The US Federal Reserve is on the brink of insolvency (not!)

Yesterday, parachute gangs from the ECB and the IMF were being dropped into various EMU nations whose only problem is that they are members of an unworkable monetary system and happened to get hit by a major demand shock. Today the IMF cavalry are apparently heading to Dublin for a “short, focused consultation”. Conclusion: Ireland is being invaded by hostile forces. I also read rumours overnight that Germans are refusing Euro notes not printed in the Bundesland. It is probably an outright lie of a similar quality to the many being spread by the deficit terrorists seeking to regain their “credibility” (an impossible mission) any way they can. In this context I get many E-mails from people each week telling me that I do not understand that the latest decision by the US Federal Reserve Bank “to flood the world with printed money” is putting it on the brink of insolvency! I also read that in a Bloomberg Business Week feature article today. And people believe this stuff. It is as much a lie as the fallacious stories recently about the US President’s Asian travel costs which the right-wing in the US (Beck, Limbaugh, Savage etc) perpetuated without scrutiny (see this analysis to see how this lie began). Anyway, rest easy … the US Federal Reserve cannot go broke!

I recently considered the QE2 decision by the US Federal Reserve in this blog – Religious persecution continues. I thought that I had said enough in that blog about the latest monetary policy choice in the US to ease the concerns of people who read this blog.

But I was wrong. Upon reading this latest Bloomberg Op Ed (November 17, 2010) – In Fed’s Monetary Targeting, Two Tails Are Better Than One – I realised the hysteria from the terrorists is taking further steps into insanity.

Overnight I was asked whether the Federal Reserve might become insolvent. Short answer: No? Relax. But here is the slightly longer answer in relation to this Bloomberg article.

The article was written by two US academics. Prospective students will know I am compiling a list of institutions you should avoid if your desire is to learn how the monetary system actually operates. As a result of this article I have now issued a further warning to anyone studying economics at the Columbia Business School and Oberlin College – don’t and if you are leave!

The authors claim that QE2 “has already damaged its credibility” and the plan:

… may destabilize global trade and finance, damage the Fed’s credibility, and cause inflation to jump.

They claim that the reassurances of the Federal Reserve that “an inflationary surge is unlikely” are “hollow” because the “Fed might be unable or unwilling to respond to a rapid expansion of bank credit supply by contracting its balance sheet sufficiently in time to prevent inflation”.

Then they get to reasoning and what a shambles unfolds. Apparently, as growth resumes and demand for credit rises the banks will “disgorge their roughly $1 trillion in excess reserves”. To “educate” (read: totally confuse) their readers they offer this gem of nonsense:

Think of the excess reserves as under-utilized lending capacity. Banks might respond quickly to global lending opportunities, and their response could be rapid and highly correlated. The money multiplier, which has fallen to historic lows during the crisis, could snap back like a rubber band, implying hundreds of billions, or even trillions, in credit expansion, unless the Fed responded by dramatically contracting its balance sheet.

My first response was the “English colloquialism” – Please? (that is, spare me from this nonsense).

If they are teaching their students this rubbish then it is no wonder there are so many confused people out there in professional life. Excess reserves are not “under-utilized lending capacity”.

In November 2009, the Bank of International Settlements (BIS) released a working paper (no 292) entitled – Unconventional monetary policies: an appraisal – which discussed these issues in detail. I provided a detailed examination of that paper in these blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary.

These academics should resign their posts and resume their education. It is clear there first attempts at becoming learned have failed.

The BIS paper argues that the “distinguishing feature” of quantitative easing policies:

… is that the central bank actively uses its balance sheet to affect directly market prices and conditions beyond a short-term, typically overnight, interest rate. We thus refer to such policies as “balance sheet policies”, and distinguish them from “interest rate policy”.

In making this distinction, they show that these policies are intended to work by altering “the structure of private sector balance sheets” and targetting “specific” markets.

QE2 is nothing more than an asset swap. In an Q&A that Bernanke gave some students earlier in November (see video and more detailed commentary below) he said (at the 22.00 minute mark) in relation to a question about how the Federal Reserve will unwind QE2 when growth returns:

What the purchases do, is, if you think of the Fed’s balance sheet, when we buy securities, on the asset side of the balance sheet, we get the Treasury securities, or in the previous episode, mortgage-backed securities. On the liability side of the balance sheet, to balance that, we create reserves in the banking system. Now, what these reserves are is essentially deposits that commercial banks hold with the Fed, so sometimes you hear the Fed is printing money, that’s not really happening, the amount of cash in circulation is not changing. What’s happening is that banks are holding more and more reserves with the Fed. Now the question is what happens the economy starts to grow quickly and it’s time to pull back the monetary policy accommodation. There are several tools that we have …

Note: swapping government bonds for bank reserves. One asset for another. No additional “money” enters the system. Further, bank lending is not constrained by the volume of reserves!

The BIS paper addresses the issue of the implications of the current build-up in bank reserves. They say:

… we argue that the typical strong emphasis on the role of the expansion of bank reserves in discussions of unconventional monetary policies is misplaced. In our view, the effectiveness of such policies is not much affected by the extent to which they rely on bank reserves as opposed to alternative close substitutes, such as central bank short-term debt. In particular, changes in reserves associated with unconventional monetary policies do not in and of themselves loosen significantly the constraint on bank lending or act as a catalyst for inflation.

So there is no sense that the build up of bank reserves “makes bank lending easier”.

Around page 16, the BIS authors note that:

… bank reserves are uniquely valued by financial institutions because they are the only acceptable means to achieve final settlement of all transactions. From this perspective, reserves may play a special role during times of financial stress, when their smooth distribution within the system can be disrupted. At such times, financial institutions may wish to hold larger reserve balances to manage their heightened illiquidity risk. Indeed, this was the case in the initial stages of the current crisis, when the precautionary demand for reserves increased materially …

However, it is clear that the liquidity role can be accomplished when the central bank offers flexible arrangements to supply reserves on demand (via exchanges for near-reserve equivalents like short-term government paper).

In other words, there is nothing particularly special about bank reserves in this context.

The reason they consider bank reserves to be “special” lies in their operational significance for monetary policy. The central bank clearly sets the interest rate and generally aims to ensure that the overnight (interbank) rate is equal to it. In this context, bank reserves are:

… powerful and unique … [and] … obliges the central bank to meet the small demand for (excess) reserves very precisely, in order to avoid unwarranted extreme volatility in the rate … But in order to induce banks to accept a large expansion of such balances in the context of balance sheet policy, the central bank has to make bank reserves sufficiently attractive relative to other assets … In effect, this renders them almost perfect substitutes with other short-term sovereign paper. This means paying an equivalent interest rate. In the process, their specialness is lost. Bank reserves become simply another claim issued by the public sector. It is distinguished from others primarily by having an overnight maturity and a narrower base of potential investors.

That statement very clearly demonstrates how the reserve dynamics impact on monetary operations and require the central bank to issue debt or pay a return on reserves to maintain control over its monetary policy target rate.

It also demonstrates that bank reserves are near-equivalents to public debt issuance a point that is lost to mainstream economists.

Finally, the BIS paper considers the reserves – bank lending – inflation nexus. The authors say:

The preceding discussion casts doubt on two oft-heard propositions concerning the implications of the specialness of bank reserves. First, an expansion of bank reserves endows banks with additional resources to extend loans, adding power to balance sheet policy. Second, there is something uniquely inflationary about bank reserves financing.

They correctly point out that those who think that an expansion of bank reserves provides banks with additional resources to extend loans assumes that “bank reserves are needed for banks to make loans”. Accordingly, mainstream economists think that the “bank lending is constrained by insufficient access to reserves or more reserves can somehow boost banks’ willingness to lend.”

The BIS authors go on to say that:

… an extreme version of this view is the text-book notion of a stable money multiplier: central banks are able, through exogenous variations in the supply of reserves, to exert a direct influence on the amount of loans and deposits in the banking system.

MMT outrightly rejects these propositions. Bank reserves are not required to make loans and there is no monetary multiplier mechanism at work as described in the text books.

Please read my blogs – Money multiplier and other myths and Money multiplier – missing feared dead – for more discussion on this point.

The BIS authors concur with the MMT viewpoint on this and say that:

In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans. The aggregate availability of bank reserves does not constrain the expansion directly.

It is obvious why this is the case. Loans create deposits which can then be drawn upon by the borrower. No reserves are needed at that stage. Then, as the BIS paper says “in order to avoid extreme volatility in the interest rate, central banks supply reserves as demanded by the system”.

The loan desk of commercial banks have no interaction with the reserve operations of the monetary system as part of their daily tasks. They just take applications from credit worthy customers who seek loans and assess them accordingly and then approve or reject the loans. In approving a loan they instantly create a deposit (a zero net financial asset transaction).

The only thing that constrains the bank loan desks from expanding credit is a lack of credit-worthy applicants, which can originate from the supply side if banks adopt pessimistic assessments or the demand side if credit-worthy customers are loathe to seek loans.

The BIS authors then demonstrate that:

A striking recent illustration of the tenuous link between excess reserves and bank lending is the experience during the Bank of Japan’s “quantitative easing” policy in 2001-2006. Despite significant expansions in excess reserve balances, and the associated increase in base money, during the zero-interest rate policy, lending in the Japanese banking system did not increase robustly

QED (really)!

So dear readers there will be no elastic bands snapping back (“the money multiplier … could snap back like a rubber band”) and flooding the world with these reserves.

The Bloomberg authors clearly do not understand the previous discussion. They go on to allege that because the “Fed’s balance sheet has changed dramatically” it may not be able to “respond effectively” when credit demand returns bceause it has around 50 per cent of its balance sheet tied up in “illiquid mortgage-backed securities” and a “quick sale of these assets would reduce their long-term recovery value and cause the Fed to realize huge capital losses”.

Then it gets really murky:

Large potential losses could threaten Fed solvency and force the central bank to ask Congress to recapitalize its balance sheet. There is a risk that Congress or the administration might block recapitalization to prevent a Fed contraction … While the Fed might contract its balance sheet using other means, those might also imply large losses. Under the scenario outlined here, a rise in long-term interest rates could impose large losses if the central bank sold long-term Treasuries ($600 billion of which it is in the process of purchasing). The Fed could try to stop credit expansion by raising the interest rate on excess reserves. If the profitability of bank lending rises sufficiently, a large increase in interest rates paid on reserves would be needed, which could also threaten Fed solvency.

So it comes down to that. The central bank will go broke. Sorry it won’t.

It is clear that the US central bank is a strange beast. Here is a good place to start.

We read:

The Federal Reserve System is not “owned” by anyone and is not a private, profit-making institution. Instead, it is an independent entity within the government, having both public purposes and private aspects.

As the nation’s central bank, the Federal Reserve derives its authority from the U.S. Congress. It is considered an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive or legislative branch of government, it does not receive funding appropriated by Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms. However, the Federal Reserve is subject to oversight by Congress, which periodically reviews its activities and can alter its responsibilities by statute. Also, the Federal Reserve must work within the framework of the overall objectives of economic and financial policy established by the government. Therefore, the Federal Reserve can be more accurately described as “independent within the government.”

The twelve regional Federal Reserve Banks, which were established by Congress as the operating arms of the nation’s central banking system, are organized much like private corporations–possibly leading to some confusion about “ownership.” For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.

So it is really a “joint-stock” institution that is owned by private commercial banks but operationally an integral aspect of the consolidated government (along with Treasury).

The other important point about the Federal Reserve is that unlike other central banks it does not create the currency. That responsibility (power) is vested in the US Department of the Treasury. You can learn about HERE.

So if the Federal Reserve made these “losses” as it tried to unwind the excess reserves and it found itself with “negative capital” which in a private corporation would amount to balance sheet insolvency (that is, it was broke) what would happen?

First, it would not mean anything in terms of it capacity to meet any financial obligations that the central bank might have. There can never be a “run” on the Federal Reserve because its monetary liabilities are non-redeemable and all assets and liabilities are denominated in US dollars. It can always pay interest on reserves if it chooses and provide reserves as required.

Further, the private analogy is inapplicable in the same way that the household-government budget analogy is flawed when applied to a fiat monetary system.

For a private corporation (like a commercial bank), they would have to swap sound assets for equity when recapitalising. This would not apply to the Federal Reserve under the current Federal Reserve Act. Things are actually much easier for the Federal Reserve.

So assume it might need to be recapitalised at some point. Note that I am not implying it would ever get into this situation – that is, I am not accepting all the bunk about the consequences of it draining the excess reserves at some point in time. I am just going along with that part of the conservative argument to get to the insolvency nonsense.

So how can it recapitalise? Answer: the US Treasury can just give “its” central bank whatever value of Treasury bonds are required to recapitalise it is a formal balance sheet sense. Simple as that! Rest easy.

Some would reply by saying this would be politically costly or amount to a loss of central bank independence. It might have political consequences but just as the ECB has become a quasi “fiscal authority” in the Eurozone to stop that system imploding (it will implode if they stop) all manner of contrivances emerge very quickly in modern politics to “save the day”.

The US Treasury would not hesitate to “bail” the Federal Reserve out if required. It cannot go broke. The US government is never revenue constrained because it is the monopoly issuer of the currency. It is not a household nor a private corporation.

On November 5, 2010, the Federal Reserve Chairman gave a lecture followed by a Q&A session to some university students in Florida. Here is the Video which runs for 45 minutes.

He discussed the two broad functions of the central bank: (a) to promote financial stability (basic rationale for creation of US Federal Reserve) via two tools – lender of last resort capacity and regulation; and (b) the dual macroeconomic mandate – maximum employment via managed growth and price stability. Federal reserve manipulates the short-term interest rate to influence aggregate demand and growth.

He noted in terms of the first function that the central bank has to be prepared to stop any short-term cash runs on the commercial banks by lending freely to institutions that are temporarily illiquid. He said that the last three years have been extraordinary and to defend financial stability all the tools available were used.

The first thing they did when faced with panic was to maintain liquidity – that is, ensure the banks could meet their cash obligations. They were just following the basic principle of central banking – lend to illiquid institutions to ensure they can pay off their liabilities. He said the basic lesson of central banking was to stand ready to make loans to stop panic.

In terms of the macroeconomic function – the “monetary policy” part of its operations he noted that very much like in the Great Depression, the financial crisis in 2008 led to a sharp global recession. The Federal Reserve tried to support the US economy by cutting short-term interest sharply. With interest rates almost at zero what else can the central bank do?

He then discussed the additional steps – quantitative easing – which involved buying guaranteed long-term securities from the market and providing “more liquidity” to the financial markets. He noted that these actions brought down interest rates in the financial markets.

He then discussed the tools available to reverse the balance sheet expansion and it is these issues that are causing all the conservatives sleepness nights at present. He then went on to list the tools. He said they can raise interest rates even though there are a large amount of reserves in the system? Why? Answer: because the Federal Reserve has the authority to pay interest on reserves. So by raising the interest rate they can raise short-term interest ratess throughout the system.

The BIS paper referred to above talks about the decoupling of reserves from interest rates. If the central bank couldn’t pay interest on reserves then they would have to drain them or lose control of its policy rate.

Bernanke then said that the Federal Reserve has a number of tools to “drain” or “immobilise” these reserves. They created time-deposits where the banks hold these reserves and this essentially freezes them. They also use reverse REPOs with drains them. He noted that both of these tools would be sufficient to drain the reserves. If for whatever reason they wanted additional draining – they could sell the assets which he said would increase interest rates on those asset classes and extinguish the reserves at the same time.

All of these tools form part of the standard liquidity management operations that the central engages in to maintain its policy target.

Later in the Q&A session things went awry and we hear some howlers about government deficits etc. He clearly doesn’t understand all that side of the monetary system or chooses to misrepresent it for political purposes. But that is another story!

More ridiculous stuff

I also read in the comments section of BBC economics writer Stephanie Flanders’ blog the following claim after the “expert” pointed out how you can identify Euro notes by nation of issue as a result of a letter code in the serial number. The “expert” then said: “There are rumours that euronotes from some countries are starting to be rejected in Germany. What economic effect this has I have no idea.” Apart from the grammar (has – would have duh) just typing these words reveals how little people understand things yet are willing to have a go at being an expert nonetheless and furthering the blind leading the blind path to nowhere.

Well please send all Euro notes with the letters T, Y, M and V before the serial number to me please and I will take appropriate action to ensure they don’t get to Germany.

A real issue

On November 15, 2010, the US Department of Agriculture (Economic Research Service) released its Household Food Security in the United States, 2009 report.

A selection of the major findings included:

  • “In 2009 … 14.7 percent (17.4 million households) were food insecure … Food-insecure households had difficulty at some time during the year providing enough food for all their members due to a lack of resources. About a third of food-insecure households (6.8 million households, or 5.7 percent of all U.S. households) had very low food security, a severe range of food insecurity in which the food intake of some household members was reduced and normal eating patterns were disrupted due to limited resources …”
  • The prevalence of very low food security was unchanged from 2008.

  • “Rates of food insecurity were substantially higher than the national average among households with incomes near or below the Federal poverty line, among households with children headed by single parents, and among Black and Hispanic households”

Most of this disadvantage is highly correlated with persistent (and long-term) unemployment.

Getting people back into employment should be the priority of the US government. QE2 will not do that. A jobs-rich fiscal policy expansion is desperately required.

Conclusion

That is my blog time for today! Now it is time to tune into the live updates from the Eurozone for the day to see what ridiculous things the bully boy bosses from Brussels and Frankfurt can dream up today.

I liked this statement in Ambrose Pritchard’s November 16, 2010 article – The horrible truth starts to dawn on Europe’s leaders:

My own view is that the EU became illegitimate when it refused to accept the rejection of the European Constitution by French and Dutch voters in 2005. There can be no justification for reviving the text as the Lisbon Treaty and ramming it through by parliamentary procedure without referenda, in what amounted to an authoritarian Putsch. (Yes, the national parliaments were themselves elected – so don’t write indignant comments pointing this out – but what was their motive for denying their own peoples a vote in this specific instance? Elected leaders can violate democracy as well.

Which relates to the way the Lisbon Treaty was used to push home the monetary union folly when it became clear that the wheels of the ratification process that was originally conceived as being the way this arrangement would be justified fell off – categorically!

That is enough for today!

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    151 Responses to The US Federal Reserve is on the brink of insolvency (not!)

    1. anon says:

      P.S.

      Put in my own comment/answer on “de novo” at KC; not up yet.

    2. bill says:

      Dear Ramanan (at 2010/11/22 at 5:24) and anon (at 2010/11/22 at 4:29) and VKJ prior to that

      Remember that we are always better off giving people the benefit of the doubt rather than take personal offence at some statements. If someone is being personally offensive I will stop them. So lets always try to stay away from inflammatory remarks about a person and keep to the argument. On ideas – vehement debate is always preferred.

      best wishes
      bill

    3. Anon and Ramanan

      1. Garbade is the right person to look at for TTL, TIO, etc, and though there have been some innovations even since then (Tsy’s reverse repos with its depositaries, for instance), they don’t change the fundamental nature of these operations. By the way, your current description (which matches Garbade, et al’s) is EXACTLY as Stephanie and I separately have explained in our previous research.

      2. Regarding Fed repos vs. Treasury TTL transfers at auction, note that the two are not mutually exclusive. The Tsy (prior to 2008) would transfer back to TTL’s (or TIO’s) as much as possible by the end of the business day to minimize changes to its account’s balance at the Fed. At the same time, the days that Tsy auctions settle are “high payment flow days” on which banks’ desired ER holdings rise significantly, requiring the Fed’s repos. Overall, like any other day, the extent to which the Fed must do repos is based upon the desired RBs of banks relative to any net changes that occur to its balance sheet.

      3. The Tsy has completely stopped using TTL’s or TIOs since fall 2008, holding all balances in its account at the Fed. It does this to reduce interest payment on rbs that ultimately reduce Fed profits returned to the Tsy.

      4. Regardless of 1, 2, or 3 above, note that RBs used to purchase Tsy’s come into circulation when there is (1) a previous deficit or (2) a loan from the Fed to the non-govt sector.

      Best,
      Scott

    4. anon says:

      “Regarding Fed repos vs. Treasury TTL transfers at auction, note that the two are not mutually exclusive”

      Is it fair to say then that the repos are required to increase the excess reserve setting according to the demand for reserves and the funds rate – moreso than provide a quantity of reserves that is directly required to settle the auction?

      “RBs used to purchase Tsy’s come into circulation when there is (1) a previous deficit or (2) a loan from the Fed to the non-govt sector”

      Just suppose the Fed ran a zero required reserve system. Then there would be no net stock of reserves that is required to purchase Treasuries – only the excess reserve setting that is required to control the Fed funds rate. Viewed that way, it seems to me the previous deficit argument is not necessary?

    5. anon says:

      Another way of saying it – if there were an auction of $ 25 billion net (pre-crisis), I would tend to doubt that the Fed would repo $ 25 billion of additional excess reserves into the system. I expect it would be less than that.

    6. anon says:

      Ramanan,

      “Dampening fluctuations in aggregate bank reserves by stabilizing Treasury balances at Federal Reserve Banks was the original purpose of the Treasury Tax and Loan (TT&L) program, and it remains a primary objective.”

      There we go.

      Music to my ears.

      :)

    7. HI Anon

      “Is it fair to say then that the repos are required to increase the excess reserve setting according to the demand for reserves and the funds rate – moreso than provide a quantity of reserves that is directly required to settle the auction?”

      I would say so. If there were no increase in ER and the TTL system could be used to perfectly offset flows due to auctions, then theoretically no repos would be needed. Of course, there would very likely be intraday overdrafts nonetheless.

      “Just suppose the Fed ran a zero required reserve system. Then there would be no net stock of reserves that is required to purchase Treasuries – only the excess reserve setting that is required to control the Fed funds rate. Viewed that way, it seems to me the previous deficit argument is not necessary?”

      You still need rbs to purchase the Tsy’s, even if they aren’t left circulating overnight, so you still have either a CB loan (or intraday overdraft) or a previous deficit (if an OMO or repo collateralized with a Tsy is used–there are some cbs that do, or used to do, intraday repos or OMOs, for instance) creating those or inserted to enable clearing of overdrafts. How that happens depends on the method the CB uses to achieve its target. But, yes, you’re on the right track. That’s why I always say “previous deficit OR CB loan is necessary to create the RBs” and not “previous deficit” alone.

    8. anon says:

      “so you still have either a CB loan (or intraday overdraft)”

      I think I’m not familiar enough with intraday overdraft – specifically in the Fed system. I tend to imagine it as unsecured, therefore overriding the issue of specific reserve supply. Is that wrong?

    9. anon says:

      Ramanan,

      I now see you said earlier:

      “Now my interpretation is that of course these operations may require some repos but these are minor compared to the amount of funds raised due to an auction. Your interpretation would be – lets say in normal times, if the auction raises $15B, the Fed would have to do $15B. Doesn’t make sense – the Treasury is doing its own cash management and it would require a lot of MSPs (reverse repos) which it rarely uses.”

      So we’re in synch on that.

    10. The point is that if there are no rbs in the system, banks will need an overdraft or a CB operation that adds rbs to the system in order to settle the auction with reserve accounts. One way is to take the overdraft, then have the Tsy add the balances back to the system via TTL’s or equivalent, which enables banks to clear overdrafts.

      I’m not understanding your question regarding secured vs. unsecured. Sorry about that. Perhaps you can clarify if I didn’t get at the point you were making here.

    11. anon says:

      We may be saying the same thing here.

      E.g. suppose bank A buys treasuries and the Fed debits its reserve account into an intraday overdraft position. Treasury transfers balances in the general account to a TTL account at Bank B the same day, which credits the reserve account of Bank B. Bank A then covers its reserve overdraft by borrowing/buying reserve balances from Bank B by the end of the day. I would think of that as an unsecured overdraft. Or are all intraday overdrafts unsecured?

      Anyway, if that were allowed as an intraday overdraft at Bank A, then all would be well without having supplied reserve balances specifically to buy the bonds. Any additional reserve balances supplied are for purposes of controlling the funds rate, as always?

    12. anon says:

      I.e. short in the morning, cover in the afternoon – type of idea

    13. Yes, same thing, except that without the intraday overdraft (which is a loan from the Fed) you couldn’t purchase the Tsy’s.

    14. anon says:

      right – a loan – I guess that’s been your point all along

      That hasn’t registered with me because I actually don’t think of it as a loan – just as a negative balance. E.g. if I buy stock in my investment account, I have three days to cover with bank funds according to lagged settlement. I don’t think of that as a loan. The three days is different due to settlement lag, but the idea is the same. My stock purchase shows up as a negative balance. It’s my prerogative to be short until 5 p.m. on settlement day. But I don’t consider to be a loan.

    15. VJK says:

      Ramanan:

      “I don’t hold views that the repos fund the Treasury purchase”
      Sorry, I did not mean that. I thought you meant that no repo are needed in the aftermath of the auction :”no need for the repos to settle an auction”. My fault entirely.

      Re. TT& program.

      There are three kinds of participants: collectors, retainers and investors. Collectors channel tax payments to the TGA; retainers retain payments on an interest bearing “main account” subject to caps (A about $80M; B about $250M;C about $8B, daily) *And* required collateral; investors, in addition to retaining, can accept Treasury transfers with one or the same date prior notification.

      There are tens of thousand of collectors, about a thousand of retainers, and about two hundred investors.

      Every day before 9 am EST, the Treasure and the Feds independently estimate the amount of tax receipts from collectors, treasury disbursements, proceeds from new bond sales, interest/principal payments, etc. At 9am, they compare there notes and decide on cash management actions.

      If the end-day estimated balance exceeds the $7B target, the treasury, with prior notification, invests with the investors provided the caps and collateral requirements are satisfied. Sometimes, the investor capacity is at the limit and more Fed repo action is needed to compensate.

      In the case of a predicted balance shortfall (<$5B), the treasury "calls" on the retainers or/and investors to transfer the required amount to the TGA.

      At 9:30 am, the fed OMO starts to conrtibute its cash management share, by repo'ing with the primary dealers, based on the earlier treasury/fed estimates and anticipated retainer/investor actions.

      After 2001, the treasury introduced dynamic account balancing intraday to shift excess cash, on an hourly basis, to the investor's interest bearing "main account" subject to caps and collateral as usual.

      That last facility is perhaps closest to you mental model of shifting cash between the treasury and the investor depositary institutions.

      The interest on treasury investment is determined though an action I mentioned earlier.

      "The Bank of Canada
      "

      Don't know about BoC arrangements.

      "The Treasury can decide what to do with the cash later. It can do a repurchase agreement with some financial market player etc.
      "
      The treasury does not do repos. The Feds do.

      What the treasury does, I tried to describe above to the best of my recollection.

    16. VJK says:

      Ramanan:

      You:
      “The Treasury can decide what to do with the cash later. It can do a repurchase agreement with some financial market player etc.

      Me:
      “The treasury does not do repos. The Feds do.

      I checked with my sources, and I must admit I was wrong wrt the Treasury not doing repo.

      Apparently, in 2009, the Treasury introduced a repo, or rather reverse repo, investment program whereby they invest cash with the investor depositories only, in the same way they do direct, term or dynamic investments with the same.

      The depositories have to sign up for the repo program voluntarily as with other kinds of Treasury investments.

      Again, mea culpa.

    17. PJA says:

      Dear Bill

      You make the point that since reserves don’t constrain lending, increasing reserves will not cause inflation.
      Is the following a realistic scenario?

      Lending runs out of control, specifically because reserves don’t constrain it.
      Out of control lending results in asset bubble creation.
      Asset prices pass the point of sustainability, and collapse, bankrupting lending institutions.
      To maintain confidence in credit/base currency, the lending institutions are not allowed to fail.
      To this end, central banks asset swap debt for base money.
      Credit money already in the system is no longer constrained by debt (in aggregate) resulting in inflation.

      Could this be the mechanism resulting in the inflation we are seeing in Emerging Markets?

    18. Ramanan says:

      VJK,

      Thanks for clarifying.

      I used to think that the Treasury’s operations cause the Fed to do repos – to prevent the Fed Funds rate for deviating from the target, though I know that other countries use some tricks to significantly reduce this.

      Anon, on the other hand seems to have raised some points on “Marshall’s Latest” and the relation of this to the Treasury’s cash management operations.

      Stephanie’s post is nice and pedagogical and seems to suggest that no repos are needed by the Fed due to the Treasury’s activity. Of course, there are other factor affecting the reserves, and the Fed has to tackle them. The reason is that in her description, all bond settlement happens without reserves. Of course, in case you didn’t know she is aware of all the details and you can read her work to see that she has discussed settlement in reserves as well.

      Now after reading that I realized that the effect of the Treasury’s operations may have little effect on Fed’s repos. And the reason I think so is that the Treasury can move funds back into the banking system without any difficulty and hence it is equivalent to Stephanie’s description. In Canada, the BoC used to transfer government deposits back into the banking system. Banks won”t complain because banks like deposits. The government realized that it can do better and earn higher because bank deposits pay low. So it started auctioning out funds. The Bank of Canada does very little open market operations in the form of repos.

      The US Treasury seems to have adopted this. The Treasury needs to borrow funds in advance because it cannot go into an overdraft at the Fed. Using complicated arrangements the Treasury seems to have made sure that it can transfer funds back into the banking system and simultaneously earn higher returns.

      So what I am saying is that it seems that the Treasury activity seems to have minimal impact on the Fed’s repos. There are forecast errors but they get averaged out to a low value over a reserve maintenance period. (Of course you can come up with some exceptions). So it seems to me that the Fed’s activity is due to other factors affecting reserves such movement of funds in and out of foreign central banks accounts at the Fed. Would like to see such analysis with some numbers.

    19. VJK says:

      Ramanan:

      I used to think that the Treasury’s operations cause the Fed to do repos – to prevent the Fed Funds rate for deviating from the target, though

      And you would have been quite right before 2004 and probably would be right today if we had “normal times” without excess reserves.

      It is not clear what division of labor between the Feds and the Treasury with respect to cash management during bond sales had been, just pre-2007. Numeric data, as you mentioned, (or the minutes of the Fed 9:30 am conferences) would be helpful but they might not be available. Looking at the OMO statistics on the Fed website is not very illuminating because we do not know what operation was motivated by what considerations. One may speculate that the Treasury cash management actions are directed at preserving the exiting level of cash in the system, while the Feds are in the business of changing that level in order to hit the targeted interest rate. However, the actual separation if any is rather nebulous in its effect while being quite different operationally.

      in her description, all bond settlement happens without reserves

      That description makes me uncomfortable for the following reasons:

      1. government securities acquisition happens on the DvP (delivery vs. payment) basis.

      2. security acquisition is intermediated through either a commercial bank, or the primary dealer custodian bank. It does not matter.

      3. the bank has to either have sufficient cash on its reserve account, or go into an intraday ovedraft with the Fed.

      Therefore, whatever way you look at it, cash, either borrowed or available, is needed to settle the transaction over Fedwire.

      the Treasury can move funds back into the banking system without any difficulty and hence it is equivalent to Stephanie’s description
      Sure, but Treasury cash management is not designed to make a bond sale succeed. It is a general mechanism to maintain a stable level of cash regardless of specific inflows and outflows. It may help a specific bank to replenish its reserves, but what if the bank is not an investor bank ? It would have to seek the usual sources of cash, or resort to an intraday overdraft with the Feds that will have to be covered sooner rather than later.

    20. anon says:

      Intraday overdrafts do not necessarily imply an increase in system reserves

      e.g. intraday overdrafts are quite possible without requiring repo or other reserve injecting activity

    21. VJK says:

      anon:


      Intraday overdrafts do not necessarily imply an increase in system reserves

      Technically, the total cash in the system will increase for the duration of the intraday loan.

      No repo may be needed, of course. Since the Fed repo is a just a longer term loan in essence, the difference, in comparison to the Feds overdraft, is only in duration.

      P.S. Not trying to antagonize anybody, just seeking for clarification.

    22. Ramanan says:

      VJK,

      Okay what I meant was that I used to think that the repo activity was driven by the Treasury activity mainly. Now I understand the situations you have provided – such as not being able to transfer funds into the banking system etc, I am trying to get to some general facts here. In no way should my comments be taken to mean that the repo activity and the Treasury action are completely independent.

      To give you an example, there are currency boards which have restrictions on doing trades involving government debt – such as outright purchase or repos. They achieve the job by transferring government deposits. Even the Euro Zone, before the crisis used the trick. The case of the Euro Zone is complicated because repos there are equivalent to Fed’s outright purchases. And the LTROs happen weekly, not daily. The neutralizing effect is achieved by transferring government deposits.

      What I am trying to say however is that the amount of repos done due to the action of the Treasury is minor compared to the size of the bonds issued. The job of the repo is to neutralize the effect of reserve drain. However the transfer of funds by the Treasury into the banking system itself does the neutralizing role.

      I also understand the present situation. There is also a TSF account in addition to TGA. But, what happened before 2004 ?

      Now you may not like the desciption I have given but the Fed itself says similar things.

      A daily conversation with the Treasury takes place around midmorning. Prior to this call, a projections staff member explains the data revisions to the open market staff member who will recommend the daily program of action to the Manager. The projector describes developments behind the staff’s preliminary estimate of nonborrowed reserves for the maintenance period in progress. The estimate gives a sense of the operations that are likely to be needed to achieve the nonborrowed reserve path.

      This estimate is refined by examining the assumptions about the Treasury balance at the Fed on that day and the next two days. As noted in Box B of Chapter 6, the Treasury balance is often the biggest source of uncertainty for daily reserve levels. After a review of the figures, a projections staff member telephones Treasury Department personnel who make their own estimates of Treasury cash flows. If the forecasts differ significantly, they will review their respective assumptions. The Treasury makes adjustments to its balance at the Fed in an effort to keep it relatively steady so as to minimize its impact on bank reserves. When the two staffs’ forecasts are significantly different, the Treasury official would normally give weight to each, being careful not to aim for a balance that was uncomfortably low on either forecast.

      When both the Treasury and New York staffs suggest that the balance is likely to move away from desired levels, the Treasury will, if possible, take action to bring the balance back in line by transferring funds to or from depository institutions’ Treasury tax and loan (TT&L) note options accounts. The transfers are made through direct investments or calls. The Treasury tries to take its actions for the following business day so as to give the banks some advance notice that they will be gaining or losing funds. Large forecast errors sometimes lead to same-day adjustments. Typically, calls and direct investments are calculated as a fraction of an earlier day’s TT&L balance. For instance, on a Wednesday, the Treasury might call 20 percent of the book balance of that Tuesday for payment on that Thursday. On rare occasions when the Treasury is very short of funds, same-day receipts may be called into the Federal Reserve. After the Treasury call, the projectors will revise their nonborrowed reserve estimates if the actual Treasury actions differed from their assumptions.

      from “U.S. Monetary Policy and Financial Markets”, Chapter 7 – NY Fed

    23. Ramanan says:

      VJK,

      “Sure, but Treasury cash management is not designed to make a bond sale succeed. It is a general mechanism to maintain a stable level of cash regardless of specific inflows and outflows. It may help a specific bank to replenish its reserves, but what if the bank is not an investor bank ? It would have to seek the usual sources of cash, or resort to an intraday overdraft with the Feds that will have to be covered sooner rather than later”

      Firstly I don’t talk in the language that repos fund purchase of government bonds. Thats an MMTer view, so you may want to discuss that with them.

      As Garbade et. al. point out, the cash management is a tool to raise funds much earlier in advance than spending and then to earn good return on that. However, they also point out that its important which account the Treasury holds funds in.

    24. anon says:

      “Technically, the total cash in the system will increase for the duration of the intraday loan.”

      That’s what I don’t understand.

      E.g. try an example leaving Treasury out of it.

      Suppose bank A pays bank B with reserves.

      Suppose A goes overdraft and B goes surplus as a result, just at that point during the day.

      Then A covers its position by end of day.

      None of that necessarily required an increase in system reserves.

      You can interpret A’s overdraft as an intra-day loan from the Fed, which I think is how S. Fullwiler and yourself interpret it.

      But it’s not a loan that increases system reserves.

      That’s why I don’t view it as a loan.

      But whether or not you call it a loan, it doesn’t necessarily require an increase in system reserves, which I think is the important point.

      So I see total cash in the system being the same, or at least not necessarily changed, for the duration of the intraday overdraft (or loan).

    25. anon says:

      I.e. I’m treating an overdraft as a negative reserve balance.

      And I’m treating a loan as something that “covers” that position, whether intraday or overnight.

      Which means a loan is something that injects system reserves.

      That’s different from a negative reserve balance per se that is offset by a positive reserve balance elsewhere, as per my example.

    26. anon says:

      i.e. loans that inject system reserves are required to cover overnight overdrafts

      they’re not required to cover intraday overdrafts

    27. VJK says:

      Ramanan:

      Firstly I don’t talk in the language that repos fund purchase of government bonds.
      I’ve never believed you do, as I said earlier.

      My misunderstanding of your position was at the other side of the spectrum, so to say, i.e. “no repo required” which I believe I have corrected as well to the mutual satisfaction.

    28. VJK says:

      anon:

      Suppose A goes overdraft and B goes surplus as a result, just at that point during the day.

      My interpretation is:

      Before the overdraft, we had $R reserves;

      After the overdraft, we have $R+$overdraft;


      Then A covers its position by end of day.

      And we have again $R upon the Feds loan repayment by the borrowing bank. Assuming everyone else is sitting idle for simplicity and the bank has borrowed from the player(s) other than the Feds, or sold some of its assets and got cash from another bank.

      So, in other words, the Feds create $overdraft of new money for the bank and then destroy the same amount on repayment.

      That’s why I was saying that the difference beween the new cash created via an overdraft and a repo is only in longevity.

    29. VJK says:

      anon:

      I’m treating an overdraft as a negative reserve balance.

      And I’m treating a loan as something that “covers” that position, whether intraday or overnight.

      An intraday overdraft is a loan, specifically from the Feds.

      There is no conceptual difference between intraday ovedrafts/loans and overnight loans, only the cost and consequences to the borrowing bank is the substantial difference. I.e. if the bank persists in overnighting, the FDIC will at first pay attention to the bank health and eventually may resolve/shut down such a bank.

    30. VJK says:

      Ramanan:

      But, what happened before 2004 ?

      Reserve fluctuations were much more severe necessitating more Feds repo activity to smooth out fluctuations. I believe the article you’ve quoted gives some examples of such fluctuations and presents a rationale for a bevy of new Treasury cash management tools, through investor-banks.

      What I am trying to say however is that the amount of repos done due to the action of the Treasury is minor compared to the size of the bonds issued.

      Well, it is minor I think primarily due to mutually cancelling cash inflows(taxation/bond sales) and outflows(treasury spending). The Treasury, I imagine, spends as soon as it can, it does not accumulate and then spends, it’s a dynamic process. So, in my understanding, cash management, both by the Treasury and the Feds just smooths out peaks and valleys of what otherwise would have equilibrate itself anyway, but at the expense of possibly wide swings in the interbank market rate. So, the goal of the cash management operations is to prevent unnecessary interbank interest rate swings.

    31. Ramanan says:

      VJK,

      Yes our agreement is contained in the quote from Chap 6 of “U.S. Monetary Policy and Financial Markets” (sorry quoting too many stuff)

      Errors occur in the day-to-day forecasts of the Treasury balance because it is
      not possible to estimate precisely the level or timing of the myriad receipts and
      expenditures of the federal government. Most of the time, a single day’s error has
      only a modest effect on the average level of nonborrowed reserves over the
      two-week reserve maintenance period because the Treasury will adjust the size of
      the next day’s call or direct investment in order to bring the balance back to the
      normal target level. When total Treasury cash exceeds the capacity of the TT&L
      accounts, however, unexpected changes in flows, such as higher or lower receipts
      than forecast, will affect the level of the Treasury’s balance at the Federal Reserve
      not just for a day or two but until the total cash balance drops below the TT&L
      capacity again, a development that may take a couple of weeks. The resulting
      reserve effect will be magnified.

      So its “modest effect” on one hand and “magnified” on the other.

    32. Ramanan says:

      VJK @2:49,

      The cash management plan is a backup to going into an embarrassing position of requiring an overdraft!

      (The Reserve Bank of India misunderstood this and even though the Indian government has an – in principle – unlimited overdraft, copied it from the Federal Reserve!)

      Since the fluctuations in bond sales and tax collection can be wide, the Treasury necessarily has to accumulate funds.

      The bond sales are typically high volume and in general G, T, interest payments and ΔB have their own fluctuations. It is true that these cancel each other out but there are fluctuations and some escape hatch is needed instead of just doing repos.

      The Treasury and the Fed have converted the cash management operation into an advantage.

    33. VJK says:

      The Reserve Bank of India misunderstood this and even though the Indian government has an – in principle – unlimited overdraft, copied it from the Federal Reserve!

      Are you saying that the RBI could have just used the overdraft option without the need to copy the Feds cash management structure ?

      Do you have a reference to an RBI document describing such an overdraft ? Perhaps, the overdraft option is so limited as to be unsuitable for buffering cash flows.

      Just thinking.

    34. Anon,

      this is a semantic point–is it a loan that adds to reserves or a negative balance? Certainly, in either case, what we have is previous qty of balances + loan/overdraft. If a bank with 0 balances takes out a loan from the Fed overnight, does it have any balances, or a negative balance? Does it matter? I don’t think so. I personally prefer to refer to an overdraft as a loan, since a liability has been created that must be cleared, but the alternative isn’t necessarily wrong (unless legally there’s a specific way it must be done, but even then there’s no real difference aside from a preference for one way over the other).

      furthermore, if the overdraft is to settle a payment with the Tsy, then did agg rbs decline (from your phrasing, given that the Tsy’s account has been credited + overdraft) or did they stay the same?

      I don’t know if one is more correct than the other, but I do know that it makes virtually no difference to understanding how the system is functioning.

    35. Ramanan,

      I think you may be misinterpreting VJK. I haven’t seen anything by VJK over the past 24 hours that would be in disagreement with MMT.

    36. Ramanan says:

      Scott,

      Not sure why you think I may be misinterpreting him.

      My intention here was to point out that the Treasury’s cash management itself does the trick of repos, something I haven’t found in the case of the US. I have found the movement of funds from the TTL into the TGA, not the opposite.

      My disagreement was on position on the “other end of spectrum” – and I have agreed on the fact that TTL accounts may go beyond the capacity on some periods and have quoted the same from Fed itself. I also believe there are workarounds there and will find out.

    37. Ramanan says:

      VJK,

      The case of the RBI is a case of a huge amount of confusion. Every time there is a tax payment, there are some issues. The Indian government does a lot of disinvestment – i.e., it sells ownership of government owned companies. When the payments arrive – and these can be huge, the CD rates zoom to 9-10% even if the bank is defending a rate of 5%. Some major goof-ups in that place.

    38. Ramanan says:

      VJK @0:37,

      Didn’t see your description which mentions DvP earlier.

      It is perfectly possible for a bank to pay by increasing its liabilities. Let us consider a simple case in which the Treasury wants to borrow $100 of funds. It delivers $100 of securities to the bank and the bank increases the Treasury’s deposits by $100.

      So conceptually there is nothing wrong with settling at a bank account.

    39. VJK says:

      Ramanan:

      It is perfectly possible for a bank to pay by increasing its liabilities.

      The commercial bank has to pay to the Treasury in cash(“base money”). It cannot manufacture cash, but can only buy/borrow cash from another bank, or from the Feds. If it borrows, its liabilities (and cash assets) increase . Is that what you have in mind ?

      The commercial bank can buy a gov security outright, at an auction, but it cannot lend to the Treasury, collateralized or otherwise.

      The treasury investment programs are operations with the cash the Treasury has at its disposal already, they can reverse repo(lend cash to the investor-bank), but they cannot repo (borrow cash from any commercial bank).

      DvP merely means that the counterparties have to have securities and cash ready on the respective accounts the moment the Fedwire message(s) arrive at the Feds computer. Cash availability is partially guaranteed by the Feds intraday lending up to the cap established for a particular bank (or up to a collateral if one was pledged).

      I am rusty on details, and you can perhaps discover a hole or two, but that’s the gist.

    40. Ramanan says:

      VJK,

      Yep I know what DvP is.

      Not necessarily a disagreement. You are highlighting an operational fact. What I am saying is that it need not be the case always. I am not saying that it happens at present in that way, but I am saying it is possible to implement. So Stephanie’s description is possible conceptually.

      The Treasury may not be allowed to “repo” if the issuance of new Treasuries can be called a repo, but thats its own requirement – that the TTL depositories need to provide collateral.

      An analogy would be a bank participating in a new issuance of a corporate bond. It can’t pay by reserves to the corporate, it pays by increasing its deposits.

      Coming back to the TTL complication, the reason I didn’t pay attention to the TTL collateral requirement is that Canada doesn’t have such a thing I think. The bank account of the Treasury outside the Bank of Canada is just like a bank account of you and me.

    41. VJK says:

      Ramanan:

      The Treasury may not be allowed to “repo” if the issuance of new Treasuries can be called a repo, but thats its own requirement – that the TTL depositories need to provide collateral.

      1. The collateral requirement is equally applicable to retainers and investors. The treasury cannot overdraw from the r/i “main accounts” in the case of shortfall. It can only seize & sell the collateral to recover the funds due. The procedure must be spelled out somewhere.

      2. When I wrote “repo”, I meant a hypothetical situation, since currently the retainers/investors cannot legally participate in repos, only in reverse repos. I am not event sure it’s altogether meaningful for the Treasury to post its own piece of paper as a collateral for more reasons than one. Seems rather ridiculous on the face of it.

      Therefore, the collateral makes sense only with reverse repo investments/direct investments/dynamic investments/term investments to discipline the participating banks. The reverse repo investment option is new to me, but it appears to conform to the same rules/laws as the other investment options.

      description is possible conceptually
      Sure, the law can be changed inasmuch as it could be changed with borrowing by the Treasury directly from the Feds.

      Historically, there are examples of governments borrowing from commercial banks.

      The bank account of the Treasury outside the Bank of Canada is just like a bank account of you and me.
      I am ignorant of that side of the Canadian banking system, but looking at the BoC balance sheet leads one to believe that the system operates in a fashion similar to the Treasury with respect to government securities handling, so I’d be surprised if that was not the case. Do you have a reference ?

    42. Ramanan says:

      VJK,

      Yes, of course settlement happens in reserves in Canada – but doesn’t have the complications like the US. So no complications arise such as TTL running out of capacity few weeks in a year.

      No breaking of law is required if the Treasury opens an account in a bank and accepts payment in the account instead of instructing payments to the TGA.

    43. VJK says:

      Ramanan:

      if the Treasury opens an account in a bank and accepts payment in the account instead of instructing payments to the TGA.

      But, that’s what the Treasury already does with its participating retainers/investors.

      Is the difference you have in mind an account with any commercial bank with no collateral requirement and with overdraft privileges ?

      For that to happen, I believe the law has to be changed.

    44. Ramanan says:

      VJK,

      The TTL technology was made because the Fed and the Treasury found that tax payments are not so smooth and the Fed had to do a lot of work to smoothen it. The advantage of TTL is that the Fed and the Treasury can smoothly withdraw funds from the banking system at their own pace.

      Banks agreed because its another source of revenues for them. Now the Treasury made some n number of rules such as banks requiring collateral etc.

      Thats the Treasury’s requirement. I and you do not ask the bank to hold collateral. Okay there is deposit insurance but many countries do not have it.

      Later they figured that not only can tax payments be withdrawn as per needs and to smoothen out things, they can also transfer the government deposits to the TTL account.

      I don’t know what you mean by “overdraft” but if banks purchase Treasuries (for customers, acting as dealers, whatever the case), the banks can simply purchase by crediting the Treasury’s deposit account at the bank. There is nothing wrong with that and it doesn’t break any law. Any institution or person can open a bank account.

      Try to do a T-account for cases where a bank purchases financial assets from other sectors. It simply pays by crediting their accounts just similar to loans creating deposits.

    45. RSJ says:

      Ramanan,

      “Any institution or person can open a bank account.”

      Yes, but the point is that Treasury is supposed to bank with the CB, not with the private sector, for purposes of executing vertical transactions.

      What makes them vertical is that they are settled with reserves, and that means that Treasury is not a customer of the bank.

      Once the funds are transferred to/from the private sector, then for horizontal transactions Treasury can have all the commercial bank accounts it wants.

      If the reserve settlement between the bank and the CB is too disruptive, you can add a reserve buffer in the form of TTL and have the Treasury be a counterparty, cutting the CB out unless there is a buffer underflow. But still Treasury is not a customer of the bank.

      Even if it functions perfectly so that inflows are exactly equal to outflows and no net reserves need to supplied to Treasury when it collects taxes/spends, still it is a reserve buffer and the vertical transactions are being settled with reserves. They can’t be settled with broad money.

      Hence the need for collateral (on the asset side of banks) to be held against the TTL account.

      If Treasury was a customer of a bank, and if Treasury happened to spend money by crediting another customer of the same bank, and collected taxes from another customer of the same bank, then you would be settling vertical transactions with broad money, and not reserves, and this has implications for the CB’s power.

      I think there is too much “it’s just credits in a computer” thinking going on. The “no law is broken” refrain is also a bit strange. Not meant as a personal attack, just pointing out that this is a strange thing to say around accountants, particularly when discussing tax settlement :)

    46. Ramanan says:

      RSJ,

      Doesn’t matter if reserves are involved or not. If a sector is in deficit, others are in surplus. If the sector “production firms” is in deficit, other sectors are in surplus, even though no reserves are involved in the financing of the deficit.

    47. Neil Wilson says:

      “then you would be settling vertical transactions with broad money, and not reserves, and this has implications for the CB’s power.”

      Why can’t broad money be equivalent to reserve money?

      Why not the simple system where the Central Bank is the only bank without regulatory constraints (ie a limit on the amount of lending they can do). Then the central bank controls the private banks simply by limiting their lending capacity to a multiple of their equity base – whatever is required to make a run on the banks a 1 in 200 year event – in return for a licence to operate a fractional reserve system along with the associated guarantee.

    48. VJK says:

      I don’t know what you mean by “overdraft”

      I was not sure what your proposal included, that’s why I put a question mark after the word ;)

      f banks purchase Treasuries (for customers, acting as dealers, whatever the case), the banks can simply purchase by crediting the Treasury’s deposit account at the bank. There is nothing wrong with that and it doesn’t break any law.

      Sure, as long as the deposit is collaterized, I do not see why the retainer/investor’s “main account” cannot be used for collecting bond sales proceeds. It was done in the past. Perhaps, the Treasury thinks it logistically easier to deal with bond sales inflows just through its TGAs at the Feds branches. Hard to say without seeing the numbers and reading the Feds meeting minutes.

    49. Ramanan says:

      VJK,

      I will ditch direct settling at banks for a while.

      However as you highlighted, depositary institutions cannot absorb deposits beyond a point. The system as a whole may have issues when tax payments are high, but on a daily basis, they may change from time to time for different institutions. To avoid any settlement fails, best to have inflows directly at the TGA and then decide what to do.

      You may not be able to find anything in the Fed’s minutes because they just decide the target and give some guidance about future policy rates, not the actual operations (except in recent times when they have been targeting the size of their balance sheet). Such information will be in guides about the open market operations prepared by the Fed.

      A lot of stuff can be figured out by the simple observation that the Fed targets the rates and to defend it, it loses the discretion of doing something about the level of reserves.

    50. RSJ says:

      “Why can’t broad money be equivalent to reserve money?”

      Then you really would be in pure credit economy. Banks could have deposit accounts with each other, and settle payment on the liability side of balance sheets rather than by transferring reserves assets. The CB would not be able to affect the economy by setting the marginal cost of reserves. You could do this, I suppose, but it would be a bit of a coup by the banks.

    51. Neil Wilson says:

      “Banks could have deposit accounts with each other, and settle payment on the liability side of balance sheets rather than by transferring reserves assets.”

      And how is that different from the ‘wholesale market’ that caused all the fun and games three years ago?

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