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The Public Money Monopoly (Pt. I) – New Economic PerspectivesNew Economic Perspectives
In which Dan K disagrees with MMR.
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TheMoneyIllusion » But what type of fiscal stimulus?
“Inflation is higher than NK models predict, and doesn’t seem to be falling. In addition, after dropping the ball in 2009, the Fed seems committed to keeping inflation expectations from falling very far below 2%. “
How in the world can anyone ignore the link between oil prices and inflation?
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Mike Norman Economics: Bill Gross smoked again??
I had forgotten gross backed up the Truck on treasuries a few months back. Unlike Cullen.
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I have said over and over again Ireland is the weak point in the Eurozone. Ireland is the most likely to leave, because they are getting ripped of the worst.
Ireland was toasted as a massive success prior to the crisis. It’s austerity programs are harsh, and the slight up tick in growth it had for 6 months was pointed at as proof austerity works by nearly every right wing economist on the planet.
But Ireland’s economy is terrible, and will be for a generation. I just hope they don’t go back to burning peat as a fuel and heat source. I could easily see Ireland leaving over the course of a weekend. Also, Philip Pilkington is a must read in general.
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ZNH12 | Commodity Futures Price Chart for 10-Year T-Note March 2012
Yields Getting crushed in U.S. Treasuries
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A Conversation with Peter Thiel – The American Interest Magazine
Peter Thiel Interview
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Why I Am Leaving Goldman Sachs – NYTimes.com
Dude flips a bird to Goldman Sachs, after making a fortune
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A Simple Technique to Turn Yourself Into a Genius | Mother Jones
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Speculators might be in for a crude awakening – Macrobits by Marshall Auerback
Posted from Diigo. The rest of my favorite links are here.
In which Dan K disagrees with MMR.
Yeah, except the whole piece is a defense of the claim that the government is a monopoly issuer of the currency and monopoly supplier of new financial assets, and that bank money consists in IOU’s for the government’s money. But other than that!
In practical terms I don’t think it makes a difference. The govt may have a paper monopoly on the issuance of currency and new financial assets but the banks long ago bent the govt to its will.
More than “bent to its will”. More like bent over for a tight ankle grab. For a so-called “monopolist” the govt sure knows how to get screwed by a sector that supposedly quivers in fear over “monopoly” power!! :-0
No quivering in fear. The government monopoly view just explains why governments have powers that banks don’t have to expand the total net quantity of financial assets, and why the government can run what I call in the post a “pure deficit” as opposed to the mere “financial deficits” that private sector households, firms, banks, etc. can run. The unified government sector as a whole has it within its power to spend more than it receives without accumulating debt.
We’re all on the same page there. I just think you guys understate the powers and reality of the horizontal in referencing “leverage” of horizontal or the monopolist in an attempt to create a relationship that isn’t as tight as you might wish. For instance, I am starting a new business and I took out a sizable line of credit. I have SUBSTANTIAL new spending power. It didn’t come from the govt. Its creation wasn’t constrained by reserves. The bank didn’t “leverage” it up as Wray says. But I have substantial spending power I can unload into the economy on command if I want. Granted, I have to then acquire income to pay it back, but that doesn’t mean that new purchasing power isn’t there or that it should be downplayed. And it certainly doesn’t mean the bank “got” the money from somewhere. Perspective is everything in this discussion.
Now, is it a ponzi scheme? To some extent because there’s only so much debt an economy can handle, but over the long-term the system has proven quite stable so long as the govt doesn’t let debt binges get out of control (which I think we’d agree it can do via deficits and regulation).
I don’t even think we’re really far off in this position except that our emphasis is a little different. You guys want to bring it back to the govt and we want to bring it back to the real economy and the banking system with an understanding that govt serves a facilitating role and not a central role….Some might even call the whole debate semantics….
Anyhow Dan, I really did enjoy the piece even though I disagree with parts so thanks for taking the time to write it!
Thanks Cullen. It’s good to see that there are still major areas of agreement.
Dan: The government is not a monopoly supplier of financial assets. The government is a monopoly supplier of NET financial assets but only with respect to the non-government sector. It’s not a monopoly supplier of NET financial assets for the domestic private sector, which can also hold net foreign assets, if it chooses to.
Super-point!
Sorry I typoed “new” instead of “net” in the comment above, but I used net everywhere in my NEP post.
This seems to be well-traveled ground now. The government is the monopoly supplier of net financial assets to the non-government sector, but obviously one part of that sector can supply assets to another part of that sector. If you and I start out with no financial assets and no financial liabilities, and I give you an IOU for $1000, then the vimothy sector now has net financial assets of $1000 while the Kervick sector has net financial liabilities of $1000, while the vimothy+Kervick sector has experienced no net change in its financial assets. You can divide a sector into as many sub-sectors as you want and point out that there are many different ways for for the various subsectors to accumulate various combinations of positive and negative financial asset balances while the sector as a whole accumulates no change, or even loses net financial assets.
As always, let’s not forget that there are NON-financial assets and these are the things that drive the economy, our will to hold money, and tend to securitize much of our bond portfolio.
The fact that loans net to zero is heavily muted by the fact that a factory exists where it once did not, is contractually attached to the mortgage (horizontal money), and will provide people with things they want/need in the real world.
A productive underpinning to the horizontal money can/should allow the economy to function on far-fewer NFA’s than an MMTer would have you believe for far longer than you might think betting on deflation as a result of a NFA drain.
I’m not sure what MMT in general would have one believe about what the total quantity of financial assets in the economy should be. But my intuitions suggest to me that in line with the usual monetary policy goal of price stability, NFAs should be increasing roughly in line with the rate of economic growth. As those factories are built and expanded and higher volumes of goods and services are produced, the financialization of the growth in real product needs to keep up with that growth. Then the only question is whether to take a more free market approach in which NFAs are only passively provided by the CB through the bank reserves channel in response to private sector bank lending decisions based on private sector production decisions, or whether we need the government to be more aggressive by pushing NFA’s into household and business banks accounts directly through the fiscal channel, either through “helicopter drops”, or by acting as an employer or consumer of last resort.
I come down on the latter side for Keynesian reasons, because I think the private sector just can’t deliver optimal performance on it’s own, and has a chronic tendency to settle into more-or-less stable equilibria of underperformance and underemployment, and it can get itself into self-destructive cycles where it’s cost-cutting on the labor side shrinks the disposable income of its own consumers and makes its aggregate situation even worse. Private sector creativity and entrepreneurialism needs to be supplemented by deliberate public investment and initiative to restore full employment and consumer income when the private sector drops the ball.
There is also a tradition going back to at least the time of David Hume according to which the government provision of money to the economy should actually run ahead of growth, not just respond to it, and maintain a moderate inflation at all times. Hume wrote:
… we may conclude, that it is of no manner of consequence, with regard to the domestic happiness of a state, whether money be in a greater or less quantity. The good policy of the magistrate consists only in keeping it, if possible, still encreasing; because, by that means, he keeps alive a spirit of industry in the nation, and encreases the stock of labour, in which consists all real power and riches. A nation, whose money decreases, is actually, at that time, weaker and more miserable than another nation, which possesses no more money, but is on the encreasing hand. This will be easily accounted for, if we consider, that the alterations in the quantity of money, either on one side or the other, are not immediately attended with proportionable alterations in the price of commodities. There is always an interval before matters be adjusted to their new situation; and this interval is as pernicious to industry, when gold and silver are diminishing, as it is advantageous when these metals are encreasing. The workman has not the same employment from the manufacturer and merchant; though he pays the same price for every thing in the market. The farmer cannot dispose of his corn and cattle; though he must pay the same rent to his landlord. The poverty, and beggary, and sloth, which must ensue, are easily foreseen.
Hume was writing in a time when gold was the foundation of the monetary system and international trade. But now we’re on the dollar standard, not a gold standard. So the magistrate’s role is not to keep the economy’s quantity of gold and silver “still encreasing” but to do the same with whatever happens to be the foundation of our monetary system – in our era just fiat dollars.
Where I disagree with the market monetarists is that they have way to much faith, I think, in the ability of the central bank alone to accomplish these things through its management of the reserves system and alleged influence on inflation expectations. I think we need the government to spend money into the economy more actively through its fiscal arms.
Dan, That’s right–so the ability to monopoly supply “net financial assets” is a function of the arbitrary way you’ve partitioned the economy into a government and a non-government. As you note, you could say with just as much validity that Dan Kervick is the monopoly supplier of NFA for the non-Dan Kervick sector.
The household sector, which is the proper unit of analysis here, doesn’t need the government to supply NFA. It can also get them from the foreign sector. Indeed, the government doesn’t add to national net wealth by supplying bonds to households, although it can add to national wealth by undertaking public investment, financed by bond issuance.
Me, Dan?
“Dan, That’s right–so the ability to monopoly supply “net financial assets” is a function of the arbitrary way you’ve partitioned the economy into a government and a non-government.”
Another good point. It is completely counterproductive to consolidate the domestic private sector and the foreign sector.
Except a deficit by any sector in the domestic private or external sectors is a very different matter from a deficit at the Fed. All currency users can only run deficits by diminishing their stock of financial assets or by adding to their stock of financial liabilities. So their net financial assets must go down. The currency issuer has no financial constraint and no finite “stock” of net financial assets, and so can run a pure deficit that does not run those net financial assets down in any meaningful way. The distinction between the currency issuer and the currency user is not arbitrary.
The Fed doesn’t run deficits!
The Fed is a central bank.
Vimothy is right. The Fed does not run deficits.
You further say that there are financial constraints bla bla but MMTers completely fail to understand the “balance of payments constraint” though its a topic for another day. It’s misleading – just wanted to point out.
You further claim “All currency users can only run deficits by diminishing their stock of financial assets or by adding to their stock of financial liabilities. So their net financial assets must go down.”. I note the word “only” and hence the statement is incorrect. This is because I can run a deficit and still have my net financial assets go up because of revaluation gains!
Too much of the usage of “impossible”, “only”, “is” etc.
And from the point of view of a stock-flow consistent model of the macroeconomy, it is incoherent to say that the government does not have a “financial” constraint. Every agent must have a budget constraint that says something like,
Resources used = resources acquired
Otherwise, you lose stock-flow consistency.
I guess it’s okay Vimothy. In the mathematical sense they are constraints – as in equations need to be satisfied, obeyed but in another sense of the phrase constraint – it’s not in many situations such as it being a behavioural constraint.
R., I’ve come round to the belief that it’s not okay. The government must finance its expenditure. Whether that financing takes the form of seigniorage, tax revenue or bond issuance, the fact remains that something must happen to satisfy the identity,
Resources used = resources acquired
This does not happen automatically or in a vacuum.
I’d say that since there is often economic potential going not being used in our country, a government that recognizes that and builds its monetary/fiscal policy around attempting to cure that ill of a purely free market economy is where the term Net Asset can come from when looking at a piece of paper.
Like I said… there’s a liability there… but it’s not a financial one, it’s a functional one.
Jeez that was horribly written… hope you get the gist… the government can facilitate the creation of real wealth, and sometimes create it itself outright. If it deos that in the right ways at the right times, there’s real value there.
It’s that unused potential of our economy that gives purely paper assets printed by gov’t net-value.
V,
Yeah but MMTers tend to say that it is an ex-post constraint not ex-ante which is fair. Which is fair.
The government is a powerful sector in the “money-creation” game loosely speaking so the government’s fiscal stance can be reasonably taken as exogenous in many circumstances – though it may have to give in and become endogenous in other circumstances.
The usage of the phrase constraint gives one the false analogy with the predicament of an individual trying to borrow.
Ramanan,
In a sense it’s fair and in a sense it’s not. I understand where MMTers are coming from but I think on balance that it’s not a helpful way to think about things. Perhaps we’re unlikely to agree about this, given our different backgrounds / approaches.
In the form that I gave the budget identity,
Resources used = resources acquired
The constraint is binding at all times, ex ante and ex post.
Vimothy,
It’s a minor point anyway. I do not prefer to phrase it that way anyway! (“does not face a financial constraint”)
Ramanan,
Agreed.
I remember reading the Fiebiger paper and thinking that MMT makes a lot of ought-type statements about the monetary system, which then get confused with is-type statements about the monetary system. I think that this is another one of those cases. The government is not like a household. But the government does face a budget constraint–its own particular budget constraint–, just like everyone else in the economy.
PS: Saturday Quiz again !
“Stock of government spending”…?
Stock of government spending was intentionally badly phrased I guess.
But its about Q1! Same confusion of saving and saving net of investment. In particular “these balances”.
Couple of commenters happy about 5/5!
Dan,
Some more thoughts re your article at NEP.
You write,
“The basic idea is that the government augments and diminishes the amount of money in circulation during some period of time whenever the monetary payments it makes to the non-governmental sectors of the economy exceed its monetary receipts from the non-governmental sectors of the economy.”
This is false.
HPM has one source and one source only: the central bank. How do I know this? HPM is a central bank liability. Nothing the treasury does by itself increases or decreases the stock of HPM held by the public because…. HPM is a central bank liability.
When the government spends, as a general rule, no one ends up with any new HPM. When the government deficit spends, as a general rule, no one ends up with any new HPM either. What they end up with in the event of deficit spending is government bonds.
I think the idea that the government possess an “infinite amount” of currency could also do with some work. In principle the central bank could issue an infinite amount of currency. It will never do this in practice, for obvious reasons. Similarly, Apple, say, could in principle issue an infinite amount of Apple stock. It will never do this in practice either, for reasons that are equally obvious.
You call a money financed deficit a “pure deficit”. It is true that the government can (again, in principle) finance its deficits by issuing currency (i.e., have the CB issue currency). However, the ability of the government to finance its net expenditure in this fashion is limited by the fact that people don’t really want to hold vast quantities of notes and coin, and by the fact that attempting to finance deficit spending with money creation is highly inflationary.
Money financed deficit spending would not diminish any stocks of money: by definition, stocks of money held publicly would increase, or, equivalently, CB liabilities would increase, to the tune of whatever that level of net spending implies.
Debt would not increase, but you still need people to want to hold that paper. Either that or you need to pay the banking system to hold reserves, in which case, the deficit is not really money financed.
Your analysis of people wanting to save via bonds instead of notes & coin is valid, but should be analyzed more. The whole idea of being paid interest for your savings implies that someone is borrowing it. Someone is probably borrowing it due to wanting to invest in an expanding economy, thereby increasing production.
Right now, we have low demand for new loans becuase the demand just isn’t there. People have no choice but to save in notes/coin unless they want to spend, or earn very, very meager interest as they “chase” after all the borrowers. But we’re WAY under capacity in our factories so if they DO decide to spend it, you’re not likely to see much inflation.
So your point about “funding deficits with printing” only holds true if we’re at/near full capacity and we have more money chasing fewer goods, and people aren’t getting paid enough by gov’t to hold their dollars in the savings account that is the treasury market.
Sorry Dan, both comments were meant to be addressed to Dan Kervick.
“HPM is a central bank liability.”
I argued against that in the essay, vimothy. I understand that that is how HPM creation is officially entered on the Fed books. But I argued that we should regard that practice as an obsolete accounting convention that misrepresents economic reality. There is no genuine “liability” – i.e. a debt or promise of future payment that represents negative value to its owner – associated with Fed money issue.
I recognized the fact in the essay that the constraint on money creation is the policy constraint of price stability and that for that reason the CB wouldn’t want to create money endlessly, since certainly at some point an overly large pure deficit becomes inflationary. But what I argued is that there is no financing constraint on money creation. By creating money the Fed is not incurring “liabilities” that it must make good on by acquiring more assets. So long as monetary expansion is not causing the price level to go haywire, it doesn’t matter how big the currency in circulation “liability” is.
The Fed and the consolidated government do have genuine liabilities that have to be taken into account. Commitments of interest payments on debt have to be made by law, and to preserve the integrity of the government and the financial system. And these commitments mean a commitment of further future injections of money. But a dollar in circulation is not an interest-bearing bond and thus not a commitment to an interest payment.
I tend to figure that the only way the government can simply “print” an asset is that it can create a more stable system of consumption, and therefore investment, and therefore total wealth. A factory is only as valuable as the widgets that are demanded out of it, so a stabilizer like NFA’s does create said asset, but I think there is a liability there… just not a very obvious one.
If the asset that NFA represents is the ability to consume when we are under productive capacity, then I think the liability there is the work a government has to do to create an environment where productive capcity, investment, and wealth can grow. Tossing more NFA’s won’t do anything to help us if we’re part of a corrupt government system, or one that doesn’t properly set the rules of competition.
So there’s a liability in there somewhere… just not one on the same plain as a liability of a currency user.
I don’t really disagree with that Dan M. The government produces a tremendously valuable quantity of real goods an services all the time – just to take one example, the entire law enforcement system that keeps our society generally safe from predators so that we can live and prosper. And there are a tremendous number of real costs involved in producing those goods and services. So it’s no free lunch. Don’t know whether I would count the costs of fulfilling its public mission as a liability of government, exactly – but I don’t want to quibble about that.
However, one of those goods and services is the monetary system, which I think of as a public utility. There are times – maybe most or all of the time – when the public good is enhanced by either a sharp or gradual increase in the active generation of net financial assets. My assumption is that in such times the marginal real cost to the government of producing an additional dollar of net financial assets is almost always less than the marginal real value gained by the production of that dollar. However, if the pace of NFA creation were pushing up against serious price instability, then the cost would exceed the benefit.
Agreed with everything you said.
Regarding your “free lunch” comment, I’m amazed by the number of deficit hawks & Austrians who claim that someone getting up at 6:00 A.M. and going to build something like a bridge or a park (or, if in the private sector, a home or widget), and going home at 6:00 at the end of a hard day’s work, is trying to claim a FREE LUNCH because paper had to be pushed into the economy to make it happen, and there’s a record somewhere that shows how much of that paper exists, and at the top of that Ledger it says: “Liability.”
Dan:
Whether or not base money(HPM in Randy’s vocabulary) is a genuine liability or “only” accounting liability is irrelevant for Vimothy’s point that, in general, government spending funded by bond issuance results in more bonds held by the private sector with both credit money(“horizontal”) and base money levels unchanged.
As I wrote elsewhere:
The net result of government spending would be person A holding a bond, person B holding horizontal money that person A used to hold assuming all the proceeds from the bond sale went to B. The amount of base money in the “system” is unchanged and its role is completely hidden from the observer.
That’s not true if bond sales are debt financed or simply taken on the books by a bank.
The Fed then buys some of those bonds, Госбанк. So you get something like the following:
1. Treasury sells $1000 bond to private dealer for $950.
2. Dealer sells bond to Fed for $975
3. Treasury pays Fed $1000 at bond maturity
4. Fed returns $50 interest payment to Treasury.
So, we get:
Total net impact on Treasury balance sheet:
$950 – $1000 + $50 = $0
Total net impact on Fed balance sheet:
-$975 + $1000 – $50 = -$25
Total net impact on dealer balance sheet:
-$950 + $975 = $25
The private sector just increased its net financial assets by $25. That increase was “offset”, so to speak, by a $25 dollar liability charged against the Fed’s infinite money well. The Fed doesn’t have to pay $25, or get $25 in assets in consequence of that so-called liability. It can run up it’s bar tab at its own bar until hell freezes over. There is no leg-breaker who comes to collect.
I could tell another story about how the Treasury, by rolling over current debt held by the Fed with greater debt held by the Fed, through the private sector dealer intermediaries, doesn’t just get a $0 impact to it’s balance sheet but a constant net addition in fiscal period after fiscal period, that is spent out into the private sector as the Fed keeps going deeper into the (meaningless) red to fund it. But it takes a little longer to fit.
Dan, I am sorry to say that, but your description is rather absurd.
The dealer buys bonds at an auction with competitive bidding at a price close to $1000, turns around and sells immediately at the secondary market at a price close to $1000. Usually, 60% of the PD inventory is gone during the very auction week.
When the feds wish to buy some bonds for whatever reason, the PD, as a rule, do not have on hand the amount needed, they have to procure the required amount at the secondary market. They it do not keep the new issues in some secret drawer, as a result of some collusion between the feds and the treasury as you seem to imply.
The PD are motivated purely by profits, they have to turn around the bond inventory as soon as possible — they make money on the bid-ask spread as any non-PD dealer would. They do not buy a bunch of bonds, stash them away and sit and think “Oh, maybe the feds will come some day and buy them”.
There is a bid-ask spread right? They aim to sell the bond to the Fed at a profit, right? So aren’t you just being pedantic about the dummy numbers I used for ease of calculation and not challenging the point they were used to make? The sequence of exchanges among Treasury, the dealers and the Fed leads to a net increase for the dealers. If it didn’t they wouldn’t be in the market. It doesn’t matter whether the margin is 1 cent per thousand dollars or $50 dollars per thousand dollars.
And what collusion? The scenario I described has nothing to do with any cooperation between the Fed and Treasury. It doesn’t matter whether the Fed and Treasury never have anything to do with each other and all the Fed is trying to do is trying to manage interest rates. All that matters is that the whole existence of these Treasury markets depends on the ability of the PDs to make a profit, and when they succeed in doing so the net financial assets of the non-government sector increase.
What is a “debt-financed bond sale” ? More interestingly, what is “simply taken on the books by a bank” ?
None of the above seems to make any sense.
If a bank “takes a bond on the books”, it loses an equal amount of reserves/base money assuming a purchase at a treasury auction. It may do that for various reasons. What it cannot do is to “simply take it on the books”, because no one will let it do that unless the bank pays for the bond, presumably to the treasury.
Госбанк:
I was referring to your point that deficit spending is just a transfer of money from Person A to B, such that the money supply (ie deposits) doesn’t change. I realize you were driving to the impact on base money, but your statement also implied deposits wouldn’t change as well.
See http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1825303 and table 3 here http://www.boeckler.de/pdf/v_2011_10_27_lavoie.pdf .
From the first paper: “(Indeed, one could go further and note that the deposits of the primary dealers used to purchase the Treasury security were themselves likely created by previous borrowing in the repurchase agreement markets (that is, primary dealers often add to their assets such as Treasury securities with funds borrowed by using their existing assets as collateral), while the Treasury security will very likely serve as collateral for further credit creation in these markets. So, far from being less stimulative or “crowding out,” the Treasury may in fact be the catalyst for more credit creation than would occur in its absence.)
That government deficits raise deposits even when Treasury securities are issued is if anything even more obvious where banks purchase them rather than primary dealers or other non-bank investors. Figure 3 presents a SAM for Treasury debt operations in the case of banks purchasing the Treasuries. As seen in row 5, the summation of the columns leaves banks holding Treasuries and the recipients of government spending holding deposits, with obviously no exchange of primary dealer deposits for Treasuries.”
Marriner Eccles makes some interesting comments along these lines: (http://monetaryrealism.com/marriner-eccles-explains-it-all/)
“Money is created by debt—either private or public debt—and to the extent that the banking system creates deposits through the purchase of Government securities or through the lending of money, either way, it is a process of monetization. You monetize private debt, but there can be no objection to that so long as the debt that is created is increasing production and employment. There may be such a thing as private debt that is purely speculative, such as the stock market, or real estate or other operations which are creating no employment and creating no production. It certainly is not a very desirable situation to have money created through that form of debt.”
Table 3 is on page 18 btw.
They aim to sell to the highest bidder, not to the feds specifically. And, no, I am not being pedantic because you hypothetical is completely unrealistic as to the numbers magnitude and thus the purported ever present opportunity to generate free cash for the treasury in your hypothetical.
And, oh, Dan, your arithmetic is wrong too. Assuming, the nonsensical numbers above, you miss the step in which the treasury pays the feds $50 in interest (which you imply the feds never gets and just fakes back to the treasury).
So, step 2a: the treasury pays the feds $50 interest
So, we get :
Total net impact on Treasury balance sheet:
$950-$1000-$50+$50 = -$50
Total net impact on Fed balance sheet:
-$975 + $1000 – $50+$50 = $25
And the dealer is $25 richer.
Sorry, but you are wrong. For ease of exposition, I was assuming a zero coupon bond. The scenario was that it was a thousand dollar face value bond with a $950 price. So the interest payment is the $50 above the price that was included in the $1000 payment to the Fed at maturity. That’s the $50 that the Fed returned to Treasury. But if you want to switch to a more realistic case of a bond with coupon payments, fine. Then you need to add those coupon payments in in both places, first as interest paid to the Fed, then as part of the amount paid back to the Treasury, which will then be $100.
Total net impact on Treasury balance sheet:
$950-$1000-$50+$100 = $0
Total net impact on Fed balance sheet:
-$975 + $1000 + $50 – $100 = -$25
It doesn’t matter how big the coupon payments are if the Fed owns the bond. They are all paid by Treasury to the Fed and then sent by the Fed back to the Treasury.
“The net result of government spending would be person A holding a bond, person B holding horizontal money that person A used to hold assuming all the proceeds from the bond sale went to B. The amount of base money in the “system” is unchanged and its role is completely hidden from the observer.”
Exactly.
As Госбанк correctly notes, whether you want to call base money a “true” liability of the central bank is irrelevant to the point I am making, which is that the central bank issues base money. Base money does not increase as a direct function of government spending. This is a point which is so basic it’s hard to see how there can be any disagreement.
MMT has to create a 1:1 relationship between the base and horizontal in order to rationalize their monopolist argument. Of course, it breaks down once you understand that horizontal money is created entirely independent of govt and reserves don’t get multiplied so instead MMT uses obscure language and says things like the banks “leverage” govt money. Or they create the hierarchy to create a very tight relationship where there isn’t one. It’s all wrong and intended to give the reader the impression that the govt is steering the ship when the reality is that the banks steer the ship in our modern monetary system. The govt could theoretically impose its will on the banks and take full control of the system, but they don’t. Hell, not even the Fed is directly intervening in setting interest rates. They set a target rate and implement silly policies like QE which don’t even focus on price, but are based on competitive bidding…..
I think that unfortunately the MMT consolidation of central bank and treasury functions serves mostly to confuse people as to their actual functions in practice.
If we KNOW that the fed won’t let a treasury auction fail, I think it’s safe to describe to layman how spending is printing money and QE operations just adjust the amount of government-issued savings instruments they have in circulation.
I think that by-far the bigger mis-statement was the way everyone else was describing it, calling QE a “helecopter drop” and deficit spending as “expanding our national debt to unsustainable levels.”
The treasury and fed basically work so hand-in-hand that looking at them as separate entities and their functiions as wholly seperate, in hindsight, only confused the issue for me more.
The consolidation doesn’t bother me so much since it’s really a semantic point in my mind. The Fed and Tsy are the same entity for all intents and purposes. If you understand their operations you can see this is pretty obvious. It’s the connection between the govt and banking system that is a real problem spot for me. MMT tries to have it both ways by using the word leverage to describe how banks use state money. But then they reject the money multiplier at the same time. The word leverage has a very specific meaning in finance and economics. It doesn’t apply to that dynamic in any way. But MMT has to create a relationship where there is none or else the monopolist argument is diminished.
You could actually argue that, in many ways, such as the one you’re referring to, MMT has created an alternate system with one vertical level (consolidated Fed, Tsy and national banking system) in order to rationalize state control of money. It all ends in a specific set of policy ideas, which to me, is why MMT is a policy agenda and not a macro explanation of the system.
Cullen,
It seems to me that the consolidation is the source of the error which causes Dan Kervick to come to the conclusion that when the government spends or net spends, the private sector ends up with more base money. In fact, reading comments at MMT blogs, it seems that lots of people are confused about this.
Vimothy, when you say “base money,” as most modern economics does, you mean, reserves, coins, notes, etc… but since treasury bonds are so incredibly similar to base money, does it do us much good to use that term in terms of describing whether we’re expanding the vertical money (which includes treasury bonds) within our economy? The term “base money” is completely misleading, because people will look at the increase in M1 and be terrified, when they don’t see the huge amount of ultra-liquid treasury bonds that are super similar to M1 were destroyed.
I guess we’re arguing this in two posts, but it’s incredibly obvious that the fed & treasury are joined at the hip in their operations… this is why treasury bonds are viewed as so risk-free and liquid.
Dan M.,
I’m a big believer in using words in a consistent way.
Base money is defined as notes and coin plus bank reserves. There might be situations in which treasuries function as “money”, as Mike has noted in an interesting thread elsewhere on this site, but that does not make treasuries base money.
In general, if you set out with equivocation as your goal you end up with confusion and little good comes of it.
Ok, I can appreciate that… but it’s pretty irrelevent in terms of operations if you take a step back and realize that the fed will NEVER let a bond auction fail. Heck, the market would look at treasury bonds in a COMPLETELY different way if they would do that.
So, yes, the only entity that on their own can increase the amount of base money is the fed. But when the treasury spends money, and the fed is both explicitly and implicitly tasked with obliging that spending, the fed is basically a puppet of the treasury & congress in the sense that it’s NOT going to hold back their spending.
So in that sense, and we see the market reinforce this every day, treasury bonds are basically as liquid as cash, and as safe on the short end of the curve. So while you would insist that base money should be kept to reserves, notes & coins, I’d say fine, but then your statement is almost irrelevant, because when taken in context of the full operational picture “base money” can play little/no role on the monetary movements of the economy. See 2008/9 when M1 expanded massively.
It seems to me that the consolidation is the source of the error which causes Dan Kervick to come to the conclusion that when the government spends or net spends, the private sector ends up with more base money.
And yes, I think that is right as long as we look at all of the government’s payments and receipts combined, including borrowings, interest payments and the rest, whether conducted by the Treasury or the CB. If you just look at Fed, or just look at Treasury, you can get the wrong calculation for the total change in NFA’s in the non-government sector.
I agree that if the Fed were somehow to stand completely aside from Treasury operations, and never buy a single treasury bond, then under existing laws the Treasury would be functioning pretty much just like any other currency user. But that isn’t the way it works. The Fed buys up lots of Treasury issues as part of its conventional open market interest rate management operations. And then it sometimes buys up a whole bunch of additional Treasury issues as part of so-called unconventional operations to push rates down even further, adjust the yield curve, etc. The result is that the political branches – Treasury + Congress – can be the instigators of monetary expansion, since Fed will generally have to accommodate their decisions to hit its rate target. On average, if Treasury issues more debt, Fed will buy more debt. If Treasury decreases its rate of debt issue, then Fed will buy less debt.
I think Cullen is right. For all the talk of “independence” between these two agencies, it’s really one combined operations.
My only question is whether we are well-served by a system that effectively requires the government to send arbitrage profits to middle-men in order to fund its operations. If the Treasury were permitted to borrow at least some portion of its funds from the Fed directly, then the end result would be that the same total quantity of NFAs would be created, but more of them would be distributed through the Treasury spending channel, rather than through the bond dealing channel.
Dan,
I think you raise an important point here.
“My only question is whether we are well-served by a system that effectively requires the government to send arbitrage profits to middle-men in order to fund its operations.”
I think the argument for bank nationalization or one vertical component where banks are not private profit motivated entities makes some sense. There’s a clear conflict of interest in being able to use govt money (which exists for public purpose) the way banks do while also generating private profit (which often doesn’t serve public purpose). I don’t have the right answer to this question. I don’t know if a nationalized banking system would serve us better. Personally, I prefer to lean towards greater regulation because of this uncertainty. I think we can reduce the risks in the banking system which will help banks maintain their interests in-line with public purpose.
But what we don’t have is a “money monopoly”. We have private banks with ENORMOUS control over price and quantity of money. Whether one thinks that is a problem is up for debate. But this is what we have and what I am focusing my work on right now is describing how the system works. Not what we want. After all, we can’t fix what we don’t even understand.
Dan,
Even if you consolidate the government and central bank, the consolidated government does not issue money when it spends.
“On average, if Treasury issues more debt, Fed will buy more debt. If Treasury decreases its rate of debt issue, then Fed will buy less debt.”
The Fed issuing money doesn’t really have anything to do with the treasury issuing debt. On another thread I linked to a series for US base money at FRED. I’m sure you could find it easily enough if you want. The pre-GFC graph is smoothly continuous with a modest positive linear slope. In other words, it has a constant first order derivative. In other words, the rate of money issuance in the US doesn’t ever change.
Yes.
Also, starting from a consolidated fed/treasury operations example can help people imagine the extreme and then back into the current situation, and when looked at close enough, as you said, it’s basically like the Treasury & Fed are in complete lockstep. Since the fed will never let a treasury auction fail, treasuries are basically forms of money that spit out interest, especially on the short end. Of course, if the fed was set up to be an inflation hawk and let treasury auctions fail, we’d be having a different conversation.
With something as potentially confusing as sovereign fiat currency, it helps to first imagine how the system is set up to run, and how it has been shown to run, rather than jumping to wild “monopolist” conclusions about what the gov’t COULD do if it WANTED to by pointing a gun at banks, taxpayers, etc, or what the fed COULD do if it let auctions fail.
We can always talk about weaknesses or potential corruption or a failure of the system to run as designed, but starting at that point is never going to yield much understanding.
you are wrong
Good point
Dan, both of us don’t know arithmetic !
1. Assume a zero-coupon.
Dealer gets richer by $25.
Treasury: -$1000+$950+$25(from the feds) = -$25
Feds: $1000-$975-$25(profit to the treasury) = $0
2. Assume a bond:
Dealer: as above.
Treasury: -$1000+$950 -$50(coupon) + ($25+50)(from the feds) = -$25
Feds: $1000-$975 + $50(coupon) – ($25+$50) (profit to the treasury) = $0
My main objection is valid: your bond price volatility numbers are unobservable historically. Perhaps in Argentina, but not here so far.
The PDs are irrelavant inasmuch as they are just a conduit for the bonds/cash between the treasury, households, banks, and the feds. We can pretend they do not exist because their existence does not change the flow of cash picture in substance.
Your point about the case when the bank buys a bond at the Treasury Direct auction, say, and the treasury spends thus creating a horizontal matching deposit elsewhere is theoretically correct but statistically insignificant because 1) the banks hold only about 2-3% percent of the gov. debt for liquidity management primarily which means that the conversion between their holding of gov. securities and base cash happens dynamically on a daily basis with little if any raise in deposits. Roughly, say, the banks in aggregate own some quantity of gov. bonds that they shuffle amongst themselves, through repos or in other ways, to manage liquidity. The treasury cannot milk that cushion much but only once, as long as the 3% bond cushion is more or less stable and not growing. The real game takes place in swapping horizontal deposits and occurring amongst households as I indicated earlier.