It is a pity that he doesn’t know the answer himself

We are deep into hard-disk crash trauma at CofFEE today with 2 volumes dying at the same time on Friday and a backup drive going down too. At least it was a sympathetic act on their behalf. Combine that with I lost a HDD on an iMAC after only 2 weeks since it was new a few weeks ago – after finally convincing myself that OS X was the way forward with virtual machines. Further another colleague’s back-up HDD crashed last week. It leaves one wondering what is going on. Backup is now a oft-spoken word around here today. But there is one thing I do know the answer to – Greg Mankiw’s latest Examination Question. It is a pity that he doesn’t know the answer himself. Further, it is a pity that one of the higher profiled “progressives” in the US buys into the same nonsense.

In his latest blog (July 3, 2011) – A Good Exam Question – Mankiw pokes fun at so-called progressive Dean Baker who wrote a column recently in The Republic (July 2, 2011) – Ron Paul’s Surprisingly Lucid Solution to the Debt Ceiling Impasse – where as the title suggests he thinks ultra-conservative US Republican politician Ron Paul is onto something good.

The truth is that none of them – Mankiw, Baker, or Paul – understand how the banking system operates.

First, let’s consider what Baker said in detail.

I think Mankiw’s summary of the Baker proposal is valid:

According to Congressman Paul, to deal with the debt-ceiling impasse, we should tell the Federal Reserve to destroy its vast holding of government bonds. Because the Fed might have planned on selling those bonds in open-market operations to drain the banking system of the currently high level of excess reserves, the Fed should (according to Baker) substantially increase reserve requirements.

Mankiw’s reaction is that “(t)his would be a great exam question: What are the effects of this policy? Who wins and who loses if this proposal is adopted?”.

I also agree that it would be an interesting examination question which I suspect all student who had studied macroeconomics using Mankiw’s own textbook would fail to answer correctly.

I will come back to Mankiw’s own answer directly – which suffers the same misgivings as the suggestion by Baker that we listen to Paul and then Baker’s own addendum to the idea.

Baker referred to Paul’s proposal as:

… a remarkably creative way to deal with the impasse over the debt ceiling: have the Federal Reserve Board destroy the $1.6 trillion in government bonds it now holds

He acknowledges that “at first blush this idea may seem crazy” but then claims it is “actually a very reasonable way to deal with the crisis. Furthermore, it provides a way to have lasting savings to the budget”.

So we have two ideas here – one to reduce debt as a way of tricking the pesky conservatives who want to close the US government down (or pretend they do for political purposes) by not approving the expansion of the “debt ceiling”. The debt ceiling is this archaic device that conservatives can use to make trouble for an elected government which has not operational validity. After all, doesn’t the US Congress approve the spending and taxation decisions of the US government anyway?

The second idea that Baker leaks into the debate is that by destroying public debt held by the central bank (as a result of their quantitative easing program) it would save them selling it back to the private sector which in turn would save the US government from paying interest on it. And he seems to think that is a good thing. Spare me!

In his own words:

The basic story is that the Fed has bought roughly $1.6 trillion in government bonds through its various quantitative easing programs over the last two and a half years. This money is part of the $14.3 trillion debt that is subject to the debt ceiling. However, the Fed is an agency of the government. Its assets are in fact assets of the government. Each year, the Fed refunds the interest earned on its assets in excess of the money needed to cover its operating expenses. Last year the Fed refunded almost $80 billion to the Treasury. In this sense, the bonds held by the Fed are literally money that the government owes to itself … As it stands now, the Fed plans to sell off its bond holdings over the next few years. This means that the interest paid on these bonds would go to banks, corporations, pension funds, and individual investors who purchase them from the Fed. In this case, the interest payments would be a burden to the Treasury since the Fed would no longer be collecting (and refunding) the interest.

First, note the recognition that the central bank and treasury are just components of the consolidated government sector – a basic premise of Modern Monetary Theory (MMT) and should dispel the myth of the central bank being independent.

Mankiw also agreed with that saying “Since the Fed is really part of the government, the bonds it holds are liabilities the government owes to itself”. Which makes you wonder why he doesn’t tell his students that in his textbook. Further, why do those textbooks make out that the central bank is independent when it clearly is part of the monetary operations of the government? The answer is that it suits their ideological claim that monetary policy is superior to fiscal policy.

Please read my blogs – Central bank independence – another faux agenda and The consolidated government – treasury and central bank – for more discussion on this point.

I will come back to that status presently.

Second, the accounting hoopla by which the treasury gets interest income back from the central bank but lets it keep some funds to pay for its staff etc might be interesting to accountants but is largely meaningless from a monetary operations perspective. It is in the realm of the government lending itself money and paying itself back with some territory.

I agree with Mankiw that Paul’s suggestion which Baker endorses “is just an accounting gimmick”. But then the whole edifice surrounding government spending and bond-issuance is also “just an accounting gimmick”. The mainstream make much of what they call the government budget constraint as if it is an a priori financial constraint when in fact it is just an accounting statement of the monetary operations surrounding government spending and taxation and debt-issuance.

There are political gimmicks too that lead to the US government issuing debt to match their net public spending. These just hide the fact that in terms of the intrinsic characteristics of the monetary system the US government is never revenue constrained because it is the monopoly issuer of the currency. Which makes the whole debt ceiling debate a political and accounting gimmick.

Third, note that Baker then falls into the trap that the mainstream are captured by in thinking that in some way the interest payments made by the government to the non-government sector are a “burden”. A burden is something that carries opportunity costs and is unpleasant with connotations of restricted choices.

From a MMT perspective, one of the “costs” of the quantitative easing has been the lost private income that might have been forthcoming had the central bank left the government bonds in the private sector. Given how little else QE has achieved those costs make it a negative policy intervention.

So the so-called “burden” really falls on the private sector in the form of lost income. Once you accept that there are no financial constraints on the US government (which means that the opportunity costs are all real) then the concept of a burden as it is used by Baker is inapplicable.

And then once we recognise that there is a massive pool of underutilised labour and capital equipment in the US at present contributing nothing productive at all then one’s evaluation of those real opportunity costs should be low. That is, at full employment the interest payments made by government to the non-government sector on outstanding public debt have real resource implications that might require some offsetting policies (lower spending/higher taxation) to defray any inflation risks.

With an unemployment rate of nearly 10 per cent and persistently low capacity utilisation rates overall, every dollar the government can put into the US economy will be beneficial from a real perspective.

But it gets worse.

Baker turns his hand to thinking about the monetary operations involved in the central bank destroying the bonds. He might have saved us the pain. He notes that the reason the Federal Reserve “intends to sell off its bonds in future years” is because they want to:

… reduce the reserves of the banking system, thereby limiting lending and preventing inflation. If the Fed doesn’t have the bonds, however, then it can’t sell them off to soak up reserves.

But as it turns out, there are other mechanisms for restricting lending, most obviously raising the reserve requirements for banks. If banks are forced to keep a larger share of their deposits on reserve (rather than lend them out), it has the same effect as reducing the amount of reserves.

Baker falls head long into the mainstream myth that banks lend out reserves.

Please read the following blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – for further discussion.

I remind you of this piece of analysis by the Bank of International Settlements in – Unconventional monetary policies: an appraisal – it is a very useful way to understanding the implications of the current build-up in bank reserves.

The BIS says:

… 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 …

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.

In answering his own “examination question”, Mankiw gets positively angry and says of the plan to raise reserve requirements that it would be:

… a form of financial repression. Assuming the Fed does not pay market interest rates on those newly required reserves, it is like a tax on bank financing. The initial impact is on those small businesses that rely on banks to raise funds for investment. The policy will therefore impede the financial system’s ability to intermediate between savers and investors. As a result, the economy’s capital stock will be allocated less efficiently. In the long run, there will be lower growth in productivity and real wages.

First, if the central bank didn’t use the bonds to drain reserves (via open market operations) then it would have to pay market rates of interest to the banks who held reserves with them or lose control of its target policy rate. So unless the central bank is going to keep short-term rates at zero for an indefinite period (which I recommend) then we would be unwise to assume they will not be paying a return on the reserves (as they are doing now).

Consistent with MMT, there are two broad ways the central bank can manage bank reserves to maintain control over its target rate. First, central banks can buy or sell government debt to control the quantity of reserves to bring about the desired short-term interest rate.

MMT posits exactly the same explanation for public debt issuance – it is not to finance net government spending (outlays above tax revenue) given that the national government does not need to raise revenue in order to spend. Debt issuance is, in fact, a monetary operation to deal with the banks reserves that deficits add and allow central banks to maintain a target rate.

Try finding this explanation for public sector debt issuance in Mankiw’s macroeconomics text book.

Second, a central bank might, instead, provide a return on excess reserve holdings at the policy rate which means the financial opportunity cost of holding reserves for banks becomes zero. A central bank can then supply as many reserves as it likes at that support rate and the banks will be happy to hold them and not seek to rid themselves of the excess in the interbank market. The important point is that the interest rate level set by the central bank is then “delinked” from the volume of bank reserves in the banking system and so this becomes equivalent to the first case when the central bank drains reserves by issuing public debt.

So the build-up of bank reserves has no implication for interest rates which are clearly set solely by the central bank. All the mainstream claims that budget deficits will drive interest rates up misunderstand their impact on reserves and the central bank’s capacity to manage these bank reserves in a “decoupled” fashion.

Second, Mankiw falls prey to the same error that Baker makes – that banks lend out reserves. As noted this is a mainstream myth. The banks could still lend out whatever they liked as long as there were credit-worthy customers queuing up for loans. So no small businesses would be affected in the way Mankiw claims.

Anyway, as to what the debt-ceiling means, I was asked by several readers about the status of the US government (by which they meant the Treasury) in relation to the central bank (the Federal Reserve).

The legal code in the US essentially recognises that the central bank and treasury are part of the government sector.

If you consult the United States Code which reflects the legislative decisions made by the US Congress you find, for example, the section – TITLE 31 – MONEY AND FINANCE § 5301 – which deals with the Buying obligations of the United States Government

The US law stipulates the following:

31 USC § 5301. Buying obligations of the United States Government

  • (a) The President may direct the Secretary of the Treasury to make an agreement with the Federal reserve banks and the Board of Governors of the Federal Reserve System when the President decides that the foreign commerce of the United States is affected adversely because -
    • (1) the value of coins and currency of a foreign country compared to the present standard value of gold is depreciating;
    • (2) action is necessary to regulate and maintain the parity of United States coins and currency;
    • (3) an economic emergency requires an expansion of credit; or
    • (4) an expansion of credit is necessary so that the United States Government and the governments of other countries can stabilize the value of coins and currencies of a country.
  • (b) Under an agreement under subsection (a) of this section, the Board shall permit the banks (and the Board is authorized to permit the banks notwithstanding another law) to agree that the banks will-
    • (1) conduct through each entire specified period open market operations in obligations of the United States Government or corporations in which the Government is the majority stockholder; and
    • (2) buy directly and hold an additional $3,000,000,000 of obligations of the Government for each agreed period, unless the Secretary consents to the sale of the obligations before the end of the period.
  • (c) With the approval of the Secretary, the Board may require Federal reserve banks to take action the Secretary and Board consider necessary to prevent unreasonable credit expansion.

§ 5301. Buying obligations of the United States Government under Title 31 of the US Code as currently published by the US Government reflects the laws passed by Congress as of February 1, 2010.

So it seems the President can never run out of “money”. Can any constitutional lawyers out there who are expert in the USC please clarify if there are exceptions to this law? The law (including the accompanying notes which I didn’t include here) appears to say that an economic emergency can justify the President commanding the Federal Reserve to hand over credit balances in favour of the US Treasury.

Conclusion

I hope you all answered Mankiw’s examination question correctly.

My attention is now turning to computer hardware!

That is enough for today!

This entry was posted in Economics, Friends like this. Bookmark the permalink.

32 Responses to It is a pity that he doesn’t know the answer himself

  1. Max says:

    In 24 years (since I got my first hard drive) I’ve never had a failure of any kind. Just lucky I guess.

  2. Chaos says:

    Why should holding risk free assets (bonds) give a fresh income stream (interests)? That’s what’s wrong with interests on bonds and not anything else: more income for the rich which they don’t need, and yet an other product to play in financial casino instead of investing it in a productive way.

    I know that you may get beat up by inflation but in any case is just not right in my opinion.

  3. James Schipper says:

    Dear Bill

    Let me confess that I don’t really understand the banking system. If you are rigt, professional economists don’t understand it either. That makes me feel much better. However, I must take issue with your claim that, since the central bank is part of the government, it can’t be truly independent. By that logic, we couldn’t have independent courts either. Courts are very much part of government, but we expect them to be independent and not folow the directives of the govrnment of the day. Couldn’t a central bank behave like a court?

    Regards. James

  4. bill says:

    Dear James (at 2011/07/04 at 19:38)

    The way in which I talk about the consolidated government sector refers to their monetary operations. But if you wanted to take it a little further then most governments are unable to overturn a court ruling I suspect but almost all governments can overturn a central bank decision or co-opt the central bank to do what they want. I don’t think a government could instruct a court to find someone guilty (that is, in systems that are non-corrupt).

    Also the tenure of judges (while determined by governments) is usually much longer (multiples of the political cycle) when compared to those of central bankers and their decision making boards.

    But I agree that ultimately, the courts reflect the dominant political paradigm (albeit with a lag sometimes when that paradigm changes).

    best wishes
    bill

  5. Philip Pilkington says:

    “Couldn’t a central bank behave like a court?”

    Doubtful. Court cases don’t (generally) have massive implications for public policy — central banks do. Take two imaginary examples:

    (1) Bernanke starts reading Bill’s excellent blog and decides that the government needs to run up much bigger deficits to soak up unemployment and allow the private sector to save/deleverage. Do you think the government is going to let Bernanke do this amidst all the current hysteria?

    (2) Rewind to the time of the US housing bubble. Greenspan decides that the bubble has gotten too big and says in private that he’s going to jack up interest-rates to burst it. Now, let’s say an election is coming up. You think the Whoever administration is going to let him jack up interest-rates and pop the bubble?

  6. Philip Pilkington says:

    Bill,

    Imagine for a moment that Baker’s idea was implemented.

    Would I be right in saying that very little would happen except that the central bank would lose control over the interest-rate (which is already flat-lining)? If Baker’s reserve requirements did nothing — as bank lending is not reserve constrained — then surely this would be the only outcome.

    It would technically work, right? Or would there be difficulties when the central banks tried to meet the new reserve requirements at the end of the day?

    Phil

  7. Mike says:

    Unrelated comment:

    Bill on the 7:30 report tonight the presenter Chris Ulman (spelling?) said to Tony Abbot words to the effect: “do you agree that taxes fund the budget.” TA responded in the affirmative, as would all members of parliament presumably.

    It might be worth contacting the ABC for a discussion.

  8. Andrew says:

    Governments are not in the habit of directly overturning court decisions in Western democracies. The population would get a bit ancy and the ruling party might lose support. Doesn’t stop them influencing appointment of key members of the judiciary and involving in groupthink to get the desired outcome. When the prisons are too full the courts always oblige with lighter sentences.

    It’s glaringly obvious the Government as legislators can rescind laws or introduce new laws if they don’t like the legal outcomes. Just as obviously they can change the remit of the independent bank if they choose to.

  9. Neil Wilson says:

    “Would I be right in saying that very little would happen except that the central bank would lose control over the interest-rate (which is already flat-lining)?”

    Why would they lose control over the interest rate? The Fed pays interest on reserves and the reserves are already in the reserve accounts.

    The bonds at the Fed are already eliminated if you create a consolidated balance sheet between the Fed and the Treasury. All Baker is suggesting is that the contras in the ledgers are run to their conclusion for real – which eliminates a chunk of the national debt held in government institutions.

  10. Benedict@Large says:

    FYI #1: Bill’s favorite Reserve Bank director, Warwick McKibbin, draws a headline in the Sydney Morning Herald: “Global ‘train wreck’ coming“. It’s a (thankfully) short fantasy about debt to GDP ratios in which apparently US and Aussie interest rates will have to go up to bring Chinese and Indian inflation under control. I don’t know if McKibbin is planning on retiring soon, but if he is, I hear Timmy Geithner will be looking for a job in a few months, and he would certainly provide good continuity were he to be McKibbin’s heir. Note however that there may be some moving allowances required, as Tiny Tim never was able to sell his mansion in New York when he moved to DC. Something about it being underwater, I think.

    FYI #1: Krugman’s Plenary Lecture on the occasion of the 75th anniversary of Keynes’ General Theory is now available (text, audio, video (streamed or download)), in which he intro’s with something about a paradox of liquidity preference versus loanable funds, marking it clearly as a lecture tailored to its audience. To be honest, I haven’t gotten any further in it yet, as it was moved down my To Do list by a Twilight Zone marathon this weekend, which I consider to be the far more realistic of the two. (At least Krugman is taking Obama to task for Obama’s latest utterance of the family-government equivalancy. Whoever thought this clown was a progressive?)

  11. joebhed says:

    Paul says to eliminate the government debt via Fed payoff.
    Baker says not a bad idea – solves a couple of problems.
    Mankiw says – not so fast, Baker – ““(t)his would be a great exam question: What are the effects of this policy? Who wins and who loses if this proposal is adopted?”.

    Bill says, everyone who studies neo-liberal economics (incl. Baker and Mankiw and their students) would get the answer wrong.
    Bill explains the difference between monetary policy effects as they are today and monetary policy operations in MM theory.
    But, what is the answer to the question?
    If the Fed were to pay off the government’s obligations directly – kind of like what many MMTers say we should do in directly funding the deficits WITHOUT DEBT in the first place – then who would be the winners and losers?

    This scenario did, surprisingly to me, come up in a Coffee With Joe a week or so ago: about 7 min. in
    http://www.youtube.com/user/EconomicStability#p/a/u/3/OMgBgzDvECk

    Maybe it’ just me, but in sympathy with Bill’s hardware problems, he seems to have forgotten to provide the right answer to Mankiw’s question.
    Next week’s quiz?
    Thanks.

  12. sidchem says:

    I say let the conservatives or neo libs (or what every you want to call them) do what ever they want to make them feel that they have solved the debt problem by shifting around bonds at the fed and treasury, since it it has no major effect. Then they would have to come up for a new reason to starve people or beat up old people besides the “deficit”. Maybe they could limit their nastiness to controlling people’s body functions and require everyone to carry guns instead. They just are looking for a way to stay in power and have to come up with new lies on a periodic basis, which they are good at.

  13. Philip Pilkington says:

    @ Neil

    Theoretically they could move the interest rate as they wanted as bill says. But we all know they won’t do that. They’d act all confused and see rates flatline, i assume…

  14. Dan Kervick says:

    Baker falls head long into the mainstream myth that banks lend out reserves.

    This doesn’t seem fair. It appears to be true that bank lending is not reserve-constrained as our banking system is presently constituted. But that is because of choices we have made about how to – and how not to – regulate our banks. Baker is clearly thinking about possible changes to those regulations. With suitable changes to the computation period or maintenance period or both, we could make reserve requirements much more stringent. We could even, if we choose, make it a requirement that banks only lend out .

    Whether money is created “endogenously” by the private banking system in a society, or “exogenously” by the central bank, is not a matter of fundamental economic principles. It is contingent on the laws and institutions that happen to exist. These are subject to change.

  15. Dan Kervick says:

    I left one sentence incomplete. I wrote:

    We could even, if we choose, make it a requirement that banks only lend out .

    which should have been

    We could even, if we choose, make it a requirement that banks only lend out against the reserves they already have.

  16. Dan says:

    My understanding makes me think that burning the notes would be a good idea regardless of its source. As reserves neither constrict nor facilitate lending, and they don’t cause inflation their level is inconsequential.

    Why not propose the idea and let the discussion begin on how the Fed will manage its target rate in the future? For some time the rate is destined to be zero anyway.

    The discussion might be enlightening and illuminate the points Prof Mitchell makes in this post.

  17. Arthur Wilke says:

    RE: Reference to:
    31 USC § 5301. Buying obligations of the United States Government
    . . . .
    (2) buy directly and hold an additional $3,000,000,000 of obligations of the Government for each agreed period, unless the Secretary consents to the sale of the obligations before the end of the period.

    Based on a literal reading what will $3 billion do when there’s a request for an increase to the debt limit of over $2 trillion or do you envision this (assuming no legal roadblocks) as simply a repeatable action for an on-going emergency?

  18. Walter_r says:

    I understand the concept that loans create deposits. What I am currently unclear about is whether those deposits also create reserves. Could someone clarify this for me? Thanks.

  19. Jan says:

    Dear Bill
    can u pls post something abt the interest rate set by the central bank
    i mean, why should a central bank set an interest rate? at what level should it be? implications etc etc
    i’ve tried to find something on your blog but i couldn’t…
    thanks

  20. Burk says:

    “Third, note that Baker then falls into the trap that the mainstream are captured by in thinking that in some way the interest payments made by the government to the non-government sector are a “burden”. … then the concept of a burden as it is used by Baker is inapplicable.”

    I have to ask whether, given the fact that government expenditure is not unlimited (i.e. it is inflation-limited), such interest payments are indeed a future burden, taking the place of other forms of spending we might prefer. They are no problem now (rationally considered) as the object of any sane government is to spend more, not less. But someday when the inflation limit starts to bite, outstanding debt is high, interest rates have risen, and taxes have to be pulled out of the economy to cool it down, then paying all this interest will be just another burden, as with any other government spending.

    “That is, at full employment the interest payments made by government to the non-government sector on outstanding public debt have real resource implications that might require some offsetting policies (lower spending/higher taxation) to defray any inflation risks.” Precisely, and this is a burden.. not now, but in the future, which in the case of 30 year bonds and enormous rolled-over debt is a significant exposure. It does not do credit to MMT to fob off future burdens in such a blase manner, as though cutting budgets and raising taxes at any time is easy.

  21. Grigory Graborenko says:

    Jan:

    Here is a blog discussing it:
    http://bilbo.economicoutlook.net/blog/?p=9089
    Also, have a look at any of the blogs under the category “RBA decisions”.

    Basically, interest rates are jacked up to try and slow economic growth down. The idea is that if the economy grows too much, too many people get jobs, and then inflation starts accelerating. Incredible, but that’s pretty much their stated goals.

  22. Fed Up says:

    Walter_r said: “I understand the concept that loans create deposits. What I am currently unclear about is whether those deposits also create reserves. Could someone clarify this for me? Thanks.”

    The way I understand it is that PRIVATE debt DOES NOT also create reserves, while PUBLIC debt DOES also create reserves. Notice the difference.

  23. Some Guy says:

    Walter_r: What I am currently unclear about is whether those deposits also create reserves. They don’t do so automatically, in the way loans create deposits. If a bank has excess reserves, an increase in required reserves caused by a deposit could first just be absorbed by the excess.

    The main point to understand is that central banks are forced to loan reserves to banks, on demand. Banks can always get the reserves the central bank requires, from the central bank. Once governments accept bank money, bank checks, bank deposits for taxes, they MUST do this. A giant tax check could drain the whole banking system of the reserves required against deposits, and leave the whole banking system short of reserves. So the Fed Funds/ interbank reserve lending rate rate would go to infinity (the other natural rate). Acceptance of checks for taxes is just one way of Uncle Sam saying to Mr. Bank: “your money, your debt, is (just about) as good as Uncle Sam money” – and it logically entails another way of saying this – reserve loans on demand by banks.

  24. ParadigmShift says:

    FedUp: “The way I understand it is that PRIVATE debt DOES NOT also create reserves, while PUBLIC debt DOES also create reserves. Notice the difference.”

    I think you’ve got the latter part the wrong way around, FedUp (was about to acronymise your handle and decided against it!). Public borrowing REMOVES reserves from the system. Government spending creates reserves, which are then removed by govt borrowing. If the CB purchases public debt that has already been issued, then reserves are created, but I don’t think that’s what you meant.

  25. Fed Up says:

    ParadigmShift, let me clarify and the way it was explained to me here.

    A PRIVATE demand deposit DOES NOT automatically create reserves.

    A PUBLIC demand deposit DOES automatically create reserves 1 to 1 (then there would be the “loan attachment part”). Notice the difference.

    Is that good enough? I’d rather not do the balance sheet transactions.

  26. Max says:

    Burk, interest payments aren’t burdensome to those receiving them. To oversimplify a bit, government gives with one hand and takes with the other. There’s no net burden aside from the administrative costs.

  27. ParadigmShift says:

    FedUp, I think it was your terminology that was confusing me. By “debt”, you were actually referring to “demand deposits”? And by “public demand deposit” do you mean a demand deposit created by a vertical transaction, while a “private demand deposit” is one created by a horizontal transaction?

  28. Fed Up says:

    “By “debt”, you were actually referring to “demand deposits”?”

    I was actually referring to the whole debt process. I’ll try not to do that in the future. It was too simplistic.

    “And by “public demand deposit” do you mean a demand deposit created by a vertical transaction, while a “private demand deposit” is one created by a horizontal transaction?”

    Maybe? I don’t remember the exact definitions. However, I like to refer to medium of exchange because that is what matters to the economy.

  29. Some Guy says:

    In addition to his comments at Ron Paul’s Surprisingly Lucid Solution to the Debt Ceiling Impasse on 31 USC § 5301, “roidubouloi”, with “years spent in one of the premier commercial banking legal practices in the country” makes relevant comments on strategies to deal with the debt ceiling at The Debt Ceiling: Why Obama Should Just Ignore It also, both at The New Republic site.

  30. Walter_r says:

    @Some Guy

    Perhaps I should have phrased it ‘where do reserves come from?’ As I understand it there are three sources:

    1. Government spending
    2. Reserve bank lending to banks
    3. Reserve bank purchases of foreign currency held by banks.

    So basically reserves all come from government through 3 different mechanisms. Do I have that right? Any others?

  31. Some Guy says:

    @Walter_r: Yes, that’s about right. Reserves are government liabilities, like cash or coins. They can only be created by the government spending on the private (non-government) sector in some way, by payments or purchases of real or financial assets – (1) widely construed contains (2) and (3). The government could buy other kinds of bank-held securities with reserves as it did after 2008.

  32. Snertly says:

    “Since the Fed is really part of the government, the bonds it holds are liabilities the government owes to itself”

    But as government has no funds of its own, all those being derived in one fashion or another from the citizens, those liabilities are properly owed to the people.

Leave a Reply

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

*
To prove you're a person (not a spam script), type the answer to the math equation shown in the picture. Click on the picture to hear an audio file of the equation.
Click to hear an audio file of the anti-spam equation