Who is in charge?

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1. Hi Bill,

   Extremely nice post.

   The US Treasury and the Fed actually controlled the yield curve during the World War 2, which you would have known from millions of years. For example the 25 year point was pegged at 2.5% annual yield.

   I will rank James Tobin as the person who … don’t know how to put it … couldn’t jump the last mile in spite of being the clear winner (amongst neoclassicals) in the penultimate mile. He had stock-flow consistency and knew loans create deposits etc. but somehow messes up endogeneity of money. He also messed up the identity involving G, T, M and B thinking that the government finances its deficits by printing a fraction of the deficit by printing money – literally… and several such last mile glitch.

2. Another great post Bill

   I think the reason I see this as so unintuitive to folks is that too many are stuck in gold standard logic. The idea that there is a fixed amount of money in the world at any one time is simply unquestioned. Any new venture happens by convincing those “with” to give up something and they must be paid to do so. Its all a zero sum game to most. Why I had no trouble switching to the MMT notion may speak to where I fall on that political spectrum you link to (down in the bottom left corner). To me money should not be a hard asset but a form of grace. My best boss never made me feel he was doing me a favor by paying me, he was grateful for what I allowed him to accomplish and made me feel I was necessary to his success.

   This is the role of currency issuer in my view. Grace is UNLIMITED. Make the people feel valuable and necessary to the success of the national endeavor. What is sorely lacking in our world is a sense of grace, especially in the “Christian” US of A. This is not America bashing but a view from within, how I see it. Too many here, and probably elsewhere too, view grace as something that is meted out to the “worthy” and we are taught that we are sole proprietors of our grace and that we know who is worthy. If we are to be responsible and not wasteful we should give it out in small doses and only to those in whom it will be received well.

   Sorry for the rant. Its what your post made me think of (Its your fault!!)

   Keep up the good work

3. Oh and one more thing.

   I think a nice summary statement of todays post might be; Bond markets need currency issuers more than currency issuers need bond markets.

4. Very enjoyable post Bill.

   You’re right, the last mile is the debate over whether funding deficits with ΔM is more inflationary than ΔB. But it is also the first mile, and every other mile in between.

   I would love to see further discussion on this topic.

   On a related, but slightly different topic, I refer back to your post as to why building bank reserves are not inflationary.

   The simple argument from the inflation crowd is that large bank reserves will be inflationary because of the “credit multiplier” model of bank lending suggests it will be. You respond that the credit multiplier model is not really how the banking system works.

   But this really gets us nowhere because it does not examine the question in the context of how the banking system actually DOES work.

   Banks are regulated in terms of capital and liquidity requirements, not reserve requirements. The large buildup of reserves occured as a result of the Federal Reserve exchanging reserve balances for other financial assets such as mortgage-backed securities, and agency bonds from banks.

   So simplistically, banks have exchanged one type of asset (loans) for another (reserves).

   Do you think this will have any effect on the banks ability and willingness to lend?

5. I’d like to criticise one sentence of Bill’s. He says “Third, the government only ever borrows what it has already spent so there is no demand on “scarce” saving.”

   I agree that “the government only ever borrows what it has already spent”. This is saying that government (in the sense of “government and central bank combined”) creates high powered money and government can borrow this from the private sector.
   But it is not the fact of government having created this HPM that causes there to be “no demand on scarce saving.” The question as to whether government borrowing crowds out private borrowing depends (or should depend) on whether an economy is near capacity.

   If it is NOT near capacity, there is no need for government borrowing to crowd out private borrowing; indeed, government borrowing in this scenario makes little sense. Government might as well fund extra spending by printing more money.
   On the other hand if an economy IS near capacity, and inflation looms, then government borrowing definitely NEEDS to crowd out private borrowing.

   In short, Bill’s phrase “what it has already spent” is irrelevant, I think.

6. Hello, Gamma

   Regarding change M vs. change B, this may be of interest–http://neweconomicperspectives.blogspot.com/2009/11/what-if-government-just-prints-money.html

   Best,
   Scott

7. Ralph: In short, Bill’s phrase “what it has already spent” is irrelevant, I think.

   Here’s why it’s very relevant politically. Most people in the US think that the government, like them, borrows against future income, which for the government is “revenue,” i.e., taxes, and the IRS is easily the most hated institution in the government. Therefore, they equate borrowing with higher taxes down the line, and the national debt as a mortgage passed on to future generations. This is just silly, because the non-government NFA created by government deficit (currency issuance) spending is merely offset by debt issuance, which is merely an exchange of one form of asset for another one that is risk-free and bears interest (such a deal).

   Currency issuance must be offset by debt issuance, dollar for dollar, by law. Therefore, absolutely no bank money (the only other kind of money than government money) is extracted from the economy by government borrowing, and there’s nothing for the government to “pay back” except the interest, which is also accomplished through currency issuance, increasing non-government NFA.

   Politically, this is a bombshell that undermines the “fiscal responsibility” meme, which is then recognized for what it is, a “moral” constraint rather than a financial one. Objectors will argue that such a moral constraint is necessary for “fiscal discipline” to prevent inflation, and that, of course, can easily be answered by Lerner’s principles of functional finance.

   It is also significant in that it would require a rewriting of the mainstream texts, which are all based on the assumed money-multiplier, loanable funds and crowding out doctrine that presumes a convertible fixed rate system, which no longer exists. Time for an update. It should be simple to convince Mankiw and the rest of this. Think of all the new editions it would require. Paul Krugman admits that the bulk of his family income is derived from the texts he co-authors with his wife, Robin Wells.

   If it is NOT near capacity, there is no need for government borrowing to crowd out private borrowing; indeed, government borrowing in this scenario makes little sense. Government might as well fund extra spending by printing more money.

   Ralph, in the US deficit spending (currency issuance) is required by law to be offset by borrowing (debt issuance). With the automatic stabilizers that are in place, the government automatically goes into deficit when the economy drops under full capacity so that unemployment increases and tax revenue falls. This means that the US government must issue debt to offset the deficit incurred.

   If an offset were not required, then functional finance could be adopted instead of having to adhere to the faux accounting that is in place now due to a political requirement that could be repealed if the truth were known. This is why the government just borrows back what it’s already spent is highly relevant today.

8. I think a fundamental problem of “the last mile” for households is this confusion of stocks and flows. Households tend not to have much capital – they live through cash flow. The conception of wealth is having “more” cash – hence cash is seen as a value store rather than as a means to accumulate value stores. A gold standard view, as Greg states above.

   Also, since households are constrained by cash supply, they wish others to be similarly constrained (in a sense of fairness). So, if the government is not “constrained”, a quasi-populist view emerges equating corruption with a lack of fiscal discipline.

9. After several commentators have been discussing how to best get the message of modern monetary theory (MMT) out to the public to gather support for it, given how unintuitive it seems to most people (I disagree that it is, but I am continually told otherwise), I have been reading up on the psychology literature on what in communications technology is called the last mile problem.

   Great! I had a couple of revelatory experiences this weekend. First, I have been posting a few comment on Open Left to counter progressive inclinations to show that historically the Democrats have run lower deficits and run up less national debt than the GOP, arguing that this just reinforces the “fiscal responsibility” meme, which I explain from the vantage of MMT. This is a running debate and every time I get push back from the management.

   One of the problems is that I cite various references and say that people who don’t have any real grasp of economics can start with Warren’s 7 Deadly Innocent Frauds, since it is written for accessibility, while the other references are written by econ profs and require either some knowledge of econ or else some personal investment. Well, Warren touches some people in the wrong way because the Tea Party association. Moreover, yesterday he was accused of being a “Friedmanite.” Bizarre.

   On the other hand, I sat down with a couple of friends to whom I’ve been explaining MMT. The guy is an MBA, but his brother has been into the conspiracy theory crowd (Money Master’s, Ron Paul, etc.) for some time, so he pretty much had the gold standard view. He was open though, and sort of got it the first time I laid it out. Then I sent him some links, which he read, including 7 Deadly Innocent Frauds. Yesterday, I went through it again and he seems to be getting it now.

   I think that the problem is not that it is counter-intuitive. People who know nothing seem to get it right off. With others, it’s a matter of changing the whole cognitive-emotional frame of reference. This is a wrench for most and requires something of a “religious” conversion because it is not rational but ideological.

   Cognitive scientist and progressive activist George Lakoff has explored this. He emphasizes that metaphor is foundational in the process of generating conceptual models. That’s why the household-government finance analogy is so powerful and so difficult to disabuse. It is intuitive. You often hear “commonsense” from the people who espouse it.

   MMT needs to be expressed in conceptual models based on intuitive metaphor if it is to be considered, and the metaphor(s) need to be repeated ad nauseam until they carve new neurological pathways and become cultural memes. Only then will they be able to shape political and economic institutions. Only when a critical mass is reached, will some mainstream players risk their considerable investment in the status quo to get on board. When this happens, it will go viral, and everyone will recognize that the emperor is naked. This is how cultural change happens.

10. Bill, a very eloquent and accurate post that should be quite compelling to those with a Collectivist bent. That is why I find it so scary, being anti-collectivist, pro-Liberty. I think your view can be boiled down to this: there is no limit on government spending as long as their right to do so is respected (see the underground economy in Greece) and such spending is necessary and beneficial for the nation as a collective when the private sector is acting irrationally and under-utilizing capacity. If you have confidence in the ability of government to manage such a process then by all means you should support allocating more of the capital allocation duties to the state. The flaws I see in your view:

    -You underestimate prices signals and what they mean. Sometimes idle capacity is idle for good reason. I live in NY and I appreciate the loft apartments in SOHO and Tribeca that were once idle capacity (sweatshops). And on the docks in Brooklyn I see idle capacity that was once used for shipping now housing movie studios. Likewise, many tech companies in SF are located in former industrial capacity that was idle before thee assets were reallocated in a fashion that could not have been planned by any centralized authority. Sometimes prices have to adjust and capacity has to disappear with the assets being reorganized into a more useful form. Essentially creative destruction.

    -You don’t seem to differentiate between the real economy and the financial economy. What I mean to say is that money is nothing other than a way to keep score- to enable the trade in real goods and services. Creating money does not create more goods and services, it just reallocates the control of the existing goods and services. In an inflationary environment those with first access to money before it inflated are advantaged as they can acquire goods and services at the lower (real) price. Govts and bankers who have first access to capital before it is inflated benefit at the expense of the wealth creators in the economy.

    -If you believe that interest rates and capital allocation can be effectively managed from the top-down, and you think the government should guarantee full employment AND what jobs those employees will be doing then you should support a completely centrally planned economy. After all, if govt has to step in to fill a 30% slack in the producing capacity of an economy, and they do so at levels of efficiency superior to the private sector, then they should also manage the remaining 70% of the economy. The Soviet Union has full employment, capacity utilization, and strong growth for a number of years. What they didn’t have was accurate pricing signals to let them know when they were wasting capital on unproductive ventures.

    -Like all economists of all political persuasions, you assume that people will not be able to handle an economy with a fixed (or slowly growing) money supply whereby prices generally fall due to improved productivity. The dreaded 1-2% deflation will end all economic activity as we know it. This is plain wrong in my view.

11. But the mainstream have such an ideological obsession against government command of resources for to pursue a socio-economic program (because such programs are “wasteful”, “inefficient”, “roads to no-where”; “undermine incentives”; “enslave free people”, etc) that they realise they can pull the emotional strings and invoke this faulty intuition in the public.

    As I understand Michael Hudson, his claim is that this isn’t just ideological. It’s disingenuous and self-serving. When the government enters the economy, it reduces the rent that FIRE is able to extract from it. This occurs especially in late stage capitalism, which switches to financialization based on rent-seeking when the service sector predominates over entrepreneurial innovation in the production sector.

    The public is suckered in by a conceptual framework that is based on individualism over cooperation, representing society as a set (aggregation) of members instead of as a complex system comprised of elements (individuals) in relationship to subsystems (groups, institutions) and also relative to the system as a whole. In this arrangement the web of relationships is as significant as the elements and subsystems.

    The systemic ideal in society occurs when individuals pursue the good of the whole in pursuing their own interests. and vice versa. Neoliberals misrepresent that this is the case by appealing to the so-called “invisible hand,” on the authority of Adam Smith. However, as Gavin Kennedy has documented in his work, this is a cartoon characature of Smith’s intent. The neoliberal construction of the invisible hand guiding free markets functions politically as an implicit metaphor for “the hand of God” in the minds of many. Yes, ideology is “religious” and has no trouble appealing to religious symbolism in service of its interests. But as Joseph Stiglitz recently said, “There is no invisible hand.” (Joe had better be careful or he is going to be called an atheist.)

    A just society requires a reality-based economics and a values system capable of producing policy that is based on a concept of society as an integrated whole, the human task of which is to keep it in balance through cooperative activity.

12. Once you start from that understanding the erroneous intuitions are easier to break down. The sovereign government can clearly pretend the GBC is an a priori financial constraint – the so-called gold-standard logic – but that is a political choice and is not ground in economic reality. Once that is understood then that political choice has to be considered against all other political choices including enforcing major fiscal austerity programs on the population… Once we get to that stage of understanding then it is quite clear that it is the sovereign government that is in charge rather than the bond markets. The government (via the central bank) can simply enforce a yield structure onto bond markets. Like it or lump it. If the bond markets don’t like it then the central bank can buy the debt. Better still, the government can simply avoid issuing debt altogether and deprive the “bond markets” of the corporate welfare.

    This is indeed the crux of it, but the gigantic problem is that mainstream macro is based on the the GBC as well as applying assumption-based theory a priori instead of reality-based national income accounting and stock-flow consistent models of what actually happens. The only introductory text I know of that challenges the mainstream view is Godley and Cripps, Macroeconomics (1983), long out of print.

    How to frame this intuitively if even the so-called experts can’t see the obvious, even when it is explained to them? I recall Thoma’s abrupt dismissal of a debate, and I regard him as one of the more open ones, judging by the links he posts. Then, there’s the inevitable pushback from the powers-that-be whose honey pot is at stake. Sometimes the last mile to top of this mountain looks like a sheer rock face. This task is going to take some hard wigging and humongous truckin’.

13. Yossarian, it seems to me that you are taking an either or approach. Either Schumpterian creative destruction or Hayek’s road to serfdom. I won’t get into the economic assumptions underlying this but leave it to the economists here if they so choose. However, I would point out that from the logical point of view, you are erecting a specious dichotomy that assumes your conclusion.

14. Felix Salmon comments here on Warren’s proposal for the ECB to print 1 T and distribute equally to the EMU countries. He doesn’t criticize, but he doesn’t see it being politically feasible either.

15. Another interesting article. I’m very glad to have found your blog; I had come to the conclusion that we were not running our (US) economy very well, but was unsure of what a better course of action would be.

    I believe that I do understand the concept of the need to increase the money supply and deficit spend to make up for the fall in private demand that we are experiencing. I can see how this stimulus would not cause inflation until the government spending was competing with private spending for a limited supply of goods and services.

    One question that I do have for you or your knowledgeable commenters has to do with imports. While deficit spending in current conditions may not cause inflation of the prices of domestically produced goods and services, will it not still cause inflation of the prices of imports? Whether this is good or bad is a political decision of course, but technically, with more money available, and especially if the foreign producers do not have excess supply, will they not demand more of the devalued currency for their goods?

16. Although I disagree with almost all your propositions (on which I’ll come back at some later stage if I may) I enjoy reading at least one opinion in this jungle of mumbo-jumbo that’s not “more of the same”. Have opened all the inline links to your previous posts and will try and understand your theoretical framework. As to whether bond markets can “shut down” governments, I beg to differ (as long as we’re not talking abolut Hitlerian shenanigans of course): In and of itself a Greek bankruptcy or bond default should -in theory- not affect the Euro as such very much, Greece being maybe 3% of the total. However, just as a Californian bankruptcy would reflect badly on the “state of the Union” as a whole so would the default of on EU country, coupled with the rising interest rates and thus further destabilisation of the remaining over-leveraged member states, make investors wonder when sovereign default across the board is likely. Thus they wouldn’t commit themseves to bonds of longer maturity and that’s the beginning of the end.

17. Tom & Bill:

    I am glad there is increasing focus on the “last mile” issue, although it will probably take someone with advertising experience to crack the code, since logic, even in stripped down form, does not appear to be the great persuader. I keep thinking we have to come up with a YouTube video to get the message across, although not one in university lecture form.

    I would guess since fiscal austerity is now being imposed on Ireland, Greece, and other European nations after a severe recession, these are places where finding the persuasive images and rhetoric to span the “last mile” on MMT might be especially important and fruitful.

    In my own efforts, especially when I run into the US government budget = the family budget meme, I find it useful to ask people where their money comes from, since neither they, nor their employers (usually), can create the money they receive as payments for labor time, products, or existing assets.

    Once you trace money creation back to bank loans and security purchases, central bank asset purchases, and fiscal deficits, you can open up other vantage points, like sovereign governments cannot run out of money and default unless they chose that path, and you can also introduce the net financial assets perspective, where government must firdst create the money it taxes and borrows back from the private sector.

    So there are ways of taking the popular meme’s that have been used to confuse the issue, and turn them against themselves to reveal MMT vantage points.

    But beyond demystifying money creation, which is a big chunk of the last mile challenge, there is, at least in the US, a persistent fear that if we were to become masters of money, rather than mastered by money, the existing government decision making process is so flawed and so corrupt that the power would be abused and it would all go haywire in short order. This is where the automatic stabilizer characteristics of a job guarantee/ELR approach must be emphasized.

18. Yossarian:

    I get your point about empty docks being converted, etc., but do ask one or two of the over 6 million US workers who have been unemployed for over half a year how they are enjoying the freedom of being an unemployed productive resource. Sometimes the creative destruction is more destructive than creative.

    Relative price adjustements unfortunately do not always get us to full employment. One need not be a statist to recognize that. Markets are embedded in societies to different degrees at different times in history. The challenge is to find the right mix. Perhaps one day the Austrian School advocates will buy their own island (or maybe even a country – Greece should come cheap soon once the tear gas clears) and demonstrate how the market driven approach really works off the blackboard.

    Many who work with perspectives similar to Bill’s have spent a lot of time thinking and writing about how monetary and real economics can be and are integrated, while much of the mainstream of the economics profession appears to work with a barter based model. In an economy organized principally around the maximization of money profits, higher monetary expenditures can and do often yield higher revenues and profits for firms, which tends to be the signal firms recgonize to expand production, right? The inventory of products available for sale is only fixed in the ultra short run, and with some services, they are not very fixed even in the ultra-short run. The increase in prices from higher monetary expenditures on a fixed inventory of products for sale can lead to a higher level of output. Output is not fixed forever, unless you wish to assume relative prices keep the economy in a constant state of full utilization.

    Regarding accurate pricing missing for decisions by institutions other than markets to allocate labor and capital, I have lived through at least two large and sustained asset bubbles where private investors have ignored the facts in order to play the game of get rich quick. Having listened to and engaged in arguments with frothing at the mouth bulls who held professional investor credentials and were employed by major institutional investment and brokerage institutions in both instances, I am quite certain government decision makers are not the only ones who can get it wrong in a big way. Yes, the Fed’s setting of an overnight policy rate played a role in the New Economy and the housing bubbles, but it is overly simplistic at best to lay all the blame on central banks (although I realize that is what many Austrian adherents do).

    A mild supply side driven deflation might work if the private sector was not sitting on such large debt loads that have to be serviced out of income flows, because servicing them out of asset sales seems to have some nasty feedback effects on net worth and borrowing capacity, as many rediscovered after September 2008.

    So before we run the supply side deflation experiment, best that we run a decade or so of financial surpluses for the private sector, so that net saving (income minus expenditures, or alternatively, saving out of income flows minus investment in tangible capital) can be used by households and businesses to pay down their existing debt. Unless you can find something better than double entry book keeping, the only way to do that is to reverse the trade deficit and/or increase the fiscal deficit. And until we find another planet to trade with, the latter course is the only one available to a a large number of countries at once.

19. Tom

    When you say that it is law in the US to issue debt $4$ with govt spending, does this include defense spending? I understand that it is not the case for defense spending but I may be wrong.

    About your cognitive/emotional frame of reference, that is what I was getting at with my grace metaphor. I realize that would probably be not a workable metaphor for broad use, sounds too mushy. However maybe the idea of money can change from a “good” to be hoarded or collected to something that is more effective when it is used. Somehow the idea of “if you really love money set it free” needs to be applied. There is plenty of money in the world, unfortunately much of it is rotting and simply doing nothing productive. It is sitting around making some insecure guy feel secure.

    Regarding a You tube series to teach the principles of MMT, has anyone seen the series ( I cant remeber who did it, I’ll find it when I get home) that was done a couple years ago that had a British guy and a dry erase board explaining things like Credit Default swaps or MBSs.? There was a whole series that went over all the fiancial issues of the day and it was very good. He would finish every segment with “Well and then we all go get a drink”. It was quite funny and effective. That would be a great model for our series I think. I’ll try to link to it later.

20. “We react intuitively all the time and this blinds us to what is going on. An the example given in the video was the following. A bat and ball costs $1.10. The bat costs $1 more than the ball. How much does the ball cost? Most people in controlled experiments acting on intuition say 10 cents whereas the correct answer is of-course 5 cents.”

    I do not agree that the problem here is intuition. Rather, it is lack of skill. To answer this question requires algebra or the equivalent. Most people never took algebra or have forgotten it. Intuition is fallible, but it is not synonymous with error. Now, ordinary arithmetic is all that is required to check the answer of 10 cents and to see that it is wrong. But people are not careful about checking their errors, either. Again, that is not a failure of intuition.

    “I have been reading this literature for sometime now because I think it resonates with the challenge that MMT has in disabusing the wider public of falsehoods in macroeconomics that arise from the application of intuition. This intuition is continually reinforced by analogies between the household and government budgets, for example.”

    This is spot on. This analogy has to be debunked.

    That debunking can be aided by another intuition: that of conservation. Small children think that if you pour water from a tall, thin glass into a short, fat glass that some of the water has disappeared. But they learn that the amount of water remains the same, and develop the intuition of conservation. Quite a number of things in ordinary life are conserved, and that intuition is familiar and well established.

    Now suppose a game with play money where two players each start with $100 and use the money in the game. The money is not just a way to keep score. At some point one player has $110. Then it is obvious that the other player has $90. Now suppose that the player with $110 saves $10 by taking it out of play. The first player still has $100 in play, but the second player has $10 less than at the start. We can say that he has a deficit of $10. (He does not owe any money, but he is at a disadvantage.) In poker a player is not allowed to take chips off the table, for just that reason.

    Now, the real economy is much more complex, but, based upon the intuition of conservation, people can see that if the government runs a surplus, that can make it harder for them to save, and vice versa. They can also see that if we want people to save, in general the government should run a deficit. Or the government can break the assumption of conservation by creating more money.

    Now, surely there are better examples than that game, but you do not need to combat intuition. You can make use of the familiar, well established intuition of conservation.

21. MacroStrategy Edge: I keep thinking we have to come up with a YouTube video to get the message across, although not one in university lecture form…. In my own efforts, especially when I run into the US government budget = the family budget meme, I find it useful to ask people where their money comes from, since neither they, nor their employers (usually), can create the money they receive as payments for labor time, products, or existing assets.

    My experience exactly. When asked, most people either have no idea where money comes from, or if they do, it is totally wrong. “The government prints it?” as if all the money were cash.

    I think that the story has to begin with the banks, because based on their experience people associate money with banks. The conspiracy theory, of course, is that the evil bankers are the wizard (not of Australia but of Wall Street and the City) who control the money creation process behind the veil. Interestingly from the point of view of doing a video on all this, The Wizard of Oz was originally likely composed as an allegory attacking the gold standard (the yellow brick road), although the authors claimed it was a “modernized children’s story.” But the symbolism is pretty transparent.

    MMT is based on the notion that money creation is of two types, vertical (government currency issuance) and horizontal (bank money generated through credit extension – loans created deposits). Beginning with the banks, it is clear from the accounting that horizontal money creation has to net to zero because everyone’s bank money is someone else’s loan. [This is a bit tricky explaining because most people have no familiarity with double entry accounting, their check books being exclusive experience. Insert graphic demo.] For convenience, the banks use government note and coin when they dispense bank money as cash. This lack of physical distinction blurs the line between bank money and government money in use. People need to understand this, because it is not obvious. To most people, money is money, and it is identified with the cash in their pockets.

    Loans extract interest on the loan from the bank money created to the degree that bank money is the only money source. Michael Hudson tireless points out that the mechanism of compound interest requires that bank money, created by private debt, has to continually increase to service the debt, driving wealth upward and creating debt peonage at the lower levels, with the lower levels constantly rising. Rentiers love this arrangement, of course, and actively work to keep the government out of the picture as much as possible in the name of “fiscal responsibility,” “liberty” and the” efficiency of private competition,” along with all the bugaboos that will happen otherwise, whereas the rest of the people are increasingly driven into debt peonage because of it.

    Aside: I particularly like Michael Hudson’s quote in this regard so I’ll cite it again: “You have to realize that what they’re trying to do is to roll back the Enlightenment, roll back the moral philosophy and social values of classical political economy and its culmination in Progressive Era legislation, as well as the New Deal institutions. They’re not trying to make the economy more equal, and they’re not trying to share power. Their greed is (as Aristotle noted) infinite. So what you find to be a violation of traditional values is a re-assertion of pre-industrial, feudal values. The economy is being set back on the road to debt peonage. The Road to Serfdom is not government sponsorship of economic progress and rising living standards, it’s the dismantling of government, the dissolution of regulatory agencies, to create a new feudal-type elite.” OK, MMT is value-neutral. So it doesn’t really need to be used in the intro.

    On the other hand, government currency issuance increases non-government net financial assets without creating non-government liabilities. Debt issuance in offset is simply a transfer of a liquid asset (demand deposit) to an interest bearing time asset (Tsy’s), and the interest on the debt issuance is a further government contribution to increasing non-government NFA gratis.

    The principles of functional finance are applied so that 1) the government uses deficit spending to increase non-government NFA and taxation to reduce it in order to balance nominal AD with real output capacity to maintain full employment and full productive potential along with price stability, and 2) the central bank set the overnight rate in the interbank market by hitting its target rate and the Treasury sets the rates paid on Tsy’s of different maturities (if the government chooses to offset deficits with debt issuance instead of offering a support rate equal to the target rate in the overnight market, then debt issuance is operationally unneeded). While the supply of bank money is at the discretion of the banks, depending on their taking risk to lend against capital and the amount of capital, the government controls the rate paid on reserves, thereby influencing the cost of money and therefore the demand for it.

    The important point here is that bank money, being based on lending, extracts rent from the economy, whereas government currency issuance is cost-free to non-government. Moreover, government money is a public utility. The government has a monopoly over currency issuance and this prerogative carries the corresponding responsibility to manage currency issuance for public purpose, e.g., generating the proper amount of nominal AD relative to output potential in order to maximize the resources of the economy, including labor – neither creating a glut that would lead to inflation, nor a shortage that would lead to deflation and economic contraction.

    It should be emphasized that this is not theory based on assumptions but rather descriptions of how the system works based on national income accounting and stock-flow consistency, as has been demonstrated in the literature.

    Then the commonly heard objections can be addressed by simple accessible explanations, citing this literature for those with the economic chops to pursue it. But all many people are interested is that credible experts are behind it. They know there are disagreement among experts and they will go with the intuitive, once they catch it and get beyond their old frame. Showing how the old frame is hangover from the gold convertibility days is a good approach in my experience.

    It should be possible to work up the basics clearly and accessibly in a paper that is clear and concise, test it on a number of people, adjust it based on feedback, and then turn it into a video script based on metaphors that can be show the basics graphically, while also deconstructing the myths. Now if this can be turned into a Monte Python type skit, it’s going to go viral fast.

22. Min, good points. Math word problems are hard at the beginning because one has to lose the commonsense framing and learn to frame things in terms of abstract symbols. Statistics provides even better examples. We use statistics to discipline our accustomed way of looking at things, which is usually mistaken in matters of any complexity. Without acquiring this skill, these things are just not visible at all and decision-making suffers.

    Most of what we ordinarily call “intuition” takes place within the framework of conceptual models. Change the framing, and what is intuitive changes too. This the point that cognitive scientist George Lakoff continually makes in counseling progressives in political communication.

    But for the nitty gritty, one has to invest oneself. However, I think a lot can be done accessibly just by adjusting the framing to fit reality. The myths are not that difficult to explode, although objections by experts have to met by experts. So I don’t think that the last mile is necessarily closed by the barrier of skill, although it would help if more people had some of the required skills.

    However, I am reminded of Warren Mosler’s story of presenting MMT to Larry Summers when he was in the Clinton administration, and Summers responding that he didn’t understand reserve accounting.

23. The quantity of money is not constrained.
    It falleth as the gentle rain from heaven.

    🙂

24. Greg: When you say that it is law in the US to issue debt $4$ with govt spending, does this include defense spending? I understand that it is not the case for defense spending but I may be wrong.

    Deficits have to be offset and ordinary military spending is part of the budget. But there are ways of keeping things off the books, too. Enron’s Ken Lay and Jeff Skilling weren’t the only one that figured this out. W’s administration did this extensively, but Obama put it back on the books, or at least said he was.

    But it’s not illegal for government to do this, or if some maneuver is, there are no penalties provided for doing it. The banks did it, too, but forebearance is saving them from accountability because it would show them to be either insolvent or their capital very severely impaired. Karl Denninger has been documenting some of this over at The Market Ticker for several years. It’s pretty outrageous to the degree he has it right. But there may be a lot of “black” stuff about which almost no one knows anything, too. If there is no public trail, there is no way even to speculate.

25. Yossarian: Like all economists of all political persuasions, you assume that people will not be able to handle an economy with a fixed (or slowly growing) money supply whereby prices generally fall due to improved productivity. The dreaded 1-2% deflation will end all economic activity as we know it. This is plain wrong in my view.

    Might you be overlooking debt deflation and the Fed inability to affect the money supply with monetary policy, the banks unwilling to lend in order to expand the supply of bank money, and the government not taking up the slack in NAD resulting from the increasing propensity to save, contracted investment, and a persistent CAD, by providing sufficient stimulus in the form of more deficit spending or reduced taxation? The world is still staring into the abyss of a deflationary spiral if things get out of hand, as well they might if money is hoarded.

26. Scott: thanks for the link to the article “What if the government just prints money”. I agree with it, as far as I can see. I made a similar suggestion (i.e. just print money and don’t bother with bonds) on Warren’s blog last February: http://moslereconomics.com/2009/02/19/deficit-spending-for-dummies/comment-page-1/ (Comment No. 17)

    Tom: Re your first comment above, your point about the number of text books that would need re-writing made me laugh.
    Re the rest of your comment, we are at cross purposes, I think: doubtless the result of me not making my point clear enough, so I’ll have another go, as follows.

    There are two very different forms of government borrowing. First, there is the form which is essentially no different from me borrowing money from you. That is, government wades into the money markets, offers an attractive rate of interest with a view to grabbing money to spend on highways, schools, etc. This is where crowding out can occur: that is the raised interest rate can discourage other borrowing (e.g. by people buying houses).

    Second, there is the SO CALLED borrowing that is involved in money printing. The net result of this operation is that the Treasury is left “owing” money to the central bank. But this is a nonsense because both institutions are owned by the people. (Or at least central banks SHOULD be run purely for “the people” or for public purpose. In the UK the central bank is technically owned by the Treasury, while I believe in the US the Fed is owned by private banks.)

    Now for Bill’s claim that “government only ever borrows what it has already spent so there is no demand on “scarce” saving.” I don’t think this claim is valid and here’s why. Assuming an economy is at capacity and inflation looms. Assume also that a government wants to increase the share of GDP that it grabs, and to do so by borrowing rather than additional tax. In this circumstance it is a good idea to go for the FIRST form of borrowing, and if this confiscates “scarce savings” from the private sector, so much the better: the effect of this confiscation is deflationary, which is desirable given the reflationary effect that comes from the additional government spending.

    In short, the fact that government “borrows what it has already spent” does not preclude “demand on scarce savings”.
    Alternatively, given a recession, a government should go for the second or “pseudo” form of borrowing. E.g. it can “borrow” from the market, give Treasuries in return, spend the money, then print money and buy the Treasuries back (i.e. do some quantitative easing). To call this borrowing is a nonsense. I.e. in this scenario the fact that there is no “demand on scarce savings” (to quote Bill) does not derive from government borrowing “what it has already spent”. It derives from the fact that no borrowing in any real sense of the word takes place.

    An alternative, given a recession, is for the government central bank machine to borrow and spend at the same time as holding interest rates constant or even reducing them. To effect this constant or reduced interest rate reduction, the central bank has to feed extra reserves to commercial banks, i.e. print money. Again, I would argue that little or no real borrowing takes place: that is, a very wild guess, the amount a government “borrows” in this circumstance will be roughly equal to what the central bank prints.

    Now I’m bound to have got my knickers in a twist somewhere there. Suggestions for untwisting them will be gratefully received.
    Finally I’ll deal with Tom’s claim (as I understand it) that the need in the U.S. for money printing to be matched by extra Treasuries derives from the population’s failure to understand MMT. This requirement, namely that money printing is carried out in a round about way via bonds also applies in Europe, including the UK. I think the reason for this paperchase is that it helps maintain a distinction between central banks and governments. Put it another way, it helps to stop politicians having direct access to the printing press.

    Coincidentally there is a similar argument to the above on government borrowing taking place on Warren’s blog under the heading, “Mortgage Delinquencies Pass 10%”. I do enjoy a good argument.

27. Dear Yossarian

    Thanks for your comments. They are appreciated. But I wouldn’t be so scared of collectivism – remember that we can have a collective with liberty – collectivism does not have to equal authoritarianism. I am on the libertarian end of philosophical thinking but I recognise that the monetary system requires the government do certain things or else we don’t have liberty. I define access to a job (if you want one) to be a fundamental liberty. Misuse or mismanagement of the monetary system by the government can undermine our capacity to enjoy that status.

    Further, when I advance MMT I am not simultaneously advancing any particular view about the size of government. I would hope my ideological preferences come out as being separate from my conceptual academic work. They should not be conflated although too often they are because those who cannot find fault with the latter choose to blur the story by inferring evil motives associated with “large government” or something. My preferences are for more government than we have that is true but an understanding of MMT can be associated with a view that a very small government sector is better. MMT has no “opinion” on that – but the persons who have developed it have and they vary quite a lot between us. But the fact remains that if the private domestic sector wants to save a proportion of GDP then depending on what the external sector is doing the government sector has a clear charter in a modern monetary system. Restricting that capacity artificially (ideologically) will create damage and impinge on our liberties.

    That is a major emphasis of MMT – you might want to expand the private sector – fine if you can and desire that. You may want to promote exports above all other activities – fine if you can and can account to your citizenry why they should be sending the real resources of the nation (net) to other countries in returns for financial claims on the other countries’ currencies. So if you can have a large private sector and an external surplus then you can run a very small government sector and still enjoy full employment. But not all countries (in fact few) can do this. Further, I question whether it is desirable to run such a strategy. But if the private sector wants to save overall more than the external surplus then you have to run a government deficit or face a downward spiral in demand and output. You cannot escape that reality.

    Next, I don’t underestimate price signals. I accept we have mixed econonmies. I have never suggested that the government should bailout private enterprise. I advocated no provision of corporate welfare at all. If a firm cannot compete and goes broke then the capital is lost and new entrants bring high productivity techniques to bear and real wages can then rise further. Many people think recession is a creative process for the reasons you mention – freeing up of poorly utilised resources/space etc for higher yielding purposes. But the costs of allowing this process to happen are enormous and while you might enjoy the loft apartments the generations that are denied jobs and drop out of education etc do not. Arthur Okun (not a MMT) realised long ago that all these dynamic upgrading effects occur in a high pressure economy as well. Competition is relentless and bad capital is always being driven out by new capital. But there is no reason to force large numbers of people (millions) to live in the poverty of unemployment to facilitate these resource shifts. A simple job guarantee can allows the labour that exits failed capital to remain employed while new capital organises and creates new work.

    Next, I very much understand the difference and the links between real and nominal. But I also do not observe inflation as the permanent problem of capitalism. I see the tendency to unemployment as the problem that we should be vigilant about.

    Finally, I don’t think you can jump from a statement that government has a fundamental responsibility to maintain full employment (by using its fiscal capacity responsibly) to the conclusion that this is a centrally planned economy. That is patently a false step to take and speaks more of emotion than reason. The point I made above cannot be overlooked – unless you want permanent stagnation – the government sector has to play a role. MMT tells you what that fiscal role should be. Nothing centrally planned about it. That is not to say I am not unsympathetic to planning but that is quite a separate issue.

    I would note that while Oskar Lange solved the so-called calculation problem (how a planned economy could allocate identically to a market system) what was lacking was the information systems. With modern networks and computing a planned economy could be very responsive to consumer needs. But that is another debate.

    best wishes
    bill

28. Here’s the link to Marketplace videos

    http://marketplace.publicradio.org/collections/coll_display.php?coll_id=20216&page=4

    Its funny, I thought they were outstanding when I first watched them over a year ago but I just watched a recent one on “Inflation” and armed with my knowledge from the billy blog I found myself thinking ” I could do better than that”

29. I would note that while Oskar Lange solved the so-called calculation problem (how a planned economy could allocate identically to a market system) what was lacking was the information systems. With modern networks and computing a planned economy could be very responsive to consumer needs. But that is another debate.

    Several decades ago R. Buckminster Fuller proposed design science based on naval, aeronautical, and rocket ship architecture, where the fundamental principle is doing more with less. He suggested looking at Earth as a spaceship with limited energy and resources but the potentially infinite resource of human intelligence. He created what he called the World Game to simulate this. I became interested in this at the time and was somewhat involved in an organization that was loosely affiliated. I became convinced that as technology developed it would become possible to allocate energy and resources more efficiently, effectively, and holistically than the present market economy could.

    This is becoming a reality with increasing computing power, and with further advances in AI the global market mechanism will likely be surpassed before long. My feeling now is that if this is not implemented soon, the world may reach a tipping point economically that will push it toward war, especially with global warming increasing more quickly than originally predicted
    – just as James Lovelock said it would, since the cumulative effect of reciprocal contributory causes acting in relation to each other was not considered sufficiently in the isolated studies. The Pentagon has been taking this into account in its strategic planning for some time. We can do better with cooperation, I hope.

    I haven’t considered the economics of this, however. It is clearly something that would require acknowledgement of a crisis that can only be solved by unprecedented cooperation. So I would very much welcome a debate on it sometime.

30. Ralph: There are two very different forms of government borrowing. First, there is the form which is essentially no different from me borrowing money from you. That is, government wades into the money markets, offers an attractive rate of interest with a view to grabbing money to spend on highways, schools, etc. This is where crowding out can occur: that is the raised interest rate can discourage other borrowing (e.g. by people buying houses).

    While it is true that since 1979, the Fed is required to purchase securities in the secondary market instead of at auction, the Fed doesn’t do this to finance the Treasury’s deficit spending. Treasuries are sold into the market at auction supposedly to “finance” deficit spending when in reality this is just an offset operation, which as Warren points out, he had an AHA experience in the ’90’s in which he realized that this was really a reserve draining operation. All of the Fed’s dealings with Tsy’s involves managing reserves, whatever it may seem like.

    Second, there is the SO CALLED borrowing that is involved in money printing. The net result of this operation is that the Treasury is left “owing” money to the central bank. But this is a nonsense because both institutions are owned by the people.

    This is how the Fed and Treasury mange deficit spending and the required offset, which isn’t really borrowing in the sense that most people take it to be. The debt issuance doesn’t draw on an existing stock of money, so that the auction competes with others for loanable funds, resulting it crowding out, because the exact amount of debt issuance is added to the money stock by the deficit spending flow. The flow in of reserves from deficit spending is precisely equal to the flow out from the debt issuance at auctions.

    I agree that the debate among Warren, Scott, Winterspeak, JKH, Ramanan, and others shows the complexity of the issues involved and different ways of expressing this. But the fundamental principle that MMT elucidates remains intact no matter how one expresses it semantically.

    But this is a nonsense because both institutions are owned by the people.

    See this post by Matt Franko, and Warren’s comment in the debate link above at #14.

    Put it another way, it helps to stop politicians having direct access to the printing press.

    But as the record shows, when the debt nears the limit under the current law, Congress just votes to up the figure to accommodate the desired expenditure. Where’s the “discipline” here. The congress critters are always promising “fiscal responsibility,” but they know that actual austerity is a can of worms politically, so they avoid it as best they can, at least trying not to seem too profligate. In each congress, the opposition howls about the fiscal profligacy and then they all line up for their pork, regardless of party affiliation. Same-o, same-o, as they say.

    Of course, now “everyone” in the markets is throwing up their hands, invoking Weimar and Zimbabwe and saying it’s up to the bond vigilantes to bring discipline. But, funnily enough, the dollar is rising and so are Tsy’s, while the equities are taking a hit, even though Congress just approved a big increase in the debt limit. A little more of this reverse vigilantism and the dollar carry-trade and inflation hedging will unwind as traders who were betting on inflation rush to cover their positions. Never a dull moment.

    In the first place, following the principles of functional finance MMT would say that the government should not be increasing its deficit at full capacity but instead preparing to take steps to reduce it through discretionary spending cuts, trimming fat, or reducing taxes if automatic stabilizers prove insufficient.

    Secondly, government borrowing (in any sense) doesn’t compete for “scarce savings,” because the government never issues debt without corresponding currency issuance, which simply switches one asset form it provides without interest to one it provides that bears interest. QE is the same in reverse. The government switches one asset form, the securities it purchases, with another asset form, reserves. This doesn’t inject NFA into non-government, only liquidity, while removing the interest paid on the securities from non-government, which goes to the government instead as long as the Fed holds them as assets. Other than the interest, in on debt issuance and out on QE, it’s a wash. That’s why Warren calls QE a “tax.”

    Thirdly, the government never taxes to “fund” its spending, any more than it ever “finances” it, no matter how it may seem, or what people think about it. Taxation simply withdraws non-government NFA, that initially had to come from government disbursements (currency issuance). However one chooses to express this semantically is irrelevant to the facts and accounting. The currency issued doesn’t come from anywhere, and “revenue” from taxation doesn’t go anywhere as far as the government is concerned, for as currency issuer and manager the government never has or hasn’t money. It just manipulates numbers on spreadsheets, and provides notes and coin for commercial banks as demanded in exchange for reserves, sort of as a sideline, since cash is very small part of the monetary apparatus.

    This is all just part of constant flow of currency into the economy and flow out or it, depending on the relation of NAD to real output capacity. As far as government is concerned, these are just changing entries on spreadsheets. Of course, people in the horizontal non-government economy see the govt. spending “coming in, ” e.g., social security payments, and their taxes “going out,” so they form a completely different idea of what’s happening. But they are just experiencing the flow of funds from their vantage point in the economy and translating it into metaphors they understand in terms of their own budgets and checkbooks.

31. Thanks for that reference to your blog posting Scott. I am also interested in the empirical evidence for and against the case that funding deficits through currency issuance is not more inflationary than bond issuance.

    Can you recommend anything?

32. Gamma,

    Scott’s analysis is the one in which there is no literal currency printing. Currency notes are not printed. The government spends by crediting bank accounts and does not issue $-for-$ bond sales for the “public sector borrowing requirement”. So there are more reserves with the banks.

    You can think of the present scenario and something similar is happening through QE, though not exactly. The Fed is purchasing Treasuries from the private sector – so it is buying “old” bonds – bonds issued earlier. There is no big difference between newly bonds issued bonds and the ones issued previously – both are promises to pay $s in the future. This has hardly created any inflation in the US.

33. Dear Bill – just a language point that would be better clarified if I may: my Concise Oxford Dictionary defines intuition as ‘immediate apprehension by the mind without reasoning; immediate apprehension by sense; immediate insight’ which confers (erroneously) intuitiveness to input from both body and mind – and then from some un-stated source as insight. Intuition(al)ism is ‘the doctrine that perception of truth is by intuition’ and ‘external objects are known immediately by intuition’.

    In other words, in the light of the intuition one should see things as they are: if not – then its not intuition.

    People may be glamoured by emotion or under the illusion of faulty logic – but intuitive they are not! Have always liked the Tibetan system where instinct, emotion, intellect, intuition, illumination are all distinct phases in evolution – together leading to insight. The people you are writing about, in this context, are mainly using their emotional facility – backed up by whatever concepts they can stitch together to support their desires. However as you ceaselessly point out, the logic is faulty. The motivation is often self-interest; the vision short.

    Warm regards,

    jrbarch

34. jrbarch, Ludwig Wittgenstein has pointed out that the meaning of a term is shown by its use in context. There are many contexts in ordinary language in which a single sign is used as different symbols. LW used “language games” to elucidate this point in Philosophical Investigations.

    Most of what people ordinarily call “intuition” is merely subjective certainty, and a lot of it turns out not to be true under scrutiny. Buddhists, for example, distinguish between insight and delusion, but most of the people who think that they are intuitively certain about the self and world, are deluded from the vantage of insight, which only very few have gone through the process of developing. For example, naive realism, which is pretty simple to show cannot be true, is taken to be “intuitively” true by “people of commonsense,” and they regard anything that doesn’t fit the commonsense view of the world as counterintuitive. That’s why scientific revolutions that question the commonsense view of the world, like the round earth, heliocentrism, relativity, and quantum mechanics take so long to penetrate the prevailing noetic culture.

    As LW shows in PI, we do not “see” (consciousness as mirror or “reality”). Rather we “see as,” relative to the noetic spectacles we are wearing, the “coloring” of which our use of language show, although the eye-glasses metaphor is commonly used by spiritual teachers rather than LW, who stuck to language games to elucidate the logic of ordinary language.

    But I agree with you, strictly speaking, a lot of what’s called intuition is not, since it is demonstrably not true. So-called commonsense is very often wrong, and turns out to be counterintuitive from the perspective of a correct frame.

35. Scott (or bill), I have asked this question before but am still looking for an answer, so here goes again:

    I agree that reserves and bonds are effectively equivalent so it doesn’t much matter which the government uses to support a deficit.

    Where I disagree is when you say banks don’t need reserves to lend. They do need reserves to make a loan since reserves equivalent to the loan amount must be transferred to the borrowers bank as part of the settlement. I think you make this statement because you say the FED will always accommodate the need for reserves.

    But this last statement is contradicted by the statement that to reduce aggregate demand (by reducing the deficit, which is the only way to reduce aggregate demand), you have to tax the population. This will result in reduced reserves.

    So how can you say the FED will always accommodate banks need for reserves while at the same time holding open the possibility that the deficit will be reduced by taxation at appropriate times. Note that when paying interest on reserves, this interest must come from taxation, unless the deficit is in fact being expanded).

    This is one of the parts of MMT I have never been able to resolve in my mind. Hoping you can help!

36. Hi Scepticus,

    If you don’t mind my interruption …

    Yes, if you borrow $100 from Bank A and deposit the cheque at Bank B, then Bank A owes Bank B $100. Banks are allowed to borrow in the interbank market from each other. In this case it is possible that Bank A borrows from Bank B itself to settle. Else it can issue a CD to Bank B and there are many such possibilities such as selling T-bills to Bank B. Typically there are many transaction happening every second and everything is netted. When a bank raises deposits, it gains reserves – another way to obtain reserves. In general we may call this a part of the bank’s Asset Liability Management and the central bank makes sure that things run smoothly.

    Also, banks are usually almost satisfying the reserve requirement. (Exception: at present in many countries the reserves level is very high). To help them satisfy the reserve requirement, the central bank lends them. The way it lends depends from country to country – the central bank could do repos, allow overdrafts, standing facilities etc. However, the central bank also expands its balance sheets so that banks are less indebted to them. So the central bank would buy some government bonds from the banks and increase their reserves level. For countries without reserve requirements, banks do keep some voluntary reserves so that the payment/settlement system is not affected. In Canada which has zero reserve requirement, the central bank encourages banks to keep less reserves and promises a smooth payment system.

    As far as the economy is concerned, the level of reserves plays a very minor role. If I pay taxes, my deposits at the banks go down and so do the reserves level in the banking system. Bond sales also decrease the reserves. However, government spending increases the level of reserves. So the reserve level increase/decrease sums to zero because of the government action. (There is a minor technicality here, which I have avoided – what fraction of the bonds do banks buy)

    The aggregate demand is dependent on the balance sheets of households and the production sector which do not have reserves in their balance sheet. Their decisions – spending, saving, getting into debt etc. are the things which determine aggregate demand and the level of reserves hardly plays any role in this. The interest rate at which banks lend plays a role but the interest rate is not dependent on the level of reserves – it is dependent on various factors such as the central bank’s target of the rate at which banks lend to each other and banks’ own “markups” on this rate etc.

    None of this is simple – took me a while to understand this and if I have made mistakes – it proves that none of this is simple!

37. Scepticus, Ramanan,

    Just a different way of saying what Ramanan is saying:

    The banking system as a whole doesn’t need reserves to expand lending and deposits. It only needs creditworthy customers and capital. The central bank supplies aggregate reserves as required. Therefore, the only issue is that of the distribution of reserves within the system after an individual bank makes a new loan. Because reserves in total are adequate, the worst that can happen is the lending bank is short reserves and the rest of the system is long. Assuming the lending bank is well capitalized and healthy, it can attract reserves directly from other banks (interbank deposits) or indirectly by transacting with the customers of other banks (e.g. selling bills; issuing deposits). That assumption is what it means for banks to be capital constrained as opposed to reserve constrained. And even in the case the lending bank can’t square it’s reserve position immediately, the central bank provides last resort funds as necessary.

    This does not conflict with the fact that the deficit may be reduced by taxation. The deficit creates excess reserves in the first instance. The only issue with excess reserves is their effect on the central bank’s interest rate control. The bank can issue bonds and/or pay interest on reserves in order to exert that control. A deficit reduction by taxation simply reduces the net excess reserve position created in the first instance. The central bank exerts its interest rate control using the same method(s) on a net reserve addition that is smaller due to taxation. In the event there is a surplus, there is a net reduction in reserves, in which case the central bank can mature or repurchase bonds in order to reverse the initial reserve reduction as desired.

38. Scepticus: Note that when paying interest on reserves, this interest must come from taxation, unless the deficit is in fact being expanded

    Interest on government securities adds to non-government net financial assets. Only currency issuance adds to NFA. Taxation always withdraws NFA. Debt issuance does not affect NFA, except through the interest, which addes to NFA, therefore requires currency issuance not currency withdrawal. Currency withdrawal never “pays for” anything, regardless of how it may seem “intuitively.” This is the basic fallacy of the “fiscal responsibility” meme and the erroneous but widespread belief that progressive programs must be “funded” by taxation or “financed” by debt. So getting this is key to MMT.

    The simple way I found think of this is to distinguish between “monetary” and “fiscal” operations. Monetary operations in this sense involve reserves for liquidity management, i.e., interbank settlement. And obviously, banks have to manage settlement by maintaining enough reserves for the purpose, or borrowing on the interbank market. This is never a problem because the Fed is committed to providing enough reserves for settlement, if needed, at its going price.

    Fiscal operations affect non-government net financial assets, disbursement through currency issuance increasing NFA and taxation withdrawing NFA. Monetary operations do not affect NFA. Neither does the creation of bank money through lending because loans create deposits and this nets to zero.

    To understand the basics of MMT its necessary to understand the government relationship to non-government as vertical, with only the government capable of affecting non-government NFA, which is does through fiscal policy – “spending” (currency issuance) and taxation (currency withdrawal), never “borrowing” (debt issuance), which is a monetary operation that does not affect NFA, other than through the interest disbursed, which increases NFA.

    Moreover, it is also necessary to be clear that reserves are exclusively for interbank settlement of accounts in the reserve system, and reserves never enter the horizontal dealings of commercial banking with their customers. The way I conceive it is this: without the interbank settlement system, the different banks would be settling accounts among themselves directly, which would be inefficient. So a central system was created to deal with this, and reserves are the chits they use instead of transferring cash among themselves. In the days of convertibility, countries actually transferred gold (and at times silver) among themselves.

    Debt issuance is both monetary and fiscal. Monetarily, debt issuance simply switches the amount of NFA that disbursements inject from deposit accounts to Tsy’s. This does not affect NFA, but its does affect liquidity by draining reserves as deposit accounts are drawn down as settlement takes place. Fiscally, the interest resulting from debt issuance increases NFA, just like any other government disbursement.

    And yes, the interest is added to the “national debt” per the $4$ offset requirement that Congress has mandated for “fiscal discipline.” There is now great hullabaloo about the mounting interest obligations, just like the mounting SS and Medicare obligations that are “unfunded,” even though the government is not financially constrained, only politically. So when push comes to shove, Congress just ups the debt limit to permit more currency issuance. Much ado about nothing.

    Of course, this is a simplistic mental model, but I think it captures the basics, so that one can start thinking more clearly about the more complex issues. It’s like accounting, where the basics are the balance sheet (assets=liabilities+equity) and income statement (revenue=expenditure+profit/loss) equations, but the accounting rules get increasingly complex as one wades into the nitty gritty. But in the final analysis, everything boils down to the balance sheet and income statement, which reveal how stock changes relative to flow, the details of which are complex in large organizations and only highly trained people can understand the details. At these levels bean-counting is not “intuitive,” as every business owner soon learns from the bean counters. Not many are going to master reserve accounting, for example, but it’s not necessary to get a basic grasp of what’s happening operationally.

39. And yes, the interest is added to the “national debt” per the $4$ offset requirement that Congress has mandated for “fiscal discipline.” There is now great hullabaloo about the mounting interest obligations, just like the mounting SS and Medicare obligations that are “unfunded,” even though the government is not financially constrained, only politically. So when push comes to shove, Congress just ups the debt limit to permit more currency issuance. Much ado about nothing.

    I don’t think I expressed what I meant clearly enough here. Debt payments are actually part of the budget and add to the deficit not the debt, which is comprised of Tsy’s. What I meant by “national debt” was the common misperception that the debt is growing through interest, so that the current generation is not only “burdening its children” with the debt it “irresponsibly ran up” through “unfunded spending” but also with the constantly accruing interest, which they will be “slaving to pay down in the future with their taxes” after “the debt burden too crushing to put off any longer.” Of course, this is just scare tactics at work. Taxation reduces the deficit numerically, but it does not “pay down” anything that is “owed.”

40. MacroStrategyEdge and Yossarian,

    > Relative price adjustements unfortunately do not always get us to full employment.

    Did Yossarian mean something along those lines?

    “The main reason capitalism would outperform socialism, is because in socialism no one knows how much anything costs, which makes it impossible to allocate resources efficiently.”. Ludwig von Mises.

    There is some truth to that statement in the market of some goods and service but

    a) The global allocation of capital allocation via financial markets is clearly sub-par, unless one submits to the unfalsifiable assertion that the
    market is “always right”

    b) Bad externalities that are not priced in the private sector, and that seriously endanger the planet call for Pigou Taxes or as some libertariens would have it, sell properties right for everything including the earth’s oxygen.

    c) Public goals are those demands, such as employment, generally expressed through the electoral process, that cannot not be met by the private sector

    That electoral process, however, is sometimes inefficient conveying public demands into action, resulting in some sectors being artificially inflated and others neglected. By the way, protecting jobs is often put forward to justify the status-quo. Take for example, interstate highways : it should have had its days, if not for the inertia of politics, in favor for IS speed rail since the 70s.

    Finally, a ‘laissez aller’ digression : The theories of the physiocrats originated in a time where land ruled. Then came the invisible hand when resources seemed aplenty and Britain extended its trade business over the world. Marxcism came with the plight of exploitative factory work etc. There just seems to be pattern of theories trying to fit the need of the moment. Are we living an MMT moment? 😉

41. Sorry chaps, I remain unconvinced. Let us simplify matters. Imagine we are in billy heaven and we have a situation in which there is no outstanding government bonds and the government has instead been increasing reserves as a result of poor aggregate demand. Let us further assume there is no demand for government bonds. MMT maintains that selling bonds is always an option but never required, so no selling bonds please.

    Some exogenous shock comes along to increase aggregate demand and accordingly the excess reserves have dwindled to the point at which there are not really any left after each overnight session.

    Now, the government would like to tighten. How does it achieve this in this circumstance except by withdrawing reserves via taxation? If this happens the central bank cannot ensure that reserve needs of commercial banks are accomodated. If they accomodate them at the discount window then no tightening is achieved.

    At this point we have a liquidity problem which will lead to bank failures.

42. In addition to the above, as a stretch exercise, imagine that the aggregate demand has exceeded supply and significant excess reserves are still in place. If youe wish to imagine a cause for this, consider as ahypothetical scenario the achievement of near full employment through a combination of increasing dependancy ratios (and correspondingly tight labour market) and the job guarantee scheme, combined with rising fuel and import prices (and declining trade deficit) due to increased demand from developing nations because BRIC has started run budget deficits to quell internal unrest.

    So now, in order to reduce demand not only must the excess be removed first, but the non-excess reserves must be reduced also, assuming that demand still exceeds supply.

    I hope you will be able to show using MMT concepts how this plausible secnario can safely be safely navigated without undue inflation which would serve to increase aggregate demand in dangerously inflationary circumstances.

43. Scepticus: The supply of excess reserve balances is fixed by the central bank. They cannot disappear in the way you describe.
    (See Keister, Martin and McAndrews, Federal Reserve Bank of New York, September 2008 for a description of the functioning of the system)

44. Keith, reserve balances are removed when the private sector is taxed without matching spending by the government. In fact, this is the process by whch MMT proposes that aggergate demand be managed. That is what my posts are about.

45. Hi Scepticus

    1. CB can always set an interest rate target wherever it wants if it (a) sets the rate paid on rbs equal to its target rate, (b) issues time deposits to drain enough rbs to get to the target rate, or (c) issue its own securities to drain enough rbs to get to the target rate. Don’t need to have the govt issue bonds.

    2. Assuming CB does one of the options in 1, then if the govt raises taxes (or taxes due rise simply because income rises and taxes are based on income), rbs are (a) already circulating if Fed pays interest at the target rate, or if not enough are circulating then there will be pressure on the overnight rate and the CB can (b) provide them via CB lending if rbs in (a) are insufficient or cb has drained them with time deposits that have yet to mature, or (c) buy back its own securities in the open market.

    3. This just elaborates the points we’ve always made. First, banks holdings of rbs don’t matter for lending; what does matter are (a) capital constraints and (b) whether the bank can find deposits to cover for inevitable withdrawal of funds created by the loan. If not, then the cb essentially sets the wholesale price of funds to replace withdrawals by setting the target rate. Second, the funds to pay taxes or buy govt bonds come from (a) previous deficits or (b) lending by the cb at the target rate.

    Hope I didn’t confuse with all the a’s and b’s.

    Best,
    Scott

46. Indeed. I guess I didn’t follow your original example. Let’s assume a huge aggregate demand surge occurs independent of government spending (a jump in exports? huge investment in quantum teleportation – I’m a science fiction fan!). OK. The economy heats up, incomes and profits are up, and government taxes go up in line with the increased activity. The excess reserve balances are still in the system. If however inflation starts up because the economy is very hot and banging up against capacity constraints then government can tax away some or all of the excess reserve balances to cool it down. If it’s exports that are driving the increase in demand the free floating currency will slow and possibly even stop it. For example the Canadian $ rose 50% against the US dollar over a few years in the 2000s due to an tar sand investment binge.

    If in spite of everything demand is still excessive, the government will have to resort to regulatory means to slow inflation: for example tighten conditions for mortgages and consumer loans. OK, I guess that’s what you’re referring to – the point at which withdrawal of money doesn’t work any more. Bill did a post on that once, under asset bubbles, focusing on housing. But in addition to restricting the consumer side , you could restrict investment, spreading out investment plans through regulation. The province of Alberta in Canada allowed uncontrolled investment in the tar sands a few years ago, driving up inflation in that province as all kinds of capacity constraints were hit. Many pointed out at the time that a bubble was being created and that it should have been controlled by spreading out the investment over time by regulation, enforcing environmental regulations more strictly, etc.

47. @stf: “1. CB can always set an interest rate target wherever it wants if it (a) sets the rate paid on rbs equal to its target rate, (b) issues time deposits to drain enough rbs to get to the target rate, or (c) issue its own securities to drain enough rbs to get to the target rate. Don’t need to have the govt issue bonds.”

    Agreed, but in that case I think you have to agree base money is credit, not money. If that is the case, then the natural rate of interest is not zero. If you hold that the natural rate is zero, you can’t use payment of interest on reserves as a policy tool. If the public believe that the CB will pay interest on reserves, then they will view base money as credit not money. Therefore the leverage of the institution extending the credit (the government in this case) becoms a matter for general concern.

    “@stf: 2. Assuming CB does one of the options in 1, then if the govt raises taxes (or taxes due rise simply because income rises and taxes are based on income), rbs are (a) already circulating if Fed pays interest at the target rate, or if not enough are circulating then there will be pressure on the overnight rate and the CB can (b) provide them via CB lending if rbs in (a) are insufficient or cb has drained them with time deposits that have yet to mature, or (c) buy back its own securities in the open market.”

    once again, if reserves can be provided via discount window they are credit not money. My point is in an aggregate surfeit of demand scenario, in which short rates are already 0 due to excess reserves and the CB wishes to raise rates, it must remove them or pay interest on the _entire_ excess reserve balance at the target rate. In either case the interest payment on the reserves or the net reduction in reserves must come from net taxation – aka net public debt reduction. Remember in my example I have forbidden bond sales. In any case I agree with you that bond issuance in such a scenario will be more inflationary than paying interest on reserves so bond sale will make matter worse not better in the aggregate surfeit of demand scenario. You can’t tighten policy in this scenario without reducing the public debt (all of which is denominated in bank reserves), which will make it impossible for the CB to accomodate the reserve needs of every single commercial bank, some of which will therefore face liquidity problems.

    You might counter that in an excess demand secnario there is more scope for taxation but this situation is also likely to result in banks assets rising in value and hence a decrease in their capital constraints, which offsets the tightening effect of taxation.

    @stf “First, banks holdings of rbs don’t matter for lending;”

    Yes they do, when banks become reserve constrained due to the CB removing the excess in order to tighten policy as per above. In an economy in which all the public debt is denominated fully in bank reserves and the private sector has reached maximum extension tightening can only be accomplished by removing reserves. At this point banks become reserve constrained.

    @stf: “Second, the funds to pay taxes or buy govt bonds come from (a) previous deficits”

    If the previous deficit has already been leveraged to maximum level by the private sector then any removal of overall public debt leads to liquidity shortage and bank failures. If you posit a situation in which tightening is needed, it makes sense to assume a worst case in which the private sector has attained maximum permitted leverage.

    @stf “or (b) lending by the cb at the target rate.”

    Paying interest on reserves which are not tax funded to make up for reserve shortfalls creates net reserves and therefore at best has zero impact on total reserve balances. Therefore this policy tool cannot be used to tighten.

48. keith, if the government uses regulation to tighten like increasing capital requirements or making rules on minimum mortgage deposits this creates deflation from current price levels and a drop in aggregate demand.

    According to MMT, now the deficit must be increased, or other ways of loosening policy must be used to restore demand. However we now find ourselves back where we started.

    I don’t think MMT can effectively reduce demand without causing deflation at that time. The reason for this is that all money is credit, including fiat currency (base money).

    Therefore the only method for safely reversing credit growth is to utilise negative nominal interest rates when the money supply deflates. This allows prices to adjust downwards while maintaining aggregate demand because debt adjsusts downwards in line with prices.

    Banks reserves in a fully extended private sector can only be reduced at the same time that aggregate debt levels in the whole economy including the public sector are reduced.

49. Scepticus, The reason for this is that all money is credit, including fiat currency (base money).

    I’m confused about this statement. Ok, base money is an accounting liability, like M1 (deposits created by loans), but there is a vast difference in that deposits create a very real loan obligation, whereas reserves are only a “liability” in the accounting sense, just as the corresponding “asset” an accounting fiction since it is just a government offset that is also fiat. Fiat money means money created without any real liability, other than the “full faith and credit of the issuer,” whatever that means, which is the constant complaint the sound money folks. The government has already shown abundantly that whenever accounting rules get in the way, it just changes them. What you are saying seems to be that the system could ultimately blow up. Well, no civilization has ever lasted forever. But I don’t see that as a realistic objection to MMT. The fundamental principle of a fiat system is that the government makes up the rules, We are already doing that and it’s not working so well. Your examples are mostly based on existing rules or hypothetical rules.

    The government not only issues the currency but also makes up all the rules or gets Congress to change them, in emergency legislation, if needed. Monetary economics just describes the rules and options that various sets of rules make possible. Governments can and often do change the rules.

    Regarding reducing demand, the government can always temporarily increase taxes if reducing discretionary spending is insufficient, just as it could declare a payroll tax holiday now in the absence of sufficient demand. There was no “John Galt” revolt. Remember that not so long ago, the top rate was 90%. It can also target taxation, for example, essentially confiscating non-wage income. While this may sound extreme, its about as improbable as your examples. The way the government has handled the financial crisis gives some idea of what it can and will do when pressed. It’s pretty outrageous if you’ve been following it. Should some exogenous shock occur in whatever the case, the government will react very strongly given the circumstances. Volcker didn’t mind standing the yield curve on its head, and is now considered a sage for having done so, even though no one would have considered what he did possible before that. Government could conceivably get Congress to drop the offset to currency issuance, for example, in the case of demand being too low if it wanted to increase currency issuance without debt issuance, as is now legislated, just by explaining how it is not really needed for anything other than “fiscal discipline,” which is out the window in extremis.

    Finally, if there is a lot of leverage in the private sector that is driving demand, the government can also act to stem that with tools that it has, makes up, or gets Congress to approve as emergency measures.

    While arguments at the margins are educationally interesting, they don’t seem to me to prove much about anticipating real situations, especially when they assume things like exogenous shocks. Yes, the the government should have contingency plans for all kinds of things that conceivably could happen, but even the Pentagon isn’t so good at anticipating known unknowns, let alone unknown unknowns. Government are ordinarily lumbering and reactive, but they are huge and powerful, and they can act swiftly when required to do so.

    Therefore the only method for safely reversing credit growth is to utilise negative nominal interest rates when the money supply deflates. This allows prices to adjust downwards while maintaining aggregate demand because debt adjsusts downwards in line with prices.

    OK, so this is where you were going. The only safe method? Really? That is a pretty sweeping assertion.

50. I can see where some of the objectors are going with their questioning that I think is a fertile area to explore. Bill would like to see MMT principles used to advance an extremely progressive agenda, a vision that I share. However, the obvious very real concern is what what this would look like financially. While government is not financially constrained in a fiat system other than politically, e.g., by the offset required in US law, there are real constraints, which if not observed result in inflation or deflation.

    The pursuit of a progressive program introduces economic concerns chiefly about inflation, inefficiency, and effectiveness that need to be addressed. It would in interesting to have a debate about that sometime. This also introduces political concerns about the proper role of government, human rights, etc. that are probably beyond the scope of this debate, but necessarily influence it. In my experience, Bill is careful to distinguish fact from value. We can disagree about values, but the facts are the facts.

    I would add that Warren Mosler takes a more conservative approach to using MMT principles with respect to policy. MMT is value-free and supports a variety of options that span the political spectrum, and some people might understandably be more comfortable with that approach or something similar.

51. Ramanan,

    Thanks. Commercial banks can purchase physical currency from the central bank using exchange settlement account balances, at a rate of 1 for 1.

    They cannot purchase physical currency directly using bonds. In order to turn a government bond into currency, a bank first needs to sell the bond for ES balances, and use the cash balance to buy currency.

    Therefore funding deficits through crediting bank balances (ie issuing currency) or issuing bonds are two different things. Currency gives the holder immediate purchasing power, bonds (while very liquid) do not.

    Some on here have claimed that bonds are effectively no different to bank balances because the RBA will supply whatever balances the system requires.

    This overlooks 2 things.

    (1) In practice most RBA transactions are repurchase agreements not outright purchases.

    (2) The value/purchasing power of a bond changes constantly as yields move around. For example if you buy $1000 face value of the March 2019 bond today, it will cost you around $1005 at current yield of approx 5.50%. If yields move to 6.00% over the next 2 weeks, the bond will be worth only $972, which is a loss of 3.3% purchasing power.

    So quite clearly, bonds and cash balances (or currency) are different things.

    Which brings me back to my initial question to Scott and others. Does anyone have any empirical evidence (papers, studies etc), either for or against the proposition that deficit spending through creating cash balances is not more inflationary than through issuing bonds?

52. Hi Scepticus. You may want to fast forward to the last paragraph, as we may have been talking past each other throughout. Not sure, though.

    @stf: “1. CB can always set an interest rate target wherever it wants if it (a) sets the rate paid on rbs equal to its target rate, (b) issues time deposits to drain enough rbs to get to the target rate, or (c) issue its own securities to drain enough rbs to get to the target rate. Don’t need to have the govt issue bonds.”

    Scepticus says: Agreed, but in that case I think you have to agree base money is credit, not money.

    Scott responds: You may have noticed I prefer to NEVER use the word “money” when discussing this sort of stuff. “Money” is always someone’s liability (and someone else’s asset), so just explain whose. Credit is similarly the simultaneous creation of liabilities and assets, so in that sense they are certainly of the same ilk. For MMT, the issue isn’t “money” vs. “credit,” but who has the liability and who has the asset. The monetary base is the liability of the government, and an asset of the non-govt.

    Scepticus says: If that is the case, then the natural rate of interest is not zero. If you hold that the natural rate is zero, you can’t use payment of interest on reserves as a policy tool.

    Scott responds: Have you not noticed that MMT’ers like Bill and Warren want to set the overnight rate at zero and have the govt not issue bonds to drain reserves? They don’t want to use the overnight rate or pmt of interest as a policy tool. That’s their policy proposal. My point was not taking a stance on such a policy, but rather IF the CB wants to, it can have alter its interest rate target even if the govt doesn’t issue bonds. There’s no problem. But, yes, setting the overnight rate at zero and manipulating the overnight rate are by definition not compatible.

    Scepticus says: If the public believe that the CB will pay interest on reserves, then they will view base money as credit not money.

    Scott responds: ?????? As I noted above, so what? Either way, it’s a liability of the state and an asset for the non-govt sector.

    Scepticus says: Therefore the leverage of the institution extending the credit (the government in this case) becoms a matter for general concern.

    Scott responds: Such as?????

    “@stf: 2. Assuming CB does one of the options in 1, then if the govt raises taxes (or taxes due rise simply because income rises and taxes are based on income), rbs are (a) already circulating if Fed pays interest at the target rate, or if not enough are circulating then there will be pressure on the overnight rate and the CB can (b) provide them via CB lending if rbs in (a) are insufficient or cb has drained them with time deposits that have yet to mature, or (c) buy back its own securities in the open market.”

    Scepticus says: once again, if reserves can be provided via discount window they are credit not money.

    Scott responds: Yes, but this time it’s different, as a loan from the cb is creates both a liability for the non-govt sector at the same time it creates rbs.

    Scepticus says: My point is in an aggregate surfeit of demand scenario, in which short rates are already 0 due to excess reserves and the CB wishes to raise rates, it must remove them or pay interest on the _entire_ excess reserve balance at the target rate.

    Scott responds: YES! That’s what we’ve always said. You’ve got it! Woot! Woot!

    Scepticus says: In either case the interest payment on the reserves or the net reduction in reserves must come from net taxation – aka net public debt reduction.

    Scott responds: NO. Interest pmt on reserve balances is just like any other govt spending that credits bank reserve accounts and is thus (assuming no change to taxation) an INCREASE in both the deficit and the national debt. If the cb wants to raise the interest rate target, it can then withdraw the rbs via its own bond sales, time deposits (which will also pay interest, and thus will also raise the deficit and debt, ceteris paribus).

    Scepticus says: Remember in my example I have forbidden bond sales.

    Scott responds: Don’t need them to pay interest on reserve balances or have a positive interest rate target.

    Scepticus says: In any case I agree with you that bond issuance in such a scenario will be more inflationary than paying interest on reserves so bond sale will make matter worse not better in the aggregate surfeit of demand scenario.

    Scott responds: Bond issuance is only more inflationary if the interest on bonds is higher than that on rbs. This is normally the case with long-term bonds, but not always (inversion of yield curve).

    Scepticus says: You can’t tighten policy in this scenario without reducing the public debt (all of which is denominated in bank reserves),

    Scott responds: MMT would agree with you because raising interest rates raises interest pmts to non-govt sector and this needs to be weighed negative effect of higher rates on private spending.

    Scepticus says: which will make it impossible for the CB to accomodate the reserve needs of every single commercial bank, some of which will therefore face liquidity problems.

    Scott responds: NO. There’s no relation to your scenario and the cb’s ability to accommodate liquidity needs. Banks in Canada have held zero rbs overnight for the past 10 years or so and can meet all their liquidity needs.

    Scepticus says: You might counter that in an excess demand secnario there is more scope for taxation but this situation is also likely to result in banks assets rising in value and hence a decrease in their capital constraints, which offsets the tightening effect of taxation.

    Scott responds: I wouldn’t counter with that. My counter is I think you aren’t understanding basic cb operations.

    @stf “First, banks holdings of rbs don’t matter for lending;”

    Scepticus says: Yes they do

    Scott responds: No they don’t.

    Scepticus says: when banks become reserve constrained due to the CB removing the excess in order to tighten policy as per above.

    Scott responds: That doesn’t make banks reserve constrained. Banks in Canada hold no excess reserves since the 1990s . . . are they reserve constrained? Has lending ceased there? In the US where there are reserve requirements, no excess reserves simply means that bank costs will rise if they create more deposits via lending (though lending doesn’t always end up in more deposits for the bank making the loan as there are withdrawals and deposits can be converted to time deposits, etc.). AND, the cb doesn’t have to remove the excess to tighten-they can pay interest on reserve balances if they want to raise the rate. I’d agree that this doesn’t necessarily slow AD, but we’re talking about “tighten” from the cb’s perspective (at least I am). Overall, when the cb raises interest rates, interest payments on the national debt rise, whether there are government securities circulating or not, as interest on T-bills rises and newly issued notes/bonds rises higher than otherwise and this raises the deficit and debt (ceteris paribus).

    Scepticus says: In an economy in which all the public debt is denominated fully in bank reserves and the private sector has reached maximum extension tightening can only be accomplished by removing reserves. At this point banks become reserve constrained.

    Scott responds: There’s no such thing as the private sector being reserve constrained unless you are under a gold standard or similar regime. That’s the point, and you haven’t demonstrated otherwise. Not even close. And the cb can still hit its interest rate target and put it anywhere it wants regardless of the qty of rbs circulating.

    @stf: “Second, the funds to pay taxes or buy govt bonds come from (a) previous deficits”

    Scepticus says: If the previous deficit has already been leveraged to maximum level by the private sector then any removal of overall public debt leads to liquidity shortage and bank failures. If you posit a situation in which tightening is needed, it makes sense to assume a worst case in which the private sector has attained maximum permitted leverage.

    Scott responds: Again, banks are not reserve constrained.

    @stf “or (b) lending by the cb at the target rate.”

    Scepticus says: Paying interest on reserves which are not tax funded to make up for reserve shortfalls creates net reserves and therefore at best has zero impact on total reserve balances. Therefore this policy tool cannot be used to tighten.

    Scott responds: This may be the crux of the issue-we may be talking past each other here and above. Please define what you mean by “tighten.” MMT doesn’t believe that the cb can actually use an interest rate target to tighten, at least not reliably, for reasons I suggested above (which appear to be consistent with your view, at least to some degree). However, neoclassical economists and cbs themselves believe that raising the interest rate target will achieve tightening. It is in this sense that I have been describing a cb tightening-raising its interest rate target, since the cb and most non-MMT economists believe that will do it. And it is eminently clear that the cb CAN raise its target. Whether it works is another matter, and it appears you and MMT agree on this (at least somewhat).

    Best,
    Scott

53. Hello Gamma,

    My responses in CAPS below.

    Best,
    Scott

    Thanks. Commercial banks can purchase physical currency from the central bank using exchange settlement account balances, at a rate of 1 for 1.
    AGREE.

    They cannot purchase physical currency directly using bonds. In order to turn a government bond into currency, a bank first needs to sell the bond for ES balances, and use the cash balance to buy currency.
    AGREE

    Therefore funding deficits through crediting bank balances (ie issuing currency)
    BANK BALANCES AND CURRENCY AREN’T THE SAME. YOU JUST SAID SO YOURSELF. OR ARE YOU CLAIMING THAT “CURRENCY” AND “PHYSICAL CURRENCY” ARE TWO DIFFERENT THINGS? OFFICIAL USAGE IS FOR THE STUFF IN RESERVE ACCOUNTS TO BE “RESERVE BALANCES” AND THE PAPER/COIN STUFF TO BE “CURRENCY.” CAN WE STICK WITH THAT TO AVOID CONFUSION?

    or issuing bonds are two different things. Currency gives the holder immediate purchasing power, bonds (while very liquid) do not.
    OK. DON’T COMPLETELY AGREE, BUT WILL PLAY ALONG. NOTE THAT IF A BANK BUYS THE TREASURY, THEN YOU HAVE LEFT THE DEPOSITS CREATED BY THE GOVT SPENDING CIRCULATING.

    Some on here have claimed that bonds are effectively no different to bank balances because the RBA will supply whatever balances the system requires.
    THAT’S NOT WHY WE SAY THAT. WHAT WE SAY IS THAT THE DEFICIT CREATES NET FINANCIAL ASSETS WHETHER YOU ISSUE BONDS OR NOT, AND IT IS THE NET FINANCIAL ASSETS CREATED RELATIVE TO THE NON-GOVT SECTOR’S DESIRE TO ACCUMULATE NET FINANCIAL ASSETS THAT SETS AGGREGATE DEMAND.

    This overlooks 2 things.
    (1) In practice most RBA transactions are repurchase agreements not outright purchases.
    YES. SO WHAT?

    (2) The value/purchasing power of a bond changes constantly as yields move around. For example if you buy $1000 face value of the March 2019 bond today, it will cost you around $1005 at current yield of approx 5.50%. If yields move to 6.00% over the next 2 weeks, the bond will be worth only $972, which is a loss of 3.3% purchasing power.
    YES. SO WHAT? IF RATES FALL, IT’S WORTH MORE. IF THE TSY ISSUES ONLY BILLS, THEN YOUR POINT IS IRRELEVANT. SO AGAIN, SO WHAT?

    So quite clearly, bonds and cash balances (or currency) are different things.
    YES. SO WHAT? SO ARE APPLES AND ORANGES.

    Which brings me back to my initial question to Scott and others. Does anyone have any empirical evidence (papers, studies etc), either for or against the proposition that deficit spending through creating cash balances is not more inflationary than through issuing bonds?
    YOU’RE MISSING THE POINT. THE POINT IS THREEFOLD. FIRST, EVEN IF YOU ISSUE BONDS, YOU HAVEN’T REDUCED “LOANABLE FUNDS” AVAILABLE. THE VIEW THAT BONDS ARE LESS INFLATIONARY COMES FROM THE “CROWDING OUT” PERSPECTIVE. WHETHER YOU ISSUE A BOND OR NOT, THE NON-GOVT SECTOR HAS THE EXACT SAME “FUNDS” AVAILABLE TO CREATE CREDIT, REDUCE ITS SAVING, ETC., TO RAISE SPENDING IF IT SO DESIRES. SECOND, WHETHER OR NOT YOU ISSUE BONDS, THE DEFICIT HAS (1) INCREASED NOMINAL INCOME OF THE NON-GOVT SECTOR, AND (2) INCREASED THE NET FINANCIAL WEALTH OF THE NON-GOVT SECTOR. THIRD, THE ISSUANCE OF BONDS DOES BOTH OF THESE PLUS ADDS AN ADDITIONAL INTEREST PAYMENT TO FURTHER RAISE THE INCOME AND NET FINANCIAL WEALTH OF THE NON-GOVT SECTOR. “EMPIRICAL EVIDENCE” ON WHAT HAS/HASN’T BEEN ASSOCIATED WITH THE MOST INFLATION IN THE PAST IS IRRELEVANT. THIS IS JUST ACCOUNTING. DO YOU DISPUTE THE ACCOUNTING?

54. Scott,

    On the question of whether bank balances and physical currency are materially different.

    As a consumer, I can make purchases using physical currency or electronically from my transaction account using a card. I can convert electronic balances to physical currency and vice versa at any time for no cost at the bank or using ATMs.

    So what is the economic difference between the two? The main difference is that the RBA pays interest on balances held in exchange settlement accounts to banks. Banks will generally not pay interest on transaction accounts to consumers (unless there is some kind of minimum balance requirement). Is this why you think bank balances and physical currency are materially different?

    YOU’RE MISSING THE POINT. THE POINT IS THREEFOLD. FIRST, EVEN IF YOU ISSUE BONDS, YOU HAVEN’T REDUCED “LOANABLE FUNDS” AVAILABLE. THE VIEW THAT BONDS ARE LESS INFLATIONARY COMES FROM THE “CROWDING OUT” PERSPECTIVE. WHETHER YOU ISSUE A BOND OR NOT, THE NON-GOVT SECTOR HAS THE EXACT SAME “FUNDS” AVAILABLE TO CREATE CREDIT, REDUCE ITS SAVING, ETC., TO RAISE SPENDING IF IT SO DESIRES. SECOND, WHETHER OR NOT YOU ISSUE BONDS, THE DEFICIT HAS (1) INCREASED NOMINAL INCOME OF THE NON-GOVT SECTOR, AND (2) INCREASED THE NET FINANCIAL WEALTH OF THE NON-GOVT SECTOR. THIRD, THE ISSUANCE OF BONDS DOES BOTH OF THESE PLUS ADDS AN ADDITIONAL INTEREST PAYMENT TO FURTHER RAISE THE INCOME AND NET FINANCIAL WEALTH OF THE NON-GOVT SECTOR. “EMPIRICAL EVIDENCE” ON WHAT HAS/HASN’T BEEN ASSOCIATED WITH THE MOST INFLATION IN THE PAST IS IRRELEVANT. THIS IS JUST ACCOUNTING. DO YOU DISPUTE THE ACCOUNTING?

    Why do you believe that all forms of “net financial wealth” are equivalent, and that it is irrelevant whether it is in the form of physical currency / bank balances (which gives the holder direct purchasing power) or bonds (which does not…..or if you have ever purchased something directly with a government bond, please feel free to correct me).

    I don’t agree that empirical evidence is irrelevant. I am not disputing the accounting, that much is trivial. I am saying that wealth held in the form of bank balances (without restriction on term to maturity) may allow or facilitate price inflation, that would otherwise be able to be restrained in the current monetary system (which includes bond issuance). I am not saying that it definitely will, but it that it could.

55. Scepticus,

    Just taking a step back here. You seem to be holding the belief that the settlement balances of banks at the central bank plays a role in aggregate demand. This is not true. The settlement balances have only one role – smooth functioning of the payment system. The correlation of changes in central bank reserves with changes in aggregate demand is zero point zero zero. The view of the role of the central bank by the central bankers themselves is slowly converging to the views written in the blog posts by Bill. The Modern Money gang has known these things for ages! Quoting from the New York Fed’s Reserve Requirements

    Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States.

    Secondly you seemed to be worried about taxes wiping out all the reserves from the banking system. This rarely happens. I suspect you think that all taxes are paid on one particular day of the year. Taxes are paid all the time and the government is spending all the time. The government is also issuing debt all the time and the central banking is working all the time. I think you have to think carefully here. For cases where the government spending is continuously lesser than taxes for a few weeks, see Scott’s points above. It is an indication that the economy may be getting hot – taxing will lead to cooling down but bringing reserves back to the original level does not mean it will increase aggregate demand. You may also find this post of Bill useful.

    The impact of government on reserve dynamics

56. @tom_hickey (in response to me: “all money is credit, includnig base money): “I’m confused about this statement. Ok, base money is an accounting liability, like M1 (deposits created by loans), but there is a vast difference in that deposits create a very real loan obligation, whereas reserves are only a “liability” in the accounting sense, just as the corresponding “asset” an accounting fiction since it is just a government offset that is also fiat. Fiat money means money created without any real liability, other than the “full faith and credit of the issuer,” whatever that means, which is the constant complaint the sound money folks.”

    Tom, base money is credit because:

    1. the CB may decide to pay interest on it.
    2. base money has value because it is demanded in tax. The government giveth base money, on the understanding that some portion of it shall later be taketh away. This is very much like credit. If it were truly money issued in the full faith and credit of the state, the state would not later take it away.
    3. because base money has value by its use to pay taxes, its value depends on the ability of taxpayers to pay, which in turn depends on economic and political futures.

    My entire thesis about this matter is set out here:

    http://knol.google.com/k/scepticus-101/the-pure-credit-economy/2tfhsu71vc11q/6#

57. scott, thanks for the detailed response, in most cases we appear to be aligned. However on the remaining points:

    1. I may have misunderstood certain aspects of how MMT proposes to tighten. You won’t use payment on reserves or short rates or any such monetarist tool. So how will you restrain private sector credit creation? Will you for example raise capital requirements?

    2. You seem to view that government liabilities are truly one sided – that the govt can hold a net negative equity position. I maintain this isn’t the case, because the public debt is effectively a loan to taxpayers, allowing them to consume goods they have not paid for. Then they pay the interest on that debt. All is well as long as the ‘silent assets’ held by the government – which is the claim through tax on future private income – effectively equivalent to an interest only loan asset held by a commercial bank. I see absolutely no reason not to extend the full force of MMT financial accounting to the government sector and make these ‘silent assets’ explicit, and I also see no obvious reason why you would claim the government can operate with a negative net equity position. This seems like a deux et machina to me and there is no justification for it. If you return that it is justified because the government can create new liabilities at will, and we agree this is credit, then where is the asset that the government has obtained by the spending that has resulted in those liabilities? Assuming it exists, then I can’t see why we can’t apply a normal financial accounting stock flow analysis to the government sector. I can easily value government assets by totting up all their real estate and infrastructure holdings and by performing an NPV calculation on future expected tax take. The willingness of the public to pay these taxes is the credit risk the government has taken on.

    3. discount windows. If we do away with the concept of reserves then when the govt extends window credit it does so in return for collateral. Assuming no govvie bonds exist then the collateral must be private sector financial assets. In this case we can add the government holdings of private sector financial assets to the asset side of the govt balance sheet. If this is the case, we ought to extend a similar treatment to the rest of the government asset side.

58. ramanan, let us agree then that if the CB agrees to provide required reserves at all times (via open market ops or by discount window) then yes demand is totally independent of settlement. The flip side of this is that taxation cannot be used to manage aggregate demand, because if taxation results in a shortage of reserves they shall be provided via other means. Therefore a broad money stock that wanted to could keep right on growing.

    MY understanding of MMT to date from bill’s writings implies that taxation is a method for withdrawing liquidity from the private sector and hence a tool for managing demand. But now you are all saying this is not the case. What you are saying If I understand is that liquidity management (i.e manipulation of settlement balances in the form of private sector NFA) is not the right tool for managing demand in the private sector. The right tool is presumably, legislation, such as setting capital requirements, requiring larger deposits for houses etc.

    However, the same outcome applies. If we had an extended private sector approaching its leverage limits, then you raise capital requirements or implement other credit-contractionary policy then deflation would follow as banks de-lever to meet the new requirements, of households de-lever to meet new regulations.

    Therefore I’m not sure you have conquered deflation. In a credit economy how can a situation of excessive leverage be corrected via MMT without deflation, regardless of whether the tool to engender private sector credit contraction is liquidity management or legislative approaches?

59. The central bank has total control over its ability to offset any change in outstanding reserves due to taxation or anything else, if that change is deemed undesirable purely from the perspective of central bank monetary policy. If taxation results in a reduction in reserves that is undesirable from the central bank perspective, the central bank can offset that impact operationally by purchasing government debt from the market, thereby reducing outstanding government debt. The net effect of that is that reserves are unchanged, outstanding government debt declines by the amount of the tax, and outstanding net financial assets held by the non government sector declines by the amount of the tax, as was intended by the policy of fiscal tightening. The result is that monetary policy and fiscal policy are aligned as they should be. There is absolutely no contradiction in the fact that taxation can reduce central bank reserves in the first instance, but that the central bank has the operational capability as it sees fit to redistribute the net financial asset compositional impact of taxation from reduced reserves to reduced government debt.

    The above is just one operational example of the way in which the central bank can accomplish what it needs to for this purpose. There are other permutations. The point is that the net operational impact of higher taxation typically is lower government debt, other things equal, and that the reserve impact on a net basis is exactly what the central bank wants it to be.

60. JKH, in the MMT ‘ideal scenario’, or at least in bills ideal scenario, there is no bond issuance at all, so any net taxation under these circumstances must by definition reduce reserves.

    Further, if said reduction in reserves has no impact on private sector credit creation because there is still an excess, then this taxation has no effect on private sector liquidity, which seems to present a bit of a problem to the foundational premise that money has value because it is demanded in tax. Because in this situation, priv sector NFA removed in tax may well be more than offset by an increase in private sector liquidity (i.e broad money). At this point the private sector endogenous money creation has totally decoupled from government spending/taxation. I suggest that this event will invalidate the currency by reference to the chartal basics..

    If said taxation _does_ reduce reserves such that there is a lack of them wrt required settlement needs and there is no new bond issuance as per bills ideal scenario then there will be a liquidity problem.

61. If you’re going to make an argument, try specifying whether you’re making it in the context of the current world we live in, or the world as it might exist in the future, but doesn’t exist now. That avoids frivolous and time wasting skipping back and forth between different logic streams.

    The “ideal scenario” is a proposed change in architecture for the future, whereby all deficits flow through the banking system using reserves as the conduit. In that concept, the notions of “required reserves” and “excess reserves” lose their distinction. Reserves are simply a passive liability of the central bank and a conduit for deficit flows. In that case, there are no bonds, and the central bank is essentially rolled up into the Treasury function. There is no need for the central bank to be concerned about reserve levels at all, because it is simply a passive tool of fiscal policy. And when the government tightens fiscal policy through taxation, it will reduce the deficit and reduce reserves, other things equal. Net financial assets consist of reserves and currency. Reserves decline; net financial assets decline. It’s a different world where the central bank has no real policy responsibility, and where monetary policy is absorbed into fiscal policy. If the “ideal scenario” includes the zero natural rate of interest, reserves don’t matter for policy at all. Even with a non zero rate, the central bank simply pays that rate on reserves.

62. “If you’re going to make an argument, try specifying whether you’re making it in the context of the current world we live in, or the world as it might exist in the future, but doesn’t exist now.”

    Isn’t the MMT premise that bonds are little different from reserves in their real world effects? In fact you seemed to agree in previous conversations with me that this is the case. Likewise scott on the KC blog in the ‘what if the government just prints money’ post, makes the same point. If we are to believe this, and broadly I do believe it, then the current situation and the ‘ideal scenario’ don’t really differ in terms of the overall MMT framework.

    In this situation removal of _any_ government debt – whether bonds or reserves – in a situation in which the private sector is close to maximum leverage is going to induce deflation. So yes under MMT the government can retain control of aggregate demand by inhaling or exhaling their debt but only if it is willing to tolerate deflation. Would you agree with this statement?

63. Scepticus,

    Because of your frequent use of the word leverage, I can only conclude that you are thinking of some “money multiplier”. It seems to me that a slight change of reserves seems to be very worrying for you. We do not live in the world of fractional reserve banking. Banks are banks.

64. The difference between the real world and a different future world matters in terms of responding to the specifics of your confusion around the compatibility of the effect of taxation on reserves, versus the effect of taxation on net financial assets. It matters in that context because the architecture for the reserve component of net financial assets changes. It doesn’t matter for the effect on net financial assets per se, but that wasn’t the primary source of your confusion.

    I don’t know what your point is on deflation. The natural response to deflation is a policy decision to stimulate aggregate demand and increase net financial assets. What’s your point otherwise?

65. Scepticus, You seem to view that government liabilities are truly one sided – that the govt can hold a net negative equity position. I maintain this isn’t the case, because the public debt is effectively a loan to taxpayers, allowing them to consume goods they have not paid for. Then they pay the interest on that debt.

    In my understanding of the MMT position, public debt is not “effectively” a loan to taxpayers, on which they pay interest. Debt issuance is a way of holding (storing, saving) NFA already created by currency issuance through government expenditure, which ends up in deposit accounts of the various recipients. Those who purchase the debt are effectively just switching the liquid aspect of the injection of NFA into a less liquid one. This simply reduces liquidity (slightly) from the non-government side and reserves from the government side. Similarly, the interest on the debt is part of government expenditure and will also end up in Tsy’s. Of course, this looks different at the micro level, because the recipients of government expenditure don’t necessarily make the switch to Tsy’s directly. But the macro effect is that the NFA that the government injects by disbursements is saved as Tsy’s if the government is required to issue debt in the corresponding amount. This is just a switch of one asset form (demand) for another less liquid one (saving).

    Regarding negative equity, I think the problem that confuses the issues is using the same accounting equations for government as business, since it leads to the erroneous perception that government is like business when it is not, of that government should be run like a business – we see how well that worked out with MBA president George Bush and CEO’s Dick Cheney and Donald Rumsfeld. Government resembles a nonprofit much more closely that a for profit business and nonprofit management and accounting are separate fields of endeavor.

    But comparing government to anything is just going to confuse the issues. Government has a constitutional mandate that establishes public purpose. Its activities must reflect that purpose as interpreted by the policy, and policy options are political issues that are informed by many branches of knowledge, with economics and finance being important contributors. Accounting is ONLY the historical record and its summary of that an entity does with its funds in terms of recording stock and flow. The accounting should be designed to fit the purpose and activity of the entity rather than being imposed on it by a model that does not fit well.

    Government neither makes a profit nor suffers a loss. Government neither has equity nor does not have it. Government neither has money, nor does not have it. Accounting procedure that makes it look like government operates as if these things were the case, or must operate this way, is counter-productive for understanding government’s activity and meeting public purpose with informed policy-making.

    A major point of PK/MMT is clearing up confusions like this by revealing the stock-flow consistency of actual activity through national income accounting that fits the case. This is set forth, for example, in Godley and Lavoie, Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth (2007).

66. ramanan you are quite right. I should use a different term. I should have said a private sector approaching its liquidity limits. Because although you say that the CB will always accommodate liquidity needs, I can’t see how this can be accomplished if it is to be simultaneous with a net reduction in public debt. You can’t have it both ways – either you increase liquidity to the financial sector or you remove liquidity.

    By saying bank liquidity needs are always to be accommodated you can’t at the same time claim to have private sector NFA management as a tool for managing aggregate demand. Which in turn means taxation can’t be used as a tool for managing aggregate demand. Remember, bonds and reserves affect financial sector liquidity equivalently (more or less).

67. Scepticus,

    This gives the balance sheets for various sectors of the US Economy. http://www.federalreserve.gov/releases/z1/current/z1.pdf

    Let us consider a period before the Fed’s balance sheet zoomed – maybe 2005.

    Let us consider a month and assume that the government didn’t spend in that month and assume that the taxes paid were $100b. The private sector net worth which is in trillions would have reduced by $100b because of taxes paid and the reserves would have drained by $100b and banks would find (would have found, since we are talking 2005) themselves with no reserves. Why would this cause deflation?. The Fed would have lend the banks $100b ! Remember the deposits in the banking system was $5.7T …

    I think you are assuming that if reserves fall to zero, deposits also fall to zero – which is not true.

68. Scepticus,

    Also as Tom Hickey says, why do you want to consider the NPV of future tax inflows of the government ? If you do want to, why not NPV of future earnings of other sectors such as households ?

69. “The private sector net worth which is in trillions would have reduced by $100b because of taxes paid and the reserves would have drained by $100b and banks would find (would have found, since we are talking 2005) themselves with no reserves. Why would this cause deflation?.”

    Because overnight rates would spike as liquidity became an issue. As teh banking sectro realises they are all collectively short of settlement assets interbank lending dries up and we end up with a 2008 style banking crisis.

    “The Fed would have lend the banks $100b !”

    In which case that increases the public sector debt by 100bn.

    Let us imagine in your 2005 example we had a chartalist government which was concerned about asset bubbles, and also wanted to promote full employment within the 2% price stability target. Ths government realises that reserves and bonds have similar effects on private sector liquidity. There is a quite highly leveraged retail banking sector and a shadow banking sector which is also facilitating credit extension to house buyers using government bonds as the underlying clearing asset for this market.

    The government would like to restrain credit creation that is bidding up house prices. How do they do it without causing deflation and bank failure?

    Consider the ball firmly in your court.

70. @ramanan: “Also as Tom Hickey says, why do you want to consider the NPV of future tax inflows of the government ? If you do want to, why not NPV of future earnings of other sectors such as households ?”

    I wish to evaluate the state of the government balance sheet to see if it is in positive or negative equity territory. If the MMT position is that governments operate with significant negative equity and that this is not an issue, then prove it by an objective analysis of the balance sheet of a major western government (not japan) using standard accounting conventions that demonstrates a government running at negative equity.

    Expectations of future taxpayer income can be treated in the same way a commercial bank would estimate the value of its loan assets by looking at the future earnings of households and firms to which it has lent money. The analysis of public equity must also include assets such as roads, schools, property and so on.

    Unless you can offer a convincing demonstration using accepted accounting methodologies (or indeed any methodology at all) of the statement that governments routinely operate with negative equity I shall have to assume its something you just made up: i.e. an article of faith like austrian economic ‘praexology’, and thus treat statements that governments are not empirically bound by normal accounting practice as a mere theoretical opinion.

    If governments do turn out to be empirically bound by standard accounting pratice then this implies there is no evidence for your negative equity claims.

71. Gamma

    There is one thing that comes to my mind ,and Scott may tell me I’m way off base here, regarding your concern about the different liquidity levels of financial assets and the POSSIBLE inflationary pressures of each. You seem to be arguing that a bond is less inflationary than cash(reserves) because you cant spend it as readily. However if your desire was to consume more than your current cash would allow you it would be quite easy to take a bond use it as collateral and get the cash you desire. Inflation seems less driven by the liquidity of a particular financial asset and more driven by the desire to spend. If I have a bond and I want cash and I cant redeeem the bond I’ll use it to borrow the cash I want. Yes it will be an extra step but I think that is trivial when it comes to needing to or feeling the need to spend.

72. Gamma, greg is right. For high net worth sectors of the economy, a government bond is better than cash because it has no principal risk. However a 250 million deposit at a bank does have principal risk because bank deposits are not insured to anywhere near that level. Therefore for entities like hedge funds, HNW individuals, foreign central banks, large corporates, and crucially, the wholesale funding sector, bonds are better than cash or MMMFs.

    It is in this domain that the shadow banking sector lives, which offers credit using government bonds as the clearing asset, just like retail banks offer consumers credit using base money as a clearing asset.

73. As regulator, the Fed as other means than rates, such as increasing loan/capital ratio. The fiscal path is targeted taxation to create negative incentives for speculating in assets. There are plenty of tools available.

    Because overnight rates would spike as liquidity became an issue. As teh banking sectro realises they are all collectively short of settlement assets interbank lending dries up and we end up with a 2008 style banking crisis.

    And what did the Fed do, too late in the opinion of many? Opened the discount window to all kinds of dodgy collateral to provide collateral. In addition, the regulators instituted forbearance, and FASB changed the rules to permit mark to fantasy.

    scepticus, I really don’t see what your problem is other than speculative. You are assuming straightjackets when there are many options, especially in extremis, when the Fed can do pretty much what it wants and ask permission later. Can MMT eliminate all problems in the economy for all time. Of course it can’t. That is not it’s job. It just describes what how the system actually operates with the rules in place and suggests how changing some rules would provide potentially more fruitful options. If problems arise along the way, new rules will emerge and MMT will describe conditions under them. But in conditions in which rules aren’t working, resulting from exogenous or endogenous shocks, then ad hoc measures will be adopted as needed. That’s just the way it is. But a lot can be done with targeted spending/spending withdrawal and taxation that is not happening because of powerful interests and constituencies that resist it politically. Then, problems arise and ad hoc measures are necessary. That was the case with the present crisis, and it continues as we speak as an army of lobbyists swarm around Washington.

    I happened to get the market turns right on the downside, first housing and then equities. But I totally underestimated the ability of government to intervene, so I missed the market turn to the upside, which I expected to be a short term very limited bear rally. I should have listened to Bill Gross’s advice to “follow the government” then. I know better now.

74. “And what did the Fed do, too late in the opinion of many? Opened the discount window to all kinds of dodgy collateral to provide collateral. In addition, the regulators instituted forbearance, and FASB changed the rules to permit mark to fantasy.”

    That is all about loosening policy, adding liquidity, increasing demand during a period of crisis. This is easy to do* and MMT provides ample ways for it to be done. I have no quarrel here.

    My question is about SAFELY decreasing demand within tthe MMT framework and withn the wider context of the credit economy.

    * I do accept that in a future constrained by demographic age-ing and increased automation that sustaining demand , rather than reducing it, may be the order of the day. However, MMT must work in both directions if it is to be considered a general solution.

75. However, MMT must work in both directions if it is to be considered a general solution.

    Agreed. I’ll let the MMT experts deal with that with you.

76. Tom

    Dont sell yourself short. You are one of the experts

77. Greg, yes that’s exactly what I’m talking about, well put.

    Do the different types of financial assets issued by the government (physical currency, bank balances, treasury bonds, treasury notes) have differing potential to cause or facilitate consumer price inflation?

    Does a different mix of these assets make it more or less difficult for the central bank to control inflation?

    The RBA thinks it does. One of the main justifications for using bonds to fund budget deficits was that monetary policy was too difficult to implement in the 1970s when budget deficits were funded using a mixture of bonds and cash balances (ie borrowing from the RBA). Monetary policy and fiscal policy were effectively intertwined, and at times the requirements of each were working against each other.

    This is the basis justification for bond issuance – the need to seperate fiscal requirements from monetary requirements. It’s not because central bankers don’t understand the workings of the money markets, or that they don’t realise that the governement is theoretically not revenue constrained, or any other reason.

    This 1993 paper from the RBA explains some of this:

    http://www.rba.gov.au/publications/bulletin/1993/nov/pdf/bu-1193-1.pdf

    Cheers

78. Scepticus,

    Your accounting is more like Steve Keen’s accounting. 🙂

    Did you happen to read the link to Bill’s post I gave you on Reserve Dynamics ?

    So you seem to agree that the Fed will intervene and offset changes to reserves by open market operations. Remember one thing – the Fed exchanges one asset for another. It doesn’t increase the public debt when it purchases government securities in the markets. You seem to be equating the reserves level with government debt. Please consider the combined balanced sheet of the central bank and the government! The combined balance sheet has reserves as liabilities but please do the math correctly. The central bank increasing the reserves level also increases its assets.

    Plus I will give you references for getting the national accounts right. In fact the Flow of Funds is consistent with the accounting talked about in this blog!!! And Yakk for the Austrian association – they are so religious. Please read the flow of funds accounting or atleast look at the Fed Z.1 accounts.

    Let us say I run a firm and am the sole owner. No equities issued. I do not know a system of accounts where I add the NPV of my projected income of the future/uncertain to some place in the balance sheet. It exists only in my mind. If I hold a bond – say a corporate bond, I will add them in assets. I may think I will earn $x in 2050 in revenues – I am pemitted to think but that does not go into the balance sheet of my firm.

79. Scepticus,

    Going back to reserves, I think you are thinking like this:

    Taxes reduce aggregate demand. Taxes lead to a reduction of reserves in the banking system. Since the claim is that taxes reduce aggregate demand, a reduction of reserves leads to a loss of aggregate demand because tax outflows lead to a reduction of reserves. Since government spending adds to reserves and hence increases liability of the government sector (which includes the central bank), any reserve addition increases the liabilities of the government sector.

    There is a lot of mixing of cause and effect in such an argument. So here is Questionable Cause corrected:

    Taxes leading to a reduction of reserves does not mean that any reduction of reserves leads to a decrease of aggregate demand. That decrease is because of the private sector having less to spend. The fact that government spending increases aggregate demand and increases bank reserves does not mean any addition of reserves would lead to an increase of bank reserves. Government spending increases aggregate demand because the private sector has more to spend. The fact that government spending increases the liabilities of the government sector and leads to an increase of reserves does not mean that any addition to reserves increases the liabilities of the government sector. Increase of reserves can be offset by an increase in the assets – e.g., the central bank doing an open market operation.

    Also, for reading the national accounting you can print a copy of the Z.1 Accounts of the United States. You can even order a guide to that accounting online at the Fed website, if you are from the US. Here are a few links:

    http://www.federalreserve.gov/releases/z1/ffguide.htm
    http://www.federalreserve.gov/releases/z1/Current/
    http://en.wikipedia.org/wiki/National_accounts

80. ramanan (and bill)

    The below is from bill’s “The impact of government on reserve dynamics …” blog post

    “Second, (unfascinating) clearly when growth in nominal aggregate demand outstrips the capacity of the real economy to respond via production then inflation results. Unambigious – we say that all the time. But there is never a question of solvency. If there is inflationary pressures then fiscal policy can fix that too – increase taxes and/or cut spending. But that problem has nothing intrinsic to do with government spending. If there was a private investment boom you could have the same issue. That is just the result of running the economy beyond the real limit. So run it a bit before the real limit!”

    The issue I have in mind is this:

    If we have a situation in which due to a long period of deficient demand, deficit spending has resulted in a large excess of reserves, and then the situation changes and strong inflationary pressures emerge then before fiscal policy can affect aggregate demand all said excess reserves must be removed. Would you agree?

    If so then the degree of control the government can exert over demand via fiscal policy at any given time is very much dependant on the level of prior deficit spending that has taken place. E.g. if I have 300Bn of excess reserves I must cut 300bn from the governments debt before it affects anything in the private sector.

    Another effect emerges at this point. Given the private sector has more than enough liquidity for its needs for the forseeable future, and that it has no intrinsic need for more reserves/NFA, and has the ability to create its own endogenous money supply, it has no need in theory to transact with the government and is in fact capable of creating one new private sector broad money liability for every equivalent public sector liability withdrawn in tax.

    I think at this point that the fiat money (gov liabilities) have lost their chartal power, unless the government is willing to pay interest on reserves.

81. I think I finally realised the points some of you have been making about reserves. The government can tax 300 Bn, which will remove both 300bn of broad money deposits and 300 bn of reserves. It can however replace the reserves at the discount window to offset liquidity issues, without replacing the 300 bn of broad money deposits.

    However I think my point above still stands. Given that in the example above the banking system can create more than 300bn of new broad money to offset 300 bn of taxation I don’t see in this case that fiscal policy could be successful in reducing aggregate demand while commercial banks remain unconstrained by reserves.

82. “Let us say I run a firm and am the sole owner. No equities issued. I do not know a system of accounts where I add the NPV of my projected income of the future/uncertain to some place in the balance sheet. It exists only in my mind. If I hold a bond – say a corporate bond, I will add them in assets. I may think I will earn $x in 2050 in revenues – I am pemitted to think but that does not go into the balance sheet of my firm.”

    Sure. So how does a bank value its loan assets? I guess it depends the asset is an amortizing loan in which case I believe there is a formula for valuing that that includes at least part of the interest and any potential impairment.

    However the right model for the current kind of relationship between government and taxpayers is one of revolving credit since there is no mention of taxpayers even being expected to pay back the national debt – it will just be rolled over. However even if the debt is in the form of 0% rbs and the government reduces the rb balance for whatever reason then it is equivalent to paying down a 0% line of credit. I think that can be valued according as if it were a 0% revolving credit asset in the case where all gov debt is 0% rbs, or as a series of non zero rate revolving credit assets where long duration debt exists at various maturities. The government s ability to arbitrarily raise and lower the rate of taxation (aka paydown of the line of credit) is exactly analogous to a credit card provider raising and lowering their rates.

    I must admit I’m not sure how such revolving credit loan assets are valued. But in any case the accounting should value the assets accruing to the government as a result of its deficit spending in this manner. If we did this would we come out with a net positive equity position for the government or not?

83. Scepticus,

    Its more the government spending which offsets tax drain due to reserves. So banks do not really need to go to the discount window as much as the tax outlflow. Imagine – the US private sector pays $1T+ in taxes every year and the discount window usage is surely not close to it.

    If the reserves level rises, it does not lead to extra creation of loans by the private sector. Borrowing is always and everywhere a demand-led phenomenon and banks are price setters (meaning set the loan rates) and quantity takers. Instead loans create deposits and this creates reserves, not the other way round. Banks are not reserve constrained – they lend and then look for reserves. Plus they do not “lend out the reserves” – even after a bank lends, its reserves stays the same. Banks lend by expanding their balance sheets. They write an L in their assets side and an L in the liabilities. Just out of thin air.

    Let us just take a simple loan where the principal amount is $100 and the bank has set an interest rate of 6%. The act of lending increases the deposits by $100 and the bank A has an asset worth $100 and nothing more. The interest payments appear in the income statement. If the overnight rate is 0.25%, it does not value it using an NPV calculation which has r=0.25% and using the monthly mortgage payments. It just values it as $100 because if this illiquid asset were to be sold to another bank B, this bank will most likely pay $100 only to bank A and not some NPV. When the monthly payments start coming in, that changes the balance sheet at that time and the bank’s net worth increases.

84. If we did this would we come out with a net positive equity position for the government or not?

    I don’t get the concern for government “negative equity.” This is a nominal, accounting, concept without real application to government. Government neither has nor does not have equity in any real sense of ownership of capital. The Fed closes out its p/l periodically, transferring the “profit” to the Treasury to help “pay down” its deficit instead of building up its own equity. Of course, really speaking, this is a nonsense, since the government neither has nor does not have money, and neither needs more does not need money as currency issuer. The accounting is just for the purpose of describing stock-flow in a consistent way. It does not affect the reality, and “government equity” is not part of the government’s reality. Equity is an accounting fiction as far as government is concerned, at least as I understand what MMT is saying.

    scepticus, I think that you are attempting to model government on non-government finance. They are inherently different and MMT is all about not confusing them by mixing conceptual models inappropriately. I am neither an economist nor a finance type, but that’s the way it appears to me looking in from the outside. I don’t get why it would be a no-no for the government’s equity account to be negative, other than the misperception that it might create in those would not understand that this is all just numbers the keep track of stock-flow.

    The same is true of all the horror over M0 going exponential. Many people looking at this are running for the hills in fear of hyperinflation being just around the corner when M0 expansion suggests on the contrary that the real thing to fear is spiraling deflation that the government is trying to head of with monetary policy instead of increasing NAD through fiscal policy. Similarly, the Fed’s increasing negative equity in deflationary times would be a sign that currency is being injected to increase NAD. In that sense it would be a positive indicator.

85. Hi ramanan, you said:

    “Its more the government spending which offsets tax drain due to reserves. ”

    Yes but we are discussing a situation in which the government is running a surplus to manage excess aggregate demand and restrain inflation. Therefore there is no offsetting effects on the reserve drain in this case.

    “If the reserves level rises, it does not lead to extra creation of loans by the private sector.”

    We are discussing the case in which the private sector loan volume is increasing endogenously, independent of reserves due to excess aggregate demand. The question is how fiscal policy restrains this credit expansion, with particular reference to the case in which the starting point is one of a significant excess of liquidity in the form of government liabilities of whatever stripe.

86. Tom, accounting practice simply delivers a model which we humans use as a scheme of law and property rights ultimately, and which has arisen from the use of money as a medium of exchange and later the use of debt instruments.

    Therefore the treatment of private sector economic activity via an accounting model is simply that – a model – of reality.

    You have not given any justification why a nominal accounting practice applied to model one set of human activity should not be extended to cover all human activity. You have just said ‘it doesn’t apply to government but not why.

    Ask yourself this – why do people in the private sector accept the imposition of financial accounting practice upon their daily lives and business activity? Why don’t they just say – it doesn’t apply to me?

    Indeed, both banks and governments are not revenue constrained. This follows from your assertion that banks will ALWAYS be provided with the required liquidity needs. Therefore given we have two fundamentally non revenue constrained entities, why shall we apply different accounting models to them?

87. Scepticus,

    Yes Tom is right. Consider the sectoral balances approach. It can be applied both at the flow level and the stock level. I will talk about the latter. The net financial assets of a closed economy is zero. Every financial asset is someone else’s liability. Make a slice on this – we have two sectors public and private. The net financial assets of the private sector is thus the liabilities of the public sector! You cannot have the private sector having a positive financial net worth without the private sector having a negative net worth!

88. “The net financial assets of a closed economy is zero. Every financial asset is someone else’s liability. Make a slice on this – we have two sectors public and private. The net financial assets of the private sector is thus the liabilities of the public sector!”

    By the same logic, the net financial assets of the public sector is thus the net liabilities of the private sector. You cannot possibly deny this.

    The MMT school seems to take a slice through the (pure credit) economy you describe above using the sectoral balances approach, and then focuses entirely on the financial assets of the private sector revealed by the ‘slice’. However in order to be complete, you should apply an analysis of identical rigorousness to the financial assets of the public sector which are revealed by this approach.

    I suggest it is entirely possible that when you do this, the NFA of the private sector are found to be entirely offset by the NFA of the public sector.

    The fact that the NFA of the private sector net exactly to zero with the NFL of the public sector, leaves open the possibility that a second class of NFA belonging to the public sector exists, netting exactly to zero with a hidden class of NFL owed by the private sector.

    In fact since each of the asset/liability classes sum to zero, there could be an infinite series of them, and your accounting approach would never detect them, if it wasn’t looking for them.

    The problem with MMT is that you choose to only analyse the class of financial assets which are held by the private sector. Therefore you achieve the result you are looking for, which is that the public sector has negative net worth, and present it as an accounting identity, and use this to rightly claim that your approach is the most rigerous economic approach. With this I agree, but while you may be rigorous, you are not COMPLETE!

    As a final point, the fact that the CB will always provide reserves at the discount window means that in the final analysis the banks of the private sector are sustained by credit, not money. The economy is therefore a pure credit economy, as you point out in your sentence above, in which all financial assets are someone’s liability. So by slicing this in two we get two pure credit economies Pub and Pri , extending credit to one another. In which case, the credit extended by Pub to Pri must be considered to teh same degree as credit extended from Pri to Pub

89. Scepticus,

    I suggest it is entirely possible that when you do this, the NFA of the private sector are found to be entirely offset by the NFA of the public sector.

    Firstly, if you include the public sector (by which I meant the central bank and the government), that accounting statement is true. If that statement is found to be not true national accountants would have to work extra hours to find if there is some error in their data. It is indisputable.

    I do not know what you mean by there being an infinite of something. At any rate are you saying that there is an error because as frequenly happens in mathematics that a limit of a series which has each term going to zero may not sum to zero or something like that ? You can throw any math at me btw …

    I do not know where your comment is leading to – if you consider the US Flow of Funds, you will find that every financial asset has a liability. A corporate bond held by households is an asset for the household sector and sits the corporate’s liabilities. Similarly bank deposits – they are banks’ liabilities and oft forgotten by economists.

    Plus I do not know what a pure credit economy is if you include the public sector.

    I think you want to consider numbers that do not enter the balance sheets right ? Such as future revenue for the government in the form of taxes etc … Mainstream economists seem to consider it all the time .. though they mostly ignore the public sector … agents maximising an objective function which has future inflows/outflows … something of that sort ?

90. “I do not know where your comment is leading to – if you consider the US Flow of Funds, you will find that every financial asset has a liability.”

    That does not mean the flow of funds has listed all the financial asset/liability pairs. A vast quantity of such pairs could be missing and the flow of funds can still sum to zero. If thats the case then flow of funds as it is doesn’t tell the whole story.

    “Plus I do not know what a pure credit economy is if you include the public sector. ”

    Why not? I’m not sure what you mean by this.

    “I think you want to consider numbers that do not enter the balance sheets right ?”

    right.

    “Such as future revenue for the government in the form of taxes etc … Mainstream economists seem to consider it all the time .. though they mostly ignore the public sector … agents maximising an objective function which has future inflows/outflows … something of that sort ?”

    exactly. if the government has borrowed x billions from the private sector they have presumably done something with that money and have accumulated some assets. If we have not accounted for all such assets we could easily conclude the public sector has a net negative position in the private sector a net positive position. This is the territory in which ricardo lives.

    Why is it that despite a vast addition on NFA to the japanese private sector that demand has not picked up and rates have stayed very low? Could it be because in reality all those NFA of the private sector are offset by hidden liabilities of the private sector in the form of future taxation.

    My point is that if you give someone money they have not asked for they’ll spend it. If you OTOH give someone credit they have not asked for they’ll keep it because they expect to have to repay it. It could be ricardian equivalence of some for does hold, and you guys miss it because you don’t consider the financial that derive from the bank like operation of the public sector in extending credit to taxpayers.

91. because you don’t consider the financial [assets] that derive…

92. Scepticus,

    That does not mean the flow of funds has listed all the financial asset/liability pairs. A vast quantity of such pairs could be missing and the flow of funds can still sum to zero. If thats the case then flow of funds as it is doesn’t tell the whole story.

    I do not think that the Flow of Funds misses anything. If you think of something please let me know.

    exactly. if the government has borrowed x billions from the private sector they have presumably done something with that money and have accumulated some assets. If we have not accounted for all such assets we could easily conclude the public sector has a net negative position in the private sector a net positive position. This is the territory in which ricardo lives.

    The government does not borrow money. That is the most important thing about Modern Money. You have a dollar in your pocket because the government of your country ran a deficit and continues to run deficits. Have you read Randy Wray’s article on why it is not good to compare a government’s budget with that of a household ? Here Plus read today’s (Friday’s) post by Bill. It is not a claim or a conjecture or anything like that. Think logically about this. If the central bank buys government debt, it means that the government spent more than it “borrowed” from the private sector. Instead of “owing more money” to the private sector, the government owes more the central bank. However the central bank is a part of the government – the Fed website is federal reserve dot gov and the central bank profits are handed over to the Treasury which again means that the distinction between the central bank and the government is for ideological reasons only. The man on the street doesn’t care.

    More importantly, I think you are falling into the fallacy that the government debt has to be “returned”. Retired is the more technical word. It is not an accusation on you, so please don’t take it like that. But yes – the government owns the/a country so if you want to consider the government debt as an asset backed security, fair enough. However, if you go to the central bank and hand them a $10 note, they will hand you two $5 notes and they are not required to hand you anything more. If you have a corporate bond as a document, you can go with that paper and demand to be paid in currency. However, the central bank IOU is the “thing” citizens of a country transact with. A corporate can extinguish its liability with the central bank’s liabilities. It is impossible for the central bank to extinguish its liabilities in that manner. The central bank can only extinguish its liabilities by the central bank’s liabilities – which essentially means, they haven’t or cannot, or – are not required to.

    I don’t know what to say about the Ricardian Equivalence really. It is a Questionable Cause. Ricardo’s logic is just the other side of the intergenerational debate! I think you want to have a behavioral system which takes into consideration the future tax payments. Unfortunately, from a Modern Money viewpoint, it doesn’t make sense. Consumers do not behave as if they will have to pay higher taxes later and nor do corporates or banks. Even Ben Bernanke does not believe in this logic, in case you want to know. Unfortunately, investment bankers keep propounding the same myth. Are we paying off our grandparents debt ? Certainly not!

93. Scepticus,

    Even the saltwaters do not believe it. See for example this post of Brad DeLong An Appeal for Help: Recent History of Economic Thought where he says

    If anyone can help me understand the process by which these strange doctrines of economics became Holy Writ among the Monsters of the Midway, I would be very grateful…

94. Scepticus: “The net financial assets of a closed economy is zero. Every financial asset is someone else’s liability. Make a slice on this – we have two sectors public and private. The net financial assets of the private sector is thus the liabilities of the public sector!”

    Bill deals with this in detail in Stock-flow consistent macro models:

    “Within a modern monetary economy, as a matter of national accounting, the sovereign government deficit (surplus) equals the non-government surplus (deficit). The failure to recognise this relationship is the major oversight of neo-liberal (and Austrian) analysis.

    “In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending. The sovereign government via net spending (deficits) is the only entity that can provide the non-government sector with net financial assets (net savings) and thereby simultaneously accommodate any net desire to save and hence eliminate unemployment.

    “Additionally, and contrary to neo-liberal (and Austrian) rhetoric, the systematic pursuit of government budget surpluses is necessarily manifested as systematic declines in private sector savings.

    “The decreasing levels of net private savings which are manifest in the public surpluses increasingly leverage the private sector. The deteriorating debt to income ratios which result will eventually see the system succumb to ongoing demand-draining fiscal drag through a slow-down in real activity. So you have to trace the private indebtedness back to the conduct of the government sector.”

    Basically, if the government runs deficit it puts financial assets into non-government than it withdraws and net financial asset of non-government are positive and offset by the government deficit on the government’s book. If the government runs a balanced budget, then non-government NFA net to zero, reflecting this. If the government runs a surplus, then non-government NFA is negative, and savings of stored NFA must be drawn down to meet the outstanding obligations to the government.

    This is foundational for MMT.

    Next: You have not given any justification why a nominal accounting practice applied to model one set of human activity should not be extended to cover all human activity. You have just said ‘it doesn’t apply to government but not why. Ask yourself this – why do people in the private sector accept the imposition of financial accounting practice upon their daily lives and business activity? Why don’t they just say – it doesn’t apply to me?

    Accounting based on double-entry bookkeeping is the sacred language of finance. It applies across the board. However, it applies in different ways to different sector because the recording of real activity in a stock-flow consistent way is different based upon the activity.

    For profit business and non-profit institutions are different in their activities and objectives, and FASB recognizes this in prescribing different accounting standards. Everyone in these sectors has to follow the standards prescribed for that sector.

    The government also is different in activity from non-government, so it has its own standards and procedures that are appropriate for recording its activities.

    In each case fundamental accounting identities apply, but they are fit to the circumstances of the type of activity of the various sectors. This isn’t theory. It’s the way it is. Experts who specialize in these fields may not even know all that much about the detailed standards applying to other fields.

95. Tom,

    Good you brought the “justification” part raised by Scepticus.

    Scepticus: The fact that people don’t even know accounting does not mean that they do not act in that way. Firms are always thinking about their numbers. They have to take care of wages, number of new hires etc. They have to price their products depending on the costs and expected sales. Households consume if they have higher incomes. Right now, they will cut down on consumption because there are uncertainties. Banks are worried about what interest rates they want to lend. Accounting is an excellent way of describing such situations.

96. “The fact that people don’t even know accounting does not mean that they do not act in that way. ”

    That is exactly the justification given for ricardian equivalence. You tell me, why the japanese don’t spend their NFA, even though they are given more and more and more of them?

97. Scepticus, I have read through your last couple of posts, and like Ramanan appears to think, you are somewhat confused by the ambiguous way that accounting terms are used because they apply differently in different sectors. Take reserves, which are government liabilities. Banks exchange reserves to get the cash demanded at their windows. For the government, this is the equal exchange of one liability for another, and the banks, one asset for another.

    What assets offset the liability that reserves create? In the days of convertibility it was gold at the fixed exchange rate. That no longer applies.

    Now when the Treasury spends, reserves are transferred to commercial banks in the interbank reserve system (FRS), and enter the economy as financial assets. Some of those assets are used to pay government obligations, chiefly taxes. That is an offset. Depending on whether the budget is in balance, deficit or surplus, the government issues debt to make up the difference if it is a deficit. These Tsy’s simply store already existing non-government net financial assets. They are not loans from the government in the ordinary sense of loan. The government doesn’t “pay them back.” When mature, the transaction at the government level is just switching the Tsy’s back into reserves. No problem.

    Since there is no longer backing for the currency, there are no real assets behind the government’s liabilities other than the ability to tax. This is what a fiat currency is. The “assets” on the government side are simply accounting entries that double-entry bookkeeping necessitates to record activity. If you don’t believe in accounting “fictions,” just check out something like depreciation. This is made up. It could be made up in many different ways, but FASB decides the standards.

    For example, when the government is in surplus, what is the surplus? It just means that taxes exceeded disbursements. But this is just a figure on the books to which nothing actually corresponds. The government doesn’t collect taxes and put the dollars in a vault somewhere. These are just accounting entries on a spreadsheets. Non-government has negative NFA in this period in which there is a surplus. Does government therefore have positive NFA? It really is meaningless, other than that non-government had to dig into savings of previously accumulated and stored NFA to satisfy its obligations to government in that period. The surplus is actually a drain on the economy, instead of the supposed boon for the government.

    Who is the national debt “owed to”? It’s just stored savings of previously accumulated non-government NFA. The government doesn’t owe anyone anything since it was already issued the currency that the debt issuance simply stores and compounds.

    As far as national accounting goes from the government side, it is horrendously complicated, if you care to glance into the regs. As Ramanan says, the people handling the books know how to double-entry account for all this. I guarantee to you that if you stick your nose into this, it will make your head spin. All we have to know is that it is a record of daily activity entered in journals and ledgers in terms of stock-flow consistency. The various government reports are summaries of this accounting of activity (flows).

    The government and non-government meet in the reserve system, where government activity (flows) intersects with commercial bank activity (flows).

    Commercial banks have there horizontal accounting, and government has its reserve accounting. Transfers of reserves involving commercial banks show the interaction (flows) between the two.

    Interactions between the Treasury and Fed show the relationship between the fiscal and monetary arms of the government. They act to complement each other and that is reflected in the accounting.

    I think that where you may be hung up is in how a fiat currency system works (it seems quirky, I know), and thinking that the government must somehow get money from the private sector in order to get the accounting entries right. But I can’t see yet just where you are going. I think you have Ramanan confused about where you are going too, and he is much more knowledgeable than I am about this. Try to be more specific and maybe we can straighten this out.

    MMT’ers have had trouble trying to explain this stuff to neoliberal economists because they persist in looking at things through their assumptions, and the problem is that the assumptions just don’t mesh with the way the system works now. I think that something similar may be going on here. When you say the following, I suspect so:

    Why is it that despite a vast addition on NFA to the japanese private sector that demand has not picked up and rates have stayed very low? Could it be because in reality all those NFA of the private sector are offset by hidden liabilities of the private sector in the form of future taxation.

    Why appeal to Ricardo and “hidden liabilities,” when that is far-fetched? It is pretty well agreed among finance types that the problem is zombie banks that the government refuses steadfastly to deal with.

    What I am saying is that MMT is concerned chiefly with stock-flow consistent macro models based on national income accounting. This is set forth in one place in Godley & Cripps, Macroeconomics (1982), for example. Wynne Godley worked at the Treasury in the UK for 14 years and went on to teach econ at Cambridge.

98. That is exactly the justification given for ricardian equivalence. You tell me, why the japanese don’t spend their NFA, even though they are given more and more and more of them?

    The Japanese prefer to store their accumulated NFA in Japanese bonds and let the interest compound. The Japanese are known as savers, as are Asians in general.

    Saving it to pay anticipated taxes? Really?

    People do act in terms of accounting in the sense that everyone needs to be aware for the stock and flow of one’s checking account. May be single entry, but it’s universal and it’s based on present circumstances – like avoiding overdraft in the days of high penalties and anticipating payday – as well as planning for future payments, including current tax obligations. Do people think about tax obligations in a year or two or three, … or ten? Nah.

99. tom, I’m fully on board with double entry book-keeping. I also agree with 95%of statements made by MMT, so that puts me much closer to MMT than it does to neo liberal dogma. I am not a neo-liberal and don’t have a neo-liberal agenda. I don’t even have a circuitist agenda, though I’m closer at the current time to being the latter than a chartalist.

    government sector accounting can be as complicated as you like but if it simply ignores a given class of assets then their absence won’t show up in a detectable way since they ought to sum to zero.

    I agree with MMT that LOANS CREATE DEPOSITS. Government liabilities are deposits, so it follows that there ought to be some loans that created them wouldn’t you say? Given that due to the nature of the slice that separates public from private sector, all loans made by the public sector must necessarily show up as new public sector liabilities – they get re-deposited in the public sector since they couldn’t go anywhere else. Likewise loans made by the private sector commercial banks must necessarily show up as deposits in the private sector.

    If loans create deposits is a universal truism then there must be a loan of some form that creates the deposits into the public sector.

    And you still fail to address my point that NFA given to the private sector by the government some part of which may be removed later for whatever reason is from the private sector point of view like a loan – it’s not money. This is a key point yet you persist in banging on about accounting identities without ever once addressing this very important point.

    A government runnnig a surplus can be considered analagous to a de-leveraging commercial bank. The purpose is the same – to de-leverage.

    And where I am going is that the economy is a pure credit economy, not least because as you all ponit out banks will always be able to borrow at the discount window, which makes the existence of not of rbs irrelevant. In one breath you say this and then in another try and make out that rbs are like money issued in full faith and credit. rbs may be this or may be a fiction or a side effect of accounting, but the existence of the discount window as the ultimate stabiliser places us firmly in the real of the pure credit economy. Therefore you have no justification for treatnig rbs specially with statements like the natural rate is zero. This latter statement has no basis in financial accounting or double entry book-keeping – it is an ideological position and one that seems contradicted by other positions taken by MMT.

100. Scepticus . . . if you’re a circuitiste, you’re the only one I’ve seen besides perhaps Keen who would question MMT on accounting, NFA, etc.

101. Scepitus, Bill Mitchell and Steve Keen had a debate here some time ago. It begins with, In the spirit of debate, and three follow up posts, Use the navigation at the top of the page to go to the next post. There is only one intervening post separating them. Steve’s portion of the debate is in the comments.

     I mentioned the complexity of government accounting because it is comprehensive. I don’t buy that these people miss anything. If it isn’t’ there, and I assume you haven’t checked, postulating it might be hidden or unrecognized is pretty close to conspiracy theory.

     Government liabilities are deposits, so it follows that there ought to be some loans that created them wouldn’t you say?

     Why? That’s adding apples and oranges. The government issues currency. (That’s a period). Bank loans create bank money. Two separate kinds of money. Nothing is required to create fiat money. “Fiat” is Latin meaning “Let it be.” In the reserve system, reserves are Fed liabilities and assets of the banks. Banks can just convert reserves for TSy’s, also goverrnment liabilities. It doesn’t imply that the Fed borrows reserves from anyone. It and it alone creates reserves. The banks can only get reserves when the Treasury spends and its reserves are transferred to the various banks as the checks clear in the interbank settlement system that only uses reserves.

     To understand how the monetary system operates it is essential to keep currency of issue and bank money distinct in your mind. They function differently and are accounted for in different systems. That’s what vertical and horizontal means.

     And you still fail to address my point that NFA given to the private sector by the government some part of which may be removed later for whatever reason is from the private sector point of view like a loan – it’s not money. This is a key point yet you persist in banging on about accounting identities without ever once addressing this very important point. A government runnnig a surplus can be considered analagous to a de-leveraging commercial bank. The purpose is the same – to de-leverage.

     This is only happening in your mind. It makes no sense in terms of the way the system is normally described or how it operates.

     the economy is a pure credit economy

     No. The commercial banking system creates bank money, aka credit money, through lending, which nets to zero. Currency issuance does not net to zero because there is no lending involved in creating it.

     Your example of the discount window suggests you don’t know how this operates. It is very seldom used, and it is a penalty form of borrowing resources from the Fed, which carries a stigma. It’s an emergency escape hatch that provides liquidity to a bank that hasn’t managed itself well.

     …This latter statement has no basis in financial accounting or double entry book-keeping – it is an ideological position and one that seems contradicted by other positions taken by MMT.

     Now you are talking nonsense. You need to study up on how this works.

102. Dear Tom

     I would not have called it a debate. It takes two sides to have a debate. Steve barely participated despite inviting me to do so and left it to his brigade of deficit terrorists to mount the charge.

     best wishes
     bill

103. Bill: Steve barely participated

     I got here though Steve’s site, specifically, the proposed debate that was announced there. I saw immediately that the vertical horizontal distinction you were making was key and was surprised to find that Steve apparently didn’t want to go there and just dropped out of the discussion. So jumped in here while I was also reading Randy Wray’s Understanding Modern Money, and was soon convinced.

104. Tom: Excellent reply. I dont think anybody could have been more clear. It always beats me why there is so much confusion over vertical transactions. Sometimes I doubt myself to miss something.

105. Secpticus said:

     Government liabilities are deposits, so it follows that there ought to be some loans that created them wouldn’t you say?

     Deposits are NOT the government’s liabilities. Deposits are bank liabilities. The combined government/CB liabilties are currency notes, bank reserves and government securities.

106. Vinodh,

     No need to doubt yourself to have missed something. There are zillions of Fed articles to support the simple accounting facts made.

     Scepticus,

     There is nothing which is wrong in this blog from an accounting point of view. For example, please read the Chicago Fed’s Modern Money Mechanics. The accounting is consistent with MMT, but it is the dynamics written there which is not consistent with MMT. For example, it gets into the money multiplier concept, and gets into Monetarism, control of money supply etc. Good to learn the article and then unlearn. More fun.

107. Scepticus,

     Also there is nothing ideological about calling zero interest rates as natural. For example check this article by some Fed authors on The Federal Reserve’s Primary Dealer Credit Facility. Page 5, Box 1 says

     When the Federal Reserve’s Open Market Trading Desk was targeting a non-zero federal funds rate, the reserve impact of PDCF loans was offset using a number of tools, including, but not necessarily limited to, reverse repurchase agreements, outright sales or redemptions of Treasury securities, a reduction in the size of conventional repo transactions, and use of the authority to pay interest on reserves. However, when the FOMC reduced the target fed funds rate to a range from zero to 25 basis points, there was no longer any need to offset or “sterilize” these loans.

     In short, the Fed was defending a non-zero overnight target rate and it had to do a lot of things to prevent the overnight rates going to zero.

     As Bill says, the last mile problem needs to be addressed. People mess up somewhere in the last mile. Some people at the Fed get a lot of things right, but somehow mess it up completely when it comes to the big picture.

108. Bill,

     Nevertheless, Keen was complimentary here, at 4:45.

     http://www.switzer.com.au/video/keen20100204

109. Props to Steve there, and he’s probably even a bit to hard on himself at the same time.

110. Ramanan, STF, JKH, and other knowledgeable folks-

     Did you see the macroeconomic balance sheet visualizer link I posted here a few days ago? Tom Hickey provided some helpful stylistic feedback but no one has commented on the content. I am still an amateur and would value someone checking accuracy-so-far.

     Bill and others have called for people to “spread the word” on MMT, and this is my first cut attempt at an alternate approach to the typical story-driven or news-driven blog commentary that is repeated in so many different permutations. My hope is that something visual and interactive can help eliminate some terminology confusion that often arises (for example the comment that “government liabilities are deposits” above).

     If my first draft content is too spotty and low-quality to be worth your time but you think the tool might have value, I’d be happy to use someone else’s content, choice of outbound links/credit, etc.

     There’s of course lots that can be improved and added in both content and functionality. One of the next things I’d like to do is a step-by-step “tutorial” that walks through government spending, taxation, etc, and shows the balance sheet validity of the MMT perspective. But I would consider other suggestions if there is interest.

     P.S. I realize I have not used the “consolidated government sector” approach that Bill and others like to use, but I don’t see how you can claim stock/flow validity without laying out in the open the actual assets and liabilities of the treasury and central bank balance sheets. Otherwise you’re just arguing via philosophy instead of real-world mechanics.

111. hbl,

     Have to check – but sounds like a fantastic idea!!! Congratulations. Somehow missed your earlier comment. I also got this message

     Invalid Operation: One or more balance sheets has insufficient assets or liabilities. Try another operation first or reset the balance sheets

     which means you have paid attention to the details. Will surely try to play with it at length. Good you have included QE as well.

112. HBL, nice stylistic changes. I can see everything fine now.

113. hbl,

     looks interesting … will review over the next few days

114. Hbl

     Very impressive! You must have put a lot of work into it.

     Are you planning to expand the option “government issues debt” to include debt purchase by banks? So far there seems to be no way to put treasury debt on the asset side of bank’s balance sheet, and so QE via CB purchase of treasury debt from banks isn’t feasible. It would be good to see CB open market operations included too (your current QE is equivalent to an open market bond purchase, I think)

     Also, I wouldn’t class the treasury asset as ‘reserves’, since this could be confusing. I assume you mean the treasury deposits at the central bank, which are not technically ‘reserves’. So then taxation would reduce reserves, rather than leave reserves unchanged as your model shows. Also, base money should include currency.

     Good stuff!

115. Sorry hbl

     Re: base money should include currency. I see that it does, my mistake. I was confused by the inclusion of treasury deposits as reserves.

116. hbl,

     Yes, as PS points out, there is something funny happening with reserves, base money etc …

     Another thing: the Central Bank has a technical net worth of 0, as its profits are handed over to the Treasury/Government.

117. Thanks for the comments so far!

     ParadigmShift –

     [1] Yes, there are still a number of operations I’m planning to add including banks buying/selling assets and typical CB open market operations. I probably should have included the latter in this first iteration so I will add it soon. Thanks.

     Incidentally I’m not sure how to treat the balance sheet liabilities resulting from equity (share) offerings as described by MMT, so would welcome any pointers on that. This topic still confuses me. If the market bids up the shares of a public company, do the executives really think “uh oh our book value is shrinking, if this keeps up we’ll be insolvent”?!? And would a soaring public share price impact the capital ratios of a bank and reduce its ability to lend? This seems like the logical result from the claim that the non-government sector can’t change its own aggregate balance sheet equity, so I’m probably missing something.

     [2] And regarding whether the treasury’s deposits at the central bank are called ‘reserves’, what would you suggest instead? Are they not a liability of the central bank, whatever you call them? The model currently does show taxation reducing reserves held by the non-government sector, but if my approach is confusing I’d be glad to change it.

     Ramanan –

     [3] If you can be more precise about the “something funny happening” I’ll fix it… I used this as a reference.

     [4] And regarding the central bank’s net worth of zero… Whenever I see published info on this, the central bank (at least the US Federal Reserve) does seem to have a small capital buffer unless I am misunderstanding, though I was aware that it just hands over profits to the treasury and does not attempt to increase its balance sheet equity. Will double check sources later but am happy to be given pointers.

118. [2] And regarding whether the treasury’s deposits at the central bank are called ‘reserves’, what would you suggest instead? Are they not a liability of the central bank, whatever you call them? The model currently does show taxation reducing reserves held by the non-government sector, but if my approach is confusing I’d be glad to change it.

     As I understand it, the reserves that Fed creates to fund Treasury disbursements are liabilities of the Fed and assets for the Treasury, which settle the Treasury’s disbursements as they clear through the commercial banking system, the reserves then becoming assets of the respective banks that are used to credit the deposit accounts of the recipients of the disbursements. Thus, reserves are Treasury/commercial bank assets and Fed liabilities.

     [4] And regarding the central bank’s net worth of zero… Whenever I see published info on this, the central bank (at least the US Federal Reserve) does seem to have a small capital buffer unless I am misunderstanding,

     This is my understanding, too. I thought that the Fed transfers its equity account to the Treasury periodically, not daily.

     Thanks for correcting, if this is not the case.

119. Hi hbl,

     I find the Flow of Funds Accounts of the United States – Z.1 Accounts very useful. Other countries also have it but I find this one very useful.

     You can get the terminologies from the table L.108 for the Treasury’s account at the Fed. I think they do not call this “reserves”. It is just called Treasury general deposit account under the heading Due to federal government. That is what I meant by something funny happening.

     The capital buffer is for “central bank independence” and talks like that. Meaning if the market value of assets go below liabilties, the central bank may lose its independence etc. – which are just talks which not do lead to anything. Simple to set the net worth to zero since the Treasury is always the owner 🙂

120. Tom said “Deposits are NOT the government’s liabilities. Deposits are bank liabilities. The combined government/CB liabilties are currency notes, bank reserves and government securities.”

     If you view the operation of the government like a bank, then it is reasonable to view government debt of various forms as a depositing of the assets created via government lending to taxpayers. Its just a terminology thing so lets not split hairs.

121. To conclude my points made in this thread, allow me to summarise my key objections to MMT in their most basic form;

     Objection 1: MMT holds that banks are never reserve constrained, therefore banks are not revenue constrained. MMT rightly claims that governments operating fiat currencies are not revenue constrained. I therefore see no reason why commercial banks and governments should be subject to different accounting regimes given that both are non-revenue-constrained entities.

     Objection 2: MMT is very vague on the real status of bank reserves. On the one hand they are held to be simply currency issued in full faith and credit. On the other hand they are held to be balance sheet entries like any other financial asset. I remain unclear what the official MMT line is on this point. Likewise on one hand MMT treats all government liabilities as essentially having the same liquidity effect on the private sector and hence interchangable, yet still (according to some commentators ) bond issuance is mooted as a way of dealing with excess demand. This seems like having ones cake and eating it.

     Objection 3: MMT remains unclear to me on how fiscal policy reduces aggregate demand given the statement that under MMT commercial banks will never become revenue (i.e. reserve) constrained. In this case it seems to me that government spending or taxation or other revenue related actions can’t have any direct controlling effect on private sector endogenous money creation.

122. Hi Hbl

     I agree with Ramanan that “treasury deposits” would be a better terminology to use. Conflating these deposits with bank reserves masks an important distinction, IMO. Although they are still a CB liability, treasury deposits at the CB are not considered to be part of the money supply, and reserve liabilities of the CB should decrease with taxation, and increase with govt spending, to reflect changes in the monetary base with those operations. It also demonstrates the arguably somewhat semantic point that the government does not possess a stock of monetary assets which is increased by taxation.

     I think your model has great heuristic value and should help people to visualise what can be at times a highly abstract set of ideas. Look forward to seeing it evolve 🙂

123. The statement that banks are not reserve constrained in lending is entirely separate from the statement that banks ARE constrained in lending by the availability of credit worthy customers and their own capital adequacy. Banks definitely face constraints in their balance sheet expansion strategies – it’s just that the central bank reserve position isn’t one of them (assuming adequate capital).

     The idea of “revenue constraint” is very odd. But because banks are capital constrained, and because internally generated capital is a function of revenues minus expenses, in that very indirect sense banks are partially “revenue constrained” in their ultimate lending strategies.

124. hbl,

     “Incidentally I’m not sure how to treat the balance sheet liabilities resulting from equity (share) offerings as described by MMT”

     I still haven’t looked closely at your model, but on this point, I’d keep the accounting in general at book value. Think of the stock market as entirely outside of your model. It’s not your purpose to reflect that external valuation perspective on these various institutions. You can overlay an interpretation of market values as you wish, but keep market values outside of the model per se, I would say.

     The stock market has no direct impact on the equity book value of an institution. It will have an effect on capital ratios only to the degree that stock market effects are captured in any asset or liability values that are marked to market for accounting purposes. But I think you can stay away from that.

     The stock market will affect the price at which new equity can be issued to the market. That can have an effect on corresponding post-issue per share book value, according to the weighting of the new issue relative to pre-issue book value. But even if you start modeling new share issues, I would think you’d be modeling aggregates rather than per share book values, so you shouldn’t need to worry about that.

     That said, your idea to model equity issues at some market price level seems a bit ambitious. I’d probably stick with internally generated capital if you’re going that far with the bank component, but I’ve not looked at your model closely enough to make that judgement wisely.

125. sorry, should have said the stock market can affect equity book value to the degree related marked to market accounting is used for some of the assets

126. “banks ARE constrained in lending by the availability of credit worthy customers and their own capital adequacy.”

     I agree. However this is NOT a revenue constraint. Since loans create deposits, loans can also create bank capital. This process of banking sector capitalising itself from the outcome of its own lending is entirely beyond fiscal control if banks remain non-reserve constrained.

     In an excess demand scenario (particularly in the presence also of excess reserves) I don’t see why banks wouldn’t be able to attract sufficient capital. Also, banks determine for themselves who is credit worthy so again fiscal policy doesn’t alter the fact that both their own capitalisation and the definition of creditworthy are factors entirely under the banks control and therefore fiscal policy cannot affect the situation.

     Regarding customers, yes banks need customers to lend. But then governments need an excuse to spend too. The government customers are the voters who determine whether they wish the government to spend on their behalf or not. In an excess demand scenario the presumption must be that voters are inclined to make their own spending decisions and are therefore not going to be in favour of deficit extensions. So once again my analogy holds up nicely – banks need willing customers to loan to, and so do governments when justifying a deficit.

     You may say that such political considerations are out of scope for this discussion but of course they cannot be because ultimately all government deficit positions or attempts to manage demand must be validated at the ballot box.

     JKH, the use of SIVs and so forth allow banks to escape their capital constraints by spreading risk to other private sector entities.

127. Scepticus,

     Reply to your posts,

     If you view the operation of the government like a bank, then it is reasonable to view government debt of various forms as a depositing of the assets created via government lending to taxpayers. Its just a terminology thing so lets not split hairs

     We are not in any sort of war here 🙂 The important thing is to get these accounting as solidly as possible. I think one needs to get a lot of things right to understand how Modern Money works. Its crucial. The fact that deposits are bank liabilities and do not sit in the government plus central bank sector’s liabilities is an important thing in my view. This is why I took it up. Else it looks as if bank is “storing” a commodity.

     Objection 1: MMT holds that banks are never reserve constrained; therefore banks are not revenue constrained. MMT rightly claims that governments operating fiat currencies are not revenue constrained. I therefore see no reason why commercial banks and governments should be subject to different accounting regimes given that both are non-revenue-constrained entities.

     See JKH’s reply for Objection 1

     Objection 2: MMT is very vague on the real status of bank reserves. On the one hand they are held to be simply currency issued in full faith and credit. On the other hand they are held to be balance sheet entries like any other financial asset. I remain unclear what the official MMT line is on this point. Likewise on one hand MMT treats all government liabilities as essentially having the same liquidity effect on the private sector and hence interchangeable, yet still (according to some commentators ) bond issuance is mooted as a way of dealing with excess demand. This seems like having ones cake and eating it.

     There is no vagueness. There are two things apart from government securities: settlement balances and currency in circulation. The change in the level of reserves has no impact on economic activity. I do not know the exact statements of other commentators. My status is (learned from Wynne Godley’s work) – buying bonds does not reduce your propensity to consume. The decision to consume is based on expected income in the near future and the assets accumulated. The decision to allocate wealth is another decision. The consumption decision decides the size of the expected wealth to be allocated. There is a hierarchy of decisions here. Consumers first decide on how much needs to be consumed and then invest the remaining. This is very different from the mainstream view where “agents” try to maximize everything they can. From these agent-based models’ perspective, interest bearing debt will reduce aggregate demand because they try to maximize some objective function. Coming back, there is a feedback effect here. The effect of the issue of an interest bearing debt adds to aggregate demand in the long run instead of reducing anything: the interest income is higher in the case where debt is issued by the government than the case in which the government does not issue debt and hence adds to aggregate demand.

     Objection 3: MMT remains unclear to me on how fiscal policy reduces aggregate demand given the statement that under MMT commercial banks will never become revenue (i.e. reserve) constrained. In this case it seems to me that government spending or taxation or other revenue related actions can’t have any direct controlling effect on private sector endogenous money creation.

     I am assuming you mean that banks are never constrained on lending. The effect is through taxation. Of course Bill prefers lower interest rates – in fact zero overnight rates. On the other hand, Bill has written at various places about the government having a direct control (though regulation or taxing) loans obtained for purposes such as real estate. The facts that so many Ponzi loans were handed out in the Noughties does not necessarily imply low interest rates are bad, but it is any day better to say that such reckless behavior should have never been encouraged.

128. Ramanan, I know that bank deposits are not government liabilities. What I am saying is that it is a valid thing to talk about government liabilities being _analogous_ to private sector bank deposits. I agree they are not the same thing.

     Regarding bonds, I’m inclined to agree that interest bearing debt issuance adds to aggregate demand if the interest payable on it is not sourced from taxation. However an MMT administration does not promise NOT to raise taxation to pay bond interest, its just that an MMT admin just says it will tax in future but not specify what the taxes are used for (they are in fact shredded). The question of whether or not RBs always pay zero regardless of aggregate demand is a key issue and unless it is fully and unambiguously specified then no conclusions about the relative impact of rbs or bonds can be reached. Therefore it is essentialy for all MMters to commit to interest free rbs forevermore, or to admit they may not be interest free, in which case you cannot utilise argumentation basd on the fact that rbs are interest free.

     So ramanan, in your MMT admin, would rbs be 0% at all times?

     Finally your points about using regulation to constrain lending is valid, and expected, but this is totally different to fiscal controls. With fiscal controls you set a government spending target and then leave the private sector to optimise their decisions. With regulatory control of spending, you in effect change the rules all the time to assist in managing demand. This is very different from just setting a deficit target and amounts to direct control of peoples spending decisions as a primary policy instrument. I think this would be regarded as unacceptable in a democratic system with pretensions to individual liberties.

129. Scepticus,

     The idea that banks are not reserve constrained is based first on the fact that the central bank supplies the reserves required for the system as a whole to clear settlement balances at the policy target interest rate.

     There is no comparable automatic, systemic supply function for capital.

     Reserves are sourced by government fiat; capital sourcing is more comparable to a gold standard dynamic.

130. JKH “There is no comparable automatic, systemic supply function for capital.”

     Which makes it even less likely the government can control it. Therefore banks are not revenue constrained due to CB accommodation, and as you kind of point out above, the absence of an obvious pathway for bank capitalisation precludes fiscal control of said pathway, which means that banks are not subject to any kind of limitations resulting from govt fiscal policy whatsoever, leaving only legislation as a tool to constrain private sector credit creation and demand.

     JKH ” capital sourcing is more comparable to a gold standard dynamic.”

     I would love to see an MMT analysis of this and how excess reserves don’t affect the process of capital sourcing, both under the deficient and excess demand scenarios. Is there one? If not, why not, because it seems critical to the integrity of the MMT edifice?

131. Hi Scepticus,

     I see your point. The system is such that bank liabilities have the same status as currency and in fact you will agree that the common man does not care much and probably that is what you are trying to say.

     Reserve balances are actually close to zero in Canada but I guess if you agree with Bill’s design part of the banking system, reserves just keep accumualting because of deficits in every period, so they would be high in such a policy.

     Taxes are looked upon differently from a Modern Money perspective. You are completely correct about taxing and interest income. It so happens that governments try to go in an austerity mode to try to target a lower debt/GDP ratio and hence cut down on the primary deficit. The effect of going in such an austerity mode actually reduces aggregate demand than in the case where the government does not change its policy! This may sound contrary to what I mentioned in my previous comment, but the situations are different.

     Not sure about the political implications of one policy versus another, but the situation is so bad – the people in power and their advisors have no idea whatsover on how an economy works! In the US, there are characters like Ron Paul. In my country – India – they have better people in the Finance Ministry. The Indian FM had told other FMs in G7/8 meets to not withdraw the stimulus and is not so worried like others. I just hope he doesn’t take backward looking steps. The Reserve Bank governor’s viewpoints, on the other hand, are simply intolerable – all his statements sound like he thinks we are still living in the Gold Standard.

132. Scepticus/JKH,

     There are two (and more) viewpoints. The first is the neoclassical – the Verticalist viewpoint and there is the Horizontalist viewpoint. The Verticalist viewpoint is not to be confused with the Vertical transactions mentioned at several places in this blog. They are called so because of how you view the money supply function to be. The y-axis is the rates space and the x-axis is the supply of money.

     In the Verticalists’ viewpoint, the central bank sets the supply of “base money” and the total supply of money is determined by the multiplier process. Interest rates are determined by where the supply and demand for money intersect.

     The horizontal position is very different. The money supply is always and everywhere an endogenous phenomenon. There is neither a shortage of money nor an excess. It is completely demand determined. The interest rate is determined by the central bank and the banks.

     Capital adequacy requirments seem to make a horizontal supply function line into a vertical one. However, there are some who argue that it is still horizontal. Here is what Marc Lavoie – one of my favourites – has to say on capital adequacy requirments: (My version of what he says in literature, not quoting him):

     The capital adequacy requirements seems to suggest that it has its own multiplier. However, that is far from the truth. The present rules of Basel 2 are very flexible. Banks raise capital easily by retaining enough of their earnings and issuing new equity. There is never a problem. Even the zombie Japanese banks did not have trouble raising capital, except for a few. If there is a problem, the central bank should capitalize the banks. So it seems he foresaw an event such as TARP in 2003 😉

     My personal position is that money is always endogenous/horizontal – even in the gold standard it was endogenous. It’s the endogeneity of money that led to the fall of the Gold Standard.

133. Ramanan,

     The entire concept of capital allocation is based on risk supported by a ratio of capital to risk. Risk is a multiple of capital.

     “There is never a problem”.

     That’s silly.

     There’s no comparison with standard central bank reserve provision.

134. Ramanan 3:30 – Thanks for the Z1 pointer, I’ve used it for other things but not yet for this visualizer (eventually I hope to plug its data into this visualizer as an alternative data set). I see the L.108 terminology, thanks… though this table does still imply a capital buffer at the Fed. I’m hesitant to set central bank net worth to zero in the tool without more evidence of real applicability vs implied only, but maybe I’ll add some commentary about this point when I attach mouse-over descriptions to each balance sheet.

     ParadigmShift 23:04 – Thanks, I will use the term “treasury deposits”.

     JKH 23:35 & 23:37 – “your idea to model equity issues at some market price level seems a bit ambitious” – Perhaps I am being too ambitious, but one of my ultimate goals is to visually document both the foundational circuitist and chartalist viewpoints regarding macroeconomic changes and outcomes. This will require showing the ability of markets to inflate/deflate the valuation of assets (stocks, bonds, etc) during valuation bubbles/busts, and the effects on wealth, spending flows, etc. I’ll need to add better visualization of the flows to be at all successful at this. I’m not knowledgeable enough to capture more than the basic principles of these fields, but one of my hopes is to help in moving the dialog (especially with newcomers, and some folks on debtdeflation.com who seem unsure of the accouting) beyond repeated explanation of the basic mechanics so that more energy can be spent on understanding the pros and cons of various solutions. If that proves overly ambitious and goes nowhere then at least I’ll have had practice learning a new programming technology 🙂

     And regarding your specific comments on market valuation of stock prices in the tool, other than suggesting I don’t attempt to go there, I think your key point is that the stock share liability held by a company that offsets the publicly held stock shares the company has issued will usually not be marked to market?

135. hbl,

     I would go for a market value for equities issued by companies. You have brought out an important point about the market bidding up the prices of stocks and the net worth turning negative, if you include equities issued in the liabilities. In fact, this is closely related to Tobin’s-q. I don’t think that it would mean that the company must file for bankruptcy – in fact it would mean that the stock market is overvalued. In fact, it actually happened in the US in the early 2000s – the net worth was negative!

     The advantage for using the market value is that everything is balanced in a balance sheet matrix – as far as financial assets are concerned. The net assets of a closed economy is then the value of the real assets.

136. JKH “There’s no comparison with standard central bank reserve provision.”

     nevertheless, banks may or may not be capital constrained, and either way it is out of the governments (fiscal) control.

     therefore I repeat my assertion that banks unconstrained by reserves cannot reliably be controlled by fiscal policy.

     the statement that banks shall always be unconstrained with respect to reserves completely undermines the MMT claims that simple fiscal tools can be used to manage aggregate demand. They can’t – its not a reliable or even close to universally applicable policy lever.

     it seems to me you must now adopt a more nuanced stance that leaves open the option of incorporating legislative AND monetary type controls. In order to make this move you would need to drop the natural rate is zero stuff. Alternatively you can propose management of demand purely via fiscal means combined with regular legislative tweaks (much like china with its stop, go, reserve requirement changes) , however I fail to see why this is preferable to control via monetary variables.

     At the very least you should show ___unambiguously___ how fiscal policy constrains (non-reserve-constrained) bank lending or give the legislative aspects of MMT demand management a much more prominent role in your theoretical writings.

137. JKH,

     I guess that is from a perspective of the banking system as a whole than an individual bank. The banking system as a whole sets the price – the interest rates offered on their lending activities. Banks add sufficient spread for the risk of default of borrowers. If the economic activitty increases, then banks would temporarily increase the interest rates so that they earn enough to simultaneously satisfy their shareholders through dividends and to retain enough funds to add to their “own funds”. During a period of good economic activity, their ability to issue new equity also increases. When they earn enough, they again reduce rates. During a period of low economic activity, the demand for loans goes down as well as the creditworthiness of borrowers. The theoretical limit (which itself is a dynamic quantity) of how much the banking system can lend at any point of time is never reached (exception: the recent crisis on Wall Street). And of course banks have done heavy securitization, all these years. In other words, there is rarely a supply shock.

     Here’s the reference: A Primer on Endogenous Credit-Money

     The production side analogy to this is the reverse-L shaped supply curve (where price is on the vertical axis and real output on the horizontal) – mentioned by Bill in this post itself. It is the reverse which is not Г – the one can’t find an HTML symbol for :)There the curve is almost reverse-L-shaped with a bit of curvature near the corner. Just like demand creates a supply of products, increase in demand for loans creates more capital. The only time, an exception has happened is during this credit crisis.

138. ramanan: “…increase in demand for loans creates more capital.”

     which is exactly what I have been saying, so thanks for the supporting links, which goes onto my reading list!

     However I think this only holds if we assume that demand for reserves is always satisfied by the CB?

139. Scepticus,

     Fiscal policy by itself cannot control bank lending – I completely agree with you. I do not think Bill has claimed anything like that in the blog. The important thing is that when Bill talks of necessary conditions, it shouldn’t be taken as sufficient. That is why you see so much criticism of policy makers – complete failure to understand anything about the system. I don’t have links – but you can see him talking about various non-fiscal things about bank lending in this blog.

140. In the last comment @4:15, I meant that Bill never claimed that fiscal policy alone can control bank lending.

141. Ramanan,

     If banks aren’t capital constrained, how would you explain the FDIC shutting down a half dozen banks every Friday?

142. hbl,

     My general point is that there is always a difference between the stock market value of an equity claim, and the value of the corresponding balance sheet equity as capital on the books of the issuer. But I probably jumped the gun on anything more specific than that, because I haven’t spent time on your model yet. Sorry.

143. ramanan, using legislative procedures to manage aggregate demand is completely beyond the pale.

     It is a big brother, socialist tyranny of the first order. Why should I be made bankrupt because the government suddenly decided to raise reserve or capital requirements with no notice and thereby induce an asset price deflation? If I am to venture out and invest in the economy I need to know I can judge for myself the price signals as best I can and make my own decisions in a free market which is regulated for the sake of participants.

     I don’t want to live in a chinese style economy managed with such very blunt tools as they do. Do you?

     Legislation should be a tool to set a foundation for fair markets with the very occasional and well debated and telegraphed change, not something that is constantly being tweaked by government wonks to manage demand. It seems that under a chartalist administration, the CB wonks get turned into lawyers and bank regulators.

     If this is to be part of bills toolset he should be more explicit about how it shall be wielded, and how often. Is a legislative process even a suitable tool in a democracy for managing demand – it’s not like such tools can be instantly deployed … unless … its not a democracy.

     Bill? Care to comment on this?

144. JKH, the current circumstances are that of deflationary depression in all but name.

     I and ramanan are talking about the case where we have an excess of demand, not a deficiency. Note that I said that banks may or may not be capital constrained and that fiscal policy has no control over that.

     Please address the question. If loans create deposits what is the detailed reasoned argument why loans can’t create capital?

145. Scepticus,

     However I think this only holds if we assume that demand for reserves is always satisfied by the CB?

     Glad we agree on various things. Yes, but the central bank always has to satisfy the demand for reserves, else it won’t be able to achieve its target. There are a few confusing things here. This may sound contrary to whatever we have been talking with each other. It is important to remember in such analysis that the demand for reserves which arose because of demand for loans by banks’ customers is not very interest sensitive. Somehow “horizontalism” is closely tied to central bank operations.

146. Scepticus,

     Where did I say loans can’t create capital?

     I said banks aren’t reserve constrained because the central bank provides adequate system reserves in order to administer the policy interest rate at target.

     Banks are capital constrained because the central bank provides no such comparable function as a matter of normal monetary architecture.

     What’s that got to do with whether or not loans can create capital?

147. JKH @ 4.23,

     The recent set of events are an exception to the rule, as I had mentioned. Of course, I understand that even big banks had a lot of issues. I would just see it as a financial famine. It is analogous to the production side … Bill says there is always a problem with demand – of course he knows that there can be severe shortage of food sometimes, but that doesn’t disprove his point right ?

148. Tom said “Deposits are NOT the government’s liabilities. Deposits are bank liabilities. The combined government/CB liabilties are currency notes, bank reserves and government securities.”

     If you view the operation of the government like a bank, then it is reasonable to view government debt of various forms as a depositing of the assets created via government lending to taxpayers. Its just a terminology thing so lets not split hairs.

     But the government is not like a commercial bank. Bank loans create deposits (bank or credit money) that nets to zero . Government deficit “spending” creates non-government NFA since there is no lending involved. Government “borrowing” (security issuance) just transfers that NFA from one form to another.

     This is a key fundamental of MMT. There is no way to interpret it differently.

     There is no lending or credit involved in currency issuance, other than the liabilities of the government being backed by “the full faith and credit” of the government, which basically means that you can exchange one government liability for another of equal worth. If you cash in a Tsy at maturity, then you get a credit to you deposit account in that amount. The government doesn’t create these funds anew or fund them with taxation, since this is just the transfer of one form of government liability to another, like making change.

     It is currency issuance that creates non-government NFA, not debt issuance. Reserves simply exist at the level of the CB for settlement purposes. Reserves are irrelevant to currency issuance and creation of NFA other than for settlement purposes. Settlement is operationally necessary for currency flow, but plays no role in currency creation.

     Now if you want to say that bank money and government issuance of currency and debt are similar in that all are liabilities of their respective issuers, then that is true. That just means that bank money as a liability of the bank can be used as an asset to satisfy liabilities to the bank. Similarly, government liabilities are used as an asset to satisfy tax liabilities to government.

149. “I said banks aren’t reserve constrained because the central bank provides adequate system reserves in order to administer the policy interest rate at target.”

     According to bill there is no target except zero, and there will never be an explicitly managed rate target since bill will have made all the monetary policy wonks redundant.

     I guess perhaps you take your own line here? If you agree with bills line then there must be another reason for providing reserves.

     If the target is > 0 then it will be required either to remove excess reserves or pay interest on yet this invalidates the idea that the natural rate is zero.

     It is important to clarify where if anywhere you depart from bills line of thinking both in terms of current best policy and ideal future policy. Do you believe that the natural rate is truly zero?

     “Banks are capital constrained because the central bank provides no such comparable function as a matter of normal monetary architecture.”

     What’s that got to do with whether or not loans can create capital?”

     It has everything to do with it if the automatic provision of reserves enables banks to raise capital as they require when this would not be possible if banks were reserve constrained. Indeed, investors in bank equity will be much more forthcoming with investment once they understand that no bank will ever suffer form liquidity issues.

     Of course they are connected. To suggest they are not seems to me a triumph of academic thinking over common sense. Your response above has simply defined capital constraints in your own terms so as to avoid the common sense conclusion that a bank that is never liquidity constrained will find it a lot easier to raise capital than one which is, especially if that banking system can use the liquidity so provided to effectively capitalise itself.

150. Tom, all the above in your post only applies as long as:

     1. all currency (which includes rbs) are set to zero interest in perpetuity.
     2. the stock of currency is left to circulate and is never destroyed or removed from circulation. The US government didn’t burn their greenbacks after the US civil war did they?

     its like giving a gift – no strings attached. You can’t give a gift and at the same time threaten to take it back.

151. Scepticus, I look at it this way. According to MMT, there are two types of money, government currency issuance (exogenous, and vertical) and bank credit (endogenous, horizontal). Government finance is for advancing public purpose, and private finance is for advancing private purpose.
     In an ideal system, government would not influence the creation and flow of the horizontal system (bank money) other than to enforce fiduciary responsibility and prevent cheating, i.e. protect the public, as is government’s responsibility. However, we don’t have an ideal system and irresponsible handling of bank money can threaten the entire economy and social fabric, so the government influences the private system through such measures as regulations and guarantees (FDIC). But government tries to keep this to a minimum other than in extremis, when it needs to act to address economic disequilibrium and social disorder.

     The reason that banks are capital constrained is because this is want risk as the foundation of capitalism is all about. When banks accept a guarantee, they are implicitly accepting that they are a public/private partnership with the government assuming some of the risk in the interest of social stability. But the general rule remains is that lending and leverage put capital at risk. This risk is borne first by owners, then creditors, and then government as the backstop, if the rules are followed. Recently, however, the government stepped in to prevent the destruction of capital by taking on more risk, since the political leaders believed that this was necessary to advance public purpose, or so they said.

     Government uses government finance to advance public purpose by altering the composition of public and private space, depending on political factors and current conditions. It is a political decision as to what this distribution should be.

     Both government finance and commercial finance affect nominal aggregate demand through money creation and withdrawal. In a capitalistic society, the government attempts to make these adjustment with monetary policy through interest rates and through adjusting fiscal policy so that it cooperates with and complements the commercial system instead of competing with it.

     There is no inherent antagonism between the two systems if they work together properly. However, this objective is often vitiated through operational ignorance, ideological bias and powerful interests.

     Some proponents of MMT would like to keep the CB out of the business of targeting interest rates, because they see it as really targeting inflation and using employment as a tool instead of a target, which violates the CB’s congressional mandate to target both. Moreover, MMT holds that it is simpler and more direct to use functional finance instead of a monetarism that has shown itself to be both ineffective and based on an erroneous understanding of how the modern monetary system actually works.

     I agree, Scepticus, that a lot remains to be specified regarding the operational details. A major objection to MMT is that monetary policy is pursued by an independent CB, whereas fiscal policy requires specific legislation, which is always political, therefore lengthy and messy – unable to respond quickly and decisively (as we now see with our dysfunctional government in the US). The MMT answer, as I understand it anyway, is that fiscal policy should be administered as much as possible through automatic stabilizers, thereby reducing ad hoc political policy intervention other than in emergencies or changed conditions.

152. Ramanan, Scepticus,

     I’m sorry. I shouldn’t have interrupted your discussion, because I haven’t followed it all. Feel free to reject my input here because of that. But I saw a couple of interesting points being raised.

     Let me go back to the beginning.

     The idea behind banks not being “reserve constrained” has to do with the erroneous textbook multiplier causality. That rendition opines that banks lend on the basis of a warehouse stock of reserves. That is plainly false as explained by MMT.

     Some time ago, I invoked the language of banks being “capital constrained”, not because it was the best language, but because I thought it was a useful parallel in the comparison between capital and reserves.

     The fact is that banks do lend on the basis of a warehouse stock of capital. The technical description that banks use for that warehouse is “excess capital”. Excess capital is capital that has not yet been allocated to risk. Banks need that excess capital in place before they can add new risk. If they don’t have it, they’re in contravention of regulatory requirements. Moreover, there is no comparable monetary architecture in place whereby the central bank or the government automatically provides such additional capital that may be required for the system to add to its risk. If you want to consider the intervention of a TARP mechanism every 80 years or so as covering such a contingency, feel free to do so. But that’s sort of like saying that the earth is not constrained by an event of the sun blowing up, because we know that Bruce Willis will save us. Fine.

     There is a question of degree in comparison of reserve constraint versus capital constraint. But what do I mean by capital constraint? I do NOT mean that banks can never raise capital when they need it, either internally or externally. That would amount to an argument in the limit that banks don’t exist, which is not quite my position. And I do NOT mean that an investor can’t take out a loan on the day of a new equity issue and buy stock.

     In the meaning of “constraint” there is the subset notion of a constraint that is “binding” versus one that is “not binding”. The binding characteristic describes the operative condition of a constraint that is strategic in its longer term influence.

     E.g. a bank that has excess capital in place has a capital constraint that at that point is not binding. It can go ahead and add risk. A bank that is exactly at its required capital level, with no excess capital, has a capital constraint that is binding at that point. Any further risk taking without capital infusion or accretion would tip it into regulatory non-compliance.

     Further, in terms of the degree issue, when the FDIC shuts down a bank on Friday, that bank is typically in reserve compliance at 3 p.m., even if that means having borrowed from the Fed. But it means that the bank is formally in capital non-compliance at 6 p.m., and it is wound down as a result. The bank’s ability to function from a liquidity perspective up until 3 p.m. is very much a function of the MMT proposition that banks are not reserve constrained. Its inability to function from a capital perspective 3 hours later is very much a function of my proposition that banks are capital constrained.

     Again I’m sorry that I haven’t picked up on all of your discussion, but that’s how I see the comparison of the two coming late out of the box.

     P.S.

     Scepticus, I’m not sure where you’re referencing a comment from Bill. But I’d bet thousand dollar bills to donuts that Bill has never said that the central bank doesn’t typically target a non-zero rate under the current monetary architecture and policy.

     The logic behind the zero natural rate is perfectly fine in my view. Whether or not the natural rate should be implemented is a policy question. Policy debates are quite separate from the prerequisite of understanding the logic, accounting, and operations delineated in MMT.

153. its like giving a gift – no strings attached. You can’t give a gift and at the same time threaten to take it back.

     The government can. :), or 🙁 as the case may be, form one’s point of view.

     Functional finance is based on the principles that 1) currency issuance is a fiscal operation that adds to non-government NFA, thereby increasing NAD, while taxation subtracts from NFA, thereby decreasing NAD, and 2) debt issuance is a monetary operation that drains the reserves engendered by currency issuance by storing them as savings of NFA in Tsy’s.

     This addition (“spending”) and withdrawal (taxation) is going on all the time, as it “borrowing,” which in reality stores non-government NFA as non-government savings at interest for subsequent consumption or investment.

     It may look like money in being redistributed by taking from those that have by taxing them and giving to those that don’t by transfer payments, for example, when what is actually happening is that government adjusting income distribution to balance NAD with real output capacity to maintain full capacity with price stability, which benefits everyone, when viewed in the big picture, by maximizing the potential of the economy.

     As many people point out, like Joe Stiglitz and Jeffery Sachs, not to mention Bill, operating at under-capacity is hugely costly in foregone opportunity. See also James Kwak, The Next Problem Hint: it’s structural unemployment.

154. Dear scepticus

     therefore I repeat my assertion that banks unconstrained by reserves cannot reliably be controlled by fiscal policy

     The government can always influence the opportunity set of the banks’ customers via fiscal policy which is more important and effective. Banks respond to the opportunities that the customers have.

     best wishes
     bill

155. Scepticus, interesting post from Warren Mosler today. Should give you something to chew regarding one person’s ideas on how to implement MMT policy-wise.

     Warren Mosler’s Proposals for the Treasury, the Federal Reserve, the FDIC, and the Banking System

156. Hi bill, you suggested above that:

     “The government can always influence the opportunity set of the banks’ customers via fiscal policy which is more important and effective. Banks respond to the opportunities that the customers have.”

     How, when there is an excess of reserves such that the short rate of interest is zero, a sufficient amount of bank capital can the government remove opportunities form the private sector if the private banking sector will immediately replace those opportunities? In this case there would be no reduction of aggregate demand.

     Can you elaborate a little on the details of this bank customer opportunity management policy? How does it work?

157. “Functional finance is based on ……………………”

     yes tom, I know all that. I don’t care what you call it or the terminology you use.

     I call something that is gifted and later retracted a loan. If I give you my car to you and decalre that I give it to you in full faith and credit and then demand it back again leaving you stranded you might say that I had lent you my car, not given it. Had you known this up front, you would have acted in this knowledge to avoid being stranded – for example by not relying on having my car at your disposal.

     Now I can call this process of my giving you my car and then taking it back again, something like ‘functional favour disbursement’, but that doesn’t alter the fact that it is still a loan. Oh, and neither does the fact that I didn’t charge you anything for the use of my car besides normal wear and tear.

     If it walks like a loan and talks like a loan, then it is a loan.

158. Tom, just to be clear, I agree that operating under capacity is idiotic. I also agree that it is exactly the sectors which caused the problems which are now hurting least.

     What we are arguing about is whether MMT and the prescriptions therein are likely to result in a safe return to full capacity, and more particularly, whether MMT would work for ongoing economic stability after that point. I remain unconvinced by a number of details as you can tell, however in the main you can generally consider me as being aligned with yourself, against the deficit terrorists.

     The differences are in the plan of attack and the nature of the weaponry involved.

159. Dear scepticus

     You seem to think that commercial banks can set an agenda and follow it without recourse to market reality. Ramanan, Tom and JKH have all indicated in this debate that they cannot.

     If the government stifles the desire for credit (say by a tax hike) within the private sector then the banks can have as many reserves as you can count but they will not lend. Fiscal policy is a reliable means of adding and subtracting demand. Monetary policy is not.

     best wishes
     bill

160. Hello bill,

     I think implicit in your statement above is that the economy will always be demand constrained. I think in a supply constrained economy (suffering from inflation as a result) banks holding 0% paying assets will indeed lend.

     “If the government stifles the desire for credit (say by a tax hike) within the private sector then the banks can have as many reserves as you can count but they will not lend. F”

     My whole point has been that in the cae of excess reserves, private sector demand and only fiscal tools to manage demand, the attempt to stifle credit demand will not succeed. Can you elaborate exactly how this net stifling will be accomplished under a cost push inflation scenario while at all times meeting liquidity needs of banks?

161. Dear scepticus

     Banks do not lend reserves. But they do lend to credit-worthy customers who seek investment opportunities and/or want to buy consumer durables. Increased taxes and government spending cutbacks in an inflating economy will surely stifle the demand for credit. It then doesn’t matter what the supply side (that is, the banks) is like.

     best wishes
     bill

162. I call something that is gifted and later retracted a loan…. If it walks like a loan and talks like a loan, then it is a loan.

     scepticus, you can’t just make up your own definitions and expect anyone to take that seriously. At the most, you might claim that it is similar to a loan, but even that I find far-fetched. I don’t see it as “walking and taking like a loan” at all. I don’t see that holding up in court.

163. JKH,

     Of course, I do not support any Paulson put around. The reason I mentioned that is that I think it is the recent credit crisis is the only time credit worthy borrowers were turned down till banks got capitalized. Of course, once they were in a position to lend again, they continued their lending operations but it slowed a bit because of reduction of demand from credit worthy borrowers. The crash was going to happen – the domestic private sector in the US had been in deficit for a long time. A nicely regulated banking system not run by Neoclassicals is less likely to have failures.

     The other thing is that the view of looking at banks as allocators of wealth is more like saying that banks bid for IOUs from households and the production sector and that there is a demand-supply game in the “free market”. However, the better view is that banks are price setters and quantity takers. The only reason a bank will turn down a customer is if there are doubts about creditworthiness. The interest rate set by the bank of course depends on cost of capital. The banking system as a whole has a supply function which is best described as horizontal, with the level determined by the cost of capital and other markups.

164. Scepticus my friend – you are confusing everyone here. 🙂 Sometimes you say things which contradict your earlier posts! I do not know why you think that banks will lend the whole world. Plus I couldn’t follow your analogy with gifts. If the government employs a contractor to build a highway, the compensation is not a loan right ? The role of the government makes everything a non-zero sum game.

165. Ramanan,

     Banks are not quantity takers.

     Banks have risk limits, including credit limits for all individual names.

166. Ramanan,

     The purpose of capital is to insure against unexpected losses.

     Risk is the origin of loss.

     Risk management and capital management therefore are joined at the hip.

     Risk management includes the portfolio management of risk diversification. Risk diversification is the ultimate rationale for risk limits (risk quantity restrictions) and specifically limits on individual credits.

     I could add some new terminology here and say that banks are capital constrained and risk constrained. But the capital constraint necessitates and drives the risk constraint in order to be effective and compliant. So the capital constraint is binding on risk limits collectively.

     As banks grow, and take on more capital, they can grow their risk limits in specifically targeted areas.

167. JKH,

     I understand your point. I am talking about direct lending by banks to households and the production sector. Banks are in a position to lend to direct creditworthy customers in whatever volumes they demand. The “constraint” is always on the demand side. They set their interest rates on these loans on expectations of various numbers such as target capital adequacy ratio, target profits – both dividends and retained, interest paid on deposits etc.

     The “risk limit” is in a sense, bad creditworthiness. I am not saying that banks will lend to anyone who walks in. But, at present there is no supply constraint on the amount of lending by the banking system – the upper limit is theoretical. A credit worthy “agent” will rarely have a problem getting a loan and will never have to wait for an “excess of money”. (Of course – Wall Street crisis: exception for a few months(?) )

168. JKH : “Risk is the origin of loss. Risk management and capital management therefore are joined at the hip.”

     Hang on, loss can come through borrower default or liquidity risk. The latter is part and parcel of the process of maturity transformation so banks engaging in maturity matching should have some of their capital at risk against this liquidity risk that arises from this aspect of their business.

     By saying that reserves can never be in short supply and will always pay 0, there is never any liquidity risk. So, where has this risk gone? Has it been eliminated or moved elsewhere.

169. Ramanan,

     Banks set risk limits for all borrowers (i.e. credit limits) – households and others.

     They certainly don’t lend in whatever volumes are demanded.

     The upper limit is not theoretical. It is a function of risk limits and capital allocation.

170. Scepticus,

     Good point.

     Commercial banks have risk limits and allocate capital to the interest rate risk associated with maturity mismatching.

     They also have risk limits on the pure liquidity or cash flow risk associated with maturity mismatching. But they don’t allocate capital to liquidity risk directly. They allocate it where liquidity risk has a potential knock on effect on market risk (price risk due to interest rate risk, equity risk, foreign exchange risk, etc.) This happens mostly in the trading books of universal banks. E.g. a bank will assess the liquidity risk associated with a particular trading portfolio of debt, and assign capital based on the market risk (i.e. price risk) that might be associated with slow liquidation.

171. JKH,

     Yes, of course. There are credit limits. A lot of this is micro vs. macro . . . one risky bank vs. the banking system . . . what I am saying is that supply side talks are about a “finite volume of money” competing for an allocation. Higher limits for one single customer decreases the credit worthiness, of course, but at the macro – they all do not simulataneously cross their limits.

     The changes in the stock of loans – the flow – are decided by the demand of those who want to get into higher debt, screened by banks’ creditworthiness checks, and not by anything else. The interest-rate sensitivity of those willing to go into debt is weak. The interest rate set is decided by the banks, based on their own algorithms. Banks face no constraints in accommodating this flow.

172. Ramanan,

     There is no difference between micro and macro on the logic of risk limits and capital allocation.

     What you may be saying is that if there were no risk limits and no capital constraints, there would be no limit on the ability of the banking system to satisfy credit demand.

     And in that fantastic sense, banks are also not reserve constrained, obviously.

     It is also the case that banks are not reserve constrained in the real world.

     But they are constrained – just not by reserves. They are constrained by risk limits and capital, micro and macro.

173. Ramanan,

     I would compare this discussion a bit with the question of whether or not governments are constrained in deficit spending. I would say they are not constrained financially or operationally. But they are policy constrained in the sense that MMT acknowledges “real economy constraints”, at least as a contingency. That’s the point at which deficit spending runs up against the capacity constraints of the real economy to absorb such spending without undue inflationary pressures.

     Those “real economy constraints” are the logical government analogy to the risk limits and capital constraints that impinge on non government credit and monetary activity.

     I wonder if Bill agrees or disagrees.

174. JKH: “Commercial banks have risk limits and allocate capital to the interest rate risk associated with maturity mismatching. They also have risk limits on the pure liquidity or cash flow risk associated with maturity mismatching. ”

     With no possibility of reserve shortages afflicting a given bank, all liquidity risk due to maturity mismatching is automatically translated into an interest rate risk (at the discount window) is it not? Of course this is also a reputational risk, which is arguably more important.

     If they get bitten by interest rates as a result of poor liquidity provisions this can presumably end up eating into capital however – because bank capital can be eaten up by simply making a loss at the end of the year even if no borrowers defaulted.

175. Scepticus,

     “With no possibility of reserve shortages afflicting a given bank, all liquidity risk due to maturity mismatching is automatically translated into an interest rate risk (at the discount window) is it not? Of course this is also a reputational risk, which is arguably more important.”

     That’s certainly the operational front end effect.

     “If they get bitten by interest rates as a result of poor liquidity provisions this can presumably end up eating into capital however”

     Yes. And that’s why banks allocate capital to interest rate risk in a more general sense.

176. JKH 0:09 – exactly.

     My point belaboured throughout is the degree of manoeuvre in terms of real economy constraints afforded to a government having already a large deficit in the form of significantly excess rbs and little private appetite to buy bonds is determined by the level of excess liquidity.

     The room for quick action to accommodate changes in aggregate demand will likely be constrained by the level of excess liquidity wrt the level of excess capacity. This is analogous to an over-leveraged commercial bank having less scope to react to market interest rate and default risk changes.

     For example, one can go on adding liquidity ad infinitum in a demand constrained/liquidity trap scenario, and it have little or no effect on excess capacity (cf japan). However this makes you much more vulnerable visavis inflation pressure to small increases in capacity utilisation.

     Capacity utilisation can increase for example simply because demographic age-ing is reducing real output. On this matter, it is interesting to introduce the concept of a labour constrained economy. In the latter increasing dependency ratios bid up worker wages and depress the return on capital. This could initiate an inflationary spiral if producers put up prices to maintain profits. This would be an example of inflationary pressure in a contracting economy, and is I feel the largest risk to MMT inspired policy over the next 20 or 30 years. Historically with normal shaped population pyramids economies would never be labour constrained, therefore it is a potentially new economic variable which is unwise to ignore.

177. Ramanan,

     BTW, you should read Nick Rowe’s comment at the Beckworth post.

     I’m not sure what the word for it is. You can probably come up with something appropriate.

     🙂

178. Scepticus,

     Good fundamental point.

     MMT assumes a judgement call on when those “real economy constraints” kick in, and what sort of fiscal trajectory adjustment would be required as a result.

     Two points:

     a) The priority I think is to acknowledge the difference between the truth of real economy constraints as a contingency, and the false arguments and ideology around the false story that the government is financially constrained right now at an operational level.

     b) A second point that I like to emphasize in terms of the liquidity issue is that it is not an issue at the level of excess reserves. At least it is not an issue if the banking system is acting rationally with respect to risk taking and capital allocation, because that process is entirely independent of the excess reserve issue, as per my comments at the Beckworth blog. Where it arguably might become an issue is the domain on the other side of commercial banking balance sheets, which is the M1 or broad M offset to excess reserves. Ironically, this is the side of the equation to which most monetarist economists seem oblivious. I guess it’s because they’re not particularly good at reading balance sheets. I also don’t think it’s a particularly alarming aspect, given that the gross M creation there largely offsets private sector deleveraging, and the Fed can phase out that part of its balance sheet intermediation over time. Anyway, that’s all a monetarist type concern which argues for additional diminished importance.

179. JKH,

     a) agreed. However MMT needs to specify more clearly the linkage between the size of the deficit and the ability to act effectively and quickly via fiscal channel. IMO most MMT writings fail completely to do this.

     b) JKH, if rbs are paying 0, and cost push inflation is at say 3% pa, what is the rational risk taking and capital allocation for a bank in this situation? I would say that in this case the only way the risk can be managed is to offload much of it onto their deposit customers and bondholders.

180. Scepticus,

     I suspect what you’re looking for in a) may be included in some of their deeper background papers. But I’d be interested to see more on this as well.

     It looks like you may be assuming the “future architecture” of a zero natural rate in your b). That’s an environment in which fiscal policy is supposed to start tightening against such conditions. Importantly, interest rate risk in terms of the risk free rate is essentially taken mostly out of the equation, since the zero rate structure is viewed as permanent policy. So the issue of risk becomes one of credit spreads and the pricing of the credit spread relative to the view of risk. That future architecture is a specific MMT proposal that I haven’t spent much time thinking through, though.

     Otherwise, in the current framework, I’d expect Fed funds and reserve interest closer to 5 or 6 per cent (assuming they keep reserve interest in place after “the exit”). In any event, banks tend to hedge as much interest rate risk out of their loan portfolios as possible – i.e. match fixed rate loans with fixed rate funding. In addition, credit risk premiums should incorporate the expected effect of future rate increases on credit risk per se. – i.e. the compensation for risk taken should be higher in an environment that is generally riskier from a macroeconomic perspective, which is sort of what you’re describing. Similarly, banks would be careful about risk limits and capital allocation in an environment that seemed to be unsustainable in terms of policy rates.

181. “It looks like you may be assuming the “future architecture” of a zero natural rate in your b). ”

     At some point the rb excess (and the wider debt structure ) becomes sufficiently large that anything much more than zero is impossible.

     You can’t ‘tighten policy’ in a labour constrained economy except by reducing the dependency ratio.Normally tightening rates or liquidity results in unemployment which reduces wage demands and costs. I don’t think in a labour constrained economy (i.e. one in which labour availability is scarce but financial capital and capital goods are not) that controlling employment to control inflation is going to work.

     I am sticking for this discussion, with bill and other MMT-ers prescription that rbs are just currency in full faith and credit and therefore don’t pay interest. The whole point of MMT is that they tighten by fiscal control not by paying interest on reserves or issuing more bonds.

     This is the current architecture of MMT, not the future one. If they propose to tighten by using interest paying reserves what is the difference between MMT and neo-classical? because as soon as paying interest on reserves is official MMT blessed policy then rbs are CREDIT, and as such their issuance is not ‘free’, they have costs when it comes time to tighten.

     And I am asserting that tightening with fiscal only when holding open the discount window and paying 0 on reserves under all circumstances is not going to tighten anything very much.

182. JKH,

     Nick Rowe should take a Keen walk

     Will come back in a while on the supply of credit.

183. scepticus, you are assuming labor shortage developing in the future driving up the cost of labor and creating in inflationary labor environment. This is undoubtedly true in the developed world and even emerging countries like China, given the intergenerational demographics. The commentators I have been reading on this agree that the US is a better position then the rest to begin with, and it is a country that is built on immigration, unlike most others, which are still rather xenophobic. They expect that the US will fare OK in this, since they expect the shortfall to be met with increased immigration.

     There generally aren’t many variables that can’t adjust or be adjusted with changing circumstances. And there is a huge labor oversupply in the world. So this doesn’t seem to be an insurmountable difficulty, even though it is a political hot potato now.

     Of course, the future is uncertain, so your question about what MMT would do is still relevant.

184. Tom,I’m not american so the US demographic situation doesn’t comfort me. The US is in any case not sufficiently well off demographically to be able to avoid confronting profound labour shortages in the next 20 years.

     “They expect that the US will fare OK in this, since they expect the shortfall to be met with increased immigration. ”

     A dangerous assumption and one almost certainly to be proved wrong.If europe and asia are having labour shortages you won’t be able to import labour from them since to do so the US would have to compete on wages. Hence the most age-ing nations will export wage bargaining inflation to the US to some extent.

185. General price increase can happen for different reasons, including excess nominal demand (demand-pull), and exogenous shock (cost-push). A contributing condition of demand-pull inflation is often leverage. Most demand pull-inflationary periods are not correlated with excessive government activity but with excessive leverage in private finance.

     The way to address leverage is at the cause, which is too excessive risk-taking. A fundamental means for addressing this is through regulation, specifically capital ratios. Just as an over-heating equity market is cooled by increasing the margin requirement, an over-heating finance can be cooled by increasing capital requirements.

     In addition to cutting spending and raising taxes to cool NAD, some have suggested that the Treasury can also issue debt in excess of the deficit to increase saving. This is a kind of sterilization operation. This type of debt issuance could also serve to crowd out some private borrowing, since no new NFA would be created through currency issuance to offset the debt issuance. It could be counterproductive, however, if it crowds out investment that would be used to increase productive capacity that would offset the growing NAD. Moreover, the interest paid on the debt would eventually add to NAD.

     The larger problem that needs to be addressed, as is clear from the present crisis, is that depressions are the result of debt-deflation (Fisher) consequent upon Ponzi finance (Minsky). There are a number of factors that need to be fixed, including the shadow banking system. Warren Mosler offers some proposals for accomplishing this here.

186. A dangerous assumption and one almost certainly to be proved wrong.If europe and asia are having labour shortages you won’t be able to import labour from them since to do so the US would have to compete on wages. Hence the most age-ing nations will export wage bargaining inflation to the US to some extent.

     scepticus, I would actually welcome an increase in the bargaining power of labor, which has been savaged politically by neoliberal policy. There are two possible results. The first is that productivity gains are more equitably shared, which they have not been for the pasts several decades. The other is, of course, inflation, which would likely have to met by progressive taxation, to which the US is no stranger, or draconian non-discretionary spending cuts. The top bracket here has been 90%, so there’s a lot of room for motion on the taxation side. Military spending is also bloated. I don’t see too much cutting in social programs coming, with memories of this still evolving debacle still fresh. But these are political decisions to be taken depending on conditions.

     However, I do think that there will be a lot immigration too. The demographics pretty clearly indicate this coming to the developed world. There’s going to have to be a lot of investment in training. The market has already been picking up on this dynamic.

187. MMT’er Marshall Auerback talks about inflation growth in China (and impending collapse?) here.

     Here’s an inflationary test case in an otherwise seemingly deflationary world. What would MMT do?

188. Steve Randy Waldman’s post, Can we handle the truth? brings up distribution/equity issues that must dealt with also. The idea that MMT is the “solution to all problems” is just not the case, in that it presumes, for example, a level playing field. That is just not the case now, and this needs to be fixed before an economic solution is possible.

     MMT is one of the tools that can contribute to a redesign of the system along line that advance but public and private purpose, which must be integrated in a money system that uses a single unit of account for government money and bank money, and the banking system is a public/private partnership. While the balance of public and private is a political decision, the design of a system that will work operationally is an economic one. The issues are pretty clear, but as SRW observes, they are not being addressed for a number of reasons, social, political, and “economic” (aka ideological).

     What MMT contributes is a reality-based view, correcting one based on ideology.

189. Dear JKH and Ramanan

     I agree with this. Currency-issuing governments are never financially constrained (hence the title of this blog – Who is in charge? the government is always in charge). But they are always constrained by the available real resources. Unlike you and I, a currency-issuing government can purchase whatever is available (that is, real stuff) for sale which doesn’t mean it always should do that. The nuance in the discussion here is that sometimes it is even unwise to buy goods or services that are available in the market place if the purchase is at market prices. So the principle of running employment buffers, for example, is based on the idea that they can always buy the unwanted labour (which in that sense has a “zero” bid price – there is no demand for it) without adding price pressures because they are not competing with other buyers.

     In the case of the banks, I think to some extent you are talking past each other. JKH is correct in detail but I had thought Ramanan’s point was something like the “short-side” of the market rules. So even though the banks face the risk and capital constraints on their lending, when there is a dearth of borrowers coming to their doors these constraints are less the issue in explaining the lack of credit creation. But clearly if there is only one borrower approaching a bank for a loan (so some demand) yet the bank judges them to be an excessively-risky borrower then no credit will be given.

     As a real world experience, I have had discussions with one of the major 4 banks here last year who wanted to use our research on regional employment vulnerability (at a suburb by suburb level across the nation) – see some discussion of this work HERE – to improve their risk profiling. They actually have points systems in place (a penalty system) for suburbs where a person from that suburb immediately inherits the risk penalty irrespective of their personal circumstances. This is called statistical discrimination in social analysis. I declined to licence the work to them and make money at the someone else’s expense because it would have increased the penalties that the most disadvantaged workers faced accessing credit. I didn’t want to be part of that inequality-augmenting system.

     best wishes
     bill

190. Bill,

     Your point (and if that is Ramanan’s point) on the banks makes sense, thanks.

191. Tom

     I really like the Interfluidity blog. He was really my first connection to MMT because Winterspeak comments there sometimes and he linked to a post by Winterspeak a while ago called “Why Tax” which really tweaked my brain. I find him VERY thoughtful and sensible. I think he would make a great MMT advocate. I dont visit him as often any more since I’ve found Bill , Warren and the UMKC site but he is great.

     You are right. His latest post brings up many “elephant in the room” issues we have tried to paper over for years (like since we became upright and sentient).

192. You are right. His latest post brings up many “elephant in the room” issues we have tried to paper over for years (like since we became upright and sentient).

     The challenge begins with the production of surplus by a theretofore subsistence society. Economics as such really begins at this point. The fantasy of economics growing out of a Robinson Crusoe or island tribe “barter economy” found in most texts is just that. Didn’t those economists read history?

     The production of surplus goods and services enabled the rise of specialists, whose technological contributions brought innovation and growth, and a military/governing class that imposed and maintained the political order necessary for stability. A money economy could arise in that environment to facilitate distribution. Since then, societies have been arguing about distribution effects, the workers claiming rightly that they provide the wherewithal for the specialists to subsist, and the specialists arguing that organization and order, and innovation and growth entitle them to a lion’s share of production.

     Economic history can be viewed from this perspective, with different societies and civilizations having produced quite different solutions, some more equitable than other, and some more successful than others.

193. Maybe somebody else would like to tackle this one; I’m done:

     http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/02/fallacies-of-composition-and-decomposition-the-supply-of-money-and-reserves.html

194. I’m done, too. No hope at all for him. No point trying, really.

195. “The power of a made-up mind.” Unfortunately going in the wrong direction. 🙁

     I held out hope for him, too. Anyway, he hosted a couple of great debates, from which I learned a lot.

196. Agree, Tom.

     BTW, JKH . . . marvelous job at Beckworth’s site. Hopefully some will read it and learn from it, even if the neoclassical “experts” didn’t. I may have to copy that off and require my students to read it as it’s probably a better discussion of how banks manage bank capital than can be found in any bank mgmt text. (Also BTW, LOVE the “so many smart people disagree with you that you must be wrong” comment–twice!–essentially an admission that he had no clue what you were talking about since he’d probably never actually seen an actual bank balance sheet throughout his entire graduate studies studying “monetary economics.”)

197. Scott, I don’t know whether you saw it, it may have been on another thread, but someone asked Nick how mainstream economists got it so wrong. He said in effect, “We didn’t study finance.”

198. Here are the links to Rowe (2), Waldman, Summer, and Beckworth

     http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/11/a-monetarist-theory-of-neochartalism.html

     http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/11/money-banks-loans-reserves-capital-and-loan-officers.html

     http://www.interfluidity.com/v2/213.html

     http://s84684.gridserver.com/?p=1032

     http://macromarketmusings.blogspot.com/2010/02/feds-exit-strategy.html

199. While it is true that all of those bloggers save Waldman don’t understand reserve accounting, cb operations, and bank reserve operations, JKH and I were both misinterpreting the desired operations (by the designers of the proposal) of the “excess reserve tax” proposal for a bit. The basic proposal was to get banks to convert their ER into RR, not by lending (which would have been misapplication of the money multiplier model, which these bloggers do, but not necessarily in this proposal) but rather by buying assets over and over again at the micro level to create deposits and thus create additional reserve requirement, which from the macro level they recognized didn’t change total reserves, but rather the relative sizes of RR and ER).

     In the end of my post here (http://neweconomicperspectives.blogspot.com/2009/07/why-negative-nominal-interest-rates_14.html) I got as close as I have seen anyone regarding what would happen if the proposal was actually in place. This quote assumes a policy is in place in which there is an economically significant difference between a return to a bank set by the CB for holding ER (negative, or essentially a “tax”) vs. holding RR (perhaps positive):

     “Banks could in fact avoid the excess reserve tax and receive the interest payment on required reserves by making NO loans at all if they instead found ways to incentivize, entice, or even force customers currently holding non-reserveable liabilities (savings, CDs, money market accounts) to shift these to reserveable liabilities (deposits). In fact, rather than lending, this sort of reclassification of existing balances is probably the outcome of the excess reserve tax plus payment for required reserves.”

     “For instance, banks would probably cease all operations related to moving customer deposits into retail sweep accounts previously intended to avoid reserve requirements. This alone would reclassify about $600 billion or so in money market accounts as deposits and create somewhere around $50 billion in reserve requirements. As banks continued to “encourage” deposit accounts over non-reserveable accounts to reflect their own incentive to convert excess balances to required balances, still more balances could be reclassified.”

     “So again, like the currency tax, we just get a reclassification of existing balances . . . this time toward deposits rather than away from them as the currency tax would do [assuming the currency tax is applied to deposits, as Mankiw had proposed]. Also like the currency tax, then, we don’t get any more spending and we therefore don’t get more aggregate demand. In other words, just as my spending plans didn’t change as I moved away from deposits to avoid Buiter’s proposed tax on transaction balances in the previous post, my spending plans also don’t change as I move toward transaction balances to avoid banks’ newly imposed disincentives for holding savings-type of accounts resulting from the mix of excess reserve tax/reserve requirement incentive they are facing.”

200. That is a nice view from ECB of who is actually in charge of what

     http://www.ecb.int/press/key/date/2010/html/sp100513.en.html

     There should be more talks like this

201. “It raises the question who is in charge – the investors or the government? The answer is that the government is always in charge … So the UK government is just confirming they have no foresight. They are willing to sacrifice the chance to invest in future productivity growth because they are living in daily fear that the corrupt credit rating agencies will downgrade their sovereign debt standing and that the bond markets which ultimately call the shots will punish them.”

     If governments are always in charge, and the bond markets ultimately call the shots, then???

     Austerity is an economic means to a political end. Yes, it makes no sense not to invest in education, provided that one believes that future productivity is a goal. It is not. The goal is to reduce the standard of living across the board, except for the neo-feudal elite.

202. Seems like your last mile problem really is just that — getting the right people into the White House, Fed, and the Treasury (in the case of the US) that understand MMT and are willing to act on it. They’re probably just down the street right now 🙂

203. Ran across your writings and while some I can concur, I am not sure your points are relevant to all.

     With regards to your comment along the lines that there is no investment more valuable 50 years from now than education. Education today is a highly consumptive activity. Education for the masses used to be productive in that it was training on skills required, needed and/or wanted. Only the very wealthy could literally afford to spend years studying art history, interpretive dance, hand ball, logic and 16th century feline addictive behaviors (ok I made that one up). But, my point is that not only is much of education today completely useless and obsolete 50 years from now, it is completely useless today. Many graduates bartending and waiting tables can confirm this if you care to ask them.