No, that is not how it works. What you are suggesting that banks do is write a loan and then go find money to cover that loan. It is the equivalent of writing a check for groceries figuring that you will have the money by the time the check clears. That is a very dangerous game, and I imagine would get a bank shut down pretty quick.
Interbank lending is done to make up for temporary shortfalls in cash. Besides, that lending is still dependent on deposits. If, for example, Bank A has an unexpectedly high number of withdraws and is short on money for the next week. They call up Bank B and strike a deal to borrow the money they are short. That money comes from deposit accounts at Bank B. To continue with my format:
My deposit account: $10 (number on a ledger)
Bank A’s drawer: $2 (in a drawer)
Bank B’s drawer: $5 (in a drawer)
I wrote a check yesterday for $3 that has reached the clearinghouse. Bank A doesn’t have enough money to cover that check. So, they call up Bank B and ask for a loan of $1. It then becomes:
My deposit account: $10 (number on a ledger)
Bank A’s drawer: $3
Bank B’s drawer: $4
Now Bank A has enough money to cover the check, but that money came out of Bank B’s drawer, which ultimately came from deposit accounts in Bank B. The term “create money” is a little bit sloppy. Bank A can’t simply poof a $1 into existence. What banks do is multiply existing dollars into more dollars. They do this by double (or triple or quadruple) counting the same dollar.
We’ve already gone over this. The treasury can print money. Which, actually, is a very important point. If there is no initial money print, there is no currency, and no way for banks to create money. Really this is a very important difference. Governments create money. Banks multiply money.
I’m getting a huge sense of deja vu now. I feel like I’ve written these bank posts in another thread, and I think you wrote a big and excellent post like this as well.
Linus, you need to really back down on the acocunting definitions and get back to some basics. I get the sense you are in real confusion over what is currency and what is money. Currency is a subset of money; the fact that there is X in currency and 8X in money doesn’t mean the 7X that is not currency is somehow nonexistent.
In the last ten years I have deposited well over half a million dollars in my bank account. I have not, in that entire period of time, deposited a single cent of currency.
Yes, that is exactly right. Central bank money is a liability only in a technical, accounting sense. (You could even use the word “fictional,” if you like.) The central bank, in reality, does not have to pay the money back. It is, in our particular case, what allows the government to spend whatever amount it chooses to spend, without the constraints that apply to households or businesses. It’s what makes involuntary default by the Federal government impossible. The Fed could, if it chose, purchase every Treasury in existence, plus every Treasury issued in the future, without ever running out of money.
The monetary base (cash and Fed funds) is created when the Fed issues money - a (fictional) liability on the Fed - in exchange for government debt. The extra step - where the Fed swaps money for Treasuries - is not really necessary, but is a sort accident of history. In any event, the final result is the same - the Fed and the Treasury, acting together, can finance any amount of spending, without recourse to bond markets or even tax receipts. Those things - taxes and bonds - are helpful and necessary for other reasons - for example, to control inflation - but they are not necessary for funding government.
This is the most controversial aspect of MMT.
Again, this is one of the arguments that MMT makes - although you’ve stated it a little differently. The way it’s usually said is something like: Only the government can provide new net savings to the private sector and therefore the government must (or at least should) provide them when they’re required.
MMTers don’t advocate hyper-inflation. They advocate taxing more and/or spending less when inflation is a problem. The difference between MMT and traditional Keynesian, as I understand it, is that MMT holds that the purpose of taxation is to prevent inflation, not to fund spending.
The mechanism for destroying money is taxation.
I agree with almost everything that you’ve said here.
If you understood me to say that banks don’t need Fed funds, or that there’s no incentive for them to obtain deposits (because deposits allow them to obtain those funds), that’s not what I intended. My point is that banks lend first, and obtain funds (if they’re needed) later, and that it is lending that creates deposits, not the other way around.
I would argue, however, that it’s higher interest rates that crimp lending - because there are fewer willing and qualified borrowers - not banks’ fear of running out of money.
That description misses completely what taxes actually are.
The creation of new money is not an alternative to taxation. The creation of new money, if it used to finance government spending, is itself a kind of taxation. Specifically, it’s a tax on holders of cash. You can’t claim that a government can go without taxes as long as it makes more money, because making more money to pay its bills is itself one form of taxation.
The total output of an economy is limited. A government that wishes to provide services must claim some percentage of total economic output for itself. This can be done either “coercively”, through enforced taxation, in which the government simply steps boldly forward and claims for itself a certain amount of resources; or it can be done contractually, through borrowing, in which private investors willingly give up a certain amount of resources in the present, based on the promise of receiving the same resources back, plus an additional fee, in the future. That makes it looks like two options there, taxing or borrowing. But the government can’t borrow forever. It must eventually resort to taxation, to pay back its debt. Government borrowing in the present is a promise to tax in the future, either through conventional taxes or through higher future inflation, which is another kind of tax. It comes down to taxation either way.
(Just to be clear: The government can sustain a certain amount of debt in perpetuity, by pushing back the promise to tax indefinitely, so long as someone else steps forward to buy more bonds. But that doesn’t negate the point. The ability of the government to borrow funds from investors in the present ultimately rests on its ability to tax in the future.)
The best taxes are those that go through the normal legal government revenue channels. But if the government chooses to inflate away its debt burden, that is also a kind of a tax. Inflation through massive money creation is a way for the government to stake its claim on our limited resources. The people who hold cash must give up a portion of their claim on resources, through diminishing purchasing power. This kind of sneaky taxation, when overused, tends to undermine the productive capacity of the total economy, which means it’s a foolish way to tax when it’s done to Zimbabwean excess. But the whole thing is about access to resources, not money creation vs VAT or whatever. Taxation is about resource allocation at its core, regardless of the technique.
Then it would seem to be just a empty definition game. Inflation based on printing money to pay government bills is itself a kind of tax. It is a technique for the government to claim resources in the present.
If MMT is keeping the concepts the same, and just shifting definitions around arbitrarily, then I don’t see much point to it.
That is an unacceptably incomplete description of things, superficial to the point of error.
Taxation destroys bank deposit money, but only until the government spends its base money again.
A reduction in the national debt is the destruction of government bonds, government IOUs, but these bonds are not themselves a kind of money unless you are stretching the definition of “money” well past M2 and into even murkier realms. T-bills are close substitutes for money, but they are not money in the normal sense. They are not a medium of exchange. They’re useful as collateral in the repo markets, which means in certain cases we’re getting into M3 territory here, but that only means that these bonds can be considered a very, very broad measure of money in very limited applications. This is so limited an application that the Fed has stopped recording the M3 because it didn’t find it to be a statistically useful figure. To be clear about that: It is obviously useful for the people who are using it, but it is not useful as a measure of money.
Taxation is not about money destruction. It’s about seizing a certain percentage of our yearly resources for government purposes.
The standard mechanism for destroying money – by which I’m talking base money, which in turn creates pressure to reduce all the broader money supplies – is a reduction in the Fed’s balance sheet. That’s the normal method of destroying money, and such a technique is not a form of taxation.
You can say that only because the central bank obliges, as a matter of policy, by providing more liquidity as needed directly into the banking sector instead of cutting checks to the public, and having the public deposit funds as the first step in expanding the base.
There is nothing in theory preventing central banks from expanding their balance sheets from asset purchases from individual citizens, instead of asset purchases from banks. Obviously, convenience is a primary matter. They go to where the money is. But we could with ridiculous effort set up a system, if we wanted, where reserve requirements were much more strictly enforced, and the Fed expanded the monetary base only through cutting checks to private individuals, who then started the multiplier process with deposits at the bank. It would be a silly thing to do, but it could still be done.
No matter the order, reserve requirements, coupled with a central bank willing to let the interbank interest rate rise, still act as a buffer against potential bank lending. This is why one of the most important parts of monetary policy is setting expectations. If banks are expecting a rate hike, their lending behavior changes immediately. Saying that loans precede deposits might be practically true, and therefore worth stating as a matter of accuracy, but it doesn’t get us any closer by itself to understanding the ultimate limitations on bank money creation. Banks expecting the central bank to stop providing so much liquidity in the near future will cut back on loans today. The order is interesting as a practical matter, but you put too much focus on it.
Again, that’s either incorrect, or an infelicitous way of describing the situation.
The interest rate, even the interbank interest rate, is ultimately a function of supply and demand. The “price” of credit – the interest rate – is not the prime cause, but is instead determined by the relationship between the supply and demand for liquidity. At the interbank level, the demand is influenced by legal requirements for reserves to back up loans, as well as any expectations of big future withdrawals such as at tax time. The supply of base money is, naturally, determined by the central bank. If the central bank restricts the supply of base money relative to the demand, then the price of credit will go up. That is to say, the interest rate will go up.
If you focus on interest rates first, you are putting the cart before the horse. Price is discovered as it comes out of the relationship between supply and demand. It does not lead the process.
People are thrown off by this for a couple reasons. Ordinarily, central banks are happy to increase the supply of base money in response to more demand from the banks to keep the interest rate near their stated target. Then people tend to concentrate on that interest rate target, instead of the supply and demand shenanigans that go on behind the scenes which are themselves the determinants of the interest rate. Then you have the feedback effect through the real economy, as businesses take advantage of low rates, and money moves even more quickly. That’s where it seems that interest rates really drive things. But we have to remember, it all starts with supply and demand for interbank funds determining the interest rate.
It is absolutely about banks’ fears of running out of cash to meet their legal requirements. Or at least, about running of out of affordable cash. Even if they can technically borrow, it does them no good if the cost of borrowing is too burdensome. If it costs a pint of blood to drink a pint of water from the well, then there’s effectively no water to be had. Banks can absolutely run out of money, even if in theory there’s still money available to be borrowed.
Ultimately the wealth of a nation lies in its annual production of goods and services. Money is just a means to an end. Government plays an important role in a nation’s ability to produce goods and services - for example, by building roads, criminalizing fraud, providing security. To say that the government must “claim some percentage of total economic output” is true, but it’s also true that government “produces some percentage of the nation’s economic output.”
The value of that production is harder to discern, because government doesn’t sell what it does in the open market, and doesn’t attempt to make a profit. But the value is there, and at least some of it shows up as added wages and profits in the private sector.
But anyway, the point is that the government does produce goods and services, even if the market value of those goods and services isn’t always known. (What is the market value of the interstate highway system?)
The value of money - like the value of everything else - is a product of supply and demand. There’s both a supply of things that can be bought with money, and a demand for those things; and a supply of money along with a demand for money.
All things being equal, an increase in the supply of money will decrease its value.
However, all things are rarely equal. The demand for money, for example, is highly volatile. In hard times, people want the security of cash. If people are sufficiently fearful, or demand for cash is sufficiently high for whatever reason, even seemingly massive infusions of new money may make little or no difference.
Moreover, an increase in the supply of money may be offset by an increase in the supply of goods and services.
Which brings me around to the main point: Unemployment.
Unemployment represents a real cost to the country, because it is the literal wasting of the time and talents and abilities of millions of people. Because the real wealth of the nation lies in the production of goods and services, leaving people unemployed really reduces our wealth.
There are something like 14 million unemployed people in the US. At $10 per hour (a low rate) that represents $280 billion of lost productivity per year, or more than $22 billion per month.
Suppose you created $22 billion of new money, used it to hire those 14 million people, and the value of what they produced was at least $22 billion. How much inflation would that create?
Assuming, for the moment, that you increase the money supply and the supply of stuff to buy equivalently, shouldn’t the effect on inflation be 0?
To respond to your point directly: Adding money to the economy, when it’s used to productively employ resources that are otherwise going to be wasted, does not create inflation, and is not a form of taxation.
To be clear, this applies when the private sector is “wasting” resources, or operating at less than full capacity. It would not apply if the economy were running at full capacity.
I’m out of time for now. I’ll attempt to respond to your other points later.
And if you assume frictionless banknotes and coins, no one can get a proper grip on them, and the new money shoots right through the economy.
This is absolutely true. We would do well to ease money right now, until our nominal spending is back on its previous trend line. But that conclusion can be reach with traditional definitions.
Also: Some of new money creation would result in “taxation”. Not all of the new money would buy up idle resources. Some of it would increase the price of already used resources. There would be some inflation-based taxation. If we increased nominal GDP strongly, we could expect the majority of the increase to be based in real GDP growth, but a decent chunk of higher NGDP would still result from higher prices. More money would be helpful right now, but nothing is perfect.
I agree with all of this. Here you show more intelligence than many of the people running our country. Note that the words “money” and “savings” appear nowhere in these excerpts. (That’s where you lose many of us, I’m afraid, starting with a confused and irrelevant understanding of “money” to eventually reach correct conclusions.)
If you believe the real wealth of a nation lies in it’s production of goods and services it follows - doesn’t it? - that the richest economy is one in which all the people who have skills and abilities are productively employed. Moreover, if there is something we need - medicine, solar panels, home health care, bridges, or a space elevator - our ability to consume those things (to have them) is the same as our ability to produce them. Or to put it differently, we can afford whatever we can produce.
Our ability to produce things, in turn, is limited (mainly) by the amount and kind of labor available, and (more rarely) by natural resources.
Which means that the idea that there is something we can’t afford, when there are skilled, willing workers standing idle, is literal nonsense.*
The difference between neoliberalism and MMT is that the former says sometimes (like now, for example) you can’t afford to put all ready, willing and able workers to work. MMT says that’s nonsense. Failing to employ those resources simply makes you poorer - in long run, in the short term, and everywhere in between.
In terms of applying this to the real world, it’s a question of understanding the actual operation of the central bank and the government, and the actual results of interactions between the two.
In the US, when Treasury issues bills or notes or whatever (and spends the dollars), the net result is that the private sector experiences a net increase in assets. The amount of money (dollars) remains the same.
When the Fed purchases Treasuries the private sector experiences a decrease in Treasuries, and an increase in dollars.
The net result of all this is that when the government spends (more than it taxes) new financial assets appear in the private sector, either in the form of Treasuries, or dollars.
The point of MMTers is that role of the Fed is not needed. The government could, if it chose, abolish the Fed as an independent entity (we’d still need someone to oversee the commercial banking system, provide liquidity, and to settle accounts) and simply credit people’s accounts when the government spent money, and debit people’s accounts when they paid taxes. It could still issue Treasuries, if it wanted. And it could keep track of the difference between taxes and spending. It could call this number “national debt” (or “private sector net savings” - they are, after all, the same thing). With or without the Fed, however, so long as it’s willing to purchase Treasuries (and it has an unlimited ability to do this) the result is the same.
The take-away is that governments (that are monopoly issuers of their own currency) are not operationally constrained by taxes, borrowing, or by the amount of debt they have. The national debt may be of academic interest, but it has no significance in and of itself.
What does have significance is unemployment and inflation. When the government spends “too much” inflation is the result. When it spends too little, unemployment results.
[I want to emphasize that this applies when there are skilled willing workers standing by. If the workforce is fully employed, then any additional government spending necessarily reduces production within the private sector. At that point it becomes a political decision, rather than an economic one: do we want guns, or do we want butter.]
Taxation destroys money; spending creates it. There’s no requirement that the government spend the same as what it taxes. It could spend more (net money creation) or less (net money destruction).
Bonds are not money. When the government issues bonds it increases net financial assets in the private sector (assuming it spends the money it gets from the bonds). If or when the Fed purchases bonds it changes one kind of financial asset (bonds) into another kind (money). The net result of those two operations together is more money in the private sector.
The distinction is important if you believe the Fed cannot or should not stand ready to purchase US Treasury bonds in whatever amount needed. MMTers would say, I think, that the Fed can and should stand ready to purchase (or sell) Treasuries in whatever amount is needed, and that the Fed’s ability to do that is unlimited.
So the Fed makes the system more complicated, but 1.) an independent Fed is not actually needed (the government could simply credit people’s accounts directly - or instruct the Fed to do it), and 2.) the ultimate result is the same.
So, yes, it’s a simplification, not an important one, according to MMT.
Taxation destroys money. Spending creates it. (A simplification, as I explained above.)
Taxation is “about” more than just destroying money, of course. It’s also a political decision about the distribution of wealth. As is spending.
From an MMT point of view, the Fed is part of the “government,” for these purposes.
I’m not sure I understand this comment, but my response, I guess, is that from an MMT point of view, there really is no multiplier. The amount of money created by commercial banks depends on the demand from credit-worthy customers, not on a multiplier of reserves. (The current situation would tend to support that POV.)
We can’t put 100% of our people to work. Eventually we get the NAIRU, “full employment”.
Nowhere do I see any mention from you of the productivity of workers. We could only put 100% of people to work if we chose an inefficient Soviet style economy. There are frictions here that I don’t see you ever acknowledge. Yes, we should be putting more people to work right now, with more money creation. And I know the exact place where I’d recommend we stop creating money, my stop-sign based on a good century or more of economic data and theory. I see the point of more money right now, and I also see the point where we should stop.
That’s a strawman argument. You’re painting with a brush so wide, you can’t see the detail of what you claim to be arguing against.
There are plenty of “neoliberal” economists who recognize the value of more money at the present. There exist a breed of modern economists, even Chicago-trained economists, who say we could put more people to work with the benefits outweighing the costs. As I said, there would still be inflation. You can’t avoid a touch of inflation, you can’t avoid the friction, you can’t avoid all of the cost. But they believe it would still be well worth doing. They would say exactly what you say, that failing to employ these people makes us poorer, except they would use conventional definitions and not your confused and inaccurate descriptions of money to make their case.
Just because the world’s major central bankers are almost uniformly incompetent doesn’t mean this knowledge has been lost. You need to read more widely and experience the whole range of “neoliberal” thought before you criticize it.
You are not offering anything new, and your bizarre definitions cloud the issue.
You’ve simplified yourself into a language that you speak shared by practically no one else. Government spending in excess of taxation creates financial assets. It need not create money. It can create government debt instead. Failing to acknowledge the distinction between those types of assets that can potentially be created by deficit spending is a total non-starter. The distinctions are absolutely vital when we speak about the economy, because the two types of assets have vastly different effects.
I’m sympathetic to what you’re trying to argue for, but you do yourself and your arguments no benefit by twisting established definitions as you go along. I’m not going to respond to any more “government spending creates money” nonsense. If you want to engage in actual communication, learn how other people describe these things first. Until you can express your ideas in the standard way, without the strawmen, there’s no more point to this.
MMTers talk about “horizontal” and “vertical” monetary systems - the vertical being government; horizontal, private sector banks. One of the key points is that the private sector, on its own, can’t create more money than debt:
“MMT states that as a matter of accounting, loans will always necessarily create a liability and a deposit equal in magnitude. Thus the net amount of financial assets (deposits – liabilities) cannot be changed via banking actions. Of course, the deposits created certainly expand the money supply; subsequently, these deposits may flow away from one bank and into another, and this must be balanced at the end of the day to meet reserve requirements (see Interactions between government and the banking sector). But banks cannot create net financial assets without an attached liability.” link
Only government can create “net financial assets”:
“MMT states that as a matter of accounting, it follows that government budget deficits add net financial assets to the private sector. This is because a budget deficit means that a government has deposited more money into private bank accounts than it has removed in taxes. A budget surplus means the opposite: in total, the government has removed more money from private bank accounts via taxes than it has put back in via spending.”
What I said about money may well have been confused, but I don’t think it was irrelevant. From my POV, none of the rest of it makes sense unless you understand why MMTers say that commercial banks can’t create (what Wikipedia calls) “net financial assets”.
Maybe I should have said “net financial assets”. (What I don’t like about that phrase is that it includes things like stocks, which are not what MMTers are talking about. What they’re talking about, literally, is bank accounts: either at the Fed or at commercial banks; and currency.)
Well, it sounds like you may know more about it than I do. I guess my only real objection is this: if the Fed provides fewer reserves than banks need, wouldn’t that necessarily put banks out of business? Doesn’t the Fed have, as a practical matter, an obligation to provide at least the amount of reserves it requires the banks to have?
What about traveler’s cheques? Are they “money”? Answer: they’re money while outstanding and, when redeemed other bank-created paper money may take their place. Note that in the United Kingdom, private banks do create pay-to-bearer paper money widely accepted in lieu of legal tender. Moreover, the Fed Res banknotes used in U.S.A. are technically created by Fed Res using the same double-entry system used by private banks.
You seem to argue that these types of money are less real than, e.g. United States Notes (no longer printed, but technically “fiat money” in a sense that Fed Res banknotes are not).
Instead you will find professional economists to be more interested in the velocities of money associated with categories (M1, M2, M3 etc.) rather than the details of the printing on the paper money.
Summary: A government operated diligently will use its powers attempting to regulate money supply, interest and inflation rates, employment, and public and private spending. We seem to agree on that. When detail is required, distinctions about debt term and money velocity become important. But I remain at a loss regarding your views on “money.” I suspect you’ve taken some incidental remark in your MMT primer, and blown it out of proportion.
A budget deficit means that the government has deposited as much money into various accounts as it removed through borrowing.
You misunderstand. MMTers are talking about employing people who are ready, willing and able. No one said anything about putting 100% of people to work.
It’s true I didn’t say anything about productivity. So far as I know, MMTers agree with every other economist when it comes to productivity: it’s good.
I’m not sure what you want me to say about friction.
From an MMT POV, the point would be to attempt, in so far as possible, to employ people who are unemployed, but ready and willing to work, without creating shortages of workers in the private sector.
So, for example, if the private sector was already hiring every software programmer it could find, the government would want to avoid hiring programmers away from the private sector, since that would mean depriving the private sector of a resource it was already using, and presumably needed.
On the other hand, if there were lots of unemployed construction workers, and lots of infrastructure that needed to be improved, that would probably be a good use of deficit spending.
What is your “stop sign” for creating money?
For MMTers, it would be whenever inflation becomes a problem.
I’m fine with using whatever terminology you like - or whatever is correct. I did, apparently make a mistake by talking about “monetary savings” or “savings”.
In terms of the different effects of the government issuing bonds, and the central bank purchasing them, what I’m arguing that the result of the two sets of transactions - taken together - is the same as if the government had simply spent the money into existence, by depositing the money into bank accounts in the first place.
I agree that the central bank, acting alone, by purchasing government debt, is merely swapping one financial asset (bonds) for another (bank deposits).
It is the action of the government, by spending more than it taxes, that creates new financial assets in the private sector - specifically, Treasury bonds (in the case of the US).
It is the action of the two together that creates new money in bank accounts.
Assuming the government spends the money it borrows, there is no money removed by borrowing. The amount that it spends = the amount it removes from the private sector. Money changes hands, but doesn’t disappear. The difference is that Treasuries come into existence that did not exist before. Since Treasuries are financial assets, the result is a net increase in financial assets in the private sector.
I’m not arguing that debt-money is any less real than commodity money.
I agree that traveler’s checks are money, and that the Fed uses the same double-entry system as any other bank.
My understanding about money is that it’s liabilities on banks. I hadn’t thought there was anything controversial about that; but maybe there is.
I don’t know that there’s anything the government can do about the velocity of money (other than increasing the amount). The government (meaning the Fed and the Treasury) can, however, change how much of it there is.
It’s the central bank’s job to ensure the stability of the financial system as a whole, not to mollycoddle individual failures. Some banks should go out business. Specifically, bad ones. They actually have a lot of loopholes to meet their reserve requirements. Deposit liabilities mandate cash reserves, but other methods of borrowing (like fed funds) don’t. If they can’t figure out a way to earn their spread without help from the sugar daddy, then they don’t deserve to stay in business.
Of course, there’s the eternal question of whether a bank is merely suffering from an illiquid market, or whether it is fundamentally insolvent. Obviously, there should be a lender of last resort function for fundamentally sound institutions suffering a temporary liquidity crisis, but ideally the central bank should not be supporting failed investments, nor propping up the bad decisions of bankers who are unable to weather a standard tightening of credit conditions when money is bouncing around a little too fast in the economy.
The central bank’s primary job, at least at a macro level, should be taking care of the (effective) money supply. They should keep the macro indicators stable. If they hadn’t made such a complete cock-up of that job, the world economy and the world financial system would be in much better shape right now. We would have been more able to tolerate bank failure without so much fear of systemic collapse.
My own favored choice is nominal GDP level targeting. This would allow higher inflation at times like now, when it would be helpful, and reduce inflation in times of stronger economic growth. It’s a more supple tool than inflation rate targeting.
Your own choice sounds like the standard inflation answer. The problem is that that isn’t very specific. Different people have different ideas of problematic inflation. Setting expectations is one of the central bank’s chief policy tools, which means clear statements are essential, not some hazy “whenever inflation becomes a problem” answer. Notice that the Swiss bank needed merely to announce its exchange rate target clearly for the markets to respond forcefully. They can do this because their statement was specific and credible. They haven’t even needed to intervene themselves yet. The mere expectation of intervention creates an arbitrage opportunity, which forced the exchange rate where they wanted it to go. (Central bank interest rate targeting works in a similar way, which is why M2 growth can actually precede monetary base growth by as much as a year. The expectation of future Fed liquidity, providing more base in the months ahead, means that loans can be made in the present before the Fed has even provided that extra base. Any notable deviation from the interest rate target provides an arbitrage opportunity.)
The majority of central banks operate on a price stability mandate, with price stability defined as somewhere around 2% inflation. The eurozone has just such a mandate, and it is about to die because the Germans are afraid of 4% inflation. Herr Doktor Stark on their central board announced his resignation this last week, apparently in protest of the efforts the ECB was taking to save their collective asses. The euozone wasn’t breaking up fast enough for his taste, so looks like he decided to push it along a little faster. Meanwhile, Trichet has been trying to defend their actions. But if they weren’t so hamstrung by their price stability mandate, then he wouldn’t have to defend himself in this way.
The US Fed has been better, mostly through the good fortune that we have our own money and thus have the ability to inflate at will in the future. We just haven’t been taking full advantage of that yet. The Fed has a dual mandate for full employment and price stability, and for a while they seemed to have decided to ignore both parts of the mandate. At present, they appear to be working on a standard 2% inflation target while still ignoring employment. We don’t even have the excuse of the miserable Germans keeping us back. NGDP growth in both the US and Europe is far below trend, and the central banks are doing nothing about it because they’re focusing more on their own particular limited ideas of problematic inflation. The problems of inflation are simply not clear enough in their minds, or maybe so all-consuming that they are not concentrating on other important factors.
They are entirely missing the productive capacity of the economy, something an NGDP target would be more able to compensate for. And an NGDP target, coupled with a futures market, provides a clear stop sign, too.
There is no “merely” here. This is an extremely important difference, because the central bank isn’t just creating “deposits”. It’s creating monetary base, high-powered money, the potentially high-velocity instrument that is the medium of exchange, a new asset out of nowhere that corresponds only to a completely fictional liability in the accountants’ fantasy ledgers.
There is no substitute for the base. It’s cash out of the void. It’s an asset with no corresponding liability. More debt from the Treasury doesn’t even remotely compare. Base money is heady stuff, and deserves to be treated with respect. I do so respect it. And now, having made my obeisances, I’m asking for a helluva lot more of it.
The government spending is not at all necessary.
Best not to have any confusion between how things are normally done, and how things must be done. There is theoretically nothing constraining a central bank from purchasing different assets. Base money can easily be created without any government debt.
In fact, the Fed has actually purchased mortgage bonds to prop up the housing market. That’s new base money creation that is independent from US deficit spending. The expansion of the balance sheet with the purchase of mortgage bonds cannot be traced back to US taxation or spending. Mortgage bonds are a kind of debt, but even that is unnecessary. Given enough legal flexibility, they could buy gold, silver, land, or even nothing at all. There was talk during the debt ceiling clusterfuck of the Fed purchasing a one trillion dollar platinum coin, which is essentially buying nothing at all. Apparently, this would have been legal, and it would have been legal even if the budget were balanced. Phantom assets and phantom liabilities, balancing each other perfectly. Yet another demonstration that the accounting ledgers don’t matter at this macro level.
Central banks buy sovereign debt out of sheer convenience and pragmatics, not out of any fundamental monetary rules. A government with perfectly balanced budgets and zero debt could still have money creation on whatever level they desired. They’d just have to design a less convenient way to do it.
You’re right: the Fed can create base money using Treasuries, mortgages, trillion-dollar coins, or nothing at all. The problem, for them, is buying nothing at all puts their books out of whack - it creates liabilities in excess of assets. Buying gold, or other market assets, creates the same problem: if the market drops enough, the Fed appears insolvent. Since an “insolvent” Fed could undermine confidence, that could create a problem.
It also undermines the Fed’s ability to contract the money supply, since once it creates money to buy nothing, it can’t get that money back again.
On the other hand, purchasing things from the private sector that are worth what the Fed pays for them creates no net increase in private sector assets. There’s an increase in liquidity, but not wealth. Which, I’d argue, is not likely to help much, so long as the Fed sticks to buying only the safest possible assets.
In other words, the Fed can create net financial assets in the private sector, but only by incurring net financial losses, which could undermine confidence in the Fed.
The idea of minting a trillion dollar coin is a nice idea, except that it involves the highest authorities in our country doing something that - if it were done by regular people - would be considered fraud.
Not to say it can’t be done, but there’s a substantial downside to doing it.
I wonder if high-powered money is as high-powered as it’s made out to be. I’ve already argued it’s not “cash out of the void,” at least not if the central bank is buying assets out of the private sector that are worth what it pays for them. I’ve also argued that there’s no money multiplier, and that the limit of bank lending is credit-worthy borrowers rather than Federal funds.
Doesn’t this chart reflect little or no correlation between Fed funds and commercial bank credit?
