Bernie Sanders on the right track but need to address the main game

On December 23, 2015, the Democrat Presidential candidate Bernie Sanders published an Op Ed – Bernie Sanders: To Rein In Wall Street, Fix the Fed – which, correctly, in my view, concluded that Wall Street (taken to be the collective of banksters wherever they might be located) “is still out of control” and policy reform has done little to alter the “too big to fail” problem that was identified in the early days of the GFC as one bank after another lined up for government assistance. Larry Summers replied to the Op Ed in his blog – The Fed and Financial Reform – Reflections on Sen. Sanders op-Ed – challenging several of the proposals advanced by Sanders. The problem is that the progressive voice of Bernie Sanders labours under some basic misconceptions about how the monetary system operates and therefore plays into the hands of those who have created the mess. Conversely, Summers clearly understands basic elements of the monetary system but continues to advocate policies which avoid addressing the main issue – the power of the financial markets.

Bernie Sanders got off on the wrong foot by suggesting that if any of the big financial institutions:

… were to fail again, taxpayers could be on the hook for another bailout, perhaps a larger one this time.

We, of course, know that taxpayers did not fund the last bailouts, the currency-issuing capacity of the consolidated US government provided the cash injections to ensure that any financial institution it desired to remain solvent did so.

I think it is essential that would-be progressives cease to use these loaded terms such as ‘taxpayer funds’ etc and instead promote new understandings which more accurately reflect what the intrinsic capacities of the currency-issuing government are.

Please read my blog – Taxpayers do not fund anything – for more discussion on this point.

As an aside, some years ago (August 20, 2010), I wrote a blog – The consolidated government – treasury and central bank – which explained why the notion of a consolidated government sector is a basic Modern Monetary Theory starting point, which allows us to demonstrate the essential relationship between the government and the non-government sectors whereby net financial assets enter and exit the economy.

In part, the notion this counters the mainstream macroeconomic obsession with central bank independence, which is nothing more than an ideological attack on the capacity of government to produce full employment. When I have attempted in the past to discuss this consolidation with members of my profession (the mainstream arm) I have been met with varying degrees of derision.

There appears to be a belief that the central bank operations are quite distinct from Treasury operations and that in the interest of inflation stability, the Treasury has to run fiscal policy consistent with the independent interest-rate target set by the central bank.

The problem with this view is that it misunderstands the intrinsic link between the daily operations of the central bank in managing liquidity in the cash system and the daily spending and taxation impacts of Treasury (that is, fiscal policy).

A Staff Report from the Federal Reserve Bank of New York (No 754) published in December 2015 – Floor Systems and the Friedman Rule: The Fiscal Arithmetic of Open Market Operations – argues that “focusing primarily on the finances of the consolidated public sector, which includes both the fiscal authority and the central bank …[is] … useful for studying a wide range of issues because it allows one to clearly state the economically meaningful constraints while abstracting from institutional details”.

I guess my mainstream colleagues will become enthusiastic for consolidated analysis from now on. Sheep.

Anyway, back to the main story.

Bernie Sanders considers the appropriate starting point for reining in Wall Street is to:

… begin by reforming the Federal Reserve, which oversees financial institutions and which uses monetary policy to maintain price stability and full employment. Unfortunately, an institution that was created to serve all Americans has been hijacked by the very bankers it regulates.

He uses the example of the recent interest rate hike in the US, which he considers served the interests of the “big bankers and their supporters in Congress” and will unnecessarily maintain higher than desirable unemployment.

It was designed “to fight phantom inflation”.

One can only agree with that assessment. Please read my blog – There was no reason for the US to raise interest rates – for more discussion on this point.

I also agree with his analysis of the conflict of interest that bedevils leading US financial institutions and membership of the central bank boards.

He wants to broaden the membership of the central bank boards to “include representatives from all walks of life – including labor, consumers, homeowners, urban residents, farmers and small businesses” but, as Summers notes “There is a tension between acquiring expertise and avoiding cooptation or cognitive capture”.

From a Modern Monetary Theory (MMT) perspective, the goals of economic policy have to be to advance the well-being of all citizens, and, in particular, ensure that those who want to work can access a job with decent pay and conditions.

The government should also ensure that the destructive and destabilising tendencies of capitalism are tightly regulated.

The dominance of the financial sector over the last three or more decades has demonstrated that these tendencies are rife and have been poorly managed by governments who have been largely co-opted by these financial interests.

The expertise that we want brought to bear to help design and implement economic policy decisions should understand the role of government as a mediator in class conflict rather than an agent of capital.

The financial sector has continually advocated suppression of real wages growth and has benefited from the ongoing redistribution of national income towards capital, which it appears to consider to be a desirable feature of the current policy settings.

Senior executives from that sector, who have pocketed millions at the expense of the workers and behaved in ways that have put millions of workers out of work, would appear not to be ideal candidates for recruitment for national public service positions that aim to advance the well-being of workers.

The more progressive approach is to advocate collapsing the central banking functions into a formally consolidated macroeconomic policy function within government.

What about central bank independence – my mainstream colleagues will scream, as if it means something.

Please read my blogs – Central bank independence – another faux agenda and The sham of central bank independence – for more discussion on this point.

Bernie Sanders is also correct in saying that the massive financial services industry does very little for anyone but the highly-paid participants.

Wealth-shuffling describes at least 95-96 per cent of the daily financial transactions in the world markets. They do not help humanity in general and when things go awry, as they did in 2008, the rest of us have to endure the negative real consequences (such as falling incomes and rising unemployment and poverty rates), while the felons (the ‘banksters’) escape unscathed (at least, relatively so).

He thinks the problem lies with the central bank.

He writes:

The Fed must also make sure that financial institutions are investing in the productive economy by providing affordable loans to small businesses and consumers that create good jobs. How? First, we should prohibit commercial banks from gambling with the bank deposits of the American people. Second, the Fed must stop providing incentives for banks to keep money out of the economy. Since 2008, the Fed has been paying financial institutions interest on excess reserves parked at the central bank – reserves that have grown to an unprecedented $2.4 trillion. That is insane. Instead of paying banks interest on these reserves, the Fed should charge them a fee that would be used to provide direct loans to small businesses.

Anyone with an understanding of central bank operations would not make these claims. They are substantially wrong.

The inference is that by paying interest on excess reserves, the central bank is providing the commercial banks with a disincentive to loan those funds out to borrowers who would invest in the “productive economy” and “create good jobs”.

The conception that Bernie Sanders creates is that the banks are being diverted by the US central bank from lending those reserves.

On Monday (December 28, 2015), my blog – Central bank propaganda from Minneapolis – explained how banks do not loan out reserves and are not reserve-constrained in their lending activities.

Bernie Sanders is just plain wrong here and is surprising that he has been allowed to maintain this misconception. If his persistence in maintaining incorrect ideas about how the banking system operates is his own doing (that is, ignoring sound advice from his team), then he is unfit to be President. Simple as that.

In the real world, banks do not wait for depositors to provide reserves before they make loans. Rather, they aggressively seek to make loans to credit worthy customers in order to profit.

These loans are made independent of a bank’s specific reserve position at the time the loan is approved. A separate department in each bank manages the bank’s reserve position and will seek funds to ensure it has the required reserves in the relevant accounting period.

They can borrow from each other in the interbank market but if the system overall is short of reserves these transactions will not add the required reserves.

In these cases, the bank will sell bonds back to the central bank or borrow from it outright at some penalty rate. At the individual bank level, certainly the ‘price’ it has to pay to get the necessary reserves will play some role in the credit department’s decision to loan funds.

But the reserve position per se will not matter.

For its part, the central bank will always supply the necessary reserves to ensure the financial system remains functional and cheques clear each day.

The upshot is that banks do not lend out reserves and a particular bank’s ability to expand its balance sheet by lending is not constrained by the quantity of reserves it holds or any fractional reserve requirements that might be imposed by the central bank.

Loans create deposits, which are then backed by reserves after the fact.

Larry Summers appears to agree with Bernie Sanders on the claim that the central bank was errant in paying interest on excess reserves.

However, he clearly understands the central bank operations more fully.

He writes:

However, when rates are raised it is a matter of necessity that the Fed either pay interest on reserves or what is essentially equivalent offer Treasury bills to banks which soak up their excess cash. In a positive interest rate environment, there is no way that banks will or should hold on to zero interest rate cash. I do not think there would be any expert support for Sanders views here.

Commercial banks maintain accounts with the central bank which permit reserves to be managed and also the clearing system to operate smoothly.

In addition to setting a lending rate (discount rate), some central banks also set a support rate which is paid on commercial bank reserves held by the central bank. This support rate becomes the interest-rate floor for the economy.

Any central bank that does not offer a return on reserves would see short-term interest rate fall to zero whenever there was persistent excess liquidity in the bank system (excess reserves). In those cases, they would have to sell government bonds or the government would have to raise taxes to drain the excess liquidity.

The short-run or operational target interest rate, which represents the current monetary policy stance, is set by the central bank between the discount and support rate.

This effectively creates a corridor or a spread within which the short-term interest rates can fluctuate with liquidity variability. It is this spread that the central bank manages in its daily operations.

In most nations, commercial banks by law have to maintain positive reserve balances at the central bank, accumulated over some specified period.

At the end of each day commercial banks have to appraise the status of their reserve accounts. Those that are in deficit can borrow the required funds from the central bank at the discount rate.

Alternatively banks with excess reserves are faced with earning the support rate which is below the current market rate of interest on overnight funds if they do nothing.

Clearly it is profitable for banks with excess funds to lend to banks with deficits at market rates.

Competition between banks with excess reserves for custom puts downward pressure on the short-term interest rate (overnight funds rate) and depending on the state of overall liquidity may drive the interbank rate down below the operational target interest rate.

When the system is in overall surplus, this competition will drive the rate down to the support rate.

The demand for short-term funds in the money market is a negative function of the interbank interest rate since at a higher rate less banks are willing to borrow some of their expected shortages from other banks, compared to risk that at the end of the day they will have to borrow money from the central bank to cover any mistaken expectations of their reserve position.

The main instrument of this liquidity management is through open market operations, that is, buying and selling government debt.

When the competitive pressures in the overnight funds market drives the interbank rate below the desired target rate, the central bank drains liquidity by selling government debt.

This open market intervention therefore will result in a higher value for the overnight rate.

Importantly, MMT characterises the debt-issuance as a monetary policy operation designed to provide interest-rate maintenance.

This is in stark contrast to orthodox theory which asserts that debt-issuance is an aspect of fiscal policy and is required to finance deficit spending.

The preferred position of MMT proponents is to set the overnight interest rate at zero and then let the longer-term investment rate structure adjust to reflect risk and inflationary expectations.

Then there is no reason to pay interest rates on excess reserves and fiscal policy assumes the major counter-stabilisation role at the macroeconomic level.

Please read my blog – The natural rate of interest is zero! – for more discussion on this point.

Bernie Sanders also wants a range of transparency reforms to allow the public to better appreciate what goes on within the central bank boards. All public institutions should be accountable but I don’t think this is the main issue that needs to be addressed at this stage.

He touches on his belief in the need to “reinstate Glass-Steagall and break up the too-big-to-fail financial institutions that threaten our economy” and to “make banking work for the productive economy and for all Americans, not just a handful of wealthy speculators”.

The fact that the Glass-Steagall rules were undermined by concerted lobbying from the financial sector and incompetent responses from government, does not necessarily mean that they should be reinstated in law.

I know that restoring the Glass-Steagall rules is a popular ‘progressive’ position but there were reasons why they were no longer providing security and traction to policymakers as originally envisaged.

The aim of the 1933 Banking Act was to divide commercial banks into deposit-taking institutions that were regulated and secure, on the one hand; and risky, speculative investment institutions, largely unregulated, on the other hand.

The plan was to ensure that the deposit-taking banks were prevented from engaging in risky activity which could incur major losses to the depositors. On the other hand, the speculative institutions were prevented from taking deposits.

However, a number of innovations (for example, asset securitisation and the rise of the corporate issue of commercial paper) undermined the strict division envisaged in the 1933 Banking Act.

As Jan Kregel argues in his 2010 study – No Going Back: Why We Cannot Restore Glass-Steagall’s Segregation of Banking and Finance:

To remedy the competitive disadvantages, member banks were allowed extensive exemptions from the section 20 and 21 interdictions against dealing in securities and with security affiliates, eroding the strict segregation provided by the original 1933 legislation.

Further, rulings under Section 16:

… laid the basis for the creation of proprietary trading by banks for their own account, as well as derivatives dealing and the provision of structured derivative lending – both of which led to the rapid growth of the over-the-counter market in credit derivatives. Paradoxically, the justification was to provide regulated institutions, which were supposed to have a monopoly advantage, a level playing field with investment banks.

I would argue that a progressive position must focus on eliminating most of the derivative transactions that have perverted the banking sector.

Larry Summers argues that the activities of banks such as JP Morgan or Goldman Sachs in this regard are “egregiously under regulated”.

I would go one step further and make them illegal.

Please read the following blogs – Operational design arising from modern monetary theory and Asset bubbles and the conduct of banks for further discussion.


I like the way that Bernie Sanders is attempting to redefine the public policy debate and have sympathy for many of his positions and values.

But I don’t think it helps when progressive voices make simple mistakes that, ultimately, ply into the hands of those who have created the mess the world economy is now in.

Happy New Year

This is my last blog for 2015. I therefore wish all my readers a fine 2016.

Tomorrow, I’m travelling a lot and so my blog will be somewhat truncated. We will see by how much when we get there.

That is enough for today!

(c) Copyright 2015 William Mitchell. All Rights Reserved.

This Post Has 51 Comments

  1. Stephanie Kelton was appointed the Chief Economist for the minority on the Senate Budget Committee, for which Sanders is the ranking member. She is a leading advocate for MMT. Why doesn’t he have her review his op-eds? It seems he lacks a grasp of the fundamentals of reserve banking.

  2. Bill,

    You said:

    “The financial sector has continually advocated suppression of real wages growth and has benefited from the ongoing redistribution of national income towards capital, which it appears to consider to be a desirable feature of the current policy settings.”

    Capital’s share of income has remained more or less constant at 0.04 for quite some time now.

    “Wealth-shuffling describes at least 95-96 per cent of the daily financial transactions in the world markets.”

    While I am somewhat sympathetic to the idea that the economy is too financialized, I think this statement ignores the valuable role financial markets play in smoothing out price shocks.

    Elwood, Barry:
    I doubt Sen. Sanders really cares too much about what MMT says or doesn’t say. He probably just views it as a convenient way to hand-wave away all talk about revenue constraints.



  3. Stephanie Kelton took two years leave of absence form her position of Chair (Dean?) of the Economics Department of UMKC to advise the minority members of the Senate and shortly thereafter was shown sitting beside Bernie Sanders as he delivered a Senate speech.
    I would be surprised if Bernie is ignoring Stephanie’s advise. Could there be some hidden aim in this recent speech?

  4. the public doesn’t want to hear the truth, a lot of politicians get MMT, but it would be political suicidal to get on-board with MMT, is just against the current ethos. Academic MMT’ers seem to have a hard time grasping this… because they speak for other audiences.

    Group thinking cannot be beaten with intellectual verbose digestions, it has to be countered by powerful simplistic narratives and memes. Bill seems to be getting this at least redirecting his last efforts on this direction.

    For someone successful into re-framing the discussion see Trump and LePen, both appealing to the reptilian brains. The current “petite bourgeois” lefties are an absolute failure at this, people like Stalin were wiser, they should learn from neolibs, neocons or fascists nowadays and drop their intellectualism.

  5. “Commercial banks maintain accounts with the central bank which permit reserves to be managed and also the clearing system to operate smoothly.” Professor Bill Mitchell

    Yes, understood. The question then is why all fiat users, including individuals, are not allowed accounts at the central bank and government deposit insurance abolished (accounts at the central bank are risk-free, at least nominally, if for no other reason than the central bank can create fiat)?

    Because of the need for endogenous money creation via bank credit? But shares in equity is an endogenous money form that requires no government privileges such as government deposit insurance and a lender of last resort (much less a fiat lender of last resort). Plus, entirely private banks can extend a limited (borrowing short to lend long is inherently risky and uncertain) amount of credit on their own.

    The question then is why we insist on what is tantamount to government-subsidized theft of purchasing power from everyone, but especially from the poor, for the sake of usurers and the rich, the most so-called credit worthy?

  6. The use of any of the language of the “deadly innocent frauds” by any politician at this point is immediately suspect. The New Democrats in Canada found that out in Octobers election. As it happens, they had indeed drunk the monetarist punch and cannot be trusted as good representatives of progressive, far less labor, interests until they publicly reject that ideology, fully and completely.

    Happy New Year!

  7. As a personal friend of Stephanie, I’ll just say that anyone who thinks it’s really easy for Stephanie to “set Bernie and his people right” are missing the point Ignacio’s point–it ain’t that easy to just come in and change the political discourse even if you’re “right.” Everyone there already thinks they’re “right.” Ignacio’s wrong, though, about MMT not “getting” this–we know all too well how this works, and we’re learning from various points on the inside how and when to pick our spots in politics in a way that builds and keeps legitimacy in those circles. It also must be recognized that there are various angles–don’t confuse Bill’s excellent writings for the purposes of teaching, disseminating research, and blogging from his expert academic perspective for the strategies and tactics that MMT uses in other arenas. There are different approaches because there are different audiences, by necessity.

  8. Happy New Year also!

    Taxes and MMT are an interesting issue. Taxes give value to money yet aren’t needed to fund spending.

    People want to feel that they pay taxes for a purpose. For many it is hard to get their minds around a ‘money of account’. Taxes can be seen as being a part of a public purse used for public benefit so politics will always be part of this issue as to how money is spent.

    The bailouts were important in focusing attention as to ‘if there is money for that then why not this’.

    I agree with you completely on interest rates on reserves not having a role in determining lending. Here I think Bernie would be better served concentrating on the values of direct government spending and of the establishment of public banks to encourage local productive lending.

    I also think your suggestions for tighter bank regulation are spot on. We are in a very volatile situation with derivatives and their superpriority status being part of the commercial banking system which also includes bail-in statutes for depositers. This is also an under addressed factor in money market funds and their involvement with tri-party repo.

  9. Don’t worry, Bill. Sanders has as much chance of becoming Pres as a snowball has of not melting in hell. But you are right. Complex derivatives should definitely be banned. And mortgage foreclosures very strictly regulated. If a bank that has provided a mortgage sells it to a separate investment bank or its investment arm and that mortgage is then bundled up into a complex derivative, and the chain is not clearly noted, as is generally the case, it isn’t clear who owns that property. What is clear is that the bank that initially provided the mortgage no longer owns the property and wouldn’t be able to provide the mortgage papers, as these were sold on, so said bank should not be able to foreclose on the property in question. But they do. The banning of complex derivatives would automatically, or should, render this kind of dubious operation much less possible. I won’t say impossible because nothing real is strictly impossible.

  10. Sanders’ objective is to garner support for Hillary and the Democratic Party. Mentioning MMT would throw a wrench into that plan.

  11. It might be that is his objective, but as to MMT throwing a wrench into the plan, I disagree. In fact if they brought MMT into the true forefront of discussion correctly it would wipe out the opposition. Because its a full win-win-win including the uber rich.

  12. Dear STF and others (at 2016/01/01 at 1:29)

    As you know, Stephanie is also a friend of mine and the blog was not, at all, intended as a criticism of her or her role in the Sander’s team. As you note Scott, I am not playing the political game.

    My role is to educate as best I can and that means pointing out these anomalies and errors.

    best wishes

  13. I never thought it would be easy. But why not get together a group of key MMT players like you and Warren and Jamie for a meeting with Sanders to try to persuade him to go this route. It would be the best shot you have of getting main stream notice.

  14. The “meme” or virus is simple enough to identify. What the many are having to contend with is “Money Fascism” which advances the interests of the few. It is a pernicious ideological virus to eradicate, however, since it requires a relatively high level of joined up thinking.

  15. ” Bernie Sanders is just plain wrong here and is surprising that he has been allowed to maintain this misconception. If his persistence in maintaining incorrect ideas about how the banking system operates is his own doing (that is, ignoring sound advice from his team), then he is unfit to be President. Simple as that. ”

    I have to disagree. If Bernie is unfit to be president, then surely every one of the other candidates without exception is unfit for the job. Not only on the grounds of incompetence, but also on the grounds of intellectual, emotional and especially moral integrity. May the good Lord spare us from the nightmare of a Trump presidency! The advantage that Bernie has over all the rest of the field is the ready availability to him of competent economic advice, which holds out some hope of rational economic policy if ever he happens to gain office.

  16. Dear John Hermann (at 2016/01/01 at 17:31)

    Anyone who thinks that banks loan out reserves and that the banks are reserve-constrained is unfit to be President of the largest economy in the world.

    best wishes

  17. Another thing to make illegal is interest-only loans and mortgages. This is pure debt slavery.

    All payments received from debtors should be assumed in law to be partly repaying principal, regardless of the terms of the loan itself. The UK system of law is more accomodating to this kind of approach, as landlords and employers have similar restrictions on which clauses on contracts can be enforced in law.

  18. “Anyone who thinks that banks loan out reserves …” Professor Bill Mitchell

    Yes, that’s clearly impossible since only* commercial banks, the monetary sovereign and other central banks have accounts at a central bank and when reserves leave a central bank they do so by being converted to physical cash or are destroyed via taxation by the monetary sovereign; in either case they cease to be reserves so reserves cannot be lent OUT of a central bank.

    However, reserves can be lent BETWEEN accounts at the central bank. The question then is what need is there for government deposit insurance when all fiat users could have risk-free accounts and transactions at their respective central banks?

    *Someone please correct me, if otherwise.

  19. Correction: ‘reserves’ not ‘interest rates on reserves’ as you pointed out. šŸ™‚

  20. larry: Don’t worry, Bill. Sanders has as much chance of becoming Pres as a snowball has of not melting in hell.

    Well Sanders is beating Clinton in Iowa and New Hampshire polls and a poll of registered US voters showed him beating all Republicans better than Clinton.

    Things are looking up!

  21. Forget lending out reserves. If Sanders keeps talking about taxing high income folks and being unpopular with businesses he will not get very far or have much of an impact. That’s why it’s so much more important to be talking about eliminating the fiscal constraint to get to full employment. Even if it means printing the money (metaphorically) to get to full employment and stay there. ” 1) Full Employment Fiscal Policy; 2) Job Guaranty ($10/hour with benefits). Over and over again. ” Any talk of sacrifice or paying your fair share is Loser Liberalism as Dean Baker would say.

  22. I would like to add my support to what Ignacio and STF have written as well as Prof Mitchell’s response to their comments.
    Before retiring a few years ago I was an insider in economic discussions with representatives from national unions and various social movements in Canada. The MMT discourse could not be advanced through slogans such as “taxes don’t pay for anything“ and associated explanations. Openings did occur to advance MMT ideas and some people were convinced by at least parts of it. But then they faced the problem of not appearing to be cranks within their own organisations and so saw MMT as a theoretically correct view but not a practical one. In addition, in Canada many important programs (health, education) are largely paid for by the provinces making MMT-related analysis less directly relevant.

    I found that on a day to day basis MMT insight is very helpful in increasing one`s own confidence in advancing progressive solutions that require federal funding. I continue to use MMT analysis to underpin comments I make in the retirees’ and healtlh care organisations I continue to participate in.

    With regard to Prof Mitchell’s blog: it is an invaluable and reliable source for ongoing personal education and as a place to point others to who are interested in learning more about MMT.

  23. Openings did occur to advance MMT ideas and some people were convinced by at least parts of it. But then they faced the problem of not appearing to be cranks within their own organisations and so saw MMT as a theoretically correct view but not a practical one.

    Are you able to provide any examples?

  24. Anyone who thinks that banks loan out reserves and that the banks are reserve-constrained…..

    There’s a significant difference between the two parts of this.

    Anyone making an overdraft on their account can have that as cash. They just need to put their card into the ATM or ask the teller at the bank. In that sense the bank is lending out its reserves. However, that doesn’t mean the bank is reserve constrained. It just needs to be able to be in a sufficiently healthy financial position to acquire those reserves if it needs them.

    It’s not just banks. I can issue a loan of HK$100, say, even though I don’t actually have any HK$ at all in my possession. But I’d just have to know that I could get hold of them if I needed to.

  25. “But then they faced the problem of not appearing to be cranks within their own organisations and so saw MMT as a theoretically correct view but not a practical one.”

    I wouldn’t put it quite like that. If it is correct it has to be practical. The problems are political and psychological. They aren’t just “within organisations”. They are more general than that.

    On a political level we have to start where people are and not where we’d like them to be. If we go in too hard and too quickly with “taxes don’t pay for anything, $ and Ā£ are just like runs on a scoreboard, the govt can never default, it can never go bust etc etc” we’ll have lost them in a matter of minutes. Bernie Sanders knows that too of course.

    However, if we are more circumspect, and use MMT, for example, to show that government deficits are exactly non-government surpluses and that we can’t just consider the budget deficit in isolation we can make real progress.

    On a psychological level people don’t like to easily accept they’ve been wrong, probably all their lives. There’s no point telling them they’re wrong. They’ll just shoot the messenger rather than accept the message. We just have to let everyone figure that out for themselves.

  26. Peter, not quite

    Firstly a bank creates a loan. So the loan is to person A, and firstly the deposit is to person A as well. At that point the bank is still fine and still fully funded.

    What happens then though is that person A wants to pay person B.

    If person B is at the same bank, then there is NO problem. The deposit is switched to person B and the bank is still fully funded.

    The fun starts when person B is at another bank.

    What has to happen that is that bank 2 has to take over the deposit in bank 1 from person A. That increases the assets of bank 2 which then creates a new deposit for person B.

    That’s how payment works. Somebody has to take the place of the original depositor in the source bank before you can create anything in the target bank.

    Of course at that point bank 2 is taking a risk on bank 1 and will expect to be paid by bank 1 an interest rate to compensate for that risk.

    And it also means that if bank 2 isn’t prepared to take a risk on bank 1, that nobody in bank 1 can pay anybody in bank 2.

    It’s this latter point that caused the creation of central banks – to make sure that the payment system clears. The theory being that all the banks trust the central bank ‘in the last resort’ and therefore the central bank can ensure payments always clear.

    So the cost of funding is really the payments bank make so they can be part of a payment clearing system.

    Central banks can then add regulations and drains, reserve ratios, capital ratios, discount windows and all sorts of other things to increase the cost of funding. This is ‘discipline on the liability side’ to try and limit what banks lend for. It doesn’t really work as we saw in 2008 – because the first thing that fails is the payment system.

    MMT suggests that this is counterproductive and that the central bank should just provide the liabilities necessary at no cost to ensure the payment system clear. Instead banks should be ‘disciplined on the asset side’, i.e. specific regulations as to what sort of loans a bank can make.

    This description is somewhat simplified (no equity and capital), but I hope it gets over the essence of what is going on. BoE doesn’t provide reserves when commercial loans are made. They provide reserves as loans to the commercial banks at a high price with quite a lot of restrictions to encourage banks to borrow from each other, as described above, first.

    And banks don’t need deposits. But they tend to be cheaper overall and more sticky than the alternative forms of funding – capital bonds and equity.

    And if the bank is big enough, it can make a few bob charging for customer transactions within its own balance sheet.

    If a Barclays customer pays another Barclays customer, then all that happens is a few numbers change position on the Barclays computer. But Barclays can charge for that and earn income literally from doing nothing.

  27. “The question then is why all fiat users, including individuals, are not allowed accounts at the central bank…”

    I’m not sure about the situation in the US, but in the UK individuals can have a National Savings account with the Govt which, given that the central bank is owned by the Govt, is just the same as having a central bank account.

    Alternatively individuals can buy Govt bonds if they wish. Or even keep a pile a of cash in a safe. That’s pretty much the same thing too !

  28. Bob,

    Thanks for your comment. I don’t disagree with any of it.

    But, the point I’m making is that if any borrower wants to have their loan as cash they can have it as cash and it really makes no difference whatsoever to the bank. Unless perhaps the loan is for a house and the bank suspects the borrower might not use the loan for the agreed purpose!

    In that case the borrower wouldn’t have to be concerned with the very tiny possibility that one bank may not accept another bank’s IOUs. Don’t they just cross each other’s IOUs off by contra anyway and settle up in real central bank money at the close of trade?

  29. “Alternatively individuals can buy Govt bonds if they wish.” petermartin2001

    Then what need for government deposit insurance? If dealing with sovereign bonds is as convenient as an account at the central bank would be?

    “Or even keep a pile a of cash in a safe. That’s pretty much the same thing too !” petermartin2001

    Really? So physical cash in a safe is as safe as a risk-free (by definition) fiat account would be at a central bank? And transactions just as convenient?

  30. “and when reserves leave a central bank they do so by being converted to physical cash …” F. Beard

    More precisely, reserves are sold for physical cash from the monetary sovereign and are transferred to the monetary sovereign’s account at the central bank. Since the monetary sovereign is NOT a bank, then the fiat in its account are NOT reserves by definition and thus any reserves transferred to the monetary sovereign’s account become simple fiat.

    “or are destroyed via taxation by the monetary sovereign” F. Beard

    Likewise, taxes and fees to the monetary sovereign are transferred from* a commercial bank’s fiat (aka “reserve”) account at the central bank to the monetary sovereign’s fiat account at the central bank where they cease to be reserves and become simple fiat since the monetary sovereign is not a bank.

    *Exception: Payment via physical cash.

  31. So while it’s accurate to say that “taxation (by the monetary sovereign) destroys bank reserves”, it is inaccurate to say “taxation destroys* fiat” or “taxation destroys money” if by “money” we mean only fiat.

    *except perhaps in the case where taxes are paid with physical fiat, in which case the bills may be simply destroyed, especially if worn. Otherwise, they might be resold by the monetary sovereign for account balances at the central bank, I suppose, which presupposes safe storage so destruction might be wiser in all cases, not just for worn bills.

  32. @ Keith Newman (at 4:01) et al, Don’t be discouraged! :

    It has been said that when Colombus ship’s first appeared off the now North American shores, most of the indigenous people at the time didn’t notice them because ships simply did not exist in their world. It was only when the few unafraid to speak of what they saw, spoke, that the idea of a ship and what that might mean, finally began to penetrate the collective consciousness of the community.

    MMT is the model for the money. Saying so doesn’t make you a crank, it makes deniers look ignorant and that may be the real problem. New ideas are hard to accept by those who have supported or believed old ones, for many reasons, not the least of which is that letting go of the old involves an admission to having been wrong. For some, especially those in power, this is difficult to do, either because of pride or fear of losing credibility.

    What makes one the greater fool though? In the fullness of time correct theories always win over minds out of practical necessity. This need is often obviated by crisis arising from following the wrong thoery, as we see happening today.
    Isn’t it better to be among the first to say “I knew it all the time” rather than the last? Political parties and progressive organizations last longer than their leaders, and need to look far to the future when deciding how to shape todays discourse and rhetoric.

    Perhaps better diplomacy in introducing MMT would be more effective than trying to find better memes for getting MMT across. After all, It’s already hard to beat the existing memes like “A sovereign currency issuing Government can never become insolvent in it’s own currency”.

    I am no economist, and yet I had understood there was something inherently wrong with what was being implied about economic theory in all of the political rhetoric I had been hearing for decades. Having no relevant economics training and little time, it was difficult to pin those feelings down with something concrete. When I did have the time, I did start looking for answers and soon found this blog, the UMKC blog and Warren Moslers book.
    Bilbo’s economic outlook is the best resource to refer those who wish to sharpen their debating skills or to just help understand when they are being lied to about current events.
    The weekend quiz demonstrates how despite being a believer in a correct theory, subtle biases planted by neoliberalism’s old tropes can still trip up our interpretation of problems unless we make make careful use of the theory every time.

    Whether Canada, Australia, UK or US, MMT is the applicable theory. The fact that states, provinces, territories, municipalities etc must collect taxes to fund projects, due to difficult to change legacy governance legislation, just makes it imperative that we, as knowledgeable taxpayers, hold federal government to account for having due reverence for all the pertinent realities when they are making distributional decisions. The politicians at the sub national levels of government must be supportive of this. All levels are accountable for “the wise use of the tax payers dollar” by law.

    For labor there is no better promise than that provided by the job guarantee proposal. MMT is the only macroeconomic school of thought which recognizes it’s importance on theoretical grounds.
    That there is value in a “work ethic”, is a thought continually contradicted by ever increasing unemployment, underemployment and ever declining workers share of income and declining availability of public goods such as universal health care. JG is not something labor leaders and left leaning politicians should hesitate on incorporating as a policy goal. It’s not a cheap gimmick that will lose relevance from one election cycle to the next and it has unifying potential.

    MMT can’t accomplish everything we wish, but it can certainly help us accomplish everything that is possible.

    Change takes a commitment to a long and continuous effort, but truth always wins. It’s best to use that as a starting point. No matter how steep the hill standing before it’s acceptance looks, it must be climbed first. Think about scientific and social revolutions of the past and that becomes abundantly clear.

  33. @F Beard,

    I have just discovered that you can buy US Savings Bonds which must be one of the safest ways to save in the USA.

    Presumably your reason for wanting to have an account at the central bank was connected with the small risk of saving in one of the High Street banks? Of course I understand that cash is not the most practical way of saving but the point is that cash is a direct IOU of the issuing government.

    So these savings bonds are the direct IOUs of the US government too, just like cash, bonds and an account at the central bank would be – were you allowed to have one.

  34. “Presumably your reason for wanting to have an account at the central bank was connected with the small risk of saving in one of the High Street banks? ” petermartin2001

    No, the question is why do we need government-provided deposit insurance when all fiat users, including individuals, could have convenient, risk-free (at least nominally) accounts and transactions at their respective central banks instead, just like the commercial banks do?

    I agree that hoarding money beyond legitimate liquidity needs is not wise. Nor is it Biblical (cf. Matthew 25:14-30 ).

    But that’s not the question here either. The question is why commercial banks should have what is clearly an unnecessary privilege – government-provided deposit insurance – instead of allowing all fiat users, including individuals, to have convenient, risk-free (at least nominally) accounts and transactions at their respective central banks just like the commercial banks do?

  35. Btw, while all fiat users should be allowed risk-free accounts at their respective central banks (and government provided deposit insurance abolished), those accounts should receive no interest unless we believe that government provided welfare should be proportional to account balance rather than need. Likewise, as Professor Bill has noted, other debts of the monetary sovereign should receive no interest either.

  36. “Of course I understand that cash is not the most practical way of saving …” petermartin2001

    Pardon me please, I misunderstood “cash” to include a fiat balance at a central bank and then assumed you were talking about the possibility of money hoarding, a legitimate concern I agree, but very ill-addressed under the present system, imo.

  37. ” but continues to advocate policies which avoid addressing the main issue – the power of the financial markets.” Professor Bill Mitchell

    One reason why financial markets are so powerful is government subsidies for the banks, one of which is government provided deposit insurance instead of allowing all fiat users, including individuals, to have risk-free accounts and transactions at their respective central banks. Indeed, those subsidies/privileges render the liabilities of the banking system as a whole largely virtual, not real, ie. physical cash and a safety deposit box or the mattress are not genuine alternatives to the banking cartel as central bank accounts for all fiat users would be.

    So it’s no wonder that the banks are a perennial source of trouble and injustice given that they are a government enabled/subsidized cartel with largely virtual liabilities, ie. because the accounting is bogus.

  38. “And banks don’t need deposits. But they tend to be cheaper overall and more sticky than the alternative forms of funding” Bob

    Because the depositors are captive, ie. physical cash and a safety deposit box or the mattress are no match for the safety and convenience of a government insured account at a commercial bank.

    However, a risk-free (at least nominally) fiat account at the central bank would be at least as safe and could easily be just as convenient with regard to transactions (via the Internet and local Post Offices and let’s build more if need be) as a government insured account at a commercial bank.

    So how about we quit legally stealing the purchasing power of everyone, but especially of the poor (since they are the least so-called “credit worthy” and therefore end up as net victims of the current system) and make lending to a bank (a bank deposit is legally a loan to the bank) a deliberate act by an individual from her/his fiat account at the central bank to the bank’s fiat (aka “reserve”) account at the central bank?

  39. “The bailouts were important in focusing attention as to ‘if there is money for that then why not this’.”

    Specifically, which “bailouts” are we talking about, though?

    Any Treasury or Fed swapping Federal Reserve bank reserves for USD-denominated financial assets (at face value or with a haircut) is a financial asset swap for the recipients of the FR bank reserves.

    What is the “this” that you’re referring to? People’s mortgages are their liabilities. What would be the asset-swap initiated by the Treasury or Fed that would provide relief for so-called homeowners who were ‘upside down’ on their mortgages and who could not service their loans?

  40. Randy Wray has done an outstanding job in analyzing this. (A Critical Analysis of the Fed)

    “”Others, however, have criticized the Fed as being anything but classical not only in exceeding traditional bounds in the magnitude of its balance sheet expansion but also for rescuing unsound institutions rather than limiting its assistance to solvent but illiquid firms, for accepting worthless collateral in security for its loans, for charging subsidy rather than penalty loan interest rates, and for channeling aid to privileged borrowers rather than impartially to the market in general.

    as the Fed bought mortgage-backed securities (MBSs), some of which were “private label” MBSs (not government backed). In the beginning of 2008, the Fed’s balance sheet was $926 billion, of which 80 percent of its assets were US Treasury bonds; in November 2010, its balance sheet had reached $2.3trillion, of which almost half of its assets were MBSs. To the extent that the Fed paid more than market price to buy “trashy” assets from financial institutions, that could be construed as a “bailout.”

    13(3) was very large. Its four special purpose vehicles (SPVs) lent approximately $1.75 trillion (almost 12 percent of the total Fed cumulative intervention) under questionable circumstances. In addition, its problematic loan programs that either lent against ineligible assets or lent to parties that were not troubled total $9.2 trillion (30 percent of the total intervention). In sum, of the $29 trillion lent and spent by fall 2011, over 40 percent was perhaps improperly justified under section 13(3) of the FRA.

    Others may come up with different numbers, but the conclusion is the same: Banks get a very big subsidy from taxpayers. This subsidy distorts markets and encourages banks to become a threat to the economy.

    Our calculation, in a Feb. 21 editorial,150 showing that the top 10 U.S. banks receive a taxpayer subsidy worth $83 billion a year has generated some, um, discussion. It’s a big number, and the subsidy is a big issue for the banks.

    If the Fed can spend by “keystroke” to buy financial assets, why can we not find a way for government to spend in the public interest by “keystroke”?””

  41. re protecting the operation of the clearing (aka payment) system:

    If all fiat users (at least the “banked” ones), including businesses and individuals, had accounts at their respective central banks, and not just* commercial banks as is presently the case, then peer-peer transactions (payments, loans, etc(?)) throughout the entire (except for physical cash) economy would be possible and the need to transact through commercial banks reduced.

    Therefore, the abolition of government deposit insurance and the provision (actually mere allowance should suffice when the future abolition of government deposit insurance is announced) of central bank fiat (aka “reserve”) accounts for all fiat users has the benefit of providing an alternative payment system to using commercial banks (or physical cash) and thus reduces the extent to which the commercial banks hold the economy hostage. Of course this alternative payment system would be limited to the extent fiat users (eg. individuals and businesses) desire risk-free as opposed to interest-paying accounts but that’s a proper limitation, imo.

    *excluding the monetary sovereign and other central banks from the definition of “fiat user”.

  42. The other day I over heard a woman say something on the radio (apropos of what I couldn’t tell you) that seemed to me to perfectly encapsulate MMT. She said “Any problem that can be solved with money isn’t really a problem.”

    Could Bernie Sanders say that and be taken seriously? I don’t think so.

    He might be disqualified in your mind for implying that taxes fund spending, but he’s still a step ahead of anyone who thinks that the problem with Social Security is that it’s running out of money. And he’s two steps ahead of anyone who thinks that the solution to Social Security’s problem is to cut benefits.

  43. The inability of all fiat users to have accounts at their respective central banks is a HUGE implicit subsidy of commercial banks. For example, the US Treasury direct deposits the benefits of millions of Social Security recipients into their accounts. Accounts at the Federal Reserve? Why no, since only commercial banks (including credit unions, I imagine), The US Treasury, and I suppose, foreign central banks may have accounts at the Federal Reserve, certainly not individuals and businesses. So those Social Security checks must go into commercial bank accounts instead and constitute a HUGE GIFT of new reserves to the commercial banks. But why shouldn’t the commercial banks have to borrow those reserves from the individual Social Security recipients, as would be the case if all Social Security recipients had accounts at the Federal Reserve and their checks deposited there by default? And Social Security spending is just a fraction of total US Federal Spending.

    And as noted before, central bank accounts are risk-free by definition so instead of providing government deposit insurance to commercial banks, another huge subsidy, the Federal Government should instead allow and even provide default, in some cases such as Social Security recipients, accounts at the Federal Reserve.

    A risk-free parallel or even superset* of commercial bank accounts at the central bank would constitute a risk-free parallel payment system too, making us less dependent on the commercial bank based payment system.

    Central bank accounts for all fiat users has other interesting possibilities too such as a Steve Keen “Modern Jubilee” to eliminate much debt without disadvantaging non-debtors, harming the banks, or even changing total purchasing power much (new loans by the banks would have to be peer-peer transfers of fiat (aka reserves if the fiat account holder is a bank) instead of new credit/liability creation by the banks for a period of time).

    Anyway, the fundamental question is why can’t all fiat users have the same rights as commercial banks?

    *The poor “unbanked” could be provided accounts at the central bank too.

  44. ” (new loans by the banks would have to be peer-peer transfers of fiat (aka reserves if the fiat account holder is a bank) instead of new credit/liability creation by the banks for a period of time).” FB

    More precisely, asset swaps of illiquid promissory notes from the borrowers for liquid, risk-free* fiat (aka “reserves” if the account holder is a bank) from the lenders. And asset swaps do not increase the money supply (eg M1) as several in the MMT crowd have noted (thanks!) hence we can have bank lending without increasing the money supply (“the loanable funds model”). Thus a Steve Keen “Modern Jubilee”-like equal distribution of new fiat to all citizens would provide new assets for debtors to pay down their debts and for peer-peer lending via asset swaps with no necessary increase in the money supply. Likewise, a temporary ban on new credit/liability creation by the commercial banks need not decrease purchasing power if the new fiat distribution is metered to just replace existing bank credit as it is repaid.

    But peer-to-peer lending of fiat (asset swaps) presupposes accounts at the central bank for both borrower and lender. Thus all fiat users should be allowed central bank accounts so that all fiat users may participate in the borrowing and lending of fiat without resorting to physical cash and so that we can have just debt relief via an equal distribution of new fiat to the population.

    *at least nominally. Fiat could be much less a risk in real terms too if we would eliminate government subsidies for the banks.

  45. “with no necessary increase in the money supply.” FB

    That is, if combined with a temporary ban on new deposit creation (“bank loans create deposits”) and metered to just replace existing deposits as they are consumed via loan repayment to the commercial banks. As noted in another comment, peer-to-peer lending of fiat between central bank accounts would accommodate the need for new loans.

  46. “why can we not find a way for government to spend in the public interest by “keystroke”?” financial matters

    That will be a topic for historians, I suppose, how government subsidies for private credit creation were ever thought necessary.

    It’s those subsidies, such as limiting central bank accounts to commercial banks instead of allowing all fiat users to have them that stand in the way of distributing new fiat equally to all adult citizens without significant inflation or deflation risk.

  47. Food for thought: A temporary ban on new credit creation by the commercial banks is less than elegant and might not be effective anyway since with central bank accounts for all, what would be in effect new commercial banks would spring up and the temporary ban on new credit creation difficult to enforce on the new entrants, not to mention unjust in some cases and otherwise unwise.

    However, while a temporary ban on new credit creation is probably not practical, deposit creation would be much more dangerous for those who dared since:
    1) Government deposit insurance would not exist.
    2) Everyone could and many would have risk-free accounts at the central bank.
    3) Therefore at least some of those deposits would end up being redeposited to risk-free individual central bank accounts, dragging precious reserves (aka fiat balances to us non-bankers) 1-for-1 with them.
    4) Since all who desired risk-free accounts of their own at the central bank could have them (for free as a necessary service from a central bank) then all sub-accounts (eg a checking account at a commercial bank) would be unnecessary. Therefore, why should a central bank care if a commercial bank has insufficient funds in its account? But if overdraft protection is nevertheless deemed necessary then the loans* of new fiat should be at punitive rates since they constitute an imposition on the purchasing power of other central bank account holders.

    So yes, a ban, even a temporary one, on new credit creation is ill-considered. But deposit creation (“bank loans create deposits”) can certainly be made more dangerous by the removal of explicit and implicit subsidies for private credit creation. That and the possibility of peer-to-peer lending via central bank accounts for all might easily lead to net deposit destruction (“bank loan repayment destroys deposits”) and thus allow a metered, equal distribution of new fiat to all adult citizens without increasing net purchasing power.

    *If made, the interest from the loans should be distributed pro rata to all other fiat accounts since it was their purchasing power that was lent. Or if the loan defaults, the proceeds of the bankruptcy likewise distributed pro rata to all other fiat accounts.

  48. [Bill edited out references to other sites]

    PS: The aboĀ­liĀ­tion of govĀ­ernĀ­ment deposit insurĀ­ance could be done gradĀ­uĀ­ally by lowĀ­erĀ­ing the amount insured (eg. $250,000) to $0 over time so the comĀ­merĀ­cial banks can acquire the needed fiat (aka reserves) legitĀ­iĀ­mately (asset sales and loans from indiĀ­vidĀ­ual and busiĀ­ness accounts at the cenĀ­tral bank) and not through cheap loans from the cenĀ­tral bank.

    [Bill edited out links]

    PPS: Adding that the new fiat disĀ­triĀ­bĀ­uĀ­tion should be direct-deposited to (the newly creĀ­ated) indiĀ­vidĀ­ual accounts at the cenĀ­tral bank and not to accounts held at comĀ­merĀ­cial banks. Indeed, all new spendĀ­ing by the monĀ­eĀ­tary sovĀ­erĀ­eign (eg. US TreaĀ­sury) should be directed to accounts (indiĀ­vidĀ­ual, busiĀ­ness, etc) at the cenĀ­tral banks, ie. if comĀ­merĀ­cial banks need reserves (aka fiat balĀ­ances at the cenĀ­tral bank) then let them borĀ­row them honĀ­estly from other fiat accounts at the cenĀ­tral bank and not receive them by default via spendĀ­ing by the monĀ­eĀ­tary sovereign.

    [Bill edited out links]

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