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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.


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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    This Post Has 151 Comments
    1. “Overnight I was asked whether the Federal Reserve might become insolvent. Short answer: No? Relax.”

      Would you say this is because the US has a rather special and unique place in the world given the USD is the only reserve currency and the final true superpower? Also many of the other top nations have such a vested interest in US debt that insolvency would seem the least of the Fed’s risks given what they have shown they are willing to do.

    2. Dear Ray (at 2010/11/18 at 18:14)

      In response to me saying the US Federal Reserve cannot go broke you asked:

      Would you say this is because the US has a rather special and unique place in the world given the USD is the only reserve currency and the final true superpower?

      No, it has nothing to do with that. The US government is fully sovereign in its own currency in its consolidated form (Treasury and Central Bank). It can always meet its financial obligations that are denominated in US dollars.

      best wishes

    3. Dear Vincent Cate (at 2010/11/18 at 17:53)

      You said:

      The way a government that can print money goes bankrupt is “hyperinflation”.

      I don’t think I mentioned “printing money” in this blog except to say what the US Federal Reserve is currently doing is not that.


      best wishes

    4. Thank you for the post. The article by Ambrose Pritchard was great. His analysis was mostly spot-on. The Euro is the ultimate attempt at financial engineering – to improve stability by reducing exchange rate risk. The problem, as Pritchard correctly points out, is that instead of reducing risk, it just substituted exchange rate risk for default risk.

      What I like most about ‘Post Keynesians’ is that, in general, they believe that microeconomics needs to have ‘macro-foundations’. The mainstream thinks in the opposite way and often ends up with conclusions that appear to make sense on a micro-level but ultimately fall prey to the fallacy of composition. Clearly this was the problem with the design of the Euro: thinking about exchange rate risk in isolation of the system as a whole.

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


      Obviously the CB must use a cash basis when its liabilities are the units of account, but the flipside of that is that the CB cannot just restate the asset side of its balance sheet and have the liability side adjust.

      The “joint-stock” nature of the CB is fictitious. The stock-holders do not receive surplus profits, but a dividend fixed by law. Their holdings are fixed by law, and the price of the stock is also fixed by law. Federal Reserve stock is a ceremonial artifact, and does play the role of a capital buffer.

      The real equity holder is the Treasury, as the Treasury is the one that receives surplus interest income and the Treasury is the one that must make up for capital shortfalls. Treasury provides the capital buffer for the CB.

      That means that CB asset write downs are paid for with fiscal policy — which must be the case, since the CB is overpaying for an asset, and the recipient of the proceeds is receiving a fiscal transfer, even if the nature of the transfer is not recognized on the CBs balance sheet in real time.

      Because of this, the CB is only supposed to buy riskless debt, so that there will be no need for asset write downs, allowing treasury to conduct fiscal policy. It is in this context that the CB can use a cash-basis and not worry about the market timing of its purchases.

      But when the CB buys risky debt — such as agencies or the assets in the Maiden Lane facilities — then Congress has to pick up the tab in case of default.

      The asset side needs to be increased by Treasury when a restatement is made, and this comes at the expense of fiscal spending for public purpose.

      Congress has already spent over $100 billion over the last year to allow the agencies to continue paying interest on their stock of MBS debt outstanding, with an allocation of over 400 Billion whose cap was later removed. They are going to ask for over $200 in funding for the next fiscal year. Estimates are that the total losses will be about a Trillion.

      Without that Congressional guarantee, the CB would not be buying agency debt.

      The Treasury has similarly guaranteed to compensate the Fed for any Maiden Lane losses, and this includes AIG losses, which are substantial.

      This year Congress only authorized about 30 billion in additional transfers to the states, who are shedding workers.

      Regardless of how you frame it, there is a limited pool of real resources, and therefore a limited pool of funds to be spent on fiscal intervention; I agree with you that during a downturn, that limit is sharply revised upwards, but the public is justifiably concerned when the government uses its current spending power and monetary policy as class warfare against the middle class, whether this takes the form of enticing households to borrow more and not default on the existing bond pool, or simply providing fiscal transfers directly to bondholders when households do default.

      In that case, you can see why they would not trust government to spend more, if the government is acting against their interests with the amount that it currently spends.

      Saying that the “private sector” owns the debt and thereby benefits misses the issue that the distribution of assets is not equal. Therefore the majority of people do not feel as if they are benefitting, because they are not, in fact, benefitting.

      Only the aggregated balance sheet benefits. If the aggregated balance sheet was a sentient being whose welfare the government is tasked with improving, then this analysis would be correct; as it stands, this line of argument is a fairly glib dismissal of the real distributional impacts of deficit spending, ones that allow median households to be deprived of real wage gains.

      Households understand this, and correctly surmise that they are “paying” for the deficit with lost consumption opportunities.

      This is the underlying complaint that the Bloomberg piece is echoing.

      This is why the these complaints resonate with the public.

      It would be better to take these concerns seriously and to try to refute them, rather than mocking them because they are framed in a language that gets the reserve accounting wrong.

    6. Dear RSJ (at 2010/11/18 at 20:24)

      I agree with your sentiments. I am not defending the Federal Reserve’s actions. I am forever advocating targetting government spending at jobs and the disadvantaged and supporting them to keep their homes and expand their consumption opportunities. If there are inflationary pressures from that I always advocate increasing top-end taxes and wiping out top-end benefits.

      But we also still have to get the conceptual understandings sorted out. The point here is that the Federal Reserve cannot go broke. It can make stupid decisions which require fiscal support that could otherwise create jobs (if near full capacity) but that is another story about accountability and who is in charge of the bank. At present, as you point out, there is so much slack that any support to defend the bank would have low opportunity costs in real terms.

      I think we agree.

      best wishes

    7. ‘The way a government that can print money goes bankrupt is “hyperinflation”’

      If the US injected $100 trillion into the economy and there would be a great big inflation.

      However they are nowhere near that point and have been nowhere near that point since 1971 when they became monetarily sovereign.

      The evidence is that a growing economy requires a much greater injection of new money all the time to keep the wheels spinning.

      If you set policy so that unemployment has to be around 2%-3% and inflation around 2%-3% then it seems to me that the policy recommendations of MMT will allow an advanced economy such as the US or UK to achieve that equilibrium point and control the economy so that it is maintained – including handling external shocks.

      Why? Because you move the policy control variable from the unemployed to the exchange rate.

    8. “The loan desk of commercial banks have no interaction with the reserve operations of the monetary system as part of their daily tasks. ”

      Is that strictly true. I appreciate that they may not interact with reserve ops as to the quantity of reserves on hand – since that is always whatever is required. But surely the loan desk needs to know what the price of the reserves mix is at the moment so they can set the correct rate to charge for lending.

    9. Does anybody else find it amusing that everybody gets excited when the Fed creates reserves ‘ex nihilo’ and buys some bonds with them, but there is no excitement about the Treasury creating some bonds ‘ex nihilo’ and buying reserves with them.

    10. Superb explanation.

      “But we also still have to get the conceptual understandings sorted out.”

      Yes – necessary, but certainly not sufficient.

      But very necessary – as firm footing.

      Just look at the alternative:



      The horror.

    11. Dear JKH (2010/11/18 at 22:05)

      You note (in line with RSJ):

      Yes – necessary, but certainly not sufficient.

      I agree. I just play to what I know and that I have two arms and legs only. There is a political campaign to be waged and other angles to address. I just do what I can.

      And I did see the alternative and to use a cricket expression “I chose to let it go through to the keeper!” – it was that bad. That stuff is being taught to American university students! He hasn’t learned much was my conclusion.

      best wishes

    12. Bill,

      Poor structure on my part.

      I meant “not sufficient” in the broad sweep of economics – not “not sufficient” in terms of the objective of your post.

      As I said, I thought it was quite brilliant in that regard, and both necessary and sufficient.

    13. S,

      OMG…… What mind boggling imbecility. At least the comments show a degree of rationality.

      Can you get paid for stuff like that?

    14. One day in summer 2009, I went back through all the information online at the Fed’s website and found that going back to about 1990 the Fed had sent well over $300B in its retained earnings to the Tsy (I think the figure was closer to $350B, but can’t find where I put the actual data this morning). This doesn’t include all the years before this or the record transfers to the Treasury of fiscal years 2009 and 2010. So, even by private sector standards, take away the very odd (for private sector standards) fact that the Fed transfers its retained earnings to the Treasury, and the Fed would be the world’s best capitalized institution by a wide, wide margin. And that’s yet another reason why the Treasury would recapitalize the Fed as Bill mentioned–the Treasury is the one that the Fed has given all of its capital to.

    15. S,

      The horror

      He looks like an angry SOB

      Especially compared to JMK, who looks tranquil

      Complete BS about Canada btw; lies actually

      He does refer to mad cow; wonder if …

    16. Scott,

      The issue isn’t wether the Fed is well capitalized — that kind of question doesn’t make sense, right? The point is that fiscal adjustments are necessary when the CB purchases risky debt. The fiscal adjustments are realizations of previous CB fiscal transfers.

      CBs should not be in the investment business, or risk-bearing business, as this does not square well with fiscal neutrality.

      Of course the Fed must spend all interest income or pass it through to treasury, otherwise CB asset purchases would be an income drain on the private sector, which is also fiscal policy. The whole system is designed to be neutral as regards to fiscal policy.

      But the ECB is another matter. The ECB has no riskless assets with which to conduct monetary policy, and so is forced to conduct backdoor fiscal policy. That backdoor fiscal policy is limited to supplying income to creditors and draining income from debtors, as with any other bank. But unlike a regular bank, if the asset side changes, they cannot reduce their liabilities, so they are reliant on TARP-like injections from the member states. It’s a fake central bank, or a “troubled” central bank.

      And in this case the likelihood of default is real. Both Ireland and Greece should see the power they have and default. Then Germany would be forced to bail out its own banks as well as the ECB system anyway, effectively paying off a portion of Greek debt, without being able to impose austerity on the periphery.

      The ECB has zero leverage. Soon, if not already, it will be conducting accounting fraud and engaging in all the gimmicks that banks do in a crisis when they are faced with a real solvency constraint and no fiscal arm to turn to. Rolling over loans on easier and easier terms, hiding assets, etc.

      It just goes to show what an absurd concoction the whole system is. It’s as if the economists had decided that only monetary policy matters, and so they created a “government” with only a monetary policy arm. But its the fiscal arm that makes the monetary arm possible. At the end of the day, you need an institution that can supply income, because that is what plugs the balance sheet hole. And the EMU has no such institution. It only has an institution that can supply money, but not income. Perhaps the best way to view the EMU is as the logical end game of monetarism; a Frankfurt monument to stock/flow confusion.

    17. Does anybody else find it amusing that everybody gets excited when the Fed creates reserves ‘ex nihilo’ and buys some bonds with them, but there is no excitement about the Treasury creating some bonds ‘ex nihilo’ and buying reserves with them.

      Neil, there is a whole movement in the US focused on this, e.g., believing that currency gets created by the US borrowing from the “privately owned” Fed at interest instead of just issuing it on it own.

    18. RSJ: “Saying that the “private sector” owns the debt and thereby benefits misses the issue that the distribution of assets is not equal. Therefore the majority of people do not feel as if they are benefitting, because they are not, in fact, benefitting.

      “Only the aggregated balance sheet benefits. If the aggregated balance sheet was a sentient being whose welfare the government is tasked with improving, then this analysis would be correct; as it stands, this line of argument is a fairly glib dismissal of the real distributional impacts of deficit spending, ones that allow median households to be deprived of real wage gains.

      “Households understand this, and correctly surmise that they are “paying” for the deficit with lost consumption opportunities.”

      Excellent point! :)

      But it is not an argument against the deficit, which is the false conclusion that ordinary citizens draw. Wall Street and Big Finance have gotten their bailouts. Now we need more deficit spending aimed at Main Street and job creation. “I am ready for my bailout, Mr. De Mille.” :)

    19. Neil Wilson: “Does anybody else find it amusing that everybody gets excited when the Fed creates reserves ‘ex nihilo’ and buys some bonds with them, but there is no excitement about the Treasury creating some bonds ‘ex nihilo’ and buying reserves with them.”

      I don’t think that it is everybody, Neil. I think that it is the creditor class, who want unemployment to remain high and the economy to limp along. Even the hint of helping the economy draws their scorn. Frankly, I am appalled.

    20. I completely agree, RSJ, and that’s all very, very well said.

      My point was to note that those who think the Fed might go insolvent–and here just going at the balance sheet definition of insolvency, or granting that for the sake of argument–don’t recognize or at least conveniently leave out the fact that the Fed would be the best capitalized institution in the world were it not for transfers of retained earnings to the Tsy. Of course, that is what should happen, as you explained, but those like Ron Paul want to have it both ways.

    21. Hi, Bill-

      “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.”

      This is false, from what I understand, since the capital-adequacy requirements are the floor telling banks how much they can maximally lend.

      It was very funny to hear about the Fed having to go hat in hand to congress to “recapitalize” its balance sheet … after they have been accused above of printing money, willy nilly. Thanks for your work!

    22. Dear Burk (at 2010/11/19 at 4:25)

      Yes, ultimately bank lending is capital-constrained. That is clear and underpins what I said. In an earlier blog I detail the impact of capital adequacy requirements on lending (cannot find it right now!).

      best wishes

    23. “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.”

      Then how about electing someone who won’t bail out the fed because they are obsessed with all new medium of exchange being debt to the benefit of the spoiled and rich and the bankers?

    24. How about a post about how currency gets created and/or how the fed wants a certain amount of currency to be in existance but does not care about how much debt is produced unless it produces price inflation (I would actually say unless it produces wage inflation)?

    25. Min and RSJ said: “RSJ: “Saying that the “private sector” owns the debt and thereby benefits misses the issue that the distribution of assets is not equal. Therefore the majority of people do not feel as if they are benefitting, because they are not, in fact, benefitting.

      “Only the aggregated balance sheet benefits. If the aggregated balance sheet was a sentient being whose welfare the government is tasked with improving, then this analysis would be correct; as it stands, this line of argument is a fairly glib dismissal of the real distributional impacts of deficit spending, ones that allow median households to be deprived of real wage gains.

      “Households understand this, and correctly surmise that they are “paying” for the deficit with lost consumption opportunities.”

      Excellent point!

      But it is not an argument against the deficit, which is the false conclusion that ordinary citizens draw. Wall Street and Big Finance have gotten their bailouts. Now we need more deficit spending aimed at Main Street and job creation. “I am ready for my bailout, Mr. De Mille.””

      Yes, it is against a deficit run with debt because of time differences between spending and earning and that interest has to be paid. You also have to keep the bondholders happy so they will rollover the debt because I believe the federal budget does not include the ability to pay down the debt at maturity. If the deficit was currency, I am thinking it would a lot harder to try to grow supply more than demand and put negative real earnings growth on the lower and middle class.

      The “bailout” for the lower and middle class needs to be currency and in the retirement “market”.

    26. I don’t understand why almost everyone thinks that most of the medium of exchange supply (say 97% to 99%) should be demand deposits created from debt.

      I’d rather see a near 100% currency supply as the medium of exchange supply or at least 1 to 1 convertibility guarantees to currency.

    27. bill said: “Dear Burk (at 2010/11/19 at 4:25)

      Yes, ultimately bank lending is capital-constrained. That is clear and underpins what I said. In an earlier blog I detail the impact of capital adequacy requirements on lending (cannot find it right now!).

      best wishes

      Let’s say the reserve requirement is 10% and the capital requirement is 5%. The 10% reserve requirement is enforced for all deposit types, and if necessary, the fed allows the fed funds rate to rise.

      Under that scenario, are the banks capital or reserve constrained?

    28. “But it is not an argument against the deficit, which is the false conclusion that ordinary citizens draw. Wall Street and Big Finance have gotten their bailouts. Now we need more deficit spending aimed at Main Street and job creation. “I am ready for my bailout, Mr. De Mille.”

      I think that is another example of what is wrong about all new medium of exchange being debt. The spoiled and rich, the bankers, and almost all economists believe this. IMO, this is just one reason why bernanke is nowhere near an expert on the Great Depression, just an economic and political hack for the bankers and the rich.

    29. Dear RSJ. Your comment regarding the ECB is disturbing for me. Looks like I must revise my comment on Trichet from yesterday. I’m the clueless idiot. And still I don’t get it. Your help is needed! Let’s assume the ECB purchases all Greek bonds on the secondary market. Then Greece declares sovereign default. The ECB must write down the Greek debt on its balance sheet. Why must the German taxpayer then bailout the ECB? I don’t get that. Why does the ECB need funding/income from its members? Thanks forward for any explanation!

    30. RSJ:

      Saying that the “private sector” owns the debt and thereby benefits misses the issue that the distribution of assets is not equal. Therefore the majority of people do not feel as if they are benefitting, because they are not, in fact, benefitting.

      Excellent point, as the rest of the analysis.

      The fact that the Fed cannot go broke is an uninteresting triviality.

    31. Suppose the Fed suffers credit losses on its QE, requiring fiscal support from the Treasury. Why would this support lessen the Govt’s ability to deficit spend on other, stimulative projects?

      I would have thought that an asset impairment at the Fed would have no bearing on the output gap – and so would not diminish the scope for more ‘useful’ deficit spending.


    32. Do krugman and others understand the difference between currency, debt, and how it relates to balance sheets? I don’t think so and from:

      “Implications for fiscal policy
      In the current policy debate, debt is often invoked as a reason to dismiss calls for expansionary fiscal policy as a response to unemployment; you can’t solve a problem created by debt by running up even more debt, say the critics. Households borrowed too much, say many people; now you want the government to borrow even more?

      What’s wrong with that argument? It assumes, implicitly, that debt is debt – that it doesn’t matter who owes the money. Yet that can’t be right; if it were, debt wouldn’t be a problem in the first place. After all, to a first approximation debt is money we owe to ourselves – yes, the US has debt to China etc., but that’s not at the heart of the problem. Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth – one person’s liability is another person’s asset.

      It follows that the level of debt matters only because the distribution of that debt matters, because highly indebted players face different constraints from players with low debt. And this means that all debt isn’t created equal – which is why borrowing by some actors now can help cure problems created by excess borrowing by other actors in the past. This becomes very clear in our analysis. In the model, deficit-financed government spending can, at least in principle, allow the economy to avoid unemployment and deflation while highly indebted private-sector agents repair their balance sheets, and the government can pay down its debts once the deleveraging crisis is past.

      In short, one gains a much clearer view of the problems now facing the world, and their potential solutions, if one takes the role of debt and the constraints faced by debtors seriously. And yes, this analysis does suggest that the current conventional wisdom about what policymakers should be doing is almost completely wrong.”

      Maybe the excess debtors need more currency (wages for the workers) so they can both spend and save/pay down debt?

      Is the other problem with their “analysis” that if the lower and middle class stop going into debt to the rich (or even try to default) will the rich get the gov’t to do it for them so the rich can maintain their excess savings/excess retirement or even increase it/them?

    33. @Burk,

      In the GFC we found that banks were not capital constrained. For example, UBS’s CDO division just claimed that all their CDOs were AAA and/or insured by monolines or AIG and so did not need capital to support them. They were also “earning” a yield higher than the internal cost of funds so the CDO division was able to book profits until the time came when they couldn’t pretend their assets were AAA any more. This is explained in the 2008 report on UBS website detailing how they lost over $50bn.

      UBS’s external and internal auditors and regulators somehow didn’t pick this up.

    34. FedUp,

      I am not arguing against deficit spending. I don’t like large amounts of deficit spending, but this should be viewed like the government budget constraint.

      A good economic management policy will result in a healthy supply constrained economy, and as a result, deficits will be low. That’s what we had in the post-war era. But if the economy is not healthy, then it is a waste to not deficit spend simply out of principle that the economy should be healthy, or that it will right itself somehow through suffering.

      If there is a persistently high deficit, or if more and more deficit spending is necessary to get the same demand boost, then I would take this as a sign that there is something structurally wrong and reforms are needed — serious reform. That reform may be very expensive, and it may require large outlays. Money should be no object, but it still needs to be justified in terms of what it will do for the economy. Government deficit spending is not an end to itself, but if people agree on the end, then no amount of spending is too large to achieve it. The real constraints are political in nature.

      Similarly, I would judge the success of the reforms at least partly by whether the deficits return to their low level as the economy returned to being supply constrained. If not, I would ask again — why does the private sector demand so many external assets in order to keep people employed? Who are these people accumulating so many assets, and how are they holding the rest of the economy hostage?

      And I think that this type of message would resonate much better than the “spend whatever it takes” message, even though operationally one is a subset of the other.

      If you say “let’s just spend a trillion to boost demand and we’ll make reforms and take on the special interests later”, then people rightly get suspicious of the proposal and you’ve given birth to a tea party movement that decries an out of touch government that is wasting money. There will be talk of “unsustainable” debt growth, but in reality, it is the economy that is unsustainable, and people know this. I honestly think that the public confuses government debt with the economy.

      But if you can convince them of what a better future would look like, then they will spend whatever it takes, and will be glad to do it. You don’t need to implement everything right away, and you don’t need all the details, but you need to garner consensus about what is wrong and where we need to go.

      The issue is that, in the U.S. at least, the Obama administration has disappointed on every important issue. His healthcare reform was a series of corporate giveaways. The financial reform was a joke, nothing on the trade deficit, nor job security, declining wages, outsourcing, de-industrialization– nothing. No special interest was too small or weak that it failed to cow him. I think there were plans to convert a bomb shelter in Maine into a night school, but the 35th Ladies Auxilliary played bridge there, sent him a protest quilt, and the Administration quickly backed down.

      Here is a near depression with rampant fraud, a middle class revolting at being squeezed for 30 years, 40 million people on foodstamps, diminishing income prospects, and terrible middle class anxiety. There is a real sense that people are being discarded — particularly for those over 50, and his solution is what — energy saving lightbulbs?

      Now it may be that there is a “technical” reason to spend even while avoiding addressing any of the reasons why we got into this mess, or how to get out, or even what a better future would look like — but in that case the public will oppose this type of spending, regardless of whether they understand the opportunities that fiat money provides.

    35. Stephan,

      How is the ECB going to plug the hole in its balance sheet? The ECBs balance sheet must balance. It must have positive capital. But unlike a currency sovereign nation, it’s ability to raise capital relies on contributions from the member NCBs. OK, it has the ability to earn interest on the assets it buys, so that’s something, but not much.


      There is 4 Billion in capital for the ECB. and an equal size reserve fund, so let’s say 8 Billion in capital. That’s not a whole lot to absorb losses against a balance sheet that was around 2 Trillion last I checked (couldn’t find more recent data than March 2009).

      In this respect, it is like any highly leveraged bank. Sure, it can create euro liabilities just like a bank can create deposit liabilities, but it can’t give them away, or give away so many that it would exceed the inflows via interest payments as well as the accumulated capital from member states.

      So if the ECB purchased Greek debt and there was a default, then this would exceed the capital buffer, and force the NCBs to supply more — e.g. the TARP like injections.

      But the NCBs have their own balance sheet constraint and their own capital requirements that are supplied by their fiscal arms with taxing power. So at the end of the day, the capital of the ECB is provided by the taxing power of the member governments, none of whom are currency sovereign, and all of whom would be forced to cover the losses — e.g. pay for the defaulted Greek debt at the expense of their own taxpayers or debt burdens.

      Obviously in case of one nation’s default, this would automatically put into question the solvency of all the other nations, and yields on them all would go up, as they would be forced to bail each other out. It’s a circular firing squad.

      In any case, it would be funny if there was a crisis, and no nation could bail out the ECB because it would violate the SGP.

      Obviously all of this puts downward pressure on how large the ECB balance sheet can get. That, plus the fact that there is no riskless debt that it can purchase.


      I’m sure Ramanan or some of the other people here will be able to supply multiple official documents about what the minimum capital requirements are, and if there are any write down procedures. Can the ECB pick up the phone and demand $X in capital from the member states whenever it wants?

    36. @RSJ

      excellent post. Thank you. I also have suspicions that MMT is too simplistic. Although government is not restricted in its spending – simply increasing spending won’t fix the problem of asset accumulation by the small minority, especially when those accumulated assets then become parasitic in their use.

    37. Well, Greg, in defense of Bill and MMT, they are making valid points about the nature of the monetary system. That is all true, and in many cases, this will open up people’s eyes to creative solutions as to how government can solve problems. Bill uses very simple models of a “parent” giving coupons to his “children” who then pay some of them back because he is trying to be a good teacher and explain very basic concepts. It’s not fair to infer from that the analysis stops there.

      He is also, I believe, trying to be neutral in terms of policy prescriptions, so that the basic facts of MMT get out even if people disagree about things like income inequality. Here I am taking the liberty of speaking for Bill.

      Having said that, I think it is possible to forget that upon further disaggregation, the initial conclusions from the parent/teacher model may be partially reversed. For example, we had low unemployment when we had low deficits in the 1945-1975 period. On the other hand, others (and I) would point out that household debt was growing rapidly at that time as well, so perhaps the deficits were too low. The amount of deficits really required is an interesting question. Whether the deficits will be accumulated by a few is also interesting. There are many such questions.

      You need a good model that moves beyond the simple private sector model. But my post was not meant to try to attack or discredit MMT in any way, merely to point out that the situation is much more complex (and interesting), and that generally lack of double entry bookkeeping is not going to be the primary constraint that prevents us from getting where we want to be.

      On the other hand, it may open the eyes of some — say some of the Geeks :) — and certainly professional economists need to make models of the economy in which there are no missing transactions, and proper accounting is a good consistency check for that.

      Who knows, there may be many young budding economists who read this blog frequently, who will add to our understanding. I don’t want to criticize the resource here, but will feel free to try to speculate on alternate affects that rely on more disaggregation, or to look at things from a different angle.

    38. I would have thought that an asset impairment at the Fed would have no bearing on the output gap – and so would not diminish the scope for more ‘useful’ deficit spending.

      MMTP, I agree that the intersection of those cases when there is a CB asset impairment and no output gap is basically zero.

      But that’s not the point, is it?

      First, you are still transferring real resources from one group to another. The fact that you can continue to supply additional resources doesn’t somehow undo the that. You have bondholders who earned undeserved income. Those bondholders may not otherwise be the beneficiaries of any fiscal transfer, but now the CB has made them beneficiaries, and the Treasury was forced to rationalize it ex post because the CB did the transfer, and Treasury has to support the CB. If you spent $X on this, and you have a total of $Y to spend before full output is reached, then you have $Y-$X left to spend on worthy causes. Whomever would have gotten the last $X is now not going to get the $X.

      But much more importantly, do you really think the public will let the government deficit spend all the way until full output if the government abuses its power this way? The output gap is a technical limit to government spending, but it is not a ‘real” limit. The real limit is political, not technical, and the public will curtail the government’s stabilization role if the government is seen as not acting in their own best interests. Fiat money is a great power that can be taken away from the government. Stabilization policy discretion can also be taken away from the government. You get Tea Parties, etc. This is a serious risk to policy, and consequently to employment. I think this second channel is the one that does the most harm, as the other channel is somewhat contrived.

    39. Gary says:
      “excellent post. Thank you. I also have suspicions that MMT is too simplistic. Although government is not restricted in its spending – simply increasing spending won’t fix the problem of asset accumulation by the small minority, especially when those accumulated assets then become parasitic in their use.”

      This may be a too simplistic but thats the kind of guy I am. Tax the assets.

    40. “The ECBs balance sheet must balance. It must have positive capital.”

      Would you therefore have a problem with Mosler’s crisis proposal for the ECB to credit EZ nations pro rata with 1 trillion Euros?

    41. RSJ – thanks for the reply.

      How does the Fed taking credit losses off the private sector constitute a transfer of real resources; surely it transfers purchasing power instead, no? I agree that it does have a distributional effect; to the extent that this helps out fixed income investors, this doesn’t necessarily disadvantage your man in the street – many of the Tea Party likely have 401ks etc which would benefit from the credit loss avoided.

      “Will the government deficit spend all the way until full output if the government abuses its power this way?” I think a bigger question is will the public wise up to how deficit spending works in general – there’s zero chance of that unless people who understand MMT do a bit more to spread the word.


    42. RSJ,

      Thanks for the reply. Now I do understand your position. You are ruling out the CB option to issue base money (as long as the liabilities are € denominated). By doing so the ECB can bail out any entity including itself. I guess you don’t consider this an option because it might be inflationary. Correct?

    43. RSJ:

      Found your description of the ECB and member bank relationships extremely interesting. At a very macro view, then this appears to be a monetary design that can only effectively function for a net exporting region. It seems that the structure is such that it is impossible to sustain internal growth and/or net imports. Is this conclusion consistent with your view?

      Given that imports are net real losses for an economy, and that Europe is demographically an aging population internally (not counting immigration), this seems about as stupid a design as possible.

      Possible resolutions to the current conditions that I can see: 1) abandon the monetary union (unlikely), 2) institute some federal structure with fiscal capacity, 3) hope and pray the ROW starts to grow, 4) continual regional member default crises – requiring stopgap measures, 5) ?. I think the current ECB strategy is a combination of 3) and 4).

      In other news, for some of us MMT neophytes, I found the following description of bond sales and deficit spending from Stephanie Kelton very helpful:

    44. Andy: This may be a too simplistic but thats the kind of guy I am. Tax the assets.

      If you don’t want to cut into productive investment, start with taxing away economic rents — land rent, monopoly rent, and financial rent. See Michael Hudson’s extensive work on economic rent-seeking as the fatal flaw in the capitalistic model. Of course, this criticism is not original with Hudson. He is also an economic historian and lays out the provenance of the concept.

    45. anon,

      Seen this ?

      Have commented there – will appear after it gets approved. Forgot to save it and will appear in some time.

      A minorly different description of bond settlement. Bond sales lead to Treasury’s account at the dealers being credited and no reserves are debited in the process. Of course it doesn’t really matter in the end – equivalent. From a practical perspective, more efficient.

    46. @RSJ

      yes, I am learning a lot from reading this blog. What I meant is that IMO your thoughts on the political limits of government spending were exactly right. Also, if beneficiaries of government spending are mostly rich – who already reached the limit of their spending on necessities and even luxuries – and simply use additional money to inflate asset prices and pressure governments to agree with their demands to implement anti labor policies – then the usefulness of this spending is rather limited.

      yes, I agree, and I think that the most useful tax would be on economic rent as Tom Hickey mentioned and Michael Hudson advocates.

    47. Tom,

      Re: See Michael Hudson’s extensive work on economic rent-seeking as the fatal flaw in the capitalistic model.

      Would you kindly recommend a particular article(s)?

    48. Stephan,

      I am not ruling out issuing more base money.

      Base money is a liability of the ECB.

      Base money is not an asset of the ECB.

      When it is “issued”, some asset is purchased with the base money (or the asset side would shrink).

      That asset is brought onto the asset side of the ECB.

      Therefore this is a balance sheet expansion in which both assets and liabilities increase by the same amount.

      Now if the ECB has too few assets in proportion to its current liabilities, how will balance sheet expansion help?

    49. Anon,

      I can’t make heads or tails of Mosler’s proposal, and I didn’t really try to pursue it.

      If i were to speculate, what he really meant was that the ECB would buy sovereign debt.

      It gets confused because Mosler thinks that bonds are “savings accounts” and “credits”, so he uses this language, and it might seem to him that these “credits” do not violate the SGP, or do not need to be extinguished with repayment, or that the ECB can purchase directly from the national governments, thereby granting them “credits”.

      The whole thing seems nonsensical, but perhaps he meant something else.

    50. Fed Up: “You also have to keep the bondholders happy so they will rollover the debt because I believe the federal budget does not include the ability to pay down the debt at maturity.”

      Well, I do not have to keep the bondholders happy. ;) Rubin might have convinced Clinton to keep the bondholders happy. But Lincoln did not keep the bondholders happy, and, despite paying off the national debt, I doubt if Jackson would have kept the bondholders happy.

    51. Ramanan,


      Doesn’t surprise me a bit. Makes sense in terms of maximum Fed control over reserve volatility.

      I do wonder about alleged “facts” on reserve operations at times.

      Notice the dance around which came first, the chicken or the egg – the bonds or the spend.


      Right. He means credit, but the mechanism is vague. It’s a fiscal transfer effectively.

      Just wanted to point it out, relative to your observation on ECB capital, which is clearer.

    52. anon,

      Maybe the simplest way to state is to say that the government can take a draft at the central bank and if someone comes back arguing overdrafts are not allowed (as in Marshall’s longest) just state that it can be broken anytime, instead of arguing on which came first. Plus state that a borrowed funds provide income to the private sector when the government spends ?

      The Euro Zone allotment of €1T is not possible in practice. Nations will run into ever expanding external debt to other Euro zone nations like Germany as the former will continue running higher current account deficits. €1T may not be enough. No amount will be enough. The Euro zone internal problems are balance of payment problems in addition to the harsh super-strict no overdraft rule for governments.

      The only way is to separate or become one nation or some arrangement resembling the latter. However separating is not the easiest thing either. I think the nations may have to be “trained” to become net exporters, WTO rules need to be broken to allow protectionist measures.

    53. Ramanan,

      “just state that it can be broken anytime”

      which means acknowledging that there is something there that must be broken

      “The Euro Zone allotment of €1T is not possible in practice”

      I’d just like to understand how it is possible in theory

      I think it has something to do with the idea that there is something there that must be broken


    54. “I’d just like to understand how it is possible in theory”

      LOL. Hence everyone busily poring over ECB procedural documents in order to find loopholes.

      But that’s not how the system was designed. You are looking for loopholes to commit accounting fraud.

      It’s backwards to look at the ECB as bailing out the national governments. The national governments are the ones with the taxing power, they are the ones that supply capital to the ECB, and they are the source of fiscal spending.

      A central bank without a strong fiscal agent to back it is just another bank. The fact that it can create reserves means that it is never liquidity constrained, hence the opportunity for a bit of accounting fraud, but that’s about as far as it goes for bailouts.

      And the reason why the ECB doesn’t have access to a central fiscal agent is because the Eurozone nations want it that way.

      In the U.S., the people in the state of california typically pay $1 in taxes for every .70 cents they receive from the federal government. That’s been going on at least since WW2. No one complains about this, since it’s a wealthier state and the understanding is that taxes and benefits are based on the wealth of the person, not the state in which they live. Wealthy people pay more, and subsidize the poor. Therefore wealthier states subsidize the poorer states in perpetuity.

      If the EU had a central fiscal authority, it would need to tax Germany in order to subsidize Greece, so that Germany could keep exporting to Greece. This would need to go on as long as Germany exports to Greece.

      The EU is not going to do that. They might urge Greece to “reform” — say give them a loan. Imagine if the U.S. told Mississippi to “reform”. It had a few years to stop being below average, otherwise it would get kicked out.

      That’s not how it works. Taking responsibility for macro income flows is the difference between having a central fiscal authority, and being just a collection of states with the same currency.

      Greece will not out produce Germany, and Germany will always need to be taxed to subsidize Greece. The “free market” alternative would be default, which amounts to the same thing. Alternately, a currency adjustment that brings the current account into balance.

      There is no free lunch for Germany in terms of export income, but they believe that they have a right to a free lunch, and become indignant when it comes time to pay the bill.

      Because there is no central fiscal authority, there aren’t going to be any bailouts. Searching ECB procedural docs for loopholes is not going to help. The institutions operate in a way that supports the political goals. If you have misconceptions about the political goals, then you might clear those misconceptions up by examining the details of the institutional operations, but you are going to find any operational details that will allow you to overturn the political goals and get different behavior.

    55. Just want to second what Pebird, Tom, Ramanan, and several others have said about the latest post by Stephanie Kelton at the New Economic Perspectives from Kansas City website. It is really excellent.

    56. – This conflicts with the other story about the Fed doing repos to supply reserves for bond auctions.

      Who’s right?

      – Wasn’t looking for theory supporting Mr. Mosler’s proposal in a manual

    57. RSJ,

      Yes I agree that the answer does not lie in the Eurosystem legal documents, but I hunt for things there to understand how the system is put into practice. Another reason the legal documents are good to look at is that legal people cannot afford to be vague and have to define and describe everything precisely.

      Human behaviour can be understood by studying law!

      All regions have balance of payments issues. California may have balance of payments with Texas and in general these are resolved by fiscal transfers and in a sociological way – promoting competitiveness etc. Both are negotiated at the sociological level. And these change from time to time. So going by your comment, you will agree with this.

      Allocating €1T to the governments is one sociological/political solution and it is difficult to see how everyone will agree with this. It is like the US saying that the states will be alloted according to performance and soon some regions will be left behind. It won’t help because the US will be bound by its rule and can’t help those states who are left behind.

      The transactions can either be recorded as the Euro Zone purchasing government debt or described as erosion of capital. Since the Eurosystem can never go bankrupt, it doesn’t matter. In the former case no law is broken and the ECB can set the term structure of the yield curve if that is required and is not restricted to zero rates. The ECB will then earn interest income and its capital won’t erode. That would mean in principle that the governments can spend as much as they want but these things will be restricted politically even if policymakers end up understanding sectoral balances.

    58. Ramanan,

      I’ve posted a question on the KC article which probably won’t appear until Monday.

      On the other thing, the 1 trillion credit proposal – and it IS a proposal to credit banks accounts – I’m still waiting for an explanantion from anybody from MMT or otherwise on how it would work – without getting a lecture on manuals or sociology or on the normal relationship between fiscal and monetary.

    59. For exactly the same reasons Bill Mitchell provides, neither the United States nor Social Security nor Medicare can go bankrupt. A Monetarily Sovereign nation cannot become insolvent, nor can any of its agencies.
      Thus, all the concern about Social Security and Medicare finances is misguided. Even if FICA were eliminated, and benefits doubled, this would not move Social Security and Medicare one dollar toward insolvency.
      No discussion of federal financing makes much sense without considerations of monetary sovereignty.

      Rodger Malcolm Mitchell

    60. anon,

      “. . . Which one are we to believe?” @ NOVEMBER 20, 2010 4:30 AM – is that you ?

      I just thought of something.

      Directly settling on the Fed’s balance sheet (borrowing words from you) is not possible without providing an overdraft to the Treasury AND huge overdrafts to the banking system.

      Of course I am not claiming it that it is completely impossible but will require a lot of effort by the open market desk at the Fed.

      Most nations have an overdraft facility provided to the Treasury with some vague clause that the “Ways and Means Advances” can’t go above some level. But in the case of the US, the overdraft rule seems to be strict even intraday (of course can be broken in the case of “catastrophic auction failure” – your terminology)

      The reason I am making a claim is that most nations have an item “Advances to banks” in the central bank’s balance sheet. See #66 on Marshall’s Latest. You seem to have made some comments on government’s accounts.

      The Federal Reserve does provide daylight overdrafts to banks and it can be huge. However these are daylight not overnight or weekly or permanent. Also the Fed does not like the discount window usage.

      What I am saying is that nations which have CB overdraft facilities to the Treasury will operate like this – Treasury spends and reduces banks’ indebtedness to the central bank. Bond sales increases banks’ indebtedness to the central bank.

      A bit vague but what I am saying is that the requirement of settling in reserves seems connected to providing an overdraft to the Treasury.

    61. Okay to support, most nations have an overdraft for the Treasury and settle in reserves (no proof for the latter) – not the US!

      So if my claim (in italic in the last comment) is correct, there are two descriptions – (i)overdraft for the Treasury + settle in reserves (ii)no overdraft, settle at commercial banks

    62. Yes, my comment.

      BTW, lost in comment so far is that I expect Stephanie Kelton is quite correct in her post. I think she is extremely capable in describing actual monetary operations.

    63. Yes, I would think large intra-day overdraft allowance for Treasury is quite standard if required according to the order of flows for the day.

      I’m mostly interested in squaring the repo activity that is asserted as required for auction settlement with Stephanie’s description.

      It’s possible both versions are right if there’s a difference between money center bank settlement and regional bank settlement for auctions (i.e. Treasury Fed account for money centers; TTL accounts for regionals). If not, I don’t know how they’re both right.

    64. anon: I’ve posted a question on the KC article which probably won’t appear until Monday.

      It’s up now along with her response.

    65. anon.

      The US Treasury doesn’t even have an intra-day overdraft, at least behaves via as if it doesn’t.

      The repo activity may be due to other activity such as FX purchases/sales, account activity of foreign central banks and “federal reserve float”. Treasury’s account at the Fed may not play much role in this. Fed’s Michael Akhtar’s “Understanding Open Market Operations” seems to say nothing about bond sales. Also it says government’s forecast errors gets averaged out to a low value because the reserve requirement is over a period and the Treasury quickly transfers deposits to/from TGA from/to TT&L.

      So government activity seems to do little with repurchase agreements.

    66. I know India has one. Australia has it. UK had a “Ways and Means Advances” system don’t know how operational it is. I think Canada also has it, though it has probably never used it.

    67. Ramanan,

      I imagine repo activity could occur for all sorts of reasons. The point is that Mosler and S. Fullwiler (I think) have said that auction settlements specifically require repo activity to supply the reserves necessary to buy the bonds. That’s at odds with Stephanie’s description.

    68. anon,

      Yes I understand your point. However the description may be valid for setups outside the US – though I wouldn’t use the language “where did the reserves to purchase government bonds come from”. I completely agree that as per SK’s description, no reserves need to be supplied by the Fed.

      Yeah, repo activity happen for all kinds of reasons, but I think the government activity has little to with it – the contribution is minor compared to other factors.

    69. Ramanan:

      “Australia has it”

      Limited to one week at the market rate. Not quite a regular source of funding. “Has it” is a bit of an exaggeration, surely.

      But that’s unimportant.

      Did not know about the UK and India, thanks.

      ECB is quite a different kettle of fish.

    70. “auction settlements specifically require repo activity to supply the reserves necessary to buy the bonds”

      Not sure how repo would help with that being a temporary 1-5 day beast by its very nature used to smooth out cash peak and valleys.

    71. VJK,

      Yes I didn’t mean unlimited overdrafts in any case. In all countries which have it, the overdraft has to be eliminated quickly.

    72. “//”

      Don’t think that is quite right.

      My understanding that TTLs are no longer, after 1970’s, used for bond sales.

      The TreasuryDirect transaction credits the Treasury account with the feds and debits the purchaser’s banks’ reserve account.

      The primary dealer transaction does the same with a lot of netting through FICC.

      In any case, TT&L is not involved.

      The Feds smooth out cash fluctuation through repo’ing primaries (in normal times).

    73. R,

      In the former case no law is broken and the ECB can set the term structure of the yield curve if that is required and is not restricted to zero rates. The ECB will then earn interest income and its capital won’t erode.

      What do you mean by this?

      First, recapitalization via interest income still means that the loss is absorbed by capital. Note that the ECB would need to raise more capital subscriptions, since it can only retain earnings up to 100% of the capital subscription, and any further earnings need to be passed back to the member states. Retained earnings belong to the capital owners — the member states. You do not “pay” for asset write downs with net interest income, you pay for asset write downs with capital.

      Second, how long would it take for the ECB to recapitalize itself via NII? The ECB earns NII of about 0.1% of the size of the ECB balance sheet. But in order to commit balance sheet fraud over long periods of time, a bank needs the cooperation of the debtors; they can’t default but must be willing to keep rolling over the debt, so that the creditor can avoid the write down and can delay requesting more capital as it builds up enough of a buffer with retained earnings.

      That arrangement is not possible with the ECB due to the cap on retained earnings and the magnitude of quantities involved. It is very difficult for a highly leveraged entity that earns razor thin spreads to recapitalize itself with retained earnings in the event of a large default.

      As soon as the debtors default, then there is nothing to roll-over, and the ECB must write down the asset. It is at that point that it will need to increase the capital subscriptions form the member states to cover the shortfall.

      The ECB will not be able to keep dribbling things out, asking for a bit more capital from member states each year over a few hundred years. The fiscal crisis will have resolved itself long before then, and when the resolution occurs, the ECB will need to either ask for the bailout amount up front, or hope that it has pushed the debt back onto private sector.

      Note that it is the bondholders, and not the member states, that are being bailed out in the event of a sovereign default.

      Finally, in terms of the comment that the ECB can “set the term structure”, I know it’s a matter of pure religion here, but try to understand what you are arguing.

      Suppose that the demand for Greek Bonds is completely inelastic. I.e. investors have $100 per period that they want to spend on Greek Bonds, and they will spend that regardless of the price. Well, that can’t be the case, right, because no one will pay above par for the debt. Why not? Because they can just hold cash instead. So you get the first glimmer of arbitrage in the basic observation that you cannot force someone to pay above cash.

      Therefore the demand cannot be inelastic.

      No one has an inelastic need for Greek debt. They can buy Spanish debt, or german debt, corporate debt, or any other kind of debt. OK, you modify your argument to say that there is an inelastic need for debt of all kind, so that when the ECB buys up 5% of the total debt outstanding, then the price has to rise by 5%.

      Fine — even in that case, how do you know that when the ECB retires some debt, that more isn’t brought onto the market?

      After all, the point of all of this is to allow the member states to keep funding themselves, right?

      And at the same time, the private sector also funds itself by issuing debt.

      To the degree that supply/demand dynamics drive yields down so that it becomes profitable for the private sector to issue more debt, then it will issue more debt up until ita net profits are zero.

      I.e., if you can earn a profit of 5% by deploying more capital, then you will be willing to borrow at 5%, and you will keep selling more debt as the ECB retires it as long as you can keep earning that 5%.

      Therefore the true questions you need to ask are

      1) As the ECB buys debt, driving yields down, and the private sector issues more, driving them back up, will the actual profit opportunities decline, so that total yields decline — and if so, by how much?

      2) Can the ECB retire enough debt (thereby causing the private sector to issue more) so that it can force down the profit opportunities in the economy to be the level that it wants?

      Now depending on your model of the economy, reasonable people can disagree on the answer to #1) and #2).

      Basically #1 is a statement of diminishing marginal returns to capital.

      But there are all sorts of problems here — i.e. an increase in bonds does not need to correspond to an increase in capital. it could just be a shift where firms fund themselves more with bonds and less with equity.

      So there is an enormous amount of slack, and you would need to buy many trillions of debt.

      So let’s suppose that we believe in diminishing returns to capital, and we also believe that as the private sector borrows more, eventually this must show up as increased investment, and the larger capital stock will be less profitable.

      In that case, what you are doing is driving the economy towards dynamic inefficiency. In terms of endowments, what you are doing is increasing the endowment of those who own capital and correspondingly decreasing the endowment of those who do not, by lowering the discount rate. Therefore more resources will be allocated increasing capital and fewer resources will be allocated towards increasing consumption. Capital owners become wealthier and more powerful at the expense of everyone else.

      In that case, it would be better to have less capital and more consumption, but instead you are creating a situation in which there is less consumption and more capital. That means that either GDP growth slows down, or more and more GDP growth is driven by investment and less by consumption — a ponzi situation.

      For #2), it seems implausible to me for the ECB to purchase enough debt to make a material difference in lowering profits by means of driving excess investment. The ECB is buying risky debt, and it has a razor thin capital margin to hold against that debt. It can’t expand its balance sheet enough, because it needs to maintain enough of a capital buffer to absorb the volatility of the debt.

      For the U.S. the Fed cannot buy risky debt at all, so it is prevented from retiring enough debt in the first place.

      So if you believe that #2) precludes a lowering of the long term rates, then what you are left with is an argument that by lowering the short rates, but not the long rates, you will supply economic rents to the financial sector, and that by supplying enough of these rents, they will buy up enough of the assets to drive the economy into the inefficient state.

      But again, now you are relying on poor bank regulation and evasion of capital requirements in order to be your “channel” by which short term rates drive down long term rates. This is why the EH is discredited — it can only work in the context of financial fraud, and such situations tend to blow themselves up.

      Perhaps some of that has happened, but it’s certainly not a simple case of the CB dictating the yield curve.

      I understand that trying to reduce dynamics to individual trade offs goes against the grain here. It is much easier to just make a statement of faith, and then run a model in which people act as automatons, rather than one in which they are looking out for their own interests. But such an approach isn’t going to give you the right answer, and it wont lead to the right economic management policy. Note that you can disagree — perhaps in your model, the ECB would only need to purchase a small amount of debt and this would cause profit opportunities in the EU to rapidly decline, forcing down yields. But if you disagree, this is how you need to argue, not by faith.

      Of course there are short term dynamics, in which the price goes up because others think it will go up. But the price can also go down because others think it will go down. For every Cb front-runner, there may be another true believer convinced that hyperinflation is around the corner. And you don’t know which mania will take hold. You can’t rely on noise traders to implement your policy, because by definition they are irrational and unpredictable.

      Note that you do not have the same situation with reserves. No one else can issue reserves, and the demand for reserves is inelastic. If the CB removes reserves, then there is no private sector actor that can take advantage of the excessively high cost of reserves to supply more. But it is pure religion and sloppy logic to extrapolate this unique situation of reserves to the capital markets. What you are left with — in terms of the discrepancy between short and long rates — is economic rents supplied to the financial sector, not lower long term rates.

      It’s ironic that you would try to appeal to these rents as the source of the ECB’s recapitalization, while simultaneously arguing that long rates will go down as the ECB buys more assets.

    74. VJK @Sunday, November 21, 2010 at 10:34,

      How about this – your story still works, but the Treasury/Fed transfer the deposits to the TTL account as soon as the funds read the TGA.

    75. RSJ,

      Will read your comment in detail.

      My argument was to just simplify the problem – take a situation in which default is not possible and then throw the complications to politics. That way it is easier to talk of politics and isolate the main problem.

      Since government debt is default-free in my scenario, no worries about capital.

    76. In no way I claim that default issues is not a problem in above.

      What I am saying is that there are hosts of other issues than default to worry about for the Euro Zone.

    77. VJK,

      To support my claim, from Federal Reserve Banks as Fiscal Agents and Depositories of the United States in a Changing Financial Environment, Autumn 2004, page 443 – pink box on the right of the page:

      Relationship between the Treasury’s Balance with the Reserve Banks and the Implementation of Monetary Policy

      The Treasury maintains its primary account for making and receiving payments, the Treasury general account (TGA), at the Reserve Banks. An increase in the balance of that account means that funds have moved from depository institutions’ accounts at the Banks into the TGA. This movement of funds reduces the amount of reserves in the banking system.1 Conversely, a decrease in the TGA means that funds have moved from that account to depository institutions, thereby increasing the amount of reserves in the banking system.

      This relationship between the Treasury’s balance with the Banks and the amount of reserves in the banking system is important from a monetary policy perspective. This is because the amount of reserves in the banking system affects the federal funds rate—the rate at which depository institutions lend reserves to other depository institutions and the operating objective of the Federal
      Open Market Committee (FOMC) in its conduct of monetary policy. Through open market operations—the purchase and sale of U.S. Treasury and federal agency securities on the open market—the FOMC adjusts the amount of reserves in the banking system so as to achieve the targeted federal funds rate. By fluctuating, the Treasury’s balance at the Banks affects the level of reserves and, therefore, the conduct of monetary policy.

      The Banks and the Federal Reserve Board work closely with the Treasury every day to ensure that the Treasury’s balance with the Banks remains stable, between $5 billion and $7 billion. The Banks use the Treasury Tax and Loan program to shift amounts in excess of the targeted Treasury balance into depository institutions’ accounts and, as a result therefore, back into the banking system.

      (Boldening in the end: mine)

    78. R,

      On the real side, you have differences in productivity and output across nations, and that shows up as a Balance of Payments problem, which given the effectively pegged currencies leads to default. The default concerns are due to financial imbalances which are the manifestation of the real imbalances. It’s the same problem, just looked at another way.

      If the exchange rates were floating, you would get a currency adjustment, with no default unless there was original sin. If there was original sin, you would still get default.

      If it was all one country, you would get fiscal transfers with good policy, and barring that a general demand failure.

      Par the Lucas quote, no one knows what to do with income flows anymore, since we have stopped caring about fiscal policy and assume that all these income imbalances will fix themselves without any government intervention. And this problem is showing up everywhere, just in different forms.

    79. RSJ,

      “The default concerns are due to financial imbalances which are the manifestation of the real imbalances. It’s the same problem, just looked at another way.”

      Yes nicely put.

    80. Ramanan,

      Your 19:23 was my understanding.

      Doesn’t that prove there is no need for the Fed to supply extra reserves by repos just to settle an auction?

    81. anon,

      Yes it does prove that there is no need for the repos to settle an auction. However one may (not I) argue that for the time between the point where the funds hit the TGA and the transfer to the TTL, the banking system was provided with a daylight overdraft (few milliseconds?) and hence the “reserves came from the government” or something like that.

      I used to think that other countries’ central banks used the procedure except the Fed. But now it seems the Fed also uses it.

    82. I’d say there are daylight overdrafts for a lot longer than a millisecond. That’s standard operating procedure. You can’t match up flows perfectly.

      But that doesn’t mean repos are required. That’s the issue I’m still looking for an answer to, as it’s been a big deal in previous MMT explanations of the Fed system. I’d like to know why that’s the case.

    83. Ramanan:

      So, the repo role varies from funding T-auctions to “no need for the repos to settle an auction” ?
      Funny how people try to twist reality to fit their pet theories, don’t you agree ?

      In fact, bond sales settle through the TGA, not TT&Ls.

      The Treasury does try to manage its cash position by auctioning extra cash, in excess $5-7B as you pointed out, by shifting it to participating TT&L.

      However, the Treasury does not just credit participants TT&Ls and debits its own account — it is not GOSBANK (yet). The Treasury *auctions* extra cash to willing and able participants. If the participants are unwilling or unable (do not have enough collateral), the Treasury cannot do much but keep the unwanted cash. On several occasions, the target was exceeded two times normal, reaching $12B or so, due to participating banks lacking

      The cash auction program is relatively new, about 2000, and the set of participants is smaller than the set of TT&L holders.

      Clearly, repo’ing is needed to smooth out cash supply in the system in the interim or even postfactum until the Treasury, through”natural” spending, replenishes possibly depleted reserves.

      That’s in normal times, not sure any repo’ing is needed today with the system floating in $1T and soon to become more of grease.

      I may be rusty on details, but that’s the gist.

      Not sure why you call repo’ing “shredding”. Perhaps, you meant printing followed by shredding.

    84. VJK,

      So, the repo role varies from funding T-auctions to “no need for the repos to settle an auction” ?
      Funny how people try to twist reality to fit their pet theories, don’t you agree ?

      Sorry is that an accusation pointed toward me ?

      At any rate, things are happening fast and the Treasury would transfer funds to the TTL from TGA and then auction the funds out later. It doesn’t wait for the counterparties to get back. It will cause the Fed funds rate to shoot upward. Now you can say that the Fed can do a repo, but that is inefficient, because it has to quickly undo it as the Treasury itself is involved in investing extra funds. Best for the Treasury to carry out transactions without causing any change to the reserves level.

      Again, the TTL is the Treasury’s bank account. The Treasury can do whatever it wants – just like I can keep doing RTGS between my accounts all day. So doesn’t make sense to compare it with Gosbank.

      Stephanie’s comments are quite right.

      The Treasury coordinates it operations (spending, taxing and bond sales) in order to minimize disruption in the private banking system. In the absence of coordination, banks would constantly see large swings in their reserve holdings, and this would be disruptive. In essence, it would force the Fed to intervene on a much larger scale, buying and selling larger quantities of bonds in order to hit its FFR (fed funds rate) target. Knowing this to be the case, the Treasury does the BEST IT CAN to minimize the impact of its fiscal operations on reserves. How does it do this? By ESTIMATING the flow of funds that will be coming into/out of the Treasury’s account at the Fed and by using its TT&L accounts to manage these flows. But it is impossible to get it just right, so the Fed must supply/drain reserves, as needed, in order to offset the effects of the Treasury’s operations.

      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.

      All major central banks use this trick – moving government deposits in and out of the banking system. Even currency boards do that! The funds are first moved into the banking system and then the Treasury decides what to do.

    85. Ramanan:

      “At any rate, things are happening fast and the Treasury would transfer funds to the TTL from TGA and then auction the funds out later. It doesn’t wait for the counterparties to get back.

      Did you read what I wrote ?

      On several occasions, the treasury *could not auction extra cash*.

      Where in the world did you find the info that the Treasury credits the bank account without auctioning treasury cash *first* and making sure there is enough collateral at the bank’s disposal ?

      So much worse for the facts ?

      Speaking of pet theories.

    86. VJK,

      You have a wrong impression and looks like you want to attribute it to me but can’t help if that is your impression. No wonder some MMTer had the impression that you have been misrepresenting people.

      I don’t hold views that the repos fund the Treasury purchase and arguments such as that.

      At any rate, not sure you understand whats going on and how movement of government deposits work compared to doing repos. The article I quoted clearly states how movement of funds into/from the banking system allows the Fed in meeting its monetary policy objectives.

      Let me know some detailed way in which what you have said works out in practice.

      The Bank of Canada earlier would simply transfer government deposits into the commercial bank accounts. It then changed the rules and now auctions out the deposits. Now the question is what is the timing of these events.

      Just like I can transfer money to any account of mine, the Treasury can transfer funds to the TTL. The TTL is just a fancy name for a deposit account at a commercial bank. The difference is that the depository institutions need to hold collateral, unlike our accounts where we do not demand collateral from the bank. The Treasury can decide what to do with the cash later. It can do a repurchase agreement with some financial market player etc.

      Here is what the Fed says

      During most of the year, TT&L capacity, defined as the sum of the lesser of the balances limit or the collateral value of the 1,282 note option depositories, exceeds the supply of tax payments. The regular exception is a two-week period around April 15, when the Treasury receives a large influx of individual income tax payments. During this time, the potential flow of tax payments into TT&L accounts exceeds the supply of maximum balances, and the Treasury must hold balances in its Federal Reserve accounts involuntarily.

      So what you are talking about is just an exception. You can’t make a rule an exception. We are talking general stuff here. Never claimed what I am writing happens all the time, but you wanted to attribute it to me.

    87. “Not sure why you call repo’ing shredding”, ET al.

      What the hell is wrong with you? We’re trying to have a simple exchange of opinion here without interruption from somebody who is ignorant of the relevant conversational history or context. If you’re going to comment on somebody’s comment, have some manners and intelligence about it. Otherwise, and better yet, stay away from threads where you have this rampantly insecure compulsion to pile on with your usual offensive, belligerent style. BTW, your analysis in general isn’t anywhere near good enough to make up for your obtuse lack of manners.

    88. Anon,

      Good one @4:29 :-)

      We are heading in the right direction. In fact, the Treasury has made sure that it can transfer funds to depository institutions, without notifying them in advance (it’s called “Dynamic Investing”). The bare case is that the Treasury immediately transfers all funds to commercial bank accounts. However, since these earn less than the market rates and there are risks plus the banks may raise objection to this activity, it has gotten into doing technical stuff such as TIO etc. The interrupter has simply missed all this.

      Here is one from FRBNY:

      Recent Innovations in Treasury Cash Management by Kenneth D. Garbade, John C. Partlan, and Paul J. Santoro

      Like other economic agents, the U.S. Treasury maintains a cash balance to buffer unanticipated and short-run differences between receipts and expenditures. Unlike other agents, however, the Treasury has to pay special attention to the question of where it keeps its cash. The Treasury disburses almost all of its payments from accounts at Federal Reserve Banks, but virtually all Treasury receipts are transfers of funds previously held at private institutions. Thus, there is a continuous flow of funds from private institutions to the Reserve Banks and back again. If the Treasury deposited all of its receipts in its Reserve Bank accounts as soon as the receipts came in, and if it held the funds in those accounts until they were disbursed, increases in its cash position would drain reserves from the banking system and, conversely, decreases would add reserves. As Chart 1 shows, Treasury balances exhibit significant trends, building up when receipts exceed disbursements and running down when disbursements exceed receipts. Maintaining Treasury balances primarily at Federal Reserve Banks would, therefore, necessitate frequent and large-scale open market operations to mitigate undesirable fluctuations in bank reserves and the federal funds rate. A more efficient strategy, and the one adopted by the Treasury, is to maintain a stable working balance in its Reserve Bank accounts and to leave the remainder of its cash in private depository institutions until needed.

      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.2 At the same time, the TT&L program is a key component of the Treasury’s fiscal management system and serves two additional purposes related to that system: processing federal tax payments and earning interest on public funds invested at private depository institutions. The program lies at the interface between Federal Reserve monetary policy and Treasury cash management and provides an outstanding example of the benefits, to taxpayers and to the economy as a whole, of the long-standing cooperation between the two agencies.

      (I assume receipts here include funds obtained from bond sales as well)

      So it ties very well with what you raised in Marshall’s Longest – the cash management operation – which was referred to as contingency operation actually works in favour of the monetary policy as the above quote shows and as suspected by you.

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