The first Fed chairman of the modern Federal Reserve (post-Banking Act of 1933) explains, under oath, in his testimony to the US House of Representatives committee on banking and currency in March of 1947 that the requirement of the US Tsy dept to have a positive balance in its account at the Fed (The TSY General Account aka TGA) is no barrier to Govt spending and deficits. And that preventing TGA overdrafts does not put the "market" in control of Govt interest rates. This means there is no such thing as a bond vigilante, and that the loanable funds theory is a myth. Its amazing that this can be such easily found information and yet all modern mainstream economics books teach these falsehoods as an article of faith. The economics orthodoxy is an embarrassment to science and an anvil around the welfare of society. This includes all mainstream left "progressive" economists like Krugman, Baker, Reich, and Stiglitz. Saying this better than I ever could is the aforementioned patriarch of the Federal Reserve, Marriner Eccles. Save this one for your bookmark collection.
https://fraser.stlouisfed.org/docs/historical/house/1947hr_directpurchgov.pdf
Mr. SPENCE. I assume the reason the authority w^as repealed in
1935 was because of the existing conditions, then, when there was no
reason for the authority: is that correct?
Mr. ECCLES. Well, as I remember the discussion—and I have referred
to it in this statement—there was a feeling that this left the
door wide open to the Government to borrow directly from the Federal
Reserve bank all that was necessary to finance the Government deficit,
and that took off any restraint toward getting a balanced budget.
Of course, in my opinion, that really had no relationship to budgetary
deficits, for the reason that it is the Congress which decides on the
deficits or the surpluses, and not the Treasury. If Congress appropriates
more money than Congress levies taxes to pay, then, there is
naturally a deficit, and the Treasury is obligated to borrow. The
fact that they cannot go directly to the Federal Reserve bank to borrow
does not mean that they cannot go indirectly to the Federal
Reserve bank, for the very reason that there is no limit to the amount
that the Federal Reserve System can buy in the market. That is
the way the war was financed.
Therefore, if the Treasury has to finance a heavy deficit, the Reserve
System creates the condition in the money market to enable the borrowing
to be done, so that, in effect, the Reserve System indirectly
finances the Treasury through the money market, and that is how the
interest rates were stabilized as they were during the war, and as
they will have to continue to be in the future.
So it is an illusion to think that to eliminate or to restrict the directborrowing
privilege reduces the amount of deficit financing. Or that
the market controls the interest rate. Neither is true."
This comment also puts into focus the myth of Central Bank independence. The CB is not independent of the Govt and the legislative body that makes the final decisions about economic society. The elected legislators are the highest authority and the CB has no choice but to follow its orders, which in a democracy are The Peoples aka "Our" orders.
Icahn is starting to figure this out:
ReplyDeletehttp://www.cnbc.com/2015/09/30/carl-icahn-no-brainer-to-elect-trump-president.html
Certainly not where we are yet but he seems to be at least interested and can see what is really going on at some level....
Great post, Auburn. Thanks!
ReplyDeleteGood info, Auburn.
ReplyDeleteExcellent Auburn!
ReplyDeleteIt's very simple really. The central bank has no authority to say no to the elected parliament, and if it did it would cause a constitutional crisis.
ReplyDeleteThere are people who want such central bank dominance, because they never want the government to change its direction.
The corporatists want it and the leftists want it. A wise design is to deny either of them by ensuring only congress/parliament can have the last say on financing.
Auburn: That's a fine excerpt from the man for whom the main Federal Reserve's building is named after.
ReplyDeleteJust one quibble regarding the list of mainstream economists named in your post. I'm not sure they would disagree with Eccles here. After all, the IS-LM model they learned allows for the setting/pegging of any interest rate.
A few weeks ago, Krugman wrote a post on how IS-LM is a refutation of loanable funds. Here's Stiglitz from his book on monetary economics: "When a bank extends a loan, it creates a deposit account, increasing the supply of money". I'd say Baker and Reich would agree as well.
One area in which the Fed does have discretion is in determining the level of the interest rate the treasury will pay for its borrowing. Another related area of discretion is over the rest of monetary policy: if the Fed decides that the level of treasury deficit-financed spending is unacceptably inflationary then it will counteract that effect by seeking to tighten credit in private channels. Direct treasury borrowing via overdraft is just another form of central bank credit. If the central bank is required to expand its balance sheet in the management of the treasury account beyond the level it would prefer, it will contract it in other areas.
ReplyDeleteOf course, all of these things could be changed. Congress created the Fed and assigned those discretionary policy powers to it, and is free to modify it, re-design it or replace it with something else whenever it wants.
Circuit-
ReplyDeleteI have personally seen both Krugman and Baker defend and articulate loanable funds as the way it works, and relatively recently too. Siglitz seems to have come the farthest, so maybe he doesnt belong up there, so thats a fair point.
Furthermore, if you watch the Modern Money and Public Purpose Dean did with Scott F, he was literally clueless about reserve operations, he didnt understand it at all and then the other week he had the balls to write in a comment on his blog that MMTers havent contributed anything much to economics. As if accounting wasnt the single most important macroeconomics discipline:
ReplyDeleteIf you dont the accounting right, you cant get the economics right.
"One area in which the Fed does have discretion is in determining the level of the interest rate the treasury will pay for its borrowing"
ReplyDeleteSet it at 200%. The Treasury then gets the Federal Reserve dividend which covers the charge.
The only thing Treasury would pay is the running cost of the Reserve system.
If you own or control a bank - such that you receive the income from the bank, then borrowing from the bank is 'free' and you have effectively infinite spending power.
"if the Fed decides that the level of treasury deficit-financed spending is unacceptably inflationary then it will counteract that effect by seeking to tighten credit in private channels"
And so it should - making space for government spending is a perfectly reasonable thing for the Federal Reserve to do. 'Money Sovereignty' suggests the Fed should always do this and taxes should be set to near zero.
The issue is whether the Federal Reserve should operate on a different model of the output gap from Treasury - particularly if they come from different sides of the political spectrum.
Auburn, I remember the exchange between Scott and Dean. My faint recollection was that they were sorta talking at cross purposes. I'll look at it again tonight after work.
ReplyDeleteCircuit, Auburn, Neil,
ReplyDeleteThere is a LOT lurking just before the surface here.
I put down some of the inter-dependencies in a longer comment here
https://plus.google.com/104140272098689841413/posts/LwGdjaVqj4p
Set it at 200%. The Treasury then gets the Federal Reserve dividend which covers the charge.
ReplyDeleteIf the Fed is buying those 200% bonds on the secondary market at somewhere near fair market value then the result is a massive redistribution of income to wealthy bond buyers.
"If the Fed is buying those 200% bonds on the secondary market at somewhere near fair market value then the result is a massive redistribution of income to wealthy bond buyers."
ReplyDeleteNot really. There is the auction and the repurchase, with a cut for the market maker. The repurchase will be near the auction price if the market is working properly.
Here's the link to Scott schooling Dean
ReplyDeletehttps://www.youtube.com/watch?v=soVyyyXrcwo
at 1:20:26 Scott confuses Dean about excess reserves, IOR and target rate. The look on Dean's face is priceless.
Not really. There is the auction and the repurchase, with a cut for the market maker. The repurchase will be near the auction price if the market is working properly.
ReplyDeleteAnd the auction price will be near the full long-term yield of the bond. Why would someone sell a bond that pays 200% to the Fed unless the Fed coughs up something pretty close to what the bond is worth from just holding it?
"Why would someone sell a bond that pays 200% to the Fed unless the Fed coughs up something pretty close to what the bond is worth from just holding it?"
ReplyDeleteWouldn't they buy a bond at "something pretty close to what the bond was worth"?