Person the lifeboats!

Last week (February 10, 2010), the ever-louder irrational rantings of Niall Ferguson about debt got another airing in the Financial Times in his article – A Greek crisis is coming to America. My two word reaction – which might be better than writing a whole blog was – Oh really! But the article demonstrates how desperate conservative academic commentary is becoming. The inflated self-importance of these characters quite obviously craves for ever increasing attention. However, not only does Ferguson demonstrate a poor attention to detail; a confusion about which monetary system is which; and a denial of history – but he also discloses such a vivid imagination that he might productively turn his hand to writing children’s fairy tales. Except then he would have to lighten up a bit or the kid’s would be having nightmares. As for the rest of us, we should be getting the lifeboats out if he is right. For me, I am staying on dry land except in the mornings when I chase those waves!

At the outset I would ask Ferguson questions such as: So since when has the US government entered a monetary system which takes the power of its central bank to set interest rates and issue currency?

And: since when has the US government abandoned its capacity to make fiscal redistributions between the regions that lie within its borders?

And: since when has the US government imposed rigid fiscal and debt parameters upon itself which require harsh pro-cyclical austerity measures to be imposed on them by non-elected officials when they are breached?

And: since when has the US pegged its exchange rate against the currencies of several other nations with vastly different industrial structures?

And: since when has an economy which is $US14.2 trillion in size (US GDP GDP) been anything remotely like one that is about $US383 billion in size (Greece GDP 2008)?

But I decided to read the article anyway because I don’t want to be considered to be a person with a closed mind like most of the people that commentate on monetary matters these days.

Ferguson said:

It began in Athens. It is spreading to Lisbon and Madrid. But it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker eurozone economies. For this is more than just a Mediterranean problem with a farmyard acronym. It is a fiscal crisis of the western world. Its ramifications are far more profound than most investors currently appreciate.

The crisis is certainly a EMU problem. No doubt. They have set up a system that cannot cope with the sort of economic downturn that has occurred. Given the fiscal and monetary constraints they have imposed on themselves, any signficant economic crisis which forced government revenue to collapse and outlays to rise would lead to this sort of disturbing imbrolgio.

The crisis reflects the flawed structure of the EMU arrangement.

Any sovereign government (of which none within the EMU enjoy that status any longer) can deal with a collapse in revenue and an increase in outlays from a financial perspective without invoking the sort of deadlocks that are now crippling the EMU zone.

Ferguson acknowledged that “(t)here is of course a distinctive feature to the eurozone crisis” and outlines fairly accurately the constraints that the Euro elites built-in to the design of the system.

However, I consider his statement that “(t)here is not even a mechanism for Greece to leave the eurozone” to be inaccurate. That is the line the ECB has been running but the fact is that the Greek people really have retained the power in this situation. They can demand their government exit the EMU system and while it would be very damaging for them to so, my bet is that in the longer haul the damage will be greater if they stay in.

Please read my recent blogs – Doomed from the start and Europe – bailout or exit? – for more discussion on this point.

While Ferguson talks mostly about Portugal, Spain and Greece, I noted yesterday that Robert Mundell (he of the Mundell-Fleming model that has been used by macroeconomic textbook writers to mislead students for years) is now claiming that Italy is the “biggest threat” to the EMU system.

Mundell is also a major intellectual force behind the creation of the common currency – he was one who pushed the optimal currency area concept, which of-course, is totally inapplicable to the constellation of countries which comprise the EMU but was used to justify its creation anyway by the ideologues.

He was quoted as saying:

Italy has got to be worried … If Italy became a target then this would create a big problem for the euro. Whatever is being done to Greece, possibly to Portugal and maybe Ireland, has to also save Italy from that problem … It would be very difficult if Italy got tarnished with the same problem … It would be very difficult to bail out Italy.

So for the commentators who have been dropping the I from the PIIGS because Italy is a strong economy with relatively low deficits and high private saving ratios, we now, seemingly, have to add it back in. As an aside: I was offended by the spelling challenge PIGS is much easier and I associated it with the bullies from the ECB and Brussels.

Now Italy?

Anyway, it is clear that Italy has fallen back into negative growth as I discussed in this blog – Europe – bailout or exit? last week. This is a trend across the Eurozone in the last quarter of 2009. So there will be no growth relief from the need to support economies with significant net public spending levels. Just the thing that the EMU arrangements cannot cope with.

But the problem of not being able to fund deficits (given the countries have acceded to impose gold standard conditions of themselves without having a central bank to help them) is not confined to the PIGs or the PIIGS. The sovereign risk problem applies to Germany, France and all the EMU nations.

Once a run on the currency starts and moves into the banking sector then none of the governments will be able to do any other than to oversee financial and economic collapse while the fiddlers in Brussels and Frankfurt try to spin some line about “special circumstances” or something without admitting the whole system they imposed on the area is the cause of this crisis. They could easily avert the crisis now by funding the deficits appropriately through the ECB to allow the governments fiscal space to move.

Of-course the ECB will step in at the point that collapse is on the cards. Then the treaty conditions will be exposed for what they are – incapable of dealing with economic crisis. That capacity is what I consider to be a primary requirement of a successful system of governance.

More generally?

Ferguson then says that the most likely option will be “some kind of bail-out led by Berlin”. Which I agree with.

But then the blood obviously rushes to his head and he still has x-column inches to fill and he concludes:

Yet the idiosyncrasies of the eurozone should not distract us from the general nature of the fiscal crisis that is now afflicting most western economies. Call it the fractal geometry of debt: the problem is essentially the same from Iceland to Ireland to Britain to the US. It just comes in widely differing sizes.

What we in the western world are about to learn is that there is no such thing as a Keynesian free lunch. Deficits did not “save” us half so much as monetary policy – zero interest rates plus quantitative easing – did. First, the impact of government spending (the hallowed “multiplier”) has been much less than the proponents of stimulus hoped. Second, there is a good deal of “leakage” from open economies in a globalised world. Last, crucially, explosions of public debt incur bills that fall due much sooner than we expect

First, fractal geometry of debt eh? What the hell does that mean? What is the mathematical foundation for that when applied to a sovereign government. I wish these guys would just say “look, I believe this but I have no underlying reason for believing it” rather than just dress it up with some scientific language. Priests in churches do the former all the time and millions still follow them religiously.

Second, no-one of any education has ever used to the term “Keynesian free lunch”. The “free lunch” term was used by Milton Friedman to advance his now-disproven and empirically failed concept of monetary targetting and related mantras.

Anyone who advances the use of fiscal policy as an effective counter-stabilisation tool is always careful to point out that all fiscal interventions come at a cost. But as I noted yesterday – the costs you have to consider are the real resources that are deployed by the policy action. These costs matter.

Fiscal policy may well waste real resources or divert them from other more productive uses. A good policy intervention has to have an acconmpanying operational plan to ensure these inefficiencies are minimised.

But when you have mass unemployment and major unmet community and environment needs then it is a pretty safe bet that government job creation initiatives targetted at meeting this unmet needs will be a better use of the idle resources than leaving them “to the market” (which means leaving them unemployed).

For sovereign governments the financial “costs” are not worth considering. Quoting a particular deficit figure as if it means something is nonsensical. A 3 per cent budget deficit to GDP ratio might under some circumstances be extravagant and dangerous and under other circumstances inadequate to meet the demand gap. You always have to relate it to the other balances in the economy (external and private) – which is one of the points the simple teaching models I have made available are aiming to show.

Third, where is the evidence that monetary policy worked and fiscal policy didn’t? I note Ferguson provides none. All the evidence I have seen from the IMF, the US Government, the OECD, the Australian treasury points to the fact that the fiscal intervention added more support to GDP than the monetary interventions.

It is also clear from the UK experience, that quantitative easing was never going to do anything expansionary anyway because it was based on a flawed understanding of how the banking sector operated. Please read my blog – Quantitative easing 101 – for more discussion on this point. Japan in the 1990s also showed that monetary policy was not able to add demand to the macroeconomy. It only started to grow again once fiscal policy reached such a level of support for the private economy, that private spending resumed.

Fourth, the leakages through net exports are obvious and just tell us that the injections from net public spending have to be larger. The problem has not been that fiscal policy doesn’t work it is that political pressures on government generated by characters like Ferguson and his ilk have intimidated governments from expanding enough.

It is patently obvious that the US needs a further major stimulus package right now aimed at creating jobs. The deficit to GDP ratio is probably at least 3 per centage points below what it should be to get the show rolling more quickly. But you cannot blame the concept of fiscal policy for the weak-kneed use of it by politicians scared by the deficit-terrorists.

Finally … to the US

Ferguson then gets positively bolshie moving from Greece to the US:

For the world’s biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the “safe haven” of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.

Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase “safe haven”. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.

No, the Japanese attacked the US with aircraft in 1941. Planes cannot bring down a monetary system run by a sovereign government that has no insolvency risk.

To prove he knows nothing much about these topics, Ferguson then starts quoting deficit to GDP ratios and public debt to GDP ratios (from the Office of Management and Budget projections) as if they mean something. See note above on why as they stand they mean nothing. Also refer back to yesterday’s blog which gives an historical perspective of cumulative deficits.

Ferguson then nearly collapses in hysteria:

The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. That’s right, never.

That is probably a good thing given that the US has been in current account deficit for several decades and in more recent times has been growing excessive levels of private debt which are unsustainable.

What Ferguson shows no appreciation of is the sectoral balances. If the US continues to run net export deficits, and I cannot see that changing anytime in the next 20 years, then if the private domestic sector is to net save, the US government has to net spend – that is, run deficits.

If the US government tries, under these circumstances to run surpluses it will first of all force the private domestic sector into deficits (and increasing debt) and ultimately fail because the latter will eventually seek to increase their saving ratio again.

You cannot argue against that even if the implications do not fit your ideologicaly persuasion.

Ferguson claims that:

The International Monetary Fund recently published estimates of the fiscal adjustments developed economies would need to make to restore fiscal stability over the decade ahead. Worst were Japan and the UK (a fiscal tightening of 13 per cent of GDP). Then came Ireland, Spain and Greece (9 per cent). And in sixth place? Step forward America, which would need to tighten fiscal policy by 8.8 per cent of GDP to satisfy the IMF.

The IMF has no authority over advanced economies. It can bully the poor nations that the advanced nations exploit and plunder but not the advanced nations. Okay, you will raise the UK experience in 1976 but that was an act of madness by the UK government who seemed to forget that Bretton Woods had collapsed some five years earlier.

So what the IMF says is irrelevant and any government seeking to advance the welfare of its citizens should not follow any plans laid out by the IMF. Its concept of fiscal stability are far-fetched and purely neo-liberal in ideology. Please read my blog – IMF agreements pro-cyclical in low income countries – for more discussion on how the IMF has been performing during the crisis.

With that Ferguson claims:

Explosions of public debt hurt economies in the following way, as numerous empirical studies have shown. By raising fears of default and/or currency depreciation ahead of actual inflation, they push up real interest rates. Higher real rates, in turn, act as drag on growth, especially when the private sector is also heavily indebted – as is the case in most western economies, not least the US.

I haven’t witnessed any debt explosions – whatever they are anyway – something exponential at least. What I have seen in the data are growing public debt levels at very low and stable yields (bar a few Eurozone pigeons) which have accompanied (not funded) the growing deficits that have provided a floor into the freefall in 2008 that would have surely resulted in a global depression.

The Debt to GDP ratios have increased around the World because the nominal volume of debt has increased and because GDP growth rates have plummetted. Guess what will happen as growth picks up again and the automatic stabilisers go into reverse?

Ferguson always claims to be a man of history. So how does he see Japan in all of this which in recent times has shown us that: (a) they can run large deficits for years and years; (b) issue large volumes of debt at stable and near zero yields; (c) have zero to negative inflation rates at the same time; and (d) withstand several severe credit rating downgrades at the same time and ignore them. The finance minister at the time told the crooked ratings agencies to take long walk off a short pier!

The is no upward movement in rates around the world. Central banks condition the yield curve not bond rating agencies or bond markets. There is also no systematic relationship ever been shown between public debt levels and economic growth. It is likely that the former rise when the latter falls but that is a reflection of the accounting relationships that the governments impose on themselves and is nothing causal.

When growth falls, deficits rise and neo-liberal governments issue debt $-for-$ to match the net spending. Of-course, public debt to GDP ratios will rise in these circumstances. And they fall when growth resumes as the process reverses. This is not causality. The growth is being driven by aggregate demand and there is not evidence that bond issuance constrains aggregate demand.

After some irrelevant statements about the Chinese reducing their demand for US government bonds (see my blog yesterday on that furphy) Ferguson decides to go for the big one:

Although the US household savings rate has risen since the Great Recession began, it has not risen enough to absorb a trillion dollars of net Treasury issuance a year. Only two things have thus far stood between the US and higher bond yields: purchases of Treasuries (and mortgage-backed securities, which many sellers essentially swapped for Treasuries) by the Federal Reserve and reserve accumulation by the Chinese monetary authorities.

Last week Moody’s Investors Service warned that the triple A credit rating of the US should not be taken for granted. That warning recalls Larry Summers’ killer question (posed before he returned to government): “How long can the world’s biggest borrower remain the world’s biggest power?”

I would just consult the Japanese about the relevance of Moody’s.

A wolf in sheep’s clothing?

A few days later, the conservative Financial Times economics writer Martin Wolf followed up with his article (February 17, 2010) – How to walk the fiscal tightrope that lies before us.

Even he wasn’t impressed with Ferguson which is saying something. Wolf said:

Niall Ferguson is not given to understatement. So I was not surprised by the claim last week that the US will face a Greek crisis. I promptly dismissed this as hysteria. Like many other high-income countries, the US is indeed walking a fiscal tightrope. But the dangers are excessive looseness in the long run and excessive tightness in the short run. It is a dilemma of which Prof Ferguson seems unaware.

Interestingly, I agree with Wolf here about the dangers. The risk of fiscal policy (and associate stock changes – that is, debt) in a sovereign nation is never insolvency. The risk is that you will not expand enough when you need to and not contract enough when you need to do that.

So the political process will interfere with the net spending requirements because the former is innately conservative and places things like fiscal policy into “comfortable” boxes beyond which hysteria breaks out. It is interesting to me how in the last thirty years we have altered our perceptions of this box.

The lower bound – unemployment – used to be heavily weighted so that it crept beyond 2 or so percent there was hysteria. Inflation – the upper bound of the box – never really a sustained issue, didn’t really rate a mention.

Now, it is the reverse. Any hint of inflation (even conceptual) leads to an outbreak of hysteria to match the insolvency hysteria (my these people are leading troubled lives!) whereas we tolerate decades of high unemployment.

In the scheme of things, once you analyse the real impact of both – unemployment is devastating while inflation is of the order of a “rap over the knuckles”. Neither is desirable but if I was to prioritise then I would always have low unemployment.

I think that is the message of the IMF’s sorry story last week – that central banks should increase their target inflation bounds. Please read my blog – We are sorry – for more discussion on this point.

So at present fiscal policy is not expansionary enough. At some point it could turn out that it is too expansionary although given the downward biases imposed by the conservative ideology that is dominant at present I doubt that will be the case.

Wolf notes that notable US economists do not agree with Ferguson:

Brad DeLong of the University of California, Berkeley, responded that parts of this argument are wrong or misleading: White House projections are for federal debt held by the public to be 71 per cent of GDP in 2012 and not to exceed 77 per cent by 2020; monetary policy would not have delivered even the limited recovery we have had on its own; and higher interest rates may indeed be on the way, but there is nothing in current yield curves to suggest it.

While DeLong is mainstream at least he can see the facts in this matter more clearly than most mainstream economists. I covered some of these issues in yesterday’s blog.

But Wolf’s point that “there is no reason to balance budgets in a country whose nominal GDP grows at up to 5 per cent a year in normal times” resonates strongly with my earlier points in relation to Ferguson’s stupidity in this regard. Governments can run deficits forever without any negative consequences and indeed they have to under the circumstances I outlined above.

Wolf then says that:

Ferguson believes instead in a conservative free lunch. This is the view that fiscal tightening today would have little effect on activity.

The neo-liberal era has been highlighted by this notion that the costs of fiscal or monetary tightening, if evident, are small and ephemeral. The serious research shows otherwise and it is clear that the real losses are huge and protracted (span generations).

Please see these blogs – We are sorry and The Great Moderation myth – among others for more discussion on this. For even more, use this search string.

Wolf also supports the view that the “9j)umps in fiscal deficits are the mirror image of retrenchment by battered private sectors” and if:

If these governments had decided to balance their budgets, as many conservatives demand, two possible outcomes can be envisaged: the plausible one is that we would now be in the Great Depression redux; the fanciful one is that, despite huge increases in taxation or vast cuts in spending, the private sector would have borrowed and spent as if no crisis at all had happened. In other words, a massive fiscal tightening would actually expand the economy. This is to believe in magic.

That is really what is at stake here. Ferguson won’t lose his job – given I assume he has tenure. I won’t lose my for the same reasons. But millions have and more will if the conservative madness is not headed off. Millions of people have not only lost significant portions of their financial wealth because of this crisis but are now without income generating capacity.

The private market will not restore either anytime soon and the former never! The deadweight losses of this period of “self regulation” that we were conned into believing would deliver us all to wealth nirvana has been exposed as a cruel sham. The perpetrators have escaped richer it seems because of the folly of government bailouts.

But for the rest of us it is time to stop believing in this hoax. Ferguson and his ilk would take us back to where we were.

Anyway, good things come to an end, and Wolf who up until then was sounding positively reasonable then loses the plot and heads off into la-la land, where he usually is. He says:

But Prof Ferguson is right: everybody knows that such deficits cannot continue indefinitely. As Carmen Reinhart and Kenneth Rogoff point out in a recent paper, once ratios of public debt to GDP exceed 90 per cent, median growth rates fall by 1 per cent a year. That would be costly. Moreover, there is a risk that, at some point, confidence would be lost and interest rates would soar, with dire impact on debt dynamics.

Please read my blog – Watch out for spam! – to find out about the inapplicability of Reinhart and Rogoff to the current situation.

Such deficits cannot continue indefinitely – they never have – growth will resume and take care of that. Everyone should be imploring their governments to get growth moving and income into workers’ pockets. Direct public sector job creation is a great way to engineer that stimulus.

I will address the issues raised about the productivity of directly created public sector jobs in another blog – although I have done it previously, several times – for example, Boondoggling and leaf-raking ….

Wolf then gets lost in a smokescreen of dire ageing projections and debt-ratings agencies reducing sovereign debt to junk. The only dire thing about this is the prose.

Consistent with many conservative commentators in this period he realises the data is telling him one thing but still has to say something bad could happen.

For example:

Now we come to the big dilemma: what if private deleveraging and fiscal deficits continue in the US and elsewhere for years, as they did in Japan? Then triple A-rated countries, including even the US, might lose all fiscal headroom. This has not yet happened to Japan. It might well not happen to the US. But it could.

Yes, and I might surf Waimea Bay at 80 foot one day!

That would be dire!

Digression: blog words

I have spent a career writing tight pieces of research to satisfy the demands of publishers. There is a formula that successful researchers learn early to follow to get their papers published in the good journals. Typically these articles are fairly targetted and formulaic.

I noted that one blogger who has been commenting a bit lately had the decency to write a blog providing Two sides to every story. He noted that:

In the interest of avoiding another lengthy comment thread discussion with those who hold the opposite view, I point you toward Billy Blog where you can read for yourself the other side of the story. Bill Mitchell is a leading proponent of Modern Markets Theory (MMT). He is intelligent and responsive, although I think his points would be much better taken if he could somehow express them with 90% fewer words – sorry, Bill, we Americans have narrow attention spans. I would do a disservice to Bill’s writing if I pulled out a few select quotes which anyone unfamiliar with the basics of MMT would find completely preposterous, but I’m going to do it anyway, with the hopes that the reader will think not “what a f’n moron, ” but rather “how on earth could he make a claim like that, maybe I’ll go check out what he’s writing.”

Anyway, he did pull out a few quotes which is fine by me. But the suggestion that I reduce by daily blogs words by 90 per cent to allow those with short attention spans to cope would be very good for me.

I agree and would love to write 500 words a day instead of say 5000 (sometimes longer). The problem is that the sorts of concepts I research and write about are difficult in themselves and not mainstream.

If I don’t spell things out in detail and provide background, context, history and analytical rigour then I risk being dismissed as an interplanetary invader without credibility.

The problem is that if I just said “governments can spend what they like” and left it at that = imagine the reception! I get it anyway, but at least thoughtful antagonists such as Kid Dynamite do feel the need to engage and delve a bit more deeply as to why an otherwise smart sounding character (senior professor, PhD, lots of high quality academic publications etc) would say something as “stupid as that”.

I hope that the curious will read further and engage further and work these difficult concepts out. Whether you agree with my ideological stance is one thing but at least separate that from the more factual concepts I develop and explain – the accounting and stock-flow considerations. Once you understand the latter you will experience a new way of thinking about the economy and you might even start to resonate with some of the policy ideas that emerge from that understanding.

In fact, as an aside, I was giving an invited presentation once at a prestigious conference on my macroeconomic views (I was the token Keynesian they used to have along to say they were providing a balanced roster of speakers! Not!).

Anyway, after I had given the presentation, the discussant started off by saying (with a whirring noise to start his spiel) “ladies and gentlemen, I think we are being visited by a presence from Mars today!”

Huge laughter at my expense – but by this stage I was a senior professor and had experienced years of this sort of ignorance. Always water off a duck’s back!

Anyway, being prolix is one of the problems I face in writing a blog of this type.

That is more than enough for today!

This Post Has 47 Comments

  1. Great post. Nice critique of Ferguson’s article. The “fractal geometry” of debt??? Wow — fractal geometry — sounds like some high-end math — I better believe this guy!

    I also like how you covered Wolf\’s rebuttal piece in the FT. You quoted a part of his piece where he mentioned a working paper by Rienhart and Rogoff which showed that debt/GDP ratios in excess of 90% are linked with negative growth amongst developed nations. I was wondering what your take on that working paper is, as Wolf linked to it in his piece. The paper did not mention which nations were running 90%+ debt and during what times, but, in my opinion, the main problem with such analysis is that it confuses cause and effect. At least in the case of the US, poor economic growth is the reason why our debt-GDP ratio is high, and not the other way around. Where are these studies distinguishing correlation and causation, not to mention the monetary regime?

    Over here in the States the big news of yesterday was the first anniversary of the much-maligned stimulus package. The White House was out taking credit for its positive contribution to growth and employment. This brought me back to some of your previous posts concerning the multiplier effect of spending. As you mentioned in previous posts, the Administration estimated a multiplier of 1.5, which was in-line with the assumptions of most mainstream, progressive economists. The conservative counter, advanced most especially by Robert Barro, is that the real-multiplier is actually more like .6 or .7.

    What I want to ask is how is the conservative expectations argument, that the multiplier is less than one, a real critique of the stimulus? Even if the real multiplier were less than one due to expectations-driven retrenchment or inflation, doesn\’t that still mean that fiscal stimulus results in a real increase in output? If anything, wouldn\’t that imply that the stimulus amounts are not enough and governments should do more? I just wanted to see if I am understanding this correctly because, even if the multiplier is .6 or .7, it doesn\’t seem to me that there is really much trade-off involved given where unemployment and capacity utilization are at present.

  2. I visited your blog for the first time today. It’s superb! Unfortunately our German politicians never read such stuff and instead devote their sole attention to lectures from Bundesbank gurus or may I say gangsters. Plus there’s no light on the horizont now that the former DE export world champion is determined to export former BuBa terrorist-in-chief Axel Weber to the ECB. PS: I appreciate long posts.

  3. Hey Bill,

    Is there a hard limit to how far a country can grow economically? As long as deficits are financed by debt then doesn’t the economy long term have to grow at a greater rate than the deficits?

    And for us privately as long as money is debt then the money supply must always increase to account for the need to repay the interest that is not created with the debt, right?


  4. Thank you Professor for your systematic dismantling of Ferguson’s tabloid writings. I can say you are much more mild mannered than me. After reading that trash at the breakfast table I blurted out that “f*cking pencil neck” (I am glad my kids were at school) and it took me a good hour and a lot more coffee to compose my thoughts for the day. Hell, what do I know – maybe you actually had a similar reaction when you first read it. Thanks again.

  5. Let me piggyback on Alex’s question.

    First, suppose a regime like the U. S., where the central bank avoids monetizing the national debt, and the debt grows with the deficit. The number that most concerns me is the percentage of the budget that goes to servicing the debt. Anyway, as long as things scale we are on a steady course. (There may be an iceberg on our path, but that’s another question. ;)) But what if the debt to GDP ratio keeps increasing? What if, like the “Ponzi scheme” people fear, we continually increase the deficit just to service the debt? That spells trouble, right?

    However, what if we just “print money”? Then there is no debt and we never have to spend just to service it. It seems to me that this is a more stable set-up. (I understand the questions of discipline that arise.) But is that so? If we face the kind of conditions that lead to accelerating debt under the other regime, are we just as screwed, it’s just that it doesn’t show in the debt?

    Thanks. 🙂

  6. Bill,

    “Whether you agree with my ideological stance is one thing but at least separate that from the more factual concepts I develop and explain – the accounting and stock-flow considerations.”

    You’ve emphasized repetition before. This point alone warrants repetition. It’s very important.

    And don’t shorten your posts.

  7. Hi Bill,

    I am a new reader to your blog and have found it very interesting, although my macroeconomic knowledge is, well, underwhelming. I do have a quick question for you and perhaps you could point me to a previous post or article for an answer.

    In this latest post you say, “For sovereign governments the financial “costs” are not worth considering,” and in previous posts remind us that sovereign governments cannot become insolvent.

    But as many governments do not issue their own currency and instead farm it out to private central banks, how are the interest payments on government decifits accounted for? Is this simply considered a leakage to the private sector?

    I ask because it would just seem to me that while a sovreign government is in fact insolvent, decifits in the end have the larger effect of simply padding the coffers of private individuals that are shareholders of central banks.

    Again, there may be a simple answer to this, but thanks for the informative posts!

  8. Min,

    When the government pays interest, that’s also income for the private sector. It’s similar to any other government spending in terms of adding to private sector income. Of course there are better ways to inject income into the private sector than pay interest, because the holders of government debt are usually wealthy individuals whose propensity to consume is low. But there is no problem with stability, as the government can always meet its financial commitments as they come due. But it would certainly be a good idea to get rid of this self-imposed constraint and stop issuing bonds. That would make it clear how the system operates in reality.

  9. Ferguson quoting the CBO projections as if they had more predictive capabilities than weather forecasts?!? They predicted ongoing deficits before the Clinton deficits, the CBO predicted surpluses just prior to the Bush deficits.

    If you want a political weather vane, the CBO is great for that – and there is some decent statistics, but for basing a forecast of fiscal position – forget it.

    When someone tells me the US debt will cripple our grandchildren, I ask them how much of their last year’s income tax was used to payoff World War II debt? Then I tell them zero and so why should our to-be-born grandchildren be worried?

    These journalists are just responding to what their contacts are saying will sell newspapers or be approved by their editors – there is this organized attempt to avoid discussion about the private debt crisis (which has a real negative impact on people’s living conditions – like housing) and shift the focus to public spending/debt (which has a had a real positive impact).

    Also, not all Americans want to read short blog posts – there are enough casual opinions out there – some of us want to try to understand and realize that anything of value requires hard work (unless you are a banker).

  10. Good on, Bill!

    I was intrigued by your comments on the “New Keynesians” a few days back, and on Lerner. I assume you are a Keynesian of some vintage as well! It would be interesting to hear sometime your thoughts on what happened to the Keynesian legacy, and where you and Mankiw parted ways (if ever together), and why the names have, in usual ideological fashion, become somewhat inverted. Not being an economist, I am perplexed by these scholastic peregrinations.

  11. Dear RebelCapitalist

    I can say you are much more mild mannered than me. After reading that trash at the breakfast table I blurted out that “f*cking pencil neck”

    Always stay calm. Once you lose your cool you have lost the argument and the issues become blurred. My first reaction when I read it was: “this guy (Ferguson) needs something better in his life!”

    best wishes

  12. Re reducing the length of your blogs:
    I do not agree that they should be shortened. They are very readable and, for a neophyte, very dense as they are. Your blog plays an important role in offsetting the deficit hysteria that plagues many countries and shows people how to argue an alternative view. It was your blog that introduced me to MMT, leading me to Marc Lavoie’s courses (I’m auditing another now!) and now to gently spread the word in the little world I function in. I shall be making a presentation on MMT to a group of economists in a couple of months. It is quite amazing how many honest, well-meaning, thinking people are seriously confused about monetary and fiscal issues. Household logic is the main stumbling block as is a complete lack of knowledge about the functioning of the monetary system.

  13. My challenge to the model were not addressed so I will post again below. Kid Dynamite (if you are reading this), in regards to your comments in the “family moves next door” post: you are exactly right- whether or not govt should ensure full employment comes down to your view of what govts role should be in an economy/society. I agree with you in that I don’t think the govt should be deciding how to keep the economy at full capacity. The Soviet Union operated at full capacity for a long time but they eventually discovered that the capacity was poor, the product poorer, and the people impoverished.

    But at the time many Keynesians on The Left were looking at Soviet as an economic (not a social) model. Calvin Hoover ( published a paper which, according to Paul Krugman in his more sober writings in 1994: “concluded that Soviet claims of astonishing achievement were fully justified: their economy was achieving a rate of growth “twice as high as that attained by any important capitalistic country over any considerable number of years [and] three times as high as the average annual rate of increase in the United States.” He concluded that it was probable that “a collectivist, authoritarian state” was inherently better at achieving economic growth than free-market democracies and projected that the Soviet economy might outstrip that of the United States by the early 1970s.” This top-down management and full-employment is exactly what Billy advocates.

    If someone is out of work because of productivity- i.e., our economy produces what we need with less labor- then he needs to either figure out how to create a new need (wash and fold laundry?), improve existing products, or re-enter the work force at a reduced rate (since he can still keep the same standard of living since productivity rose). Our disagreement with many on this board will not be resolved as we view government’s role and ability in a completely different light.

    But perhaps my previous question regarding the model can be addressed this time:

    But why are your kids paying the same amount of tax that they were paying before their incomes fell? And what is happening to their expenses- are you charging them the same amount for food, rent, and utilities? If they are trading with each other why are the prices of trade-able goods and services not falling along with the supply of business cards? Perhaps the prices are staying high because China Family is spending the cards that they accumulated, buying up all of your kid’s Vegemite.

    You describe the economy: “there is no longer much work being done around the house. The garden is in a sorry condition and rubbish is piling up.” Why are your kids so lazy? Or is it that the Draconian Emperor (you as the govt) running the economy stubbornly refuses to bring their expenses down proportionately with income?

    What happens when we introduce Arab Family who just discovered their house sits atop a geothermal energy source. They supply both your family as well as China family with heat and electricity. The winter is particularly cold and China family desires more heat so they send more of their spare cards to Arab Family in exchange for more heat. But Arab family only has a fixed supply and tells your family that they will have to either pay more for heat or get less heat. Your family would rather forgo a snack than be cold so they pay the higher price for heat. But now they have less to pay for Vegemite and so your kids are forced to go into your pantry so they can sell more Vegemite to China family so that they won’t have to go over the fence and earn back the purchasing power (work). In economic-speak, the inflation is eroding the purchasing power of your children and thus their quality of life sue to your resistance to any sort of restructuring.

  14. Dear Bill,
    Have been trying to commit core principles of MMT to a simple exposition, that I might use as explanation to friends. Am wondering if I could post this to the blog in hope of being corrected where necessary; and helped where suggestions are forth coming.


    *All concepts sourced and adapted from

    Before Government
    Values & Trust
    • Human beings ‘value’ things;
    • They do not like their values compromised;
    • Sometimes they exchange things according to their values;
    • People created ‘credit’ as a ‘store of value’ – the ‘credit’ of one person a ‘debit’ for another
    • When human beings respect each other, values and credits/debits are sustained – trust, respect, and right human relationships, are always the life breath of credit (credit bases);
    • Credit for goods and services was soon measured in some ‘unit of value’;
    • For everybody’s convenience, people created ‘money’ as a physical token of the unit;
    • The amount of goods and services that can be exchanged, is limited only by the natural world, and human creativity productivity and relationships (natural constraints);
    • The amount of credit that can be created for exchange in these, is limited only by the bases of credit and natural constraints;
    • The amount of money created is always a matter of convenience;
    • If technology and values made commerce redundant we would still have to credit each other (or live alone) as all of life is interdependent in one way or another.

    • When human values are compromised, the credit bases diminish;
    • When credit diminishes so does human creativity and productivity, and the exchange of goods and services *(some of which are essential such as living standards, education, the arts and sciences);
    • When material values eclipse all other human values, inequity, suffering, war and environmental destruction result.

    Introducing Government
    • Government credits are now the only legal credits available, used for the exchange of goods and services;
    • Government alone can create credits (by spending), and destroy credits (by taxing). Taxes create the demand in the population for government credits;
    • People tolerate this, because the Government runs a public benefit program;
    • Government does not have to steal – beg – BORROW – SAVE – TAX or work to create credits; it simply credits as we once did (hopefully understanding the bases of credit and natural constraints);
    • Government provides credits to the people in trust, that they will in return provide the goods and services the Government needs – to fully implement all public benefit values the Government are privileged to serve;
    • People receive the credits in trust, that they will be able to exchange things in a stable economy according to their values, making secondary use of the credits supplied by Government;
    • Government should never allow public benefit values to be compromised by private sector activity;
    • Government spending should guarantee livelihood in the public sector when there is not enough livelihood in the private sector – unemployment is not a natural state. In the public sector there are always more jobs that could be done for the public benefit, than there are people to do them;

    Private Banks
    • Banks too are ‘financed’ by government credits;
    • Banks use government credits (reserves) and their own capital as a guarantee to back up any loans they make;
    • As bank loans expand and contract, government creates and destroys credits (reserves) to support the private credit structure (real economy);
    • However, banks also extract from, gamble with, and inflate wealth from the real economy; which upon collapse, is bailed out by the Government who pass the cost on to the real economy, already damaged through the predatory activities of the banks – thus both the Government and the banks compromise both private and public benefit values;
    • All bank loans are met by repayments and sum to zero; and never impact on government’s ability to price or supply credits, or run its public benefit program.

    • A deficit of Government credits in the society causes recession, unemployment, private debt and under-funded public and private sector values – and demonstrates both Government and society have forgotten that to govern means not only to accept the responsibility of steering and stability, but to spend according to demand, in accordance with the credit bases and natural constraints;
    • Traditional banking supports the real economy; investment banking extracts from the real economy and produces no useful public benefit;
    • A surplus of Government credits in the society is the only cause of persistent inflation.

  15. Dear jrbarch

    Very comprehensive and thank you. I will consider them in more detail. But the initial point that I try to emphasise to avoid misunderstandings is this. There is Bill the MMT person and there is Bill the person. The former is about national accounting, stocks and flows, which are and accurately capture the way in which the monetary system we live in today operates – down to the nitty gritty of banking, reserve maintenance and all the rest of it. The latter is an ideologue like all people who has values and preferences and political views. The two in my view are separable and I trust they come out that way when I am writing.

    I think your set of core principles mixes ideology with the former conceptual basis of MMT which I think leads people who are unclear or antagonistic from the start to blur the debate. They quickly move from reading that the government is not revenue-constrained (which is clearly isn’t) to statements about wild-spending socialist hydras that will impinge on their very existence. It doesn’t help anyone to discuss things in this way.

    They could still hate and mistrust all government activity but they should realise how this will impinge on the operational reality of the monetary system. It just might turn out (and it will!) that what they wish for is unachievable given the way these operations work and that they might think differently if they understood that.

    But very impressive work and thanks for contributing it to our community here.

    best wishes

  16. Bill, please do not cut the length of your posts.

    I do not want to abuse any american but it looks like it is a basic trait of their nation (though can be a common myth). I my real life I hardly ever watch TV (maybe 1h a month apart from movies which I watch maybe 3-4 times a month) which means that all information I get into my brain comes from two sources: people and reading.

    Having said this I do sometimes feel that your posts are a bit long but this is a constraint of time I am able to devote to them at any point of day. And having said this I think I skipped only one post ever since I stumbled upon your blog (sometime 3 months ago) but have read lots of posts and comments from your huge archive. Please keep on. Sometimes I get scared thinking that you might get bored or tired and stop writing 😉 Incredibly huge daily effort from your side and it is definitely appreciated

  17. Hear, hear! I love billy blog, and the wit makes it bearable to keep up with the dismal science.

    Nice work by jrbarch…

  18. Guys,

    If a bank creates a loan for £10000 but demands repayment of £11000 (£1000 interest) then where does that additional £1000 come from? Net government spending? From someone else not repaying *their* loan?


  19. Bill:

    Am wondering whether the following holds true for a country like Greece that does not have a sovereign currency and so government cannot spend money/reserves into existence:

    Only way the private sector can get money/reserves to pay taxes or buy bonds is to:

    1. Run a trade surplus with the remaining countries in the currency union;
    2. Sell assets to the central bank of the currency union;
    3. Run down current liquid holdings on private balance sheets

    Bank created money/deposits cannot be used, as there is a liability for each asset banks create for private sector (inside money nets to zero).

    There is no mechanism I can identify yet that insures trade balance is of the right size, or currency union central bank net purchases are the right size to insure any given planned government spending in any accounting period is matched by net money inflows into the domestic private sector, so domestic private sector may have to run down existing liquid balances or be forced to sell assets to foreigners holding common currency.

    Trying to spell out the design flaws in more detail here, as well as make explicit the linkage between so called fiscal sustainability measures that impose unsustainable conditions on the domestic private sector.

  20. If a bank creates a loan for £10000 but demands repayment of £11000 (£1000 interest) then where does that additional £1000 come from? Net government spending? From someone else not repaying *their* loan?

    If there were no government currency issuance and all money were bank money created by lending, then everyone’s bank money would be someone else’s loan, and there would be no extra money created to service both principal and interest. Therefore, this type of system can only continue if more loans are made that enable interests payment, ad infinitum. This is the definition of a Ponzi scheme. MIchael Hudson is the expert on the consequences of debt.

  21. Tom,

    “there would be no extra money created to service both principal and interest”

    Please have a look at:

    where it is shown that as long as total debt in the system is not repaid the system where there is only credit money backed by debt is stable even if interests are charged.

    This issue is critical because the stability of the system is the cornerstone of the private income redistribution model currently in place (rich get richer because they debt of the poor is their asset – debt assets generates income flow). Yes the system is unstable but in my opinion for different reasons and at a different time scale, today I wrote a rather long rant against the Austrians who reappeared on the Steve’s blog, it will be interesting whether you agree or not with my conclusions:

    I should write a companion post for Bill’s blog addressing why I think MMT will never be understood by people subscribing to the neoclassical/Austrian school. I believe it is because of the same reason – there is an assumption that property rights are absolute (sacrosanct) and this implies the way they define what the money is.

    I have an issue with the supposed non-destruction of credit money when the debt is repaid discussed in the paper mentioned above but let’s leave this problem for now. There is no leak in the model as the money is removed from the circulation anyway but the way it is described is simply very confusing.

  22. Dear Bill,

    Many thanks for your reply.

    …your set of core principles mixes ideology with the former conceptual basis of MMT

    I did hesitate before posting because I have read many times about Bill the musician, Bill the surfer, Bill the educator, Bill the ideologue and Bill the MMT theorist (am sure there are many more)! Then of course there is Bill of whom the others are just expressions. And from the perspective you have (a few decades of presenting MMT) I sincerely agree that it is ‘logical’ to compartmentalise all of these – however, from another perspective with which I think you may also agree, there is also a synthesis – since Bill is but one existence. So too in life!

    There may be say politics, law and government; religion, psychology and the humanities; education, arts/sciences and concrete knowledge: but all of these are aspects or expressions of human existence. Cleavages between for example, the political expression and science result in inane climate policy. Harmony means intelligent synthesis or integration between the expressions in the individual, civilisation or racial types. So, synthesis is important also – as is clarity in the compartments.

    The other aspect of this is the ‘power of the message’. A Bob Dylan captures a generation whilst a Mark Latham sparks a wet cracker. The realm of concepts is circumscribed, but for a message to break out and resonate with people all over, there is another creative power at work. People gawk at architecture (mainly because they are told to) but if you really want to see something incredible look towards the architect who created the show in the first place. On the other hand, if architects designed the sky it would be an incredible mess! The way through is always down to creativity that strikes a chord within the human psyche, that resonates both magnetically and radiantly – supported by logic searching for expression. That is, creativity is both the child and parent of logic. When the band is humming, isn’t it a little life of its own! My little piece was a poor attempt at being creative and I am sure many could do much better. Can already see some flaws myself!!

    Cheers Bill ….


  23. where it is shown that as long as total debt in the system is not repaid the system where there is only credit money backed by debt is stable even if interests are charged.

    The problem today that policy is managed to protect creditors, and in a deflationary environment debtors are left with the same nominal debt, money/jobs scarce and reduced lending. This spells default. That is the dynamic of debt-deflation, e.g., Irving Fisher’s The Debt-Deflation Theory of Depressions. See also Yves Smith, Irving Fisher’s Debt Deflation Theory and Its Relevance Today.

    If the system remains stable, then the interest flows to the rentiers, which is non-productive wealth extraction. This is the basis of economic feudalism. The problem is not that the system cannot continue if stable; debt peonage can go on as long as the serfs put up with it, since it is in the rentiers’ interest to perpetuate the system by expanding the money supply. However, a problem arises when the system becomes unstable, and debt cannot be serviced. That’s where we are now.

  24. “First, fractal geometry of debt eh? What the hell does that mean? What is the mathematical foundation for that when applied to a sovereign government…”

    Anytime someone throws in a scientific term they don’t understand to bluff their way through an argument they don’t really understand either, I make it a point to take my own hostages and throw in an even more obscure scientific term to make the counter-argument… Lately I’ve been a fan of the General Relativity term, “intertial frame-dragging” (“Ferguson neglects to account for the inertial frame-dragging effect of a non-convertible sovereign currency”). No it doesn’t make any more sense than “fractal geometry”, but let the other guy figure that out. :o)

  25. So Adam what you are saying is that as long as those that extract the interest spend it back into circulation then the system can continue indefinitely?

  26. Tom, Alex,
    The system is unstable because the amount of debt compared with the income rises over time and investors gamble on asset markets. But the large scale instability described by Fisher and Minsky develops over decades rather than years.
    Let’s see whether application of MMT will provide a cushion (obviously at a certain cost) or whether we will experience a deflationary collapse.
    This only depends on political factors and I am quite pessimistic.

  27. I can think of four forms of commercial bank money that are debt-free as far as the private sector is concerned (there may be others):

    1. Bank deposits resulting from net government spending in excess of taxation
    2. Spending by commercial banks
    3. Bank credit associated with a defaulted loan (in excess of any bank sale of collateral, which destroys bank deposits)
    4. Bank deposits created via central bank open market bond purchases

    Only (1) increases the net financial assets of the private sector. while (2)-(4) leave private NFA unchanged.

    Government deficits and central bank loosening via open market purchases increase the stock of debt-free money available to the private sector. $4$ borrowing to ‘fund’ the deficit effectively deprives the private sector of debt-free money by reducing total bank deposits while leaving private debt obligations to banks unchanged.

    At least, that’s how it appears to me..

  28. Adam, interest accumulates as bank capital and this increase is able to fund further lending (banks lend against capital). But it also results in a redistribution toward the top that destabilizes the system when financialization begins to trump production and financial rent-seeking overshadows real investment. At that point the Ponzi stage of the financial cycle begins, and this ultimately brings down the house of cards as unsustainable bubbles form and then burst.

  29. ParadigmShift $4$ borrowing to ‘fund’ the deficit effectively deprives the private sector of debt-free money

    I don’t think that this is true at the macro level since it government disbursement through currency issuance that is transfers from deposit account to savings through debt issuance (Tsy’s). NFA are simply switched from one asset form (demand) to another asset form (time), and can be switched back at any time by any individual, since Tsy’s are liquid. However, someone else purchases the Tsy’s, so the effect does not change at the macro level. The interest on the debt increases NFA, too, since it is a government budgetary expenditure that must be offset by debt issuance when it contributes to a deficit. Bank money and currency/debt issuance are entirely separate, even though denominated in the same unit of account, i.e, the currency.

    The basic principle of MMT is that vertical money (currency/debt issuance) affects non-government MMT whereas the creation of bank money through credit extension does not, because it nets to zero.

  30. Adam, I had said, “there would be no extra money created to service both principal and interest.” This true eventually, since interest redistributes wealth to the rent-seeking rentier class. Eventually, the working class is driven deeper into debt due to debt service (a form of Ponzi finance). Ultimately this becomes unsustainable, so there has to be a reset. This is Michael Hudson’s thesis, if I understand it correctly.

  31. Tom

    You are naturally correct that $4$ debt issuance leaves private sector NFA unchanged. But the effect on the stock of debt-free bank money is, I think, different, at least until the debt matures. The point is admittedly not especially pertinent to MMT, but there has been some discussion of this lately, and I sense that some people new to MMT may arrive here via an interest in debt-free money creation, so perhaps it is relevant. The MMT/PK meme “loans create deposits” is valid but of course shouldn’t be construed as implying that all deposits are created by bank loans – something that most of us are aware of, but there is a significant contingency of people who believe that all bank money is created as debt, and so I think it is useful to discuss where the concepts of NFA and debt-free money intersect and where they differ.

    E.g. when the central bank conducts an open market bond purchase, the stock of debt-free bank credit increases. This is true despite the fact that private sector NFA remains unchanged. So here we have a vertical transaction that leaves private NFA unchanged but increases the stock of debt-free bank money. The reverse occurs when govt debt is issued to the public (private sector NFA unchanged, debt-free money stock decreases). I don’t think you can consider treasury debt held by the public to be debt-free bank money, although it is a debt-free (from POV of private sector) financial asset. Having said that, interest payments on any debt issued would amount to a drip-fed refund of debt-free bank money into the system, and payment of the principal at maturity would have the same effect, provided the bond was still held by the private sector.

    Also, horizontal transactions can increase the stock of debt-free money, despite the fact that they cannot change private sector NFA. Expenditure by a bank is one example.

    Maybe I’m belabouring a triviality, but my original point was that unsterilised (no $4$ govt debt issuance) government deficits, in addition to increasing private sector NFA, may also reduce the aggregate debt/interest burden of the private sector by increasing the ratio of bank deposits to outstanding bank loans. Sterilisation by $4$ debt issuance cancels out this effect, at least temporarily, and so perhaps advocates of “debt-free money” should side with unsterilised government deficits (?).

  32. Paradigm Shift . . . could you define “debt-free bank money”? Appears you are making your own terms up, so I want to be clear on what you are talking about.


  33. Sure, Scott. I realise this a slippery thing definition-wise. Obviously, all forms of modern money are either a central bank or commercial bank’s liability and hence no money is truly “debt-free” in that sense. I’m considering this from the perspective of the non-bank private sector.

    I suppose what I’m referring to are commercial bank deposits that are not created in parallel with an interest-bearing liability for the non-bank private sector. Since this definition refers to it’s mode of creation, and bank deposits are to an extent fungible, I would extend the definition to include destruction of “debt-free money” as any reduction of aggregate bank deposits that is not associated with an equal decrease in aggregate interest-bearing liabilities of the non-bank private sector.

    Ok, now you can rip into my post 🙂 I’m bound to have overlooked something important. Always eager to learn!

  34. I’ll let Scott sort this out when he is around, but as far as I can see money is created in only two ways.

    First, currency issuance where the liability is on the government side, so no liability on the non-government side, so an increase in financial assets. Subtract taxes and you get NFA.

    Secondly, bank extend credit and loans create deposits, which are debts. Net zero.

    Everything else is just transactions that do not and cannot affect what happened through money creation, because no new money is created. Existing money is just moved around at the micro level, but the macro remains the same. OMO just moves Tsy’s to the Fed’s balance sheet in exchange for reserves, which shows up as deposits in the sellers’ accounts. This is a transfer in which sellers forego interest for liquidity. And vice versa. This is recorded as switch in asset type on the seller’s book. Nothing created.

    The exception is, as I understand it, that banks can add funds to their own deposit account for expenses, there is no offsetting loan, hence, no interest obligation.

    Maybe I’m not following you, if you think that something else is involved.

    all forms of modern money are either a central bank or commercial bank’s liability and hence no money is truly “debt-free” in that sense.

    All money is someone’s liability, but not all money is debt-burdened, only bank money. “Liability” does not imply debt. Reserves are Fed liabilities, and currency is a Treasury liability. But there is no debt involved. Tsy’s are Treasury liabilities as well, and “debt” issuance involves “debt” in the sense of bearing interest. But debt issuance does not create NFA, only provides another way of holding existing NFA. Government “debt” is not debt in the same sense that bank loans are debt. Treasury “debt” just means that the Treasury will accept Tsy’s for reserves when Tsy’s are sold to the Fed or exchanged in the horizontal sector among various buyers and sellers.

  35. Tom

    Sorry if I have muddied the waters unnecessarily here, it wasn’t my intention. I agree 100% with your comments to the effect that government created money is not debt-burdened, while bank-created money is. The liability on the government side is purely nominal.

    On the other hand, most, but not all, bank money is created as an exchange of IOUs, with the bank promising to pay the borrower the full amount of the loan in base money, or to transfer that amount of base money in the form of reserves to another bank at the borrower’s request. It is this exchange of IOUs that lies behind the colloquial claim that bank-money is “debt-based”.

    With regard to OMO purchases, although they are essentially an asset swap, new bank reserves are created ex nihilo by the CB for the purpose of the swap, and new bank deposits are also created in the process. So money (both base money and broad money) is created by this process.

    Scott will correct me if I’m wrong, but even though private sector NFA are only altered via fiscal operations, both monetary and fiscal operations may alter the quantity of base money.

  36. I think ParadigmShift just wanted to know all the situations under which money aggregates increase but not the “loans” on the balance sheets of banks. As she/he himself says, she/he just wants to understand this without any specific purpose or criticizing or challenging someone. she/he wants a list of all possibilities where the deposit liabilities of banks increases without Loans on the assets side increasing.


    There are various other ways for M2 (Fed’s definition, as these Ms having country specific definitions) to increase in the context you mentioned. Just considering a few horizontal transactions here:

    1. Banks paying dividends
    2. Banks paying interest on your deposits
    2. Banks paying coupons/principal on the bonds issued by them
    3. Wage payment of banks’ employees
    4. Banks buying back their issued equity
    5. Banks exchanging a customer’s foreign currency
    6. Banks buying an asset from you such as Treasuries
    7. Banks’ trading activity such as payment on a call option written by them.
    8. Any payment such as to the furniture shop.

  37. Hi Paradigm Shift,

    “I suppose what I’m referring to are commercial bank deposits that are not created in parallel with an interest-bearing liability for the non-bank private sector.”

    That would seem to be the vertical component (NFA of the non-govt sector) less currency. The vertical component is the Treasuries held by the non-govt sector + reserve balances + currency less cb loans to the non-govt sector, so what you’re talking about would be Treasuries held by the non-govt sector + reserve balances + currency less currency less cb loans to the non-govt sector.

    However, for the part of the national debt held as Treasuries, there is usually not net increase in bank liabilities (that is, the recipient of govt spending or a tax cut has more deposits than otherwise, but some other saver’s bank liability is drained to buy the Treasury). The exception is if the Treasury is sold to a bank, there is a net increase in deposits with the deficit. So, if you wanted a net measure, you’d need Treasuries held by non-govt sector + reserve balances + currency less currency less cb loans to non-govt sector less Treasuries held by non-banks.

    Netting that all out, it’s Treasuries held by banks + reserve balances less cb loans to the non-govt sector.

    I’m not sure if you were equating this to the monetary base in your reply to Tom, but it’s definitely not the same thing, as under pre-Lehman operating procedures, the monetary base is about 97% currency, and currency isn’t part of the measure you were after.

    I’m also not sure what, if any, macroeconomic significance this measure would have, particularly the net measure (which is actually the one that matches your definition) over the more common MMT use of NFA or vertical money.


  38. Tom,

    I thought that currency was a Fed liability. At least it says “Federal Reserve Note”, and when I hold a dollar in my hand, I look at it and think, “Ha! I’m holding a note on the Fed!”

  39. RSJ/Tom,

    Tom has pointed out an interesting thing. This article U.S. Currency at Home and Abroad says

    Technically, currency is a liability of the Federal Reserve Banks. But, because the Banks hold Treasury securities as specific collateral against currency and return to the Treasury nearly all the interest they receive on these bonds, for practical purposes currency may be regarded as a liability of the Treasury.

    This one FAQs: Currency Legal Tender Status says

    Congress has specified that a Federal Reserve Bank must hold collateral equal in value to the Federal Reserve notes that the Bank receives. This collateral is chiefly gold certificates and United States securities. This provides backing for the note issue. The idea was that if the Congress dissolved the Federal Reserve System, the United States would take over the notes (liabilities). This would meet the requirements of Section 411, but the government would also take over the assets, which would be of equal value. Federal Reserve notes represent a first lien on all the assets of the Federal Reserve Banks, and on the collateral specifically held against them.

    Of course, Randy Wray puts it well in the article Seigniorage or Sovereignty? about them having complicated all this and made it even more complicated for mainstream economists

    Just as the ” external” world does not care about the accounting maneuvers practiced by husband and wife within the household, the internal accounting machinations between the Fed and the U.S. Treasury are not important for our analysis. Many economists find all this so very confusing because they do not understand the nature of the internal accounting procedures followed by the Fed and Treasury – procedures that they have imposed on themselves and which are not dictated by logical necessity. For example, the Treasury spends by drawing on an account it holds at the Fed, relying on the Fed to debit its account and credit a bank’s reserves. It would be more transparent, but would change nothing of significance, if the Treasury simply spent by crediting a private bank account directly. Similarly, taxpayers send checks to the Treasury, which deposits them at the Fed, leading to a credit to the Treasury’s account and a debit to the private bank’s reserves. Again, it might be easier for economists to follow the steps if the payment of taxes simply led to a direct reduction of bank reserves by the Treasury. Things are made even more complex because the Treasury maintains accounts at private banks, depositing its tax receipts, then moving the deposits to the Fed before spending them down. Obviously, so long as Treasury deposits are held within the banking system, there is no impact on banking system reserves, and, hence, Treasury deposits at private banks can be ignored – because the bank simply debits the taxpayer’s account and credits the Treasury’s account.

  40. It’s true, of course, that Federal Reserve notes are a Fed liability, but what that means is blurred because of the public/private nature of the FRS, which is confusing to a lot of people. In fact, a lot of people think that the FRS is a private institution, which it is not. According to Fed literature, “The Board of Governors of the Federal Reserve System is a federal government agency.” It is generally accepted that the currency of issue is a government liability backed by the full faith and credit of the US. If the Fed were a private institution that issued the currency, that were not actually the case, the US would be in big trouble for lack of confidence in the dollar.

    As I understand it, currency is created by issuance, and the Treasury does this through national budgetary disbursements in accordance with Congressional appropriation bills. Therefore, Congress has direct control of currency issuance. The Fed doesn’t issue currency directly, since its operations all relate to reserves, which provide interbank liquidity for settlement. Fed notes are tokens for reserves, banks exchanging reserves for notes, as demanded by the public. So Fed notes don’t add to the money supply.

    There is a lot of other confusion since bank money is denominated in US currency. So it appears to some that banks create govt. currency, too, when they do not.

    Lots of opportunity for confusion here and the structure of the Fed just adds to it. The US CB is a government agency not a private institution, even through some of its functions are administered privately. I think we are witnessing a similar confusion arising in the DOD through the use of private contractors that do not fall under the purview of the DOMJ. Best keep public and private at arms length. There are a lot of problems politically in the US right now because of confusion about the Fed, and it is difficult to remove this confusion because the FRS itself is an ill-conceived hodge-podge that is long overdue for revision.

  41. Ramanan

    Thanks for your comprehensive list, it certainly seems to cover all possibilities. BTW, to save you the awkward respectability of gender neutral pronouns, I’m a “he” 🙂


    Thanks, I think you’ve illuminated the vertical component of what I would call “debt free bank money” very well. I consider currency to be “debt free money” as well, but it lay outside of my original definition so you were right to exclude it.

    There is also a horizontal component of “debt free bank money”, as per Ramanan’s list of modes of bank deposit creation via bank spending, as opposed to lending. This is offset by interest payments to banks, which effectively reduce horizontal “debt free bank money”.

    I’m probably in a little world of my own, pondering all this, but I’ve been trying to explain MMT to a friend who is preoccupied with the evils of so-called “debt-based money”, and I’ve been trying to find some common ground between our points of view. It’s as if we’re talking different languages. It is surprising how many people don’t realise that government spending provides the private sector with money that is unencumbered by an associated private sector debt obligation. Of course, MMT views this in terms of NFA, and rightly so – it’s a much cleaner way of viewing things, as my little exercise has shown – “debt free money” (at least as I defined it) has an awkward intermingling of horizontal and vertical elements, but perhaps it has some use in analysis of debt dynamics, I don’t know, perhaps not.

    Anyway, thanks for your input, it’s shed some light for me. I’d also be interested in your opinion (Scott/Ram) as to whether you would agree that (profitable) commercial banks act horizontally as sinks of NFA (i.e bank NFA increases over time), at the expense of non-bank NFA, since it seems to me that this is the case.

  42. Ha ha ParadigmShift … really laughed at your repeated usage of “debt free bank money”, inspite of clear opposition to stop using that terminology. Went to get coffee from the machine and tried to turn my laughter to a smile on the way and one lady must have thought why I have suddenly started smiling at her 🙂

  43. Heh

    Glad to spread some mirth around, Ramanan 🙂 Gotta watch those “private smiles”, they can get you into trouble!

  44. PS,

    Yes, it is true that the banking system net worth increases over time. However, the consumption sector net worth and the production sector net worth also increase over time. This is because the government sector net worth keeps decreasing over time. This is in nominal space. If you do real stock-flow accounting, a long run scenario is where the real net worths of the consumption, production and the banking sector increases at a growth rate with full employment and reaches a steady state in real terms. With the way fiat/credit money works, there is no guarantee of full employment and this necessarily means that the government sector has to be active.

  45. Yes, Ramanan, that’s what I suspected. So the addition to private sector NFA provided by government deficit spending is required to keep the non-bank private sector from going into negative NFA territory as a result of it’s interaction with the banking sector.

    And any tendency of the non-bank private sector to become more indebted (to banks) in response to government surpluses squeezing private liquidity must be self-defeating from a balance sheet perspective as it only serves to deplete non-bank NFA further.

  46. ” government spending provides the private sector with money that is unencumbered by an associated private sector debt obligation.”

    But it does result in a public sector debt obligation – ultimately born by the private sector via taxes. The only alternative is to monetize the debt or not issue government bonds, which are basically the same thing. MMTers are not very clear on this point.

    Someone help me out here: When MMTers advocate massive deficit spending, are they assuming monetization/no public debt issuance?
    How then are MMTers any different from the many many people who have advocated monetizing deficits?
    It’s not exactly a new idea, and neither is the concept that the CB & Treasury face no nominal constraints, while still facing real constraints.

  47. PS: And any tendency of the non-bank private sector to become more indebted (to banks) in response to government surpluses squeezing private liquidity must be self-defeating from a balance sheet perspective as it only serves to deplete non-bank NFA further.

    And it’s the oligarchs plan to speed this up through shadow banking. Then these folks scream about “redistribution” when it comes to progressive taxation.

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