Regular readers will know that I have spent quite a lot of time reading the…
Operational design arising from modern monetary theory
Many readers have asked me to comment on the recent financial reform proposals from the Obama Administration. Some have tied their questions into more general requests to outline a specific modern monetary approach to the reform process. So I thought I would take this Sunday blog time to put some notes together in this regard. I cover the treasury and central bank in this blog. At some later point I will consider how to better regulate the commercial banks and the role of governments in deposit insurance.
Last week, President Obama addressed Wall Street as part of the dubious anniversary of the fall of Lehmans. Here is the full text of the speech. You can see some video of the talk – Part 1 and Part 2. The President said that sweeping reforms of the financial system and the bodies that are intended to regulate the system are required.
He started by noting that the so-called GFC required large-scale government intervention because the crisis had moved into the real economy.
This was no longer just a financial crisis; it had become a full-blown economic crisis, with home prices sinking, businesses struggling to access affordable credit, and the economy shedding an average of 700,000 jobs each month.
We could not separate what was happening in the corridors of our financial institutions from what was happening on factory floors and around kitchen tables. Home foreclosures linked those who took out home loans and those who repackaged those loans as securities. A lack of access to affordable credit threatened the health of large firms and small businesses, as well as all those whose jobs depended on them. And a weakened financial system weakened the broader economy, which in turn further weakened the financial system.
I could take exception to the way he constructs the government bail-out and subsequent events but that would be peripheral to the objectives of this blog. For example, he keeps talking about the taxpayer funds being used and with the banks now returning some of the injection to the government he says the “taxpayers have actually earned a 17-percent return on their investment”. No they haven’t. The government has reduced the net financial assets in the economy by draining some of the initial injection.
Anyway, Obama motivates his agenda by saying:
While full recovery of the financial system will take a great deal more time and work, the growing stability resulting from these interventions means we are beginning to return to normalcy. But what I want to emphasize is this: normalcy cannot lead to complacency.
So while many of us are thinking that with the crisis over the neo-liberals will return to business as usual Obama intends to make some changes to prevent that. Good luck to him.
My reading of the current situation is that the bank and corporates have been saved by the fiscal stimulus packages launched in various guises around the world but they will be leading the charge through their mouthpieces (media, lobbyists, conservative politicians) against any continued stimulus which might actually help the disadvantaged (many of whom will remain unemployed long after the executives have returned to the golf course and long lunches).
But Obama said this:
Unfortunately, there are some in the financial industry who are misreading this moment. Instead of learning the lessons of Lehman and the crisis from which we are still recovering, they are choosing to ignore them. They do so not just at their own peril, but at our nation’s. So I want them to hear my words: We will not go back to the days of reckless behavior and unchecked excess at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall.
The upshot of this sentiment is that Obama claims that his administration is “most ambitious overhaul of the financial system since the Great Depression” and the reforms will “set clear rules … that promote transparency and accountability”. He believes that the reforms will “make certain that markets foster responsibility, not recklessness, and reward those who compete honestly and vigorously within the system, instead of those who try to game the system”.
I won’t go into the detail of the institutional changes he proposes. They include the establishment of a new agency to help consumers get better financial advice on the products available.
Now from the perspective of modern monetary theory, what changes would I like to see instituted. Most of this can be taken as applicable to all sovereign governments (those states that issue their own fiat currency and run flexible exchange rates) even if sometimes I am talking about the institutional arrangements that are in place in Australia.
Role of the national government
Before we establish specific arrangements in the financial markets etc, we need a clear statement of purpose for any national government. I think some of the erroneous reasoning in the media and within the broader debate stems from a lack of clarity about what it is that the national government should be doing on our behalf.
From the perspective of modern monetary theory, the national government which issues the currency as a monopolist has a charter to advance public purpose (welfare) at all times even if, in doing this, specific private interests are impeded. In general, the advancement of public interest will provide a sound basis for private benefit also. But at times this will not be the case.
From that broad charter, full employment, poverty alleviation and environmental sustainability become the most significant expressions of public purpose although in choosing those policy targets I am expressing my values rather than making an economic statement.
However, it is highly unlikely that an economy will perform to potential if these policy targets are compromised in any way so I think there is a good case for making them the starting points in the pursuit of public purpose.
Conduct of Treasury
The Department of Treasury in any country implements fiscal policy on behalf of the elected government. At present most governments have voluntary arrangements in place which resemble the constraints they faced under the Gold Standard. These relate to constraints on net spending and the necessity to borrow from the non-government sector (either domestically or foreign) every time they net spend a new dollar.
These arrangements are a denial of the opportunities that a fiat monetary system offers the elected government. They open the government to criticism from the conservative elements in the society who equate the government budget with the household budget. An examination of the reasoning behind these constraints typically uncover ideological statements along the lines of needing to put a strong check on government so they deliver fiscal discipline.
Of-course, the conceptualisation of “fiscal discipline” is far-fetched and biased towards the government running surpluses and reducing its command of the economy’s resources. This manifests as the government being bullied into reducing its spending, particularly on social welfare and public goods (education, health etc) and reducing taxes for the high income earners). But there is a sickening hypocrisy displayed when it comes to payments to business (so-called corporate welfare).
This form of government spending is never challenged by those who receive them and criticised as being wasteful or undermining incentive and action. Accompanying this rhetoric is a firm belief in self-regulation of private markets, which means that transparency and accountability are reduced.
The voluntary constraints, in turn, create political constraints on the government such that it has been pressured to maintain high rates of labour underutilisation for the last 35 years in most countries because they are unable to run deficits that are required to match the saving desires of the non-government sector.
As a consequence, aggregate demand has been restricted and even undermined in recent decades by the pursuit of budget surpluses and the non-government sector has been pushed into dis-saving (and increased indebtedness).
These voluntary constraints thus lead to unsustainable outcomes but the costs of the dysfunction that follows are borne mainly by the less advantaged groups in the society.
In that regard, I would abandon all voluntary constraints on net spending and the institutional machinery that has arisen to implement these constraints (for example, the Australian Office of Financial Management which was created to place government debt issues into the private markets).
That is, I would recognise the differences and advantages that a government in a fiat monetary system has over one operating in a convertible currency system (Gold Standard) and create behaviours and institutions that allowed the the government to exploit those advantages.
Specifically, I would stop issuing Treasury debt instruments – that is, stop public borrowing.
Such borrowing is unnecessary to support the net spending (deficits) given that the national government is not revenue-constrained. There is nothing positive in terms of advancing the primary goals of the national government
This would mean that the net spending would manifest as cumulative excess reserve balances at the central bank.
Some people will immediately ask: so this will be the “printing money” option that is spelled out in the macroeconomic textbooks.
To which I say: it has nothing to do with “printing money”. All government spending occurs in the same way – altering bank account balances in the private sector or issuing cheques that end up in bank account balances.
What the government does otherwise doesn’t alter that. Taxation – is just the reversal of the spending processes (debiting bank accounts).
In the case of debt issuance, the government only really borrows as part of monetary policy – to manage the reserve impacts of the net spending. So the issuance of Treasury bonds allows the central bank to maintain a positive target rate of interest at the short end of the term structure which, in turn, conditions the longer maturity interest rates.
It is clear that this leads to higher interest rates than would be the case if there was no debt issued and it is hard to imagine why this would be seen as being economically beneficial. If the government wants the private sector to have less spending capacity at any particular time, then it can use taxation increases to accomplish this goal.
Further, the government can always instruct the central bank to pay a return on excess reserves if it wanted to maintain a positive overnight interest rate. As you will see soon, I don’t think this is necessary because typically the central bank should run a zero interest rate policy.
I also note that the issuance of Treasury bonds acts like corporate welfare for the purchasers who typically are financial institutions and foreign governments. Why should they enjoy a risk-free government annuity? There is nothing to be gained from that. The futures traders use the government bond as a pricing vehicle (as the risk-free asset).
But why couldn’t they develop a private benchmarking asset to fulfill the same function but which wouldn’t carry the public transfer of funds connotation? The answer is that they clearly could and their continual claims that the government has to issue debt to maintain financial stability in futures markets etc are just special pleading and are spurious.
What about sovereign funds? These involve the national government via its treasury speculating in financial markets through the purchase and sale of financial assets. There is no public purpose that can be achieved by using net spending to build stockpiles of financial assets.
Typically, this behaviour is constructed as the government “storing its surpluses” in some asset for later use – to permit some future liability (public pensions, public service superannuation, ageing-society demands etc) to be “funded” more easily. But, of-course, that logic is inapplicable to a sovereign government in a fiat monetary system which is not revenue-constrained.
The purchase of the financial assets is not “storing surpluses” – it is just plain government spending – in this case on financial assets instead of other uses that the spending could be put to – such as, better schools, better hospitals, higher employment, more generous research funding etc.
While the true test of the benefits of any government spending is what you might be doing otherwise with the spending, I cannot imagine that it could ever be “better” to buy shares in some company as a speculative venture rather than to improve public education or health. Further, we know that great discoveries come from research. Perhaps the next dollar spent by the government on research in the university system will discover the cure for cancer! That will never come from speculating on the share price of a telecommunications company (as an example in Australia of this sort of behaviour).
Thus, as an operational rule I would ban the government from purchasing speculative financial assets (note I am not including the central bank in this rule).
Conduct of the Central Bank
The central bank should manage the liquidity (cash) system to maintain a zero overnight interest rate as a permanent feature of the monetary system. All adjustments to aggregate demand are better made using fiscal policy.
A zero interest rate policy would reduce the rates right across the term stucture and would be beneficial to investment, output and employment. This policy would to some extent alter the behaviour of saving (positive interest rates reward savers) but any desired adjustments to the behavioural changes (reduced saving) can be accomplished via fiscal policy.
The notion of a natural rate of interest (derived from Wicksell) which is neutral with respect to output is not sustained in the acceptable research literature. The short-term rate of interest which would emerge if the non-government sector was net saving and the government was maintaining full employment (with positive deficits – as a matter of accounting) would be zero. The central bank would have to do something (artificial) like sell bonds to alter that “natural” tendency.
At times the central bank lends to its member banks (those who have reserve accounts with the central bank). This lending should never be constrained and should be priced at whatever the current rate for lending to banks is (this is called the federal funds rate in the US). No special arrangements are needed to facilitate this.
For example, reflecting on Obama’s proposals, the US central bank (Federal Reserve) currently requires collateral from the banks it lends to despite the fact that the assets used already fall under the Fed regulative ambit. So as long as the regulator is ensuring the assets held by the banks are viable then demanding collateral is a waste of time.
Some analysts think that if the central bank restricts its lending to the banks, then this will serve to restrict credit. If it is thought that there is too much private borrowing then this would suggest that the central bank should not offer unlimited loans to the member banks.
But once we reject the “money multiplier” view of the world, then we learn that commercial bank lending is not reserve-constrained (as it is in the text book models that students learn from). That is, banks lend to any credit worthy customer and worry about getting the necessary reserves after the fact. So constraining the central bank lending to the banks will not alter their own lending.
What will happen though is that the rate it lends to banks and its target interest rate will be affected. The central bank has to offer whatever reserves are demanded by the commercial banks if it wants to maintain control over these two rates. Further, by making this offer the interbank market would disappear and that eliminates the inefficient process of banks borrowing and lending reserves between each other.
Still to come … how to regulate the commercial banks.
The general point is that once you jettison the mainstream economics, the institutional machinery that governs the behaviour of the financial markets and the way in which the government (treasury and central bank) interact with the private financial organisations alters significantly.
Once you decouple public borrowing from net spending then all the debt and inflation hysteria would turn to inflation hysteria. That is a much easier pathology to deal with because it becomes obvious every quarter how fast the price level is accelerating. It is virtually impossible to de-condition notions such as “public debt eating our kids” via the regular release of economic data.
The fact that no kid ever gets eaten seems to be overlooked!
This Post Has 31 Comments
The zero natural rate emerges when the commercial banking system is forced to intermediate the entire national debt by holding zero interest earning reserves of the same amount with the central bank.
What’s “natural” about forcing the commercial banking system to do that?
You said Further, by making this offer the interbank market would disappear and that eliminates the inefficient process of banks borrowing and lending reserves between each other.
So if I have $100 in Citi and move it to BoA, Citi’s liability goes down by $100, BoA’s liability increases by $100 and Citi owes BoA $100 which in the present system is settled in the interbank market with high powered money. It can settle it immediately or borrow in the interbank market from another bank which could be BoA itself. In your proposed system however, Citi and BoA independently settle it with the Fed.
You said For example, reflecting on Obama’s proposals, the US central bank (Federal Reserve) currently requires collateral from the banks it lends to despite the fact that the assets used already fall under the Fed regulative ambit. So as long as the regulator is ensuring the assets held by the banks are viable then demanding collateral is a waste of time.
Do you mean that the Fed should not demand collateral because it is better to regulate it that way ?
Also, I would assume that reserve requirement is also not needed
My use of the word “natural” here is a bit tongue in cheek. It is just the rate that would occur as a consequence of reserve position that would be associated with full employment and a positive saving desire by the non-government sector. In that sense, without any further government intervention (via central bank operations), the rate would drop to zero. So the mainstream like to use the word “natural” to describe the outcome that a free market would deliver. In this case, the zero interest rate is the outcome of no central bank intervention.
No collateral is needed as long as the regulator is doing its job properly.
Also no reserve requirements other than a non-negative balance (over some period of accounting).
Lemme try to answer JKH – though not sure if I am accurate. If I understand you correctly, you are asking “isn’t that penalizing banks in some sense ?”
Let us assume that the interest on reserves are set to zero. The reserves for banks increase because of government spending. The banking system by itself cannot change the quantity of reserves. Banks will respond by setting the M1 accounts’ interest rates to zero as well (They may be already zero in some countries, though not all at present). A government spending of $100, say, today morning will increase both assets and liabilities of the banking system by $100. If they are paying zero interest for these accounts, how can they be expected to get an interest on the reserves ? Rather banks should earn only by lending.
Exactly. Stop the corporate welfare – welfare by definition should be to advance the material interests of the disadvantaged.
I understand the mechanism. My point is that the central bank takes full advantage of the reserve account architecture of the commercial banking system in order to force feed its deficit through that system in a zero interest cost way. In that context, I can see how the natural rate becomes zero. But I’m not sure that the context itself is entirely natural. So I’m slightly puzzled about how to think about it. In a sense, it’s a nationalization of a particular section of the commercial banking balance sheet, as opposed to the alternative of issuing securities into a free market that might otherwise demand non-zero pricing. It’s really the effective nationalization of deficit “financing” through excess reserves that allows the natural rate to be zero. The banks have no choice but to accept a zero interest rate when the architecture is designed in this way. And I’m not saying that nationalization per se with regard to this aspect is better or worse than the alternative. Just that the idea of the natural rate seems to me to depend on a somewhat larger idea in this sense.
I think you may have the causality reversed just in this particular instance. If the central bank pays no interest on an amount of excess reserves equal in size to the cumulative government deficit, the banks certainly can’t afford to pay interest on the deposits that have been created as a result of this cumulative deficit. But to the degree they may pay no interest in general on such accounts, I see your point in that context.
Your charge of corporate welfare is spot on. Social welfare is, at worst, just partial reciprocity for the redistributional effects of our financial system.
I understand that the natural rate of interest for a fiat currency is zero. But I get a little confused when the discussion turns to Wicksell’s (and the Austrian) natural rate, which I take to mean a yield on real capital, and thus, in aggregate, a positive rate of interest equal to time preference. Where the Austrians go astray is assuming that the sovereign’s natural rate is equal to the Wicksellian natural rate in equilibrium. A confusion of nominal with real factors…I think? Please clarify.
Maybe a gedanken could lead you into how I would think about it:
Let us say that the interest rate has been set to zero. Of course banks would still charge firms (on loans) an interest rate according to costs, risk of default, competition and various other factors. Let us assume it is 0.25% per month. (Could be anything) Let us look at a hypothetically constructed scenario. Period: 1m. Firms borrow $30b for a month. Government spending is $100b and taxes $80b Ceteris Paribus. The latter causes the banks’ assets and liabilities to go up by $(100-80)b. The former increases deposits by $30b at the beginning of the period and banks’ balance sheet grows by $30b. At the end of the period, the loan causes the balance sheet to shrink by $30b. However, because of interest payments, there is a deposit reduction of $75m because of loans and hence a liability reduction of $75m.
So banks are still making money – it is a capitalistic society.
Capitalism is why banks, when forced to hold more zero interest earning reserves, will tend both to charge more interest on loans and pay less interest on deposits.
I should also add that the zero natural rate/maximum excess reserve proposal will actually lower the risk adjusted cost of capital for the banking system. This is because a greater proportion of their assets (excess reserves) will be zero risk weighted. That lowers the cost of capital and the required return on capital, thereby lowering the required average net interest margin in order to cover the cost of capital. Banks will be less risky as a result, other things equal.
I may be stating the obvious, but I think there’s a larger issue here (increasing corporate control over the levers of government) which stands as a barrier to the implementation of your ideas. The public purpose role of government has been largely usurped by private interests, and the challenge to wider acceptance of modern monetary theory is more political than academic. I’m sure you are acutely aware of this. It’s hard to convince someone of the truth of a proposition, when their livelihood depends on their not understanding it, etc.
Yes, the political resistance and vested interests represents a fundamental constraint on progress. But there is still a lot of academic resistance too because they also have a lot to lose in giving up the paradigm they were trained in and have built their reputations on. But paradigms do change and while it is always better to have planned change, history tells us that it generally happens after some major calamity.
Another good pieces. Here are a few comments and questions:
* Good point about the hypocrisy of accepting corporate welfare and rejecting social welfare.
* You note that purchasers of Treasury bonds are “typically financial institutions and foreign governments”. It is worth noting that much of the buying by financial institutions is by pension/superannuation funds, so the ultimate beneficiaries there are not just fat cats at the top end of town. Of course, you may also have the view that the whole system of superannuation is unnecessary and should be dismantled.
* You argue that futures traders “clearly could” develop a private benchmark as an alternative to futures linked to government bond yields. It is in fact notoriously difficult to successfully launch new futures contracts. The SFE has tried many times before and have failed to achieve the necessarily liquidity for the contracts to succeed. A relatively recent example is their attempt to launch futures based on interest rate swaps.
* You make the point that government bonds are only created as a tool for the central bank to manage interest rates. In contrast to futures, for this purpose, other assets do serve perfectly well. An article in the AFR the other day noted that while there are only about $90bn of Commonwealth bonds on issue, Australian banks hold about $350bn in their liquidity portfolios. The rest is made up of a range of other securities, including bonds issued by State governments, other banks, mortgage-backed securities and bonds issued by “Supra-nationals” (e.g. international development banks). All of these are eligible collateral for Reserve Bank open market operations.
* Side-stepping the “natural” label for interest rates for the moment, you argue that having a cash rate at 0% would be very beneficial. Would that not lead to bubbles in financial assets (shares, property prices, etc), which can be very destructive when they burst?
* When you argue that collateral should not be required for banks borrowing from the central bank? Is that because, if the regulator is doing their job (“ensuring the assets held by banks are viable”) there is no risk of default by a bank? Or is it because, even if a bank defaults, since the government is not revenue constrained, it doesn’t matter if the government loses money in this way? If the former, I would say that this is unrealistically optimistic. No amount of regulatory oversight can ensure that a bank can never become insolvent. If the latter, I would have though that this would create moral hazard in bank lending.
I will attempt to add my understanding to the questions you have raised – of course I will wait for Bill to answer as well since he is the expert. In random order:
1 Interest rate maintenance can be classified into two types: Zeroth order and First Order (fine tuning)- my terminology. Because of a deficit, the supply of reserves will be high compared to the demand for reserves. So the first step is to bring it back to the original level. For this, the government has to issue new debt. Once this has been done, it is still possible that because of various other factors – mainly uncertainty – the supply and demand are not equal. Hence the ‘First Order’ or fine tuning is required and this is typically the Open Market Operation.
2Mutual funds and pension funds are invested heavily in government bonds. In the absence of any issue of government bonds, they will ‘suffer’. Thats true! But interest income on government securities is free money and welfare in Bill’s terminology. Even though the government’s cheque can never bounce, there will be some sort of upper limit to its total spending. But this can be better utilized by cutting down on interest expenses and using it instead for increasing employment. The pension funds can instead invest in corporate bonds for example. It is like arguing that holders of bonds help the other side to expand or simply do their usual business and get an interest in return but since the government is not like a corporate, the bond holders didn’t really help the government and hence shouldn’t be getting a return.
Point 2 may sound very leftist or communist but it is not really – I would argue it this way – at zero interest rates and no government debt issue there is more money looking for investments, firms may raise a lot of capital and that too at a cheaper rate and its probably even better.
Dumb question from the back of the class again:
Why couldn’t the government create balances at the central bank by selling IOUs at 0% to the central bank? Then there would be no concern about the interest component on government debt spiralling out of control.
Is there a concern that government debt at 0% wouldn’t be saleable due to prospective buyers concerns over inflation? Or is it that the central bank may run at a loss in such a situation?
Why does the government borrow at interest, when it needn’t?
Here is an illustration: Let us say that the Government spends $100b over a period of say a month and the tax receipts over that period is just $20b. Let us say that the money doesn’t go into banks and just to production firms carrying out various projects. Let us say that they haven’t paid the salaries as yet to households. The firms’ deposits at the banks will increase by $80b. Thus, there is a liability increase of banks of$80b. In return, the Central bank+government compensates by increasing the reserves by $80b. (It is mostly good to treat the CB+Govt as the same).
Let us assume that the central bank is targeting an interest rate of 3.00% per annum. A bond sale of the government decreases reserves level of the banking system. If in the period mentioned in the example, there is no bond sale by the government, the banking system will find itself in an excess of $80b of reserves. The demand increase for reserves is not going to be much. (Because at the start of the period, the reserves position was such that supply = demand) Hence the situation is such that supply>>demand. The overnight rates will fall to zero because there is nothing else the reserves can do and overnight traders will lend it cheap and you can say that there will be a “rate war” causing rates to fall to zero.
Another complication is interest paid on reserves. But that itself is a 1-day bill.
That’s actually a great question and demonstrates that you’re getting it!
Operationally, your suggestion would work, and it’s essentially what we propose. It’s not done primarily because of miguided political fears (fuled by the inapplicable neoliberal paradigm) that doing so would be hyperinflationary . . . the dreaded “monetization” of the national debt.
Scott and Ramanan
Thanks for your replies. Ramanan, I understand the application of government borrowing as an interest rate tool, it was more the question of why the government needs to pay interest itself on such borrowing that I was getting at.
Scott, regarding neoliberal fears of “debt monetisation”: if the government is only permitted to spend pre-existing money (in the neoliberal paradigm, via taxes or borrowing), and the central bank cannot create money without driving short term rates down, how do the neoliberals propose that base money is supplied to a growing economy?
Might be answering my own question, but presumably it goes something like this: growing economy->increased demand for credit->upward pressure on funds rate->central bank supplies reserves to restore interest rate target. So all base money would arise as a consequence of central bank interest rate targeting operations?
Let me just point out that NYC has been buying dollars with it’s subway tokens and for years has spent more tokens than it’s collected.
That’s called deficit spending.
And the city’s token deficit spending = the private sectors accumulation of tokens.
They also have a zero interest rate policy as the city doesn’t offer accounts denominated in tokens that pay interest.
And there is no inherent inflation.
As single supplier of tokens, NYC sets the price, and let’s quantity adjust, as most monopolists do.
Yes, they could instead announce how many tokens they were going to sell, and then let the market
decide the price, but that would be chaotic and disruptive, much like the way our government operates its currency monopoly.
All well stated!
Just let me add that a negative balance in a reserve account is in fact a loan from the CB as a matter of accounting,
so no problem there!
Here’s a real simple, basic question: If no one has to worry about increasing deficits (currenty called “gov’t debt) “eating their children” (meaning that these debts will have to be paid back someday through increased taxation, because they can exit harmlessly (even beneficially!) forever, then why collect any taxes at all? Why go through the complication of having the gov’t take money from the pockets of business and workers, only to return it to them through gov’t spending? Why not spend the unrestrained fiat money at levels somewhere between zero and whatever level suits “general welfare” needs, and skip the whole taxation part? Talk about “efficiency”!
How do you persuade the non-government sector to use your (otherwise worthless) currency given it is not convertible into anything of value?
Taxation is also an excellent way of moderating the amount of purchasing power the non-government sector has to allow the government to balance its plans with the capacity of the economy to absorb the spending without inflation.
Further, we still operate with a “gold standard” mentality where the national governments were revenue-constrained. We haven’t moved beyond that thinking unfortunately.
In relation to your two responses to my comments/queries. I am not sure what (1) was in response to. As far as (2) is concerned, I agree that, with some fairly drastic changes to current arrangements, alternative arrangements could be made to provide for people’s retirement and in fact I hinted as much in the comment. My point was merely that when people talk about buyers of Government bonds, there seems often to be the assumption that it is all for the benefit of large institutions. My point was that, while these institutions certainly take their cut, many of the ultimate owners of these bonds are ordinary people. Not so different from the old days: http://www.youtube.com/watch?v=93q5_8olpPs
I’d still be interested in your thoughts on the risk that the “natural” 0% interest rate would lead to further asset bubbles.
Yes I wasn’t clear why I made my point (1) – It was in response to your comment: You make the point that government bonds are only created as a tool for the central bank to manage interest rates. In contrast to futures, for this purpose, other assets do serve perfectly well. Over time, without government debt issue, the reserves will keep increasing in the banking system. So the typical Open Market Operations will not be sufficient. Imagine, in the US the deficit is around $1.5-2T now and the open market operations typically are of the order of only a few billions. If the Fed wants the overnight rates to be tightly around 2.5% say, it has to necessarily ask the Treasury to issue debt, even if the Treasury isn’t required to do (or doesn’t want) so. So interest rate maintenance are of two types – outright sale, and reverse/repos. Just repo/reverse repo wouldn’t do. Were you talking on similar lines ?
For point (2), this paper by Randy Wray is a good read http://www.levy.org/pubs/wp_510.pdf
Hello Professor Mitchell,
Just to be sure I understand your point regarding sovereign funds:
By the end of 2008 Norway had used its oil revenues to buy domestic and foreign financial assets worth $330 billion US dollars for its “Government Pension Fund” . The stated purpose is to fund future pensions and other liabilities, all paid in Norwegian currency. This amounts to useless financial speculation since Norway is sovereign in its free floating fiat currency. Norway should therefore keep its surplus oil, selling only what it needs to allow it to import what its citizens and governments want. On a yearly basis this requires that the sum of exports and the amount of financial assets issued in Norwegian currency and held by foreigners, be equal to imports.
With respect to its Norwegian financial assets, these would be better spent on increasing spending on education, health, employment etc, or possibly lowering taxes to allow the non-government sector to consume more. Its foreign financial assets are pointless and constitute speculation on international financial markets. Illustrating the final point, the value of the fund declined by about 25% between 2007 and 2008 due to the financial crisis.
Thanks for any comments you may have.
Also interesting how ‘green’ Norway sells its fuel to the world petro market where much of it is burned.
In fact, many of the most green nations are large exporters of fossil fuels.
It might have been Bob Dylan who said, ‘money doesn’t talk, it swears.’
Last, the currency itself operates as a simple public monopoly. So in that sense it isn’t ‘natural’
the way a ‘competitive market’ might be considered ‘natural.’
Thanks for the response. The idea of Norway being green is indeed ironic. I hadn’t made that connection.
I do have a question. I’m afraid I’m new to this. I don’t follow what your final paragraph explains in this context.
Typo in Bill’s text: The word “investment” should be substituted by the word “interest“, making the relevant sentence as follows:
“It is clear that this leads to higher interest rates than would be the case if there was no debt issued and it is hard to imagine why this would be seen as being economically beneficial.”
Obs: I’ve read about Bill in the last GMO research from JM. MMT is finally making some sense, since Blanchard and Sachs seem like a “pile of unsound” premises, I’m still enjoying and have a lot to read from Bill that said here is my firsts “only partially informed questions”.
Zero interest rate lowering the cost of capital wouldn’t impact the capital return and the ratio between time return of labor and capital?
High return on capital could be good to reach prosperity, supposing we had a proper sharing of capital ownership and its risks and returns. Instead of a higher income from labor I tend to think that a high capital income along with capital distribution policies could have a better result than lowering or criticizing capital income. But actually in your proposed model, I think real capital income could still be considerably high, not sure what you think of the whole dilemma of capital vs labor income and would like to know if possible.
End of the corporate welfare seems great to me, especially since I live in Brazil. But what would you think of hybrid instruments in capital and taxing structures? For instance more capital transfer as part of tax payments (the deal could include mutual agreement, I’m still thinking about it). Also savings instruments for lower income were government and the rich help to “buffer the loss” on the recession part of the cycle and more equally share the gains during the booming years. My impression is that savings account skew the risks and rewards toward the rich, during booming years higher income capture all the gains, during the bust the individual risks that the rich took becomes systemic and ends up on the poor man’s lap, who suffer the most.
This mechanism in my view is also present in fixed wage labor contracts. A better sharing of risks and rewards in my view could bring more “social mobility” to our society, which can be more crucial than inequality. Lower inequality with lower social mobility could be worse than what we have now, because power would never change hands and bring diversity to our decision making. As things are today, risks and reward are concentrated in the rich, where there maybe more social mobility, but the lower income is miles away from the true rewards of our economic development, although several of them provide the “savings” to fund our growth.
My main question of apparently Piketty high tax solutions (haven’t read his book, only several analyses of it and an interview with Piketty), and you proposal of beneficial government spending/taxing is how to separate power from corruption, central planning from capital inefficiency? I see we need better control of both our capital and our government, but I’m still indifferent of government size, since we lack control of both capital and government no matter what sizes they are. Better ownership sharing could promote more control, and lower capital income could be a bad outcome, don’t you think? (I have some other questions I would like to address you, not sure what’s the proper channel for them tough)