This might help:
“The myth of the money multiplier”
http://www.businessspectator.com.au/article/2012/10/22/commodities/myth-money-multiplier
Everything I know about money I learned from Rothbard. He makes it quite clear: What Has Government Done to Our Money? | Mises Institute
Frylock, I’m going to make some comments about what your friend said. I know you’re not your friend, but I feel compelled to do it.
I’m not sure what he means by this:
“The US Treasury does hold a balance.” The Treasury does hold a balance with the Fed. It’s a Federal Reserve account. All US government checks, to my understanding, are paid from that account. If you get a check from the Treasury, and deposit it at your bank, it results in a transfer from the Treasury reserve account, to the bank’s reserve account: the Fed decreases the balance in one account, and increases it in another. If that’s what he means, I think everybody agrees with that.
“The fact that the Fed makes loans from air is a complete red herring”. Again, not sure. The significance, I think, is that when the Fed makes loans it also makes money. I mean that in the literal sense: when the Fed makes a loan (or purchases an asset, like a Treasury) it creates money. That money shows up as reserve funds in Federal Reserve accounts.
“[M]onetary policy and accounting is totally different from fiscal accounting and policy”. Monetary policy is different from fiscal policy: monetary policy is decided by the Fed. Fiscal policy is decided by the House and Senate (and the President, in the sense he has veto power). They are, however, all parts of the same government.
Not sure what he means by “monetary accounting” and “fiscal accounting”. I suspect, by monetary accounting, he means the balance sheet of the Fed. And that by “fiscal accounting” he’s referring to deficits and debt. If so, then it’s true. The balance sheet of the Fed shows its liabilities and assets. Deficits and debt are the difference between how much the government taxes and how much it spends. They’re two different things.
I’d argue this statement is wrong. What I’m about to say might sound nit-picky, but I think it turns out to be important.
When you pay taxes, two things happen: your bank debits your account for the amount of tax, and the Fed transfers the same amount from your bank’s Fed account to the Treasury’s Fed account. When the government spends money, the process is reversed: if you get a check from the government, your bank credits your account for the amount of the check. At the same time, more or less, the Fed transfers money from the Treasury’s account to your bank’s Fed account.
Why it’s important is this: what you’ll notice is that the total amount of money in Fed accounts doesn’t change. The money only moves from one Fed account to another.
What is true of this transaction is true of others, as well. If commercial banks increase or decrease their lending, it has no effect on the total amount of money in Fed accounts. US commercial banks currently hold around 2.5 trillion in excess reserves. People sometimes ask: “Why don’t banks lend out their excess reserves?” The answer is they can’t. No amount of commercial bank lending, itself, affects excess reserves. The amount of reserves, including excess reserves, is determined by the Fed. Banks can transfer reserves back and forth, but they can’t get rid of them, collectively.
The exception would be if the government increased taxes and decreased spending, to the point where there was a surplus, rather than a deficit. In that case, bank reserves, collectively, would be transferred to the Treasury. The Treasury would then have two choices: it could either hold the reserves, in its reserve account, or use them to purchase Treasuries - which would mean paying down the debt. In that case, the Treasuries would disappear, and Treasury would send checks to the former owners. Those checks would be deposited at commercial banks, which would credit the owners, in the form of commercial bank money. Simultaneously, more or less, the Fed would transfer reserves from the Treasury account, to the commercial banks’ Fed accounts. In that case, the excess reserves would return to the banks. That’s still not a bank decision, however: it’s one made by the Treasury.
To repeat myself: banks themselves, collectively, can’t affect the amount of money in their reserve accounts. They can’t lend out reserves: they can only lend commercial bank money.
I’d argue this statement is wrong too. When the Fed lends money, it also creates money. Furthermore, the Fed is a non-profit organization. The amount the Fed has lent out is irrelevant to the Fed itself. It’s only relevant in terms of how the size of its balance sheet affects the rest of the economy. The Fed does not “need” to be paid back. The Fed can hold Treasuries for whatever length of time it decides is appropriate - up to, and including forever. (If the Fed was a for-profit institution, its interest would be in increasing the amount of its balance sheet as much as possible - because the more it lends, the more “profit” it makes. However, it is not a for-profit organization, and in fact gives its profits to the Treasury. So, again, the size of the Fed’s balance sheet is irrelevant, to the Fed itself.)
The second sentence is wrong. The government does in fact print money. The Fed has been “printing” money for years. That is what QE is: it’s the Fed printing money.
I’m not sure what he means by “balances the fiscal accounts exactly”. The fact that the government has a deficit means that it doesn’t balance fiscal accounts exactly: it spends more than it collects in taxes. The difference (the government deficit) is a substantial windfall for the non-government sector of the economy. It could be that he means the Treasury prints Treasury bonds to make up the difference. If so, the statement is accurate. Printing Treasuries, however, increases the wealth of the non-government sector by the amount of the value of the Treasuries. Or to put it differently, it increases non-government wealth by the difference between what it spends, and what it collects.
Again, not sure. It is true that fiscal and monetary policy are not the same thing. I’d argue, for example, that the Fed should keep interest rates permanently low, and that inflation - if or when there’s any sign of it - should be handled by fiscal policy, not monetary policy. I’m not sure what he means by “the whole distinction”. MMT recognizes that fiscal and monetary policy are two different things. What it says is that the government - unlike you and me - is creator of money, not merely a user of money. The Fed (which is part of the government) creates money. The Treasury (also part of the government) creates bonds. The bonds are not money, but they are assets of substantial value, to the non-government sector. They represent a way for people to save for the future. Since there’s a substantial demand for financial savings, a government that provides them is doing a service for the economy. The non-government sector, itself, cannot collectively create financial savings. Furthermore, the attempt by the non-government sector to create financial savings is not only futile, it’s recessionary. (BTW, and FWIW, the non-government sector can, and does, create “real” savings: office buildings, factories, homes, vehicles, etc. The problem with real savings, is that they are exposed to depreciation, risk, and must be maintained and/or managed. Financial savings, on the other hand - Treasury bonds, for example - require no maintenance, little or no management, are not subject to risk or depreciation.)
The article I shared might help, as it refers to Austrian economists.
There are a million articles about MMT on the web. And that’s probably not much of an exaggeration.
Anyway, MMT doesn’t dismiss inflation. It says that inflation, not the numerical size of a deficit or the debt, is the real constraint on deficit spending. And that, of course, the US cannot go broke, or run out of money, the way a monetary user (like you and me) can. So complaints that the US is going to run out of money, or that it won’t be able to pay its debts, are literal nonsense.
My own view is that the US should deficit spend in order to reach full employment. It should increase taxes/decrease spending when inflation becomes a problem.
It’s also my view - and I definitely don’t speak for MMT here - that increasing taxes should start at the top down, because the rich both contribute the most to inflation and because many of them don’t work: meaning that they don’t contribute to production. Inflation is what happens when production is unable to keep up with demand. It’s a supply and demand issue.
And, as a precaution: I don’t hate the rich. In fact, I’d very much like to become one of them.
Simplfications are often good! (But not over-simplifications 
). One virtue of Mosler’s MMT is that a lot of superfluous confusion is cleared away.
In technical senses, there are clear differences between fiat money and central-bank money. But one can simplify with the “consolidated statement” model, and agree that central bank money (for a sovereign-currency country) is akin to fiat money. The FRB’s program of QE makes that very clear. (If the “QE money” continues to grow, will foreigners “get wise” and start demanding higher dollar prices and interest rates? I don’t know. But psychology is beyond the scope of this discussion.)
And Mosler is of course also correct when he asserts that taxes are NOT to raise revenue, but to sop up excess spending power.
Again, LinusK shows better intuition than many of his detractors, although focus on bank accounting is beside the point. It is agreed by all that the U.S. should avoid an inflationary spiral; certainly MMT’ers agree with that. The real question is: Can their plans be implemented without inflationary pressure?
I agree with much of this. But I’m very reluctant to support a “guaranteed employment” plan (as the Kevin Spacey character does in House of Cards) without assurance that the new employment is productive, or at least productive training. Subsidizing private employment may be better than creating government jobs. Making the first $15,000 of wages exempt from SS tax would be a good start.
I’m interested in your comments. It’s been a few years - or at least a couple - since I read it.
Mosler, of course, can speak for himself. But I think the MMT view is that Federal government surpluses suck money and/or wealth out of the non-government sector.
The “non-government sector” is basically MMT-speech for the private sector. They use it for technical reasons, and so they don’t get bitch-slapped by critics for using the wrong terminology. It doesn’t mean exactly the private sector, so they use “non-governmental” sector instead. However, the two terms overlap. They’re often close enough for government work.
Anyway, when the government runs a surplus, that means it’s accumulating money in its Treasury account. That money comes directly from commercial banks’ Fed accounts, and indirectly from the checking accounts at commercial banks, owned by people like you and me, as well corporations and other businesses and organizations.
When banks, corporations, and people like you and me have less money, that means they have less money to spend. When people have less money to spend, they often cut back on spending. Spending, of course, is income to somebody else, so reduced spending is the same as reduced income. So the government, if it initially reduces private-sector spending, may begin a process, within the private sector itself, that’s self-reinforcing. People spend less, which reduces incomes, which reduces spending even more, which reduces incomes even more, etc.
I don’t know if Mosler is right that the Clinton surplus(es) led to the 2001 recession. Those surpluses, to my understanding, were relatively small, and didn’t last very long.
The wealth effect is another possible cause. When stock prices go up, people feel wealthier, and increase spending, which leads to GDP growth. When stock prices go down, they feel poorer, and reduce spending, which leads to falling GDP. There was a stock bubble in the 1990’s, which is what I think you’re referring to.
If it is, it’s important to note that people buying stocks (investing in stocks) is not “real” investment, from an economic point of view. Real investment is not just buying and selling stocks, or tulip bulbs, or gold. It’s building or creating things that last a long time, and that help increase production (or at least reduce the need for production) in the future. Houses, railroads, streets, better schools, new technologies, and even cars can be examples of real investment. Buying stocks is not.
But, like I said, a rising stock market can give people the illusion of wealth, which generates spending, and in turn drives GDP. Similarly, when a stock bubble bursts, people feel poorer, reduce spending, and GDP falls.
I personally don’t know whether the Clinton surpluses or falling stock prices - or both - were causes of the 2001 recession.
But when Mosler talks about investment, he’s talking about real investment, not stocks. He’s talking about spending money on - and the production of - new technologies, education, transportation and housing (etc.).
Thank you, nice article. It hadn’t occurred to me to compare the predictions of the money multiplier effect to the real world. And as your article shows, it doesn’t show up in the real world.
I liked this quote, by Alan Holmes:
This is what I would have said, if I was more articulate, and more knowledgable.
I’m curious what you mean by “fiat” money. The dictionary definition is:
Under that definition dollars are fiat money. Most, if not all, modern currencies are fiat money. Demand for fiat money comes from the ability of the government to require payment of taxes in its own currency. (And because dollars, for example, are a good store of value and a good way to pay for things that you want.)
But dollars are still fiat currency. The method the Fed uses to create them - buying Treasury bonds, for example - means that they’re “backed” by Treasuries. But when - or if - the Treasury buys them back, it will pay with dollars created by the Fed. In other words, if you consolidate the Fed and the Treasury (which is a perfectly fair thing to do - they’re only two different parts of the same government) the government is “printing money” - just in a complicated and round about way.
Which is a good thing, btw, just so I’m clear about that. A growing economy needs a growing money supply, and relying on commercial banks alone to increase the supply of money is dangerous and unreliable. When commercial banks are relied upon alone to increase the money supply, you wind up with an eventual and inevitable financial panic and a consequent recession or depression.
Btw, thanks for the compliment. Usually people just hate on me when I write these threads.
Which is probably fair. After all, this is a hobby, for me, that I do in my spare time. It’s not my full time job, like it is for Hellestal.
I added emphasis to that quote from Alan Holmes. It might be worthwhile to compare my own response in this thread. From Post Six:
Alan Holmes was an old Senior Vice President of the New York Fed.
Now here is the full quote from Holmes, meaning that I complete the last sentence instead of cutting it off like Steve Keen did in the cited article above. (PDF of original document)
Emphasis added. Keen actually had a mild violation of punctuation rules there. He should’ve ended his quote with a four-dot ellipsis.
I’m not partial to nitpicking.
But I really don’t like it when other would-be nitpickers don’t do the job properly. So I’m going to do this one last post.
This isn’t true.
Bank Reserves = Total Monetary Base - Currency in Circulation
The Fed controls the total amount of base that they’ve created. The Fed does not control how much cash is withdrawn from the system to enter circulation, and so it necessarily doesn’t control bank reserves. Theoretically, any central bank could decide it wanted to target X bank reserves and then attempt to immediately replace any cash that leached out of bank vaults. But there is a trade-off. If they wanted to target bank reserves directly, they’d have to give up influence on both interest rates and total base money. The trade-off isn’t worth it.
I don’t know a single central bank that targets reserve amounts. They target the interest rate with total base money, and let actual reserve totals go where the markets take them.
This isn’t true.
Banks lend out reserves literally every working day. If a bank makes a loan which is immediately cashed, the banknotes promptly shipped to Nicaragua, then the bank has lent out its cash reserves and not any commercial bank money. This is not just an academic distinction. Since 2008, total physical currency in circulation (outside of bank vaults) has expanded by more than half a trillion dollars. A big chunk of this is owing to increased international demand for portraits of Benjamin.
Only if a loan check is redeposited within the banking system, rather than cashed, can we say that the banking system has expanded commercial bank money with a loan. What is normally the case is not always the case.
This isn’t true.
Specifically the first sentence. Most Fed operations are outright purchases of assets, not directly lending to banks, but the Fed does lend money directly to banks both through its usual discount window and also during the financial crisis through the various facilities to prop up banks. And when the Fed lends money, it expects to be paid back, just as Frylock’s friend stated. There was no purpose taking issue with that perfectly true statement. If the Fed lent money without expecting repayment, that would be an open invitation to corruption. And in fact, the loans that the Fed made through its emergency facilities were often below-market and with substandard collateral. There have been major accusations of impropriety made against the Fed for these sweetheart deals. Most of the public cannot get financing for less than the market cost, but somehow the industry that was most irresponsible got treated with the most beneficial deals.
It has been argued that the fact of these loans were necessary for total financial stability. That might easily be true. I’m inclined to believe it, given how bad Fed policy was in other ways. But even in that case, the exact nature of those loans is still suspect, and even more broadly, the claim made by Frylock’s friend remains strictly true. The Fed expects that loans be paid back, and if the bank is unable to do so, then the bank will fail.
This isn’t true.
There are major political concerns about central bank balance sheets. If we all lived in a land of make believe and powers of the Fed were integrated with the rest of the government, then the Fed balance sheet wouldn’t matter.
But given the Fed’s quasi-independence, the size of the balance sheet comes with an immediately observable political cost. Fed chairs have to visit Congress in order receive their scheduled beatings. The FOMC has come under fire, with Congressional threats to restrict the Fed’s autonomy. The size of the balance sheet is the number one weapon that the opposition in Congress cites to criticize the Fed.
This is an equivocation.
Frylock’s friend had explicitly chosen a language of treating the Fed independently. It wasn’t even a hidden choice. It’s stated outright, clear as day. Rather than accepting the definition as given – which is how 99% of people talk about the Fed and the “government” – a useless nitpick is introduced. Bad pool.
It’s difficult to talk about the Fed and the government because the government isn’t in one piece. Treasury is executive branch. They spend the money. Congress is legislative. They appropriate the funds for Treasury to spend. There is no good word except “government” that lumps together both Treasury and Congress. Technically, that word should encompass the Fed as well. But the Fed is legally empowered to act independently. Treasury is guided by Congressional dictates every year, but the Fed is not. Their powers are changed only at irregular intervals.
That means the most useful distinction is to refer to the Fed and to the “government” as separate decision-making institutions. To call this a “mistake” is just horseshit, most especially when the other person explicitly acknowledged that the Fed is still a government agency. Frylock’s friend admitted the government prints money in the very next sentence.
This is the absolute worst part of your posts, LinusK.
It’s not the various errors. Those can be fixed. The problem is the blind dogmatic insistence on your own special unicorn literalist language that is contrary to how the rest of the goddamn world speaks. Absolutely everybody but some wacko libertarian loons realizes that the Fed is a government agency. This is not an issue. There is no confusion here. If someone says that the Fed “prints” and the government doesn’t, their meaning is crystal clear. (The loons are dead easy to spot. They speak about the Fed as a “private” institution. And don’t even get me started on people who bring up the Bureau of Engraving and Printing…)
Now, I’m tired of nitpicking the nitpicking, so unless there’s a specific question for me I’m going to bow out. But I would strongly recommend figuring out how real hyu-mon language works before attempting to correct other people as if this is the first time you’ve ever visited the planet.
Confusing thread is confusing. I thought you two were basically agreeing at the top of the thread, but now there are curses being thrown and strong disagreement is happening. Somewhere in the middle MMT was brought up, and I thought Hallestal was speaking sympathetically about it, but now it appears he is vociferously and angrily agin’ it? I don’t know.
Money is hard.
Like I don’t even know what there is to disagree about. I am flummoxed by the fact that, apparently, well-informed intelligent people can disagree about the basic facts concerning what, in a purely mechanical sense, is actually happening to the money in our economy–where it comes from, where it goes.
I don’t know what to make of this.
Probably I’m just misunderstanding the conversation.
I hold MMT’s conclusions in contempt. But this is the like the uncanny valley. My contempt would be less if they disagreed with me on more things.
Where we agree:
- There are sometimes aggregate demand shortfalls in the economy as a whole. This is so obvious that it hardly needs to be stated.
- More money can stimulate more demand.
- The “government” (variously defined) can create more money.
- This means we have an easy tool to fight demand shortfalls.
From there it goes haywire. My uncharitable interpretation of MMT’s next step would be:
- In order to use this tool, we should take a pistol, aim firmly at our own temple, and pull the trigger.
MMT doesn’t start badly. The first steps are an attempt to describe the money system with a literal language. Nothing wrong with that. As long as they’re clear about what they’re saying, then it’s just fine. And frankly, there are plenty of talking heads out there – including real economists, to my chagrin – who don’t understand the literal reality. So MMT starts with a literal language with the belief that the rest of the world is confused.
The problems begin immediately thereafter. At least some of them have convinced themselves that everybody is confused except them. So we have cases like the OP here, who “corrects” other posters even when it’s crystal clear that no mistake has been made.
The key dispute is between monetary policy and fiscal policy. In essentially all advanced countries, these two powers are legally separated. In the United States, monetary policy belongs to the Fed and fiscal policy belongs to Congress.
Monetary policy is creating new base money. The Fed creates and destroys money in its manipulation of interest rates and its targeting of broad nominal variables like the inflation rate. The Fed influences the business cycle with these choices, cooling things down when inflation is running too hot, and heating things up when there’s crisis, as in 2008. Fiscal policy is taxing and spending. Congress decides the tax rates and appropriates money for Treasury to spend. Congress can increase the deficit by cutting taxes or increasing spending, or they can try to cut the deficit with higher taxes and less spending. Their concerns when making these fiscal decisions should include long-term growth and debt sustainability.
Economists have been arguing about the proper roles of these two powers for at least 80 years.
The current conclusion of some major mainstream economists, like Paul Krugman, is that the breakdown I outlined above is entirely appropriate. Monetary policy is normally more powerful. So let’s say Congress thinks the economy needs some stimulus and raises spending in order to heat things up. Then in normal times, what happens? If the Fed thinks things are already fine, then the Fed will increase interest rates and completely nullify the effect of fiscal spending from Congress. The “fiscal multiplier” will be approximately zero. Congress’s attempt to stimulate the economy will almost completely fail. The Fed has the power to stop it.
In order to stimulate the economy, you have to convince the Fed board to do so. Anything else will be a waste of time. I want to emphasize again that this is mainstream opinion. Very few “reputable” macroeconomists doubt that the Fed can pull back on the chain whenever they want.
However, there is an important exception that applies right now. The conventional policy instrument that the Fed uses, according to many mainstream economists, is the interest rate. When interest rates hit zero, they believe there is finally some possibility that fiscal policy can stimulate the economy. Rates are basically zero, right? So they believe the Fed has run out of conventional ammunition. That means Congress’s decisions to tax and spend can actually have a genuine effect. When interest rates are zero, Congress can pass a stimulus and the Fed won’t yank back on the chain. This is the belief of many mainstream economists like Paul Krugman.
But you have to understand, this is a special case. The “liquidity trap”. In an era of more normal rates, there’s no point in Congress doing any stimulus because the Fed is the institution that steers the nominal economy.
MMT goes against that. They are fiscalists. They are hyperfiscalists. The OP wants the Fed to keep rates near zero perpetually, and then have Congress exclusively influence the business cycle. This is like advocating fighting a bear blindfolded, with both hands tied behind your back. It’s insane. Under Reagan, the deficit exploded in the 1980s (fiscal policy) but inflation came down sharply. All that fiscal “stimulus” from those gigantic deficits, and they didn’t increase inflation at all because the Fed was tightening so strongly. There are plenty of other major examples, including modern European deficits in the eurozone. Central banks have major mojo.
I stand slightly apart from the mainstream, in that I think the central bank maintains its mojo even when rates are zero. The “liquidity trap” is, in my view, purely a political effect. It’s an excuse for the Fed to dodge responsibility for their choices. This is, in fact, the primary reason I returned to grad school. I intend to gather evidence that can better show one way or the other.
But I want to emphasize, again, that the mainstream divide is not whether the Fed or Congress is the main power in steering the nominal economy in normal times. That discussion is over. Central banks won. The mainstream divide is whether the Fed remains the main power, even when rates are near zero. I say yes, but as I was writing earlier to Measure for Measure, the case is strong but not a complete lock. There is room for disagreement.
The hyperfiscalist conclusion of MMT has basically nothing going for it. It’s all theory in the clouds, nitpicking the language of others rather than focusing on data, because there is no data. Deficits were relatively lower as a percentage of GDP in the 70s when inflation exploded. When deficits rose in the 1980s, inflation came back down. European deficits are extremely troublesome within much of the eurozone, but inflation is muted and even negative in some places. Monetary policy is obviously an extremely important tool. The only remaining question is not whether we should rely on fiscal policy exclusively. The actual question is whether there remains any place for fiscal policy at all to regulate the business cycle.
Discussing whether the conventional story of money creation is a “myth” doesn’t get us even a single step closer to answering that question.
Hellestal, I’m going argue with some of what you wrote in post #34.
Starting with Mr. Adams and Ms. Bertram:
This is an accusation you’ve raised with me, but in this case I think you’ve made the mistake: confusing bonds with money.
I want to start with the money. If B purchases bonds, she’s exchanging money for bonds. If she buys them from the government, the money is immediately spent back into the economy, by the government. It becomes “hot money” again. If she buys them from someone else, that someone is presumably someone who wants cash, rather than bonds (or else he wouldn’t be selling his bonds for cash). If he want’s cash, it’s presumably in order to spend it. Again, it’s still hot money.
To put it differently, money is not locked up, or even slowed down, by the government issuing Treasuries.
If you look at it from the Treasury point of view, when the government prints Treasuries, it simply adds assets to the non-government sector. It’s not adding to or subtracting from the amount of money in the economy, but it is increasing the wealth of the non-government sector.
Increasing people’s wealth has an effect on the economy. When people have wealth, they tend to “save”* less and spend more. It has an effect similar to rising stock prices, or rising home prices. The additional spending increases the velocity of money, adding to GDP and increasing employment.
Looking at it from the top down, that’s the net effect of printing Treasuries: it increases the net wealth of the non-government sector, and creates a wealth effect, which tends to encourage spending, and increase GDP and employment. In other words, Treasuries, all things being equal, Treasuries tend to increase the speed of money, not slow it down.
There is certainly a point where production can’t keep up with demand. When that happens, inflation is the result. Printing Treasuries increases demand. Not by adding money, but by creating a wealth effect. Printing Treasuries has no effect on the amount of money out there. But, other things being equal, it tends to increase velocity.
Quantitative easing - which is what is what happens when the Fed purchases bonds previously printed by the Treasury - reduces the number of Treasuries in the non-government sector, and replaces them with money. Considered by itself, QE has no effect on the wealth of the non-governmental sector. It simply exchanges Treasuries (by buying them) with money (by “printing” it).
So the Treasury increases wealth without increasing money.
The Fed increases money without increasing wealth.
But when you combine they’re doing, collectively - by printing bonds, and then swapping them for money - it is just the same as “printing money”. It’s just a more round-about way of doing it.
The government is already printing money, and has been for years, and the result has not been prices spinning out of control; it’s been greater employment and higher GDP.
I can’t be too careful about saying this, so I’ll say it again. Just because the government has been printing money for years, with consequent substantial improvements in the economy, and low inflation, doesn’t mean the government can do it indefinitely. If or when the point comes when production can’t keep up with demand (because, for example, of a labor shortage) the result will be inflation. (Also: increases in wages and salaries, as employers compete for employees, in an effort to keep up with demand.)
At that point, it becomes a policy issue: how much inflation are we willing to put up with, in exchange for full employment, and increases in salaries and wages?
I’d argue, that given that wages and salaries have been stagnant for so long, and given that so much of the country’s wealth is owned by so few of its citizens, that inflation as high as 5-7% is acceptable, if it leads to higher incomes for middle and lower-class workers, effectively eliminates unemployment, increases GDP and real wealth, and helps alleviate the income gap between the very rich, and everyone else. YMMV.
I’ve sort of already addressed this, but I think it’s worth addressing again: The bonds don’t move, but the money does.
You’re focusing on the fact that people who’re predisposed to purchasing safe, low-yielding investments often purchase Treasuries. But those same people would be equally predisposed in favor of safe-low yielding investments, whether or not it was government printed bonds. If there were no government bonds (because, for example, the Fed purchase them all) they’d just have to purchase some other investment, like a CD, or high-rated corporate bonds. In other words, people who want to save, will save. Treasuries don’t cause them to do that.
I think this is just wrong. The amount of reserves is determined by only a few things. First, and most important, is the Fed. The Fed creates reserves by buying things (usually Treasury bonds) and eliminates them by selling things (usually Treasury bonds). Another, and less important factor, is an increase in the amount of money people choose to hold as currency. Governments can affect the amount of reserves in the banking system by hoarding money in their reserve accounts.
The banks themselves, however, are not in control of any of those things. For the most part, the total amount of reserves in banks is whatever the Fed decides it should be. Banks themselves, cannot loan out reserves. They can only loan out commercial bank money.
Banks can purchase things - like, for example Treasury bonds - but since spending is income to somebody else, purchasing Treasuries only shifts reserves around. It doesn’t eliminate them.
The Fed may not be purchasing Treasuries for the purpose of financing government spending, but that is exactly what it is doing. And I’d argue that the purpose is irrelevant so long as the effects are the same. And I’d argue it’s not “nearly always a terrible idea”. Recent history suggests it can be a very good idea.
The problem is that you’ve made these sorts of arguments before.
I responded to several of them in previous threads. I tried to walk you through a different way to think through some of these issues in previous threads. I pointed out what I perceived to be holes in your argument. You didn’t respond to the issues I raised, as I noticed in the last post of the first thread I just cited. You left with those issues almost entirely unacknowledged. Then later you started new threads and made the same mistaken assertions all over again.
I took a dim view of this behavior.
I’m willing to walk through these issues again. This stuff isn’t easy. You’re trying to argue a “balance sheet effect” (what you call a wealth effect). This balance sheet effect does not work as you believe. I’m willing to rephrase my previous arguments in a way that might make more sense this time around. But if I make a criticism against your argument that goes unacknowledged, if I see an error that’s not admitted, only to see the same argument or error resurface three months later in another thread, my current dim view is not likely to change. You should also know that my patience is much more limited past the first page of one of your threads. My expectations are low based on previous experience. If few other people are reading, as would often be the case past post 50, there’s less incentive for me to put extended effort into the explanations.
The point is that the total amount of base money stays identical when the government issues Treasuries. If the government were to issue new currency in order to finance its spending, then total base money would increase rather than staying the same.
Before the present “liquidity trap” conditions, there was an extremely strong relationship between increases in monetary base and the inflation rate. Robert Barro’s macro textbook lists part of these relationships.
Country MB growth RGDP growth Inflation Time period
Brazil 77.4% 5.6% 77.8% 1963-90
Argentina 72.8% 2.1% 76.0% 1952-90
Bolivia 49.0% 3.3% 48.0% 1950-89
Peru 49.7% 3.0% 47.6% 1960-89
Uruguay 42.4% 1.5% 43.1% 1960-89
Chile 47.3% 3.1% 42.2% 1960-90
Yugoslavia 38.7% 8.7% 31.7% 1961-89
Zaire 29.8% 2.4% 30.0% 1963-86
Israel 31.0% 6.7% 29.4% 1950-90
Sierra Leone 20.7% 3.1% 21.5% 1963-88
. . .
Canada 8.1% 4.2% 4.6% 1950-90
Austria 7.1% 3.9% 4.5% 1950-90
Cyprus 10.5% 5.2% 4.5% 1960-90
Netherlands 6.4% 3.7% 4.2% 1950-89
U.S. 5.7% 3.1% 4.2% 1950-90
Belgium 4.0% 3.3% 4.1% 1950-89
Malta 9.6% 6.2% 3.6% 1960-88
Singapore 10.8% 8.1% 3.6% 1963-89
Switzerland 4.6% 3.1% 3.2% 1950-90
W. Germany 7.0% 4.1% 3.0% 1953-90
The question is what’s likely to happen when the government finances with base money. The answer pops out of the data. There is a strong relationship between more base money and more inflation before the “liquidity trap” era.
There are a couple slightly more subtle things to notice here. First is that the relationship is stronger in high inflation countries. In the low-inflation group, the relationship isn’t as strong, because in low-inflation countries, “real” factors in the economy have a disproportionately strong effect on any price changes. This makes sense because price changes are so small, “real” factors are better positioned to push around nominal figures.
This relates to the reason why “liquidity trap” conditions can only happen in low-inflation countries, but that’s a more troublesome area.
Let’s posit that this is correct.
The federal government has a deficit. They issue Treasuries to finance the deficit. There’s a “wealth effect” (a balance sheet effect) that increases the velocity of base money, with total base money held constant. All else equal, as you said. This means expected NGDP has increased. There is more aggregate demand.
The problem here is that all else is never equal in macro.
The microeconomists can get away analyzing the effects of a price change on a single good and then flatten out the rest of their analysis by ignoring the rest of the world. Macro theorists, in stark contrast, must have a theory of general equilibrium (or cynically stated, a theory of general disequilibrium) where we try to come to terms not only with an effect but the rest of the economy’s reaction to that effect. Most important in this context, we have to consider what’s sometimes called the Fed reaction function.
How does the Fed react to more bond issuance? Might they raise interest rates? Might they pull back on the chain? For an example of this idea, here are some PDF notes from former Treasurer of Australia Wayne Swan:
The question is not whether the issuance of more Treasuries might lead to more demand all else equal. The question is whether more Treasuries will lead to more demand all else not equal, if the central bank intends to offset any fiscal operations. If the monetary authority has a firm nominal target of a macroeconomic variable, then the fiscal multiplier will be approximately zero.
Yes.
But inflation can also result when there is still slack in production. Inflation was positive from 1934 to 1937 during the early New Deal, even when the unemployment rate was still over 10%. Unemployment was coming down after the inauguration of FDR and the abandonment of the previous gold peg, but it was still double-digit. There was high unemployment and rising prices.
The difference between the two time periods, 1929-1933 and 1934-1937, was that NGDP was plummeting during the Great Contraction, while NGDP was rising during the early New Deal. Prices can rise even when there is still productive slack in the economy, as long as total spending is on its way up. When there is no more productive slack and demand keeps increasing, then that’s when inflation really spikes. When there is slack in the economy, any increase in demand will be felt predominantly with more real production. Predominantly, but not exclusively. Some of the extra demand will be felt in price increases.
This is flatly wrong.
This is by far the most important mistake that I was pointing out previously. This is one of the issues that I was pressing the most.
You’re looking at a balance sheet like it’s a static device. As if the numbers recorded in the balance sheet are carved in stone. Asset for asset, one value exchange for an equivalent value at a given point in time.
This is the burden of accountants as they record transactions and draw up the financial statement. Any particular balance sheet is created at a single moment in time. It is a snapshot. Or to look at a specific ledger entry, any purchase of an asset is going to record the price of the asset at the time of the purchase. If a bank sells some Treasuries to the Fed, they will record something like:
DEBIT Cash reserves 1000k
CREDIT Treasuries 1000k
But that entry exists in a static point in time. It does not register what price the Treasuries were last week. It does not record what price Treasuries will be two months from now. If you want to think about the balance sheet effects (the “wealth” effects) from Fed asset purchases, you absolutely cannot look at that single moment and say that like was exchanged for like, and that no financial wealth was created or destroyed. That is completely wrong.
Suppose bonds were trading at 95 last week when the Fed announces a new round of asset purchases. Bond prices rise to 98 when the Fed makes its purchase. Saying that the Fed purchased a bond priced at 98 on the day of purchase tells us nothing about the net effect on the balance sheet, because the important price movement happened before the purchase when they originally announced their intention to buy stuff. That right there is a “wealth effect”, caused by the extra liquidity increasing demand in that particular market.
But Fed purchases can have more than one effect. Suppose bonds were priced at 99 last week, and the Fed made an announcement that it would be targeting a higher inflation rate. Some economists are recommending a target inflation rate of 4%, so there is no more danger of hitting zero when a recession strikes. Maybe the Fed listens to them and raises the inflation target. Then the Fed promises to make a lot of purchases to increase the amount of monetary base in the system for the specific purpose of increasing inflation. The price of bonds might actually fall to 96. The Fed is a new purchaser, yes, but the increase in inflation expectations means that the long bond prices will fall when the Fed announces its new target. (Long bonds are more vulnerable to inflation since it takes longer to mature.) If we look at the very moment of the transaction, it looks like bonds priced at 96 were sold at market value. If we look at the dynamic situation, we see that everybody holding Treasuries took a hit the moment the Fed made its announcement. The wealth effect happened before the purchase.
You cannot cannot cannot look at a static event of a single purchase and say there was no “wealth effect”. You cannot even look at the Treasury market alone, and ignore other markets, because expectations of a better economy will increase the value of companies because those companies will be expected to be more profitable. A superficial read of static financial statements won’t pick up on this dynamic real wealth effect.
Then you are mistaken.
This is plain fact. It’s not up for debate.
We’ve already seen this isn’t true. It is wrong on multiple levels. You are, once again, repeating previous flawed arguments rather than directly engaging the criticisms against those arguments.
This will be the last time I correct this.
First and most important, and previously mentioned quite clearly in this thread, a bank must have reserves on hand in order to make a loan. The majority of loan checks are going to be deposited at a different bank. Without the available reserves to lend out, a bank simply cannot make a loan. It will be insolvent.
You cannot look at the total reserve balances of the banking system as a whole and say that everything is swell, because individual banks will be loaning based on their individual liquidity situations. From the perspective of an individual bank, they must have the reserves on hand if they’re going to make a loan. Those reserves might stay in the banking system (maybe) but that does not mean that those “same reserves” will come back to the same bank ever again in the future. The individual bank might fail based on poor decisions. The flow of reserves out of the bank to the public and to other banks might perpetually exceed the flow of reserves back in (at a price that the bank can afford to pay). That’s why the interest on excess reserves is an important effect for bank lending, though not the most important effect. If an individual bank is earning 0.25% on excess reserves, that’s a slightly better return than 0%. They’re making a little bit of money doing nothing with the reserves.
This is not about the banking system. It is about the profitability of a single bank.
If the Fed stopped paying interest to banks for excess reserves, that would decrease profitability for each individual bank holding those excess reserves. A single bank would look at that situation and maybe decide it was worth the risk to make a loan with its excess reserves instead of holding the 0% asset of cash. They might make loans.
A certain percentage of those loans would expand the supply of commercial deposits of the system as a whole. But that doesn’t matter to the individual bank. The individual bank is interested in its individual profitability, and the bank will fail if it can’t attract enough reserves back in a cheap manner to balance the reserves that get leached away.
Bottom line is that it is flat fucking wrong to say that banks don’t lend reserves.
Now there is one possible way you might believe can salvage that sentence. You can start talking about the “banking system”. The banking system, you might say, cannot loan out reserves. You avoid the literal error just above if you express yourself that way, but then you just introduce another error. When the banking system expand deposits with loans, the holders of those deposits will decide to take a certain amount in cash. The exact amount is going to depend on many factors, but it’s not at issue that the public at large has a certain demand for physical currency compared to deposits, and an increase in total deposits from a spike of lending will change the ratio of deposits to currency, which will tend to encourage more cash withdrawals at the margin.
The net result is that any increase in bank lending from the banking system as a whole will mean a certain chunk of the loan kept as deposits, and a certain chunk of the loan converted into currency. (The relative sizes of the chunks will fluctuate.) And at this point, you’re trying to make the argument that, golly gee, it’s the public’s decision to withdraw cash, and not the banking system’s. If the public takes cash, that’s their choice. The banking system can only make a loan by increasing commercial bank money.
Your claim here: “The banks themselves, however, are not in control of any of those things.” That’s still not true.
Your statement is not true no matter how charitable I try to be. The public doesn’t just randomly choose how much cash it wants. It depends on a lot of factors, but one of those factors is how much banks offer in interest to their depositors. This is part of the bank’s cost of funding. If banks think more liquidity from the Fed is coming for cheap, then they won’t give a shit about offering good rates for deposits, and the public will subsequently tend to withdraw more cash from the system than otherwise. It’s the banks’ decision whether to provide an incentive for the public to keep more of their liquid assets in deposit accounts instead of cash.
Another factor of the public’s money demand is the perceived stability of the financial system as a whole. The entire public make try to demand cash all at once, a gigantic bank run. Don’t say that the Fed will always in every case stop this from happening. The Fed didn’t stop the bank runs of the 1930s. Deposits are federally insured today, but only to a certain point and only in commercial banks. What we saw from 2008 was a run on the shadow banking system: everybody wanting their cash at once, which was causing stress in the system. Something similar might happen in Greece if they exit the euro. (Though the Greek people have been preparing for this for a long time. They’ve had an extended bank walk for some years, rather than a quick bank run. The ECB has been propping up the system, and that might just bite them in the ass soon, which would be entertaining watch in a depressing sort of way.)
The point of all this is that the banking system has a great deal of influence on how much of the average new loan is withdrawn in cash, and how much stays as deposits. They obviously don’t have total control. But this isn’t a binary situation. You can’t honestly claim they are “not in control” with an absolutist statement, while ignoring how banks can nudge things at the margin. Banks can lure reserves back from the public if they want to pay the price for doing that. They’re not omnipotent in this, but they can nudge. Bottom line is that banks lend reserves. Even the banking system as a whole lends reserves, based on the incentives that the system provides to customers to maintain deposits rather than withdraw cash.
It’s a primitive theory that assigns to banks only one decision while ignoring important others dimension that they influence. Banks can attract more reserves by paying higher rates, and so slow the leaching of reserves out of the system. This power doesn’t have to be absolute in order to exist in some form.
One last time for emphasis: a bank can decide to decrease the incentive of its customers to maintain deposits by cutting the rate they pay on deposits.
It’s hardly any wonder that more than half a trillion in physical cash has leached from the banking system since the beginning of 2008. US banks have continually cut rates and now they’re paying almost nothing. There’s no incentive for them to pay for deposits when they can get reserves cheap from other sources. That, in turn, means there’s relatively more incentive for the public to keep cash. The opportunity cost of cash is very low in a time of low rates and low inflation. In this case, the “public” tends to be more international but the argument is the same. More foreigners would be keeping their cash in US institutions if those institutions were paying higher rates.
That’s a dumb argument. The purpose is essentially everything.
The purpose is 99% of what makes the entire system work.
If inflation suddenly jumped up to 6% under the Fed’s current purpose, they would be yanking back on the chain. They’d be collapsing their balance sheet, sucking liquidity out of the system, raising interest rates, throwing up the big red stop sign, and ending the party. If you ever read their regular policy announcements from their scheduled meetings, a big chunk of the minutes details the worries from the FOMC members and the hope that they can start yanking back the chain sooner rather than later.
They want to normalize rates. They want it bad. They say it every chance they can get. They are itching to raise rates this year.
And every single banker out there knows it. Every single banker out there has seen Chekov’s conditional gun ostentatiously displayed in the first act. They can feel it in their ulcers that if they start lending at 2% today, they might suffer big-time if rates jump to 3%. In that case, they’d be losing money. They’d be in trouble. So every loan decision that a bank currently makes is with at least half a mind thinking about the future, about the conditional pistol that might fire at them if they’re not careful, and how screwed they would be if they overexpose themselves. All of this is because the primary purpose of the Fed is to think about inflation and the broad economic situation, and not about the government’s financing needs.
The base money that the Fed has created is conditional. It’s not permanent. The base money that’s been created is totally dependent on the broad macroeconomic situation, and the government’s budget deficits are irrelevant to that. If US debt was low and there weren’t many Treasuries, then the Fed would be making essentially the same size purchases, they’d just be doing what the Swiss National Bank does and buying up more international assets.
This is all-important stuff. Chekhov’s conditional gun guides their actions. When we look at interest rates and wonder when rates will start to rise, we’re looking exclusively at the broad economic situation. We don’t give a shit about the budget deficit directly. Banks making loan decisions don’t give a shit about the deficit directly. They care about expected inflation. They care about the conditions that will cause the Fed to pull that trigger. The purpose is controlling inflation. QE is conditional, not permanent, because it would be reversed if inflation started ticking up quickly. The deficits are simply not a relevant factor. (Obvious deficits would become more relevant to monetary policy if US debt were in a more precarious position, but that’s not the case at present.)
If the Fed’s purpose were different – if there were a different condition to pulling that trigger – then bank behavior would be vastly different. If the Fed shredded half the assets on its balance sheet, so that it no longer had enough things to sell to suck all the cash out of the system, then QE would be effectively permanent. You’d better believe monetary velocity would explode in that case. The Fed might have to sell every remaining financial asset it had to keep things under control.
Purpose is so important that almost nothing else matters.
I agree with you and Holmes. In the short run, the Fed has little choice but to supply reserves that are needed. In the long run, the Fed can influence commercial bank lending by raising interest rates, which reduces demand for loans.
I agree. Neither banks nor the Fed directly control the demand for Federal Reserve notes. (They can influence it, by raising interest rates, but they don’t directly control it.) To the extent people choose to hold cash - and holding everything else the same - each dollar of currency withdrawn is one less dollar of reserves.
I agree. Holding everything else constant, each dollar of currency is one less dollar of reserves.
I agree. When I said, “When the Fed lends money, it also creates money,” I meant to say “When the Fed lends money or purchases assets, it also creates money.” I realize that most Fed spending is on assets - specifically bonds. Since bonds are loans, I took a shortcut. My bad.
I agree. The Fed is part of the government, and its degree of independence is determined by law. Congress could, if it chose, change the rules. When I said, “the size of the Fed’s balance sheet is irrelevant, to the Fed itself,” I was trying to exclude political considerations. The people at the Fed, I think, understand that the Fed can’t go “bankrupt”. But there are people in Congress who don’t understand, and because they’re in Congress, their opinions are important - even if they’re misinformed. But you’re entirely right: the people at the Fed have to take into consideration the opinions of the public and of Congresspeople, even if some of them are uninformed or misinformed, about what the Fed is doing. Which is why it’s so important to get them to understand.
I think the sentence you’re referring to is this one: “The government does in fact print money.”
I won’t back off of that statement. If your complaint is that I used it in the wrong context, you may be right. (Honestly, I’m too lazy to go back and look.)
But as far as the statement itself is concerned, it’s correct. The US uses a round about way of doing it, but it does do it, and it should continue doing it.
As long as people don’t realize the government is the source of money, and not a mere user of it, the US will continue to stumble from one unnecessary recession to another. Employment - which is the real source of wealth, in every country - will continue to be artificially and unnecessarily restricted. People who could be creating real wealth will instead be collecting unemployment checks (if they’re lucky). And we’ll keep hearing about how the budget has to be balanced, and how we’re creating a debt for our grandchildren, and we’ll continue to follow self-defeating economic policies.
I don’t really get your complaints about “unicorn language.” The statement is literally true, using the standard English definitions for each and every word.
The only way to make it untrue is to pretend the Fed is not part of the government. But it is part of the government. You know it’s part of the government. So what’s the point in pretending that it’s not?
The Fed is a private consortium of commercial banks which operates independently of the government.
Measures like reserve requirements have little effect on M2. See the article shared earlier for details.
Much of money supply is created not by government or by central banks but by commercial banks as loans are extended.
Finally, money is a fraction of total credit, with the largest component consisting of unregulated derivatives. The notional value is estimated to be between $600 trillion and over a quadrillion dollars worldwide.
Delusion.
First: Everyone understands the government creates money.
Second: Educating the peoples is only a tiny little step in the art of persuasion. A populace with detailed knowledge of the mechanics of money would still disagree with you because most of them would believe that what you suggest is a bad idea.
The budget should be balanced-ish.
The debt is a burden.
I don’t disagree with you because I’m ignorant. I disagree because I think what you suggest is a bad idea.
No one is pretending anything.
No one is pretending the earth is motionless when they use the world “sunrise”.
You may be confusing your contempt or me, with contempt for MMT. I may fully deserve your contempt, but you should try not to confuse me with MMT. Like I said before, there’s plenty of people who know more about it than I do. I linked Mosler’s Seven Deadly Innocent Frauds of Economic Policy earlier, but Mosler’s not an academic. The main center for MMT research in the US is UMKC. They run a webpage called New Economics Perspectives. Some of their leading researchers includeL. Randall Wray and Stephanie Kelton. James Galbraith, at UT-Austin, regularly lends his voice to MMT, but when I talked to him, he also disclaimed MMT. So I don’t know what’s going on with him. :dubious:
To my understanding, MMT is to academic status what being in the marching band is to High School popularity. (Yes, I stole that from John Oliver.) So I’m not asking you to adopt it or anything. Just keep an open mind.
I think everybody agrees central banks have Mojo Jojo.
The proposal to keep interest rates indefinitely low is mine. So far as I know, it’s nothing that comes from MMT.
Again, the proposal to keep interest rates low is mine, not MMT’s.
Hallestal, what is the power the central bank yields when the interest rate is zero?