Thursday, June 25, 2020

Funding deficits with cash, not bonds could help avoid oversized stimulus debt — Felix Salmon

My thought bubble: There's a paradox here. The people who want to print money to avoid adding to the national debt are also the people who say that the size of the national debt doesn't matter. The hope is that monetization would placate the deficit hawks, but that seems unlikely.
Yes, it is only a paradox and not a contradiction. A paradox appears to be a contradiction but it not on analysis.

There are several reasons that some MMT economists favor not necessarily offsetting fiscal deficits with interest-bearing government securities.

In the first place, it is not necessary operationally. Therefore, since public payments are involved, the question arises about public purpose or some others justification based on public interest — instead of being directed toward special interests.

The obvious fact is that the policy of paying interest on public debt favors savers, for two reasons. First, owing to the interest and also owing to default-free risk. Why is paying interest to hold default-free securities not a favor to those that save. Is it in the public purpose to encourage saving?

Those who say that favoring savers is beneficial in that it provides funds for lending are mistaken. Saving doesn't cause investment, but rather investment causes saving, in that saving is the residual of income after consumption. New money is either issued by the currency issuer or results from credit extension by banks that have access to the central bank. No prior saving needed.

There could be public interest in providing default-risk free securities at interest even though it is not necessary operationally. For example, it is argued that this provision of "safe assets" reduces systemic risk. It also plays a role in the operation of the monetary and financial system. For example, debt issuance is used in monetary operations when the central bank is not setting the policy rate directly. Government securities are  also the highest form of collateral.

While Bill Mitchell recommends ending the subsidy to savers as waste, since it is not needed operationally, Warren Mosler recommends limiting securities issuance to the short-term.

On the other hand, some argue, and I assume that Stephanie Kelton is in this group, that although securities issuance is not necessary operationally, there is widespread belief that it is. "Monetizing" as least part of the deficit instead of offsetting it with securities would break that false view.

One more observation is in order here. Paying interest on the debt adds spendable funds to the economy and it is therefore more inflationary than not doing so. Under ordinary circumstances, this might not show up. However, under current thinking, raising the policy rate and thereby increasing  interest rates over the curve, is the preferred tool of monetary policy, in the belief that raising interest rates across the board dampens investment and cools inflationary pressure. But as rates rise, government securities pay higher interest and that adds spendable funds, increasing inflationary pressure.

While there is no operational problem in increasing the government's interest burden, since the interest is paid with issuance, there could be a problem with exacerbating inflation when inflationary pressure is rising owing to monetary policy as currently administered.

Paradox resolved.

Funding deficits with cash, not bonds could help avoid oversized stimulus debt
Felix Salmon


Matt Franko said...

“But as rates rise, government securities pay higher interest and that adds spendable funds, increasing inflationary pressure.“

That is not what we saw in 2018 they were raising all that year to the point where by 4Q they caused over 50b in unrealized losses on available for sale securities at the depositories and financial asset values collapsed... equity indexes fell by 20% from previous highs and they had to stop increasing the rates and reverse to lowering them in 2019...

There is no empirical evidence that their thesis here is true in fact the latest evidence would indicate their thesis is false..,

Matt Franko said...

Here from today:

“ OCI losses from AFS securities are computed directly from the projected change in fair value, tak- ing into account credit losses and applicable interest- rate hedges on securities. All debt securities held in the AFS portfolio are subject to OCI losses, including
• U.S. Treasuries;
• U.S. agency securities;”

If they raise the policy rate it creates unrealized losses on the available for sale Tier1 quality non risk assets they have to possess due to regulatory requirements...

This creates a reduction in Residual (A-L) and banks have to reduce their assessed value of the risk assets they possess ...

It reduces the price of risk assets... they might think this is opposite of “inflationary “...

Clint Ballinger said...