Stephanie Kelton on why the US doesn't borrow to spend

Excerpt from Stephanie Kelton
"Can Taxes and Bonds Finance Government Spending?" (1998)
(h/t y in the comments)

Federal Reserves notes (and reserves) are booked as liabilities on the Fed's balance sheet and these liabilities are extinguished/discharged when they are offered in payment to the State. It must be recognised that when currency or reserves return to the State, the liabilities of the State are reduced and high-powered money is destroyed. 

The destruction of these promises is no different from the private destruction of a promise once it has been fulfilled. In other words, when an individual takes out a loan, she issues a promise to a bank. Once she 'makes good' on that promise (i.e. repays the loan), she may 'destroy' that loan debt (liability) by eliminating it from her balance sheet. 

Thus, while bank money (M1) is destroyed when demand deposits are used to pay taxes, the government's money, HPM, is destroyed as the funds are placed into the Treasury's account at the Fed. Viewed this way, it can be convincingly argued that the money collected from taxation and bond sales cannot possibly finance the government's spending. This is because in order to 'get its hands on' the proceeds from taxation and bond sales, the government must destroy the money it has collected. Clearly, government spending cannot be financed by money that is destroyed when received in payment to the State! [This may be intended meaning of Warren Mosler's metaphor that tax dollars are destroyed when the tax liability has been removed from the record, rather than being used to fund future spending as most assume — th.]

How, if not by using the money received in payment of taxes and bond sales, does the government finance its spending? Notice that the government writes checks on an account that does not comprise part of the money supply or HPM but that as it does, the funds become part of the money supply (M1 if deposited into checking accounts, M2 if savings accounts, etc.) and part of HPM. It is therefore apparent that while the payment of taxes destroys an equivalent amount of money (M1 immediately and HPM as the proceeds go into the Treasury's account at the Fed), spending from this account creates an equivalent amount of new money - both bank money and HPM. Modern governments, then, finance all of their spending through the direct creation of new (high-powered) money.

Nick Rowe — Wicksteed, stocks and flows

Hmmm. That's starting to sound like a transactions demand for money function. But if we have a demand to hold money for transactions purposes, we can still get an equilibrium in which money is held and valued even if T(t) is always zero.

(Wicksteed said (HT David Glasner) that fiat money has value because the government requires it for payment of taxes. I'm saying that's not sufficient. And it's not even necessary, in the sense that if my local recycler accepted fiat money, even at a negligible price, that would be enough to replace T(t)>0 in ruling out the equilibrium in which fiat money has a price of zero.)

Read it at Worthwhile Canadian Initiative
Wicksteed, stocks and flows
by Nick Rowe

Seems like Nick is saying that the money supply is set exogenously by government whereas the operational reality is that in a system in which the central bank is the lender of last resort the money base is determined by demand for reserves for settlement and reserve requirements based on credit creation. Moreover, the size of the money supply (M2) is set endogenously by credit extension that creates credit money.

There is no doubt that money is an idea rather than a thing, that is, a human social construct that underlies a primary social, economic and financial institution. The state theory of money does not deny this and admits that credit money predates state money historically. Anthropologists have also observed that credit money grew out of social relationships involving reciprocity and trust.

The Chartalist claim is that state money, that is, currency, gets value from the necessity of the private sector to settle its government-imposed obligations with government when government only accepts is own liabilities as credits. This allows government to shift private assets to public use through currency expenditures.

Randy Wray — Does Chairman Bernanke Know Squat About Money?

I think the biggest policy failures in Washington over the past three or four decades are caused by confusion over the nature of money, and more specifically, the nature of a sovereign currency. So many of our policy makers simply do not understand that a sovereign issuer of the currency is not like a household user of the currency. For a sovereign issuer, there is never a solvency constraint. And a sovereign issuer spends by issuing its currency—not by borrowing it.

Read it at Economonitor | Great Leap Forward
DOES CHAIRMAN BERNANKE KNOW SQUAT ABOUT MONEY?
by L. Randall Wray

Neil Wilson — The fixed exchange rate system at the heart of MMT

Systems thinker Neil Wilson gives a very clear exposition of how the exogenous (vertical) and endogenous (horizontal) system interact, with the central bank and its currency powers at the apex of the hierarchy that includes the Treasury and banks as public-private partnerships. This system is at the core of modern economies, all of which use state money as central bank created currency in addition to credit money created by bank loans that presupposes use of currency for final settlement.

Read it at 3spoken
The fixed exchange rate system at the heart of MMT

by Neil Wilson

Roger Mitchell on bank nationalization

Rodger says nationalize 'em. They had their chance and blew it.

Read it at Monetary Sovereignty
The end of private banking: Why the federal government should own all banks
by Roger Malcolm Mitchell

Money creation is a public utility. In the United State, the US Constitution, Article 1, section 8,10 establishes the federal government as the currency sovereign with a monopoly on currency issuance. Under present institutional arrangements, the federal government creates a central banking system, the Federal Reserve System, and allows banks and bank-like institutions to generate credit money denominated in USD by extending credit. The banking system is a public-private partnership already, and the argument that banks are "private" is simply mistaken. Regulators are already required to put insolvent institutions into resolution. According to Bill Black, the law did not fail in the present crisis, the regulators did.

There is little question that the federal government acting through elected representatives can determine money and banking in the US largely as it sees fit. The question is to what extent should the money creation process and banking in general be public or private. 

Those who favor free banking would like to see money and banking completely under the control of the private sector, with government borrowing from the private sector to fund itself and using taxation for revenue. Thus government would be a currency user, and its policy space would be extremely limited.

At the other end of the spectrum is a currency only system in which government issues currency directly without needing to tax to get revenue or to borrow to finance itself. This, of course, puts an enormous amount of power in governmental (political) hands, and it greatly expands policy space.

I don't think that there is a way to resolve the issues involved through going to either an entirely private or an entirely public system, or, for that matter, a remix of the present system. The problem isn't configuration bu rather perverse incentives that distort the system. Any system can work with the appropriate incentives and controls to make it work as desired.

One thing we do know for sure is that the present system is broken and that if it is not repaired, the next crisis is already in the making.

Dan Kervick — Interesting piece by Gavyn Davis today in the Financial Times

Dan Kervick comments, "Interesting piece by Gavyn Davis today in the Financial Times. Further evidence that core insights of MMT are penetrating the mainstreamm" and cites this quote:

Davis: It is now widely recognised that a central bank cannot become insolvent in the same way that a private company can. Even if it incurs losses on its assets which more than completely eliminate its equity, it can never find itself in a position where it is unable to settle its debts, at least in its own domestic currency. Most of the liabilities of a central bank come in one of two forms: banknotes, and commercial banks’ deposits at the central bank. It is impossible for the private sector to force the central bank to exchange these assets for any other asset (like gold, for instance), and in any event the central bank can create more of each of them at will. Hence it can never become illiquid.

Read it at The Financial Times
ECB Liquidity Is Not A Free Lunch
by Gavyn Davis
(contributed by Dan Kervick from the comments)

Steve Keen — MMT Convergence?

Neil Wilson recently posted A Double Entry View on the Keen Circuit Model

at 3spoken.

This elicited some excellent comments, including a couple of extensive contributions by JKH.

Keven Fathi emailed me that Steve Roth just posted at angry Bear that he regards Neil's post as The Most Important Econoblog Post This Year.

Congratulations, Neil, on moving this debate significantly forward.