Thus, the equity position of the Fed was unchanged.
And the total equity of the government? Well, it increased by $100. Plus $100 to Tsy + zero to Fed = Plus $100 to consolidated government.
That is, it increased by exactly the amount of the tax payment by Mr. A.
"The Treasury gained an Asset (deposit at Fed) with no corresponding liability. Its equity thus increased by $100."
ReplyDeleteNo corresponding liability?
The Fed has the corresponding liability!
If you combine them into a "consolidated government" the Treasury's asset (and equity) is the Fed's liability!
$0
Starting points (before tax payment) were:
ReplyDeleteTsy:
(X) assets; (X) Liabilities & equity
Fed:
(Z) assets; (Z) Liabilities & equity
Ending points (after tax payment) were:
Tsy:
(X + 100) assets (X + 100) L & E
Fed:
(Z) assets; (Z) L & E
NOTE: same amounts as starting point, no change.
Conclusion: (Tsy plus Fed) gained $100 in equity.
This increase in "consolidated government" equity was a result of the tax payment.
I think that y is arguing here that the consolidated government books net to zero, just as the consolidated private sector books net to zero, since RHS = LHS by identity?
ReplyDeleteI'd put it this way:
ReplyDeleteConsolidated govt: + $100 equity
Private sector: minus $100 equity
The two sectors net to zero.
Government surplus equals private sector deficit. A tax payment, ceteris paribus, generates a government surplus.
(T - G) + (S - I) = zero. This accounting constraint holds, in every case.
Seems to me it comes down to borrowed v. non-borrowed reserves.
ReplyDelete1. According to MMT (Warren's Soft Currency Economics) government as currency issuer must do a reserve add to do a reserves drain. Deficit expenditure is the add and bond issuance is the drain. Net zero, no borrowing from private sector.
2. Some argue that govt borrows using bank money rather than its own money. Since auctions don't settle in bank money but govt money (rb or cash), if the govt doesn't provide the funding, then private banks have to borrow the reserves from the central bank.
Which is the case?
y is cancelling out the Fed's liability against the tsy's asset, but the Fed has its own asset, which backs the deposit, and its side of the equation nets to zero.
ReplyDelete"y is cancelling out the Fed's liability against the tsy's asset, but the Fed has its own asset, which backs the deposit, and its side of the equation nets to zero."
ReplyDeleteBut the Fed's asset (Treasury bond) is the Treasury's liability...?
So still zero in this case...
government as currency issuer must do a reserve add to do a reserves drain
ReplyDeleteI think those arguments over what came first - the chicken or the eggs - inevitably lead to infinite regress (that is, a road to nowhere).
Anyway, bond issuance constitues a reserve drain only if the government gets financing from the private sector.
In Canada, where the central bank is authorized to buy bonds at primary market auctions, there need be no reserve drain. The accounting entry at the central bank will be in the form of an asset (tsy bond) and a liability (govt. deposit). Commercial bank deposits at the central bank (reserves) will not be touched in this case.
But a tax payment will necessarily involve a reserve drain. The subsequent government spending, however, will provide a reserve add, for a net change of zero.
Of course, we could say the same thing the other way around: govt. spending first provides a reserve add, and taxes will provide a reserve drain. From an accounting POV the statements are equivalent.
In a pure MMT-system, where the government gets funds directly from its central bank (and not from private markets as is the case of present-day US of A) there are two possible sources to fund govt. spending:
a) the government's own central bank "money"
b) payment of taxes
In practice, taxes will provide the overwhelming majority of funds. Otherwise, inflation would threaten the system.
Of course, many MMTers object to the expression "taxes financing government spending".
To accomodate said objections we might find an alternative expression, involving the word "rules". We could say, e. g., that there must be rules in place to dictate that govt. may spend only if its account at the central bank has a positive balance - resulting from either tax payments or bond sales.
But the Fed's asset (Treasury bond) is the Treasury's liability...?
ReplyDeleteAgain, when taxes are paid the Fed does not add any liability or asset to its balance sheet.
The Treasury, however, has added an asset with no corresponding liability: it thus has an increase of equity on the L & E side of its balance sheet.
"In a pure MMT-system, where the government gets funds directly from its central bank"
ReplyDeleteIt's not possible for the government to get funds from its central bank in a "pure MMT system". You have things upside-down. Apparently because you think banks have mysterious special magical super powers, for some reason.
All books have to balance, including within within govt. The books we are concerned with are cb and Treasury. The cb's books balance, and so do the Treasury's.
ReplyDeleteThe private sector can hold both cb and Treasury liabilities as assets, also although bank money nets to zero, consolidated non-got can net save using govt liabilities, which are tax credits.
Jose at 4:01
ReplyDeleteYou didn't answer the question but rather avoided it. Which is it?
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ReplyDeleteJose, let's start everything from zero.
ReplyDeleteFed: $0
Tsy: $0
Non-govt: $0
For the government to get a net surplus in this situation, the 'non-govt' has to go into debt to the government.
So, let's say the Tsy imposes $100 a tax on the non-govt in the above scenario. Where does the non-govt get the money to pay the tax from?
Answer: it has to borrow it from the Fed.
So, after the tax is paid:
Tsy: $100 deposit (asset)
Fed: $100 loan (asset)
$100 deposit (liability)
Non-govt: $100 debt (liability)
In the above example, the "conslidated government" has an asset in the form of a loan to the non-govt.
ReplyDeleteHowever, the 'government' still doesn't have any funds to spend, as the Treasury's asset is a government liability.
Jose, let's start everything from zero
ReplyDeleteIt's first ying and then yang. But it could also be first yang and then ying. This kind of argument will lead us nowhere.
First the private sector loses equity (it pays taxes). Then the govt. spends - and the private sector regains said equity.
And yes, you may also state it the other way around. It won´t change anything to the fact that when the private sector pays taxes the govt. sees its "equity" increased. The opposite, when it spends.
Jose, let's start everything from zero
ReplyDeleteIt's first ying and then yang. But it could also be first the yang and then the ying. This kind of argument will lead us nowhere.
First the private sector loses equity (it pays taxes). Then the govt. spends - and the private sector regains said equity.
And yes, you may also state it the other way around. Or argue that, logically, the govt. must come first.
But it won´t change anything to the fact that when the private sector pays taxes the govt. sees its "equity" increased. The opposite, when it spends.
You didn't answer the question but rather avoided it
ReplyDelete1. Deficit expenditure is the add and bond issuance is the drain
Correct, in the present U.S. system
2. if the govt doesn't provide the funding, then private banks have to borrow the reserves from the central bank
In fact, the Fed buys back the bonds from the banks, thus providing an injection of reserves (and also preserving its interest rate target). So, it's also correct.
I'd also like leave a couple of questions of my own:
1. Do tax payments drain resources from the private sector and provide resources for the government to spend?
This was what was being discussed, after all.
And also another (related) question:
Can the government spend when its account at the Fed has a balance of zero?
Since we are in quotation mode (as per the warren Mosler passage above) let me also add a quote from L R Wray, describing the process of deficit spending as it really is, at present in the U.S.; if you don't mind, I'll add the corresponding accounting entries in balance sheet form:
ReplyDeletethe Treasury sells the treasuries to the private banks, which create deposits for the Treasury...
Banks' BS:
Asset: + tsy bonds liability: + govt deposit
...that it can then move over to its deposits at the Fed...
Banks' BS:
Asset: minus reserves Liabilities: minus govt deposit
Fed BS:
Liabilities: minus bank reserves, plus govt deposit
And then ‘Helicopter Ben’ buys treasuries from the private banks…
Fed BS:
Assets: plus govt bonds liabilities: plus bank deposits
Banks' BS:
Assets: minus govt bonds, plus reserves
And the conclusion naturally follows:
The Fed ends up with the treasuries, and the Treasury ends up with the demand deposits in its account at the Fed – which is what it wanted all along, but is prohibited from doing directly"
It's not possible for the government to get funds from its central bank in a "pure MMT system"
ReplyDeleteWell, you'll have to explain that POV to Stephanie Kelton (then Bell).
In her paper "Functional Finance: What, How and Why" she starts the process of deficit spending with an accounting table under the title "Step A: The sale of a Government bond to the Central Bank", where one can read the following entry:
Central Bank:
Asset: + government security
Liability: + balance owed to Treasury
That is, a perfect description of a "pure" MMT system - unfortunately, not (yet) the one we have in the U.S. of A.
"when the private sector pays taxes the govt. sees its "equity" increased"
ReplyDeleteI'm trying to see you point here so I'll break it down to the very basics. I'm sorry but here's another simple example:
1. govt issues a $100 liability to non-govt.
govt: $100 liability
non-govt: $100 asset
2. govt takes back $100 liability from non-govt
govt: $0
non-govt: $0
Where is the govt's increase in equity?
I'm trying to see you point here
ReplyDeleteIf the govt has a $100 liability and zero assets it must have (accounting rules) negative equity of $100.
When the private sector pays $100 in taxes, govt assets increase by $100 (it received or "earned", if you prefer, $100). Consequently, govt equity must change from minus $100 to zero.
That equity thus increased (net change) by exactly $100.
Simple accounting arithmetic.
And also economic logic. A private sector deficit necessarily results in a govt surplus.
"A private sector deficit necessarily results in a govt surplus"
ReplyDeletebut they both end up with zero.
So next time the govt issues a liability, it's starting from zero - not drawing on existing assets or funds, or surplus, or equity. Just zero. What am I missing?
1. Deficit expenditure is the add and bond issuance is the drain
ReplyDeleteCorrect, in the present U.S. system
2. if the govt doesn't provide the funding, then private banks have to borrow the reserves from the central bank
In fact, the Fed buys back the bonds from the banks, thus providing an injection of reserves (and also preserving its interest rate target). So, it's also correct.
I'm talking about when the bonds are bought by non-govt entities that intend to hold them and not sell them. In aggregate, do they buy them to hold with reserves that are borrowed from the Fed or reserves are not borrowed from the Fed? If they are not borrowed from the Fed, then how does non-govt get them?
BTW, in using OMO, govt doesn't purchase bonds from the private sector but rather does repo agreements. Prrchase is only in POMO, when the cb pays IOR.
I'd also like leave a couple of questions of my own:
1. Do tax payments drain resources from the private sector and provide resources for the government to spend?
According to MMT,taxes draw down consolidated non-govt net financial assets previously provided by govt through deficit spending. Govt doesn't take what it did not previously give, in aggregate.
According to MMT, if govt runs a balanced budget or a deficit, it adds the financial assets it taxes in aggregate. If it runs a surplus, then it draws down consolidated non-govt saving of net financial assets provided previously by govt.
Some opponents of MMT hold that govt borrows credit money created by banks. If this is what is meant by draining resources from the private sector, the answer MMT gives is, no.
And also another (related) question:
Can the government spend when its account at the Fed has a balance of zero?
No, not with the existing Treasury no-overdraft rule.
In her paper "Functional Finance: What, How and Why" she starts the process of deficit spending with an accounting table under the title "Step A: The sale of a Government bond to the Central Bank", where one can read the following entry:
ReplyDeleteCentral Bank:
Asset: + government security
Liability: + balance owed to Treasury
That is, a perfect description of a "pure" MMT system - unfortunately, not (yet) the one we have in the U.S. of A.
I would not call it a "pure MMT system" in that no MMT economist does. Scott, for example, distinguishes between general and special case.
The above is a description of general case operations in a non-convertible floating rate system. Different countries modify the general case with politically chosen (voluntary) conditions that limit general case operations iaw special rules.
So, let's say the Tsy imposes $100 a tax on the non-govt in the above scenario. Where does the non-govt get the money to pay the tax from?
ReplyDeleteAnswer: it has to borrow it from the Fed
Very well, then.
I understand what you mean, but unfortunately your accounting entries are incomplete.
Lat's recap.
The non govt (starting from a zero position in assets and L & E, in your exemple) must pay the $100 tax by determination of the govt.
Here are the entries required for the non-govt to pay:
Asset: minus $100 deposit
L & E: minus $100 equity
Note how equity is the plug. By definition equity equals (assets minus liabilities). Since assets went down by $100 without a corresponding reduction in liabilities, equity took the hit.
But, as you say, the non-govt does not really have any asset so it must borrow from the Fed.
Here are the entries for the Fed loan, from the non-govt perspective:
Assets: + advance from Fed
L & E: + funds owed to Fed
What's the overall situation now? Assets are again at $0. But liabilities are at $100 (owed to the Fed). Applying the identity (equity = assets - liabilities) we have, equity = zero minus $100.
Conclusion: after the Fed loan to pay the tax, the non-govt equity is still at a negative $100 position.
Whereas before the tax was imposed its equity stood at $0.
Net change: a loss of $100 in equity.
Again, to the penny.
If it (the govt)runs a surplus, then it draws down consolidated non-govt saving of net financial assets provided previously by govt
ReplyDeleteOk, I understand that; but the point in discussion was never about the primeval origin of financial assets. It was exclusively about what happens - in terms of changes to the balance sheets of the various parties involved - when Mr. A, a private sector agent, pays his taxes.
Can the government spend when its account at the Fed has a balance of zero?
No, not with the existing Treasury no-overdraft rule
Yes; and said account may be replenished via either tax payments or bond sale proceeds.
I'm glad we've reached an agreement on this!
I would not call it a "pure MMT system" in that no MMT economist does
ReplyDeleteWe can change "pure" to "general case", no problem at all. The intended meaning is the same.
Unfortunately, the only country that likely comes near to that general case is Canada. The U.S. still suffers from many "voluntary restrictions" that do very much put it in the "special case" category.
Ok, I understand that; but the point in discussion was never about the primeval origin of financial assets. It was exclusively about what happens - in terms of changes to the balance sheets of the various parties involved - when Mr. A, a private sector agent, pays his taxes.
ReplyDeleteI think that there are two separate things going on here. First, Jose and y debating certain accounting issues, which I have not been following closely.
What I am interested in is the objection to MMT that govt uses bank money when it taxes or borrows. That may be true in individual cases but it cannot be true in aggregate because taxes and bond auctions settle in reserves, which come only from the side of govt. So to settle, non-govt either has to get the reserves from govt by borrowing from the cb or through fiscal injection by the Treasury. The MMT position is that taxes and bonds sales are generally settled in aggregate with funds that govt provided through injection. However, if there were to be no govt debt and no reserves from injection due to persistent fiscal supluses, then non-govt would have to borrow from the cb for taxation and to purchase govt securities.
"A private sector deficit necessarily results in a govt surplus"
ReplyDeletebut they both end up with zero
The private sector only ends up at zero after the govt has spent the proceeds from the tax payment back into the economy again.
And the private sector will be in a surplus position after the govt starts deficit spending.
We can change "pure" to "general case", no problem at all. The intended meaning is the same.
ReplyDeleteYes, better to stick with the terminology that MMT economists use.
What MMT economists claim is that limiting the general case limits govt policy space. The obvious question then is why?
Unfortunately, the only country that likely comes near to that general case is Canada. The U.S. still suffers from many "voluntary restrictions" that do very much put it in the "special case" category.
Yes. I would add that the current system of bond financing doesn't fit the general case either, since bonds are operationally unnecessary under a non-convertible floating rate regime, and the interest constitutes a subsidy since it too is unnecessary. That is to say, this method of departing from the general case stands in need of justification since it is not operationally unnecessary and introduces inefficiency. What is the trade-off for introducing inefficiency or it is a special interest insertion that creates privilege?
What I am interested in is the objection to MMT that govt uses bank money when it taxes or borrows
ReplyDeleteActually, there is a much more important objection to what we might call the MMT world view (as far as it goes beyond MMT's plain description of government spending).
It's the objection that in the real world that we all live in, most of the money created does not derive from govt activity: it's commercial bank money (bank deposits that do not result from govt deficit spending).
According to estimates for the UK provided by Prof. Richard Werner, about 97% of money is created by banks, rather than by the govt.
That seems to me a much more important objection (or should we say, different perspective?)for dedicated MMTers to comment upon.
Also, an important point to add as a summing up of the present discussion is the following one:
ReplyDelete(a) If the govt may not spend when its account at the Fed is at zero,
And
(b) if payment of taxes provides a positive balance for said account, allowing the govt to spend when it previously couldn't
Then it necessarily follows that
(c) taxes do fund govt spending.
At least according to the dictionary definiton of "funding", which is "the action or practice by an entity of providing money for a specific purpose".
Also, an important point to add as a summing up of the present discussion is the following one:
ReplyDelete(a) If the govt may not spend when its account at the Fed is at zero,
And
(b) if payment of taxes provides a positive balance for said account, allowing the govt to spend when it previously couldn't
Then it necessarily follows that
(c) taxes do fund govt spending.
Yes, and since taxes are paid in rb and govt spends by crediting rb to bank accounts, govt is spending its own money.
I would add that the current system of bond financing doesn't fit the general case either
ReplyDeleteNo, it doesn't.
The purpose of this system is to create and maintain the fiction that the govt needs the private markets' funding in order to deficit (underline: deficit) spend.
When in fact it doesn't.
To place the govt in a subordinate role on the people's minds.
That's why I never thought the platinum coin idea stood a chance. It was too dangerous for TPTB.
govt is spending its own money
ReplyDeleteIMO, it's more correct to state that govt is spending money that it originally created.
But after it spent that money, govt lost the control of it. The "ownership" was transferred to "the private sector".
Govt only recaptures that ownership when the private sector pays taxes.
Then and only then can govt spend that money into the economy.
Actually, there is a much more important objection to what we might call the MMT world view (as far as it goes beyond MMT's plain description of government spending).
ReplyDeleteIt's the objection that in the real world that we all live in, most of the money created does not derive from govt activity: it's commercial bank money (bank deposits that do not result from govt deficit spending).
According to estimates for the UK provided by Prof. Richard Werner, about 97% of money is created by banks, rather than by the govt.
That seems to me a much more important objection (or should we say, different perspective?)for dedicated MMTers to comment upon.
MMT of course recognizes this, since it is a combination of Chartalism and the credit theory of money, and distinguishes bank created money that nets to zero from govt created money that doesn't. MMT also agrees that money creation is endogenous with the cb as the LLR.
The important thing that most people don't realize is that most of what they call "money" indiscriminately — and most people think that the money comes from the goverment — is actually credit that has a corresponding debt and that bank "money" is the debt created by lending. It has no backing and is subject to default.
What sustains bank money is the banks' promise to settle in govt money on demand, either through cash at the window or in bank reserves at the cb in the case of payment by other means. That is to say, the bank promises to obtain government money to settle on demand since banks cannot create the government's money currency. All they can do is issue credit denominated in the unit of account, which is generally the currency, along with the promise to deliver currency on demand either at the window or in the payments system.
Obviously, this is a very unstable system, when the overwhelming percentage of money is based on private promises, that is, the borrowers' promise to pay and the banks' promise to settle in govt money that banks cannot create but must obtain from equity or borrowing.
I suspect that if the public realized this, the system would change pretty quickly, since it is clearly a house of cards, other than the small fraction of government money.
Then and only then can govt spend that money into the economy.
ReplyDeleteBut it is not required in the general case. Only if a special case requires it.
Of course, in the general case, when taxes are received they are created to the TGA and the Treasury has those reserves to credit to non-govt accounts. But it doesn't need them to spend since it can create currency as desired.
However, it is true that if a govt running the general case decided to spend only what it taxes, i.e., a balanced budget, then non-govt cannot net save in aggregate without a deficit to provide the net financial assets.
But it doesn't need them (taxes) to spend since it can create currency as desired
ReplyDeleteIn practice, it cannot create currency "as desired" and forget about tax receipts. That would mean inflation, a very real constraint.
In modern societies (even if ruled by anti-welfare state ideologues), G-T is always much smaller than G.
Such societies will always have a large state sector, most of which will have to be financed by taxes, not by deficits (currency creation).
I suspect that if the public realized this, the system would change pretty quickly, since it is clearly a house of cards
ReplyDeleteThat's precisely what the people from the "Positive Money" site and campaign are trying to achieve in the UK: explain how money really works so that people will realize the con job being played on them and start demanding profound changes to the system.
If that happens, the days of absolute rule by the banking cartel may well be numbered.
In practice, it cannot create currency "as desired" and forget about tax receipts. That would mean inflation, a very real constraint.
ReplyDeleteIn modern societies (even if ruled by anti-welfare state ideologues), G-T is always much smaller than G.
Such societies will always have a large state sector, most of which will have to be financed by taxes, not by deficits (currency creation).
Agreed.
The size of the deficit is based on the saving desire of non-govt, so currency creation through deficits to meet non-govt saving desire results in the desired net financial assets in aggregate in a full employment budget. Increasing deficits beyond that limit will be inflationary. If govt wishes to spend more than non-govt wishes to net save, then it must tax more to prevent inflationary pressure. Govts generally wish to spend more than non-govt desires to save, so taxes are needed to manage the size of the deficit to keep it in line with non-govt saving desire.
That's precisely what the people from the "Positive Money" site and campaign are trying to achieve in the UK: explain how money really works so that people will realize the con job being played on them and start demanding profound changes to the system.
ReplyDeleteIf that happens, the days of absolute rule by the banking cartel may well be numbered.
Agreed. Advocacy is needed in all countries. Positive money in the UK and AMI in the US have been able to get the most publicity so far.
Jose,
ReplyDelete"but they both end up with zero"
"The private sector only ends up at zero after the govt has spent the proceeds from the tax payment back into the economy again."
No.
This should be very simple.
1. Start with zero.
govt: $0
non-govt: $0
2. govt issues a $100 liability to non-govt (i.e. spends)
govt: $100 liability
non-govt: $100 asset
3. govt takes back $100 liability from non-govt (i.e. taxes)
govt: $0
non-govt: $0
As you can see above, they both have zero.
Please explain to me why you think $0 does not mean zero.
Your example implies the govt going into negative equity when it spends. (An increase in liabilities without a corresponding increase in assets implies a negative equity entry).
ReplyDeleteThat is correct.
And reverting to zero equity when the private sector pays taxes.
This is also correct.
You should notice, however, that when taxes were paid, the govt saw its equity increase by $100. Indeed, it went from a negative $100 to zero.
Zero minus a negative $100 equals a positive $100 change.
This has been my consistent point all along this debate: when taxes are paid the government sees an increase in its equity.
It can't be otherwise. And I'm glad to see you fully agree.
Jose and y,
ReplyDeleteConsolidated govt books balance, and consolidated non-govt balance. I think there is agreement on that.
Govt can issue currency (Fed liabilty) and bonds (Treasury liability) that non-govt holds as assets. I think that is agreed.
Govt can then tax back assets (tax credits) that it created in non-govt through issuance, some of which (fiscal deficits) is saved in tsys. I think that there is agreement there, too.
The tax credits that are issued come from the Treasury account at the Fed, and tax credits are credited to the Treasury account when taxes are paid.
The Treasury can only spend by having reserves that it can neither issue directly,nor obtain directly from the Fed under current law. I think this is also agreed.
The Treasury spends by getting reserves from taxation, and it deficit spends by getting reserves from tsy issuance via auction. Agreed?
Taxation creates private sector liabilities that can only be satisfied with government liabilities (rb or cash). Agreed? (Some seem to object to this.)
So the accounting shows these "vertical transactions" between govt and non-govt that show up in the respective books and can be aggregated. I assume this is agreed, too.
Govt liabilities are only created when the Fed issues its liabilities and the Treasury its liabilities. I think this is agreed.
Treasury liabilities are cancelled when tsys are redeemed for reserves. Non-govt tax liabilties are cancelled when taxes are paid. Some Fed liabilities are created when the Fed loans rb to non-govt and cancelled when the loans is repaid. Agreed?
The Fed only creates rb without lending when it purchases tsys from non-govt, in what MMT calls an asset swap. Similarly the Fed exchanges bonds for rb as an asset swap when it sells tsys. Agreed?
Is there anything else of note going on?
Ok, so when the government has $0, does it have funds?
ReplyDeleteDoes it have $100 funds?
Does it have $3.50 funds?
Does it have -$5 million funds?
Or does it have $0 funds?
@Tom,
ReplyDeletePretty good wrap up.
There is one point, however, that I think deserves further discussion:
Taxation creates private sector liabilities that can only be satisfied with government liabilities (rb or cash). Agreed? (Some seem to object to this.)
There is no doubt, IMO, that tax payments are ultimately made with commercial bank deposits at the central bank ("reserves").
This is implied by the accounting entries of a tax payment on the Balance Sheets of the several actors concerned:
For private sector: minus bank deposit, minus equity
For commercial banks: minus reserves, minus private sector deposits
For the Fed: minus commercial bank deposits ("reserves"), plus Tsy deposits
For Tsy: plus deposit at Fed, plus equity
But the big question is the following: since the Fed is "condemned" to always provide commercial banks with the needed reserves - otherwise the payment and settlement system will collapse, a result that central banks want to prevent from occurring at all costs - we could say that (ultimately) it's the commercial banks who hold the keys to the supply of reserves (so-called "govt money" or "base money").
So we might interpret the present situation as: yes, the government sector creates reserves via its central bank - but it does so at the pleasure and discretion of the commercial banks.
In a sense, it's the commercial banks who hold the keys not only to the money supply (deposits) but also to the creation of base money ("reserves") by the government's own bank.
Yes, that is what endogenous money creation involves and both circuitists and chartalists agree on that point.
ReplyDeleteThat is to say, the size of the M2 money stock is determined endogenously by credit extension chiefly (net zero) and partially by deficit spending ($NFA).
The fiscal balance is also largely determined endogenously, rather than exogenous by discretionary fiscal policy, due to the variability of tax receipts and automatic stabilization over the cycle.
What this analysis shows, btw, is the centrality of leverage and its use in the present institutional arrangements through which money is created.
ReplyDeleteEconomic cycles involve expansion and contraction of leverage and leverage ratios. This is the basis of risk and risk management. The higher the gearing the greater the exposure of borrowers, lenders, and the system itself.
So addressing leverage is fundamental.
the size of the M2 money stock is determined endogenously by credit extension chiefly (net zero) and partially by deficit spending ($NFA)
ReplyDeleteI'd add the proviso that deficit spending only increases the money stock as far as government bonds/bills are bought by the commercial bank sector.
If it's non depository institutions or households that are buying the govt securities, there will be no net increase in bank deposits ("money").
There will be an increase in the amount of bonds outstanding, of course; but that would lead us back to the old discussion on whether Tsy secutities are "money" :)
There will be an increase in the amount of bonds outstanding, of course; but that would lead us back to the old discussion on whether Tsy secutities are "money" :)
ReplyDeleteRight, but tsys are not included in M2.
Right, but tsys are not included in M2
ReplyDeleteRight.
So it is technically possible to have a situation where govt deficit spending does not involve any "money" creation.
That would be the case when commercial banks don't hold any Tsy securities on their balance sheets.
All increases in the "money" supply (as opposed to the monetary base) would result entirely from the commercial banks' deposit creation.
And since the monetary base, issued by the Fed, also responds to the whimsical behaviour of commercial banks we´d have - in practice - both "base money" and "money" creation under the spell of a small number of unaccountable private institutions: the commercial banks.
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ReplyDelete"since the Fed is "condemned" to always provide commercial banks with the needed reserves"
ReplyDeleteIt lends reserves at an interest rate it chooses, or buys govt bonds from banks to maintain an interest rate in the interbank market.
Sure, if banks have assets (bonds) they can sell, or they can afford to borrow, then no worries.
"There will be an increase in the amount of bonds outstanding, of course; but that would lead us back to the old discussion on whether Tsy secutities are "money" "
ReplyDeleteThat's a pretty pointless discussion. If you have a bond and want to spend, you can sell it asap. The difference is pretty meaningless.
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ReplyDelete"since the monetary base, issued by the Fed, also responds to the whimsical behaviour of commercial banks we´d have - in practice - both "base money" and "money" creation under the spell of a small number of unaccountable private institutions: the commercial banks."
ReplyDeleteIf its under their "spell" then why can they go bust?
And since the monetary base, issued by the Fed, also responds to the whimsical behaviour of commercial banks we´d have - in practice - both "base money" and "money" creation under the spell of a small number of unaccountable private institutions: the commercial banks.
ReplyDeleteLargely the case in most modern economies.
However, as MMT economists point out, the govt has control over this to the degree it chooses to exercise it. Central banks are creatures of law. The banking system is also a creature of law.
But the way things stand now, the role of government in money creation is secondary, acting through economic policy that is mostly based on partisan politics.
And although government does provide non-govt with net financial assets in aggregate through deficit spending and bond issuance, the size of the deficit is also determined endogenously.
This is the system that MMT describes and is mostly content to live with, other than Bill Mitchell, it seems. Warren has proposed banking reform but this would still leave the existing system largely in place.
I would say that most (all?) MMT economists would recommend removing political imposed restraints on govts using the full potential of the existing monetary system due to concerns that are not relevant economically and get in the way of public purpose.
Beyond that, MMT economists recommend fashioning economic policy based on applying a correct economic understanding, which MMT purports to deliver, to the use of available resources for public purpose based on choices arrived at democratically, and to do this in way that optimizes growth, employment, and price stability.
Nothing radical about this. Pretty much says, use what you got intelligently instead of not.
If its under their "spell" then why can they go bust?
ReplyDeleteBasically over-leveraging against dodgy collateral and other aspects of Ponzi finance. According to Warren, regulators have control over what counts as collateral and they failed to step in and regulate the asset side of banks' balance sheets. The loans were unrealistic based on value. For example, the run up in the housing bubble was not based on increasing value of the house, e.g., evaluated in terms of replacement value, but rather of gigantic increases in land value, which was assessed unreasonably, based on increasing marginal price alone, and not taking things like income into consideration.
Govt delegates money creation to the private sector since the private sector is considered better at risk management than govt. But left to itself that is not the case over time, as financial cycles that culminate in a Ponzi stage go to show. As Minski points out, financial instability goes with the territory.
Could govt improve on this record? Remains to be seen. In my view probably not under neoliberalism.
If its under their "spell" then why can they go bust?
ReplyDeleteWell, in practice they rarely if ever go bust.
The commercial banks can always rely on the helping hand of the central bank to provide the necessary funds to keep them alive.
This is so in both the U.S. and the eurozone. A very recent example can illustrate this attitude: the Dutch central bank, when it decided to rescue the bank SNS Reaal a couple of weeks ago, had the following explanation: "...as a ‘system bank’ (it is) an institution which should not be allowed to fail because of the damage it would cause to the Dutch financial system".
No further comments are needed, IMO.
Could govt improve on this record?
ReplyDeleteIt could by changing the rules of the game for banks. No need to nationalize them - just regulate their activity in a different way, that severely dents their capacity for money creation.
This is the line being followed by the Positive Money campaign in the UK: propose specific, carefully studied reforms that may point a dagger at the heart of the financial system's current, immense power.
There were significant bank failures leading up to the Great Depression and as a result of the ensuing debt-deflation. Governments and central banks learned that lesson, excepting the case of Lehman Bros. When it was allowed to fail, it nearly brought the global financial system down. So, TBTF and TBTJ, and hope not TBTB (to big to bail).
ReplyDeleteThe financial system provides finance capital necessary for a capitalistic system to function. Therefore, the financial system is a matter of national security, and therefore, it receives the highest priority.
It could by changing the rules of the game for banks. No need to nationalize them - just regulate their activity in a different way, that severely dents their capacity for money creation.
ReplyDeleteThe skeptical view says:
1. The clout of the financial sector will smother that in the crib.
2. Even if the baby survives and grows, the financial sector will always be scheming about how to weaken it and eventually kill it.
What should banks do? (L R Wray)
ReplyDeletehttp://www.levyinstitute.org/pubs/ppb_115.pdf
"the Dutch central bank, when it decided to rescue the bank SNS Reaal a couple of weeks ago.."
ReplyDeleteIt's strange that banks should have to be rescued by the government if it is banks that "control" the money system.
It might be more appropriate to say that the banks' influence over policy is a form of corruption, or that banks have a privileged position, or that their debts have been allowed to grow to such crazy levels that they pose a risk to the whole economoy, etc.
It's strange that banks should have to be rescued by the government if it is banks that "control" the money system.
ReplyDeleteBecause modern banking ia a public-private partnership, banks are quasi-agents of the government and therefore, when they get the system banking itself into difficulty, government needs to step into rescue the system.
but if banks supposedly "control" the money system because they can create money by magic because they have super powers and "rule the roost" and other such nonsense, then why should they need the help of government?
ReplyDeletethey can create money by magic
ReplyDeleteYes they can - but for third parties, not for themselves.
They can thus go bust whenever PV of Assets < PV of Liabilities.
Then they can call govt (that is, society as a whole) to foot the losses.
It's simply socialism for the Financial sector.
It's simply socialism for the Financial sector.
ReplyDeleteUnder neoliberalism, the powerful control the reins of power through wealth rather than land as under feudalism. In both, power equates with ownership. So welcome the new aristocracy — the super-class.
This is a big reason for opposing disproportionate per capita distribution
"Yes they can - but for third parties, not for themselves"
ReplyDeleteWhen a bank goes bust it can't create money for anyone, including third parties.
"socialism for the Financial sector"
ReplyDeleteok, so basically corruption.
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ReplyDeleteWhen I suggest banks "can't create money by magic", what I mean is that there's nothing magical about what banks do. Bank deposits are bank liabilities - i.e. bank debts. When they "create deposits" they simply increase their debts.
ReplyDeleteThat's why I said "anyone can create a deposit". Anyone can promise to pay someone else money. That's what a bank deposit is: a promise to pay.
ReplyDeleteAnyone can promise to pay someone else money. That's what a bank deposit is: a promise to pay
ReplyDeleteIn the banks' case, it's implicitly backed by the government.
That is a priceless - though certainly not costless - guarantee. :)