The Central Bank and the Yield Curve

In a recent post it was noted that the central bank could dictate longer interest rates if this were deemed appropriate. This deserves brief elaboration. The relevance of the observation is not that it would necessarily be a desirable policy, but rather that in a modern monetary system – one in which the government is the monopoly issuer of its own flexible exchange-rate fiat currency – ultimately interest rates are at the discretion of the central bank. The government chooses the form of debt it issues and the central bank can control the interest rates applying to that debt. It follows that the government’s risk of facing “unsustainable” interest obligations, in the orthodox sense of causing runaway inflation, is eliminated barring deliberately self-destructive policy.

When modern monetary theorists say that the central bank could dictate all interest rates, including longer ones – see, for example, Bill Mitchell’s Who is in charge? – they mean that the central bank could use a price rule rather than a quantity rule. This is what it currently does with the short-term interest target. The central bank could say it will stand ready to buy or sell whatever amount of debt of particular maturity is necessary to maintain its target for that interest rate, just as it stands ready to maintain its target short-term rate. Since the consolidated government sector (including fiscal and monetary authorities) faces no financial constraint, the central bank has the capacity to do this.

But this is not to suggest that such an approach is necessary, or even desirable, when it comes to longer interest rates. The important point is that, ultimately, interest rates have a monetary/political determination, not a real determination, and are at the discretion of the central bank. I discuss this point further in Interest, Money and Crisis, but see especially Scott Fullwiler’s Interest Rates and Fiscal Sustainability.

The observation that interest determination is a matter of political economy is a critical one. Some orthodox economists attempt to show that ongoing government net spending creates an excessive interest obligation that, when paid, gives rise to runaway inflation by causing demand to outstrip the capacity of the economy to respond. This fear subsides once it is understood that interest rates are at the discretion of the central bank.

In practice, it is not necessary to dictate longer rates. The Treasury and central bank, working in tandem, can instead do one of two things:

1. Stop issuing debt and just pay the target rate on reserves; or

2. Only issue short-term debt so that short-term rates are the only relevant ones for fiscal “sustainability” in the orthodox sense.

Since the central bank controls the short-term rate, and even more easily can control the rate paid on reserves, the interest obligation on public debt is directly controllable. Provided this approach is taken, it won’t matter from the perspective of the government’s debt obligation whether longer rates are allowed to be influenced by markets through inflationary expectations and arbitrage. Further, as long as fiscal policy is pursued with an eye to both strong employment outcomes and price stability, there will be little reason to fear steep increases in longer rates due to expectations of rapid future inflation.

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196 thoughts on “The Central Bank and the Yield Curve

  1. If govt spending exceeds its income from tax, it can counter the stimulatory or inflationary effect that would otherwise occur with some borrowing. More accurately, it’s the deflationary effect of the borrowing that has the desirable effect.

    If demand is at the maximum level consistent with acceptable inflation, and govt then tries to drive interest rates down by buying back those bonds, the deflationary effect is lost or reduced. Demand then becomes excessive, and inflation rears its ugly head. Thus I suggest govts do not have freedom to drive interest rates down.

  2. The MMT position is that the inflationary consequences of the deficit expenditure will be the same whether the injected net financial assets are held in the form of reserves or bonds. The buyers of the bonds want to save, not spend. It is just a matter of the form in which they save.

    But I’m guessing you’ve received this response from others previously. Can you elaborate on why you think the inflationary consequences are different?

  3. Re why bonds are different to cash, I think the two are different because….

    1. When govt injects bonds, it injects an obvious asset into the private sector, i.e. bonds. But at the same time it injects a liability which scarcely ever gets a mention, namely the obligation on non bond holders to pay extra tax to fund the interest on the bonds. In contrast, in the case of cash, there is no such corresponding liability. I am not saying the liability is equal in value to the asset, but the liability does exist.

    2. To say that bonds and cash are identical in all respects is to say that QE has no effect at all, since QE involves swapping bonds for cash. Pound for pound, I don’t think the effect of QE is dramatic compared to an Abba Lerner “print and spend” policy. But QE does result in the private sector holding more cash than it otherwise would have. I would expect the private sector to use some of that cash to acquire other assets, which will boost asset prices: witness the recent stock market revival. And that rise in asset prices has a stimulatory effect. Indeed I think Bernanke has specifically said this is one objective of QE.

  4. “And that rise in asset prices has a stimulatory effect.”

    Allegedly has a stimulatory effect. Do we have solid evidence that secondary market changes have any direct effect in the primary market that can’t just be explained by the general confidence level or the current position in the business cycle?

    I don’t think its the rise in asset prices. I feel that it is eliminating a sure fire income stream that is the causation factor.

    Once you get rid of bonds you have removed an income stream from the private sector. The private sector will then adjust their portfolio holdings to the new indifference level based on the new level of income available.

    That may mean that projects that were non-viable when there was a 4% guaranteed freebie on offer suddenly become worth doing when the best alternative freebie is 0.5%.

    Are there any studies that show this happening?

  5. “But at the same time it injects a liability which scarcely ever gets a mention, namely the obligation on non bond holders to pay extra tax to fund the interest on the bonds”

    That’s just a form of government spending. When you issue bonds you are increasing government spending in a particular direction.

    When you don’t issue bonds you have more ‘space’ to direct that government spending elsewhere (or reduce government spending which would be deflationary).

    So is it the case that if a government stops issuing bonds it must redirect that spending elsewhere, and is it the redirection elsewhere that is the ‘stimulatory effect’?

  6. Ralph Musgrave:

    “If demand is at the maximum level consistent with acceptable inflation, and govt then tries to drive interest rates down by buying back those bonds, the deflationary effect is lost or reduced. Demand then becomes excessive, and inflation rears its ugly head. Thus I suggest govts do not have freedom to drive interest rates down.”

    By “demand at maximum level consistent with acceptable inflation” I assume you mean economy working with full capacity?

    You can’t be sure that “demand then becomes excessive”.

    Aggregate demand is a flow. The fact that the stock of reserves becomes bigger than before doesn’t mean that it is going to start flowing with higher speed. It can stay in its big lake, or go and inflate some smaller sister lakes, like the stock or gold markets.
    Aggregate demand can become excessive for economy working with full capacity any time when private sector starts spending more than its current income using credit or previous savings in any form.

    When/if such excessive (for economy working with capacity) cash flow actually starts looking for goods and services, then through budget surpluses purchasing power should be reduced.

  7. Neil, I’ll take your points in turn. First “asset prices” and “general confidence level”. It would be useful to be able to distinguish between “confidence” and “asset prices”, but it strikes me there is not much point in anyone busting their guts to distinguish between the two because when asset prices rise, confidence is almost bound to rise as well.

    Re “sure fire income stream”, an “outgoing” stream is removed at the same time. That is lenders no longer get interest, but taxpayers no longer have to fund the interest, so there is no net effect.

    Warren Mosler would answer that by saying that the income stream is new money. That’s how he arrives at his conclusion that interest rate reductions are deflationary. I.e. less interest paid by govt means less financial assets flowing from govt to the private sector.

    But that argument is flawed, I think. To guage the effect of interest rate changes, one must do it on the “other things being equal” assumption. That is, one cannot assume that private sector net financial assets change at the same time. One might as well argue that money spent on roads is very stimulatory by assuming that all road spending is “new money”.

    Re your second comment, my answer is “no”. I am claiming (with less than 100% confidence!) that the stimulatory effect comes from the effect on asset prices. The interest payment point is irrelevant, I think, because as I said above, receipts of interest by bond holders are cancelled out by the obligation on non bond holders to pay tax to fund the interest.

  8. “That is lenders no longer get interest, but taxpayers no longer have to fund the interest, so there is no net effect.”

    And the evidence that the bondholders spend their interest at the same propensity as taxpayers/government is?

    Bondholders are wealthy. In the UK the bulk of recent gilts are with corporations and financials, all of whom are stockpiling cash at the moment. They ain’t spending.

    So whether it is ‘new’ money or ‘old’ money surely isn’t the key issue. It’s which recipient is more likely to repeatedly spend the money.

  9. Peter: When you say that the government can control “all interest rates”, do you mean, all interest rates on government debt or all interest rates in the economy?

  10. Vimothy – are you being disingenuous? I suspect that Peter is referring to sovereign curve, rather than credit spreads.

  11. Anders,

    How charming.

    “MMT economists say that the central bank in a modern monetary system could dictate all interest rates, including longer ones”

  12. Nothing personal, have just detected a certain archness to your style; I read the same phrase you did but made an inference. Perhaps it would be wise to just let Peter reply.

  13. Re: targeting price for longer yields (as opposed to quantity as of today). MMTers understand this, knowing that bonds don’t fund spending. However, in the current (wrong) paradigm this is not an option since the govt thinks it has to target the quantity to match the deficit spending $-4-$. So, the only option for the govt in the current paradigm is to shift the mix of maturities in such a way as to optimize overall bond offering at the points of most demand so that the resulting yields are consistent with the goal of reducing the interest payments. Right?

  14. Anders, vimothy: Anders’ interpretation is correct.

    Peter D: Yes, that’s what I had in mind: the central bank could stand ready to buy or sell whatever quantity maintained the price of its choosing for a security of particular maturity.

  15. Peterc: Cheers

    BTW, Ralph’s description of QE is correct. I don’t follow what the Fed does particularly closely, but in the UK QE was designed to reduce the cost of corporate funding (via the portfolio balance channel).

    So Ralph has correctly identified at least one side effect of the MMT “no bonds” proposal: rates of near substitutes for govt debt fall. Typically, one would expect to see such a thing in a situation where govt spending was down, but obviously here we are imagining that private income is up and the non-govt is flush with cash. It is hard to see how this could fail to be inflationary to some degree both in terms of asset prices and the real economy. Indeed, it is hard to see why one would want to follow such a policy if it were not.

    Peter D also makes a worthwhile observation, which is that accepting that the govt does and should set rates up and down the YC is dependent on accepting a lot of other stuff that is unique to Neo Chartalism and not uncontroversial to the rest of us. To me, this policy proposal smells strongly of coordination failure and bubble economics, but hey, I guess if there ain’t no such thing as the long run anyway, there’s probably no need to worry!

  16. Doesn’t that assume (once again) that an economy without gilts won’t quantity adjust to compensate.

    Why won’t the private banks start to issue more fixed interest rate bonds?

    Where’s the crowding out argument when you need it?

  17. “Where’s the crowding out argument when you need it?”

    It’s in the second para of my comment.

    You’re saying that if the govt reduces its borrowing, interest rates will fall and the private sector will increase its borrowing?

  18. Vimothy. if I understand you correctly you think that in no-Tsys world fixed rate investors will flock to municipal and corporate bonds (“near substitutes for govt debt fall”)?
    Now, what I don’t get about Tsy vs. no-Tsys is that even if we accept the idea of Tsys reducing demand via reducing purchasing power (not the MMT way of looking at things), then all we’re doing is shifting this demand in time. Sooner or later the demand will come out in this paradigm, right? So, the problem again becomes not the issuance of debt per se, but rather the effect of the released demand on prices. Which is what MMT seems to be saying anyway: excess demand over capacity is bad. In other words, the issue is not whether MMT is wrong about Tsys-vs-no Tsy but rather whether we should be trying to increase demand when economy operates under capacity.
    I am not sure I formulated this very well….

  19. “You’re saying that if the govt reduces its borrowing, interest rates will fall and the private sector will increase its borrowing?”

    Look at it from the other viewpoint. Government gilts are tradeable fixed interest savings certificates. If the government stops issuing tradeable fixed interest saving certificates and the trading of saving certificates has some perceived value in the secondary market then the private sector banks should pop up, start offering them and make a profit out of manufacturing them.

    After all they are supposed to be experts at short/long transformations and hedging. And they tend to manufacture the financial instruments their clients want to buy.

  20. Neil,

    Of course that’s going to happen (price of near equivalents rises; supply increases). This is a standard argument that Neo Chartalists tend to rubbish elsewhere (i.e. crowding out).

    The question is: will this be inflationary or not? Ordinarily, we’d say maybe. Cet par if rates fall then it should be, but you also have to net out the effect of a fiscal contraction. But if there’s no fiscal contraction (because all we’ve done is stopped issuing bonds, not reduced govt spending), then it seems hard to imagine how it could be anything other than inflationary. Right?

  21. PeterD,

    I’m saying that if the govt stops issuing debt, everyone who previously held govt debt is going to have to find something else to hold their wealth in. Obviously, in practice this is going to be near equivalents, so that other high quality low yield debt is going to be bought up by investors looking to rebalance their portfolios. The effect of which will be to raise prices on assets in this class (or, equivalently, to lower rates).

    Normally, we might expect this situation to be associated with some kind of investment boom that might or might not offset the fiscal contraction that caused the reduction in interest rates, depending on a myriad of other factors. However, in the MMT proposal, there is no fiscal constraction to offset, there is just the expansionary reduction in interest rates. So there is only price level pressure in one direction: upwards.

  22. Thanks, Vimothy. I guess it is hard for me to see why it smells like “bubble economics”. I am thinking of all the money used to be put in Tsys which now will be channeled into state and muni bonds, making the financing of local projects cheaper. This could lead to the contraction you’re looking for – if the states will be able to initiate more infrastructure projects, for example, then the employment will pick up and the federal government can reduce its own spending. I am probably thinking of all this in very naive terms?

  23. “This is a standard argument that Neo Chartalists tend to rubbish elsewhere (i.e. crowding out).

    No I don’t think it is the same argument. I don’t see neo-classical commentators shouting about how the gilt market is crowding out the savings industry and it should be stopped forthwith.

    In the UK you hear it a lot about National Savings causing banks pain by having great products, but never about the DMO – even though the function is identical. In fact gilts used to be available via National Savings at one time.

    Hardly surprising I suppose since gilt interest is essentially unemployment benefit for feckless banks and corporations.

    “But if there’s no fiscal contraction”

    There is. You forget the 3.5% interest that will be no longer happening. That reduces the deficit spend unless you redirect the stimulus elsewhere.

    If you do redirect it elsewhere then it is the stimulus that is stimulatory.

  24. Peter D,

    I think the problem is more that you’re not putting all of the pieces of the jigsaw together, so you’re only getting part of the picture.

    At present, when the government wants to spend in excess of its income it borrows from the private sector (for example, from pension funds, which hold large quantities of govt debt). In other words, when the government wants to spend more than it earns it does so by ensuring that someone somewhere is earning more than they spend (that is, by ensuring that someone somewhere is saving). Why is this important? It’s important because everyone can’t consume the same piece of the pie at the same time.

    Say we have GDP equal to $X. Now, the govt wants to consume a proportion of that output, say equal to αX, where 0 < α < 1. It is necessarily the case that the government cannot consume this quantity if private or non-govt consumption is equal to X—because there would be no output left to consume!

    So, if no one defers consumption (saves), what is going to happen?

  25. Neil,

    Your argument is that if the government supplies less financial assets (i.e. borrows less), someone else will supply (borrow) more. This proposition is often called “crowding out”, because it implies that govt borrowing is crowding out private borrowing.

    “Hardly surprising I suppose since gilt interest is essentially unemployment benefit for feckless banks and corporations.”

    Why would banks lend money to the govt? Doesn’t make any sense.

    I think you probably mean, “gilt interest is essentially unemployment benefit for feckless pensioners”: http://news.bbc.co.uk/1/hi/business/8530150.stm

  26. Vimothy: “So, if no one defers consumption (saves), what is going to happen?”

    That much is clear – inflation. But who claims otherwise? MMTers always say that govt deficits only make sense since the non-govt sector is a net-saver. As soon as private sector’s desire to save decreases, the govt deficit has to be reduced or even eliminated.
    What I meant is that given that the desires of private sector to save stay about the same as before, it will have to find other outlets to channel those saving into. I guess you’re trying to say that monetization of debt will cause a big shift in the private sector’s propensity to save?

  27. Peter D,

    “That much is clear – inflation. But who claims otherwise?”

    Different people will tell you different things—I’ve heard plenty of MMT types implicitly claim that all govt spending is productive, even govt consumption expenditure. Possibly you might have even made a claim with this implication yourself on this very blog. I don’t know, and it’s not hugely important WRT the main thrust of my argument here.

    “I guess you’re trying to say that monetization of debt will cause a big shift in the private sector’s propensity to save?”

    I was just trying to set the scene with the previous comment. You’re quite right; we probably shouldn’t expect agents to change their saving preferences just because the govt has stopped issuing bonds. So let’s say that rates of saving don’t change. Instead, someone else does the same amount of borrowing and spending as the government did previously, and which absorbs the same amount of savings as before. So far so what. However, on top of all that you need to add the now uncovered by bond issuance govt spending net of taxes. This is now equivalent to the case above which you agreed was inflationary—“who claims otherwise?”—because there is no deferred consumption which would allow govt to eat its slice of the pie without having to fight you for yours.

    Do you agree, see how we got here, etc? Again we’re left with an unambiguously inflationary side-effect of the no bonds proposal.

  28. OK, Vimothy, trying to wrap my head around your comment. Here is my thinking:
    Assume 3 agents: G (gevernment), A (a person with propensity to save 1/2 of income and invest 1/2 of income) and C (a corporation).
    1) G spends by paying $100 to A.
    2.a) In scenario with Tsy issuance, A consumes $50 on widgets produced by C and buys $50 of Tsys.
    2.b) In scenario with no Tsy issuance, A consumes $50 and buys $50 of C’s bonds.
    3) In both scenarios the G’s liability is $100, but in 2.a part of it is in the form of Tsys.

    I guess in this simple model I am missing what C going to be doing with the extra $50 in 2.b that it gets from selling its bond. Hm, lets see. In scenario 2.a the rates were too high for C to issue bonds, so, it cut on its investment. In 2.b the rates went down enough for it to decide to issue $50 of bonds to finance some project. I guess whatever it spends those $50 on, this is the inflationary effect you’re talking about…
    What if we add a forth agent U who is unemployed. The govt pays her $50 in unemployment benefits. Now in scenario 2.a the government liabilities are $150. But in 2.b, U gets employed by C to work on the new project and the govt no longer needs to spend the $50 on the unemployment benefits. The govt liability going forward just shrank by $50. The extra $50 are not inflationary since U was getting those anyway before.
    Thoughts?

  29. “Your argument is that if the government supplies less financial assets (i.e. borrows less), someone else will supply (borrow) more.”

    No, that’s your belief based on your ‘model world’ view.

    At macro level, in absence of bond sales, deficit spending merely results in a net increase in aggregate bank reserves.

    “Why would banks lend money to the govt? Doesn’t make any sense.”

    They invest it for a guaranteed return rather than getting 0.5% variable on the reserves. As I said ‘unemployment benefit’.

    The ONS ‘Financial Stats’ financial account for the third quarter 2010 show that ‘monetary financial institutions’ acquired £14 billion of gilts and the insurance sector just £6.3 bn.

    And thanks for making the obvious point that all pensions should be paid directly by government – since they are anyway.

    Seems that we already have a Job Guarantee scheme – for some in the financial sector at least.

  30. “It is necessarily the case that the government cannot consume this quantity if private or non-govt consumption is equal to X—because there would be no output left to consume!”

    In a fixed economy with no slack and no ability to import additional stuff.

    You are arguing the case at the resource limit of the economy.

    That isn’t the case at the moment (Five million people without work and two million short of work in the UK say not).

    So your argument must be that an economy with that amount of slack and an open import market cannot under any circumstances quantity adjust.

    The fairly obvious solution to all this bouncing around is to try it. Put the stimulus in, see if it causes inflation. If it does, tax it out again. If it doesn’t then lots of people get a job that they don’t have at present.

    What’s not to like?

  31. Neil,

    You can see a breakdown of gilt holders if you look at the second chart on the BBC article I linked to. Of course, you need to look at the data before the financial crisis. It’s obvious that banks holdings of gilts are typically rather thin. Since it is not easy to borrow at a lower rate than HM Govt, it’s not going to be easy earn a cushty spead and hit the golf course at 3pm and this makes bankers sad. Banks hold gilts for liquidity management, not because it’s profitable to lend to the govt.

    “No, that’s your belief based on your ‘model world’ view.”

    It’s my belief that that’s your argument, based on what you wrote. If you don’t think that the private sector will step in and supply the missing financial assets, why did you claim that it would?

    “At macro level, in absence of bond sales, deficit spending merely results in a net increase in aggregate bank reserves.”

    That isn’t true.

  32. “That isn’t true.”

    It is as a matter of accounting logic.

    The quote is directly from Stephanie Bell’s published paper on the subject: http://ideas.repec.org/p/wpa/wuwpma/9808008.html

    “You can see a breakdown of gilt holders if you look at the second chart on the BBC article I linked to. ”

    Yes it needs to be brought up to date.

    Looking at the current UK statistics shows you exactly what you would expect from the sector balance chart I drew up and the predictions from MMT.

    The household sector is no longer requiring mortgage assets so the government sector is swapping the excess reserves run up by financial corps et al for bonds as an alternative asset that pays them ‘unemployment benefit’.

    That effect started between 2008 Q3 and 2009 Q1.

    In the latest financial stats from the UK office of national statistics (Q2 2010), the money financial institutions (banks and building societies) have £276.5 bn of gilts (or which £200bn is the BoE I believe), Other Financial institutions have £93.4 bn, insurance companies £258.8bn and £274bn Rest of World.

    So that’s at least £76.5bn of gilt holdings by money financial institutions, which in turn means a hell of a lot of ‘unemployment benefit’ paid to them.

  33. Neil,

    On the contrary, it does not need to be brought up to date. Rather, you need to go back–back to before the GFC, back to before the financial system went all fruity–to see what the typical gilt holdings of banks are. Some MMTers are very good with stuff like this. In particular, Scott Fullwiler. Why not ask him? Or just email the Bank directly–in my experience, they are very helpful.

    You could also look at the DMO’s Quarterly Review, which breaks down the distribution of holdings, e.g., look at Jan 2006 (selected at random):

    http://www.dmo.gov.uk/documentview.aspx?docname=publications/quarterly/oct-dec05.pdf&page=Quarterly_Review

    Go to the bottom of page of page one and see table titled “Distribution of gilt holdings at 30 September 2005”. Very instructive, no? Banks’ holdings at end of Q205: -5,087 bn £; at end of Q305 -4,677 bn £. Negative holdings, eh. Those feckless bar stewards!

    If you look at the most recent release (Dec 10), which contains the Q310 figures, banks held under 7% of total gilts (by way of comparison, pension funds held just under 30%–in Q305, they held about 60%). More typically, this number is around the 1% mark, give or take.

    Again, it’s obvious if you think about it. If the banks held large amounts of govt paper, whither QE? Since banks borrow to lend, how can they earn a spread on loans made to the govt? Presumably, you when read something I write it trips some kind of alarm in your brain, which is why you end up contradicting yourself in successive comments and why you are engaged in this weird effort to prove me wrong on what is self-evident to most regardless of alignment with Neo Chartalism.

    “The household sector is no longer requiring mortgage assets so the government sector is swapping the excess reserves run up by financial corps et al for bonds as an alternative asset that pays them ‘unemployment benefit’. ”

    Ummm…

    “It is as a matter of accounting logic.”

    Yes, yes–isn’t everything? Loans create deposits, aren’t monetarists stoopid, and 15 other popular classics also appear on this collection that you’ll want to keep coming back to again and again and again…

    I’ve already read Stephanie Bell’s paper. It doesn’t prove your point.

    If, “in absence of bond sales, deficit spending merely results in a net increase in aggregate bank reserves”, there would be no point putting it forward as a policy prescription. Or can we now eat bank reserves, along with fixed investment?

  34. Minor clarification:

    “Banks’ holdings at end of Q205: -5,087 bn £; at end of Q305 -4,677 bn £.”

    Should read

    “Banks’ holdings at end of Q205: -5.087 bn £; at end of Q305 -4.677 bn £.”

  35. Vimothy, was my comment very stoopid? Just wondering, I am a novice at this stuff.

  36. “which is why you end up contradicting yourself in successive comments”

    No, I’m trying different angles to get you to see something you are filtering out and of course it is impossible because you don’t want to see it.

    You see it as contradiction. I see it as switching viewpoints to see if there is a way in. There clearly isn’t.

    It’s quite amusing to watch actually – much like reading the Watchtower.

    And I come back to the most important bit that you filtered out. Why not put it to the test?

    Which I will copy from above just to make sure that I’m not ‘contracdicting’ myself.

    “The fairly obvious solution to all this bouncing around is to try it. Put the stimulus in, see if it causes inflation. If it does, tax it out again. If it doesn’t then lots of people get a job that they don’t have at present.

    What’s not to like?”

    I say we try it and see.

    Are you frightened of being proved wrong by reality? I’m not.

  37. “If you look at the most recent release (Dec 10), which contains the Q310 figures, banks held under 7% of total gilts ”

    Interesting switch to percentages.

    The Q2 2010 absolute figures from:

    http://www.dmo.gov.uk/documentview.aspx?docname=publications/quarterly/jul-sep10.pdf&page=Quarterly_Review

    Banks £64,954 million
    Building Societies £11,226 millions

    Total MFI exluding BoE: £76,180 million

    Bank of England

    £200,368 million

    Total for banks £276,548 million with is 30.1% of the total.

  38. Again, no–use of percentages is obviously necessary. You’re missusing statistics to try to prove an erroneous point.

    You claimed that interest on govt debt is unemployment benefits for “feckless BANKS and corporations”. However, banks do not hold large amounts of govt debt. Even now, in our post GFC through the looking glass world, their holdings are under 10% of the total.

    Adding that to the BoE’s APF holdings just compounds your original error. Most gilts are not held by banks–this statement is unarguably true. So why bother?

  39. Peter D,

    Not stupid, but maybe not tight enough to be fit for purpose. You seem to have mostly forgotten about one half of the action—income.

    Say also in your example that aggregate production in any period is equal to X, where X is just some arbitrary quantity of output. X might be ten apples, 100 widgets, a box full of textbooks on real analysis, a BBC3 of excruciatingly bad television programmes—whatever you like. And let the current market price of this output be $100.

    Scenario 1, govt spends $100, and so ends up with all of the output. Y = G = $100. If this spending is funded by borrowing, then private income is $100 and private consumption is zero, i.e. private saving is $100 (in the form of govt bonds). In this case, the economy has produced an amount of goods and services, which the government has consumed in toto, in exchange for some bonds, which the private sector now holds.
    Funding the same amount of government consumption with taxation has an equivalent effect—that of removing the private sector’s ability to purchase its economic output for that period.

    Now, imagine the no bonds case. The govt again spends $100, but this time there is no private saving and the private sector also spends $100. Of course there is only one outcome: the price level must rise. Why? Because there is only X amount of output at any one time, and uses of output is zero sum.

  40. Neil,

    “The fairly obvious solution to all this bouncing around is to try it.”

    We’ve already tried it. We tried the weak form and it didn’t work. I don’t know why you think that doubling up on the dose is going to produce better results.

  41. Vimothy: ”Now, imagine the no bonds case. The govt again spends $100, but this time there is no private saving and the private sector also spends $100.”

    Why? What did the govt spend $100 on? How’s that different from case with bonds? The govt spends $100 on X in case with bonds and it spends $100 on X in case without bonds.
    Why is there no private savings? In case with bonds the savings are in the form of bonds and in case without bonds the savings are in the form of cash/reserves.
    Looks to me you assumed what you set out to prove, namely, that govt spending without bonds will translate into increased consumption in the private sector.

  42. “We tried the weak form and it didn’t work.”

    Yes it did. It worked for 35 years from the end of the second world war until the oil shocks of the 70s – and that was under a non-floating exchange rate.

    It has been working keeping Japan from destroying itself for 20 years.

    To prove something in science requires that you try and prove the null-hypothesis and fail. Your null-hypothesis is MMT. So let’s try it and you can sit back and look forward to its collapse.

    There isn’t anything to lose by doing it.

  43. “Even now, in our post GFC through the looking glass world, their holdings are under 10% of the total.”

    That’s £75bn of gilts they are not supposed to have if I’m reading your assertions properly, which translates into roughly £3bn of government spending.

  44. You guys are fscking trolling me here, I swear.

    Peter D,

    You probably need to actually think about it to understand it.

    The govt spent $100 on X output. In the case with bonds, the govt also spent $100 on X amount of output, but the private sector is unable to spend any income on output because it has spent its entire allocation on govt bonds. This is the essential difference between the two cases–the private sector is unable to consume its income if it has spent it all on govt bonds.

    Another way to say “not conuming income” is “saving”, so the private sector saved in the case with bonds.

    The private sector will not match govt consumption with its own non-consumption (i.e. saving) in the case with no govt bonds because the govt did not issue any bonds. Now, it is possible that the private sector may by sheer coincidence decide not to consume any output in this period. But making policy on the assumption that everything is going to turn out fine regardless is not very responsible.

    If the govt issues $100 bonds then it knows that the private sector must reduce its consumption by that amount if it purchases them.

    Neil,

    1, I guess the irony is going to be lost on you but if you are going to advise on the proper “scientific” way to prove a proposition, then it might be a good idea to, you know, understand it…? Just a thought.

    2, You claimed that interest payments on gilts are unemployment benefits for banks and corporations. In fact they mostly are held by pension funds and not banks.

  45. You guys are fscking trolling me here, I swear.

    I know it must be frustrating to explain things to people who are well below your level of understanding such as myself. So, no offense taken if you just ignore me.
    However, at least to some extent, if you cannot explain something to an uninitiated person then you do not truly understand this yourself either (assuming the person in question is not a total nitwit and makes effort to understand.) This is why Richard Feynman, for example, was so adamant that professors should teach, despite all the time and effort it takes – he insisted that they will understand their own research better doing this. I think Heteconomist is doing very well with the dilettantes like myself.
    Anyway, back to your point:

    but the private sector is unable to spend any income on output because it has spent its entire allocation on govt bonds.

    Here is the rub, it seems to me, as you are using a language like “unable” which somehow predisposes one to think that the private sector is forced to buy the bond. But of course nobody forced it to buy the bond, so, if the private sector saw a better deal it would have jumped on it. You make it sound like the private sector will now need to spend this income on output, while MMTers say that the fact of buying a bond was a manifestation of savings desires and so the same desires will have to be channeled into some other outlet for savings. So, it is not “sheer coincidence” that it will continue to save but rather a more likely outcome (form MMT perspective) than assuming propensity to save will change abruptly.
    Peterc, I hope you don’t mind serving somewhat of a bridge here – provided you understand what I miss in Vimothy arguments or where I could be totally off?
    I really appreciate everybody’s time involved, so, won’t take any offence if I am ignored.

  46. I’m enjoying the discussion. Since I have the prerogative to put up posts, I don’t want to dominate the discussion that ensues, although numerous times the discussions have motivated a later post, which reflects my appreciation for the views expressed in the commentary.

    Peter D, what you see as the rub is also how I see it. That is, it is the saving desire that is limiting non-government spending, not the bond issuance. If and when the non-government wishes to spend more, there will be less need for deficit expenditure, which (like Neil) I see as the actual source of demand stimulus. I agree with Ralph and vimothy that there is the potential for interest-rate or wealth effects in the case of QE, although I doubt the strength or direction of the former effects (and see the latter as probably disruptive in their impact on financial markets). But in the case of fiscal policy, the preferred MMT policy approach would be to deficit spend to the extent appropriate and pay the target rate on reserves. If there is demand-side inflationary pressure, this means the deficit expenditure is excessive. But the excessiveness, in this view, is in the deficit expenditure, not the issuance or non-issuance of debt.

    Having said this, I am still in the process of trying to understand exactly where vimothy is coming from, and appreciate his patience in expressing his neoclassical perspective. The same goes for other MMT critics who have participated in various threads. I find the back and forth educational. The aim need not be to convince anyone but to clarify the theoretical differences, since this enables a better understanding of each theory.

  47. All,

    Very much enjoying the debate. Please ignore the occasional outbursts of frustration.

    Peterc,

    In full agreement with your final two sentences.

  48. PeterD,

    What is the relationship between taxes and aggregate demand in the MMT paradigm?

  49. Peter D,

    I’m in a bit of a rush, but…

    “However, at least to some extent, if you cannot explain something to an uninitiated person then you do not truly understand this yourself either”

    Really? What if we both speak different languages? Let’s say that I go to see a prof in stats and ask him to explain, I dunno, frequency domain analysis to me. At what point can we conclude that the prof “understands” his own subject—when I write a thesis on it?

    “Here is the rub…”

    It’s not really a rub though, you’re just not putting the pieces together properly and so you fail to get results that are probably obvious to you in other spheres (e.g. taxation & AD). Assume govt decides to start spending by issuing currency. CETERIS PARIBUS agg spending and nominal agg income has increased. Agreed? Otherwise, why bother?

  50. What is the relationship between taxes and aggregate demand in the MMT paradigm?

    Hm, not to try to pass for an MMT guru, but I see a certain “duality” between taxes and demand-pull inflation, namely: zero taxation corresponds to potentially infinite inflation and death of currency (consistent with the Chartalist view of tax-driven money), with other levels of taxation regulating AD. Inflation itself can be viewed as a tax (X% of inflation is equivalent of X% of taxation in that both reduce one’s purchasing power by X%.) In other words it is kind of “you can run but you can’t hide” situation: tax too little and you’ll get a backdoor tax in form of inflation.
    Of course, I have no idea whether I said anything worthwhile 🙂

    Really? What if we both speak different languages? Let’s say that I go to see a prof in stats and ask him to explain, I dunno, frequency domain analysis to me. At what point can we conclude that the prof “understands” his own subject—when I write a thesis on it?

    Don’t take it too literally. It is a matter of degree and being able to explain things is also a talent. So, if your prof of stats can’t explain frequency domain analysis to you – not to the point of you writing a thesis, but to the point of you understanding the general idea behind it – it could be that that prof is simply inarticulate. But in general, did you ever try explaining something to your classmate and then realized in the process that you yourself started understanding it better?
    I think what happens is this: you can be sure you understand something very well because you thought about it for some time and created the necessary mental shortcuts that allow you to test hypotheses and reach conclusions quickly. However, when trying to explain this thing to a novice, you cannot employ the same mental shortcuts, because the novice doesn’t have them yet. So, you have to start from a different perspective, trying to anticipate the difficulties and questions the novice might have when encountering something completely new. Then, magically, you might come to realize that some of the shortcuts you were so happy with actually cut across territory that was really important for an even deeper understanding of the subject. Depending on the degree, what one thinks of as deep understanding could actually turn out pretty shallow. That is not to say shortcuts are bad – on the contrary, they are absolutely necessary, but not all shortcuts created equal and it is always good to know how to get somewhere the usual way. Oh, well, I don’t know whether I did not confuse you and myself with this metaphor – maybe I am not understanding it deeply myself either 🙂

    It’s not really a rub though, you’re just not putting the pieces together properly and so you fail to get results that are probably obvious to you in other spheres (e.g. taxation & AD). Assume govt decides to start spending by issuing currency. CETERIS PARIBUS agg spending and nominal agg income has increased. Agreed?

    Agg spending includes govt, right? Or is govt simply dropping money from the heli? If the latter, then one can imagine a nation of misers who pick up the money and put it in a mattress.

  51. Btw, I think I see where you are going. I think you are testing the boundary condition and then making an inference about what happens “inside the region”, just like with your example of ”govt spends $100, and so ends up with all of the output. Y = G = $100” above. What happens inside the region will be influenced by the boundary condition but the question is to what degree.

  52. Peter D,

    zero taxation corresponds to potentially infinite inflation

    That’s interesting—why does taxation prevent potentially infinite inflation? Can you explain the process to me in a bit more detail? Do you see an inconsistency here with the claims made about the no-bonds policy?

    But in general, did you ever try explaining something to your classmate and then realized in the process that you yourself started
    understanding it better?

    Of course—it’s a feeling that I’m very familiar with. My point is that it’s not easy to derive a rule that finds an expected value for your understanding (or lack of it) given your classmates understanding (or lack of it). Perhaps you don’t understand it very well; perhaps your classmate doesn’t actually care; perhaps you lack the heuristic tools to convey it; perhaps she lacks the mathematical tools to understand it—I’m sure we could come up with a great many scenarios that also give the result “classmate doesn’t get it” besides “person explaining it doesn’t get it either”.

    Think of all the academics who work in this field. Where did they acquire their knowledge? Did they study, or did they ask questions in blog comments? Did they work for themselves, or was there some teacher in each of their pasts who unlocked the subject for them with a heroic cry of “ta-da”? I’m afraid that, in economics, there is really no substitute for sitting down with a pad of paper and a textbook and working through some problems—because that’s the only way you ever really understand the models. It’s like riding a bike. Of course, you may have a good teacher—but how many hours would they have to spend lecturing you for you to be able to ride the damn bike if you never get on it and try? A lot, probably. And what, does that prove they don’t know how to ride?

    Agg spending includes govt, right? Or is govt simply dropping money from the heli? If the latter, then one can imagine a nation of misers who pick up the money and put it in a mattress.

    Agg spending is just the sum of all the spending (on final goods) in the economy. Consider two cases: one case is the baseline: NGDP = X, where X is just an arbitrary number and a second case where we hold everything else constant but increase the amount of govt spending. NGDP—the same in both cases? What about real GDP?

  53. “zero taxation corresponds to potentially infinite inflation”
    That’s interesting—why does taxation prevent potentially infinite inflation? Can you explain the process to me in a bit more detail? Do you see an inconsistency here with the claims made about the no-bonds policy?

    Well, the usual Chartalist explanation, I guess. As long as someone needs to pay tax he or she will work to acquire the currency, which automatically gives the currency some value (of course all premised on the state’s ability to enforce the tax.) So, as long as you collect at least 1 unit of currency in taxes, the inflation won’t be infinite (the currency won’t totally lose its value.) On the other hand, with no taxation, the currency exists only by virtue of it being a useful medium of exchange. This could potentially lead to people abandoning it for other forms of exchange with, say, more stable value and the currency becoming worthless – which is the same as infinite inflation. This is my naïve understanding.
    Inconsistency with no-bonds policy… I guess I still don’t see it and that’s why I am trolling you to try to really understand it 🙂 You keep looking at bonds as liquidity drains, while MMT is looking at them as asset swaps. Let me ask you this. Suppose all the bonds issues are say 1 month T-bills. How much delayed consumption is there in such a bond? In one month the investor will either consume or roll into another 1 month T-bill. If he or she consumes then there is very little difference between this and currency. If he rolls, then he/she really wants to save, not to consume. If there were no T-Bill to buy the investor will have to find something else to invest into. Now let the maturity of the T-Bil approach 0 (so, no bonds in the limit). The T-Bills become almost indistinguishable from currency. Does this force all the investors to consume? Or do those that want to save seek other outlets?

    “I’m sure we could come up with a great many scenarios that also give the result “classmate doesn’t get it” besides “person explaining it doesn’t get it either”. “

    Correct. But I am talking about an average case, so to speak. If all your classmates don’t understand “it” then it is probably your fault. It could mean you are very bad in explaining things. It could also mean that the way you’re conditioned to think about “it” (and hence to explain “it”) is very particular and not well suited for communication to others and in fact may mean that you’re missing a way to explain “it” in simpler, more accessible terms. And this, I argue, means that you’re not totally understanding “it” either.

    Think of all the academics who work in this field. Where did they acquire their knowledge? Did they study, or did they ask questions in blog comments? Did they work for themselves, or was there some teacher in each of their pasts who unlocked the subject for them with a heroic cry of “ta-da”? I’m afraid that, in economics, there is really no substitute for sitting down with a pad of paper and a textbook and working through some problems—because that’s the only way you ever really understand the models.

    I actually agree with a lot of what you are saying. I don’t fool myself that I could become an economist by reading blogs or without ever doing exercises etc. I know this is impossible. But to gain some basic understanding I might. And think about it: we’re not talking about quantum mechanics here. Economics is different in that the electorate as a whole is expected to make decisions about it. If Warren Mosler runs for President and in his platform is a no-bond proposal, you cannot tell people that in order to understand whether it is good or bad they need to acquire a PhD in Economics. You better find a way to translate the debate in such a way as to be accessible to the electorate.

    Consider two cases: one case is the baseline: NGDP = X, where X is just an arbitrary number and a second case where we hold everything else constant but increase the amount of govt spending. NGDP—the same in both cases? What about real GDP?

    In this stylized example, if I understand it correctly, NGDP goes up in the second case why real GDP stays the same, since you stipulate we hold everything else constant. In other words, the additional govt sspending just diluted the everybody’s money without the real output changing. Did I follow you?

  54. Above should read
    “In this stylized example, if I understand it correctly, NGDP goes up in the second case while real GDP stays the same”

  55. vimothy,

    I agree with Peter D. Richard Feynman: “If you can’t explain something to a first year student, then you haven’t really understood it.”

    If everyone struggles to grasp what you are trying to say, you are never going to make a compelling case for your point of view.

  56. “On the other hand, with no taxation, the currency exists only by virtue of it being a useful medium of exchange.”

    I don’t buy this 0 taxes = hyperinflation idea. It wanders into the religious from the scientific.

    I could accept the argument that you can’t get to 0 taxes as you would hit the capacity of the economy first and cause inflation. It’s an edge case and we haven’t thought about it because it won’t happen.

    I could accept that you won’t get the necessary leakages from net saving to offset the natural inefficiencies in the distribution system.

    I could even accept the suggestion that fiscal policy is more responsive and targeted than monetary policy and therefore running 0% interest rates and dealing with the inflationary impulses via targeted taxation is preferable.

    But I don’t buy the idea that 0 taxes is hyperinflationary and 1c taxes isn’t. That needs a better explanation.

    From where I sit, the imposition of taxes in a currency is a pump primer. It keeps things circulating and will always start up a fiat currency from scratch. It explains what is need to get one started.

    However if there is enough inertia in the currency and people use it due to prior habit then 0 taxes would work if that doesn’t cause demand inflation. Lack of taxes doesn’t stop people using a currency if it convenient. People only change if there is a reason to do so.

    Don’t forget the other implication of 0 taxes – no government at all beyond managing the currency system. Practically Austrian heaven. And certainly heavy swings between boom and bust.

    I’d go with the “You always need taxes at some point” line because at some point you will have maximum capacity and will need to make space for some sort of public works.

  57. Jeff65,

    Okay, but I’m a first year (postgrad) student, not a professor. Since Peter D does not study the subject, it shouldn’t be that surprising that he has trouble with some of the concepts. Read economics for one year at university and come back to this and it will make a lot more sense.

  58. Neil:

    I don’t buy this 0 taxes = hyperinflation idea. It wanders into the religious from the scientific.

    Note that I said “potential”. I did not say it would necessarily happen, but that under certain circumstances it might. For example, I could imagine a country with unstable currency moving into transacting solely in $US and in fact this dynamic happens in countries with hyperinflation. In Israel in not so distant past all the real estate transactions (including rent) were denominated in $US. It wouldn’t be a stretch to imagine people moving into $US to save the trouble of conversion etc. After some time a dynamic like this could lead to the death of currency.

    Don’t forget the other implication of 0 taxes – no government at all beyond managing the currency system. Practically Austrian heaven. And certainly heavy swings between boom and bust.

    Hm. I guess this is also not necessary an implication but a possible outcome. You could also have 0 taxes and a totally planned economy without private sector. How long this would last is another issue.

  59. Since Peter D does not study the subject, it shouldn’t be that surprising that he has trouble with some of the concepts.

    If it were only me who had trouble then I’d grant your point. It looks like you fail to convince more than one person here.

  60. Fine, but by extension, no one involved in pushing MMT understands it either, for the same reason.

  61. Peter D,

    “Well, the usual Chartalist explanation, I guess.”

    What I am trying to get at is the role of taxation in MMT thought as a regulator of AD. In a later comment Neil writes, “at some point you will have maximum capacity and will need to make space for some sort of public works”—what does he mean?

    “You keep looking at bonds as liquidity drains, while MMT is looking at them as asset swaps.”

    But I also view govt bonds as asset swaps. Can we say more about this? Have you ever paid your hairdresser with a one month t-bill? I doubt it. Sure we swap assets. We take one type of asset, money, and swap it for another type of asset, govt paper, which is a discounted claim on some money in the future.

    “Let me ask you this. Suppose all the bonds issues are say 1 month T-bills. How much delayed consumption is there in such a bond?”

    Well, it depends. Say that these are the only form of saving in the economy and that no more bonds are issued—consumption is delayed for one month. Why were the bonds originally issued? Because the govt wanted to increase its own consumption. So, in the period when the bonds were issued, govt consumption increased and private consumption decreased by exactly the same amount. The govt effectively paid the private sector not to consume; that portion of output that was not consumed by the private sector as a result of this is the portion that was consumed by the govt. They exactly off-set one another. Now, when the bills reach maturity, that income will return to the private sector. Where does it come from? It comes from the govt. So the private sector is now going to increase its consumption and the govt is going to reduce its consumption by exactly the same amount.

    “Now let the maturity of the T-Bil approach 0 (so, no bonds in the limit). The T-Bills become almost indistinguishable from currency. Does this force all the investors to consume? Or do those that want to save seek other outlets?”

    Yes, in the limit they become indistinguishable from money. That’s quite a sophisticated point actually, but it’s not related directly to what I’m trying to show here. The government wants the private sector as a whole to reduce its consumption (govt and the private sector cannot both consume the same unit of output), and so it removes some purchasing power by locking up private income in govt bonds, the maturity of which is irrelevant to our discussion, or by taxing it.

    “Correct. But I am talking about an average case, so to speak.”

    I’m not sure if the commentators on this thread actually represent the average. It seems to me that many people intuitively understand these ideas on a basic level and consequently, those of us who disagree with them have to write blog posts with titles like “the government is not a household”, or even run for govt to get a look in at the policy table. 😉

    “Did I follow you?”

    Kind of. If nominal spending is higher then nominal income must be higher (because the two are identical). Consequently, no-bonds implies higher nominal income cet par. Do you understand? If everyone’s spending is equal to £100 over a period, and the government spends another £100 by issuing currency then spending must be equal to £200. If the government instead funded some or all of its spending by taxing or issuing bonds, then it would be reducing the ability of the private sector to spend, and total spending would be less than £200.

    This doesn’t tell us anything about real GDP. What would real GDP do? MMTers claim that real GDP will increase if there is unemployment, and that inflation will increase if there is not, which is a straightforward extension of an old and once upon a time mainstream theory. What do you think? Why?

    Think about what would happen if the govt mailed everybody a cheque for £100 tomorrow. Would we be better off? Would we be better off as a whole? What if the govt mailed everybody a cheque for £5000, or £500,000—how much better of would we than in the case with £100?

  62. “After some time a dynamic like this could lead to the death of currency.”

    Only if you don’t reintroduce taxes to keep the engine going.

  63. “Have you ever paid your hairdresser with a one month t-bill? I doubt it”

    You don’t pay your hairdresser with bank deposits either. You’ll notice that nobody takes cheques any more so even checking accounts are considered illiquid.

    However you can envisage an account that is just a store of T-bills, but has a debit card attached. When you spend on the debit card, some T-bills are liquidated in the market as required.

    Operationally and functionally it would be impossible to identify just from the debit card which account was backed by T-bills and which by bank-deposits. You could spend freely on both up to the limit of your facility.

  64. What happens to the t-bills when you spend the balance in your t-bill account?

  65. Neil: I don’t buy this 0 taxes = hyperinflation idea.

    I suspect that the margin is higher than 0. The question is where Gresham’s law kicks in. The US seems bent in finding out by lowering taxes incrementally until the marginal reason to hold dollars to meet tax obligations declines sufficiently, and more and more people run to tangible assets like PM’s to save, since tangible assets produce a better return than interest on dollars due to increasing demand.

  66. “What happens to the t-bills when you spend the balance in your t-bill account?”

    They are cleared in the market that exists for t-bills which has sufficient fractional liquidity to allow everybody who wants to spend today to do so.

  67. Vimothy

    What I am trying to get at is the role of taxation in MMT thought as a regulator of AD. In a later comment Neil writes, “at some point you will have maximum capacity and will need to make space for some sort of public works”—what does he mean?

    Taxation is always disinflationary in that it takes NFAs from the private sector. Let’s imagine a regime where you could pay your taxes in bonds as well. From MMT perspective, it doesn’t really change anything, since bonds and currency are both considered NFAs. Taxing both will reduce the private sectors ability to consume.

    Why were the bonds originally issued? Because the govt wanted to increase its own consumption. So, in the period when the bonds were issued, govt consumption increased and private consumption decreased by exactly the same amount. The govt effectively paid the private sector not to consume

    I beg to differ. You see the interest rate on the bonds as the equilibrator between the private sector’s desire to consume and desire to save. In your view the govt “bribes” the private sector not to consume so that it may do so. In my view the private sector’s dilemma here is not between consumption or saving. A household won’t postpone consumption when bond interest is high enough (OTOH, it will postpone consumption when its income falls). A bank or a pension fund will switch between investments. So, the bond interest is an equilibrator not between consumption and saving but between saving in bonds vs. saving in something else. Btw, here I guess some of the jargon might get in a way, since the boundary between saving and investment becomes murky to me. If I switch between bonds and stocks, am I investing or saving? What about buying a house?
    I think I might summarize my thinking as this: in no-bonds regime, the money that won’t be put into bonds will flow into something else. The question is whether this something else will be consumption items or other investment/savings vehicles. I think it is the latter for the most part.
    “Correct. But I am talking about an average case, so to speak.”

    I’m not sure if the commentators on this thread actually represent the average. It seems to me that many people intuitively understand these ideas on a basic level and consequently, those of us who disagree with them have to write blog posts with titles like “the government is not a household”, or even run for govt to get a look in at the policy table.

    Did not follow you re: “these ideas “ and “those of us who disagree with them…”. Which ideas? Are you saying most people agree with you?

    MMTers claim that real GDP will increase if there is unemployment, and that inflation will increase if there is not, which is a straightforward extension of an old and once upon a time mainstream theory. What do you think? Why?

    Well, I think it depends on the nature of spending. If the govt. throws money from a helicopter only on penthouses of millionaires, then I doubt there will be any big change in anything. I think the nature of spending is important and the time between spending and the effect will differ as well.

    Think about what would happen if the govt mailed everybody a cheque for £100 tomorrow. Would we be better off? Would we be better off as a whole? What if the govt mailed everybody a cheque for £5000, or £500,000—how much better of would we than in the case with £100?

    Seems to me again more of a discussion on the nature of spending as opposed to bonds vs. no-bonds.

  68. Neil: “Only if you don’t reintroduce taxes to keep the engine going.”

    But I was talking about 0 taxes regime.

  69. vimothy: “Fine, but by extension, no one involved in pushing MMT understands it either, for the same reason.”

    I contend it is your approach. Your critiques are not specific, though they might seem so to you.

    Above you seem happy to argue about the validity of an identity when it is clear that you have a different view about the definition of it’s terms. If you believe the terms are not useful as defined then you should make a case for that belief. The terms as defined are the terms; if you change the definitions then of course you are going to disagree with the identity! Not any point arguing about it.

  70. vimothy: “The government wants the private sector as a whole to reduce its consumption (govt and the private sector cannot both consume the same unit of output), and so it removes some purchasing power by locking up private income in govt bonds, the maturity of which is irrelevant to our discussion”

    How does holding a $10000 T-bill alter an individual spending decision as compared to another individual holding $10000 in Federal Reserve Notes? Either one of them can be holding a flat screen TV tomorrow. Since consumption is the aggregate of individual spending decisions, there is no “locking up” of incomes going on when the government sells bonds to the private sector. It’s just swapping one highly liquid asset for another highly liquid asset.

  71. Further to my point, because “someone” must hold the T-Bill to maturity is not a convincing argument. “Someone” must hold a dollar bill until it is physically destroyed, too. This fact doesn’t prevent any one of those “someones” from spending it at any time they choose.

  72. “They are cleared in the market that exists for t-bills which has sufficient fractional liquidity to allow everybody who wants to spend today to do so.”

    Right. Somebody else holds the govt debt–so the bills are passed around within the private sector. There are therefore no effects on the BOP between the private and govt sectors.

  73. “Above you seem happy to argue about the validity of an identity when it is clear that you have a different view about the definition of its terms.”

    I’m afraid that I don’t follow. What identity?

  74. “How does holding a $10000 T-bill alter an individual spending decision as compared to another individual holding $10000 in Federal Reserve Notes?”

    Okay, let’s think about this in a bit more detail. Write the government budget constraint as satisfying the inequality less than or equal to Y, which is just another way of saying that the government’s spending cannot exceed the sum total of all resources available to the economy. Let’s further say that income is the sum of private spending and govt spending, or Y = P + G. finally, let’s say there is no difference between Fed Reserve notes and treasury bills—they are both legal tender accepted as final payment anywhere. What are the implications for the sectors’ abilities to consume resources? Whatever the implications, it certainly doesn’t alter the fact that one sector has to consume fewer resources if the other sector is to consume more. Consequently, if the government is consuming more resources than it earns, it must be the case that the private sector is consuming less. Surplus requires deficit.

  75. Peter D,

    “Taxation is always disinflationary in that it takes NFAs from the private sector.”

    I get that, but WHY is taking NFAs from the private sector disinflationary?

    “In my view the private sector’s dilemma here is not between consumption or saving.”

    The economy’s dilemma is the division of output between the different actors. If the government consumes net of its income, the private sector must save (not consume). That just follows directly from basic identities. The government will then either pay back the private sector in real terms or it will not.

    “So, the bond interest is an equilibrator not between consumption and saving but between saving in bonds vs. saving in something else”

    Interest on the bonds is the rate at which the private sector discounts its loans to the government of flows of output. Think of it as the intertemporal terms of trade between govt and non-govt sectors—inter-sectoral, not intra-sectoral. As such the “decision” by the privates sector to lend the government output is very much a decision not by the private sector not to consume that output.

    “If I switch between bonds and stocks, am I investing or saving? What about buying a house?”

    In economic terms, buying stocks and bonds is saving. Building a house is investing.

    “I think I might summarize my thinking as this: in no-bonds regime, the money that won’t be put into bonds will flow into something else. The question is whether this something else will be consumption items or other investment/savings vehicles. I think it is the latter for the most part.”

    We’re not looking for saving within the private sector; we’re looking for saving from the whole private sector with respect to the government.

    “Which ideas?”

    The ideas I am discussing.

    “Are you saying most people agree with you?”

    I’m afraid so!

    “Well, I think it depends on the nature of spending.”

    Obviously. Can’t you say anything more substantive about such a key issue, given the changes you want made to the way governments fund their spending?

    “Seems to me again more of a discussion on the nature of spending as opposed to bonds vs. no-bonds.”

    Bonds vs no-bonds is about spending (and saving).

  76. “Whatever the implications, it certainly doesn’t alter the fact that one sector has to consume fewer resources if the other sector is to consume more.”

    Based on the assumption of no slack, ie Y cannot move. You’re describing the situation at full employment (proper full employment I’m talking about, not the watered down version that leaves millions without work) which has never happened in the last 40 years.

    The GBC isn’t a description of a constraint. It’s a description of the accounting ex-post.

    Once all the counts are in and the output produced there will have been an amount consumed by the public sector and amount consumed by the private sector which will total up to income.

    In other words its applicable at the end of the period after the decisions have been made, not at the beginning to inform decisions.

    That is the mistake that neo-classical economics makes that ensures the economy always runs sub-capacity.

    Y = P + G.

    Are there any unemployed people not doing anything? Yes? Right let’s increase G then and see what that does to Y and P.

    The econometrics suggest (I’m reliably informed) that the economy will quantity adjust to absorb the new spending.

    It is the key point to all this. Y is less than it could be.

  77. “Based on the assumption of no slack, ie Y cannot move.”

    No. This is the case irrespective of both the level and the change in Y. I gave the constraint in terms of Y, which is a variable–and the variable can take on any number you like.

    “You’re describing the situation at full employment”

    No. What I described is true at every level of employment. How can any one of the components of aggregate spending be greater than the whole, given that the whole is just the sum of the components? This can only happen in your model if you suck at maths–it’s not something that reflects actual economic behaviour.

    “The GBC isn’t a description of a constraint.”

    Of course it is a constraint. Are you claiming that the government can consume more resources that exist within the economy at any one time? Over a period of time?

    “Once all the counts are in and the output produced there will have been an amount consumed by the public sector and amount consumed by the private sector which will total up to income.”

    Right. So you’ve just told me that at the end of a period, the amount of resources that the government consumed will be less than or equal to the amount of resources generated by the economy during that period, which is precisely the inquality I gave initially.

    “That is the mistake that neo-classical economics makes”

    Why not understand it first and then criticise?

    “Are there any unemployed people not doing anything? Yes? Right let’s increase G then and see what that does to Y and P.”

    This was the question that I asked Peter D, which he didn’t think was relevant. Instead of conducting a massive experiment at huge cost, why don’t we first of all see if we can come up with a theoretical justification for what you’re suggesting?

    “The econometrics suggest (I’m reliably informed) that the economy will quantity adjust to absorb the new spending.”

    So you’ve said, many times. And as I’ve said many times–show me the damn research then.

    Let me make a couple of related observations: Given the supposed strength of the econometric research (“reliably informed” suggests that you haven’t even read any of it!), isn’t it strange that, in your view, neoclassicals disagree? I mean, where do these econometrcians work? Furthermore, your assertion is at the level of such generality I can’t see that it even makes sense as a proposition that can be evaluated for accuracy: The economy will “quanitity adjust” to accomodate any new spending without changes in prices–regardless of market structure, source of funds, where the economy is in the business cycle, etc, etc, etc, etc, etc…?

  78. One last point: as you may or may not have noticed we currently have both inflation and unemployment. Weird, huh?

  79. “Only if you’re an Austrian.”

    What? No, that’s not right either. If you think that the economy will “quantity adjust” to accomodate any increase in demand without generating inflation, then the fact that we experience inflation as a rule should strike you as strange. Austrians don’t have a problem squaring inflation with unemployment, because they think that govt intervention causes both.

  80. “why don’t we first of all see if we can come up with a theoretical justification for what you’re suggesting?”

    Kaleki, Keynes, Lerner?

    “No. What I described is true at every level of employment”

    If you ignore the opportunity cost of having resources out of action. The unemployed are prima facie evidence of resources out of action.

    Where there are resources stood idle G can be increased without reducing the value of P. Why? because Y increases.

    So your statement “Whatever the implications, it certainly doesn’t alter the fact that one sector has to consume fewer resources if the other sector is to consume more.” is flawed where there are underutilised resources.

    It can only apply when all resources are fully utilised.

    And it has been mentioned many times that the standard MMT description requires that the government sector backs off if it is overstretching resources and generating demand side inflation.

    One of the beauties of the Job Guarantee suggestion is that it does just that – being an enhanced automatic stabiliser.

  81. I think Neil mean Austrian in the sense that Austrians define inflation as increase in money supply, not in price level. And we are not really having any increase in price level beyond some supply shock effects. In the US inflation is basically 0, I don’t know about UK.
    More later.

  82. vimothy,

    It appears you’ve changed your argument from “locking up purchasing power” (your words) to one of crowding out. Two different things.

    Which do you mean?

    But your crowding out scenario is flawed too. In order to crowd out private sector spending, you’re assuming that much govt spending competes with private sector bids. This assumption is plainly invalid.

    On top of that, you’re assuming debt issuance makes room for government spending to do it’s crowding out. This assumption is not true either. A monetarily sovereign government could spend without issuing debt.

  83. I get that, but WHY is taking NFAs from the private sector disinflationary?

    Because you are reducing income. People spend less when they feel their income reduced. Prices fall because demand falls.

    The economy’s dilemma is the division of output between the different actors. If the government consumes net of its income, the private sector must save (not consume). That just follows directly from basic identities. The government will then either pay back the private sector in real terms or it will not.

    I think I am spotting an issue. You assume G is about government consuming, i.e., competing with private sector for resources. This is what I see as a fallacious identification of size of deficit with “size of government”. But what if part of G is simply putting money in non-govt sector’s pocket? The non-govt sector still decides how to spend the income. Government’s use of real resources does not increase. Or what if the government uses idle resources?

    Interest on the bonds is the rate at which the private sector discounts its loans to the government of flows of output. Think of it as the intertemporal terms of trade between govt and non-govt sectors—inter-sectoral, not intra-sectoral. As such the “decision” by the privates sector to lend the government output is very much a decision by the private sector not to consume that output.

    Or not to “consume” available labor as in the example I gave in this comment and wanted you to point out where the example went wrong. In this example once A did not have the govt bond, he switched to a corporate bond, and the corporation was able to hire an unemployed person. Seems to me in this example the government size went downsince in no-bond proposal the government stopped “crowing out” the corporation and the unemployed (who was really part of the government sector by virtue of receiving unemployment benefits) moved to private sector, which allowed the output to go up.

    “I think I might summarize my thinking as this: in no-bonds regime, the money that won’t be put into bonds will flow into something else. The question is whether this something else will be consumption items or other investment/savings vehicles. I think it is the latter for the most part.”
    We’re not looking for saving within the private sector; we’re looking for saving from the whole private sector with respect to the government.

    Again, if the government used the spending not to take resources from the private sector but simply to “drop money” on the private sector then the private sector as a whole may decide to consume more or to save more without competing for the same resource with government.
    You keep insisting that government and non-govt are competing for the same resources and that by issuing bond the govt makes room for its use of resources without inflationary pressure. But to me it seems that the government by not issuing bonds may allow the money to be used for idle resources in the private sector. You assumed the govt would be using the same resources. Again, as in my example, the govt pays the unemployed but the output from that is less than if the unemployed was paid by the private sector and produced some output to boot.

    “Well, I think it depends on the nature of spending.”
    Obviously. Can’t you say anything more substantive about such a key issue, given the changes you want made to the way governments fund their spending?

    I just don’t see where this is going. I think the best way to spend is (a) by putting money into pockets of people most likely to spend it – the lower class, the unemployed ; (b) by investing in infrastructure projects; (c) investing in research and education. I’m sure there is tons of research on multipliers and such. I am not an expert on that but some things seem like no-brainers to me. What does it have to do with how this is “funded”?
    Let’s drop the jargon and too much abstraction. Show me a concrete example how no bonds causes inflation in a simple model. For example in my model I think you’d need A to go and spend money on consumption items for inflation to occur and that seems to me improbable. Why would A start consuming if his whole desire was to save for the rainy day?
    You make it look like you have some sort of logical proof for that but I am still not able to see it. Economics is also a behavioral science. Unless your model behaves in a believable way it is useless.

  84. Peter D, government does compete with the private sector for real resources in the sense that government spending (G) on stuff moves real resources to the public sector, presumably for public purpose. According to Chartalism, taxes serve to create demand in the private sector for government currency, which the government then uses to move resources to the public sector. That is what state money is principally for. Government can also influence distribution through transfer payments, which means that real resources get used differently than they otherwise would be or would lay idle.

    This could become inflationary if government actually competes aggressively with the private sector, e.g., the government’s cost of capital is nil. Being the currency creator, government is the monopolist and will win in any competition over price or quantity. But being the monopolist government also has the ability to set prices.

    According to Warren, government must therefore be careful not to bid up prices. Government must be careful wrt price and quantity. Government should bid down not up and not hog resources other than in emergencies. If government does this, it can increase productive capacity as well as increase value without affecting market prices.

    Here, too, government must be careful not to make resources scarce by affecting quantity. Obviously, government should not be topping off its oil reserves when prices are making new highs but when they are making new lows, i.e., when demand is low.

    As long as real resources are available and government is judicious in its bidding and allocation, inflation can be avoided and the private sector can have access to the desired resources at a market price that government minimally influences, while public purpose is being served iaw political decisions made by elected representatives.

    Of course, government does not compete for funds in the loanable funds market, because it injects the funds that get saved. Government does not “borrow” because it funds itself through issuance.

    Regarding no bonds, tsys are savings vehicles provided by government for the convenience of savers. They are not operationally necessary under the current system. It seems naive to think that if there were no government bonds available that the private sector would not be innovative enough to provide savers with alternatives. The notion that savers would increase their propensity to consume in the absence of government securities is unsubstantiated. Such a program would be introduced incrementally, allowing the private sector to create suitable substitutes, which I am sure Wall Street would be happy to do.

    The real question is not inflation due to increased consumption but whether the private sector would be able to handle the risk. There might be justifiable public purpose in some government participation for this reason.

    There are other problems that might arise from no bonds, which could be addressed if they did. The real question is not inflation due to increased consumption but whether the private sector would be able to handle the risk. There might be justifiable public purpose in some government participation for this reason.

    On the other hand, why should government provide a mandated subsidy for a risk-free parking place when it is operationally unnecessary? Should government be paying people to save risk-free?

  85. Peter D, government does compete with the private sector for real resources in the sense that government spending (G) on stuff moves real resources to the public sector, presumably for public purpose. According to Chartalism, taxes serve to create demand in the private sector for government currency, which the government then uses to move resources to the public sector. That is what state money is principally for. Government can also influence distribution through transfer payments, which means that real resources get used differently than they otherwise would be or would lay idle.

    Yes, but this is all very abstract and what Vimothy is saying is that the government issues bonds and pays interest to the non-govt sector so that it can consume itself. What is that the govt consumes exactly when it issues a Social Security check? I know the resources get shifted because without the check the person would’ve been poorer and everybody else richer, but this seems totally beyond the point here and in the real of Austrian bitching.
    What you’re saying afterwards makes a lot of sense. Vimothy keeps insisting that the bonds fund government expenditure while MMT is saying that the government expenditure has already been funded and that the bonds are an ex post interest maintenance operation. I am waiting for a logical proof that without issuing the bonds the private sector’s consumption has to go up.

  86. Peter D., when government injects into the economy it does so either by purchasing goods and services from the private sector, e.g., infrastructure, military goods and services, etc., or it gives funds away for public purpose, e.g., interest on bonds, welfare contributions, etc. That is to say, somethings involving injection also involve a transfer of resources to the public sector and some do not, they, simply increase the purchasing power of the recipient. Since government simply issues its currency, neither taxes nor borrowing funds injection.

    Presently, the US government requires itself (though Congress) to issue Treasury securities to offset its deficits. This means that government is forcing savings in Treasuries and it is willing to pay people their privilege of risk-free parking place. Since this is operationally unnecessary, it constitutes a subsidy, i.e., a transfer in which government gets no goods or services in exchange.

    If government just injects its deficit without forcing savings equal to it by a required offset of tsy issuance, then the deficit is either consumed or saved by the private sector. The ratio of consumption to saving would likely vary according to conditions. It is an established fact that the propensity to consume and the propensity to save change. According to FF, as the desire to save increases, which constitutes a demand leakage, deficits have to increase to offset this leakage, unless net exports increase to fill the gap resulting from the leak to savings. similarly, if the propensity to consume creates inflationary pressure, then taxes are called for to draw down demand.

    What actually happens is that the funds injected by G flow through the economy creating demand until they wind up in savings. If there were less saving and more consumption due to a no bonds policy, that would mean that demand would increase and less injection would be required to increase demand, which is the intention of injection iaw FF. If there were inflationary pressure, then some of the injection would have to be withdrawn through taxation, again iaw FF.

    What MMT is presuming is that issuance of Treasury securities is not crucial in determining the propensity to save, and without tsys this propensity would not be altered significantly. Again, if saving went to zero (which is highly unlikely), it doesn’t make much difference, because in the Post Keynesian view, saving does not fund investment anyway. See Empirical post Keynesian economics: looking at the real world by Richard P. F. Holt & Steven Pressman, p. 7. Holt and Pressman note that PKE and neoliberalism disagree over saving and investment and that this is a testable hypothesis.

    If saving went to zero and the entire deficit were consumed without ever being saved, then demand would be higher (cet. par.) since there would be no leakage to saving. The budget balance would have to be adjusted accordingly to maintain full employment and price stability. If government wished to spend more for public purpose than the economy could accomodate in this scenario, then taxes would have to be raised to adjust the deficit to the desired level of net injection. For example, extreme military spending during large-scale war might have to be neutralized by either raising taxes significantly or forcing saving through war bonds in order to prevent inflation, since production of goods and services would be commandeered — as happened during WWII. This was called “shared sacrifice.”

    Actually, Keynes preferred more consumption and less saving anyway, because consumption is about flow, and saving, being a drain, interrupts flow. A certain amount of saving is required due to planned postponement of consumption and uncertainty about the future resulting in the need to prepare for eventualities. But hoarding just slows things down and creates a rentier class that lives off the work of others. This is not healthy for the economy or society.

  87. Neil,

    “Where there are resources stood idle G can be increased without reducing the value of P. Why? because Y increases.”

    If Y increases any components of Y can increase, because Y is the sum of its components. No one disagrees with this.

  88. Jeff65,

    “It appears you’ve changed your argument…”

    It would help if you could quote the relevant bits of my argument. As it stands I have no idea what you are referring to here.

    “On top of that, you’re assuming debt issuance makes room for government spending to do it’s crowding out. This assumption is not true either. A monetarily sovereign government could spend without issuing debt.”

    If the government could spend without issuing debt, it would still be the case that it either 1, paid back the principal (replaced its current net consumption of output at some point in the future), or 2, did not pay it back. If 1, it is a no interest loan, if 2, it is effectively taxes.

  89. Let me see if I can explain this a bit better.

    Every period, the government wants to consume an amount of the output produced by the economy. By convention, we give output the symbol Y and govt consumption the symbol G. Y and G are variables that refer to real flows over time (for instance, Y is the flow of (final) goods and services produced by the economy over a given period). Their actual values are not important, but can potentially take on whatever you like, subject to the constraints we’re going to outline here.

    Government consumption is a use of output, like household consumption and business investment. As such, it is bounded by output: either G < Y or G = Y. Notice that we have not yet placed any restrictions on the actual level of G other than the fact it must be less than or equal to the level of Y at any given time. Where does this output come from? Some comes from taxes and some from borrowing. So we can write, G = T + B, where T is taxes and B is borrowing. We could potentially treat the no-bonds proposal as a special case of this where the government borrows at a zero rate of interest.

    Consider a two period model with households and a government. You might like to think of period 1 as “now” and period 2 “the future”. Ignore investment for simplicity’s sake. Economy produces Y_1 in period 1 and Y_2 in period 2. Government borrows at rate of interest r and has is no initial debt. In period 1, G_1=T_1+B_1. In period 2, G_2=T_2-(1+r)B_1. Notice that whether the government has to run a surplus in period 2 depends on whether its tax receipts are enough to cover its expenditure plus its borrowing from the previous period, so that T_2=G_2+(1+r)B_1. Dividing G_2 by (1+r) and adding to G_1, we have G_1+G_1/((1+r))=T_1+T_2/((1+r)) , which can be read as stating that the present discounted value of lifetime government expenditure must equal the present discounted value of government wealth, which is a formula for the lifetime budget constraint of the government in our model.

    We can derive a lifetime budget constraint for households in a similar fashion, and, assuming that household’s borrow at the same rate for simplicity, show that C_1+C_2/((1+r))=(Y_1-T_1 )+((Y_2-T_2))/((1+r)) , which tells us that the PDV of lifetime consumption is equal to the PDV of lifetime wealth net of taxes. If we add the two budget constraints together, we get a national lifetime budget constraint, which is C_1+C_2/((1+r))+G_1+G_2/((1+r))=Y_1+Y_2/((1+r)) . This is equation tells us that over its lifetime, the economy consumes the resources it produces.

    Remember that because we have given the constraints in terms of output, Y, the actual values that C and G take on depend on the actual values of Y. Higher levels of income allow higher levels of household and government consumption. We can expand this framework if necessary, for instance to analyse the case in which the government borrows from abroad at a different rate to the private sector, where r^G<r, so that C_1+C_2/((1+r))+G_1+G_2/((1+r))=Y_1+Y_2/((1+r))+((r-r^G)/(1+r))(G_1-T_1 ) .

    If we wanted to we could go on and incorporate seigniorage and economic growth into the government’s budget constraint. But in any case we are left with a situation where the government consumes a quantity of economic output. Some of this output is taken as taxes and the remainder is borrowed. If an amount is borrowed, this implies that it will be paid back in the future, and this can only be done out of future taxes, which implies future surpluses, or more typically, growth in output that increases tax receipts.

  90. “If Y increases any components of Y can increase, because Y is the sum of its components. No one disagrees with this”

    Good. So you’re saying what you said originally was incorrect then.

  91. Oh, and I never thought I’d say this, but hooray for Tom Hickey, who at least understands MMT. As Clay Davis would say, “”sheeeeeeeeeeee-it”.

  92. “Good. So you’re saying what you said originally was incorrect then.”

    Don’t be an idiot. It is impossible for that statement not to be true. There is no school of economic thought that disagrees with it. As I said earlier it is a principle of basic laws of algebra–a non-issue. If you think the fact that if the sum of C and G is higher either one or both of C and G is also higher is support for a policy of money financed deficit spending you are tripping balls, as the young people like to say.

  93. “Government borrows at rate of interest r and has is no initial debt. In period 1, G_1=T_1+B_1. ”

    Where does the currency come from in period 1 that would allow the government to spend? There is no debt – therefore there is no currency in issue.

  94. “Where does the currency come from in period 1 that would allow the government to spend? There is no debt – therefore there is no currency in issue.”

    The issue is irrelevant, but it can come from wherever you like. We take as axiomatic whatever we want to given our problem and then examine the results.

  95. “The issue is irrelevant”

    It’s very relevant – in fact it is the crux of the matter. You are arguing for a prior constraint. Therefore the government must have funds to spend. Where are the funds coming from in period 1? Who has them?

  96. “It is impossible for that statement not to be true.”

    Sorry, v, but I’m not with you.

    You said above:

    “Whatever the implications, it certainly doesn’t alter the fact that one sector has to consume fewer resources if the other sector is to consume more.””

    So if Y = P + G then that statement appears to say if G goes up P comes down.

    I’m saying that G can go up withoutP coming down if there are unutilised resources.

    So I’m saying that “one sector does not have to consume fewer resources if the other sector is to consume more where there are underutilised resources” which goes back to my argument that you are constantly assuming that everything is in use – when it patently isn’t in the real world.

    So have I understood your statement properly, or would you like to clarify?

  97. Government consumption is a use of output, like household consumption and business investment.

    What does the govt consume when it issues a SS check?

    Where does this output come from? Some comes from taxes and some from borrowing.

    You’re arguing out of MMT paradigm here. In MMT paradigm G comes from nowhere. Taxes regulate demand while bonds change interest rates. In other words, the government spends or consumes or whatever before it taxes or issues bonds. If you want to refute the MMT paradigm, I think you need to show where it goes wrong, not start with another paradigm that MMT seeks to discredit.

    We could potentially treat the no-bonds proposal as a special case of this where the government borrows at a zero rate of interest.

    Interest going to zero doesn’t seem to be the no-bonds case. Even a bond with zero interest rate would have an effect of locking the money into savings. I think the no-bond case is when your maturity goes to zero, not the interest rate.

    If we wanted to we could go on and incorporate seigniorage and economic growth into the government’s budget constraint. But in any case we are left with a situation where the government consumes a quantity of economic output. Some of this output is taken as taxes and the remainder is borrowed. If an amount is borrowed, this implies that it will be paid back in the future, and this can only be done out of future taxes, which implies future surpluses, or more typically, growth in output that increases tax receipts

    So far, I can see nothing different or that is not covered in more generality in Scott Fullwiler’s paper “Interest Rates and
    Fiscal Sustainability”
    . Specifically, if the rate of growth of your economy (Theta) is less than the interest on borrowing (r) then for the series in RHS of eq. (13) on page 7 to be convergent to b0 (the current debt-to-GDP ratio) “a government must anticipate sooner or later to run primary surpluses”. If, on the other hand, Theta>r then (page 27):

    As in Domar’s paper, Blanchard et al. (1990) agree that “if (r – Θ) were negative, the government would no longer need to generate primary surpluses to achieve sustainability. . . . The government could even run permanent primary deficits of any size, and these would eventually lead to a positive but constant level of debt, [g – t]/(r – Θ)” (p. 15).

    But vimothy, this is not what you set out to prove. You set out to prove that in no-bonds regime the consumption of the private sector will have to go up and cause an inflationary pressure. If I may revisit your argument just to make sure we’re on the same page and I understood you correctly:
    1) The government issues bonds in order to consume thus depriving the non-govt sector of the power to consume
    2) If the government spends without issuing bonds then non-govt sector consumption will have to go up.

  98. Tom

    If there were less saving and more consumption due to a no bonds policy, that would mean that demand would increase and less injection would be required to increase demand, which is the intention of injection iaw FF. If there were inflationary pressure, then some of the injection would have to be withdrawn through taxation, again iaw FF.

    Precisely. If for the current level of G there is no gap in demand, then G can be reduced. If G cannot be reduced any further and you still have inflationary pressure then taxation has to go up. Since bond issuance is an interest rate operation, it is a monetary tool which proves pretty ineffective and blunt when used to control demand in economy. For example, interest on bonds creates a sense of increased income for bond holders which can cause increase in demand. Additionally, bond holders know that they can always switch out of bonds into cash (either by selling the bond or using it as a collateral for a loan) and thus are not likely to feel constrained in their spending capacity.

  99. Since bond issuance is an interest rate operation, it is a monetary tool which proves pretty ineffective and blunt when used to control demand in economy.

    That’s certainly how I see zero bonds. Except of course that the dynamics will be different to a normal interest rate change.

    In a normal interest rate drop money is moved from savers to borrowers and savers rejiggle their portfolio to the new indifference level. Borrowers do similar.

    With zero bonds the ‘savers’ still rejiggle their portfolios to the indifference level, but the money is retained by the government and what you get on the other side depends whether they spend that money elsewhere or ‘reduce the deficit’ with it.

    If the government increases spending by the amount of the interest not paid then the effect of zero bonds should be similar to cutting interest rates

    However if they ‘reduce the deficit’ then its surely got to be deflationary – neutral at best – since an amount of vertical income has been removed from the non-government sector.

  100. vimothy said:

    “so it removes some purchasing power by locking up private income in govt bonds, the maturity of which is irrelevant to our discussion”

    vimothy later said:

    “Whatever the implications, it certainly doesn’t alter the fact that one sector has to consume fewer resources if the other sector is to consume more. Consequently, if the government is consuming more resources than it earns, it must be the case that the private sector is consuming less. Surplus requires deficit.”

    These are two different arguments. It doesn’t stop both of them from being wrong.

    Here’s why:

    1. Individual spending decisions are not influenced by ownership of govt bonds vs holding cash.

    2. Not all resources have a private sector bid.

  101. Jeff65,

    The arguments are in fact related, but even if they were not, what does that have to do with anything?

    For the whole economy, income is equal to expenditure. This is the meaning of the GDP identity, Y = C + I + G, where the right hand side is income (i.e. output) and the left hand side is the components of aggregate expenditure. This logically implies that if spending from any of the three sectors (households, business, and the government) exceeds its income then it must be matched by a surplus in one of the other sectors (that is, since one sector is spending more than it earns, one of the other sectors must be earning more than it spends). Consider a two sector economy. If one sector is in surplus this is logically equivalent to saying that the other sector is in deficit.

    BTW, this point is central to much MMT analysis; if you dispute it, then…

  102. Sorry, should read:

    “…Y = C + I + G, where the left hand side is income (i.e. output) and the right hand side is the components of aggregate expenditure.”

  103. Peter D,

    “If there were less saving and more consumption due to a no bonds policy, that would mean that demand would increase and less injection would be required to increase demand, which is the intention of injection iaw FF. If there were inflationary pressure, then some of the injection would have to be withdrawn through taxation, again iaw FF.

    “Precisely.”

    I notice that when someone from within the camp writes it, it becomes obvious. No-bonds is inflationary because it increases aggregate demand, which is why you want the policy in the first place. “Precisely”!

    “What does the govt consume when it issues a SS check?”

    Nothing. Social Security is a transfer. It isn’t consumption. What do you consume when you write a cheque?

    “You’re arguing out of MMT paradigm here.”

    I make only the blandest and most boring statements and somehow you disagree with them. Look, in any period the govt’s expenditure is either covered by its revenue from taxes or it is not. If it is not we say that the government is in deficit, which means that its spending net of its “income” is positive. That’s what it means for the government to be in deficit. This is not theory.

    “In MMT paradigm G comes from nowhere.”

    But this is completely bonkers. Govt consumption comes from society’s economic output, the product of its activity during that period—G comes from the supply side of the economy, like I and C.

    “Taxes regulate demand”

    Because if demand increases and supply does not we get an increase in prices.

    “Bonds change interest rates”

    Bonds must also “regulate demand”, because bonds are savings. Saving is not spending on consumption—that’s what the word means.

    “In other words, the government spends or consumes or whatever before it taxes or issues bonds.”

    That’s not actually how the system works in this country and I’m pretty sure that it’s not how the system works in the States either, but let’s say that it is for argument’s sake. Does it change anything WRT the government’s budget constraint? No, of course not. The government consumes a portion of output every period. The difference between its borrowing and its consumption is its tax revenue. Again, not theory, and the chronology is irrelevant. We know that if the government intends to repay its debts, then current borrowing must be paid for from future taxes.

    “If you want to refute the MMT paradigm, I think you need to show where it goes wrong, not start with another paradigm that MMT seeks to discredit.”

    I’m starting to wonder whether you really understand the MMT paradigm. How long have you been reading these guys?

    “Interest going to zero doesn’t seem to be the no-bonds case.”

    If the government finances its net consumption expenditure by printing money, I think it’s safe to say that it won’t be paying any interest on it. You’re not going to get this unless you remember that we’re talking about real activity. The government is consuming a quantity of the final goods and services produced by the economy in any given period. It can print money by changing numbers on a spreadsheet, but it cannot print goods and services. You claim that this consumption comes from “nowhere”, because you think that the money the government uses to pay for it comes from nowhere. But money itself does not have value—it’s just an accounting entry, as Scott Fullwiler wrote elsewhere on this site. It’s the goods and services that have value and the goods and services that are taxed or borrowed. These goods and services are produced by the economy—they are its income. When the government consumes, it consumes this income. Some of this income (a flow of goods and services over time) it agrees to pay back in the future: this is the amount the government borrows. And some it expropriates outright: this is the amount the government taxes.

    Think about a situation in which the government is in deficit to the private sector. Since the government is in deficit (total debits > total credits), its spending exceeds its income and the private sector has effectively extended it a loan of goods and services equal in value (at current prices) to the balance on its account.

    You may have seen others on this thread calling for no-bonds because it removes the interest income the private sector earns on this loan, which they consider unfair. That is, they still want the private sector to lend the government output net of its tax revenue, but they do not want the government to pay interest on that loan. That’s the proposal—it isn’t my idea.

    “Even a bond with zero interest rate would have an effect of locking the money into savings. I think the no-bond case is when your maturity goes to zero, not the interest rate.”

    Notice how you’re now agreeing with things that you disagreed with earlier in the thread (“a bond… would have an effect of locking the money into savings”).

    Yes, there are obvious problems with this proposal.

    One of the biggest problems is—what are the terms of this loan under a no-bonds policy? If the government intends to repay the loan (of a quantity of output) it does so at a zero rate of interest. But when will it repay the loan, and how? It cannot repay the loan instantly, because that would imply that the loan was never made, and the government is not in deficit. When it repays the loan, it must return that output back to the private sector and it can only do this out of its income, which is its tax revenue (the flow of goods and services it expropriates outright). Otherwise the loan is rolled over and is not repaid. If the government does not repay the loan, then we cannot say that the government borrowed the output; effectively, it was taxed. There is no free lunch.

    “I can see nothing different or that is not covered in more generality in Scott Fullwiler’s paper “Interest Rates and Fiscal Sustainability”.”

    Scott’s paper is (partly) a review of the neoclassical theory of the government’s intertemporal budget constraint, a simplified version of which I gave in my comment.

    “If (r – Θ) were negative, the government would no longer need to generate primary surpluses to achieve sustainability. . . . The government could even run permanent primary deficits of any size, and these would eventually lead to a positive but constant level of debt, [g – t]/(r – Θ)”.

    Yes—this is a direct implication of the neoclassical GBC. Since borrowings have to be repaid from tax revenue, fiscal sustainability implies either future surpluses or economic growth, or some combination of the two. Are you quoting it because you agree with it?

    “This is not what you set out to prove”

    In order to understand why not funding government spending is inflationary, we need to understand what happens when the government spends. We also need to understand what is actually proposed, and what it replaces. I’m not sure that we’ve managed to do any of those things yet, and we haven’t even got onto the effect of money supply growth or inflation expectations.

    “The government issues bonds in order to consume thus depriving the non-govt sector of the power to consume… If the government spends without issuing bonds then non-govt sector consumption will have to go up.”

    This isn’t my argument.

  104. vimothy,

    As long as you and others are happy to mix up real resources and financial assets in this discussion, we’re not going to get anywhere.

    Of course the government must compete for real resources, but the federal government as currency issuer never needs to compete for funds.

    You said this: “so it removes some purchasing power by locking up private income in govt bonds, the maturity of which is irrelevant to our discussion”

    Did you mean it or not? If you did, what is the mechanism for removal of purchasing power?

  105. “In order to understand why not funding government spending is inflationary…”

    We’ve moved from “no bonds” to “no funding”. Two different things…again.

  106. Vimothy,

    I notice that when someone from within the camp writes it, it becomes obvious. No-bonds is inflationary because it increases aggregate demand, which is why you want the policy in the first place.

    But Tom used the conditional language “If there were less saving and more consumption due to a no bonds policy”, so, agreeing with him I did not necessarily agreed that this will happen. Besides, this was also my point earlier – if there was indeed an inflationary effect due to no-bonds policy then the government can automatically spend less. And it could spend less and less until there was no inflationary effect resulting from the no-bonds regime (or, if it cannot spend less, then it does need to start taxing more).

    I make only the blandest and most boring statements and somehow you disagree with them. Look, in any period the govt’s expenditure is either covered by its revenue from taxes or it is not. If it is not we say that the government is in deficit, which means that its spending net of its “income” is positive. That’s what it means for the government to be in deficit. This is not theory.
    “In MMT paradigm G comes from nowhere.”
    But this is completely bonkers. Govt consumption comes from society’s economic output, the product of its activity during that period—G comes from the supply side of the economy, like I and C.

    You’re switching between real (as in atoms and sweat) and nominal (as in $) terms here. When we’re talking about no-bond policy, we’re talking about issuing bonds to replace dollars injected into the economy, not atoms or sweat. I disagreed with you on nominal terms. In other words, when we talk about dollars, then those come from nowhere and taxes remove some of those dollars while bonds replace some of those dollars. Nothing about real resources, atoms and sweat here.
    And inflationary effect is a nominal phenomenon – the prices go up in dollars, not in atoms. At least this is the inflation we seem to care about. So, seems to me you cannot just switch to real terms and continue to argue inflationary effects. Am I wrong?

    Bonds must also “regulate demand”, because bonds are savings. Saving is not spending on consumption—that’s what the word means.

    Except govt bonds are not the only saving vehicles out there.

    “In other words, the government spends or consumes or whatever before it taxes or issues bonds.”
    Again, not theory, and the chronology is irrelevant. We know that if the government intends to repay its debts, then current borrowing must be paid for from future taxes.

    No problem with what you said, except that if the govt did not issue bonds at all, then it could simply accumulate overdraft at the CB and this spending, as Neil Wilson says

    will either pay for itself by expansion in the real economy (in which case inflation will stay steady and there will be no tax/interest rate rises), or it won’t (in which case this tax will go up or this interest rate will change).

    Where is the need for bonds here?

    It’s the goods and services that have value and the goods and services that are taxed or borrowed. These goods and services are produced by the economy—they are its income. When the government consumes, it consumes this income. Some of this income (a flow of goods and services over time) it agrees to pay back in the future: this is the amount the government borrows. And some it expropriates outright: this is the amount the government taxes.

    Again you’re switching between real and nominal, while no-bonds proposal refers specifically to nominal. When government borrows by issuing bonds it does not borrow atoms and sweat, it borrows dollars.

    “Even a bond with zero interest rate would have an effect of locking the money into savings. I think the no-bond case is when your maturity goes to zero, not the interest rate.”
    Notice how you’re now agreeing with things that you disagreed with earlier in the thread (“a bond… would have an effect of locking the money into savings”).

    I meant into this particular savings. In other words, this money cannot go into anything else: other forms of savings, investment or consumption for the maturity of the bond. What I disagreed with before was that the money will necessarily find its way into increased consumption.

    One of the biggest problems is—what are the terms of this loan under a no-bonds policy? If the government intends to repay the loan (of a quantity of output) it does so at a zero rate of interest. But when will it repay the loan, and how? It cannot repay the loan instantly, because that would imply that the loan was never made, and the government is not in deficit. When it repays the loan, it must return that output back to the private sector and it can only do this out of its income, which is its tax revenue (the flow of goods and services it expropriates outright). Otherwise the loan is rolled over and is not repaid. If the government does not repay the loan, then we cannot say that the government borrowed the output; effectively, it was taxed. There is no free lunch.

    I don’t see anything to object to in this. Again, if the Tsy simply has an overdraft at the CB – a zero interest loan from the private sector, as you call it – then indeed it will either have to tax later or the economy will expand and “pay” the loan as per Neil Wilson’s comment above. I can still see no reason why we couldn’t abolish interest-bearing govt bonds.

    In order to understand why not funding government spending is inflationary, we need to understand what happens when the government spends. We also need to understand what is actually proposed, and what it replaces. I’m not sure that we’ve managed to do any of those things yet, and we haven’t even got onto the effect of money supply growth or inflation expectations.

    We’re not talking about “not funding government spending“, but rather not funding government spending with bonds. And from your last sentence, seems like you are also going to invoke some sort of behavioral argument, hence your reference to inflation expectations. In other words, there might be no ironclad logical reason why the government spending with no bonds is inflationary, but there could be a psychological impact on agents in economy. That is true and was addressed above, I think.

    “The government issues bonds in order to consume thus depriving the non-govt sector of the power to consume… If the government spends without issuing bonds then non-govt sector consumption will have to go up.”
    This isn’t my argument.

    Can you please succinctly formulate your argument then? I just went back and re-read the whole thread. The miscommunication seems to occur here:

    The private sector will not match govt consumption with its own non-consumption (i.e. saving) in the case with no govt bonds because the govt did not issue any bonds. Now, it is possible that the private sector may by sheer coincidence decide not to consume any output in this period. But making policy on the assumption that everything is going to turn out fine regardless is not very responsible.
    If the govt issues $100 bonds then it knows that the private sector must reduce its consumption by that amount if it purchases them.

    To which I replied that “it is not “sheer coincidence” that it will continue to save but rather a more likely outcome (form MMT perspective) than assuming propensity to save will change abruptly.” In other words, you seem to say the consumption is likely to go up (although at other places you seem to imply that it has to go up) which MMT says in unlikely. MMT further says that if consumption did go up then the government expenditure could go down, as I indicated (in a special case) and Tom Hickey elaborated upon and confirmed in his comment.

  107. I see that while I was compiling my response, Jeff65 came up with the same objection, but in a more succinct form 🙂

  108. “We’ve moved from “no bonds” to “no funding”. Two different things…again.”

    Assuming that “no-bonds” does not mean “no deficits”, they are not two different things.

    But rather than have me write another massive comment, why don’t you explain the distinction you’re tying to make.

  109. But rather than have me write another massive comment, why don’t you explain the distinction you’re tying to make.

    Deficits can be funded by future growth and taxation without bonds.

  110. Vimothy, the whole discussion was about no bonds regime. If no bonds resulted in inflation – which in itself was under discussion and as far as I can see not shown logically – and this inflation was undesirable, MMT deals with that by: 1) reducing spending; 2) taxation.
    Several people also noted that with idle resources there should not be inflation as these resources come into play due to increased govt spending.
    What you insisted upon is that no-bonds will result in increased consumption, as far as I can tell.

  111. Actually, I’m not sure if that statement makes sense. It looked kind of like you were saying that deficits can be be funded by future taxes, but now I dunno.

  112. Vimothy, what about Tsy having overdraft at the Fed you find objectionable?
    Future taxes can remove inflationary pressure if and when it results.
    Why won’t you formulate your position in a few lines? What do bonds add to the toolbox of a monetary regime that is not already there with taxes?

  113. vimothy,

    The distinction I was making is just that, a distinction. I do not know which you meant, “no bonds” or “no funding”. I thought it important to clarify. Let’s put that aside.

    Question:
    Why is an unfunded deficit more inflationary than the same deficit funded by bond issuance?

    That was carefully worded. I don’t think anyone argues that government deficit spending is never inflationary.

  114. I’m not arguing about taxes vs bonds, I’m arguing about MMT regime with money financed deficit spending (“no-bonds”) vs the status quo. The are a variety of effects associated with the MMT proposal (on interest rates/asset prices, on demand, on government spending, on inflation expectations, on the money supply), all of them are stimulatory. (That’s the effect you’re looking for). Now, anything could happen, I agree. Perhaps the world ends in 2012 and no one’s any the wiser. But say you could run history a few thousand times–what would the effect be on average?

  115. “Why is an unfunded deficit more inflationary than the same deficit funded by bond issuance?”

    Agreed, carefully worded.

    You can imagine a variety of effects using different ways to think of the problem. One in particular that I’ve been trying to describe is that the interest on government debt is the return to the private sector from deferring consumption of GDP to the government. If this return is zero, what is the likely effect?

    The there’s interest rates coming down, and money supply and inflation expectations going up.

  116. “Why is an unfunded deficit more inflationary than the same deficit funded by bond issuance?”

    BTW, this is a good question because you make explicit the cet par assumption: it’s the same deficit, the same amount of govt consumption and the same amount of taxes.

  117. Damn, we’re back to square one, it seems.
    The whole thread I tried to make it clear that I think people decide on consumption vs. spending/investment based on their general propensity and economic outlook, not based on availability of govt bonds or the rate thereof. I know of myself that I save even when I don’t invest in anything. I won’t be running out buying stuff just because the rate on govt bonds dropped.
    It is true that inflation expectations may result in some increased consumption (even though Winterspeak tried to discredit the idea), which is why it is probably wise to go to no-bonds gradually, as Tom Hickey suggests above, letting the private sector adapt. The fact that QE did not produce inflation may be a step in that direction. But, again, logically, there is no proof that no-bonds will result in higher consumption, as far as I can tell.

    The are a variety of effects associated with the MMT proposal (on interest rates/asset prices, on demand, on government spending, on inflation expectations, on the money supply), all of them are stimulatory.

    Stimulatory does not mean inflationary, does it? Productivity may go up in line with M and/or V going up in MV=PQ.

  118. By the way, I don’t think that what Scott Fullwiler and Warren Mosler say about deflationary effect of no-bonds due to removal of interest income is necessarily true. Again, this is because I think people will switch to some other savings/investment options and not just stay in cash.

  119. vimothy,

    Eliminate the transitional effects of changing from a system of bonds to one of no bonds, again, assuming the same deficit for both. What is left to account for the no bonds system being more inflationary than the other?

  120. “You’re switching between real (as in atoms and sweat) and nominal (as in $) terms here.”

    No I was referring to real variables throughout that. The same identities and relationships can also be understood in nominal terms.

    “When we’re talking about no-bond policy, we’re talking about issuing bonds to replace dollars injected into the economy, not atoms or sweat.”

    I realise that. That’s the fallacy. I’ve been trying to explain why it’s a fallacy, but I don’t think I’ve done very well.

    The bonds are issued to replace dollars that we injected into the economy when the atoms and sweat were taken out. When the loan is repaid, the atoms and sweat will have to be put back in.

    “Again you’re switching between real and nominal, while no-bonds proposal refers specifically to nominal.”

    But does it? Government consumes a flow of real goods and services. The dollars that it uses to pay for them come from the Fed or Ron Paul’s ass or wherever. But the goods and services are society’s income (in both real and nominal terms), and it is this that is taxed or borrowed. The dollars are just accounting entries.

    “I disagreed with you on nominal terms.”

    I’m not really talking in nominal terms.

    “In other words, when we talk about dollars, then those come from nowhere and taxes remove some of those dollars while bonds replace some of those dollars. Nothing about real resources, atoms and sweat here.”

    The dollars represent income, real income, meaning what was produced. Govt doesn’t consume dollars, it consumes what was produced. It has no need for the little bits of paper in and of themselves. As you note, it can print up more whenever it likes.

    “And inflationary effect is a nominal phenomenon – the prices go up in dollars, not in atoms.”

    Inflation is like the rate of change of the difference between real and nominal.

  121. “I won’t be running out buying stuff just because the rate on govt bonds dropped.”

    Think of the fallacy of composition. We want the whole private sector to save as a whole, not just individuals.

  122. “What is left to account for the no bonds system being more inflationary than the other?”

    Which system has the greater liquidity? If people’s desire for liquidity is the same in both, what is the likely result? More spending. Not more production, because the deficit is the same in both cases.

  123. Think of the fallacy of composition. We want the whole private sector to save as a whole, not just individuals.

    Fallacy of composition does not apply, as far as I can tell. The fact that all the participants of the economy don’t change their saving propensity does not lead to contradictory outcome, as is the case in paradox of thrift, for example. If everybody just put their money into a mattress this will not defeat the saving desires of the private sector as a whole.

  124. “Which system has the greater liquidity?”

    I contend that both systems have the same liquidity. The net mix of government issued financial assets is different, but the value is the same. I can use T-Bills or FRNs as collateral for a loan to buy real goods and services. I can swap T-Bills for FRNs at will for a relatively small premium. If I want to buy a car, the fact that I am holding only T-Bills is no obstacle. And neither is it an obstacle for the guy who bought the T-Bills from me.

    One could imagine scenarios where bond issuance acts as a real constraint on individual spending decisions, but this is an extreme. You’d need to explain how we get to the point where the secondary market in government bonds disappears.

  125. “I can use T-Bills or FRNs as collateral for a loan to buy real goods and services. I can swap T-Bills for FRNs at will for a relatively small premium.”

    But why would you need to if the two are equally liquid?

    “If I want to buy a car, the fact that I am holding only T-Bills is no obstacle. And neither is it an obstacle for the guy who bought the T-Bills from me.”

    You want to stop lending to the government, so you sell the t-bill. Now the person who bought the t-bill is lending to the government. Unless you sell the bill back to the government, then the sector as a whole is still lending to the government.

    Neo Chartalists say that govt bonds are an “interest rate maintenance account” (or something similar–I forget the exact phrase in Randy Wright’s book). How can this work if bonds and money are equivalent in all ways? Think of an OMO–if what you say is true, OMOs should have no effect.

  126. vimothy,

    “But why would you need to if the two are equally liquid?”

    I didn’t say that FRNs and T-Bills are equally liquid. I said that the two systems we were talking about before have “the same liquidity”. Not a precise statement on my part, but I was in a hurry.

    I should have said the existence of the the secondary market in government bonds makes the systems functionally equivalent in liquidity.

    I don’t want to get sidetracked, but OMOs work because bonds and bank reserves are not equivalent in all ways – I never said they were. Banks must have bank reserves in their reserve accounts.

  127. “I didn’t say that FRNs and T-Bills are equally liquid.”

    By assumption the only difference between the two systems is that in one the private sector net acquires bonds and the other it net acquires currency. If the two systems have the same liquidity, then govt bonds and currency must have the same liquidity.

    Money is the means of final settlement of all obligations. A govt bond is a discounted risk free claim on some quantity of this means of payment sometime in the future. The two are not the same. Liquidity is a spectrum—a 30 year US govt bond is less liquid than currency and more liquid than a 2006 vintage subprime ABS CDO, for example.

    “I should have said the existence of the the secondary market in government bonds makes the systems functionally equivalent in liquidity.”

    The secondary market makes the bonds system more liquid than would otherwise be the case, but it does not make it as liquid as the case with no-bonds, because in the secondary market, someone has to give up currency for you to sell your bond. If there is an argument to be made, you need to focus on the repo market, but even this is not particularly strong.

    “I don’t want to get sidetracked, but OMOs work because bonds and bank reserves are not equivalent in all ways – I never said they were.”

    The implication of what you said is that they are equivalent in terms of
    liquidity.

    “Banks must have bank reserves in their reserve accounts.”

    The rules are different in different countries. (Although, that statement is obviously literally true). Putting requirements to one side, banks need to hold reserves. Why? What happens when they have more reserves than they want (or need) to hold?

  128. “What happens when they have more reserves than they want (or need) to hold?”

    They get paid interest just like a bond, but at a lower rate.

  129. “They get paid interest just like a bond, but at a lower rate.”

    If the banks hold reserves in excess of their needs, there is an opportunity cost (in terms of the lost return that could be gained from lending to the market, or depositing in the BoE’s OSF, say). If they hold reserves in excess of their target, there is a penalty. Consequently, banks want to economize on their holdings of reserves. They want as much as they need and no more.

    So when the Fed increases the quantity of reserves through OMO, banks who are long lend to banks that are short. If the whole system is long on aggregate, then interest rates fall as the banks try and fail to offload the excess reserves onto each another.

  130. Out of interest, anyone fancy explaining what in their view causes inflation?

  131. “Consequently, banks want to economize on their holdings of reserves. They want as much as they need and no more.”

    I’m sure they do. But they can only get rid of them to the other banks or the central bank. They are the only people with accounts at the central bank.

    And the interest rate will drop to the support rate paid on reserves.

    As the Bank of International Settlements (BIS) states, when the central bank pays the commercial banks a return on excess reserves (above the minimum required for settlement purposes) equivalent to the policy rate.

    “there is no opportunity cost of holding excess reserves and banks will be indifferent about the amount of reserves they hold as long as the minimum for settlement purposes is satisfied.”

    Billy Blog post on it here: http://bilbo.economicoutlook.net/blog/?p=6624

  132. “I’m sure they do. But they can only get rid of them to the other banks or the central bank… And the interest rate will drop to the support rate paid on reserves.”

    Which was my point.

  133. Vimothy:

    The bonds are issued to replace dollars that we injected into the economy when the atoms and sweat were taken out. When the loan is repaid, the atoms and sweat will have to be put back in.

    I said before, this is all too “cosmic” for me. I realize that there is some correspondence between nominal and real, but sometimes it seems to me there could be a real disconnect. What atoms are put back when the govt repays the bonds? Much easier to think about it in nominal terms – actual dollars changing hands.
    Additional objection comes from the fact that a large part of government spending – transfer payments, subsidies etc – is not about consuming resources, as we agreed. Imagine an extreme case where all of govt spending is like that. Then the whole idea of repaying atoms to the private sector stops making sense.
    Let me be clear – there is some real equivalent of repaying private sector’s loans. Since by borrowing the real resources from the private sector the government uses the money to supply the public with public infrastructure, protection etc, I guess that when the debt is paid back, then this corresponds to the opposite effect – namely depriving the public of all these potential government services. But once we start thinking in these abstract terms, we’re losing almost any connection actual monetary phenomena we’re talking about.

  134. “Which was my point.”

    Not sure what you read into what I was originally saying but ‘They get paid interest just like a bond, but at a lower rate.’ meant precisely that – the support rate.

  135. Out of interest, anyone fancy explaining what in their view causes inflation?

    Basically effective demand in excess of productive capacity. There are two key reasons for this occurring:

    1) Excess funding available when the economy is approaching capacity. This is usually due to excessive availability of bank credit that leads to momentum-driven pricing. At the end of financial cycles, this can lead to a credit bust, when private debt levels become unsustainable, demand chokes, and momentum-driven prices peak out, igniting deflationary fears which collapse the market.

    2) Supply shortage of vital resources like petroleum or food, which reduces production potential. Contemporary inflations have resulted from oil/gasoline shortages (Rodger Mitchell), e. g., the 70s inflation grew out of a supply constriction imposed by the oil cartel in reaction to Western support of Israel the Arab-Israeli war, after US oil production had peaked and could not meet the marginal shift. The shortage was eventually met by deregulation of natural gas in the US. (Warren Mosler’s view, as I recall.) Supply shortages can lead to price rises due to hoarding.

    I don’t like the term “inflation” though. It is ambiguous at best. Inflation is difficult to measure with any empirical precision because it is definitional and the definers often have an axe to grind. In the absence of clear technical definitions that are empirically grounded, it is too easy to see inflation hiding behind every tree if one is so inclined, and many are.

    For me, the best indicator of inflationary expectations would be endogenous market-determined free-floating interest rates. But in an era of independent central banking as a command system at the top of the money chain, interest rates are set exogenously, so they are imperfect indicators also.

    Technical traders try to filter out these imperfections, but there is no clear standard and top traders often disagree. For example, Gross and Gundlach are apparently on opposites side of this trade.

    But in the end a moving average of changes in the long bond is probably the best rule of thumb indicator. For me, the question is not what economists think, or what the general public thinks, but what traders think, and that shows up in LT yields.

    So, in short, to speak of “inflation” as though anyone has a handle on it is presumptuous. Experts disagree at the moment whether we are facing an inflationary bias or a deflationary one.

  136. “Not sure what you read into what I was originally saying but ‘They get paid interest just like a bond, but at a lower rate.’ meant precisely that – the support rate.”

    I see. Well, that’s very good and I agree: in a system where the central bank pays interest on excess reserves, when the banks have excess reserves they earn the support rate. This is the situation in the US at present, or was the last time I checked. I was thinking of the textbook case, which is the US system prior to that. The UK system has more similarities with the US today.

    So to tie this into my point, what happens when the banks have excess reserves? They try to get rid of them, and this drives down rates. In the US, the Fed pays the banks to hold the reserves, because it does not want this to happen. US banks hold large amounts of excess reserves, and would ordinarily try to lend them to the market, but being both sides of the market, they would be defeated by composition effects (if everyone is trying to lend, no one is borrowing). Thus the price falls.

    There is a supply and demand for liquidity, for money. If the government tries to supply more than is demanded, its price goes down and the price of everything else goes…

  137. From the MMT perspective, the difference between a T-bill and an equivalent amount of bank reserves is that final settlement of transactions takes place either directly in cash or through the medium of bank reserves (intermediation). Accounts settle in the FRS in reserves, not T-bills. T-bills have to be exchanged for reserves for settlement of accounts.

    T-bills and other tsys serve to drain reserves from the interbank system, even though there is almost no difference in liquidity between the two, practically speaking. But settlement-wise, there is a big difference, because only reserves are liquid in the interbank settlement system. The cb uses this difference in OMO, and tsy issuance is a reserve drain.

    Strictly speaking, there is no “lending” to the government because there is no operational need for government to borrow to finance itself. The interest paid on bonds is therefore properly viewed as a subsidy, rather than as a “cost of money” to government, since government as the monopolist issues the currency and sets the interest rate .

  138. vimothy,

    “If the two systems have the same liquidity, then govt bonds and currency must have the same liquidity. ”

    No. I don’t agree. None of your arguments otherwise were convincing.

    By the way, notice I rephrased from saying “the same” to “functionally equivalent”.

  139. “No. I don’t agree. None of your arguments otherwise were convincing.”

    Why?

    What is the difference between “equivalent” and “functionally equivalent”?

  140. vimothy,

    “Why?”

    You said: “The secondary market makes the bonds system more liquid than would otherwise be the case, but it does not make it as liquid as the case with no-bonds, because in the secondary market, someone has to give up currency for you to sell your bond.”

    Under what circumstances would I not be able to sell my bonds for a modest premium on the secondary market whenever I desired? Explain how we get to those circumstances. I contend that if the system with bonds has a secondary market that is liquid “enough”, then they are functionally equivalent.

    Also if the system with bonds ever got to a point where liquidity was constrained, the Fed stands ready to exchange reserves for bonds. That’s what an OMO does – it ensures the right amount of liquidity is in the system.

  141. “functionally equivalent”=”equivalent for all intents and purposes under consideration”?

  142. “That’s what an OMO does – it ensures the right amount of liquidity is in the system.”

    Exactly. So why does the Fed need to ensure the right amount of liquidity?

  143. “Exactly.”

    Yes, exactly. Therefore bonds do not constrain my liquidity if I can always find a buyer. The system is constructed so that I can always find a buyer.

  144. Because the Fed wants to control the price. Think about a currency peg. It’s the same principle.

  145. I don’t understand why the Fed wanting to control the price is significant. As long as the Fed controls the price, my bond is as good as money.

  146. We can talk about these operational details, but the bottom line is that in order for purchasing power to be constrained you’ve got to show that individual people who want to spend can’t or don’t do so because they hold bonds.

  147. “I said before, this is all too “cosmic” for me.”

    Dude, whatever it is, it’s definitely not cosmic.

    I suggest you worry less about money, which is just a load of numbers on a spreadsheet, and worry more about what those numbers represent. Unfortunately, Neo Chartalism / MMT gets this all wrong. They are known as “nominalists” for a reason.

    “I realize that there is some correspondence between nominal and real”

    I think you may be misunderstanding what the terms mean. But let’s just ignore them for a moment. We know that in any period the government is consuming goods and services produced by the economy. These goods and services are the economy’s income. Some of this income is taken outright as taxes by the government, and some is borrowed.

    “What atoms are put back when the govt repays the bonds?”

    Some of the income taken as taxes is returned to the private sector. In the case with no growth, this means that the government “earns” a quantity of output as taxes in excess of its consumption and returns the difference to its creditors.

    “Much easier to think about it in nominal terms – actual dollars changing hands.”

    It seems to me that this makes it more complicated than it needs to me. Just focus on the actual processes of production, exchange and consumption. Forget about the dollars for a moment.

    “Additional objection comes from the fact that a large part of government spending – transfer payments, subsidies etc – is not about consuming resources, as we agreed.”

    In those cases, the government is not consuming, but the recipient of the transfer is.

    “Imagine an extreme case where all of govt spending is like that. Then the whole idea of repaying atoms to the private sector stops making sense.”

    I can’t see that it makes much difference. The recipients of the transfers consume resources, which the economy has produced and the government redistributed. Some of these are taxed and some are borrowed. The borrowed resources need to be replaced in the future.

    “I guess that when the debt is paid back, then this corresponds to the opposite effect – namely depriving the public of all these potential government services.”

    Yes, but if the economy is growing we will have higher wealth and the government will find it easier to pay off these debts.

    “But once we start thinking in these abstract terms, we’re losing almost any connection actual monetary phenomena we’re talking about.”

    In the main, these are social phenomena. Money is a sideshow.

  148. We know that in any period the government is consuming goods and services produced by the economy. These goods and services are the economy’s income. Some of this income is taken outright as taxes by the government, and some is borrowed.
    […]
    Some of the income taken as taxes is returned to the private sector. In the case with no growth, this means that the government “earns” a quantity of output as taxes in excess of its consumption and returns the difference to its creditors.
    Just focus on the actual processes of production, exchange and consumption. Forget about the dollars for a moment.
    […]
    In the main, these are social phenomena. Money is a sideshow.

    Maybe. But what I contend is that focusing on actual processes and using the proxies of bond issuance you are liable to create confusion and reach false conclusions. If you only treat money as a sideshow, then why even talk about monetary transfers? You see yourself that when you are trying to convince us that no bonds is inflationary in nominal terms it seems to be hard. One reason could be we’re stupid and don’t understand your argument. Another is that your argument, while being correct, is not presented well. And, finally, it could be that in your switching between real and nominal you are actually confusing things and your argument is wrong. I say, for the purposes of this discussion, stick to tangible things like money changing hands, not on abstract notions of atoms changing hands. When you are saying things like “In the case with no growth, this means that the government “earns” a quantity of output as taxes in excess of its consumption and returns the difference to its creditors” I am not even sure what it means.
    Maybe you’re used to think of these things in these terms – they are the mental shortcuts you developed for yourself. Now imagine you need to convince a Warren Mosler voter that the no-bonds proposal is inflationary. Good luck talking like that.
    That said, back to the question why the government could not use only taxes – instead of bonds – to ultimately post-fund its spending. It issues no bonds, it simply spends and whatever doesn’t pay for itself in increased taxes due to increased output will be paid by proactive taxation. The advantage is that interest payments stop being part of government spending and this money can be put to productive use.

  149. Unfortunately, Neo Chartalism / MMT gets this all wrong. They are known as “nominalists” for a reason.

    This is basically a difference between paradigms. For example, in epistemology, there are several major paradigms,  realism, idealism, nominalism, and within these categories there several subcategories. Just about everyone holds some version of one of these as intuitive true. However, there are no agreed-upon overarching criteria for deciding which is superior, or which may be untenable. The world can be seen (structured) from any of these vantages.

    Paradigms are different ways of “seeing the world,” i.e., modeling the particualr reference points that are given or selected. There can be more than one way of viewing, and it is possible that each way could be equally useful, or useful for different purposes. Judging among different paradigms requires agreement over criteria for evaluating them.

    Paradigms are explanations, and there are different criteria for evaluating explanations. In those areas claiming to be scientific, predictive power is the confirmation of genuine explanatory power. Here the more comprehensive explanation generally wins, cet. par.

    Otherwise, the criteria are formal (logic, consistency and coherence) or aesthetic (simple, elegant). For example, major inconsistencies is a disqualifier. Ockham’s razor is another.

  150. “If you only treat money as a sideshow, then why even talk about monetary transfers?”

    I am talking about transfers of income, not money.

    “You see yourself that when you are trying to convince us that no bonds is inflationary in nominal terms it seems to be hard.”

    Not sure what you mean by “nominal” here, or what it would mean for something to inflationary “in nominal terms” (as opposed to real terms?). One way to compute real income is to measure the value of output over a period at constant prices. Nominal income is the value of the output at current prices. One measure of inflation is known as the GDP deflator and is nominal GDP divided by real GDP. When I say that no-bonds will be inflationary I mean that it will cause this ratio to be greater than 1.

    I know that Tom wrote in his comment that the term “inflation” is ambiguous, but really it is not. It is the growth rate of the price level.

    “One reason could be we’re stupid and don’t understand your argument. Another is that your argument, while being correct, is not presented well. And, finally, it could be that in your switching between real and nominal you are actually confusing things and your argument is wrong.”

    Hypothetically, anything is possible, so why worry about it?

    “I say, for the purposes of this discussion, stick to tangible things like money changing hands, not on abstract notions of atoms changing hands.”

    But we’re not interested in the money for its own sake; we’re interested in the actual transactions, the exchange of goods and services that the exchange of money accompanies. Imagine a simplified economy as a giant circuit. On one side are households and on the other, firms. Firms “rent” labour services from households and pay them a money income. Households buy the output produced by firms and pay them with their newly acquired dollars. Production and consumption flows in one direction round the circuit, and the dollars flow in the other.

    “When you are saying things like “In the case with no growth, this means that the government “earns” a quantity of output as taxes in excess of its consumption and returns the difference to its creditors” I am not even sure what it means.”

    It means that if the government borrows some money in one period, it is going to have to put it back the next. Because it took the money and spent it on goods, there were fewer goods to consume. When it returns the money, there must be more goods to consume. Thus it needs to lower consumption or raise taxes. Let’s say that the economy produces 10 units of output for $10. The government consumes 1 unit of output, paid for by borrowing $1. In the next period, it returns the $1, say by printing it. If it consumes the same amount of output, then value of the money has changed. However, note that even if the government does not consume, there will only be 10 units of output against the $11. So it needs to tax the private sector by $1. If you just ignore the flows of money, then what happen is that the government borrowed 1 unit of output in the first period, and then taxed 1 unit of output in the second period in order to repay whoever it was who deferred consumption originally.

    “That said, back to the question why the government could not use only taxes – instead of bonds – to ultimately post-fund its spending.”

    What do you mean by post-fund its spending with taxes?

  151. I know that Tom wrote in his comment that the term “inflation” is ambiguous, but really it is not. It is the growth rate of the price level.

    And you know how to measure that?

  152. vimothy,

    “I think you may be misunderstanding what the terms mean. But let’s just ignore them for a moment. We know that in any period the government is consuming goods and services produced by the economy. These goods and services are the economy’s income. Some of this income is taken outright as taxes by the government, and some is borrowed. ”

    You have a funny way of looking at things. You’re intentionally mixing up real and nominal here. You can’t even talk about MMT until you separate real from nominal.

    BTW, the government doesn’t consume any goods or services until it spends. And it doesn’t need any income in order to spend if there is demand for it’s currency.

    I think the issue is that you believe your understanding is deeper than everyone else’s somehow, but really you just have a confused understanding of what MMT says. Until you can articulate your criticism of MMT in a way that is understandable, if not compelling, I’m going to continue to believe that. Economics is not the only field that requires mathematical understanding.

  153. “BTW, the government doesn’t consume any goods or services until it spends.”

    Exactly.

    The classical mathematics presented on this thread always start half way round the spending cycle. It requires that money is exogenous and that there is ‘something to borrow’ in nominal terms because it cannot (or more likely doesn’t want to) explain how you can start from zero.

    It is that period zero insight that shows that a currency issuer is fundamentally different in its capacity from a currency user. The classical economic approach is like somebody in physics saying that nothing interesting happened in the universe before the atoms formed – let’s just assume they were there all along.

    “In fact, Aristotle dismissed the atomic idea as worthless. People considered Aristotle’s opinions very important and if Aristotle thought the atomic idea had no merit, then most other people thought the same also. (Primates have great mimicking ability.)” http://www.nobeliefs.com/atom.htm

  154. “And you know how to measure that?”

    Well, I must know at least one way, because I described it. I agree that the problem is non-trivial though.

  155. “You have a funny way of looking at things. You’re intentionally mixing up real and nominal here. ”

    I’m intentionally focusing on quantities, not prices, so that the distinction between real and nominal is not important.

    “You can’t even talk about MMT until you separate real from nominal.”

    It’s not me who thinks that by increasing the nominal value of income, real GDP can be made to increase.

    “BTW, the government doesn’t consume any goods or services until it spends. And it doesn’t need any income in order to spend if there is demand for it’s currency.”

    Income is output. Everyone knows that the government can print more money if it chooses to. It cannot print more output. If the economy’s real income is zero, real govt consumption will be zero too.

    “I think the issue is that you believe your understanding is deeper than everyone else’s somehow, but really you just have a confused understanding of what MMT says.”

    Fair enough, but I don’t recognise that at all. It seems to me that you guys think that your understanding is deeper than everyone else’s, which is why you’re so instantly dismissive of the mainstream. I don’t think that I’ve written anything particularly “deep”–what we’ve discussed is quite basic (if maybe slightly tricky conceptually).

    “Until you can articulate your criticism of MMT in a way that is understandable, if not compelling, I’m going to continue to believe that.”

    That’s okay too–I’m not trying to convert anybody. But look: if you don’t understand the mainstream view, how can you be sure that it’s wrong?

    “Economics is not the only field that requires mathematical understanding.”

    What does that have to do with anything?

  156. “Basically effective demand in excess of productive capacity. There are two key reasons for this occurring…”

    I think this was a nice comment. Do others agree with what Tom wrote?

  157. Hmmm Interesting comment Vimothy.

    Because you described ‘it’ you know how to measure ‘it’.

    So what price level are you referring to?

    I’d like to suggest that there is no single price level to be measured which is why different people see inflation in so many different places.

    I’d additionally like to suggest that an increased quality of life costs us all more….as it should. We have to pay more, in real terms, for quality. What many of us complain about being inflation is actually paying more for a better quality of life.

  158. Because you described ‘it’ you know how to measure ‘it’.

    Because we can describe it conceptually, we can design instruments to measure it empirically.

    “I’d like to suggest that there is no single price level to be measured which is why different people see inflation in so many different places.”

    Different groups of people faces different rates of inflation. It also makes sense to think of the expected or average rate of inflation faced by everyone in the economy.

    “What many of us complain about being inflation is actually paying more for a better quality of life.

    We want to be able to distinguish between changes in relative prices (real prices) and changes in the overall level of prices (nominal changes). By definition, inflation is paying more for the same quality of life.

  159. vimothy: Well, I must know at least one way, because I described it. I agree that the problem is non-trivial though.

    There are many ways to measure inflation, and that is one reason the meaning of “inflation” is ambiguous. If there is a standard, it is the official government statistics. But all government do not agree on this, and even within a single country parameters shift over time, so that comparing inflation rates over some periods is comparing apples to oranges.

    Inflation has a precise definition in economics in terms of a general rise in prices but it is very difficult to get agreement on how to measure this. So we have a definition but no agreed-upon way to apply it in context. This results in ambiguity.

    I am coming at this not so much from the side of economics but from the side of trading. Traders need to know about the current and anticipated price volatility, and they also know that indexes are not only not the final word, but also that they can be misleading. Moreover, the data on which indexes are based are not current. Current for traders means “now.”

    Traders realize that no one actually knows the current rate of inflation, velocity and acceleration, with any degree of precision due to complexity. Traders also suspect government statistics and pay for independent analysis like John Williams’ Shadow Government Statistics — Analysis Behind and Beyond Government Economic Reporting. So traders tend to look to interest rates and yields to determine what the market itself is saying about inflationary expectations. since there are different ways of approaching this, there is disagreement. There is a big kerfuffle among traders now as to whether the trend in the US is inflationary or deflationary, and there are major analysts on opposite sides of not only the debate but also the trade.

    The other reason that the term is ambiguous is that people use “inflation” rather indiscriminately to mean price appreciation. Especially because of the latter use, “inflation” is not only ambiguous but confusing.

    In addition, “inflation” has taken on a pejorative connotation that is often marshaled in both theoretical and policy arguments, whereas it is simply a technical economic term that purports to be objective in the scientific sense of divorced from subjectivity.

    But I agree that the issue concerning price stability/volatility is determining the relation between the nominal and the real. The principal focus here should be determining changes in real wages in that changes in real wages determine shifts in living standard. This is also difficult to measure with any degree of precision.

    For example, in a recovery after a recession prices may begin to rise generally before wages catch up, and while economists and politicians are proclaiming recovery and growth, ordinary people see their standard of living falling. This is a political problem, and one we are witnessing now.

  160. vimothy,

    Forgive me for quoting a previous article from this site, but given your comments on the article I’m quoting below and your comments in this discussion, I can only assume you didn’t actually read this:

    “A Comment on MMT Internet Discussions

    There is one particular straw man that is repeatedly erected by critics of MMT. I’m sure most foot soldiers reading this will have noticed it. It is one that I find especially grating. The best (i.e. most irritating) phrase I’ve seen to encapsulate the nuances of this particular straw man is the refrain:

    MMT claims we can print prosperity.

    The phrase “print prosperity” is shorthand for the common message board accusation that MMT ignores real resources and gets bamboozled by money as if it is magic. The accusation is very common. The term “print prosperity” was coined, to the best of my knowledge, by a Math Professor, no less, who happens to be keen on the kind of “fiscal conservatism” advocated by the Concord Coalition.

    I consider it a perverse injustice that, in online discussions, MMT sympathizers are frequently reproached for imagining that “we can print prosperity” when in fact it is us who constantly stress as a fundamental point that the only true constraints are resource based, not financial or monetary in nature. We are the ones insisting that if we have the resources, we can put them to use. It is the neoclassical orthodoxy and others who try to make out that we can’t use resources, even if they are available, because of some magical, mysterious monetary or financial constraint. Just who is it that believes in magic here?

    MMT shows clearly that if we have the resources, money is no obstacle to a government that issues its own flexible exchange-rate fiat currency. It is not saying that creating money magically creates goods and services. It is saying that it is nonsense – superstitious nonsense – to think affordability for such a government could be about money rather than resources.

    Obviously, anyone is entitled to disagree with the MMT position. But they are not entitled purposefully to misrepresent MMT as suggesting that it is oblivious to real resource constraints when it is alternative theories that attempt to obfuscate matters by conjuring up fictitious “financial constraints” (e.g. the neoclassical “government budget constraint” framework).”

  161. “That said, back to the question why the government could not use only taxes – instead of bonds – to ultimately post-fund its spending.”

    What do you mean by post-fund its spending with taxes?

    What I said in the next sentense: “It issues no bonds, it simply spends and whatever doesn’t pay for itself in increased taxes due to increased output will be paid by proactive taxation.” In other word, keep injecting money till you get demand pull inflation (which corresponds, according to MMT, to saturated desire for holding of NFAs by the non-govt sector) in which case you either reduce spending or increase taxation.

  162. “Are we agreeing here? As I tried to make clear in my comments over at heteconomist, people first decide to save, then choose a particular vehicle of saving. So, interest paid on bonds can only shift their savings to or from bonds, not between bonds and consumption. So, the price of, say, real estate may go up, but the price of computers would not, just as an example!”

    Peter, if you are interested in the answer to this question, and our host doesn’t mind, I’l answer it here. Think of all the assumptions you’re making in the course of this comment. We need to pay careful attention to them.

    You’re saying that for a given amount of income, people want to save X. Some portion of that X is going to be made up of govt debt. Say that govt buys all that paper back and replaces it with base money. Now people still want to save the same amount, because their income is the same. However, they’re only going to be indifferent between assets if their expected return is equivalent (subject to some conditions), so in order for the private sector to hold the same amount of savings as base money, the expected return on other assets has to come down to equal the expected return on base money. This implies falling interest rates and asset price inflation.

    In order to get this result we had to hold savings desires constant. However, in reality they are not constant. If you lower the return to savings, at the margin you are increasing the opportunity cost of saving, and so we would expect individual consumers to substitute out of saving into current consumption to some degree (implying that saving is an increasing function of the interest rate).

    So both effects–static and dynamic–are inflationary. Remember, we’ve held constant income, so no one has more purchasing power or wealth initially. We’ve just made them more liquid, and lowered the cost of consuming today vs the cost of consuming in the future.

  163. “I am saying it is unrelated to return on saving in the form of govt bonds”

    But you already agreed that asset prices were going to go up, which is equivalent to saying that yields / interest rates are going to come down. If asset prices rise, the return to saving falls.

    Think of it this way. The public holds outstanding govt debt. Say govt buys back this debt so that the whole debt is held by the private sector as base money. In order for the private sector to hold this level of base money, the return on other assets must fall. Yes? That’s why the Fed is paying interest on excess reserves at present. You want the private sector to regard bills and base money as perfect substitutes and so you need them to deliver the same return. Otherwise, the private sector will not want to hold that level of base money, and your condition for it not causing inflation is that they will. And since the private sector can’t get rid of the excess base, just swap it around, thi will cause yields on other assets to go down / prices go up.

  164. @vimothy these scenarios sound like one-time price appreciations, not inflation

  165. “If you lower the return to savings, at the margin you are increasing the opportunity cost of saving, and so we would expect individual consumers to substitute out of saving into current consumption to some degree (implying that saving is an increasing function of the interest rate).”

    this doesn’t seem like a relevant margin.

    you seem skeptical that the private sector would provide satisfactory savings vehicles to accommodate the aggregate desire to save. why?

  166. Vimothy, I think I made it clear long ago (fromt he beginning of this thread) that there will be asset price inflation – you explain it your way, which is correct, but I see it following easier from the fact that saving desires (in the absence of govt bonds) would have to be channeled into other savings vehicles (~assets), so, the price of those will go up. Hence my comment that I can see real estate prices go up. Are we finally agreeing on this point?
    Now, this is asset inflation which is a different creature from consumption items inflation, in my understanding. I could be wrong. You say:
    If you lower the return to savings, at the margin you are increasing the opportunity cost of saving, and so we would expect individual consumers to substitute out of saving into current consumption to some degree
    Now I believe this “some degree” is very small. I don’t see people moving consumption forward because it is not in human nature. You won’t start eating more or buying more electronic etc just because the rate in your savings account fell. To be clear, bu consumption items I don’t mean things like durable non-depreciating things which can be seen as investment. So, maybe the price of art and antiques will go up as well, but not electronics, food, gasoline, what have you. I don’t believe in “bringing consumption forward” in this respect, similar to that Winterspeak post about inflation expectations.
    And to whatever small degree of consumption would be brought forward – again, the question remain, why any of this cannot be dealt with functional finance and without any bonds? I think that question of mine is still left unanswered.

  167. vimothy,

    There is an assumption you are making that saving preferences are based solely on return. That’s a highly debatable assumption especially at the short end of the curve.

    Most of the money at the short end is in treasuries due to risk tolerance and not return. If the short treasuries were not available the vast majority of those investors would hold cash even at zero return.

  168. If the govt bought back the national debt with new base, would pension fund managers do with their new deposits? what would banks do with their excess reserves?

  169. Pension funds and banks don’t have to sell bonds unless they want to. The Fed would have to meet their indifference level, and they would switch the funds to the another opportunity at that level.

  170. Vimothy, what would they do? Buy food at the supermarkets? Buy electronics? Buy cars?
    They would buy munis and state bonds and corporate bonds and whatever else will be stamped with enough letters A so that they can sleep happy at night.

  171. Tom: but this is a thought experiment where we try to see how inflationary replacing the national debt with base money would be. Just assume they do. It’s your imagination.

    Peter: Yes, they’d buy other assets–near equivalents for whatever they were holding. So those prices go up/yields go down. But the private sector can’t get rid of the excess cash on its own–it needs the government to remove it. So it passes it around amongst itself until…?

  172. Why would it be inflationary at all. Interest paid on tsys will no longer be injected. That is deflationary rather than inflationary.

    For inflation, there has to be a transmission from reserves to spending. Where is the transmission from reserves to consumption? As Warren says, if there are no bonds, the Chinese can just hold reserves if they want to sell stuff to the US but not buy US stuff. Banks can just hold reserves. too, unless they prefer something else, like corporates or munis.

    What about the cash in deposit accounts? Mostly in pension funds. Pension funds are unlikely to want to hold cash instead of something that pays better, and their preference will be determined by what is available and their risk appetite. I would expect increased competition for corporates and munis, etc.

    You apparently think that an increase in base money (reserves and cash) is going to result in a spending spree, instead of another from of saving. There is no reason to believe that banks and pension funds are going to do anything differently than they are doing now. They will just have to do it without the luxury of a government subsidy for a default-free parking place.

    What is likely to happen is that interest rates will fall as corporates, munis, etc. are bid up. That encourages investment (residential RE is part of investment). With no bonds and zero FFR, se could see the prime rate fall to ~3% on an extended basis. That reduces rent and rent-seeking, and low rates were not inflationary in the fifties.

  173. @vimothy

    to be clear, we are talking about a scenario with no IOR, correct? looks like that’s the scenario tom’s addressing, as well.

    “But the private sector can’t get rid of the excess cash on its own–it needs the government to remove it. So it passes it around amongst itself until…?”

    this is the process where the rates fall to zero?

    i have a specific question about the makeup of ‘reserves’: they are a combination of the reserve *balances* kept at the fed, and of ‘reservable’ vault cash, correct? or do i have my definitions mixed up?

  174. The monetary base is notes and coins held by public, notes and coins held by banks and reserve balances held at the Fed. The Fed can determine the total supply of base money, and the private sector then determines how it is held.

  175. “to be clear, we are talking about a scenario with no IOR, correct?”

    Yep

  176. Leaving government spending as bank reserves is likely to cause some additional spending on consumable or investment items – which increases activity and therefore taxation.

    Therefore leaving the ‘deficit’ (not the national debt) as base money does two things

    – increases private spending by some undetermined amount which should increase taxation.
    – decreases government spending due to the reduction of interest payments.

    Therefore by definition not issuing bonds increases the tax take and reduces government spending – which means the deficit will be lower than it otherwise would be.

    So arguing for bonds is arguing for higher government spending and a higher government deficit.

  177. Neil, if people have the same level of nominal income, and for the same nominal deficit, you think that increasing the nominal stock of money they hold is going to reduce real government borrowing…?

  178. vimothy said @12:44am, “if the govt bought back the national debt with new base…” and @3:01am: “But the private sector can’t get rid of the excess cash on its own.”

    While the private sector can’t get rid of the monetary BASE on its own, I believe the private sector can get ride of extra BROAD MONEY if it wants, and that’s what counts. I did a post on this late last year:

    http://www.thoughtofferings.com/2010/10/how-loanbond-choice-helps-private.html

    I suspect that after large scale QE (or similar ways of government buying back the debt), bank loans get crowded out by other forms of lending, thus shrinking the money supply independently of changes in the overall level of borrowing. Ramanan seemed to think this was consistent with theory of circuitists like Marc Lavoie. I would be glad to hear if anyone finds flaws in the analysis. If true, there might be little effect even on interest rates over the medium term.

    That said, I don’t know how fast this process operates in the real world, and I do have slightly more concern than most MMTers over the potential financial market instability that can (in some situations, but not always?) be amplified by negative real interest rates. But my concern could be misplaced if the effect I described in the post above is true and is powerful enough.

    Sorry if I missed other relevant comments on this thread, I’ve only read a small portion of them but hadn’t noticed this angle covered.

  179. hbl: I asked Marc Lavoie about QE WRT the BoE’s APF programme in the UK, and (IIRC) he seemed to think that the new broad money created by the bond purchases mostly went on paying down existing debt, so that QE was allowing private sector to effectively refinance at lower rates (broad money grew by less than the value of the APF programme). I don’t know if you’re familiar with the term “reflux”…?

    The Bank’s own lit suggests that it deliberately targeted the non-bank credit channel, reducing the cost of non-bank corporate funding.

    “If true, there might be little effect even on interest rates over the medium term.”

    I’m not sure if I follow you here. If so, why do leading MMTers like Scott think that the use of an interest on reserves policy allows the govt to expand the base without necessarily lowering rates? How can QE make non-bank borrowing cheaper if it doesn’t lower rates?

  180. vimothy,

    Interesting that you asked Lavoie about this topic directly! If the question was framed as “why isn’t the broad money supply increasing given all this QE?”, then his answer makes perfect sense. There are lots of things going on at any given time, and deleveraging that involves paying back of bank loans could reduce the money supply faster than QE increases it.

    If you framed the question differently and that was still his answer, then perhaps his answer is not consistent with what I have postulated (i.e., I could be wrong). But it still seems logical to me unless someone shows me the flaws in the logic.

    My comment on little effect on interest rates even over the medium term was something I mentioned in that post, plus above Tom Hickey said “What is likely to happen is that interest rates will fall as corporates, munis, etc. are bid up.” I was suggesting that if the private sector can “shake off” that excess broad money supply, then there is no reason for debt prices to be influenced [beyond short term technicals] by supply and demand… i.e., prices can remain anchored to some collective assessment of fundamentals (credit risk, inflation risk, interest rate risk, etc).

    “why do leading MMTers like Scott think that the use of an interest on reserves policy allows the govt to expand the base without necessarily lowering rates?”

    Sorry to be ambiguous, I was discussing longer term rates, not the short end of the curve.

    “How can QE make non-bank borrowing cheaper if it doesn’t lower rates?”

    I don’t think it does either of those things. I’m claiming it might not have much impact on interest rates of treasuries or anything else. (Warren has explicitly stated he doesn’t think QE as practiced impacts interest rates other than via minor technicals, and I agree).

  181. “Neil, if people have the same level of nominal income, and for the same nominal deficit, you think that increasing the nominal stock of money they hold is going to reduce real government borrowing…?”

    Sorry I lose you when you start talking jibberish. Can you try expressing yourself without jargon.

  182. hbl: I’m an avid reader of Marc Lavoie’s research on monetary policy, actually, so I was interested in his take on UK QE. I can’t remember how I framed the question exactly, but it was something like that, yes. How come the broad supply money expanded by only X amount given that QE should have expanded it directly by 6X (since it involves buying assets from non-banks)? I forget the exact wording and figures/ratio.

    Also suggests, absent QE >> broad money supply growth would have been negative.

    “I was suggesting that if the private sector can “shake off” that excess broad money supply, then there is no reason for debt prices to be influenced [beyond short term technicals] by supply and demand… ”

    Right, but base money stays in the system until the govt/CB drains it out.

    If people still want to “save” the same amount, they won’t want to hold cash, they’ll want to hold assets that earn a return, & this implies that they will want to trade their new broad money for higher yield instruments >>> asset prices rise / rates fall. E.g. see charts at end of this paper:

    http://www.bankofengland.co.uk/publications/speeches/2009/speech405.pdf

    “Sorry to be ambiguous, I was discussing longer term rates, not the short end of the curve.”

    But both Warren has said that he thinks the expectations hypothesis explains the term structure and that it gives the govt power to set long rates. Since long rates are just the average of expected short rates (under EH), logically this implies that if short rates fall, long rates fall as well.

    “I don’t think it does either of those things”

    Have a look at the charts in Bean’s paper. What you write looks pretty weird to me though. What does affect the price of assets, then, if not people buying and selling them?

  183. Er okay Neil.

    Nominal: current market prices
    Real: constant prices
    Deficit: difference between spending and taxation
    Stock of (base) money: notes and coins held by public, notes and coins held by banks and reserve balances held at the CB
    Govt borrowing: public debt: sum of previous deficits

  184. “Right, but base money stays in the system until the govt/CB drains it out.”

    Yes but your original question pertained to “what would investors do” and they only interact directly with broad money, not base money.

    “Since long rates are just the average of expected short rates (under EH), logically this implies that if short rates fall, long rates fall as well.”

    I mostly agree, though how big the impact on long rates is depends on how long investors expect those short term rates to stay low.

    “Have a look at the charts in Bean’s paper.”

    I did but I’m not sure which you are most focused on. And anyway, I’m not sure what conclusions I would draw given how many factors in an economy are influencing asset prices at any given time.

    “What does affect the price of assets, then, if not people buying and selling them?”

    I worded it poorly… I’m saying prices of assets are about price-sensitive supply and demand, not price-blind supply and demand. If the money supply goes up I don’t think it automatically generates an equivalent increase in price-insensitive demand for a given asset class.

    If three investors each have four quarters and I have a dollar bill for sale, and you suddenly give them each an extra quarter before the bidding starts, odds are none of them are going to bid $1.25 in quarters for that dollar bill. Debt assets don’t have as unambiguous a value as that silly example, but hopefully it illustrates where I’m coming from.

    The key observation in my post I linked to, whether you agree or not, is that I think the private sector via the very portfolio shifts you suggest they will want to make has at least partial ability to choose investments such that any unwanted broad money “disappears” at a macro level.

  185. vimothy,

    Still don’t see what you’re trying to say – primarily because you are using ‘real’ in that inflation mode again whereas around here we use ‘real’ for physical things. That’s confusing, so you’ll have to translate what you’re saying into terms I can understand.

    My point was that removing bonds seems that it will reduce the government deficit as it will increase taxation and reduce spending.

    Can we get that resolved first. Is that the case?

  186. Vimothy:
    Peter: Yes, they’d buy other assets–near equivalents for whatever they were holding. So those prices go up/yields go down. But the private sector can’t get rid of the excess cash on its own–it needs the government to remove it. So it passes it around amongst itself until…?

    Until nothing. In this game of musical chairs the last person left with the dollar bill just shrugs and puts it in his pocket.

  187. Seems to me that Warren’s comment under this thread is saying what I’ve been trying to say this whole discussion:

    the questions posed in these comments like ‘if someone gets his tsy secs exchanged for reserve balances, will he spend them’ can be said to miss the point.
    anyone can sell tsy secs at any time and spend the proceeds.
    The fed isn’t needed for that.
    The only thing that changes when the Fed looks to buy is that the Fed becomes an ‘additional’ buyer and presumably rates are that much lower, just as they’d be if any buyer came into any market.
    So the relevant question is whether any particular term structure of rates/mix of nfa is working to increase or decrease savings desires.
    And whether the interest income effects, presumed to work in the opposite direction, are stronger or weaker forces.

    And from Sergei in the same place:

    However the claim about bond vs. reserves/deposits needs additional qualifications to be either right or wrong. MMT makes such additional qualifications by saying that sellers of bonds are indifferent savers and therefore do not spend their deposits in the real economy. This message is very clear and repeated very often. It is obviously impossible to prove this claim but in general it *can* be accepted. There will be certain spill-overs at the margin and I am sure MMTers understand them but they rather choose to ignore. It might be one of those cases where MMT would probably benefit from a bit softer stance providing a bit broader explanations of all important qualifications involved. There are no 100% laws in economics and everything depends.

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