Oh, please. What you see as junk, somebody else may value, and what you value, somebody else may see as junk. As for “world-destroying,” if there is an externality that is not accounted for in the price of some outlandish, imported tchotchke, then propose a targeted tax to cover it (or a recycling deposit).
Warren, what is so terrible about having 1 spouse stay at home unemployed raising several kids? A nation cannot survive by 100% employment alone, someone actually has to procreate and then raise the children. Warren, were you raised in daycare or by a nanny while both your parents worked? Or did you have a parent that gave up some job or worktime to spend some quality time at home parenting you? Also your children Warren, did they get raised by daycare or a nanny or did you or your spouse stay at home some and not work all the time?
The problem is that most care and household work has no monetary worth ascribed to it, so not doing it (and working somewhere else instead) turns out to be a FINANCIAL benefit just as importing a poor sod to do it for $3/h. More hours are spent doing unpaid household chores, child minding and other voluntary care work than all paid work put together. Before we manage to factor in this work (which will inevitably be to the disadvantage of what is now paid work) the reasons for preferring one over the other, both on a macro and personal level, are clear. It’s something I’d like see more economists address. It’s never even mentioned – just taken for granted.
Oliver, Bill Mitchell has addressed this issue.
these are all political choices. our institutional structure now treats children as expenses rather than investments, with the obvious results.
Absolutely, and before we start trading child default swaps to hedge against ADHS we might want to plan the financialisation of procreation carefully.
Not sure if this is the right forum, but it’s a good point. Haven’t taken the time to look into the detail, but it seems to me up here in Canada we recently changed federal tax rules or maybe it was pension…details details…to have a more progressive view on the the value of being a stay at home mom/dad and adding actual monetary value on the time done for work/ child rearing. All that to say, it’s not impossible for governments to address this, albeit one small step at a time.
Most “progressives” don’t see making life easier on stay at home moms as being a good thing – forcing women out into the workplace (whether they want to be there or not) has been a long time goal of feminism…
Good points Jim.
Far right conservatives are most supportive of women staying at home and not working. There are positive externalities if many (all) women are not in workplace–they can get help from each other the way they did pre-1970s.
Feminism, and Progressive movement, undid this for better or for worse. And they also introduced the unmarried welfare mother (only for worse)
well me thinks you are doing a bit of a pop-culture twist of the feminist movement because it was not about forcing women into work camps it was about empowering women to make choices for themself and changing institutional powers to enable equal opportunity if a woman chose to have a career. True feminism never faulted a woman for choosing to stay home and raise her kids..it just so happens that conservatives (largely of the religous vein) like the thought of that also. The problems lie in the institutional thinking of what is value and of course value today is perceived as something that makes a profit and that’s what the point was about.
Jason M:
Feminist writings are available for everyone to read and make up own mind. Like many Progressive movements, they try to have it both ways–true feminists are like true scottish and their porridge.
problem lies with institutional thinking that all people are the same.
I have had family and friends run into this problem regarding insurance claims. The stay at home spouse – man or woman – who worked themself to the bone raising the kids and handling matters of the home (groceries, clothes washing, house cleaning – etc etc – basically the work of a STAFF of people in some countries) got in a car wreck. They could no longer do all those duties and needed to hire some people to do it for them temporarily until they healed. The insurance companies said they did not do paid work, so they are not getting any money, so the households in some cases collapsed into ruinous destruction – very seriously hurting the children. In some cases the man was the stay at home spouse domestic goddess, so it is gender neutral. I like warren’s policies, We really have to start walking in the shoes of the common man and try to do things from the ground up, this top down approach doesn’t seem to be working. Obama just signed a new bill that will reduce the payroll taxes of employers, but it is not giving a a payroll tax break to the workers, we are destroying our seedcorn. I hope in the future we can find a way to value and compensate this WORK that is being done. What about 8 an hour for stay at home spouses whose only job is to raise kids and shop for groceries and wash clothes and such?
Tom, could you post a link to Bill’s post or are you referring to a scientific paper or book of his? Thanks.
Oliver, I can’t recall offhand where Bill mentions this, but I recall seeing it. If you want to follow up, head over to billy blog and send him a message through Contact (in the right column at the upper left).
“The real question about industrial policy is not whether it should be practiced, but how. Here are three important principles to keep in mind.”
Interesting stuff. I’m a history buff and watching The Pacific on HBO (Spielberg’s Marine Corps version of Band of Brothers) has got me reading more about World War II lately. I just learned that one of the founders of the European Union, Jean Monnet (best known for rebuilding the postwar French economy with Indicative Planning) actually spent a couple of years helping Uncle Sam plan its wartime economy while his homeland was occupied by the Nazis. He also coined FDR’s famous description of the United States as “the Arsenal of Democracy”. http://en.wikipedia.org/wiki/Indicative_planning
If you discount the 20% LaRouche insanity factor (man, does that guy hate the British), this article about Monnet and FDR by a French disciple of Lyndon LaRouche seems to be fairly accurate.
Quoting Monnet’s memoirs : “We [he and his close group of friends] decided to reverse the logic of the financiers, who accommodate needs to existing resources, absurd logic when the needs are those of the survival of the free world: for such an undertaking, one always manages to find the resources”. http://www.schillerinstitute.org/fid_97-01/002-3_monnet.html
well that’s a tough go over there on Huffington Post…I did my best (I am bohemiangrooves on that site) but man, there is much hostility. The labels are killer…are you a bankster? a tea partier? Red stater? It seems the labels preclude any serious discussion about operations and economics. Sad really, also a reason I like coming on this site as the discussions are (98% of the time) informative and polite. Quite refreshing these days!
In your banking analogy, the point at which China moves their deposit from “savings” to “checking” is exactly the point at which mainstream analysis would say “money has been printed”. Because what is happening here is that the Chinese Central Bank has decided not to rollover its Treasury Bond holdings, but demand payment instead. The Fed pays them by creating the checkable deposit ex-nihilo.
Your analogy makes this sound like it’s not a big deal, and maybe it isn’t. That’s what I’m struggling to understand. If it is true, that would mean that T-Bills are pretty close to being money already, so that trading one for the other really doesn’t make that much difference in terms of the inflation this action will or will not produce. In that case, I’d expect T-Bills to be included in some measure of the money supply, such as M2, or M3, but as far as I can tell, they are not. How come?
It may be that I’m still laboring under a Friedmanite “Quantity Theory of Money” paradigm, and that this is part of the problem. I’ve read all of your “Mandatory Readings” already, but I’m still puzzled by this.
As far as I’ve understood, the story re China (and other private or foreign entities) goes something like this: the only way for them to get their hands on T-Bills is by paying for them with their money which by definition has already been created ex nihilo by government. They then get back the exact same amount plus interest once the bill matures. So there is no net change in the system through any of these transactions except for the amount of interest – hence the savings account analogy.
As for not measuring T-Bills as money, I assume this can be traced back to gold standard times in which the amount of money in circulation was more or less predefined. Bonds and money had to net out to zero much the same as all private credit nets to zero, even under a fiat system. Under a (real) gold standard the net creation takes place at the gold mine and government is in debt to this entity to the extent it spends / prints / whatever. T-Bills constitute a real liability that is redeemable in gold with interest. This is where the inter-generational debt argument comes from. Fractional reserve banking under a gold standard is an intermediate step with some fiat features which allow government to influence the amount of money by changing the reserve requirements (as opposed to mining more gold). Arguments with Austrianites usually get stuck somewhere in between these two. Under a pure fiat system the accounting is reversed. Government becomes the paper gold mine and can define the amount of base money in circulation. The gold constraint ceases to exist. Debt issuance become an operational frill because debtor and creditor are on the same level and thus not revenue constrained, so future solvency is a non-issue. The only remaining constraint is inflation.
Too many politically connected people have told me the dollar is truly based on oil, and a yuan revaluation and china in general is such a small issue compared to that.
UBS’s head of Asia-Pacific economics argues that the real global trade imbalance isn’t U.S.-China, it is U.S.-oil. As shown below, current account surpluses from fuel exporting-nations have been a far larger driver of total global trade imbalances coming from emerging markets.
China’s current account surplus (in blue) has been large in recent years, as a percentage of the global economy, but it has been dwarfed by fuel exporters (in green):
money is not based on the gold standard, nixon broke that – now it is based on a Black gold standard, cause that MT900 can’t go vroom vroom without some 🙂 How does the fed print up oil?
How does the fed print up oil?
That’s what the military is for.
Tom! Nailed it!
prices are a function of buyers and sellers coming together. if china’s funds are in their reserve account or their securities account there is no further effect on anything from that. it’s when they, or anyone else, spend those funds that they can drive up prices. and when they sell real goods and services that keeps prices down.
so china just selling to us keeps prices down, and real goods and services flowing from them to us, and them not spending their dollar financial assets means they have no further economic impact.
So, to the extent our ‘debt’ is held abroad, either as dollars or bonds, doesn’t this represent a kind of inter-generational wealth transfer?
In other words — if 30 years from now the foreign sector decides to divest itself of its dollar surplus and demand real goods and services instead, our children’s generation will be forced to sacrifice their own standard of living in order to export real goods and services abroad (assuming an otherwise full employment economy).
Kent, this is a consequence of the present generation having consumed those goods, and foreigners postponing consumption. This is just an exchange of goods in trade, and, yes, it can be intergenerational. The present generation can commit future generations through its present consumption.
first, they have the right to buy from willing sellers at market prices. They can’t ‘demand’ anything.
Second, yes, if they do spend their $ that will represent a transfer of real wealth from us to them. Of course, our fearless leaders would call that a ‘success’ as they are now on a proclaimed effort to ‘double US exports’ to ‘balance trade’ and ‘create jobs.’
Third, we control the foreign funds which exist only as data on the fed’s computer. That means they are vulnerable to a ‘computer virus’ for an extreme example, that resulted in ‘loss of data.’ They are also vulnerable to a lot of other things, if we decided we didn’t want to export. These could include export taxes and other monetary penalties for exporting.
Point is, we hold all the cards. we have the goods and services to consume and they have data on our computer.
Are there any downsides to your policy framework? For example, if the business cycle as we know it is eliminated, and we have a full employment economy all of the time, will this allow inefficient enterprises to limp along far past their useful lifetime? If so, would this imply decreasing productivity for the economy as a whole over time?
In other words, are periodic downturns necessary for the long term health of the economy much as wildfires are to the ecology of a forest?
That’s kind of a big question, so if you’ve already answered it somewhere else, please let me know 🙂
Ken
P.S. From what I gather, my question may reflect the “Austrian” POV … I’m not trying to advocate their viewpoint (which I only partially understand) … I’m really trying to figure this stuff out.
business cycle still happens. businesses that don’t get it right lose. just that the $8 job and agg demand management means other business will emerge to compete for the consumer dollars and unemployment as we define it always remains relatively low
With full employment by definition (because of the job guarantee), we would no longer have the Phillips Curve trade off between unemployment and inflation.
Is there another relationship which will replace it as government spending gets close to the limits of productive capacity?
If deficit spending were to occur without issuing T-Bills, there would be a buildup of bank reserves instead of a buildup of “Treasury debt”, correct? Would this money just sit idle, or would it try to seek some rate of return, like in the shadow banking sector, or inflating some other asset class?
Is this a legitimate concern? What would be the solution — having the Fed pay interest on reserves? Seems that would amount to the same thing as issuing T-Bills, just in a different disguise.
Ken I wish the government would pay me to borrow money
That is the interest rate that JPM had to pay for Fed Funds i.e. for money borrowed from the Federal Reserve.* The number is –0.05%. That’s right, negative 0.05% for what were $271.9 billion in repo liabilities. That’s unbelievable!
You can see how the yield spread has steadily increased over the past six years to where JPMorgan Chase is now making a spread that is 1 1/2% greater than it was in 2004.
Moreover, the interest it has paid on repos has plummeted. Fed Funds rates started coming down in mid-2007 when the subprime crisis blew up, but they fell off a cliff after Lehman hit the wall in September of 2008. As of Q1 2010, JPMorgan Chase was being paid to borrow $271 billion. Talk about free money! I sure wish I could get a deal like that.
Right now, if a bank holds excess reserves, it can lend those funds in the inter-bank market, or it can buy T-Bills. That’s my understanding of their options, anyway.
So, my question is: Lacking those options, is there something else the bank can try to do with those funds to earn a return? Or is that pretty much it?
For example, if they were able to buy commercial securities of a certain quality with that money, there could be an effect on those markets. Or are they prohibited by law from engaging in such activity?
Ken, think of reserves as liquidity for interbank settlement. Reserves are never “spent” into the economy. Transactions involving interbank settlement are settled in reserves, and banks either have to have the reserves on account at the regional Federal Reserve bank with which they deal, or borrow them in the interbank market or from the Fed.
Banks can conduct any operations in the economy that bank regs permit, and they have to settle up with reserves. It is the profitability of transactions that counts, not available reserves, and banks engage in transactions based on risk in relation to return, not whether they have excess reserves. If they don’t have excess reserves then there is the interest cost.
But if they have excess reserves they can loan them to other banks that need them. If they can get more in Tsy’s then they can in the overnight market, then they may choose to park them there. Right now, the Fed is paying interest on excess reserves, so they are like T-bills.
Rest assured that banks are always figuring how to generate maximum return on capital commensurate with risk. Juggling reserves is just one of the many factors. To a bank dealing with large sums, even a very small amount of interest overnight adds up over time. Banks are well aware of this and take advantage of it. If they see better opportunities, that’s where they will go. In fact, the biggest banks make the most on prop trading these days, where they can maximize return through leverage.
yes, they have those options, but that merely shifts the reserves to the bank they are buying the tbills from or lending the reserves to. total bank reserves remain unchanged.
without interbank markets there is no interbank lending to move reserves from bank to bank, but banks can still buy things which does same.
the buying and selling of secs alters the prices of those secs but total reserves are unchanged
What I’m trying to work out in my head is whether the build up of bank reserves with no corresponding issuance of treasury debt truly has no inflationary consequences (assuming the economy not over capacity at the time of initial spending).
With no more T-Bills to buy (because the government stops issuing them) and no more interbank lending market (because every bank has more than enough reserves and the fed funds rate is 0), the banks will presumably try to earn some return on this money.
Perhaps they will lend it via the overnight repo markets … the so-called “shadow banking sector”. The investment banking sector will borrow this money short term via the repos and lend it out long term for all sorts of things, trying to make a profit. Wouldn’t this massive influx of funds lead to all sorts of assets bubbles and/or CPI inflation? Why or why not?
This isn’t my field, so let me know if I’m typing gibberish 😉
Reserve do not influence the decisions banks make about entering into profitable transactions other than through interest charges on borrowed reserves. The reserves are for settlement. There will always be an interbank market for settlement and reserves will be required for clearing.
Even though there are more reserves in the system, they won’t be evenly distributed all the time. Some banks will likely still need reserves for settlement.The Fed will continue to be the lender of last resort for banks that may be short reserves at the end of a particular settlement period and the discount rate will apply.
The question is whether the CB decides to maintain control over the overnight rate by paying interest on excess reserves, or lets it go to zero.
If deficits were no longer required to be offset with debt, the Treasury ceased issuing securities, and the Fed decided to let the overnight rate go to zero, then interest rates would be endogenously determined, that is, by market forces. The financial sector might actually prefer to continue to have an exogenous benchmark for short and long term rates on risk free instruments, so it might be that Treasury and Fed decide to accommodate this. The Treasury could still issue some Tsy’s along the curve without the need to offset the deficit. Moreover, the government might decide that it is in its interest to retain control over interest rates to some degree instead of letting rates be determined solely by markets.
The amount of reserves simply affects overnight rates, not banks’s decisions on operations, which are determined based on risk/return and availability of bank capital. It really doesn’t matter whether the bank holds reserves or Tsy’s, since Tsy’s can be converted to reserves immediately. Holding Tsy’s just adds some interest, while increasing the government deficit. That’s a gift of a claim on real resources to the banks that it’s really necessary for operations, and it could be eliminated.
Maybe the way to think about this is in terms of your own savings and checking accounts. Are you more likely to spend if you have funds in a checking account rather than in a savings account? Most people aren’t, I would think. Especially now with Internet banking, most people probably keep most of their funds in their savings account and just transfer what they need to cover their checks into their checking account as necessary. All that is needed now is few key strokes. If there were no savings accounts, would people therefore spend more just because it was in checking? They would likely just look for another place to earn some interest, like CD’s or securities of another country, instead of spending more.
Of course, if governments generally stopped issuing debt, that would change the financial picture considerably, because that’s a huge pile of funds that would have to park somewhere else. This is probably more to the point of what you are asking. Where would it go, with no risk-free place to park at interest? Corporate bonds, equities, other financial instruments, and productive investment are the options. Probably more would be invented.
Thanks Tom. That last paragraph, and last sentence of the previous paragraph, is exactly what I’m trying to get my head around. Wouldn’t this huge and increasing pile of funds cause significant asset and possibly CPI inflation as it looks for a place to park? If so, running deficits without issuing debt wouldn’t be completely benign, right?
Ken the essential point, which Warren makes clear in his comment, is that eliminating the deficit offset requirement and debt issuance will not increase nongovernment net financial assets and therefore will not be inflationary, since it simply eliminates the ability to switch from one asset type (reserves, cash) to another (Tsy’s).
In fact, eliminating debt issuance would also eliminate interest payments, which would also eliminate the increase in NFA that this disbursement would have involved in the case of debt issuance. So instead of increasing inflation by increasing NFA, eliminating debt issuance decreases “government spending” and deficits, since interest payments are government disbursement that increase nongovernment bank accounts and get charged to the Treasury’s book.
If the option to buy Tsy’s were eliminated, then other options would be exercised in the markets, based on risk/return, if the preference were against holding non-interest bearing reserves/cash. Really, the only difference is that the publicly subsidized parking place would be gone. Were this to come to pass, markets would deal with it in ways that are based on market principles.
Moreover, if people realize that debt issuance is unnecessary to finance deficits in lieu of increasing taxes, they would also come to realize that the interest payment of the debt is subsidized risk-free parking place that transfers claims that the public has on real resources through currency issuance to the recipients of these payments. This is essentially a form of the “redistribution” that the right bemoans so loudly.
Viewed in this light a publicly subsidized risk-free parking place is a form of “welfare,” or “waste.” So those on the right should be for this, and I suspect that the center and left would support it, too. That’s just about everyone, if the truth comes out and enough people get it.
Wouldn’t this huge and increasing pile of funds cause significant asset and possibly CPI inflation as it looks for a place to park?
Here is another way to look at it very simply. Suppose that banks eliminated interest-bearing saving accounts and left CD’s in place. People would have the option of switching the funds in their savings accounts into their non-interest bearing checking accounts or into CD’s. This is just a switch between forms of holding financial assets, so nothing really changes but the type of account, along with the interest associated with the account type. nothing either complicated or inflationary here. Canceling savings accounts is very unlikely to result in a rash of spending for no other reason, for instance. Neither the amount of money or its velocity changes due to these switches among account types.
Now suppose the government eliminates debt issuance. The option banks now have of transferring reserves to Tsy’s, and individuals and companies of transferring cash to Tsy’s, similar to transferring funds from a deposit account to a savings account is no longer available. But government doesn’t issue CD’s. What to do?
Individuals and firms could transfer cash to CD’s at their bank instead of buying Tsy’s, and banks would respond to this government action by offering competitive options. Banks, however, would not have this option, and they would have to either hold reserves or look for non-government interest-bearing instruments if they didn’t want to hold reserves. Individuals could do the same, since they would have the same options. All that goes is the asset form of Tsy’s. There are plenty of other options from reserves/cash to junk bonds depending on risk appetite. At any rates, it’s just different “boxes” for holding assets, some riskier than others in return for higher interest payments. All that disappears are the boxes with government subsidies for risk-free parking.
This is an important question politically, Ken. I am glad that you asked it, and that I got to think about it.
In any case, the private sector would evolve mechanisms for dealing with the new conditions. This can be viewed as another form of “privatization.” The right would like that, too.
Thanks Tom.
I guess it’s the “private sector evolving mechanisms” that I’m concerned about. This is, after all, where mortgage backed securities and other fancy instruments came from.
Warren says below that these reserves have no where else to go, so they’re nothing to worry about. I’m having a hard time seeing why, unless he’s talking about some sort of regulatory regime to make this a matter of law. We’re talking about a **lot** of money here, so there is an enormous incentive to achieve even a small rate of return in some vehicle that the banks at least **believe** to be safe (we’ve seen that movie). As you say, the financial sector will be only too happy to innovate to accomodate all of these funds looking to earn interest … that, in my naive view, is the danger.
Also, there are the non-bank investors who formally held T-Bills that will now need new innovative financial products to invest in to achieve their goals.
Even if these innovative financial instruments work as advertised next time, and there is no fraud or bad assumptions involved, the end result of employing them would be to direct funds to someone, somewhere in the real economy to do something. In the case of MBS, that “something” was to build houses … who knows what it will be next time. Hence my concern about various asset bubbles or other forms of inflation.
So … even though the banks aren’t “operationally constrained” by their reserve positions when I walk in the door and ask for a car loan, their attempts to earn interest on their excess reserves via private sector provided innovative investment vehicles has to show up in the real economy somewhere. So they are, in effect, through the use of intermediates with more risk appetite, making these funds available to “other than well qualified borrowers”. This isn’t the case with T-Bills … money used to buy these gets (metaphorically) shredded, as you guys have made clear, so we don’t have to worry where it ends up.
So it seems like this would be a very dangerous experiment to me … has this been studied, does it need to be, or am I just out to lunch?
Ken
Ken, I don’t know that eliminating debt issuance, and therefore the public subsidy for risk-free parking, complicates the issue all that much. There is already a “giant pool of hot money” out there looking for the next promising vehicle to rush into. As you say, a lot of the securitization that resulted in the crisis was to service that giant pool looking for even a small advantage in risk/return. And, yes, we see how well that went, when Wall Street attempted to service that demand with dodgy products and misrepresentation of risk, aided by complicit ratings agencies.
What we need is comprehensive reform to prevent a repeat of that experience, regardless of whether debt issuance would be eliminated. There are already trillions out there looking for the next best thing, and many minds are busy trying to provide it. So I don’t think that’s a good reason to continue the subsidy.
Better to reform the system and establish adequate oversight. That’s why there are independent audits in business and finance. But there have to adequate penalties as well. And there has to be real accountability, with the prospect of jail time for those tempted to break the rules. But even though Skilling (and Martha Stewart) went to the pokey, others were not deterred. This has to be a real threat — not just a scapegoat here and there, but otherwise a double standard in the law.
As Minsky observed, there is no magic bullet regarding regulation or reform. There will be a bevy of lawyers looking for loop holes, and crooks are in abundance where there’s money. It’s a matter of staying out in front of the crooks and sharks instead of lagging behind, or even not bothering to look or do anything about it.
Warren has already set forth his proposals for reform. It also comes down to incentives and disincentives. The incentive structure in finance is just wrong. As Joseph Stiglitz observes in The Non-Existent Hand, the purpose of the financial sector is to “manage risk, allocate capital, run the payments mechanism, and all at a low cost.” Everything else is essentially froth and should be eliminated as socially useless, especially if it potentially harmful. Markets are not supposed to be casinos. Issuing or not issuing debt doesn’t really impact this as far as I can see. But I’m not an expert in finance either.
Ken,
“We’re talking about a **lot** of money here, so there is an enormous incentive to achieve even a small rate of return in some vehicle that the banks at least **believe** to be safe (we’ve seen that movie). As you say, the financial sector will be only too happy to innovate to accomodate all of these funds looking to earn interest …”
Ive had a hard time here too. But Ive had to keep coming back to the edict that “banks dont lend reserves” Ive had a hard time undestanding the sort of esoteric nature of reserves but the posts of others here like JKH and Ramanan have helped over time. Once I read something like “reserves are ONLY transacted between banks” ie the Fed and depositary institutions (not even the Treasury). Ive had to just put the idea of reserves out of my thinking, as it should be meaningless to me as I do not work at a bank in charge of compliance.
I think this is where Warren is going wrt his statement that “there is no place else for them to exist.” Reserves are exclusively an issue between banks (both Central and depository).
Looks like Princeton University Press was the publisher of the Reinhart/Rogoff Book on debt doomsday. Maybe they were contracted.
if governments generally stopped issuing debt, that would change the financial picture considerably, because that’s a huge pile of funds that would have to park somewhere else.
IT JUST PARKS IN RESERVES OR ACTUAL CASH. NO WHERE ELSE FOR THOSE DOLLARS TO EXIST.
right, Mat, and ask yourself this, if the tsy switched to only 3 month bills, and nothing longer, or only 1 week bills, or only overnight bills which is all that reserves are, what would change, apart from lower longer term rates/flatter yield curve as indifference levels changes via the supply changes, and maybe some risk spreads?
“Ive had a hard time here too. But Ive had to keep coming back to the edict that “banks dont lend reserves” Ive had a hard time undestanding the sort of esoteric nature of reserves but the posts of others here like JKH and Ramanan have helped over time. … snip … Ive had to just put the idea of reserves out of my thinking, as it should be meaningless to me as I do not work at a bank in charge of compliance.”
It doesn’t seem like the concept of reserves should be so mysterious. They are simply the bank’s checking account at the Fed, so transactions can clear between banks, right? So when my paycheck is deposited in my bank account, my bank gets funds in its reserve account from another bank’s reserve account, and it also credits my account. If the bank already has sufficient reserves in its Fed account to cover its mandatory requirements, it wants to do **something** with that excess to earn a bit of interest, right? Traditionally, that **something** has been inter-bank lending or T-Bills. If those go away, then what? Doesn’t the bank try to do something else to achieve the same thing, perhaps lending in the overnight repo markets and taking safe (grin) AAA rated MBS as collateral? Can’t that lead to problems? Perhaps that “safe public subsidized parking space” that Tom refers to (Treasury Debt) is an important safety value in the system to prevent this kind of thing from happening?
The consensus here is that these funds will be happy to sit inert earning no interest and causing no further mischief. This is the one piece of the MMT paradigm I’m still struggling with.
Perhaps there is operational experience in other countries that shows this to be true?
Thanks for bearing with me folks … I really do **want** to believe!
Ken you sound like you may understand it better than I do at this point!
“it wants to do **something** with that excess to earn a bit of interest, right?”
I dont think the banks options are unlimited at that point, I could be wrong but I think the only thing it can do is “lend” in the overnight funds market, or if you will “provide overnight funds” to another bank. (I can hear them at GS now: “darn, no overnight forex speculation!”:) Again it comes back to “banks dont lend reserves”. It may be that the bank doesnt “want” to do something with the excess reserves, it is that it is “allowed” to do something with the excss reserves. Interbank lending perhaps is a privilege.
“Traditionally, that **something** has been inter-bank lending or T-Bills.” Above on interbank lending, now I think the tbills come at the initiation of the Fed. ie the Fed monitors the situation system wide, and if it sees there are excess reserves in the system, it may sell some Treasuy securities to drain overall system reserve levels. It may not be like the bank initiates the transaction for the bills because it thinks it can make some overnight money (not allowed), ie the Fed takes the initiative on behalf of the system, not an individual bank, then the interbank market distributes/adjusts from there.
I’m getting in over my head here. Resp,
I know I’m **way** over my head. But I’m determined to understand it. 🙂
Ken
Well there are several countries that have no reserve requirements:
UK, Canada, Australia, Sweden, Mexico
Obviously all of them still probably are selling their own government bonds.
But I guess the point here is, typically treasury bonds offer the lowest interest rate available, because the are the safest possible parking space.
So no bank would buy a treasury bond until it had exhausted all alternatives. So the opportunity for mischief is the same whether you sell treasury bonds or not.
I think it was RSJ (I hope I’m not misquoting) who pointed out that, assuming banks would not take on more risk to ‘park’ their excess reserves, cutting out Treasury Bonds is a cost for banks in the sense of lost income which ultimately the customer has to pay for through a higher price of credit.
they have zero reserve requirements, not no reserve requirements.
Canada has a reserve requirement, it is a requirement of zero (while US has requirement of 10% I thinks).
Reserve accounts can go into overdraft. Canadian banks need to make sure that the overdraft is covered, so they have target just like US banks. Just their target is zero. It can be 3%, 50%, 27% etc. But they still have target they need to hit, so they still have overnight interbank window just like US.
Saying Canada has no reserve requirement suggests that banks there do not need to hit a reserve target and that is not the case.
They need sufficient reserves to clear their inter-bank checks, but there is no government imposed requirement.
Ken
try looking at it this way
the cumulative ‘debt’ of the US sits as some combination of reserves, tsy secs, and cash in circulation and = total $ net financial assets.
the gov controls the mix of the three. they let cash be available on demand, so for all practical purposes they manage only the mix between tsy secs and reserves- both simply accounts at the fed.
so all deficit spending is ‘trapped’ as accounts at the fed.
‘alternatives’ for one bank represent indifference levels between the ‘alternative’ and the fact that the entity selling the ‘alternative’ prefers what the govt offers as either secs or reserve balances. it’s all done at ‘market’ prices so those prices presumably reflect indifference values.
Sure, now the entity selling the ‘alternative’ to the bank has control of the reserves. Since that entity is in the business of taking on risk, their standard of what constitutes a “well qualified borrower” is different from the original bank. So now a new set of borrowers gets control of the reserves. They, in turn, do something else with the money, so the reserves change ownership yet again …. and so on and so on.
As the reserves keep moving around between accounts at the Fed … well, that’s economic activity, isn’t it? Initially in the financial sector, but eventually bleeding into the ‘real’ economy. And that activity can cause asset and price inflations, right?
Whereas with T-Bills, this open ended chain of events doesn’t exist. Because when reserves are given to the Govt, they go no further. A bond is issued, and that’s that. The money is now in a Fed “savings account”, as you put it.
Ken, are you saying that if reserves aren’t parked as Tsy’s, velocity might increase, and implying that nominal aggregate demand = money supply multiplied by velocity? Even if that were the case, it would not be inflationary unless the economy was approaching full capacity.
Yes – I think that’s what I’m getting at … I wrote more below…
Ken
the cumulative ‘debt’ of the US sits as some combination of reserves, tsy secs, and cash in circulation and = total $ net financial assets.
Another way to picture it. Only the Fed can create reserves. These are held by nongovernment in three asset forms.
1) in the interbank settlement system as bank reserves. Only financial institutions having access to the FRS deal directly in reserves.
2) in a super-liquid form (cash), In a cash transaction settlement takes place directly, with the transaction at the time of the transaction, rather than through the settlement system. Banks exchange reserves for cash based on customer demand.
3) in a slightly illiquid form as Tsy’s, which store reserves at interest.
These are all the same thing — reserves created by the Fed — in different form.
Banks cannot create reserves (or cash, or Tsy’s). Government is the monopoly provider. Reserves are created when the Fed credits the Treasury account for government disbursement. Banks loan against capital and they need to get reserves for settlement purposes. The fractional aspect of banking is set by the capital requirement not the reserve requirement, thus the government can control bank’s ability to create credit money through credit extension by changing the capital requirement.
Incidentally, I would not call reserves, cash and Tsy’s ‘debt’ but rather liabilities. Calling government liabilities “debt” confuses the issue because government liabilities are essentially different from nongovernment liabilities. For example, the only thing the government “owes” on its liabilities is an equal amount of government liabilities in return, which is creates, and the only thing that government liabilities are good for with respect to nongovernment interacting with government are exchanging government liabilities for nongovernment liabilities to the government (taxes, fines, fees), although a small portion goes to buying stamps, government land offered for sale, etc.
On the other hand, government liabilities give government a claim on real resources. This is not claim on which the government “owes” anything of economic value in return, other than the obligation to use this claim for public purpose instead of diverting it for private use not directly related to public purpose.
So while reserve are for settlement purposes in the FRS, when the Fed credits the Treasury’s reserve account for settlement of disbursements, financial assets are created in nongovernment in exchange for creating government claims in the economy.
Yes, I’m totally on board with everything in this post.
Ken
Initially in the financial sector, but eventually bleeding into the ‘real’ economy.
Ken, reserves don’t “bleed” into the economy. They enter the economy through the Fed crediting the Treasury account for settlement of its disbursements into the economy, which creates nongovernment financial assets.
These financial assets can exist as bank reserves, cash or Tsy’s, and they are regularly switched around through transactions that are either settled directly (cash transactions) or through transfers involving bank settlement.
Where do you seeing the bleeding that might lead to inflation coming from?
I guess I need to be more careful with my terminology here. I shouldn’t say that the reserves “bleed” into the economy, but rather that they keep moving about between accounts at the Fed. But that’s another way of saying that they’re generating economic activity, because that’s how payments are made in our system.
You’re right – if the economy is at less than capacity, that’s not going to cause inflation, at least not CPI inflation. What kind of asset bubbles may result in the financial sector I’m not sure of.
My problem is as follows. Government deficit spends initially because the economy is at less than capacity. Of course, this isn’t inflationary and provides much needed stimulus. However, there seems to be an assumption here that this is the end of the story … these dollars simply become inert and non-circulating in Fed checking accounts after this initial round of spending. My argument is that they would, in fact, continue to circulate … the first step in this new circulation being the bank investing them via some private sector financial vehicle (since this is now their only option for getting some return on them), and that vehicle propagating a further chain of circulation from there.
So … even after the initial Govt spending has corrected the output gap, the funds that were spent to do so don’t sit inert, but keep moving … eventually driving up prices.
Ken, when the Treasury disburses more financial assets than are withdrawn by taxataion, funds, a deficit results, and the Treasury is required by law to issue Treasury securities in offset. The Fed auctions these securities to primary dealers, who then sell them into the market. Composition of Tsy’s holding is approximately a third held by banks, a third other domestic, and a third foreign. Those holding Tsy’s desire a modest return at very ow risk and high liquidity.
If the Treasury ceased issuing securities in offset, should the law be repealed, then these parties would have to choose among remaining options, which are essentially 1) staying in reserves if bank or foreign government or deposits if other domestic, or else 2) parking somewhere else low risk/high liquidity at modest interest (basically hedging against inflation instead of being perfectly liquid at no interest). There are plenty of options, and it’s a matter of an indifference map associated with different utility levels based on individual preferences. The market might even come up with new forms, but private solutions would not carry a public subsidy — that is the big difference.
Given current preferences indicated by the appetite for risk-free Tsy’s, one would assume that the desire would be for similarly low risk instruments rather than “flyers.” I don’t see an inflationary threat here.
“Given current preferences indicated by the appetite for risk-free Tsy’s, one would assume that the desire would be for similarly low risk instruments rather than “flyers.” I don’t see an inflationary threat here.”
Yes, the bank would desire some low risk vehicle. However, there are financial intermediaries who thrive on taking on risk. So the bank gives them money in the overnight market (but rolling it over indefinitely), taking some form of high quality collateral in return (that’s why it’s low risk to the bank). One such form of collateral would be a T-Bill, but since they won’t exist anymore, something else will have to do. Maybe the AAA tranche of an MBS bond, for example. This intermediary then turns around and makes the high flyer loan.
This is my oversimplified understanding of how the “shadow banking sector” operates.
Ken
What wrong with an AAA tranche if is really is AAA? That’s what “caveat emptor” is about on one hand, and bank reform, on the other. Personally, I think that people ought to be going to jail for misrepresentation and outright fraud over what just went down. And you can be sure that investors will be much more alert in the future and much less trustful of the big names. This game needs fixing big time, where the Treasury continues to issue securities or not.
“What wrong with an AAA tranche if is really is AAA?”
Nothing, actually. So the bank will get a low rate of interest backed by nice, safe, AAA collateral. The intermediary now has funds to lend out for more dangerous ventures at a higher rate of interest. That’s how the money continues to turn over. That’s what ultimately leads to the inflation. If the money was parked in T-Bills, it would stop turning over. Because the Government will not lend it on to someone else, and has no operational need for funding itself, as you guys always point out. So with the T-Bill, the chain of spending stops. With the AAA backed bank loan, it doesn’t. That’s the difference.
If it’s not really an AAA asset, a different set of issues ensue.
Ken, it seem that you are thinking that funds get parked in T-bill and get rolled over long term. That’s not really the way it works. Generally speaking T-bills, being highly liquid, are a short term parking place for entities dealing in large denominations where even very short term, very low interest adds to profitability. This is money on the way to the next deal, not funds taken out of circulation. Even the long bonds are seldom bought to be held to maturity unless they are obtained at a very favorable rate that can’t be bettered through other use down the line. Only “retail investors” buy and hold, and that’s a relatively small portion of the bond market. Foreign government are large holders of Treasuries until they have use for reserves, and if Treasury issuance were abolished, the US would work something out with them, since this serves the public purpose of promoting international trade.
From the point of view of any individual investor, this is true.
For the system as a whole, it still represents a pool of inert money. Inert in the sense of: when I lend money to the Govt, the Govt does not further lend it, nor does it spend it. Because we’ve established that Govt spending is independent of any need to generate ‘revenue’, either by borrowing or taxing.
So, even though the individuals and firms the comprise the pool of T-Bill holders may rapidly turn over, there is still this big pool of funds which is essentially inert (we happen to call it the “national debt”, but that is only one point of view).
An analogy would be a lake behind a dam. Water flows in, water flows out, the lake is still there, even though the individual water molecules keep changing. If you blow up the dam, there are bound to be consequences.
What i am saying, Ken, is that there is a demonstrated preference to hold highly liquid, short term funds at modest interest. This would just shift to other options if Tsy’s aren’t available. If there aren’t enough other options, then the private sector will create them — without a public subsidy. Call it “privatization.” What’s the problem here?
I understand exactly what you’re saying. And I agree that’s what would happen.
The problem: Even if the private sector gets it exactly right in terms of safety and ratings, etc, on the new or existing private “savings” vehicles, the funds that the Govt initially injected into the economy via deficit spending will continue to circulate in the economy until they are somehow removed. That’s because these new “savings” vehicles will propagate the funds from those who want to “save” them to those who want to “spend” them. And whoever that party spends them with will do something …. “save” or spend … etc. This chain of propagation will continue indefinitely … another name for it is “velocity”.
This is different for T-Bills. Because when you buy a T-Bill from the Govt, it is a dead end. The spending propagates no further, because the Govt doesn’t do anything with this money (because the Govt has no need to collect money in the MMT paradigm). Therefore, there will be no ongoing chain of spending, so these funds will not be bidding up assets or prices. Velocity goes to zero. Not the case with the private sector provided vehicles.
Now, I know you say, from an individual saver’s point of view, when he buys a T-Bill:
“What do you mean? My velocity hasn’t slowed down! I’m just parking my funds here for a few days/weeks/months while I wait to do something else with them.”.
And that’s perfectly true from his perspective. However, while it’s parked there, it isn’t doing anything in the real economy, just like all the cars in the mall parking lot aren’t contributing to congestion on the freeway. Not the case for funds “parked” in the private sector provided alternative … they never really get to “park” at all, they just keep moving, even if the individual “saver” doesn’t notice the difference.
Ken
This is different for T-Bills. Because when you buy a T-Bill from the Govt, it is a dead end. The spending propagates no further, because the Govt doesn’t do anything with this money (because the Govt has no need to collect money in the MMT paradigm). Therefore, there will be no ongoing chain of spending, so these funds will not be bidding up assets or prices. Velocity goes to zero. Not the case with the private sector provided vehicles.
Assuming this is the case, which I don’t think it is as I have said, this possiblity is worth a public subsidy for those who are able to buy Tsy’s that are only issued in large denominations? That public subsidy is the transfer of a financial claim on real resources from public to private, and is concentrated at the peak of the wealth and income curve. I do not see the proportionality here. Looks to me like a redistribution of resources to those who do not need it and have done nothing for it, in order to prevent something that might or might not happen.
Another thing to consider, Ken, is trading volume in Tsy’s. It’s the largest market in the world in dollar volume. The average volume in 2009 was 600 billion a day. The national debt now is 12.8 trillion. So that means that turnover is pretty large. A lot of these transactions are short term trades, often day trades. I have friends who do this for a living. A single trade is in the range 100K depending on the actual price of the security. Trading is done on leverage, which can be very high if the person chooses. Lots to be made if one is good at it. The US is partially funding this game with its interest payments on the securities — unnecessarily. Does that make sense? I doubt very much that the US public would condone these interest payments if people think it is necessary financially knew it was actually unnecessary, especially considering the percentage of the budget that goes to debt service. In my view, it is a prime example of “waste, fraud, and abuse,” and as well as gross ignorance.
Tom, I don’t disagree with any of your politics. They sound similar to mine. I’m just trying to figure out if this notion of continued deficit spending without issuing debt would actually work, and my (still refutable) conclusion is that it would not. See my post #24 below for a summary of my current thinking.
But if we spend enough to put these bodies to work, without issuing corresponding debt, won’t we need to withdraw these funds (via taxation, in your model) when the economy “heats up” and velocity increases?
Ken, Tsy issuance does not withdraw net financial assets from the economy as taxation does. It just stores them, usually temporarily. Tsy’s are highly liquid and are traded in massive volume. They are just parking places. In addition, they provide excellent collateral for loans.
If the $4$ Tsy offset of issuance neutralized the funds issued, then fiscal policy would have no effect at all other than the interest it adds, which is patently not the case.
They’re highly liquid from the individual holder’s point of view because he or she can easily sell theme, or borrow against them. But that’s a zero sum game, right? The total amount of funds tied up in T-Bills as a whole has been rendered inert as far as driving economic activity or inflation.
So I’m still left to wondering what happens if T-Bills no longer exist and all those funds start running around in the wild (by which I mean … shuffling around between 100% liquid Fed checking accounts).
Ken
all those funds start running around in the wild (by which I mean … shuffling around between 100% liquid Fed checking accounts).
Ken, what do you foresee happening exactly? As I said, those who are used to parking in Tsy’s will either stay liquid or hold something else that is highly liquid and low risk that pays modest interest. Why would that behavior suddenly change? I think you are just having nightmares unless you can propose a plausible scenario instead of generalities.
See my response above, where you ask:
“What wrong with an AAA tranche if is really is AAA?”
I think it’s pretty specific, or at least I’m not sure how to get more specific without naming specific companies or products (which I’m not sure I can do).
KenM:
Debt does not withdraw assets, just changes their term structure.
Only taxation withdraws assets. And yes, if inflation gets too high, you need to withdraw assets to bring it down. THis is whether you issue Treasuries or not.
Treasury debt may not withdraw assets, but it does stop those assets circulating as money. Yes, they’re pretty liquid, but to spend them I have to sell my T-Bill to someone else or post it as collateral for a loan, which means that other person stops spending for a while. Either way, the total volume of outstanding T-Bills represents funds that are not chasing after goods and services or other financial assets, therefore not bidding up prices.
If I buy a commercial bond, the person I buy the bond from either spends the money, or lends it on again to someone else who spends it. If I buy a Govt bond, the chain of spending just stops, because, as we all know on here, the Govt has no operational need to collect money.
In other words, those dollars are rendered inert when used to buy Govt debt, which they wouldn’t be if that debt wasn’t available for purchase. But you’re right – they are not withdrawn – they’re still somebody’s asset.
Tim Congdon,a monetarist, makes the case that KenM is trying to make:
He says that On 5 March, the BOE announced a programme of so-called “quantitative easing”,
in which enormous purchases of gilt-edged securities, mostly from non-banks, would deliberately
add to the level of bank deposits (i.e. the quantity of money).
Lending to the private sector is a totaly different entry on a bank balance sheet from the figure
for deposits. Increases in banks’ loan portfolios add to assets and require extra capital to anticipate
the risk of default: increases in bank deposits expand liabilities and may not need any more capital
at all. The point is that banks can grow their deposit liabilities by acquiring assets with a
negligible risk of default. These assets are of two main kinds, claims on the government (Treasury bills
and gilt-edged securities) and claims on the central bank (their so-called “cash reserves”). When the
quantity of money increases as a result of banks’ acquisition of such assets, no new bank capital is
required.
He says that the purpose of quantitative easing was not to increase lending, the intention of the BOE’s QE
is to increase the quantity of money by direct transactions between it and nonbanks. It does this by adding
money to the bank accounts of holders of government securities to pay for these securities. He goes on to say,
that pension funds, insurance companies, hedge funds and so on try to get rid of their excess money by purchasing
more securties, ie. more equities from each other but they can’t get rid of their excess supply of money.
They all have an excess supply of money and excess demand for equities, which will put upward
pressure on equity prices. If equity prices rise sharply, the ratio of their money holdings to total assets
will drop back to the desired level. Once, the stock market starts to rise, companies find it easier to raise
money by issuing new shares and bonds. At first, only strong companies have the credibility to embark on
large-scale fund raising, but they can use their extra money to pay bills to weaker companies threatened with
bankruptcy. But this money soon trickles down to profitable companies with strong balance sheets and then to
marginal businesses with weak balance sheets, and so on. The cash strains throughout the economy are eliminated,
asset prices recover, and demand, output and employment all revive.
So basically the BOE swaps cash for bonds from the private sector, private sector deposits increase, reserves increase
to match the deposits but are earning very little interest so they goose the markets. But how is that sustainable?
The private sector are now without secure government bonds but have more equities. Is this not an illusion of demand, not
based on increased earnings and profits. He also says that government deficits don’t work, citing Japan as an example.
But that is hard to believe since government deficits are one of the main determinants of the profit equation. I can see
this market faltering again in the next year.
So basically the BOE swaps cash for bonds from the private sector, private sector deposits increase, reserves increase to match the deposits but are earning very little interest so they goose the markets.
And how well is that working? This theory of reflating has been roundly disconfirmed.
Well, its working from the point of view of a rising market. But I’m not sure if it can continue. It’s still not addressing the main problem of household/business debt. But, thats what people said after the tech bubble.
More people I know think that it was the declining dollar and low rates rather than QE that was responsible for the climb in US equities.
as mentioned elsewhere on this site, it’s about price (interest rates), not quantity.
the only effect of qe is lower term rates than otherwise, which is what Tim was saying in his explanation.
buying securities lowers the yields for those securities from where they would have been otherwise. the seller of the secs sells at his price because at that price he’d rather have the cash balances than the securities.
All you are describing is what normally happens with any dollars we have in our bank accounts, but you are suggesting that no one will want to ever have dollar savings in their bank accounts if there are no treasuries to buy. That they will spend/loan continuously. That’s unlikely, but even if they did do just that, the resulting full employment and eventual inflation would be taxed away automatically, over time. Since Warren’s proposal is to have government deficit spending only on the employed labor pool, this pool would shrink to zero and deficit spending would stop. Increasing prices and wages would be subject to higher tax brackets, and eventually the government would be running a surplus.
So I guess if you are saying there would be eventually a new steady state of total savings that are less than currently if we stop issuing treasuries, yes that seems true to me. But it would automatically happen, and as long as the employed labor pool was still set as a fixed wage there would not be any net inflation after the initial transition.
Also you are totally discounting the fact that having treasury bonds, means paying interest, which means the total dollar pile has to increase exponentially forever. This could eventually boost demand, but we would be eliminating that channel.
Well, I didn’t come here with any agenda, but after discussing this here for the last two days, the following is the position I’ve argued myself into. I didn’t think any of this two days ago, so it’s probably not fully baked, and I’m still open to refutation. Anyway, here goes (in the words of Homer Simpson, I just know I’m going to pay for this…):
As the Govt deficit spends, probably to close an aggregate demand output gap, reserves will build up in the banking system. Some of these reserves will be required to meet regulatory requirements (10% of demand deposits in the U.S.). Even in countries that do not have such requirements, some amount of reserves will be needed for inter-bank checks to clear. Anything over and above these needs are excess reserves. And they really, really want to find some way of safely (OK … safe-ishly) earning money.
Traditionally, this need has been met either by investing in T-Bills, or lending inter-bank overnight to banks with reserve position shortfalls. However, if the Govt stop issuing T-Bills, and lets the inter-bank lending rate fall to zero (no more open market operations by the Fed to stop it from going there … zero is considered the “natural rate”), neither of these profit opportunities is there anymore. Will the free market (i.e. the financial sector) come up with some innovative new financial instruments to meet this need? Of course they will! Or, they might just recycle less innovative older ones.
Any private sector constructed investment vehicle cannot act exactly like a T-Bill. When you buy a T-Bill from the Govt, the Govt does absolutely nothing with the money you pay it. It (metaphorically) just shreds it, just like your tax payments. That’s because, according to the MMT axioms, Govt spending is completely independent of any Govt “income” … the Govt does not need “income”. So once you buy the T-Bill, the funds you spent become inert, at least as long as you hold the bill. Velocity on this money goes to zero. It can no longer bid up the price of assets or real goods (because the Govt does nothing with it).
If you sell the bill, even after only a short time, someone else will jump in and buy it, rendering their money inert for a while even while yours is freed up. But there’s still this big pile of zero velocity, inert money which we now call the “national debt”, even if the individual holders of it keep changing.
When a private sector financial intermediary comes up with it’s own instruments to replace the defunct T-Bills, they cannot possibly work the same way. That’s because no private entity can stay in business by just taking your money and doing nothing with it, then handing it back to you with interest (like the Govt can). They must do something with that money to make a profit, so that they can pay part of that profit back to you as interest. If you’re a bank, perhaps the intermediary will give you some AAA collateral in return for your excess funds. The collateral makes the loan “safe” for you, the bank, at least in theory. They will then make their profit by lending the funds out for some riskier, higher payoff venture. That venture will either spend money in the real economy, or engage in further financial sector activity. And so forth. This money will continue to have “velocity”, unlike the excess funds previously invested in T-Bills, which had none. Therefore, this money can continue bidding up prices for assets and/or real goods.
If the money the Govt originally deficit spent in order to close the demand gap (the extra stimulus money) continues to circulate, as I argue in the last paragraph, it will start to become inflationary when full employment is achieved and velocities in general go up (the economy has “heated up”). Therefore, the extra stimulus money will have to be removed, through taxation, according to MMT.
My hunch (which I cannot prove — perhaps this is a weak point?) is that the amount to be removed will be around the same order of magnitude as the original stimulus. To be fair, you guys **do say** that tax increases will be required at times to absorb excess demand, but I’m under the impression that you’re underestimating the magnitude of the necessary increases. This is because I believe you are imagining that the banks will simply let excess reserves pile up forever in zero velocity, non-interest bearing reserve accounts at the Fed. I don’t know for sure that’s what you’re thinking, so correct me if I’m wrong, but it is the impression I’ve gotten from the various readings I’ve done here and over on Billy Blog.
In non-MMT, conventional terms, this removal operation through increased taxation would cause a “budget surplus”. Thus, the “budget” will more or less be in “balance” over the course of the business cycle (using non-MMT terms in scare quotes). Deficit spending during downturns, excess taxation to produce surplus during the good times.
The thing is, this is the **same** conclusion I would have come to using a more mainstream, non-MMT analysis.
So, while MMT has provided a new and interesting way of breaking down the problem, I’m not really sure we’ve ended up any place different.
Sticking with an MMT perspective, if we want to run net deficits over time, we still need to issue debt. From an MMT perspective, this debt is to give the excess reserves generated by deficit spending somewhere to go to earn a safe, positive rate of return, while bringing their velocity down to zero. That’s how inflation is avoided. The purpose of this debt is not to provide operational funding for the Govt, because the Govt doesn’t require funding under MMT axioms.
The critical point where I seem to differ with everyone else is that I **do not believe** that excess reserves will sit happily at or near zero velocity in non-interest bearing Fed checking accounts once the publicly subsidized, interest bearing alternative (T-Bills) has been removed from the equation. If that were the case, there would be no need to issue debt. I believe, however, that those funds will seek some return, and velocity (and thus potentially inflation) will be imparted to them as the private sector moves to fill this need.
Sticking with an MMT perspective, if we want to run net deficits over time, we still need to issue debt. From an MMT perspective, this debt is to give the excess reserves generated by deficit spending somewhere to go to earn a safe, positive rate of return, while bringing their velocity down to zero. That’s how inflation is avoided. The purpose of this debt is not to provide operational funding for the Govt, because the Govt doesn’t require funding under MMT axioms.
The critical point where I seem to differ with everyone else is that I **do not believe** that excess reserves will sit happily at or near zero velocity in non-interest bearing Fed checking accounts once the publicly subsidized, interest bearing alternative (T-Bills) has been removed from the equation. If that were the case, there would be no need to issue debt. I believe, however, that those funds will seek some return, and velocity (and thus potentially inflation) will be imparted to them as the private sector moves to fill this need.
Ken, according to MMT, the reason to issue debt is monetary not fiscal. The government issues debt to drain excess reserves so the Fed will be able to hit its target rate. According to MMT, it the government ceased debt issuance, the Fed could also hit its rate by paying interest on excess reserves equal to the target rate.
There is nothing in MMT that says government issues debt “to give the excess reserves generated by deficit spending somewhere to go to earn a safe, positive rate of return, while bringing their velocity down to zero,” thereby avoiding inflation. That’s your idea, not anything implied by MMT.
There is nothing to suggest that these funds would be deployed unusually if Tsy’s ceased to be issued. Some comparable option would draw them depending on preferences. There is no financial or economic reason to expect any kind of “wild” behavior resulting. If the preference is currently for low risk, highly liquid instruments, the expectation is that this preference would remain, and comparable vehicles would be substituted for Tsy’s — without the public subsidy.
One could argue along your lines that the cessation of Tsy issuance would result in greater investment, increased growth, more employment, and greater prosperity. Except there is no good reason to posit this either. Lots of things could happen. But what is most likely based on evidence. The best evidence seems to be current preferences as demonstrated by current behavior.
I appreciate your playing the devil’s advocate here and getting us all to think this through, but I think you have backed into a dead end. I don’t see any evidence to support your hypothesis. It’s much more likely that some variant of the status quo would result.
Finally, although the Fed might let the overnight rate go to zero, it might also decide to hang on to its ability to set the rate. Therefore, interest would need to be paid on reserves to keep the rate from going to zero. I suspect that this is the most plausible scenario if debt issuance were terminated.
“Finally, although the Fed might let the overnight rate go to zero, it might also decide to hang on to its ability to set the rate. Therefore, interest would need to be paid on reserves to keep the rate from going to zero. I suspect that this is the most plausible scenario if debt issuance were terminated.”
Yes – it’s a very plausible scenario. However, as I see it, a policy of paying interest on reserves is ***exactly the same*** as a policy of issuing T-Bills! Just in a different disguise. So now we have an interest bearing checking account, which is an exact replacement for the savings account the Govt took away when it stopped issuing T-Bills.
So, the U.S. Govt is still making interest payments to the same sorts of people who would have previously held T-Bills … bankers, foreign central banks, etc. Doesn’t really matter that it’s technically the Fed doing it, not Treasury. As I’ve often heard here, it’s not really all that important in the scheme of things what pieces the U.S. Govt wants to divide itself up into.
Ken
Yes, that’s why I oppose this option. But it has the positive effect of breaking the illusion that debt finances spending, and that would be a step in the right direction. So it’s better than leaving the status quo in place.
Yes, I suppose that if it changes the terms of the political debate, and helps people reason about these issues differently, it could be worth a try … even though it doesn’t change the underlying reality.
Ken
The other reason I would rather see the Fed let the overnight rate go to zero is that I think that interest rates are best left to the private sector. The Fed should not be using monetary policy (interest rates) to target inflation, while using unemployment as a tool. Well-designed and managed fiscal policy avoid this waste of output capacity and human resources in the name of “fighting inflation.”
Adding together the cost of interest payments as a public subsidy and foregone opportunity and human degradation caused by inflation targeting, the amount over time is huge — and unnecessary.
Pretty much agreed. I’m just not sure we can avoid the interest payment part if we want to run large sustained deficits/debt over the long haul. For technical reasons … not because I like it 😉
Ken
“There is nothing in MMT that says government issues debt “to give the excess reserves generated by deficit spending somewhere to go to earn a safe, positive rate of return, while bringing their velocity down to zero,” thereby avoiding inflation. That’s your idea, not anything implied by MMT.”
You are right … it is my idea. But I believe that it is a theorem that one can derive using the core axioms of MMT and rational expectations of how banks and the financial industry will behave if deprived of their current options. That is what I’ve been trying to show.
“There is nothing to suggest that these funds would be deployed unusually if Tsy’s ceased to be issued. Some comparable option would draw them depending on preferences. There is no financial or economic reason to expect any kind of “wild” behavior resulting. If the preference is currently for low risk, highly liquid instruments, the expectation is that this preference would remain, and comparable vehicles would be substituted for Tsy’s — without the public subsidy.”
Well, what I’ve been trying to show is that there’s a big difference. When the funds get used to buy T-Bills, they go to zero velocity. For reasons I’ve laid out, when the private sector tries to create their own version of a low risk, highly liquid instrument, it can’t possibly work like a T-Bill in this respect. The funds will circulate through the financial sector and the real economy in the latter case. In the former (T-Bill) case, they won’t. They become inert with zero velocity (yes, I know you’re not buying that right now, but to me the logic seems irrefutable … so I’m thinking maybe you will buy it after you’ve thought about it some more …). I think that could make a significant difference.
“I don’t see any evidence to support your hypothesis. It’s much more likely that some variant of the status quo would result.”
Yes, but where’s the evidence to support yours? Where has this idea of not issuing debt (or paying interest on reserves as an equivalent substitute) while continuing to deficit spend been tried to good result? I’m happy to examine the evidence if there is any…
Really, it seems like we’d be entering a brave new world here, with little but these thought experiments to go on. Unless, of course, we pay interest on reserves … then we’re back to exactly the same place we are now, just with the furniture shuffled around a bit, as I indicated in one of the replies above.
Ken
Well, generally, it is supposed that like behavior will continue unless there is a reason to suppose it won’t. Behavior is rather inertial in this regard. I don’t think you have presented a compelling case that it would shift course.
Really I assume the same behavior as always … profit maximization … also known as greed 😉
The nature of the available instruments change, so the manifestations of this behavior also change. That’s all.
Ken
I don’t know if you’ve read Gary Gorton’s papers on the financial crisis, such as this one:
Only tangentially related to this discussion, but I learned a lot about the “shadow banking sector” from him, and it definitely influenced my thinking on these matters.
Ken
According to Hyman Minsky, stability breeds instability. That’s why static regulations and controls don’t work. They have to be dynamic and adaptable, because the cheaters are. It’s an unsolvable problem, but that doesn’t mean that the cheaters should just be left to their own devices or that the foxes should be allowed to run the hen house.
These are separate issues in my view.
The critical point where I seem to differ with everyone else is that I **do not believe** that excess reserves will sit happily at or near zero velocity in non-interest bearing Fed checking accounts once the publicly subsidized, interest bearing alternative (T-Bills) has been removed from the equation.
Ken, I believe you need a consultation with Dr. Fullwiler. :o)
This paper has discussed how interest payment on reserve balances could both simplify monetary policy operations of the Fed and free the Treasury and the Fed from selling bonds to support the Fed’s interest rate target.
“Paying Interest on Reserve Balances: It’s More Significant Than You Think” http://www.cfeps.org/pubs/wp/wp38.html
Yes to echo Beowulf here Ken and Tom (just to reiterate (for other readers) that the Fed is now paying interest on both required and excess reserves of 0.25%, the 30-day bill rate is 0.14%.
Right now they pay at the FFR 0.25% but when they started this policy they paid at FFR minus 0.75%. (ffr was at 1.0% then)
so if the US govt was to let all the outstanding approx $7T of Treasury bonds just be redeemed and sit as excess reserves today, 7T x 0.0025 = 17.5B (mere bag of shells!) the Fed would renumerate to the banks annually. I suppose they wouldnt need an appropriation to do this? The Fed could just credit the accounts of the depository institutions for the 17.5B under authority granted to them by the Federal Reserve Act in their conduct of Monetary Policy. Then just tell the banks that they cant do anything with excess reserves other than receive the Feds renumeration rate on them. (doesnt say “life, liberty, and the pursuit of banking”).
Resp,
Matt, I believe this is correct. The interest on the debt goes on the Treasury’s book. It’s a standing appropriation that doesn’t have to be specifically approved annually. However, Fed operations are FRS charges, and this doesn’t require budgetary appropriation. That’s one reason that monetary policy is preferred to fiscal policy. Politically, it’s less messy.
Wow, $17.5 billion interest charge on a $7 trillion debt, you could fund that with customs duties! ($23 billion this year). Is there a reason that the IOR rate (.25%) is higher than the 30 day rate (.14%)?. If the IOR rate was .14% on a $7 trillion debt, Interest charge is $9.8 billion. That’s about what the Dept. of Interior collects annually in oil and gas lease revenue.
Of course if, as Warren has suggested, the Federal Funds market was replaced by the discount window, the interest revenue from overnight market loans would go to the Fed (and thence to Tsy).
It seems we agree that some method must be employed to inert these funds and stop them from circulating freely in the economy.
One method is issuing Govt debt … if we stop doing that, having the Fed pay interest on reserves is a viable alternative, but really amounts to the same policy.
I’m skeptical that the Govt would be able to effectively freeze that amount of money while paying only .25% without significant leakage, especially in a recovering economy. Seems more likely that they would have to pay something similar to what they pay now in the form of T-Bills.
I’m not sure what the effect of a mandate would be …. telling the banks that this is their only option, as you suggest. Maybe that would work, but I have to wonder how the entire system would morph in response to such a regulation. For example, would the banks continue paying interest on depositor savings accounts if they didn’t feel they were getting sufficient returns on their excess reserves? Would they loose incentive to continue taking deposits at all? Would consumers start moving funds to the non-bank financial sector … etc, etc. I have no idea what would happen, but I suspect attempting to address this problem simply by making a rule would elicit some kind of response that needs to be studied.
Bottom line is I’m still skeptical of the notion that long term deficits/debt can be maintained without doing something similiar to what we’re doing now, either via T-Bills or via Fed interest payments. The prevailing opinion here seems to be that we only pursue these policies because the people in charge are either ignorant (guilty of ‘innocent fraud’) or perhaps in some way corrupt. Well … maybe, but then again … maybe not.
I’m always skeptical of those who claim special knowledge or insight that proves the consensus wrong. I’ve learned a lot about fiscal and monetary policy from trying to think this through … just as I’ve learned a lot about climate change science by considering the claims of the skeptics. Now, I’m not ready to say you’re as wrong as they are (and maybe this is a horrible analogy), and sometimes the consensus **is** in fact wrong. But I consider the idea that we can continue to run large deficits without issuing something that resembles Govt debt, however configured, to be an extraordinary claim. For me at least, case not proven. However, I’m still listening.
Ken
Ken, everybody respects your feelings and hunches but they are much more about quantity theory of money than about MMT and reality. In Japan 5Y swap rates, i.e. not even riskless government, have been about 1% for more than 10 years. Yet private sector has not come up with a super-duper instrument to recycle this “free” money in some yield chasing way. And inflation has not poped out on the radar screen. So while your gut felling might be telling you something you should also try to reconcile it with the world out there. 500 years ago everybody’s gut feeling was that earth is fixed and sun goes around it. We all know where it ended up
“Well, generally, it is supposed that like behavior will continue unless there is a reason to suppose it won’t. Behavior is rather inertial in this regard. I don’t think you have presented a compelling case that it would shift course.”
Well, generally I do assume the same behavior … profit maximization … also known as greed.
My argument is that the nature of the available underlying investment instruments change under the scenarios discussed here, which provides further opportunities for the human and institutional actors to do what comes naturally …
Are you familiar with Gary Gorton’s papers on the financial crisis? Only tangentially related to our discussions here, but I learned a lot about the “shadow banking system” from him. Here is the simplest one, but you can search for more:
The Failure Mechanics of Dealer Banks – Duffie http://www.stanford.edu/~duffie/dealers.pdf
Also check the “Are Brokers Broken?” (Sep 2008) by Citi in the references if you can access.
the lower rates that make borrowing more attractive are the same lower rates that take income away from savers.
and there are maybe $13T more $ saved than borrowed as the cumulative national debt = net financial assets for the non gov sectors.
so think of yourself as ‘the economy’ going to the bank for a loan. Yes, interest rates are down, but so is your income. Maybe the income is more important?
the lower rates that make borrowing more attractive are the same lower rates that take income away from savers.
That may be so, but high interest rates add to production costs, reduce real fixed capital investment and slow growth of productivity. If you were a business producing, you would pass on the increased interest charges onto your products which would result in increased inflation. Hypothetically speaking if the interest rate was 50%, savers would be delighted but business has to service that interest rate.
and there are maybe $13T more $ saved than borrowed as the cumulative national debt = net financial assets for the non gov sectors.
so think of yourself as ‘the economy’ going to the bank for a loan. Yes, interest rates are down, but so is your income. Maybe the income is more important?
I’m not sure take the following historical graph of the BOE interest rate since its inception side by side with UK inflation, the BOE held its interest rate at 5% for 103 years. And you get bouts of inflation/deflation ranging from +30%-20%. Its only in the latter half of the 20th century do you see hugh interest rates by historical standards, due to inflation targetting. What made them think that they could control inflation with interest rates? The result was stagflation.
BUTTTT is fueling America’s cheap throw away world destroying appitite for junk a good idea?
Oh, please. What you see as junk, somebody else may value, and what you value, somebody else may see as junk. As for “world-destroying,” if there is an externality that is not accounted for in the price of some outlandish, imported tchotchke, then propose a targeted tax to cover it (or a recycling deposit).
http://news.yahoo.com/s/ap/20100415/ap_on_re_la_am_ca/cb_atlantic_ocean_junk
point taken.
but unemployment isn’t the answer either
Warren, what is so terrible about having 1 spouse stay at home unemployed raising several kids? A nation cannot survive by 100% employment alone, someone actually has to procreate and then raise the children. Warren, were you raised in daycare or by a nanny while both your parents worked? Or did you have a parent that gave up some job or worktime to spend some quality time at home parenting you? Also your children Warren, did they get raised by daycare or a nanny or did you or your spouse stay at home some and not work all the time?
The problem is that most care and household work has no monetary worth ascribed to it, so not doing it (and working somewhere else instead) turns out to be a FINANCIAL benefit just as importing a poor sod to do it for $3/h. More hours are spent doing unpaid household chores, child minding and other voluntary care work than all paid work put together. Before we manage to factor in this work (which will inevitably be to the disadvantage of what is now paid work) the reasons for preferring one over the other, both on a macro and personal level, are clear. It’s something I’d like see more economists address. It’s never even mentioned – just taken for granted.
Oliver, Bill Mitchell has addressed this issue.
these are all political choices. our institutional structure now treats children as expenses rather than investments, with the obvious results.
Absolutely, and before we start trading child default swaps to hedge against ADHS we might want to plan the financialisation of procreation carefully.
Not sure if this is the right forum, but it’s a good point. Haven’t taken the time to look into the detail, but it seems to me up here in Canada we recently changed federal tax rules or maybe it was pension…details details…to have a more progressive view on the the value of being a stay at home mom/dad and adding actual monetary value on the time done for work/ child rearing. All that to say, it’s not impossible for governments to address this, albeit one small step at a time.
Most “progressives” don’t see making life easier on stay at home moms as being a good thing – forcing women out into the workplace (whether they want to be there or not) has been a long time goal of feminism…
Good points Jim.
Far right conservatives are most supportive of women staying at home and not working. There are positive externalities if many (all) women are not in workplace–they can get help from each other the way they did pre-1970s.
Feminism, and Progressive movement, undid this for better or for worse. And they also introduced the unmarried welfare mother (only for worse)
well me thinks you are doing a bit of a pop-culture twist of the feminist movement because it was not about forcing women into work camps it was about empowering women to make choices for themself and changing institutional powers to enable equal opportunity if a woman chose to have a career. True feminism never faulted a woman for choosing to stay home and raise her kids..it just so happens that conservatives (largely of the religous vein) like the thought of that also. The problems lie in the institutional thinking of what is value and of course value today is perceived as something that makes a profit and that’s what the point was about.
Jason M:
Feminist writings are available for everyone to read and make up own mind. Like many Progressive movements, they try to have it both ways–true feminists are like true scottish and their porridge.
problem lies with institutional thinking that all people are the same.
I have had family and friends run into this problem regarding insurance claims. The stay at home spouse – man or woman – who worked themself to the bone raising the kids and handling matters of the home (groceries, clothes washing, house cleaning – etc etc – basically the work of a STAFF of people in some countries) got in a car wreck. They could no longer do all those duties and needed to hire some people to do it for them temporarily until they healed. The insurance companies said they did not do paid work, so they are not getting any money, so the households in some cases collapsed into ruinous destruction – very seriously hurting the children. In some cases the man was the stay at home spouse domestic goddess, so it is gender neutral. I like warren’s policies, We really have to start walking in the shoes of the common man and try to do things from the ground up, this top down approach doesn’t seem to be working. Obama just signed a new bill that will reduce the payroll taxes of employers, but it is not giving a a payroll tax break to the workers, we are destroying our seedcorn. I hope in the future we can find a way to value and compensate this WORK that is being done. What about 8 an hour for stay at home spouses whose only job is to raise kids and shop for groceries and wash clothes and such?
Tom, could you post a link to Bill’s post or are you referring to a scientific paper or book of his? Thanks.
Oliver, I can’t recall offhand where Bill mentions this, but I recall seeing it. If you want to follow up, head over to billy blog and send him a message through Contact (in the right column at the upper left).
“The real question about industrial policy is not whether it should be practiced, but how. Here are three important principles to keep in mind.”
http://www.project-syndicate.org/commentary/rodrik42/English
Instead, the US gets bailouts and other public goodies to FIRE that promote financialization.
Interesting stuff. I’m a history buff and watching The Pacific on HBO (Spielberg’s Marine Corps version of Band of Brothers) has got me reading more about World War II lately. I just learned that one of the founders of the European Union, Jean Monnet (best known for rebuilding the postwar French economy with Indicative Planning) actually spent a couple of years helping Uncle Sam plan its wartime economy while his homeland was occupied by the Nazis. He also coined FDR’s famous description of the United States as “the Arsenal of Democracy”.
http://en.wikipedia.org/wiki/Indicative_planning
If you discount the 20% LaRouche insanity factor (man, does that guy hate the British), this article about Monnet and FDR by a French disciple of Lyndon LaRouche seems to be fairly accurate.
Quoting Monnet’s memoirs :
“We [he and his close group of friends] decided to reverse the logic of the financiers, who accommodate needs to existing resources, absurd logic when the needs are those of the survival of the free world: for such an undertaking, one always manages to find the resources”.
http://www.schillerinstitute.org/fid_97-01/002-3_monnet.html
well that’s a tough go over there on Huffington Post…I did my best (I am bohemiangrooves on that site) but man, there is much hostility. The labels are killer…are you a bankster? a tea partier? Red stater? It seems the labels preclude any serious discussion about operations and economics. Sad really, also a reason I like coming on this site as the discussions are (98% of the time) informative and polite. Quite refreshing these days!
And not just on Huffpo Jason. Winterspeak and others have tried their best at Megan McArdle too. It is like brick wall.
And even when you have receptive audience (like Nick Rowe) you get exactly nowhere.
I have a question.
In your banking analogy, the point at which China moves their deposit from “savings” to “checking” is exactly the point at which mainstream analysis would say “money has been printed”. Because what is happening here is that the Chinese Central Bank has decided not to rollover its Treasury Bond holdings, but demand payment instead. The Fed pays them by creating the checkable deposit ex-nihilo.
Your analogy makes this sound like it’s not a big deal, and maybe it isn’t. That’s what I’m struggling to understand. If it is true, that would mean that T-Bills are pretty close to being money already, so that trading one for the other really doesn’t make that much difference in terms of the inflation this action will or will not produce. In that case, I’d expect T-Bills to be included in some measure of the money supply, such as M2, or M3, but as far as I can tell, they are not. How come?
It may be that I’m still laboring under a Friedmanite “Quantity Theory of Money” paradigm, and that this is part of the problem. I’ve read all of your “Mandatory Readings” already, but I’m still puzzled by this.
Thanks!
Ken
As far as I’ve understood, the story re China (and other private or foreign entities) goes something like this: the only way for them to get their hands on T-Bills is by paying for them with their money which by definition has already been created ex nihilo by government. They then get back the exact same amount plus interest once the bill matures. So there is no net change in the system through any of these transactions except for the amount of interest – hence the savings account analogy.
As for not measuring T-Bills as money, I assume this can be traced back to gold standard times in which the amount of money in circulation was more or less predefined. Bonds and money had to net out to zero much the same as all private credit nets to zero, even under a fiat system. Under a (real) gold standard the net creation takes place at the gold mine and government is in debt to this entity to the extent it spends / prints / whatever. T-Bills constitute a real liability that is redeemable in gold with interest. This is where the inter-generational debt argument comes from. Fractional reserve banking under a gold standard is an intermediate step with some fiat features which allow government to influence the amount of money by changing the reserve requirements (as opposed to mining more gold). Arguments with Austrianites usually get stuck somewhere in between these two. Under a pure fiat system the accounting is reversed. Government becomes the paper gold mine and can define the amount of base money in circulation. The gold constraint ceases to exist. Debt issuance become an operational frill because debtor and creditor are on the same level and thus not revenue constrained, so future solvency is a non-issue. The only remaining constraint is inflation.
Too many politically connected people have told me the dollar is truly based on oil, and a yuan revaluation and china in general is such a small issue compared to that.
UBS’s head of Asia-Pacific economics argues that the real global trade imbalance isn’t U.S.-China, it is U.S.-oil. As shown below, current account surpluses from fuel exporting-nations have been a far larger driver of total global trade imbalances coming from emerging markets.
China’s current account surplus (in blue) has been large in recent years, as a percentage of the global economy, but it has been dwarfed by fuel exporters (in green):
Read more: http://www.businessinsider.com/china-trade-imbalance-usa-oil-2010-4#ixzz0lD8rBi91
money is not based on the gold standard, nixon broke that – now it is based on a Black gold standard, cause that MT900 can’t go vroom vroom without some 🙂 How does the fed print up oil?
How does the fed print up oil?
That’s what the military is for.
Tom! Nailed it!
prices are a function of buyers and sellers coming together. if china’s funds are in their reserve account or their securities account there is no further effect on anything from that. it’s when they, or anyone else, spend those funds that they can drive up prices. and when they sell real goods and services that keeps prices down.
so china just selling to us keeps prices down, and real goods and services flowing from them to us, and them not spending their dollar financial assets means they have no further economic impact.
So, to the extent our ‘debt’ is held abroad, either as dollars or bonds, doesn’t this represent a kind of inter-generational wealth transfer?
In other words — if 30 years from now the foreign sector decides to divest itself of its dollar surplus and demand real goods and services instead, our children’s generation will be forced to sacrifice their own standard of living in order to export real goods and services abroad (assuming an otherwise full employment economy).
Kent, this is a consequence of the present generation having consumed those goods, and foreigners postponing consumption. This is just an exchange of goods in trade, and, yes, it can be intergenerational. The present generation can commit future generations through its present consumption.
first, they have the right to buy from willing sellers at market prices. They can’t ‘demand’ anything.
Second, yes, if they do spend their $ that will represent a transfer of real wealth from us to them. Of course, our fearless leaders would call that a ‘success’ as they are now on a proclaimed effort to ‘double US exports’ to ‘balance trade’ and ‘create jobs.’
Third, we control the foreign funds which exist only as data on the fed’s computer. That means they are vulnerable to a ‘computer virus’ for an extreme example, that resulted in ‘loss of data.’ They are also vulnerable to a lot of other things, if we decided we didn’t want to export. These could include export taxes and other monetary penalties for exporting.
Point is, we hold all the cards. we have the goods and services to consume and they have data on our computer.
which side of that trade would you rather be on?
OK – that’s a good answer.
Are there any downsides to your policy framework? For example, if the business cycle as we know it is eliminated, and we have a full employment economy all of the time, will this allow inefficient enterprises to limp along far past their useful lifetime? If so, would this imply decreasing productivity for the economy as a whole over time?
In other words, are periodic downturns necessary for the long term health of the economy much as wildfires are to the ecology of a forest?
That’s kind of a big question, so if you’ve already answered it somewhere else, please let me know 🙂
Ken
P.S. From what I gather, my question may reflect the “Austrian” POV … I’m not trying to advocate their viewpoint (which I only partially understand) … I’m really trying to figure this stuff out.
business cycle still happens. businesses that don’t get it right lose. just that the $8 job and agg demand management means other business will emerge to compete for the consumer dollars and unemployment as we define it always remains relatively low
Thanks for answering my questions.
Here’s another one:
With full employment by definition (because of the job guarantee), we would no longer have the Phillips Curve trade off between unemployment and inflation.
Is there another relationship which will replace it as government spending gets close to the limits of productive capacity?
Ken
the trade off will move to the size of the elr pool vs ‘inflation’ depending on how we define ‘inflation’
If deficit spending were to occur without issuing T-Bills, there would be a buildup of bank reserves instead of a buildup of “Treasury debt”, correct? Would this money just sit idle, or would it try to seek some rate of return, like in the shadow banking sector, or inflating some other asset class?
Is this a legitimate concern? What would be the solution — having the Fed pay interest on reserves? Seems that would amount to the same thing as issuing T-Bills, just in a different disguise.
Ken
Ken I wish the government would pay me to borrow money
That is the interest rate that JPM had to pay for Fed Funds i.e. for money borrowed from the Federal Reserve.* The number is –0.05%. That’s right, negative 0.05% for what were $271.9 billion in repo liabilities. That’s unbelievable!
You can see how the yield spread has steadily increased over the past six years to where JPMorgan Chase is now making a spread that is 1 1/2% greater than it was in 2004.
Moreover, the interest it has paid on repos has plummeted. Fed Funds rates started coming down in mid-2007 when the subprime crisis blew up, but they fell off a cliff after Lehman hit the wall in September of 2008. As of Q1 2010, JPMorgan Chase was being paid to borrow $271 billion. Talk about free money! I sure wish I could get a deal like that.
http://www.nakedcapitalism.com/2010/04/jpmorgan-gets-paid-to-borrow-271-billion-from-the-government.html
it would just sit idle in the sense that if anyone spent theirs it would show up in another reserve account.
there’s no problem with this.
reserves are functionally nothing more than one day tsy secs.
yes, if the fed wants a positive interest rate target it can simply pay that rate on reserve balances
Right now, if a bank holds excess reserves, it can lend those funds in the inter-bank market, or it can buy T-Bills. That’s my understanding of their options, anyway.
So, my question is: Lacking those options, is there something else the bank can try to do with those funds to earn a return? Or is that pretty much it?
For example, if they were able to buy commercial securities of a certain quality with that money, there could be an effect on those markets. Or are they prohibited by law from engaging in such activity?
Ken, think of reserves as liquidity for interbank settlement. Reserves are never “spent” into the economy. Transactions involving interbank settlement are settled in reserves, and banks either have to have the reserves on account at the regional Federal Reserve bank with which they deal, or borrow them in the interbank market or from the Fed.
Banks can conduct any operations in the economy that bank regs permit, and they have to settle up with reserves. It is the profitability of transactions that counts, not available reserves, and banks engage in transactions based on risk in relation to return, not whether they have excess reserves. If they don’t have excess reserves then there is the interest cost.
But if they have excess reserves they can loan them to other banks that need them. If they can get more in Tsy’s then they can in the overnight market, then they may choose to park them there. Right now, the Fed is paying interest on excess reserves, so they are like T-bills.
Rest assured that banks are always figuring how to generate maximum return on capital commensurate with risk. Juggling reserves is just one of the many factors. To a bank dealing with large sums, even a very small amount of interest overnight adds up over time. Banks are well aware of this and take advantage of it. If they see better opportunities, that’s where they will go. In fact, the biggest banks make the most on prop trading these days, where they can maximize return through leverage.
yes, they have those options, but that merely shifts the reserves to the bank they are buying the tbills from or lending the reserves to. total bank reserves remain unchanged.
without interbank markets there is no interbank lending to move reserves from bank to bank, but banks can still buy things which does same.
the buying and selling of secs alters the prices of those secs but total reserves are unchanged
What I’m trying to work out in my head is whether the build up of bank reserves with no corresponding issuance of treasury debt truly has no inflationary consequences (assuming the economy not over capacity at the time of initial spending).
With no more T-Bills to buy (because the government stops issuing them) and no more interbank lending market (because every bank has more than enough reserves and the fed funds rate is 0), the banks will presumably try to earn some return on this money.
Perhaps they will lend it via the overnight repo markets … the so-called “shadow banking sector”. The investment banking sector will borrow this money short term via the repos and lend it out long term for all sorts of things, trying to make a profit. Wouldn’t this massive influx of funds lead to all sorts of assets bubbles and/or CPI inflation? Why or why not?
This isn’t my field, so let me know if I’m typing gibberish 😉
Reserve do not influence the decisions banks make about entering into profitable transactions other than through interest charges on borrowed reserves. The reserves are for settlement. There will always be an interbank market for settlement and reserves will be required for clearing.
Even though there are more reserves in the system, they won’t be evenly distributed all the time. Some banks will likely still need reserves for settlement.The Fed will continue to be the lender of last resort for banks that may be short reserves at the end of a particular settlement period and the discount rate will apply.
The question is whether the CB decides to maintain control over the overnight rate by paying interest on excess reserves, or lets it go to zero.
If deficits were no longer required to be offset with debt, the Treasury ceased issuing securities, and the Fed decided to let the overnight rate go to zero, then interest rates would be endogenously determined, that is, by market forces. The financial sector might actually prefer to continue to have an exogenous benchmark for short and long term rates on risk free instruments, so it might be that Treasury and Fed decide to accommodate this. The Treasury could still issue some Tsy’s along the curve without the need to offset the deficit. Moreover, the government might decide that it is in its interest to retain control over interest rates to some degree instead of letting rates be determined solely by markets.
The amount of reserves simply affects overnight rates, not banks’s decisions on operations, which are determined based on risk/return and availability of bank capital. It really doesn’t matter whether the bank holds reserves or Tsy’s, since Tsy’s can be converted to reserves immediately. Holding Tsy’s just adds some interest, while increasing the government deficit. That’s a gift of a claim on real resources to the banks that it’s really necessary for operations, and it could be eliminated.
Maybe the way to think about this is in terms of your own savings and checking accounts. Are you more likely to spend if you have funds in a checking account rather than in a savings account? Most people aren’t, I would think. Especially now with Internet banking, most people probably keep most of their funds in their savings account and just transfer what they need to cover their checks into their checking account as necessary. All that is needed now is few key strokes. If there were no savings accounts, would people therefore spend more just because it was in checking? They would likely just look for another place to earn some interest, like CD’s or securities of another country, instead of spending more.
Of course, if governments generally stopped issuing debt, that would change the financial picture considerably, because that’s a huge pile of funds that would have to park somewhere else. This is probably more to the point of what you are asking. Where would it go, with no risk-free place to park at interest? Corporate bonds, equities, other financial instruments, and productive investment are the options. Probably more would be invented.
Thanks Tom. That last paragraph, and last sentence of the previous paragraph, is exactly what I’m trying to get my head around. Wouldn’t this huge and increasing pile of funds cause significant asset and possibly CPI inflation as it looks for a place to park? If so, running deficits without issuing debt wouldn’t be completely benign, right?
Ken
Ken the essential point, which Warren makes clear in his comment, is that eliminating the deficit offset requirement and debt issuance will not increase nongovernment net financial assets and therefore will not be inflationary, since it simply eliminates the ability to switch from one asset type (reserves, cash) to another (Tsy’s).
In fact, eliminating debt issuance would also eliminate interest payments, which would also eliminate the increase in NFA that this disbursement would have involved in the case of debt issuance. So instead of increasing inflation by increasing NFA, eliminating debt issuance decreases “government spending” and deficits, since interest payments are government disbursement that increase nongovernment bank accounts and get charged to the Treasury’s book.
If the option to buy Tsy’s were eliminated, then other options would be exercised in the markets, based on risk/return, if the preference were against holding non-interest bearing reserves/cash. Really, the only difference is that the publicly subsidized parking place would be gone. Were this to come to pass, markets would deal with it in ways that are based on market principles.
Moreover, if people realize that debt issuance is unnecessary to finance deficits in lieu of increasing taxes, they would also come to realize that the interest payment of the debt is subsidized risk-free parking place that transfers claims that the public has on real resources through currency issuance to the recipients of these payments. This is essentially a form of the “redistribution” that the right bemoans so loudly.
Viewed in this light a publicly subsidized risk-free parking place is a form of “welfare,” or “waste.” So those on the right should be for this, and I suspect that the center and left would support it, too. That’s just about everyone, if the truth comes out and enough people get it.
Wouldn’t this huge and increasing pile of funds cause significant asset and possibly CPI inflation as it looks for a place to park?
Here is another way to look at it very simply. Suppose that banks eliminated interest-bearing saving accounts and left CD’s in place. People would have the option of switching the funds in their savings accounts into their non-interest bearing checking accounts or into CD’s. This is just a switch between forms of holding financial assets, so nothing really changes but the type of account, along with the interest associated with the account type. nothing either complicated or inflationary here. Canceling savings accounts is very unlikely to result in a rash of spending for no other reason, for instance. Neither the amount of money or its velocity changes due to these switches among account types.
Now suppose the government eliminates debt issuance. The option banks now have of transferring reserves to Tsy’s, and individuals and companies of transferring cash to Tsy’s, similar to transferring funds from a deposit account to a savings account is no longer available. But government doesn’t issue CD’s. What to do?
Individuals and firms could transfer cash to CD’s at their bank instead of buying Tsy’s, and banks would respond to this government action by offering competitive options. Banks, however, would not have this option, and they would have to either hold reserves or look for non-government interest-bearing instruments if they didn’t want to hold reserves. Individuals could do the same, since they would have the same options. All that goes is the asset form of Tsy’s. There are plenty of other options from reserves/cash to junk bonds depending on risk appetite. At any rates, it’s just different “boxes” for holding assets, some riskier than others in return for higher interest payments. All that disappears are the boxes with government subsidies for risk-free parking.
This is an important question politically, Ken. I am glad that you asked it, and that I got to think about it.
In any case, the private sector would evolve mechanisms for dealing with the new conditions. This can be viewed as another form of “privatization.” The right would like that, too.
Thanks Tom.
I guess it’s the “private sector evolving mechanisms” that I’m concerned about. This is, after all, where mortgage backed securities and other fancy instruments came from.
Warren says below that these reserves have no where else to go, so they’re nothing to worry about. I’m having a hard time seeing why, unless he’s talking about some sort of regulatory regime to make this a matter of law. We’re talking about a **lot** of money here, so there is an enormous incentive to achieve even a small rate of return in some vehicle that the banks at least **believe** to be safe (we’ve seen that movie). As you say, the financial sector will be only too happy to innovate to accomodate all of these funds looking to earn interest … that, in my naive view, is the danger.
Also, there are the non-bank investors who formally held T-Bills that will now need new innovative financial products to invest in to achieve their goals.
Even if these innovative financial instruments work as advertised next time, and there is no fraud or bad assumptions involved, the end result of employing them would be to direct funds to someone, somewhere in the real economy to do something. In the case of MBS, that “something” was to build houses … who knows what it will be next time. Hence my concern about various asset bubbles or other forms of inflation.
So … even though the banks aren’t “operationally constrained” by their reserve positions when I walk in the door and ask for a car loan, their attempts to earn interest on their excess reserves via private sector provided innovative investment vehicles has to show up in the real economy somewhere. So they are, in effect, through the use of intermediates with more risk appetite, making these funds available to “other than well qualified borrowers”. This isn’t the case with T-Bills … money used to buy these gets (metaphorically) shredded, as you guys have made clear, so we don’t have to worry where it ends up.
So it seems like this would be a very dangerous experiment to me … has this been studied, does it need to be, or am I just out to lunch?
Ken
Ken, I don’t know that eliminating debt issuance, and therefore the public subsidy for risk-free parking, complicates the issue all that much. There is already a “giant pool of hot money” out there looking for the next promising vehicle to rush into. As you say, a lot of the securitization that resulted in the crisis was to service that giant pool looking for even a small advantage in risk/return. And, yes, we see how well that went, when Wall Street attempted to service that demand with dodgy products and misrepresentation of risk, aided by complicit ratings agencies.
What we need is comprehensive reform to prevent a repeat of that experience, regardless of whether debt issuance would be eliminated. There are already trillions out there looking for the next best thing, and many minds are busy trying to provide it. So I don’t think that’s a good reason to continue the subsidy.
Better to reform the system and establish adequate oversight. That’s why there are independent audits in business and finance. But there have to adequate penalties as well. And there has to be real accountability, with the prospect of jail time for those tempted to break the rules. But even though Skilling (and Martha Stewart) went to the pokey, others were not deterred. This has to be a real threat — not just a scapegoat here and there, but otherwise a double standard in the law.
As Minsky observed, there is no magic bullet regarding regulation or reform. There will be a bevy of lawyers looking for loop holes, and crooks are in abundance where there’s money. It’s a matter of staying out in front of the crooks and sharks instead of lagging behind, or even not bothering to look or do anything about it.
Warren has already set forth his proposals for reform. It also comes down to incentives and disincentives. The incentive structure in finance is just wrong. As Joseph Stiglitz observes in The Non-Existent Hand, the purpose of the financial sector is to “manage risk, allocate capital, run the payments mechanism, and all at a low cost.” Everything else is essentially froth and should be eliminated as socially useless, especially if it potentially harmful. Markets are not supposed to be casinos. Issuing or not issuing debt doesn’t really impact this as far as I can see. But I’m not an expert in finance either.
Ken,
“We’re talking about a **lot** of money here, so there is an enormous incentive to achieve even a small rate of return in some vehicle that the banks at least **believe** to be safe (we’ve seen that movie). As you say, the financial sector will be only too happy to innovate to accomodate all of these funds looking to earn interest …”
Ive had a hard time here too. But Ive had to keep coming back to the edict that “banks dont lend reserves” Ive had a hard time undestanding the sort of esoteric nature of reserves but the posts of others here like JKH and Ramanan have helped over time. Once I read something like “reserves are ONLY transacted between banks” ie the Fed and depositary institutions (not even the Treasury). Ive had to just put the idea of reserves out of my thinking, as it should be meaningless to me as I do not work at a bank in charge of compliance.
I think this is where Warren is going wrt his statement that “there is no place else for them to exist.” Reserves are exclusively an issue between banks (both Central and depository).
Resp,
PS All: another Princeton connection here.
Looks like Princeton University Press was the publisher of the Reinhart/Rogoff Book on debt doomsday. Maybe they were contracted.
if governments generally stopped issuing debt, that would change the financial picture considerably, because that’s a huge pile of funds that would have to park somewhere else.
IT JUST PARKS IN RESERVES OR ACTUAL CASH. NO WHERE ELSE FOR THOSE DOLLARS TO EXIST.
right, Mat, and ask yourself this, if the tsy switched to only 3 month bills, and nothing longer, or only 1 week bills, or only overnight bills which is all that reserves are, what would change, apart from lower longer term rates/flatter yield curve as indifference levels changes via the supply changes, and maybe some risk spreads?
I’m not grasping why reserves are equivalent to overnight T-Bills, unless you’re assuming interest is paid on the reserves.
Ken
Matt:
“Ive had a hard time here too. But Ive had to keep coming back to the edict that “banks dont lend reserves” Ive had a hard time undestanding the sort of esoteric nature of reserves but the posts of others here like JKH and Ramanan have helped over time. … snip … Ive had to just put the idea of reserves out of my thinking, as it should be meaningless to me as I do not work at a bank in charge of compliance.”
It doesn’t seem like the concept of reserves should be so mysterious. They are simply the bank’s checking account at the Fed, so transactions can clear between banks, right? So when my paycheck is deposited in my bank account, my bank gets funds in its reserve account from another bank’s reserve account, and it also credits my account. If the bank already has sufficient reserves in its Fed account to cover its mandatory requirements, it wants to do **something** with that excess to earn a bit of interest, right? Traditionally, that **something** has been inter-bank lending or T-Bills. If those go away, then what? Doesn’t the bank try to do something else to achieve the same thing, perhaps lending in the overnight repo markets and taking safe (grin) AAA rated MBS as collateral? Can’t that lead to problems? Perhaps that “safe public subsidized parking space” that Tom refers to (Treasury Debt) is an important safety value in the system to prevent this kind of thing from happening?
The consensus here is that these funds will be happy to sit inert earning no interest and causing no further mischief. This is the one piece of the MMT paradigm I’m still struggling with.
Perhaps there is operational experience in other countries that shows this to be true?
Thanks for bearing with me folks … I really do **want** to believe!
Ken
Ken you sound like you may understand it better than I do at this point!
“it wants to do **something** with that excess to earn a bit of interest, right?”
I dont think the banks options are unlimited at that point, I could be wrong but I think the only thing it can do is “lend” in the overnight funds market, or if you will “provide overnight funds” to another bank. (I can hear them at GS now: “darn, no overnight forex speculation!”:) Again it comes back to “banks dont lend reserves”. It may be that the bank doesnt “want” to do something with the excess reserves, it is that it is “allowed” to do something with the excss reserves. Interbank lending perhaps is a privilege.
“Traditionally, that **something** has been inter-bank lending or T-Bills.” Above on interbank lending, now I think the tbills come at the initiation of the Fed. ie the Fed monitors the situation system wide, and if it sees there are excess reserves in the system, it may sell some Treasuy securities to drain overall system reserve levels. It may not be like the bank initiates the transaction for the bills because it thinks it can make some overnight money (not allowed), ie the Fed takes the initiative on behalf of the system, not an individual bank, then the interbank market distributes/adjusts from there.
I’m getting in over my head here. Resp,
I know I’m **way** over my head. But I’m determined to understand it. 🙂
Ken
Well there are several countries that have no reserve requirements:
UK, Canada, Australia, Sweden, Mexico
Obviously all of them still probably are selling their own government bonds.
But I guess the point here is, typically treasury bonds offer the lowest interest rate available, because the are the safest possible parking space.
So no bank would buy a treasury bond until it had exhausted all alternatives. So the opportunity for mischief is the same whether you sell treasury bonds or not.
OK – that’s a good point.
But … they obviously **do** buy Treasury Bonds, or else the Fed’s open market operations wouldn’t work.
So … does this mean they really don’t have many better alternatives? Would that picture change if Treasury Bonds ceased t exist?
Ken
I think it was RSJ (I hope I’m not misquoting) who pointed out that, assuming banks would not take on more risk to ‘park’ their excess reserves, cutting out Treasury Bonds is a cost for banks in the sense of lost income which ultimately the customer has to pay for through a higher price of credit.
they have zero reserve requirements, not no reserve requirements.
Can you explain the difference Zanon? Thanks.
Canada has a reserve requirement, it is a requirement of zero (while US has requirement of 10% I thinks).
Reserve accounts can go into overdraft. Canadian banks need to make sure that the overdraft is covered, so they have target just like US banks. Just their target is zero. It can be 3%, 50%, 27% etc. But they still have target they need to hit, so they still have overnight interbank window just like US.
Saying Canada has no reserve requirement suggests that banks there do not need to hit a reserve target and that is not the case.
They need sufficient reserves to clear their inter-bank checks, but there is no government imposed requirement.
Ken
try looking at it this way
the cumulative ‘debt’ of the US sits as some combination of reserves, tsy secs, and cash in circulation and = total $ net financial assets.
the gov controls the mix of the three. they let cash be available on demand, so for all practical purposes they manage only the mix between tsy secs and reserves- both simply accounts at the fed.
so all deficit spending is ‘trapped’ as accounts at the fed.
‘alternatives’ for one bank represent indifference levels between the ‘alternative’ and the fact that the entity selling the ‘alternative’ prefers what the govt offers as either secs or reserve balances. it’s all done at ‘market’ prices so those prices presumably reflect indifference values.
Sure, now the entity selling the ‘alternative’ to the bank has control of the reserves. Since that entity is in the business of taking on risk, their standard of what constitutes a “well qualified borrower” is different from the original bank. So now a new set of borrowers gets control of the reserves. They, in turn, do something else with the money, so the reserves change ownership yet again …. and so on and so on.
As the reserves keep moving around between accounts at the Fed … well, that’s economic activity, isn’t it? Initially in the financial sector, but eventually bleeding into the ‘real’ economy. And that activity can cause asset and price inflations, right?
Whereas with T-Bills, this open ended chain of events doesn’t exist. Because when reserves are given to the Govt, they go no further. A bond is issued, and that’s that. The money is now in a Fed “savings account”, as you put it.
Ken
Ken, are you saying that if reserves aren’t parked as Tsy’s, velocity might increase, and implying that nominal aggregate demand = money supply multiplied by velocity? Even if that were the case, it would not be inflationary unless the economy was approaching full capacity.
Yes – I think that’s what I’m getting at … I wrote more below…
Ken
the cumulative ‘debt’ of the US sits as some combination of reserves, tsy secs, and cash in circulation and = total $ net financial assets.
Another way to picture it. Only the Fed can create reserves. These are held by nongovernment in three asset forms.
1) in the interbank settlement system as bank reserves. Only financial institutions having access to the FRS deal directly in reserves.
2) in a super-liquid form (cash), In a cash transaction settlement takes place directly, with the transaction at the time of the transaction, rather than through the settlement system. Banks exchange reserves for cash based on customer demand.
3) in a slightly illiquid form as Tsy’s, which store reserves at interest.
These are all the same thing — reserves created by the Fed — in different form.
Banks cannot create reserves (or cash, or Tsy’s). Government is the monopoly provider. Reserves are created when the Fed credits the Treasury account for government disbursement. Banks loan against capital and they need to get reserves for settlement purposes. The fractional aspect of banking is set by the capital requirement not the reserve requirement, thus the government can control bank’s ability to create credit money through credit extension by changing the capital requirement.
Incidentally, I would not call reserves, cash and Tsy’s ‘debt’ but rather liabilities. Calling government liabilities “debt” confuses the issue because government liabilities are essentially different from nongovernment liabilities. For example, the only thing the government “owes” on its liabilities is an equal amount of government liabilities in return, which is creates, and the only thing that government liabilities are good for with respect to nongovernment interacting with government are exchanging government liabilities for nongovernment liabilities to the government (taxes, fines, fees), although a small portion goes to buying stamps, government land offered for sale, etc.
On the other hand, government liabilities give government a claim on real resources. This is not claim on which the government “owes” anything of economic value in return, other than the obligation to use this claim for public purpose instead of diverting it for private use not directly related to public purpose.
So while reserve are for settlement purposes in the FRS, when the Fed credits the Treasury’s reserve account for settlement of disbursements, financial assets are created in nongovernment in exchange for creating government claims in the economy.
Yes, I’m totally on board with everything in this post.
Ken
Initially in the financial sector, but eventually bleeding into the ‘real’ economy.
Ken, reserves don’t “bleed” into the economy. They enter the economy through the Fed crediting the Treasury account for settlement of its disbursements into the economy, which creates nongovernment financial assets.
These financial assets can exist as bank reserves, cash or Tsy’s, and they are regularly switched around through transactions that are either settled directly (cash transactions) or through transfers involving bank settlement.
Where do you seeing the bleeding that might lead to inflation coming from?
I guess I need to be more careful with my terminology here. I shouldn’t say that the reserves “bleed” into the economy, but rather that they keep moving about between accounts at the Fed. But that’s another way of saying that they’re generating economic activity, because that’s how payments are made in our system.
You’re right – if the economy is at less than capacity, that’s not going to cause inflation, at least not CPI inflation. What kind of asset bubbles may result in the financial sector I’m not sure of.
My problem is as follows. Government deficit spends initially because the economy is at less than capacity. Of course, this isn’t inflationary and provides much needed stimulus. However, there seems to be an assumption here that this is the end of the story … these dollars simply become inert and non-circulating in Fed checking accounts after this initial round of spending. My argument is that they would, in fact, continue to circulate … the first step in this new circulation being the bank investing them via some private sector financial vehicle (since this is now their only option for getting some return on them), and that vehicle propagating a further chain of circulation from there.
So … even after the initial Govt spending has corrected the output gap, the funds that were spent to do so don’t sit inert, but keep moving … eventually driving up prices.
Ken
Ken, when the Treasury disburses more financial assets than are withdrawn by taxataion, funds, a deficit results, and the Treasury is required by law to issue Treasury securities in offset. The Fed auctions these securities to primary dealers, who then sell them into the market. Composition of Tsy’s holding is approximately a third held by banks, a third other domestic, and a third foreign. Those holding Tsy’s desire a modest return at very ow risk and high liquidity.
If the Treasury ceased issuing securities in offset, should the law be repealed, then these parties would have to choose among remaining options, which are essentially 1) staying in reserves if bank or foreign government or deposits if other domestic, or else 2) parking somewhere else low risk/high liquidity at modest interest (basically hedging against inflation instead of being perfectly liquid at no interest). There are plenty of options, and it’s a matter of an indifference map associated with different utility levels based on individual preferences. The market might even come up with new forms, but private solutions would not carry a public subsidy — that is the big difference.
Given current preferences indicated by the appetite for risk-free Tsy’s, one would assume that the desire would be for similarly low risk instruments rather than “flyers.” I don’t see an inflationary threat here.
“Given current preferences indicated by the appetite for risk-free Tsy’s, one would assume that the desire would be for similarly low risk instruments rather than “flyers.” I don’t see an inflationary threat here.”
Yes, the bank would desire some low risk vehicle. However, there are financial intermediaries who thrive on taking on risk. So the bank gives them money in the overnight market (but rolling it over indefinitely), taking some form of high quality collateral in return (that’s why it’s low risk to the bank). One such form of collateral would be a T-Bill, but since they won’t exist anymore, something else will have to do. Maybe the AAA tranche of an MBS bond, for example. This intermediary then turns around and makes the high flyer loan.
This is my oversimplified understanding of how the “shadow banking sector” operates.
Ken
What wrong with an AAA tranche if is really is AAA? That’s what “caveat emptor” is about on one hand, and bank reform, on the other. Personally, I think that people ought to be going to jail for misrepresentation and outright fraud over what just went down. And you can be sure that investors will be much more alert in the future and much less trustful of the big names. This game needs fixing big time, where the Treasury continues to issue securities or not.
“What wrong with an AAA tranche if is really is AAA?”
Nothing, actually. So the bank will get a low rate of interest backed by nice, safe, AAA collateral. The intermediary now has funds to lend out for more dangerous ventures at a higher rate of interest. That’s how the money continues to turn over. That’s what ultimately leads to the inflation. If the money was parked in T-Bills, it would stop turning over. Because the Government will not lend it on to someone else, and has no operational need for funding itself, as you guys always point out. So with the T-Bill, the chain of spending stops. With the AAA backed bank loan, it doesn’t. That’s the difference.
If it’s not really an AAA asset, a different set of issues ensue.
Ken, it seem that you are thinking that funds get parked in T-bill and get rolled over long term. That’s not really the way it works. Generally speaking T-bills, being highly liquid, are a short term parking place for entities dealing in large denominations where even very short term, very low interest adds to profitability. This is money on the way to the next deal, not funds taken out of circulation. Even the long bonds are seldom bought to be held to maturity unless they are obtained at a very favorable rate that can’t be bettered through other use down the line. Only “retail investors” buy and hold, and that’s a relatively small portion of the bond market. Foreign government are large holders of Treasuries until they have use for reserves, and if Treasury issuance were abolished, the US would work something out with them, since this serves the public purpose of promoting international trade.
From the point of view of any individual investor, this is true.
For the system as a whole, it still represents a pool of inert money. Inert in the sense of: when I lend money to the Govt, the Govt does not further lend it, nor does it spend it. Because we’ve established that Govt spending is independent of any need to generate ‘revenue’, either by borrowing or taxing.
So, even though the individuals and firms the comprise the pool of T-Bill holders may rapidly turn over, there is still this big pool of funds which is essentially inert (we happen to call it the “national debt”, but that is only one point of view).
An analogy would be a lake behind a dam. Water flows in, water flows out, the lake is still there, even though the individual water molecules keep changing. If you blow up the dam, there are bound to be consequences.
What i am saying, Ken, is that there is a demonstrated preference to hold highly liquid, short term funds at modest interest. This would just shift to other options if Tsy’s aren’t available. If there aren’t enough other options, then the private sector will create them — without a public subsidy. Call it “privatization.” What’s the problem here?
I understand exactly what you’re saying. And I agree that’s what would happen.
The problem: Even if the private sector gets it exactly right in terms of safety and ratings, etc, on the new or existing private “savings” vehicles, the funds that the Govt initially injected into the economy via deficit spending will continue to circulate in the economy until they are somehow removed. That’s because these new “savings” vehicles will propagate the funds from those who want to “save” them to those who want to “spend” them. And whoever that party spends them with will do something …. “save” or spend … etc. This chain of propagation will continue indefinitely … another name for it is “velocity”.
This is different for T-Bills. Because when you buy a T-Bill from the Govt, it is a dead end. The spending propagates no further, because the Govt doesn’t do anything with this money (because the Govt has no need to collect money in the MMT paradigm). Therefore, there will be no ongoing chain of spending, so these funds will not be bidding up assets or prices. Velocity goes to zero. Not the case with the private sector provided vehicles.
Now, I know you say, from an individual saver’s point of view, when he buys a T-Bill:
“What do you mean? My velocity hasn’t slowed down! I’m just parking my funds here for a few days/weeks/months while I wait to do something else with them.”.
And that’s perfectly true from his perspective. However, while it’s parked there, it isn’t doing anything in the real economy, just like all the cars in the mall parking lot aren’t contributing to congestion on the freeway. Not the case for funds “parked” in the private sector provided alternative … they never really get to “park” at all, they just keep moving, even if the individual “saver” doesn’t notice the difference.
Ken
This is different for T-Bills. Because when you buy a T-Bill from the Govt, it is a dead end. The spending propagates no further, because the Govt doesn’t do anything with this money (because the Govt has no need to collect money in the MMT paradigm). Therefore, there will be no ongoing chain of spending, so these funds will not be bidding up assets or prices. Velocity goes to zero. Not the case with the private sector provided vehicles.
Assuming this is the case, which I don’t think it is as I have said, this possiblity is worth a public subsidy for those who are able to buy Tsy’s that are only issued in large denominations? That public subsidy is the transfer of a financial claim on real resources from public to private, and is concentrated at the peak of the wealth and income curve. I do not see the proportionality here. Looks to me like a redistribution of resources to those who do not need it and have done nothing for it, in order to prevent something that might or might not happen.
Another thing to consider, Ken, is trading volume in Tsy’s. It’s the largest market in the world in dollar volume. The average volume in 2009 was 600 billion a day. The national debt now is 12.8 trillion. So that means that turnover is pretty large. A lot of these transactions are short term trades, often day trades. I have friends who do this for a living. A single trade is in the range 100K depending on the actual price of the security. Trading is done on leverage, which can be very high if the person chooses. Lots to be made if one is good at it. The US is partially funding this game with its interest payments on the securities — unnecessarily. Does that make sense? I doubt very much that the US public would condone these interest payments if people think it is necessary financially knew it was actually unnecessary, especially considering the percentage of the budget that goes to debt service. In my view, it is a prime example of “waste, fraud, and abuse,” and as well as gross ignorance.
Tom, I don’t disagree with any of your politics. They sound similar to mine. I’m just trying to figure out if this notion of continued deficit spending without issuing debt would actually work, and my (still refutable) conclusion is that it would not. See my post #24 below for a summary of my current thinking.
Ken
maybe he got it from Bernanke’s speech…
deficit spending does ‘circulate’ and as it adds to income and saving.
yes, at any time it’s theoretically possible for any one of us to dip into savings and spend, moving it to someone else’s spending.
so we watch the level of agg demand by counting bodies in the unemployment line, and act accordingly
But if we spend enough to put these bodies to work, without issuing corresponding debt, won’t we need to withdraw these funds (via taxation, in your model) when the economy “heats up” and velocity increases?
Ken, Tsy issuance does not withdraw net financial assets from the economy as taxation does. It just stores them, usually temporarily. Tsy’s are highly liquid and are traded in massive volume. They are just parking places. In addition, they provide excellent collateral for loans.
If the $4$ Tsy offset of issuance neutralized the funds issued, then fiscal policy would have no effect at all other than the interest it adds, which is patently not the case.
They’re highly liquid from the individual holder’s point of view because he or she can easily sell theme, or borrow against them. But that’s a zero sum game, right? The total amount of funds tied up in T-Bills as a whole has been rendered inert as far as driving economic activity or inflation.
So I’m still left to wondering what happens if T-Bills no longer exist and all those funds start running around in the wild (by which I mean … shuffling around between 100% liquid Fed checking accounts).
Ken
all those funds start running around in the wild (by which I mean … shuffling around between 100% liquid Fed checking accounts).
Ken, what do you foresee happening exactly? As I said, those who are used to parking in Tsy’s will either stay liquid or hold something else that is highly liquid and low risk that pays modest interest. Why would that behavior suddenly change? I think you are just having nightmares unless you can propose a plausible scenario instead of generalities.
See my response above, where you ask:
“What wrong with an AAA tranche if is really is AAA?”
I think it’s pretty specific, or at least I’m not sure how to get more specific without naming specific companies or products (which I’m not sure I can do).
KenM:
Debt does not withdraw assets, just changes their term structure.
Only taxation withdraws assets. And yes, if inflation gets too high, you need to withdraw assets to bring it down. THis is whether you issue Treasuries or not.
Treasury debt may not withdraw assets, but it does stop those assets circulating as money. Yes, they’re pretty liquid, but to spend them I have to sell my T-Bill to someone else or post it as collateral for a loan, which means that other person stops spending for a while. Either way, the total volume of outstanding T-Bills represents funds that are not chasing after goods and services or other financial assets, therefore not bidding up prices.
If I buy a commercial bond, the person I buy the bond from either spends the money, or lends it on again to someone else who spends it. If I buy a Govt bond, the chain of spending just stops, because, as we all know on here, the Govt has no operational need to collect money.
In other words, those dollars are rendered inert when used to buy Govt debt, which they wouldn’t be if that debt wasn’t available for purchase. But you’re right – they are not withdrawn – they’re still somebody’s asset.
http://www.imr-ltd.com/graphics/recentresearch/article6.pdf
Tim Congdon,a monetarist, makes the case that KenM is trying to make:
He says that On 5 March, the BOE announced a programme of so-called “quantitative easing”,
in which enormous purchases of gilt-edged securities, mostly from non-banks, would deliberately
add to the level of bank deposits (i.e. the quantity of money).
He says that the purpose of quantitative easing was not to increase lending, the intention of the BOE’s QE
is to increase the quantity of money by direct transactions between it and nonbanks. It does this by adding
money to the bank accounts of holders of government securities to pay for these securities. He goes on to say,
that pension funds, insurance companies, hedge funds and so on try to get rid of their excess money by purchasing
more securties, ie. more equities from each other but they can’t get rid of their excess supply of money.
So basically the BOE swaps cash for bonds from the private sector, private sector deposits increase, reserves increase
to match the deposits but are earning very little interest so they goose the markets. But how is that sustainable?
The private sector are now without secure government bonds but have more equities. Is this not an illusion of demand, not
based on increased earnings and profits. He also says that government deficits don’t work, citing Japan as an example.
But that is hard to believe since government deficits are one of the main determinants of the profit equation. I can see
this market faltering again in the next year.
So basically the BOE swaps cash for bonds from the private sector, private sector deposits increase, reserves increase to match the deposits but are earning very little interest so they goose the markets.
And how well is that working? This theory of reflating has been roundly disconfirmed.
Well, its working from the point of view of a rising market. But I’m not sure if it can continue. It’s still not addressing the main problem of household/business debt. But, thats what people said after the tech bubble.
More people I know think that it was the declining dollar and low rates rather than QE that was responsible for the climb in US equities.
as mentioned elsewhere on this site, it’s about price (interest rates), not quantity.
the only effect of qe is lower term rates than otherwise, which is what Tim was saying in his explanation.
buying securities lowers the yields for those securities from where they would have been otherwise. the seller of the secs sells at his price because at that price he’d rather have the cash balances than the securities.
Ken,
All you are describing is what normally happens with any dollars we have in our bank accounts, but you are suggesting that no one will want to ever have dollar savings in their bank accounts if there are no treasuries to buy. That they will spend/loan continuously. That’s unlikely, but even if they did do just that, the resulting full employment and eventual inflation would be taxed away automatically, over time. Since Warren’s proposal is to have government deficit spending only on the employed labor pool, this pool would shrink to zero and deficit spending would stop. Increasing prices and wages would be subject to higher tax brackets, and eventually the government would be running a surplus.
So I guess if you are saying there would be eventually a new steady state of total savings that are less than currently if we stop issuing treasuries, yes that seems true to me. But it would automatically happen, and as long as the employed labor pool was still set as a fixed wage there would not be any net inflation after the initial transition.
Also you are totally discounting the fact that having treasury bonds, means paying interest, which means the total dollar pile has to increase exponentially forever. This could eventually boost demand, but we would be eliminating that channel.
Well, I didn’t come here with any agenda, but after discussing this here for the last two days, the following is the position I’ve argued myself into. I didn’t think any of this two days ago, so it’s probably not fully baked, and I’m still open to refutation. Anyway, here goes (in the words of Homer Simpson, I just know I’m going to pay for this…):
As the Govt deficit spends, probably to close an aggregate demand output gap, reserves will build up in the banking system. Some of these reserves will be required to meet regulatory requirements (10% of demand deposits in the U.S.). Even in countries that do not have such requirements, some amount of reserves will be needed for inter-bank checks to clear. Anything over and above these needs are excess reserves. And they really, really want to find some way of safely (OK … safe-ishly) earning money.
Traditionally, this need has been met either by investing in T-Bills, or lending inter-bank overnight to banks with reserve position shortfalls. However, if the Govt stop issuing T-Bills, and lets the inter-bank lending rate fall to zero (no more open market operations by the Fed to stop it from going there … zero is considered the “natural rate”), neither of these profit opportunities is there anymore. Will the free market (i.e. the financial sector) come up with some innovative new financial instruments to meet this need? Of course they will! Or, they might just recycle less innovative older ones.
Any private sector constructed investment vehicle cannot act exactly like a T-Bill. When you buy a T-Bill from the Govt, the Govt does absolutely nothing with the money you pay it. It (metaphorically) just shreds it, just like your tax payments. That’s because, according to the MMT axioms, Govt spending is completely independent of any Govt “income” … the Govt does not need “income”. So once you buy the T-Bill, the funds you spent become inert, at least as long as you hold the bill. Velocity on this money goes to zero. It can no longer bid up the price of assets or real goods (because the Govt does nothing with it).
If you sell the bill, even after only a short time, someone else will jump in and buy it, rendering their money inert for a while even while yours is freed up. But there’s still this big pile of zero velocity, inert money which we now call the “national debt”, even if the individual holders of it keep changing.
When a private sector financial intermediary comes up with it’s own instruments to replace the defunct T-Bills, they cannot possibly work the same way. That’s because no private entity can stay in business by just taking your money and doing nothing with it, then handing it back to you with interest (like the Govt can). They must do something with that money to make a profit, so that they can pay part of that profit back to you as interest. If you’re a bank, perhaps the intermediary will give you some AAA collateral in return for your excess funds. The collateral makes the loan “safe” for you, the bank, at least in theory. They will then make their profit by lending the funds out for some riskier, higher payoff venture. That venture will either spend money in the real economy, or engage in further financial sector activity. And so forth. This money will continue to have “velocity”, unlike the excess funds previously invested in T-Bills, which had none. Therefore, this money can continue bidding up prices for assets and/or real goods.
If the money the Govt originally deficit spent in order to close the demand gap (the extra stimulus money) continues to circulate, as I argue in the last paragraph, it will start to become inflationary when full employment is achieved and velocities in general go up (the economy has “heated up”). Therefore, the extra stimulus money will have to be removed, through taxation, according to MMT.
My hunch (which I cannot prove — perhaps this is a weak point?) is that the amount to be removed will be around the same order of magnitude as the original stimulus. To be fair, you guys **do say** that tax increases will be required at times to absorb excess demand, but I’m under the impression that you’re underestimating the magnitude of the necessary increases. This is because I believe you are imagining that the banks will simply let excess reserves pile up forever in zero velocity, non-interest bearing reserve accounts at the Fed. I don’t know for sure that’s what you’re thinking, so correct me if I’m wrong, but it is the impression I’ve gotten from the various readings I’ve done here and over on Billy Blog.
In non-MMT, conventional terms, this removal operation through increased taxation would cause a “budget surplus”. Thus, the “budget” will more or less be in “balance” over the course of the business cycle (using non-MMT terms in scare quotes). Deficit spending during downturns, excess taxation to produce surplus during the good times.
The thing is, this is the **same** conclusion I would have come to using a more mainstream, non-MMT analysis.
So, while MMT has provided a new and interesting way of breaking down the problem, I’m not really sure we’ve ended up any place different.
Sticking with an MMT perspective, if we want to run net deficits over time, we still need to issue debt. From an MMT perspective, this debt is to give the excess reserves generated by deficit spending somewhere to go to earn a safe, positive rate of return, while bringing their velocity down to zero. That’s how inflation is avoided. The purpose of this debt is not to provide operational funding for the Govt, because the Govt doesn’t require funding under MMT axioms.
The critical point where I seem to differ with everyone else is that I **do not believe** that excess reserves will sit happily at or near zero velocity in non-interest bearing Fed checking accounts once the publicly subsidized, interest bearing alternative (T-Bills) has been removed from the equation. If that were the case, there would be no need to issue debt. I believe, however, that those funds will seek some return, and velocity (and thus potentially inflation) will be imparted to them as the private sector moves to fill this need.
Ken
Sticking with an MMT perspective, if we want to run net deficits over time, we still need to issue debt. From an MMT perspective, this debt is to give the excess reserves generated by deficit spending somewhere to go to earn a safe, positive rate of return, while bringing their velocity down to zero. That’s how inflation is avoided. The purpose of this debt is not to provide operational funding for the Govt, because the Govt doesn’t require funding under MMT axioms.
The critical point where I seem to differ with everyone else is that I **do not believe** that excess reserves will sit happily at or near zero velocity in non-interest bearing Fed checking accounts once the publicly subsidized, interest bearing alternative (T-Bills) has been removed from the equation. If that were the case, there would be no need to issue debt. I believe, however, that those funds will seek some return, and velocity (and thus potentially inflation) will be imparted to them as the private sector moves to fill this need.
Ken, according to MMT, the reason to issue debt is monetary not fiscal. The government issues debt to drain excess reserves so the Fed will be able to hit its target rate. According to MMT, it the government ceased debt issuance, the Fed could also hit its rate by paying interest on excess reserves equal to the target rate.
There is nothing in MMT that says government issues debt “to give the excess reserves generated by deficit spending somewhere to go to earn a safe, positive rate of return, while bringing their velocity down to zero,” thereby avoiding inflation. That’s your idea, not anything implied by MMT.
There is nothing to suggest that these funds would be deployed unusually if Tsy’s ceased to be issued. Some comparable option would draw them depending on preferences. There is no financial or economic reason to expect any kind of “wild” behavior resulting. If the preference is currently for low risk, highly liquid instruments, the expectation is that this preference would remain, and comparable vehicles would be substituted for Tsy’s — without the public subsidy.
One could argue along your lines that the cessation of Tsy issuance would result in greater investment, increased growth, more employment, and greater prosperity. Except there is no good reason to posit this either. Lots of things could happen. But what is most likely based on evidence. The best evidence seems to be current preferences as demonstrated by current behavior.
I appreciate your playing the devil’s advocate here and getting us all to think this through, but I think you have backed into a dead end. I don’t see any evidence to support your hypothesis. It’s much more likely that some variant of the status quo would result.
Finally, although the Fed might let the overnight rate go to zero, it might also decide to hang on to its ability to set the rate. Therefore, interest would need to be paid on reserves to keep the rate from going to zero. I suspect that this is the most plausible scenario if debt issuance were terminated.
I feel compelled to answer this last part first:
“Finally, although the Fed might let the overnight rate go to zero, it might also decide to hang on to its ability to set the rate. Therefore, interest would need to be paid on reserves to keep the rate from going to zero. I suspect that this is the most plausible scenario if debt issuance were terminated.”
Yes – it’s a very plausible scenario. However, as I see it, a policy of paying interest on reserves is ***exactly the same*** as a policy of issuing T-Bills! Just in a different disguise. So now we have an interest bearing checking account, which is an exact replacement for the savings account the Govt took away when it stopped issuing T-Bills.
So, the U.S. Govt is still making interest payments to the same sorts of people who would have previously held T-Bills … bankers, foreign central banks, etc. Doesn’t really matter that it’s technically the Fed doing it, not Treasury. As I’ve often heard here, it’s not really all that important in the scheme of things what pieces the U.S. Govt wants to divide itself up into.
Ken
Yes, that’s why I oppose this option. But it has the positive effect of breaking the illusion that debt finances spending, and that would be a step in the right direction. So it’s better than leaving the status quo in place.
Yes, I suppose that if it changes the terms of the political debate, and helps people reason about these issues differently, it could be worth a try … even though it doesn’t change the underlying reality.
Ken
The other reason I would rather see the Fed let the overnight rate go to zero is that I think that interest rates are best left to the private sector. The Fed should not be using monetary policy (interest rates) to target inflation, while using unemployment as a tool. Well-designed and managed fiscal policy avoid this waste of output capacity and human resources in the name of “fighting inflation.”
Adding together the cost of interest payments as a public subsidy and foregone opportunity and human degradation caused by inflation targeting, the amount over time is huge — and unnecessary.
Pretty much agreed. I’m just not sure we can avoid the interest payment part if we want to run large sustained deficits/debt over the long haul. For technical reasons … not because I like it 😉
Ken
“There is nothing in MMT that says government issues debt “to give the excess reserves generated by deficit spending somewhere to go to earn a safe, positive rate of return, while bringing their velocity down to zero,” thereby avoiding inflation. That’s your idea, not anything implied by MMT.”
You are right … it is my idea. But I believe that it is a theorem that one can derive using the core axioms of MMT and rational expectations of how banks and the financial industry will behave if deprived of their current options. That is what I’ve been trying to show.
“There is nothing to suggest that these funds would be deployed unusually if Tsy’s ceased to be issued. Some comparable option would draw them depending on preferences. There is no financial or economic reason to expect any kind of “wild” behavior resulting. If the preference is currently for low risk, highly liquid instruments, the expectation is that this preference would remain, and comparable vehicles would be substituted for Tsy’s — without the public subsidy.”
Well, what I’ve been trying to show is that there’s a big difference. When the funds get used to buy T-Bills, they go to zero velocity. For reasons I’ve laid out, when the private sector tries to create their own version of a low risk, highly liquid instrument, it can’t possibly work like a T-Bill in this respect. The funds will circulate through the financial sector and the real economy in the latter case. In the former (T-Bill) case, they won’t. They become inert with zero velocity (yes, I know you’re not buying that right now, but to me the logic seems irrefutable … so I’m thinking maybe you will buy it after you’ve thought about it some more …). I think that could make a significant difference.
“I don’t see any evidence to support your hypothesis. It’s much more likely that some variant of the status quo would result.”
Yes, but where’s the evidence to support yours? Where has this idea of not issuing debt (or paying interest on reserves as an equivalent substitute) while continuing to deficit spend been tried to good result? I’m happy to examine the evidence if there is any…
Really, it seems like we’d be entering a brave new world here, with little but these thought experiments to go on. Unless, of course, we pay interest on reserves … then we’re back to exactly the same place we are now, just with the furniture shuffled around a bit, as I indicated in one of the replies above.
Ken
Well, generally, it is supposed that like behavior will continue unless there is a reason to suppose it won’t. Behavior is rather inertial in this regard. I don’t think you have presented a compelling case that it would shift course.
Really I assume the same behavior as always … profit maximization … also known as greed 😉
The nature of the available instruments change, so the manifestations of this behavior also change. That’s all.
Ken
I don’t know if you’ve read Gary Gorton’s papers on the financial crisis, such as this one:
http://tinyurl.com/yywbo9h
Only tangentially related to this discussion, but I learned a lot about the “shadow banking sector” from him, and it definitely influenced my thinking on these matters.
Ken
According to Hyman Minsky, stability breeds instability. That’s why static regulations and controls don’t work. They have to be dynamic and adaptable, because the cheaters are. It’s an unsolvable problem, but that doesn’t mean that the cheaters should just be left to their own devices or that the foxes should be allowed to run the hen house.
These are separate issues in my view.
The critical point where I seem to differ with everyone else is that I **do not believe** that excess reserves will sit happily at or near zero velocity in non-interest bearing Fed checking accounts once the publicly subsidized, interest bearing alternative (T-Bills) has been removed from the equation.
Ken, I believe you need a consultation with Dr. Fullwiler. :o)
This paper has discussed how interest payment on reserve balances could both simplify monetary policy operations of the Fed and free the Treasury and the Fed from selling bonds to support the Fed’s interest rate target.
“Paying Interest on Reserve Balances: It’s More Significant Than You Think”
http://www.cfeps.org/pubs/wp/wp38.html
Yes to echo Beowulf here Ken and Tom (just to reiterate (for other readers) that the Fed is now paying interest on both required and excess reserves of 0.25%, the 30-day bill rate is 0.14%.
Right now they pay at the FFR 0.25% but when they started this policy they paid at FFR minus 0.75%. (ffr was at 1.0% then)
so if the US govt was to let all the outstanding approx $7T of Treasury bonds just be redeemed and sit as excess reserves today, 7T x 0.0025 = 17.5B (mere bag of shells!) the Fed would renumerate to the banks annually. I suppose they wouldnt need an appropriation to do this? The Fed could just credit the accounts of the depository institutions for the 17.5B under authority granted to them by the Federal Reserve Act in their conduct of Monetary Policy. Then just tell the banks that they cant do anything with excess reserves other than receive the Feds renumeration rate on them. (doesnt say “life, liberty, and the pursuit of banking”).
Resp,
Matt, I believe this is correct. The interest on the debt goes on the Treasury’s book. It’s a standing appropriation that doesn’t have to be specifically approved annually. However, Fed operations are FRS charges, and this doesn’t require budgetary appropriation. That’s one reason that monetary policy is preferred to fiscal policy. Politically, it’s less messy.
Wow, $17.5 billion interest charge on a $7 trillion debt, you could fund that with customs duties! ($23 billion this year). Is there a reason that the IOR rate (.25%) is higher than the 30 day rate (.14%)?. If the IOR rate was .14% on a $7 trillion debt, Interest charge is $9.8 billion. That’s about what the Dept. of Interior collects annually in oil and gas lease revenue.
Of course if, as Warren has suggested, the Federal Funds market was replaced by the discount window, the interest revenue from overnight market loans would go to the Fed (and thence to Tsy).
It seems we agree that some method must be employed to inert these funds and stop them from circulating freely in the economy.
One method is issuing Govt debt … if we stop doing that, having the Fed pay interest on reserves is a viable alternative, but really amounts to the same policy.
I’m skeptical that the Govt would be able to effectively freeze that amount of money while paying only .25% without significant leakage, especially in a recovering economy. Seems more likely that they would have to pay something similar to what they pay now in the form of T-Bills.
I’m not sure what the effect of a mandate would be …. telling the banks that this is their only option, as you suggest. Maybe that would work, but I have to wonder how the entire system would morph in response to such a regulation. For example, would the banks continue paying interest on depositor savings accounts if they didn’t feel they were getting sufficient returns on their excess reserves? Would they loose incentive to continue taking deposits at all? Would consumers start moving funds to the non-bank financial sector … etc, etc. I have no idea what would happen, but I suspect attempting to address this problem simply by making a rule would elicit some kind of response that needs to be studied.
Bottom line is I’m still skeptical of the notion that long term deficits/debt can be maintained without doing something similiar to what we’re doing now, either via T-Bills or via Fed interest payments. The prevailing opinion here seems to be that we only pursue these policies because the people in charge are either ignorant (guilty of ‘innocent fraud’) or perhaps in some way corrupt. Well … maybe, but then again … maybe not.
I’m always skeptical of those who claim special knowledge or insight that proves the consensus wrong. I’ve learned a lot about fiscal and monetary policy from trying to think this through … just as I’ve learned a lot about climate change science by considering the claims of the skeptics. Now, I’m not ready to say you’re as wrong as they are (and maybe this is a horrible analogy), and sometimes the consensus **is** in fact wrong. But I consider the idea that we can continue to run large deficits without issuing something that resembles Govt debt, however configured, to be an extraordinary claim. For me at least, case not proven. However, I’m still listening.
Ken
Ken, everybody respects your feelings and hunches but they are much more about quantity theory of money than about MMT and reality. In Japan 5Y swap rates, i.e. not even riskless government, have been about 1% for more than 10 years. Yet private sector has not come up with a super-duper instrument to recycle this “free” money in some yield chasing way. And inflation has not poped out on the radar screen. So while your gut felling might be telling you something you should also try to reconcile it with the world out there. 500 years ago everybody’s gut feeling was that earth is fixed and sun goes around it. We all know where it ended up
Tom:
“Well, generally, it is supposed that like behavior will continue unless there is a reason to suppose it won’t. Behavior is rather inertial in this regard. I don’t think you have presented a compelling case that it would shift course.”
Well, generally I do assume the same behavior … profit maximization … also known as greed.
My argument is that the nature of the available underlying investment instruments change under the scenarios discussed here, which provides further opportunities for the human and institutional actors to do what comes naturally …
Are you familiar with Gary Gorton’s papers on the financial crisis? Only tangentially related to our discussions here, but I learned a lot about the “shadow banking system” from him. Here is the simplest one, but you can search for more:
http://tinyurl.com/yywbo9h
If you so feel inclined, have a read of that, and then take a look at my argument again…
Ken
You may also be interested in
Darrel Duffie http://www.stanford.edu/~duffie/dealers.pdf
Brian Sack http://www.newyorkfed.org/newsevents/speeches/2010/sac100326.html
Tobias, Mcandrews et. al. See box 2 http://www.newyorkfed.org/research/current_issues/ci15-4.pdf
Mehrling http://ineteconomics.org/sites/inet.civicactions.net/files/INETSession1-Mehrling.pdf
Ken,
You may be interested in these links …
The Failure Mechanics of Dealer Banks – Duffie
http://www.stanford.edu/~duffie/dealers.pdf
Also check the “Are Brokers Broken?” (Sep 2008) by Citi in the references if you can access.
The Federal Reserve’s Primary Dealer Credit Facility – Tobias Adrian, Christopher R. Burke, and James J. McAndrews
http://www.newyorkfed.org/research/current_issues/ci15-4.pdf
The New Lombard Street – Perry Mehrling
http://ineteconomics.org/sites/inet.civicactions.net/files/INETSession1-Mehrling.pdf
Dollar Asset Markets: Prospects after the Crisis – Fed’s Brian Sack
http://www.newyorkfed.org/newsevents/speeches/2010/sac100326.html
the lower rates that make borrowing more attractive are the same lower rates that take income away from savers.
and there are maybe $13T more $ saved than borrowed as the cumulative national debt = net financial assets for the non gov sectors.
so think of yourself as ‘the economy’ going to the bank for a loan. Yes, interest rates are down, but so is your income. Maybe the income is more important?
the lower rates that make borrowing more attractive are the same lower rates that take income away from savers.
That may be so, but high interest rates add to production costs, reduce real fixed capital investment and slow growth of productivity. If you were a business producing, you would pass on the increased interest charges onto your products which would result in increased inflation. Hypothetically speaking if the interest rate was 50%, savers would be delighted but business has to service that interest rate.
and there are maybe $13T more $ saved than borrowed as the cumulative national debt = net financial assets for the non gov sectors.
so think of yourself as ‘the economy’ going to the bank for a loan. Yes, interest rates are down, but so is your income. Maybe the income is more important?
I’m not sure take the following historical graph of the BOE interest rate since its inception side by side with UK inflation, the BOE held its interest rate at 5% for 103 years. And you get bouts of inflation/deflation ranging from +30%-20%. Its only in the latter half of the 20th century do you see hugh interest rates by historical standards, due to inflation targetting. What made them think that they could control inflation with interest rates? The result was stagflation.
http://www.iimahd.ernet.in/~jrvarma/blog/index.cgi/Y2009/UK-315-year-low.discuss