Monetary Realism

Understanding The Modern Monetary System…

A Possible Rule for Government Money Creation

We’ve had some discussions within the MR team on the costs of minting a coin vs. the costs of borrowing. It turns out it’s more expensive for the U.S. government to mint a coin than it is for the the government to borrow money. It sounds crazy, but it’s true.

If the U.S. mints a coin, the coin will be deposited at the Fed. As the Treasury spends this money, the money will find it’s way back to the Fed through the banking system. The Fed pays interest on reserves at .25%

If the U.S. borrows money, the government pays the market interest rate for the specific bills, notes, or bonds it issues when borrowing. Here is the curve:

We can borrow money out to 1 year for cheaper than we can mint the money!

It’s possible this provides us with an easy way to determine if we should be minting/printing money or borrowing it. Here’s the proposed rule: The larger government should do whatever is the most expensive. The Treasury should print money if the Interest on Reserves is higher than the cost of borrowing. The Treasury should issue bonds if Interest on Reserves is lower than the cost of borrowing.

So today we should be printing money, minting coins. The market will tell us when it’s had enough by raising the cost of borrowing higher than the Interest on Reserves.

It’s a handy little rule, something we can use to determine when to mint and when to borrow. Today, we don’t have anything in place at all. Zero.

It’s become clear the division between fiscal and monetary policy isn’t as clear as it once was.

As has become more clear in the last few years, monetary and fiscal policy are closely intertwined. It’s hard to tell where fiscal policy stops and monetary policy starts. When the Fed swaps short-maturity government debt for long-maturity government debt, or purchases mortgage-backed securities with reserves, are those monetary policy actions or fiscal policy actions? You tell me.”

JKH pointed out we are speeding towards a combined monetary and fiscal policy institution in his classic Contingent Institutional Approach. Fiscal and monetary policy are two sides of the same coin (Ha! please forgive me!)

If the Treasury and Central Bank are linked at deep levels of accounting, it follows that monetary and fiscal policy should be linked and used as a combined policy tool.

Right now, we don’t have a combined policy. We just badger the government for spending too much and use the fed to try and clean up the mess after. Here is a rule which might help us just a little bit, and give us just a little more structure on what to do. It doesn’t tell us how large to set the overall budget deficit, like the Strong Economy Rule (formerly the TC Rule) does.


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118 Responses

  1. Jose Guilherme says

    Another way to see it is this one:

    When there is full employment the economy can produce extra restaurant meals only at the cost of giving up producing something else. Deficit spending in said conditions would just shift resources from one sector to another – from the spa sector to restaurants, say – likely putting upward pressure on the price level in the process.

    Below full employment, however, we can afford those extra meals without giving up on anything. Said meals, if lunches, are really free lunches.

    And for the meals to be served the government will deficit spend. In Canada, where the NCB can buy debt in the primary market, the government may even simply credit its account at the NCB and then proceed to transfer the deposits to the restaurants. The meals can then be served having been “paid” for by mere computer keystrokes.

    Opportunity cost: zero. The lunches were free.

  2. vimothy says

    In my example, by assumption there’s no desire to spend the money, it’s just going to stay stuffed in the mattress or invested in some kind of fund. It’s just an example and it’s not terribly important, but it’s supposed to pose a choice between something and nothing. So the opportunity cost of something is nothing.

    The point is that cost and opportunity cost are not the same thing. Just because something has no opportunity cost does not mean that it has no cost. Think about what it means if the effect of government spending is to raise GDP by an equivalent amount: it means that the effect on output is equal to the cost of the spending programme. Say that the effect is less. Then cost is greater than the return. In neither case are costs zero. Costs are whatever they are, regardless of the multiplier on spending.

  3. Jose Guilherme says

    Oops, my answer showed up way above this line at “In order to buy the $1000 investment I have to give up the possession of valuable dollar bills …” :)

  4. Jose Guilherme says

    In order to buy the $1000 investment I have to give up the possession of valuable dollar bills presently stuffed in my mattress, worth a total of $1000 in goods and services at market price. So the opportunity cost of said investment is $1000.

    If the government deficit spends $1000 on goods and services that would otherwise not be produced – say, meals for poor kids served at a restaurant lacking in clients due to a deficiency in demand – the opportunity cost of doing so is zero. After all, the alternative to serving the meals is not serving the meals. And “not serving any meals” at a restaurant is worth exactly zero at market price.

  5. vimothy says

    The fact that costs are non-zero is the reason why you need to have idle resources (or maybe more accurately, a fiscal multiplier at least equal to unity) for your example to work. Otherwise, the cost will exceed the return.

  6. vimothy says

    Imagine that you have $1000 stuffed in your mattress. Say that there’s a $1000 investment that pays out $1050 with certainty. Then the _opportunity cost_ of the investment is zero, But the _cost_ is still $1000.

    Say that the government can spend $1000 and raise output by a $1000, and that otherwise, output would be $1000 below its long run potential. Then the opportunity cost is zero, but the cost is going to be around $1000, depending on how the spending is financed.

  7. Jose Guilherme says

    Opportunity cost: the cost of the alternative foregone to pursue the chosen action.

    At full employment, for the government to deficit spend (chosen action) someone else will have to give up on consumption of goods and services. Goods and services that have a value for that someone.

    At below full employment no one has to give up on anything. The alternative forgone was inactivity, not the making of other goods and services of value. Opportunity cost is zero.

    So it all follows from the definition of opportunity cost.

  8. vimothy says

    I don’t understand why you keep saying “by definition”. If the economy is below full employment, then government spending, deficit or otherwise, still has a cost. Being below full employment might make it easier to meet that cost (for instance, if you think that multiplier is always greater than or equal to one when the economy is below potential, which you implied earlier). But it might not. It certainly doesn’t follow from the definition that there is *no* cost.

  9. Jose Guilherme says

    Yes, deficit spending below full employment – either via borrowing or “money printing” – has no cost in the sense that there is no waste of resources, by definition. If the government hadn’t spent, said resources – land, labor, capital – would have stayed put, idle, non-used (yet waiting to be used).

    And when the government taxes-and-spends nothing substantial happens. The government is just “taking (some would say robbing) from Paul to pay to Peter”.

    Taxes destroy; spending creates.

    That’s the great lesson we’ve all learned from the likes of Keynes and Kalecki.

    And why, oh why, can’t the likes of Obama and Merkel simply apply it? :)

  10. vimothy says

    If the multiplier is zero, then government spending has no effect whatsoever. It’s probably possible to imagine some scenarios where that would be the case, but there’s no reason to think that this is true for _every_ conceivable spending programme at potential or full employment output, as far as I can see.

    I don’t agree that the economy can’t produce at above its full employment level. At any rate that’s not how I define full employment. It can produce above it or below it, and we would like to minimize those deviations. It’s also possible for GDP to increase over time, which is why we have economic growth.

    How this relates to our discussion, I’m not totally sure. From where I’m sitting, the point is that if you have a multiplier of one (or greater), then the government can offset its costs against the new gains to national income. You and Greg seemed to be arguing that the government has no costs whatsoever, in which case the multiplier would seem to be irrelevant.

  11. Jose Guilherme says

    With the economy at full employment the multiplier is zero, in real (inflation-adjusted) terms. By definition, said economy cannot produce extra goods and services, so government spending (indeed, any new spending) simply crowds out other spending. Real GDP CANNOT increase in said situation.

    Btw, that’s the point made by Krugman during the Clinton boom, when the American economy was near full employment. Clinton claimed his export-promoting trips abroad would serve to “create jobs” for Americans. Krugman countered that said trips could only create jobs in the export sector at the cost of destroying the same number of jobs in the sectors producing for the domestic market. The net creation of jobs would have to be zero, since the economy was already at full employment.

    Clinton probably didn’t like it. But Krugman was – simply and unimpeachably – right.

  12. vimothy says

    Your case has a multiplier of one. That’s what it means to say that when the government spends, GDP increases by the same amount: dY/dG = 1. (Simply assuming that the economy is below capacity will not get you there, incidentally. It is an additional assumption.)

  13. Jose Guilherme says

    My case doesn’t even consider possible multiplier effects.

    The government spends one dollar, commands services produced by previously idle producers and GDP increases by one dollar, immediatly. What happens next – after the producers receive that one extra dollar of income – need not concern us here.

    The only assumption we need is that the economy be below full employment of resources.

    However, if an economy is at full employment there are no idle producers available to offer extra goods and services for bidders. In such situation, the government can only spend by forcing someone else in the economy to “not spend”. That will likely mean bidding for resources at a price higher than the prevailing one, generating an increase in the price level.

    With full emloyment, there are no free lunches available for anyone. :)

  14. vimothy says

    I don’t think we need to worry about “operations” here, we can say this in much simpler language: the fiscal multiplier is greater than one. (The fiscal multiplier is the ratio of a change in income to the change in government spending that caused it.)

    That multiplier is invariant to the source of government financing. If the fiscal multiplier is one, then however the government takes hold of the resources, it’s exactly offset by the increase in resources available to the economy.

    In your example, the multiplier is greater than or equal to one. The government can send some money and it will cause national income to grow by at least an equivalent amount. Then the government can either borrow (your example) or tax (equivalent counterfactual case) that increase. Any net increase over and above that is pure stimulus.

    None of that contradicts what I’ve said, as far as I can see. It’s not pulling those resources out of thin air. It’s either borrowing them or it’s appropriating them outright. If it’s the former, then the expected marginal effect on the price of borrowing resources (i.e. the _real_ interest rate) should be positive, other things equal.

  15. Jose Guilherme says

    “”It’s hard to keep track of these threads!

    Let’s assume arguendo the best, most restrictive case from your point of view: Say that there are idle resources that the government can put to use on some project”.

    Say U.S. spas are idle because of lack of demand.

    The government (worried about the recession and also its possible effects on the general health condition of citizens) deficit spends $3 bilion ($10 per American citizen) on Spa vouchers mailed to the population – that the receiveing Spas may later on exchange for U.S. dollars.

    The government goes to the markets for financing. Institutional investors buy $3 billion in bonds, paying for them with their bank deposits.

    Then, after the vouchers are spent the Spas see their bank deposits increase by the very same $3 billion.

    The final results of this operation will be the following.

    Net creation of bank deposits for the private sector: zero (decrease for investors exactly matched by increase for Spas).

    Net creation of Financial assets for the private sector: $3 billion in T bonds.

    Net increase in U.S. GDP (abstracting for possible multiplier effects): $3 billion in “Spa services”.

    Previously idle spa resources have been deficit spent into the economy.

    Everybody’s happy (Spa consumers and Spa employees: the government, who’s just improved the health of the population; and the new bondholders, who freely chose to exchange their deposits for U.S. securities).

    And no one lost anything in the process :)

  16. vimothy says

    It’s hard to keep track of these threads!

    Let’s assume arguendo the best, most restrictive case from your point of view: Say that there are idle resources that the government can put to use on some project. Say that this project _only_ requires idle resources (the project organises itself, so there’s no administration or management needed; the only capital used is idle capital, etc, etc). Finally, say that the output produced by the project is strictly positive, so that the net effect on real income is strictly positive. Great!

    But it doesn’t turn over basic facts about consistency. Where did the resources for this project come from? Wherever it was, they came from somewhere. The government can either pay for these resources by taxing a now greater aggregate income, or borrowing from it.

  17. Jose Guilherme says

    The opportunity cost of resources that are idle because of lack of demand for them is effectively zero.

    The government wiil exchange a bond for a bank deposit of the private sector. Then it wiil spend that deposit to command the use of idle resources. The beneficiaries wil gain a deposit in exchange for the goods and/or services that they will sell.

    Net cost of the whole operation in real economic terms: zero.

  18. Oilfield Trash says


    I almost fell out of my chair on the reported Kochs brother quote “Focusing on [the debt ceiling] makes the messaging more difficult.””

    This caught my eye,

    “The reason that was significant isn’t so much that it would affect bond yields (the Fed has been keeping a lid on them of late) but that the possibility of a downgrade by a second rating agency could widen repo haircuts on Treasuries and government guaranteed bonds, and the effects would ripple through the entire financial system.”