A Comment on Lavoie’s MMT Paper

In my previous post, I linked to an interesting working paper by Marc Lavoie in which he takes a friendly critical look at MMT. While considering MMT analysis to be essentially correct, and pointing out significant areas of consistency with Post Keynesian perspectives, particularly of the circuitist and horizontalist persuasions, he questions the need for some of the more controversial aspects of the approach. His central focus is on the MMT abstraction of collapsing the Treasury and central bank (referred to as the Fed in the case of the U.S.) into the consolidated government sector.

In his conclusion, Lavoie writes:

There is nothing or very little to be gained in arguing that government can spend by simply crediting a bank account; that government expenditures must precede tax collection; that the creation of high powered money requires government deficits in the long run; that central bank advances can be assimilated to a government expenditure; or that taxes and issues of securities do not finance government expenditures. All these counter-intuitive claims are mostly based on a logic that relies on the consolidation of the financial activities of the government with the operations of the central bank, thus modifying standard terminology. I believe that such a consolidation leads to the avoidance of crucial steps in the analysis of the nexus between the government activities and the clearing and settlement system to which the central bank partakes, and hence leads to confusion and misunderstandings.

In my view, if the abstraction of the consolidated government sector is an appropriate one, MMTers would be correct to state explicitly any conclusions that follow from it, even if these might seem counter-intuitive or controversial. The more important question is whether the abstraction is appropriate.

My current understanding is that the abstraction is a good one to make, but I will be interested to see the responses of the academic MMTers. A good resource on the topic is provided by Fullwiler in his introductory post on monetary operations.

Even if MMT analysis of the consolidated government sector is appropriate, at the very least Lavoie’s discussion is illuminating in identifying key points in dispute.

Consider this passage from p.18:

What seems to truly happen in the USA is thus illustrated by Table 3 below, which reproduces in T-accounts the sequence most recently described by Wray in the same blog: “So, instead, the Treasury sells the treasuries to the private banks, which create deposits for the Treasury that it can then move over to its deposits at the Fed. And then ‘Helicopter Ben’ buys treasuries from the private banks…. The Fed ends up with the treasuries, and the Treasury ends up with the demand deposits in its account at the Fed – which is what it wanted all along, but is prohibited from doing directly” (Wray 2011C). In the first step, as in Table 2, the government sells its securities to the commercial banks. In the second step, the government deposits are shifted from the commercial banks to the central bank, thus creating a negative reserve position for banks. The central bank then takes defensive compensatory measures, purchasing back the Treasury bills on the secondary markets, and thus eliminating the deficiency in bank reserves at the Fed.

So, due to current self-imposed arrangements, in step 1 the Treasury, rather than selling treasuries directly to the Fed, first sells them to private banks. The private banks pay for these treasuries (assets of the private banks) by crediting the government’s accounts with the private banks (liabilities of the private banks).

In step 2, the government transfers its deposits from the private banks to the Fed. For the private banks, there is a decrease in government deposits (private bank liabilities) and a debiting of reserve accounts (private bank assets). For the government, there is an increase in deposits with the Fed and a matching decrease in deposits with the private banks.

The combined effect of steps 1 and 2 on the private banks is to reduce their reserves but increase by a matching amount their holdings of treasuries, leaving private bank assets unchanged.

To replenish reserves, in step 3 the Fed purchases the treasuries from the private banks by crediting reserve accounts. Again, this leaves private bank assets unchanged.

The private banks are back to the point they were before the beginning of the three steps. In aggregate, they temporally held and then relinquished treasuries, they credited and then debited the government’s accounts, and they lost and then regained reserves.

In contrast, in the government sector, the Fed has extra treasuries and the Treasury has extra deposits in its account at the Fed.

The overall effect of these three steps is as if the Treasury had simply sold treasuries directly to the Fed, but this is prohibited under current arrangements, so the same effect is achieved in a roundabout way.

Okay, so far everyone agrees, Lavoie and the MMTers.

On pp.18-19, Lavoie continues:

The purpose of this whole exercise is to show that there is no point in making the counter-intuitive claim that securities and taxes do not finance the expenditures of central governments with a sovereign currency. Even in the case of the US federal government, securities need to be issued when the government deficit-spends, and these securities initially need to be purchased by the private financial sector. It seems to me that the consolidation argument – the consolidation of the central bank with the government – cannot counter the fact that the US government needs to borrow from the private sector under existing rules. Thus, if even the USA does not really fit the bill, one may wonder whether there is any other nation that corresponds to the strictures of neo-chartalism.

It is clear that the government only needs to issue treasuries because of the self-imposed arrangement that is in place. It would actually be much simpler to do away with treasuries altogether and simply spend as required and allow reserves to mount as a result, and then pay the interest rate on reserves. By stating this point clearly, MMT makes transparent that other, simpler arrangements could achieve the same effect.

However, since this is not currently allowed, it raises the issue – as Lavoie discusses – of whether government deficit spending should be considered as funded by the private sector.

To consider the nature of steps 1-3, it may help to ponder a series of questions and answers. In step 1, the Treasury sells securities to the private banks. What do the private banks do in exchange for the treasuries they receive? They create private bank deposits for the government. Why is this an acceptable exchange from the perspective of the government? Simply because the government deems the created private bank accounts (bank money) to be transferrable into reserves (government money), which it is willing to accept in fulfilment of the tax obligation it imposes on the non-government. Why are private banks satisfied? Precisely because the treasuries are convertible into reserves, and these are what are needed to extinguish tax obligations.

In step 2, the Treasury moves its account to the Fed and the Fed debits the reserve accounts of the private banks. Why is this acceptable to the private banks? Because they know that in step 3 they can get the reserves back again in exchange for the treasuries they still hold. Do the private banks lose anything in this process? No. At the end of the three steps there is no change in their holdings of treasuries, their reserve levels or deposit liabilities.

In short, there is no risk of this convoluted process breaking down. The Fed can always create reserves in exchange for the treasuries issued by the Treasury, and will always do so to the extent that this is necessary to enable banks to meet reserve requirements. The Fed is lender of last resort. Any action of the Treasury that causes an excess or deficiency of reserves must be offset by the Fed. By necessity, the Fed works in tandem with the Treasury.

The Treasury and Fed, in their actions, behave as two departments of the government sector.

The MMT position is therefore that, for most purposes, it makes sense to abstract from the details of the convoluted three-step process and collapse the Treasury and Fed into the consolidated government sector. These details add no additional insights except when the object of analysis is these details themselves.

Once the Fed has the securities and the Treasury has the matching deposits at the Fed, it is straightforward to understand that government spending leads to a net increase in non-government bank accounts and a corresponding rise in reserves, which are then drained, if there is a positive interest target, through further purchases of securities.

It is only at this point – when the government spends – that the non-government’s net financial assets are affected. For this reason, most elementary MMT renditions of fiscal policy commence at the point where the government spends and taxes by crediting and debiting non-government bank accounts. Then, to the extent spending exceeds taxes, the Fed will normally drain excess reserves by purchasing securities (this is not necessary when the short-term interest rate is zero).

This is why it seems appropriate to think of government spending first and draining reserves at the end of the process. It also makes sense to state that government spending (state money creation) is logically prior to taxing (state money destruction). Logically, the capacity of the non-government to pay taxes or purchase bonds comes after the government has spent or the Fed has lent, because the payment of taxes or the purchase of bonds requires the prior creation of reserves.

This point is clearly expressed by Fullwiler in the post linked to above:

This all leads me to the often noted MMT point that “spending comes before tax revenues are received or bond sales.” If one expands this a bit to include loans from the Fed, then this statement is absolutely correct in terms of the operational realities of the monetary system. That is, according to both the tactical and accounting logics, taxes credited to the Treasury’s account and the settlement of Treasury bond auctions can only occur via bank reserve accounts, while the original source of banks’ balances in their reserve accounts can only be previous government deficits (which are net credits reserve accounts) or loans from the Fed (repos, loans, purchases of private securities, or overdrafts—note that an outright purchase of a Treasury security by the Fed to add reserve balances requires a previous government deficit). Therefore, it very much is the operational reality that for taxes to be paid or bonds to be settled, there has to have been previous government spending or loans from the Fed to the non-government sector, and this is true whether or not the Fed is legally prohibited from providing overdrafts.

With this point in mind, it is worth reflecting one more time on the convoluted three-step process between the Treasury, Fed and private banks that the government imposes on itself. Because this process ultimately has no aggregate effect on reserves, it is clear that it is not the place to look when asking where the funds to pay taxes originate. The capacity of the non-government to pay taxes comes from reserves, and these are always the result either of prior government spending or Fed lending.

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103 thoughts on “A Comment on Lavoie’s MMT Paper

  1. I agree completely that the entire dance between the Fed/Treasury and private banks is nothing more than a kind of ritual. The fact that smart people get hung up with these smoke-and-mirrors constructs leaves me bewildered.

    I was exposed to MMT ideas just over a year ago but “got it” almost right away – It had me at “arithmetic”. Maybe my background as an engineer and system-analysis tools made it easier, but I have never been a fan of lying to myself. I don’t really care what the truth is I just want to know what is the truth.

    In the real world the short time the new money exists in the banking system before it gets in the Treasury’s hands (computers) is irrelevant and operationally-speaking may as well have never happened.

    The frustrating part of this for me is that in trying to explain these ideas to friends and acquaintances most get caught up in their pre-conceived definitions of money and debt and stubbornly push back, implying that I am a crackpot and “everyone knows” we have a serious debt problem.

    Fortunately I am ten times more successful with young people as they are not ham-strung with bad ideas to begin with. Hope for the future.

    I would rather teach a beginner tennis than someone that has had years of practice learning bad technique.

  2. In Spain, commercial law obliges two companies to consolidate their balance sheets when a company has power to appoint the majority of the members of the board of directors of another company.

    The objective of this legislation is to know the “true picture” of its annual accounts.

    ¿Isn´t that valid for the public accounts?

  3. The consolidation is valid if government bonds are (even if only implicitly) guaranteed by the central bank. In that case, the various steps involved in selling bonds will always be successful.

  4. I find it useful to view matters from both the abstract perspective of the unified government and the less abstract, more articulated perspective of the institutionally divided government, depending on context.

    For most purposes, I think the pure simple MMT picture is both correct, important and useful. The more you think about it, the more enlightenment it yields in all sorts of areas. The key point, it seems to me is that draining financial assets from the economy and injecting financial assets into the economy are independent operations. Seen that way, one understands that the ultimate role of the former is to manage such things as interest rates and price stability, not to create aggregate government spending capabilities that would not otherwise exist.

    But it is important to recognize that the more detailed structure of actual “voluntary” arrangements is not merely an arbitrary and insignificant detail.

    The complex process for actual government spending is not just a ritual. It plays an important systemic political role in that it permits more political players to place a “block” on spending – to use an OWS term. Because the Treasury cannot overdraw its accounts, Congress can impede previously authorized expenditures by refusing to raise additional tax revenues or by refusing to grant authority for debt issuance beyond a statutorily imposed limit. If Treasury could simply credit private sector accounts unilaterally, then not only would a ritual be missing but the distribution of powers within the government would be very different. As we just saw this year, the nature of the actual arrangements makes quite a difference, and significantly limited the executive branch’s scope of action.

    And note that that the Congressional block would still exist if the Treasury could issue debt directly to the Fed, and never had to borrow from the private sector at all. Because so long as Treasury is required by law to have a positive balance in its Fed account in order to spend, and so long as the only legally permissible means of creating balances in those accounts is via tax revenues or bond sales, then Congress has fast-acting tools it can use to step in and block previously authorized expenditures.

    Also, I think one additional fact didn’t make it into your analysis. When Treasury sells bonds to the private sector and then those bonds are sold to the Fed, the private sector dealers typically make a profit, no? So while the private sector does not need to fund government spending, the current arrangements might be seen as rewarding the private sector to with a fee for government spending. The private sector gets to collect rent on our spending operations. But I don’t think that means we should get rid of bond-issuance altogether. One thing that makes people willing to to accept dollars for products is the knowledge that they can then store those dollars in interest bearing accounts. And I believe MMT authors have emphasized that Treasury bonds are in effect just a kind of savings account.

  5. Very informative, Dan. Yes, I should have made mention of the fact the private sector dealers profit from the exchanges with the Treasury and Fed. It helps to explain their willingness to participate more than a little.

    Thanks to everyone for their comments.

  6. @Dan Kervick

    “…and never had to borrow from the private sector at all…”

    Although I agree mostly with what you have written these kinds of phrases are maddening.

  7. @Dan

    I think the key word here is “had”.

    By no stretch of the imagination does the Fed “have” to borrow from the private sector, unless you define reserves created by the Fed as private-sector assets, which they are not.

    If the Fed increases reserves in the banking system, which in turn buys Treasuries with those reserves, which in turn are exchanged for reserves from the Fed, How is this construed as borrowing from the private sector? Private sector assets, as well as banks assets remain unchanged at the end of this operation.

    What is mandatory is the ritual. It “has” to be done. Borrowing not so much.

    I’m not trying to be argumentative but if you phrase things in that way it assigns a false sense of importance to the operation. The transaction could be completed in a more simple and direct manner without any change in the intended outcome, which was to increase net financial assets of the private sector.

    I am aware that there are side benefits to selling some Treasuries to private investors and maybe that was part of the original intent of the law, but that intent (if it existed) has been lost in the translation.

    Practically speaking, if all (or even most) Treasuries were sold to private investors using their own money it would be nearly impossible to increase the money supply (the part of the money supply that increases financial assets).

  8. Paul J,

    First I agree that the transaction could be accomplished in a more simple and direct manner, with more-or-less the same net outcome. I think the only point I am trying to make is that to understand all of the constraints under which real world institutions operate – as those institutions are currently structured, not just as they might be structured instead – it is not sufficient to look at the way things stand at the end of the operation, but to understand all of the things that have to happen to get to the end of that operation. It makes a difference whether I am permitted by law to drive directly from A to B, or am required to take some detour through C. Requiring the latter gives C some potential influence over the process that it might not otherwise have.

    The Fed doesn’t have to borrow from the private sector. But Treasury does. It doesn’t have to net borrow to be sure: but it has to borrow at an initial stage to set the operation in motion. And the two-stage transaction includes an auction, and time delays, which means market forces intervene in some way that they wouldn’t if the whole operation was conducted intra-governmentally. This so-called ritual imposes a real institutional and political constraint on permissible operations.

    It also means that the net financial outcome is not exactly the same as it would be if it were simply an operation between two government agencies, because in the existing two-step process the private sector intermediaries make a profit. Another way of looking at that latter point is that the distribution of the total increase in net financial assets is not determined entirely by government spending decisions. Some of that increase gets diverted to bond purchasers – and thus throughout the financial system to savers.

    It seems to me that economics has to be focused not just on aggregates, but on the question of distribution – that is, who gets what as aggregates move up or down. If the current system were entirely a ritualized way of conducting some operations that could be accomplished with exactly the same outcome in some other way, then there would be no difference at all in the distribution of assets and liabilities when they were done in either manner. But there is some difference.

  9. @Dan

    Yeah we’re disagreeing on very small differences but this…

    “The Fed doesn’t have to borrow from the private sector. But Treasury does…”

    in my view is inaccurate. The Treasury must participate (by law) in an operation that makes it LOOK like it is borrowing funds from the private sector. It is purposeful obfuscation in my view in that I believe that it was structured this way to benefit the financial class at the time. Typical of “deals” made with financial interests throughout history.

    The financial assets do not originate with the private sector, they originate with the government sector. The private sector is not (necessarily) involved with the transaction in any way operationally. The fact that the Fed CHOOSES to sell bonds to private actors leads to a different argument.

  10. Absolutely PaulJ & I think that is the risk Lavoie runs with this paper and dispute about “standard terminology” – I believe it is unintentional but using “standard terminology” could result in security through obscurity so prominent in orthodox economics.

  11. “The financial assets do not originate with the private sector, they originate with the government sector.”

    Let’s be careful about that line. Technically the financial asset originate with the currency issuing entity – which in most jurisdictions is the central bank.

    Only where you have the central bank under control of the government in all senses do you have a ‘government sector’ in reality.

    In the UK statistics, for example, the central bank is included in the private sector.

    That classification is an attempt to redraw the financial boundaries on all nations so that the government is just another currency user. That is after all the ultimate end game with the first skirmish being played out in Europe right now.

    As even the right wing commentators are pointing out: why will the central bank accept government bonds as collateral for as much money as is required from private banks but not when coming directly from the government?

    The evolution of legislation and regulation is attempting to wrest the central bank out of the control of the government and make it truly ‘independent’.

    Or in other words for the control of the economy to be removed from government and placed in the hands of bankers.

  12. “The evolution of legislation and regulation is attempting to wrest the central bank out of the control of the government and make it truly ‘independent’.”

    That’s why I have been making such a big deal out of the way we frame our descriptions of monetary operations.

    In the U.S. the Fed has been co-opted by private interests and works against the public good. The trouble is the vast majority of the people that want to “end the Fed” misunderstand the operational realities. Further confusing them by being sloppy in our characterizations can’t be helpful.

  13. One argument (not mentioned above) for collapsing the Treasury and central bank into a consolidated government sector is thus. In a “non collapsed” regime, it is possible to have fiscal and monetary policies work independently. In a collapsed regime, it is not. So are there any good arguments for separating fiscal from monetary (apart from the fact that separating them gives ten thousand economics commentators an excuse to exude hot air)?

    I think not, and for the simple reason that providing stimulus via just monetary or fiscal policies is bound to be distortionary. For example interest rate adjustments work only via those who are significantly reliant on variable rate loans. Where is the logic in boosting an economy just via those dependent on loans while ignoring those dependent primarily on equity finance?

    Abba Lerner advocated that where stimulus was required, it should take the form of simply creating new money and spending it. (i.e. fiscal and monetary policy are merged). I think he was right.

  14. I liked Lavoie’s paper. Probably no surprise given my leanings toward circuit theory. I thought the arguments were well presented (not a surprise, Lavoie is one of the best in the business). Any idea if anyone responded? Perhaps we’ll see the debate revert back to the more scholarly approach of the early the ’00s. Those debates on neochartalism in the JPKE were a real blast. Although I didn’t agree with everything neochartal, I thought Wray had the upper hand back then.

    That said, I tend to agree with Lavoie that the consolidation of the fiscal and monetary authorities isn’t necessary. I also think the idea that taxes don’t fund anything is difficult to reconcile with conventional economic terminology. My understanding is that even modern money economists would say that taxes fund government spending in real terms rather than in nominal terms.

    Also, I think it’s important to theorize using the existing institutional context as reference. The legal and institutional structure of government matters. If not, you get in a situation where we’re debating in terms of hypotheticals, which then opens MMT to criticism from a theoretical standpoint. My beef with neoclassical is that it holds an idealized view of the economy while it accepts the political/institutional context and constraints as given. MMT seems to holds the reverse: it has a realistic view of the economy but oftentimes seeks to depict the political/institutional context in terms of its possibilities and ideal configuration. This is not always the case, but more or less so.

    Now, don’t get me wrong, I side with MMT on most everything in terms of policy prescriptions. Also, modern money economists and commentators are some of the most exciting contributors to economic discussion currently out there. As Lavoie suggests, there are just a few things that need to be tweaked. With that accomplished, I think the mainstream would have a hard time competing with a synthesized ‘endogenous money’ approach (I tend to view this is the unifying element). BTW, peterc, you have a great site here – way up there on my list.

  15. “Also, I think it’s important to theorize using the existing institutional context as reference”

    I disagree. It’s important to theorize in terms of what the system can do free of existing legal constraints.

    Then you need to do the difference between where we are and the ideal and see what can be done to move things along.

    That’s the difference between theory and policy. Policy has to look at the existing constraints and see what ‘baby steps’ can reasonably be implemented given the political landscape.

    So MMT is a description that uses a consolidated government sector where the central bank is essentially eliminated and the government simply has the power to mark up and mark down accounts across the private banking system at will.

    And from that description comes the policy of the Employer of Last Resort funded by the government ‘borrowing’ directly from the central bank – because the abstract model shows that the central bank is just an operationally useful tool rather than a fundamental requirement.

    Words matter. Using ‘conventional’ phrases traps you in somebody else’s framing of the debate.

  16. I disagree. It’s important to theorize in terms of what the system can do free of existing legal constraints.

    I think it is useful to look at things from both perspectives – both the very detailed, gritty institutional level and the level of only the most general and universal institutions. But it is important to recognize that legal and institutional constraints come in many shapes and sizes. Some laws and institutions could be changed with a relatively simple and effective advocacy effort or campaign. Others are so deeply ingrained into the traditions and constitutional structure of the country, that imagining changes to them is unrealistic.

    I think this is important to bear in mind when making statements about what the government “can” or “can’t” do. These things come in degrees.

  17. Really enjoying the discussion. Thanks to all those participating.

    circuit, I appreciate the kind words. I also read your excellent blog regularly. The endogenous money approach does seem to offer a good basis for an integrated non-neoclassical framework, combining elements of MMT and circuitist theories. The causation in each of these theories seems clear, and highly compatible with Keynes and Kalecki (and Marx). The result can be a framework that is open enough to accommodate different perspectives in an overall coherent way. I find the prospect exciting and agree that it would pose a formidable alternative to the current orthodoxy.

  18. Peter,

    So what do you think? Does Lavoie essentially agree Steps 1-3 don’t place any further constraints on govt spending, or is he still on the fence?

    Admitting that I haven’t read all MMT papers that exist, I have never seen anyone explicitly walk through Steps 1-3 and justify why each individually pose no constraint, like you did, until this webpage. I’ve seen the same steps presented in Kelton and Fullwiler papers (Fullwiler has a cool one using matrices), but it seems they provide more general explanations and assertions why the process as a whole doesn’t pose a constraint on spending. Do you not agree, that in the academic literature, step-by-step robust and rigorous justifications are necessary, particularly if we are trying to achieve a paradigm shift in the econ community? I think it is self-evident, since even a friend like Lavoie isn’t 100% satisfied.

    For this reason, I think Lavoie has something meaningful to say, even if he only 90% agrees Steps 1-3 pose no constraint.

    And honestly, perhaps there is something institutional or technical that can actually throw a wrench in Steps 1-3. I can’t see it, and so for all realistic intents and purposes I see them as no constraint, but I haven’t seen a robust and rigorous argument to rule it out.

  19. Or rather, I haven’t seen an argument that *directly addresses each of those steps, in turn* to rule it out.

    For MMTers it perhaps seems anal, but I don’t see why it’s necessary in the lit. Lit is anal.

  20. Peter, I am posting some thoughts I’ve placed at Mike Norman’s place. Particularly interested in hearing your thoughts on the last 2 paragraphs.

    “Also, I want to quote Kelton here- http://neweconomicperspectives.blogspot.com/2010/11/yes-government-bonds-add-to-private.html

    “As we in the MMT tradition consistently insist, spending must, as a matter of logic, precede taxation in the first instance.”

    Regarding taxes specifically, this seems to be everywhere and always true, regardless of self-imposed constraints.

    So I think Mark is logically wrong to complain about this point.

    HOWEVER, a complaint regarding that ‘issuance of securities does not fund the deficit’ I think is slightly more reasonable. The reason is that, though it is not necessary to fund, given current US constraints, bond issuance HAS TO PROCEED spending. Even in the first instance, if in the beginning of the fiat regime we had the same constraints, bond issuance would proceed spending! The govt would have to erect a private banking system, separate from the Fed, to accept its bonds in exchange for a govt checking out.

    Which leads me to an interesting observation, which is that, though we say the Fed can’t provide overdrafts or buy bonds directly from the govt, doesn’t the private banking system effectively do that anyways? So is there any difference?

    I’ve never seen that point made in MMT literature. Though maybe it’s a stupid one.”

  21. ” it is clear that it is not the place to look when asking where the funds to pay taxes originate.”

    This may be true, but I think Mark is very literally saying that, “nevertheless, there are procedural steps taken before the spending occurs, even in the first instance, in the US under its current constraints. So why obfuscate these? Take them head-on and convince others why it still doesn’t matter, step by step. It doesn’t change your end takeaway.”

    Now, as I said above, I think MMT has more grounds to argue on the taxes point, but less on the bonds point, at least under today’s self-imposed constraints.

  22. Hi wh10. This is in response to your first comment (posted at 3:59am). I didn’t notice your latest two comments until after composing this response. I think you raise a good point in your second last comment, and I agree with your point in your latest comment.

    Regarding your first comment, my own opinion does not carry any authority. I will be interested to see what, if anything, is the response of the academic MMTers.

    But for what it’s worth, personally I disagree that the MMT arguments are counter-intuitive. On the contrary, for me they cleared up a lot of confusion. Before encountering MMT, I always had trouble understanding in what sense the government could be financially constrained. I knew about the Post Keynesian view on endogenous money and so understood that the money multiplier was inapplicable and that there was no direct transmissions mechanism from reserves to prices. Since it was also obvious that the government could (as I thought of it at the time) “print money”, I couldn’t see how it could possibly be constrained in a financial sense. Clearly, I was thinking of the government as including both the fiscal and monetary authorities (perhaps unjustifiably, since this seems to be what the debate is mainly over) even though my thinking at the time was not based on MMT’s representation of a consolidated government sector.

    Since I accepted that the government, as monopoly issuer of the currency, is the only possible origin of government money (currency and reserves) and that taxes can only ultimately be paid with the government’s money, it seemed completely intuitive to me that: (i) the government must issue its money before taxes can be paid; and therefore that (ii) taxes cannot fund government spending; and (iii) borrowing from the non-government is an unnecessary political construction. From my perspective, to think the opposite (as I was trying to do) seemed counter-intuitive.

    It also seems intuitive to me (though this does not necessarily make it correct) that the central bank’s actions are tied inextricably to the fiscal authority’s actions, and that they should be considered different departments of the government. Once the central bank has chosen its interest-rate target (or targets), fiscal policy dictates its operations. There does not seem to be any meaningful central bank independence (which is a good thing, in my opinion).

    Having said all this, as I indicated in my post, I don’t think whether something is intuitive or not is the question that matters. What matters is whether the MMT depiction is correct or incorrect. My understanding at the time of posting, as indicated in my post, was that the MMT representation of the fiscal and monetary authorities as a consolidated government sector is sound, but I am open to being persuaded otherwise, and so far have taken on board the comments posted here by circuit and Dan. I’ll be reading any exchange that occurs between the experts on both sides with interest.

    My feeling on all this is very similar to the sentiment expressed by PaulJ in the first comment above, and I’d imagine many other supporters of MMT feel the same way. I don’t really care what is correct. I just want to know what is correct.

    I do think, though, that once the correct position is agreed upon, there is no point beating around the bush, even if it seems controversial or counter-intuitive. It is better to state the position directly and clearly. If there are complications and necessary qualifications, they need to be stated directly and clearly as well. If the current position of MMTers is only valid for certain purposes, that needs to be clarified as well.

    At the very least, I think Lavoie’s paper has pinpointed areas that need clarification (and maybe it has done more than this).

  23. Thanks for the response PeterC. I think we’re generally seeing things the same way.

    I’ll be interested in hearing your thoughts on my 6:56AM (and 7:07AM) post(s).

  24. Ah sorry- I see you’ve shared them.

    Is there any meaning to being more upfront about that point in the economic discourse, or is it trivial? For sake of complete accuracy in what one says, perhaps not… even consolidating the Fed/Treasury does not change the fact that bond issuance proceeds spending, with those constraints.

  25. wh10, I would also like to see clarification on the point you raise in your 6:56 AM comment on bonds. In particular, why does the fact that bond issuance precedes spending under current arrangements not alter the MMT argument that bonds do not fund deficits under current arrangements.

    Regarding your 7:07 AM comment, I take your point and agree with it.

    Thanks for your input! It is much appreciated.

  26. Sorry, struggling to keep up with your comments. 🙂

    Re: 7:41 AM, I think it is good to be up front and clear. But once a position is agreed upon, it may be that in discussing issues at an elementary level to the public we just include words such as “in effect” or “the details are more complicated, but the effect is this”, etc. As long as what we are saying is “in effect” the case is actually correct. However, we need to agree upon the position first.

    By the way, I don’t discount the possibility that the MMT position may in fact be correct as it stands. It is just that I am not clear on whether the academic MMTers would modify their statements in response to Lavoie’s paper.

  27. Well, in that first instance where we imagine a new fiat regime with the same constraints as today, is the government “taking from a pool of funds?” It doesn’t appear so. Banks can create loans without constraint, and we’re allowing the Fed to provide reserves on demand ad infinitum.

    That being said, we may be running into an issue here regarding realistic banking regulations and capital requirements. In my hypo, no fiat money has yet entered the economy. That new bank essentially needs to be govt sponsored it seems, or at least regulations quite lax.

    Nevertheless, once ‘enough’ fiat is in the economy and capital has been invested to start banks, do those banks not theoretically have infinite capacity to create further loans to the Govt in acceptance of their treasuries?

    So I still don’t see it as funding as one might imagine a fixed pool of funds.

  28. I think the ‘starting from scratch’ hypo is interesting. I wish the MMTers would present this as a thought experiment, and explain how things would start, including govt spending, setting the FFR, maintaining it, etc.

    I think it underscores

    1)that current arrangements would be quite silly to use if you were starting from scratch

    2) THOUGH on the other hand, to encourage people to start banks, maybe telling them you’ll give them bonds that pay interest is an enticing deal, as Dan alluded to above

    3) banking and loan creation is weird 🙂

  29. So I still don’t see it as funding as one might imagine a fixed pool of funds.

    Agreed. Government and banks both create their money from nothing. Anyone else could try to do the same thing. To me, though, the critical point is that only the government money can extinguish tax obligations and demand for bank money derives partly from the fact that it is convertible into government money on demand (or with a specified delay).

  30. Sorry, I keep adding addenda.

    It also underscores why I posed that it is relevant to explain why ‘step 1,’ specifically, is not a constraint.

    You actually addressed this in your post. And then Dan added the profitability point. These are interesting, and like I said, I have never seen them explicitly laid out for each step, but mentioned as part of the broader accounting process for deficit spending.

  31. You have to be careful here. The particular settings of the parameters of a system may alter the behaviour of that instance, but that doesn’t necessarily mean that the system construction can’t exhibit other behaviours with different parameter settings.

    In computer science object orientation terminology, MMT describes the class of systems called ‘free-floating fiat currency monetary systems’.

    You can create a version of that class, called an ‘instance’ which has certain parameters set. In the current case the parameters are that the central bank is removed from the public sector part of the economy and placed in the private sector. The currency issuing power is vested in the central bank and the parameters are set so that the government has to borrow before it spends – and never directly from the central bank. That attempt to constrain the behaviour but ultimately it is a sham – because the bond market makers always know that the central bank is under government control and they will be instructed to ‘make the auctions work’ eventually.

    But for me they have failed to take the final decisive step – which is to fully privatise the central bank and place it under judicial control rather than the control of the executive or congress.

    Only where the constitution or the judiciary of a country would literally prevent the executive/congress telling the central bank what to do would I consider that we have created a separate class of monetary systems. One’s where the creation of money is truly and irrevocably privatised. And they haven’t had the guts to do that even in the Eurozone.

  32. ” That attempt to constrain the behaviour but ultimately it is a sham – because the bond market makers always know that the central bank is under government control and they will be instructed to ‘make the auctions work’ eventually.”

    Neil- we’re in agreement here. I think, from the standpoint of rigor, it’s valid to show this. To convince the Lavoie’s and everyone else.

  33. Well, actually, it’s not so much that the central bank will make the auctions work specifically, but it’s that they will make the banking system function more broadly by providing reserves on demand. The auction works as soon as the private bank puts a govt bond on its asset side and the govt deposit on its liability. The Fed is technically not needed. But it’s the assurance from the Fed that going forward, if the private bank needs reserves for whatever reason, it can get it.

  34. Thanks for your thoughts, Neil. I understand that the MMTers talk about the “general case” and current arrangements being a special case. For this to hold, it seems that the special case needs to be consistent with the general case. It will be consistent if, as you say, the current parameter settings are ultimately a sham. I guess it is the reasoning leading to this conclusion (i.e. that the specific parameters are just a sham that change nothing significant) that may need clarifying, or at least is not being accepted by some economists trying to evaluate MMT.

    Do you feel this case has been established? I’d be interested in any clarification you can provide. I must admit I would not feel competent as yet to state the MMT position on this point.

  35. So I want to continue this thought experiment with you guys. In this hypo, how is the FFR and yield on the govt bond determined?

    What limits the bank from demanding an absurdly higher interest rate?

    I guess the Fed announces that it will pay 2% IOR, and the govt holds an auction with enough competitor soon-to-be-banks that bid the price of the govt bond down to 2%?

  36. PeterC, I agree on “I guess it is the reasoning leading to this conclusion (i.e. that the specific parameters are just a sham that change nothing significant) that may need clarifying,”

    You have to have the explicit discussion we’re having about bank loan creation and the Fed backstop *in context of that first step.* Certainly, MMTers have discussed these concepts before more generally; it’s the only reason I can reason through this. (And frankly, Lavoie being the horizontalist he is, why is he having any concern over the constraint in step 1?… though perhaps he isn’t, and like I’ve argued, he just wants more literal step by step explanation).

    BUT I’ve never seen MMTers explicitly lay this out in a paper. I’ve been having to trust my own logic; frankly, it’s nice to hear you agree. The closest I’ve seen the MMTers come is here (http://neweconomicperspectives.blogspot.com/2010/11/yes-government-bonds-add-to-private.html) or one of Fullwiler’s papers (the social matrix paper for example, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1825303).

    But in none of those papers do I explicitly see them explain even if step 1 is the starting point, there is no constraint, and then justify it. Instead, it is presented as self-evident.

  37. Thanks for the links, wh10. I’ll need to take some time to read over them and think some more about the issue. We seem to have reached a similar place. Maybe someone else will be able to jump in and add light..

    (Sorry for the delay in your latest comment showing up. It should be automatic except for the very first post. Not sure why it went into the queue.)

  38. For me the clincher is that the central bank won’t let reserves be a constraint. In other words they will not let banks fail due to cash flow issues and won’t let their policy rate be determined by the market.

    So that means that ultimately the private banks can create money to buy government bonds knowing full well that the central bank will accommodate their cash flow requirements.

    So there is a simple arbitrage. The private bank buys a government bond at 4% then repo’s it with the central bank to clear the purchase at a lower rate. Result: instant risk free income and no failed auctions.

    The QE system demonstrates that when things get bad and monetary policy fails the central bank will buy the bonds back for real. So there is always going to be a ready market whichever way things go.

    And we’ve seen that the central bank won’t deal with the consequences of cash flow restrictions. The central authorities tried a different system (let Lehmans fail ‘pour engourager les autres’), and then panicked at the inevitable consequences of that action throwing out liquidity like there was no tomorrow (and at that point they probably believed there wasn’t much of a tomorrow).

    So the actions of those in charge demonstrate the class of system we have – where the central bank passively ensures there are no cash flow constraints on the banks, and when things get bad they swap central government liabilities around.

    And therefore, in mathematical terms, you can simplify the structure algebraically and come up with parameter settings that do the same thing. If you do that you get to no bonds, interest on reserves and the central bank supplying the government with ‘loans’, ie this variation: http://www.3spoken.co.uk/2011/07/mmt-transaction-model-variation.html

    From there to the full power of the MMT model then merely requires the restrictions on spending to be loosened.

  39. Thanks, Neil. I probably lean towards your argument, but to be honest, I’m not sure exactly what to make of the situation.

    By coincidence, I happened to be re-reading the books by Mitchell and Wray (FE Abandoned and Understanding Modern Money) when I came across Cullen Roche’s link to Lavoie’s working paper and I found both books a bit brief on the points at issue. Admittedly, they are books, not journal articles, with broad scope, but they are not really any more detailed than the blogs on the finer points of MMT.

    Fullwiler and Kelton seem to have provided the most detailed explanations, but I still don’t find the key points in dispute sufficiently clear in my head. In the case of their contributions, which are quite in depth, I am more than willing to think it is my lack of comprehension ability that is holding back my understanding. But I am not sure.

    In retrospect, I am annoyed at myself for trusting the MMT depiction of the monetary operations without reading more deeply on the subject. I certainly should have done so before starting this blog!

    Don’t get me wrong. I find MMT useful as part of a wider approach to macroeconomics. But if you take away the operational insights pertaining to a post-Bretton Woods system, there does not appear to be a great deal added to what was already understood about the actual, existing system on the basis of Keynes, Kalecki, Lerner, Minsky, endogenous money theory, etc. Anything new it has to say about the system as it currently is hinges on the validity of the operational depiction and the conclusion drawn from it that the monetary and fiscal authorities are best treated as a consolidated government sector. It was the apparent clear depiction of monetary operations that I found most striking upon encountering the approach, because if valid, it holds a lot of implications that flow logically from it. But is it valid?

    None of this alters what I think is a deeper point, which is that MMT shows that a sovereign currency issuer need not be revenue constrained and need not issue debt provided operational aspects are appropriately designed. I am glad of that understanding. It opens up social possibilities. It also means that, even in retrospect, I would decide to start this blog focusing to a significant degree on MMT and its implications.

  40. Hello all,

    Interesting discussion. I don’t have time to post original thoughts right now, but as an FYI, I sent my comments to Marc after seeing the paper. He has adjusted a subsequent draft somewhat. Here are my comments (with a few deletions due to privacy):

    2. Regarding Febrero’s paper, my main concern there was the points made in criticism of neo-Chartalism (NC) either are misrepresentations of NC (i.e., using the Eurozone as an example to disprove NC) or complete misinterpretations (NC’s view of govt controlling the price level and “leverage”). To quote others who have had the same disagreements did not represent new scholarship.

    3. “Vertical” money doesn’t mean the same thing as inside money or the monetary base. Vertical here means net financial assets of the non-government sector, which by accounting identity equal currency+reserve balances + Treasuries-loans from the cb and/or govt to the non-govt sector. In other words, there definitely is something different being said when we say “vertical” than was said previously by endogenous money folks, etc. That said, I can see where there has been some confusion in interpreting the NC view here, as some of the literature has certainly used terminology that might have reasonably been interpreted that way—but I do think a careful reading (and recognition of the “general case” that I will refer to below) does make the point clearly. It is interesting that those in the NC camp have always understood what we meant and those outside NC have always interpreted NC literature differently on this point—looks like room for discussion here, particularly since I think we all agree on how this works if we do in fact sit down and agree on terms first. I want to just add that Mosler’s paper from 1997 (“Full Employment and Price Stability”) was very clear about net financial assets (NFA)—perhaps that’s why we all “got it” and others didn’t (??) http://moslereconomics.com/mandatory-readings/full-employment-and-price-stability/) . (Marc subsequently changed the paper to include Warren’s paper with Mat on the H-V approach, http://moslereconomics.com/mandatory-readings/a-general-analytical-framework-for-the-analysis-of-currencies-and-other-commodities/)

    4. Regarding leverage, it’s always been a mystery to me how the horizontalists have been so against this terminology. We are using “leverage” the exact same way that it is used in accounting and financial management—indeed, it’s the same way that all the corporate finance textbooks I use teach it. That is, leverage to NC refers to a leveraging of the balance sheet, as in assets divided by equity—the “equity multiplier” or “leverage” (my students have to learn that this measure is called “leverage” since that’s what the business simulation we use calls it, for instance). In other words, “leverage” here has nothing at all to do with leveraging reserves as in the money multiplier, and it has nothing at all to do with suggesting that reserves or anything else are a priori necessary for leverage to occur. To bring this together with vertical money or NFA, the point of “leverage” as NC uses it is to describe leveraging of NFA, again as an expansion of debt leverages existing equity (in fact that’s exactly what we mean, since NFA are equity for the non-govt sector). Note that some folks commenting on the blogs that are highly skilled with accounting have from the start been completely on board with NC on NFA, vertical money, and leverage [in terms of how] NC defines and uses these terms.

    I would want to add, then, here that I think that at least from the NC perspective part of the problem with points 3 and 4 has been that horizontalists seem to have interpreted NC from a rather narrow lens of overreacting to anything that might sound like monetarism if one doesn’t investigate too carefully what is actually being said.

    5. Most of your points of criticism are related to what I have come to call the “general” vs. “specific case” framing inherent in the NC literature. In short, much of the core NC literature has been describing a “general” case, while most of the critics have been pointing to “specific” or “special” cases. I think NC literature has driven this confusion at times—it was a new paradigm trying to define itself, afterall, and started off at times a bit sloppily perhaps or at least said things in a way that would later be refined—since I don’t think there’s been a lot of clarity on this point. I explained this in some detail in a post I did to Naked Capitalism last fall– http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1723198 Also, for this reason what sounds to you like NC backtracking is from the NC perspective an attempt to clarify the “general” vs. “special” or “specific” case distinction that obviously wasn’t understood by the critics previously.

    6. I think you hit an important point when you ultimately point to the importance of the interest rate on the national debt as the core issue (which you very carefully and skillfully get at through analysis of the overdraft/settlement system—that was fantastic!), though perhaps at times NC has focused on other things that you think are less important overall. As you know, this has been my perspective, too, which I explained carefully in “interest rates and fiscal sustainability” (JEI, 2007; wp version at ssrn) and then again at the end of the link above). Then you further mention your paper with Wynne on the importance of the fiscal policy rule. We discussed previously how your paper actually demonstrated that a functional finance fiscal policy rule was in fact Ricardian, which might even be more important than the interest rate, depending on how one sets up a model’s assumptions. I agree and made both points in my critique of Paul Krugman’s criticism of MMT (originally posted to Naked Capitalism and also provided a link to your paper with Wynne) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1799068

    7. As above, the “consolidated Treasury/Central Bank” should be thought of as a “general” case. I personally have never used this—I don’t find the idea that the Treasury would have an account at the central bank to be analytically limiting even in the general case if we understand how the hierarchy of decision making (i.e., who has the policy control over whom?) and the hierarchy of money are necessarily situated in the “general” case NC is describing. My approach here combines my link above in 5 with this newer piece on the specific case of the US– http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1825303 –this uses the SFC/SAM modeling you and Wynne did so well)

  41. I should also add that we shouldn’t overinterpret or over-critique Marc’s paper. The basic points he is making are (1) MMT and horizontalists/circuitistes completely or at least almost completely on how the monetary system works, and (2) the two groups disagree on what the best way is to present how the monetary system works to others in academia and elsehwere–that is, how the framework should be explained overall.

    It used to be that horizontalists/circuitistes thought neo-Chartalists were saying something different than what they were saying. It’s now recognized that’s not the case–they just don’t like how we’ve presented it. There are some nuances beyond that, but that’s mostly it.

  42. Scott,

    This is great to read.

    Regarding point 7, I love that paper. From what I have seen, it is the most comprehensive MMT paper out there on Treasury/Fed ops.

    Do the points I made above, about the justification of each step posing no constraint, resonate at all with you?

    Even in Lavoie’s paper, he writes, after illustrating most of the accounting, “While the end result of these two processes illustrated by Tables 1 and 2 are identical, if all goes well (!), the processes as such are different.”

    It seems he is not yet convinced why all ‘should not go well.’

    It seems self-evident that the ‘minutiae’ of ‘self-coordination’ shouldn’t be a problem, but again, I have never seen this *explicitly* addressed, though it may be an easy job.

  43. I see “the general case” as a stylized model. (I’m talking about the sovereign floating-exchange-rate-fiat-currency-issuing-consolidated-“government”-model now.) The instances out there in the real world depicted by the model may not always be perfect fits. Some are better, some worse. It’s perhaps a gray-scale.

    This is akin to a perfect geometrical square, which could be a useful stylized model of the various squiggly and askew squares in the real world. (Some of them may even be more appropriately modeled as circles or triangles).

    In this sense, the “general case” is not really a super-type of the “specific cases”, as in computer science object orientation, since the specific cases do not necessarily inherit all features of the general case. There are “imperfections”.

    The model of choice of course is just that — of choice. It is a point of view. Other models may be fruitful as well. The MMT model emphasizes the role of the government though, so others may think it is somewhat ideological. MMTers would probably respond that the model is based on anthropological and historical research, on operational realities, on pure accounting logic and other on sound basis.

    But still, any “imperfections” out there in the real world need to be acknowledged, and also taken into account whenever the context requires it. Perhaps MMT can improve in this regard, I don’t know.

    Arguments about Central Bank independence is the counter-MMT arguments that I have the most problems responding to.

    (For me personally, the MMT model has otherwise been humongously useful.)

  44. “Arguments about Central Bank independence is the counter-MMT arguments that I have the most problems responding to.”

    Do you mean regarding political factors, such as the ECB perceiving that they can’t ‘print’ and function like every other central bank so that they can maintain independence and credibility?

    I think the political factors can be separated from the economic factors, especially for the purposes of establishing theory and publishing in academia. Once the economic arguments are firmly established, it can be shown the political issues one might bring up regarding CB independence are actually symptoms of irrational market participants.

  45. “Do you mean regarding political factors, such as the ECB perceiving that they can’t ‘print’ and function like every other central bank so that they can maintain independence and credibility?”

    Hmm.. Well, maybe.. I mean the argument that it is misleading to consolidate the Treasury with the Central Bank.

    — “You can’t just assume away Central Bank independence”, they would say. “The Treasury can’t just spend without operational constraints like MMTers say”.

    — “Well, MMTers do assume away CB independence” I say then. “CB independence is a stupid idea anyway”.

    — “But that’s an ideological statement”, they would respond. “You assume away CB independence because you don’t like CB independence?”

    — “Um.. Well, no..” I argue, “I assume it away because of historical and anthropological parallels, because it is removes unnecessary complexity from the model, and thus an lead to important insights — none of which is lost when detail is put back into the model. Look: Central Banks are not really independent, so therefore MMTers assume that they aren’t. It’s logical.”

    — “Nah, that’s just wishful thinking. You can’t assume away CB independence because your theory says CB isn’t independent.”.

    Maybe MMT is right here? It’s just that I haven’t really grasped the arguments.

  46. Hugo,

    Have you taken a look at the t-accounts in Mark’s paper?

    This is my point. I think it is imperative to step away from the abstract and just look at the accounting head-on.

    The Treasury *can* spend without real operational constraints even with the Fed and Treasury separated. Look at step 1. There is no hindrance to primary dealers making that transaction with the govt. It’s as if the Treasury was consolidated with the Fed, because the reality is that the primary dealer knows the Fed is there to ensure smooth functioning of the banking system. Those reserves will show up when needed, as the Central Bank’s named price.

    Do you see what I am saying? This argument is easy to win if you know the accounting.

  47. I feel that the key point is “which sector does the central bank belong to”. MMT puts it in the government sector. Neo-classicals want it in the private financial sector.

    The UK statistics office (much to my annoyance) puts the central bank in the private financial sector *despite* the UK having probably the clearest government ownership and direction of a central bank in the entire world – the UK government owns all the ordinary shares in the Bank of England.

    That to me represents the key to all of this – who directs and controls the currency issuer?

    One of the interesting outcomes of the pure MMT model is that the central bank literally isn’t required. The Treasury, if it uses its power to simply mark up private bank accounts, can deal with all the functions of a central bank.

    Then you can move onto whether the it would be better for everybody if either the Central Bank did the purchasing on behalf of the Executive, or if the Treasury provided the banking for the private banks.

    And the reason for eliminating one or the other is to show conclusively that the currency issuer is part of the government sector and *will never* be part of the private sector.

  48. “Nah, that’s just wishful thinking. You can’t assume away CB independence because your theory says CB isn’t independent.”

    It doesn’t matter if the central bank is ‘independent’ or not. If it is not prepared to let private banks fail due to cash flow constraints then it is a passive player in the game who has to react to the demands of a private bank – much like a mother responds to the demands of a screaming infant.

    The simple fact is that the current system has not provided full employment and has not ensured optimal outcomes. The Eurozone being a case in point of what happens when you rely on the ‘magical central bank’ to sort things out.

    So suggesting an independent central bank is required in an optimal economic design is simply not supported by the data. At best it is curve fitting. At worst it is ideologically driven rubbish. The independent central bank ensures the stability of the financial sector and to hell with everybody else.

    Therefore a design where the central bank has a different role and is clearly controlled by the government is entirely reasonable when searching for an optimal design.

  49. ‘In this sense, the “general case” is not really a super-type of the “specific cases”, as in computer science object orientation, since the specific cases do not necessarily inherit all features of the general case. There are “imperfections”.

    That’s old fashioned static typing thinking. In modern dynamic type systems classes are generally composed rather than inherited. ‘Duck typing’ is more appropriate to economic modelling (if it walks like a duck and quacks like a duck, its a duck).

  50. @wh10

    > “The Treasury *can* spend without real operational constraints even with the Fed and Treasury separated. Look at step 1. There is no hindrance to primary dealers making that transaction with the govt. It’s as if the Treasury was consolidated with the Fed, because the reality is that the primary dealer knows the Fed is there to ensure smooth functioning of the banking system. Those reserves will show up when needed, as the Central Bank’s named price.

    Do you see what I am saying? This argument is easy to win if you know the accounting.”

    I vaguely see what you’re saying… (will look more closely at Lavoie’s paper later) Let me try to spell out an argument step by step, to check.

    Those who take the other side of the debate would argue thusly:

    — “The Treasury can’t spend “freely” (MMT-sense). The reason is that one can’t know for sure that the Primary Dealers will be willing to purchase the Treasuries. It is up to the market, to some degree, whether the Treasury will be able to spend or not.”

    And to that you would respond:

    — “The middle-man role of the Primary Dealers is totally irrelevant. They know that the Fed will not let these Treasuries default. The Treasuries are considered default-free financial assets. Therefore, for Primary Dealers it is always a safe bet to buy the Treasuries. Interest rates will never hike. (They are in fact under ultimate control of the Fed.)”

    — “But the how can they know that the Fed will back these Treasuries? The Fed can do as it wants.”

    — “No, the Fed must ensure smooth functioning of the banking system, that is one of its main obligations. It can’t just stop participating in Treasury auctions. So, the Treasury can do what it wants to, and the Fed just has to accommodate.”

    Something like that? (Sounds weak to me, probably errors in there? Aargh, I don’t know what I’m talking about, will have to check Lavoie’s paper.)

  51. @Neil,

    Thanks — many good points. (Ok, duck typing ftw!)

    > “It doesn’t matter if the central bank is ‘independent’ or not. If it is not prepared to let private banks fail due to cash flow constraints then it is a passive player in the game who has to react to the demands of a private bank – much like a mother responds to the demands of a screaming infant.”

    > “That to me represents the key to all of this – who directs and controls the currency issuer?”

    In my previous comment just above, I put a piece of argumentation in bold face. Would that piece be relevant to your thinking?

  52. wh10, your comment of 11:24 PM makes sense to me. The 3-step process does not inhibit the government’s ability to spend, because there is no reason the primary dealers would knock back a guaranteed risk-free return, and it is guaranteed by the fact the central bank must ensure smooth functioning of the payments system and is lender of last resort.

    This indicates there is no financial constraint to government spending.

    Also, the imperative for the central bank to ensure the smooth functioning of the payments system means that it must offset any impact of the fiscal authority’s actions, which seems to justify the MMT depiction of the fiscal and monetary authorities as a consolidated government sector.

    There still seems to be the question of bonds preceding spending. I understand Scott to be saying that the purpose of the bonds is to ensure smooth functioning of the banking system – meaning the issuing of bonds to the non-government in step 1 is a monetary, not fiscal, operation – and therefore spending logically precedes bonds (though it does not temporally precede bonds).

    Is this how you are seeing it?

    I appreciate everyone’s input. Even if the discussion has caused some annoyance elsewhere, it is helping to clarify things for me and I would guess for some others here.

  53. @peterc — yes, exactly what I would have wanted to write! wh10 — thoughts?

    peterc: > “I appreciate everyone’s input. Even if the discussion has caused some annoyance elsewhere, it is helping to clarify things for me and I would guess for some others here.”

    Yes, helpful for me too. Oh, has it caused annoyance? Where? Are we being bashed? (Or did you mean “even if” as in “even if rather than “even though?)

  54. Nothing serious, Hugo, at least that I’m aware of, but a few people at Mike Norman’s blog seemed a bit surprised with our confusion. I am referring to this thread. It was only peripheral to the main discussion.

  55. PeterC and Hugo – I am on board! I’d be curious to hear Fullwiler’s thoughts.

    PeterC, I am not sure exactly what you mean by-

    “There still seems to be the question of bonds preceding spending. I understand Scott to be saying that the purpose of the bonds is to ensure smooth functioning of the banking system – meaning the issuing of bonds to the non-government in step 1 is a monetary, not fiscal, operation – and therefore spending logically precedes bonds (though it does not temporally precede bonds).”

    If bonds, under current constraints, unequivocally precede spending, at least temporally, why can we still describe spending as preceding bonds?

    And, to Mark’s point, what more do we gain by presenting it that way? Either way, the govt is unconstrained.

    However, I think we all agree, spending ALWAYS precedes taxes.

  56. wh10, I hope I’m not misinterpreting, Scott. I trust he’ll jump in and correct me at some point if I am.

    Maybe I should have written “logically prior” even though not “before”.

    I mean that the issuing of bonds in step 1 is a monetary operation to neutralize the effect of reserves that will result from the spending. It is not to provide the fiscal capacity for the spending.

    But maybe I am over-reaching here, or misinterpreting. Need to wait for someone else to help out.

  57. What is meant here by “smooth functioning of the banking system”?

    Scott: I’m thinking “smooth functioning” means ensuring settlement occurs smoothly and if there is a positive interest target, monetary operations are consistent with it.

    The central bank needs to neutralize the impact of fiscal actions as necessary to achieve this. (?)

  58. Scott,

    I think Neil has expressed it best above. It’s my terrible short-hand for what he said and what I have read in your writings. The Fed simply has to swap the reserves for the treasuries or provide reserves on demand to ensure withdrawal/payment settlement (“smooth functioning of the banking system”). There is no other way (it seems).

  59. Or what peterC said.

    “I mean that the issuing of bonds in step 1 is a monetary operation to neutralize the effect of reserves that will result from the spending. It is not to provide the fiscal capacity for the spending.”

    Well, I do think, under current constraints, it does provide the fiscal capacity since we require the Tsy to have a positive balance in its account.

    Note, there is no drain of *excess* reserves in the step by step procedure presented in Lavoie’s table. Reserves actually go negative, with the CB replenishing. This goes against the oft-held MMT presentation that bonds serve to drain excess reserves. I need to go back to Fullwiler’s matrix paper, but the “bond drains excess reserves” maxim might better apply to when the Fed engages in a repo with primary dealers prior to the bond auction to ensure that the auction settles.

  60. ^ And the above would apply to non-bank primary dealers.

    Dr. Fullwiler, are most treasuries auctioned off to non-bank PDs as opposed to banks? In other words, what % settle as shown in Lavoie’s table (starting with a bank loan to the Tsy) vs pre-empting with a repo as show in your social matrix paper so that nonbank PDs can purchase treasuries with deposits?

  61. PeterC, I just want to clarify:

    I am not saying that bonds provide fiscal capacity in the same way non-MMTers might, since I am presuming that the bond will auction will never fail since there appears to be no reason why a bank would not lend to the Treasury with the Fed standing by with its infinite reserves. Ie, effectively there is no constraint on govt spending.

    HOWEVER, I do say it provides the capacity, because, in the first instance of a new fiat regime, unless that bond was auctioned, under current constraints, it would be impossible for the Treasury to spend.

    Thought I completely realize this is a specific case of the general case (table 1), in which spending would precede anything.

  62. @all,

    Yes, this may all be in the specific case of the U.S. And a bit outside of MMT paradigm. But it would be interesting to lay this out within “mainstream” paradigm if possible, as has been sort of indicated here. I’ve never thought of it like this before.

    However, I’m a bit lost right now! I’ve tried to structure the argument point for point as follows. Please comment!?

    * Treasury issues bonds, not currency.

    * However, MMT holds that this does in no way restrict Treasury spending. [Is this true?]

    * Why? Because the Treasury is guaranteed that Primary Dealers will purchase the bonds. [Is this true?] That is, the Treasury is guaranteed that the bonds are always convertible to currency.

    * Why? Why will the Primary Dealers necessarily purchase the bonds? [I don’t know]
    (1) Because they are legally required to?
    (2) Because they are guaranteed to make a profit on them?
    (3) Both (1) and (2)?

    * Why are (2) Primary Dealers guaranteed to make a profit on them? Because the Central Bank will necessarily, due to its mandate, blah blah … [I’m lost here…!]

  63. Hugo, I still think this is effectively ‘in MMT paradigm’, which is that govt spending is unconstrained (beyond the ability to impose taxes- see Wray’s latest MMP), though outside of the general case. I apologize for the following caps:

    * Treasury issues bonds, not currency.

    * However, MMT holds that this does in no way restrict Treasury spending. [Is this true?] –> I AM ASSERTING IT DOES NOT AND WAITING TO HEAR FULLWILER’S THOUGHTS.

    * Why? Because the Treasury is guaranteed that Primary Dealers will purchase the bonds. [Is this true?] That is, the Treasury is guaranteed that the bonds are always convertible to currency. MORE TECHNICALLY CONVERTIBLE TO RESERVES. I THINK THERE IS AN IMPLICIT GUARANTEE THAT IF YOU ARE GRANTED THE PRIVILEGE OF BEING A PRIMARY DEALER, YOU DO NOT LET AUCTIONS FAIL. HOWEVER, BANK PD’S DON’T REALLY “PURCHASE THE TREASURIES.” IT’S LIKE A LOAN- THE TREASURY SIMPLY IS TAKEN ON AS A BANK ASSET AND A DEPOSIT GIVEN TO THE TREASURY AS A BANK LIABILITY. HOWEVER, IF THE PRIMARY DEALER IS NOT A BANK WITH A RESERVE ACCOUNT, THEN THEY ARE PURCHASED WITH A DEPOSIT ACCOUNT, AS FULLWILER SHOWS IN HIS MATRIX PAPER; BUT BEFORE THAT HAPPENS, THE FED WILL ENGAGE IN A REPO WITH THE NON BANK PRIMARY DEALER TO ENSURE THAT IT HAS DEPOSITS AND ENOUGH RESERVES ARE CIRCULATING IN THE BANKING SYSTEM AS A WHOLE SO AS TO DEFEND THE FFR.

    * Why? Why will the Primary Dealers necessarily purchase the bonds? [I don’t know]
    (1) Because they are legally required to?
    (2) Because they are guaranteed to make a profit on them?
    (3) Both (1) and (2)?

    ESSENTIALLY, YES. PD’S JOB IS TO MAKE A MKT IN TREASURIES AND ENSURE AUCTIONS DON’T FAIL, AS FAR AS I UNDERSTAND…

    * Why are (2) Primary Dealers guaranteed to make a profit on them? Because the Central Bank will necessarily, due to its mandate, blah blah … [I’m lost here…!]

    BECAUSE THEY EARN INTEREST VS RESERVES WHICH DO NOT IF THE FED DOESN’T PAY INTEREST ON RESERVES. THERE MIGHT BE A WAY TO PROFIT AS A RESULT OF THE REPO TRANSACTION, WHICH NEIL ALLUDED TO, BUT I AM LESS CLEAR ON THIS.

    -Disclaimer: These are wh10’s musings, no one else’s. Though it is myself, this is where all of us (peterC, Neil, Hugo) are.

  64. Understanding how bank loans are created is crucial to understanding this. MMT says loans create deposits and bank loans are not reserve constrained, since the Fed will supply reserves on-demand. This applies to the case of the Treasury spending in the first instance of a new fiat regime, and it actually makes the point quite clear IMO. Why would a bank not make a loan to a risk-free entity for which they earn interest, let alone their contractual obligations to make sure tsy auctions settle and make a mkt in tsys? And this further makes clear that the interest rate that the auction settles on govt bonds will be determined by where the Fed sets the FFR.

  65. If this line of thought works, then I want to add it to the Wiki somewhere. Will ask on the Wiki mailing list (including Warren and Scott if they have time) for feedback — and report back if anything turns up.

  66. I hope Scott and Warren don’t hate me for opening up this can of worms and spreading potential misinformation, but this is how I interpret what Lavoie is trying to say.

    But if my interpretation is correct, and Fullwiler claims Lavoie’s paper isn’t that big of a deal, then my interpretation isn’t really that big of a can of worms :).

  67. I’ll blame it on Cullen for providing the link. He can blame it on Lavoie for writing the paper. Lavoie can blame it on Fullwiler and Mosler for writing what they did. Full circle. 🙂

  68. Hahaha. Also, I’ll further blame Cullen, because a while ago he told me that Primary Dealers are key to this whole process ‘working.’ They won’t let auctions fail. This is my accounting-based interpretation of why they won’t.

  69. Many things going on here. Let me try and clarify by first saying that I think that both WH10 and Neil are right–that is, the points being made aren’t mutually exclusive.

    First, regarding WH10’s arguments, the “self-imposed constraint” of needing balances in the account to spend isn’t actually a constraint. There’s the coin seigniorage example, for instance. But more generally, as I put it in the primer on operational realities:

    “Finally, to fully understand the operational realities associated with the Treasury’s account at the Fed, it must be recognized that the lowest rate the Treasury would reasonably expect to pay on the national debt in the case of overdrafts on its account would be the Fed’s target rate. Operationally, the Fed would have to pay interest on reserve balances at its target rate or otherwise offer its own time deposits at competitive rates in line with the current and anticipated target rates to drain the reserve balances and achieve its target rate (in the case that the remuneration rate on reserve balances is below the target rate or even zero), both of which reduce the Fed’s profits returned to the Treasury and act functionally like debt service for the Treasury. The situation is unchanged even if the Treasury deficit spends via a “helicopter drop” of pure cash or coins, since the private sector will deposit the vast majority in banking accounts, and banks will return excess vault cash to the Fed in exchange for reserve balances.”

    “One can then think of three different degrees or “forms” (to borrow the taxonomy used by financial economists in describing the efficient markets hypothesis) related to deficits and interest on the national debt for a currency issuer under flexible exchange rates. The “strong form” deficits would be where the Treasury has an overdraft or similar at the Fed and interest on the national debt is essentially at the Fed’s target rate or on average a bit higher if the Fed issues time deposits to drain reserve balances. While the “strong form” is operationally “pure,” it is again obviously not current law in the US. The “semi-strong form” deficits would be where the Treasury is not provided with overdrafts and must issue its own securities to have positive balances in its account before spending again while the securities issued—given their zero-default-risk that results from operational realities and the fact that any “constraint” on the Treasury is self-imposed—mostly arbitrage with the Fed’s target (for short-term Treasuries) and the expected target rate (for longer-term Treasuries) aside from some technical effects (like convexity) and some demand/supply issues (like maturity and liquidity at different maturities). Examples of the “semi-strong form” would be here and here. The “weak-form” deficits would consider that bond markets might at some point choose to repudiate even a currency-issuer’s debt with zero default risk (the “semi-strong form” does, too, but presumes the effect is temporary as arbitrage relationships would over-rule at least in the medium-term), but recognizes that the Fed always has the ability to set the market rate on Treasuries as long as it is willing to buy all quantities offered at its bid price (and has no operational or even legal constraint for doing so). Examples would be the Fed’s “Operation Twist” or the Fed prior to the Treasury Accord, or in the non-currency issuer case, consider how the recent EMU crisis quickly faded once the ECB began purchasing the debt of troubled member nations.”

    “All three forms, while different in degree, agree that the interest on the national debt for a sovereign currency issuer under flexible exchange rates is a policy variable—not a market-set rate—or at the very least could be if the government so desires. And note that this is the case whether or not the Treasury receives overdrafts at the Fed. In other words, since the outcome is roughly the same in all three cases, it really doesn’t matter if the Treasury receives overdrafts in its Fed account or not—if it can sell its debt at roughly the Fed’s target, then there is no economically meaningful difference from the Treasury’s perspective between the government enabling itself to obtain an overdraft and the government forbidding itself from doing so. That self-imposed “constraint” is really not a constraint at all even if it is never abandoned.”

    This is slightly different from WH10’s point. That is, it’s not legally guaranteed in the US (it is in other countries, as Lavoie points out) that the auction won’t fail. They have in the past and can in the future. This could certinatly happen as another debt ceiling debate arrives, and if the Congress isn’t willing to guarantee payment on its debts, then there’s no reason why tsy rates can’t rise–Warren even argued before summer (I think) that the ratings agencies should downgrade the US based on willingness to pay. Even in that case, though, the CB can step in and buy the issue and guarantee a price–as the Fed did during WWII and as the ECB is doing now to some degree. The operative word there is “can”; it is not obligated to do so, and I don’t think allowing a 10y tsy rate to rise to, say, 7% or even more from the current 2% level necessarily threatens the “smooth functioning of the banking system” (though I’m not sure what that means and I’m not sure the Fed guarantees it). So, self-imposed constraints are just that–self imposed—which means they can be constraints in a given case, but it’s the govt’s own choice to allow that. Moreover–a point that Lavoie emphasizes and I did, too, back in “interest rates and fiscal sustainability”–this further emphasizes the crucial issue is not “which comes first, spending or revenues/bond sales?” but rather what rate of interest the govt can issue its debt at. Note that there would be no crisis (aside from a slumping economy) in Greece or now Italy if those nations could issue debt at a risk-free rate–and they are not even currency issuers.

    Now, to Neil’s point, note that there are layers involved here. In terms of a given monetary regime, there are operational realities; in some regimes, like a currency board, there are operational constraints on the govt, obviously. Outside of that context, there’s another issue related to legal/institutional structure. The US has no operational constraints, but self-imposes some, meaning that it can get rid of these without changing the monetary regime. Argentina, on the other hand, under the currency board had operational constraints, but still its govt had the legal authority to get rid of that monetary regime and its govt had legal authority over the cb. Greece has operational constraints, but also unlike the US has legal constraints–it can’t dictate policy to the ECB. It does have the authority to leave the EMU, of course, but not without consequences–and in Argentina there were significant consequences, too, at least temporarily. But this authority to leave is different from ,say, California, which cannot leave the monetary regime it operates within.

    Then there’s the related point about central bank “independence.” Normally, independence simply means the ability to set a policy target and also an interest rate target without interference from govt. In this sense, the Fed has independence, but this independence is clearly at the pleasure of the govt. The ECB has additional legal independence that the Fed does not, but even this could be taken away if EMU members so decided. So, whenever someone says “cb independence,” they need to define it, but they also need to recognize that “independence” implies legal hierarchy–the “independence” was granted by somebody, and in every case I know of can be taken away. And this goes for whether or not a CB is “private.”

  70. WH10,

    It’s a big deal to some people, for sure, but it really is about how to present how the monetary system works in a general way GIVEN that it is already agreed upon how that monetary system works. The differences therein can be significant, for sure–framing is obviously very important. For the short term, it’s important to find ways to communicate–I think Marc’s paper shows that there are some things MMT’ers say that he and others still don’t understand and/or misinterpret. “Leverage” and “vertical money” are good examples.

    To give an analogy, about 15-20 years ago there was a fairly fierce debate between horizontalists and so-called “structuralists” about “how” endogenous bank money is. The horizontalists were criticized for taking an “extreme” position that banks would always and everywhere lend at a given rate of interest without limit. Structuralists–like Randy–argued that banks would raise the rate they charged over time, for various reasons. The horizontalists interpreted Randy as saying that the banks’ supply curve was upward sloping, implying that the bank was somehow operatinally constrained in lending more. It’s now understood that this was all a big misunderstanding–Horizontalists meant that banks could operatinally lend without limit at the rate they posted, but that they wouldn’t necessarily post the same rate (or markup to the target rate) to everyone or at all points of the business cycle, which was the structuralists point. It also became clear that structuralists were basically arguing the same thing, not that banks were somehow operatioanlly constrained. Randy gave a bit of a synopsis of this here of his view of Moore http://www.cfeps.org/pubs/wp-pdf/WP30-Wray.pdf

    Any way, my reason for going through this is to suggest that at some point it might be the same with MMT and other PK’ers. Hopefully. And in that sense, Marc’s clarification of the differences is very useful.

  71. OK, so what is meant by “smooth functioning of the banking system” is “smooth functioning of the payments system.” Please say the latter, then, as the former implies something very, very different. And, given that we are talking about the payments system, then we have no guarantee at all that a tsy auction won’t fail, at least in terms of its relationship to the payments syste. That is, an auction can fail without threatening the payments system.

  72. Let me clarify . . that the Fed must provide that funds are available to buy the tsy’s purchased at auctions doesn’t mean that all the tsy’s offered at auction will actually be sold.

  73. Scott, thanks so much, this is great. Ah, lots of thoughts and clarifications I’d like to make here.

    For the moment, I’d like to arbitrarily pretend that the ability for the Fed to provide overdrafts and for there to be platinum coin seigniorage does not exist and never will exist.

    With those assumptions made, let me walk through the following thoughts-

    “Let me clarify . . that the Fed must provide that funds are available to buy the tsy’s purchased at auctions doesn’t mean that all the tsy’s offered at auction will actually be sold.”

    Okay this is key. Is this not because there is some sort of political uncertainty that the govt won’t make payments on the debt (for example, by not raising the debt ceiling)? Would there be any other reason?

    But if we assume a world in which there is zero political uncertainty and the debt is actually considered ‘risk-free,’ then would not all the tsy’s offered at auction be sold? This is essentially what I was assuming in my walkthrough with Hugo.

    Okay, now let’s allow for a world in which there is some political uncertainty. In that world, is the following a better way to put it?

    There is some price at which auctions will settle (or perhaps fail), the price determined by perceptions regarding the level of risk of debt payment. However, should that level of risk perceived to be near zero, then the issuance of bonds poses no real constraint on govt spending.

    And that I think drives to this-

    “Moreover–a point that Lavoie emphasizes and I did, too, back in “interest rates and fiscal sustainability”–this further emphasizes the crucial issue is not “which comes first, spending or revenues/bond sales?” but rather what rate of interest the govt can issue its debt at. Note that there would be no crisis (aside from a slumping economy) in Greece or now Italy if those nations could issue debt at a risk-free rate–and they are not even currency issuers.”

  74. WH10

    “But if we assume a world in which there is zero political uncertainty and the debt is actually considered ‘risk-free,’ then would not all the tsy’s offered at auction be sold? This is essentially what I was assuming in my walkthrough with Hugo.”

    Yes, that’s my “semi-strong” form.

    Okay, now let’s allow for a world in which there is some political uncertainty. In that world, is the following a better way to put it? There is some price at which auctions will settle (or perhaps fail), the price determined by perceptions regarding the level of risk of debt payment.”

    Yes, my “weak form.”

    “However, should that level of risk perceived to be near zero, then the issuance of bonds poses no real constraint on govt spending.”

    Yes, “semi-strong form” again.

    “And that I think drives to this-“Moreover–a point that Lavoie emphasizes and I did, too, back in “interest rates and fiscal sustainability”–this further emphasizes the crucial issue is not “which comes first, spending or revenues/bond sales?” but rather what rate of interest the govt can issue its debt at. Note that there would be no crisis (aside from a slumping economy) in Greece or now Italy if those nations could issue debt at a risk-free rate–and they are not even currency issuers.””

    Yes, that’s the key issue. I like to say it this way: If you are given the choice of obtaining an overdraft at the cb’s target rate vs. issuing debt at essentially the cb’s target rate, do you care if then the option of obtaining the overdraft is removed? there’s no economically significant difference. this demonstrates that the real issue here is the interest rate, not whether there is an overdraft. I’ve been saying this since at least 2006, probably earlier (actually, since 2003-4 with “setting interest rates in the modern money era” and “paying interest on reserve balances . . . “).

  75. Scott, that’s immensely helpful.

    There’s one more issue I’d like clarification on, again assuming no Fed overdrafts or primary mkt purchase or coin seignorage BUT assuming the mkt views govt debt as ‘risk free.’

    Do we have to assume that there are *bank* primary dealers available for the auction that can simply take tsys onto their balance sheet (like a loan)? Or can an auction settle (pretend its super massive) with nonbank PDs and the private sector with their deposit accounts essentially fixed?

  76. WH10,

    What you need for the semi-strong form are (a) sufficient investors, be they PD’s, hedge funds like Mosler, or whatever, willing to buy the tsy’s due to arbitrage condition against current/expected cb targets, and (b) for these investors to have financing. For the latter, PD’s have the repo mkt. All have LIBOR, banks, etc.

  77. Scott,

    I’m almost there; my question is trying to understand how their could theoretically be infinite financing for infinite debt issuance.

    You’ve made this point before regarding PDs and the repo market. I have your matrix accounting paper in mind. There you show the PDs engaging in a repo to swap their Tsys for deposits. But there, it looks like they can only receive deposits worth the value of their Tsy. But you’ve said before 1 Tsy can be ‘levered’ several times over. How and why does that happen? Are you essentially saying that banks, even if they don’t participate in the auction, can still perform their ‘infinite’ loan function which is not reserve constrained?

    I’m trying to establish firm understanding of where the ‘loanable funds’ model breaks down if I assume bank PDs can’t participate at the auction. If they can, it’s clear they can take theoretically an ‘infinite’ amount of tsy debt onto their balance sheet; just as the Fed could if it provided direct overdrafts or primary mkt purchase.

  78. “Are you essentially saying that banks, even if they don’t participate in the auction, can still perform their ‘infinite’ loan function which is not reserve constrained?”

    Yes, although ability to leverage a repo is not infinite due to haircuts–there actually is a multiplier constraint there.

    “I’m trying to establish firm understanding of where the ‘loanable funds’ model breaks down if I assume bank PDs can’t participate at the auction. ”

    It breaks down before you start, because it’s inapplicable. The limit for a bank expanding its balance sheet is capital, but even that’s pretty fuzzy, or can be made fuzzy, especially by the big banks, though probably not without limit.

    So, I would say that if tomorrow the Tsy were to do an auction that was 2x the normal size, it would not fail, though the rate might be a bit higher given that investors would require financing and that might not be available quickly. But I’d be surprised if it failed, and if it did fail, it wouldn’t be too long before investors were ready to handle that amount. But if the Tsy were to try tomorrow to do an auction that was $900 bazillion, it would likely fail, and might always fail. So, it’s not infinite, for sure. That’s why I call it the “semi-strong” form. There’s no theoretically defined limit, because that depends on too many context-specific things.

  79. But, in our pretend world, if bank PDs do participate, why can’t they take $900 bazillion onto their balance sheet? They don’t require financing.

  80. I mean I am assuming away capital requirements. But I feel like direct bank PD participation gives extra slack. But I guess, for that matter, in our pretend world, then there is no reason they can’t finance others if they can’t participate at auction.

    So like you said, it’s context- specific.

  81. I’ll take your word for it and go read up on capital reqs myself, since I’ve taken up so much of your time already, but did you mean ‘no theoretical limit’ or still ‘a theoretical limit?’

  82. @wh10 — any chance you can summarize your new understanding in baby language, slow and easy?

  83. You’re the best, as usual, Scott.

    For PeterC, Hugo, and the rest, was this at all helpful or did I just chase myself around in circles from your perspective?

    For me, it was helpful because

    1) I finally got clarity on what semi-strong and weak-form meant, and using the brand new fiat regime accounting thought experiment with Hugo helped at least me

    2) It reinforced the point about how establishing a risk-free rate in the market’s eyes is more important than whether we perceive bonds or govt spending to precede each other.

  84. Hugo,

    I’m going to let it sink in, I am going to revisit Scott’s paper on int rates and sustainability, and at a later point hopefully I can some up in my own words to solidify it. But it’s all there, and nothing here really changes any fundamental points we know about MMT, but I think there is a depth of understanding and nuance here that is valuable, namely regarding the supremacy of the risk free rate and understanding how, for its practical intent and purpose, MMT in the real world still holds even once you exit the pretend world I just went through with Scott.

  85. Absolutely, wh10. I found your contributions to the discussion very beneficial. (And Neil and Hugo’s as well.) Thanks.

  86. Fullwiler is secretly pissed off because he is saying in his head “I’ve said this all FOR YEARS!!!!!”

    🙂

  87. I have to play Devil’s Advocate here…

    “In step 2, the Treasury moves its account to the Fed and the Fed debits the reserve accounts of the private banks. Why is this acceptable to the private banks? Because they know that in step 3 they can get the reserves back again in exchange for the treasuries they still hold. Do the private banks lose anything in this process? No. At the end of the three steps there is no change in their holdings of treasuries, their reserve levels or deposit liabilities.”

    Certainly, the private banks will eventually be provided with the reserves they need to meet reserve requirements after any loans that they desire to make have taken place.

    But we are not talking about a purely static situation here. Time has to intervene. And, if my understanding of these things is correct, the private bank may, in the interim between the holding of treasuries and the next Fed intervention in the interest rate, make enough loans that they have to hit the discount window. This would eat into their profits — and we can be sure that, good capitalists that they are, they’re keenly aware of these.

    If I’m right on this (and I may not be, by all means correct me if I’m wrong) the MMT approach of aggregating the sectors may be veneering over some ‘friction’ in the system — friction that does indeed determine private banks’ actions under certain conditions.

    (In fact, whether I’m right or wrong on this I should say now that I’ve long thought that the MMT literature on the discount window and when it is used etc. was a tad vague. Maybe someone could point me in the right direction?)

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