Originally published December 21, 2011 on the New Economic Perspectives blog.
Comments are thankfully few and I already dealt with some of them. I doubt there will be many readers this week, but here we go:
Q1: Is it possible to show these transactions simply from a nominal perspective?
A: Look if you buy a stick of gum we need to show the “real”–you exchange a demand deposit forgum, your store gets the demand deposit and you get the gum. We can stick to purely “nominal” only if it is a financial transaction only. But you do pay “money” (the gum you buy was denominated in dollars) so it is valued in nominal terms: $1.45. If you did not think it was worth that you would not buy it. So that is the nominal value we put on it. Kenneth Boulding had a very nice way of looking at it. You exchange your liquid savings (deposit) for illiquid assets (gum); then you dissave over time as you consume them. As Boulding said, consumption is destruction of your assets–you chew your assets away. He said you get no satisfaction from consumption = destruction of assets.
Tires on your car are a clearer example. You “consume” them over 5 years as you wear them out. You’d rather that they do not wear out, but they will. That is destruction of assets. It is a stock-flow consistent model.
Boulding was among the most clever and greatest of economists.
Q2 by WH: You wrote in Blog #24, referring to foreigner’s accumulation of reserves, such as China’s:
“Neither of these activities will force the hand of the issuing government—there is no pressure on it to offer higher interest rates to try to find buyers of its bonds… Government can always “afford” larger keystrokes, but markets cannot force the government’s hand because it can simply stop selling bonds and thereby let markets accumulate reserves instead.” In world with self-imposed constraints like the US’s, it doesn’thave the option to stop selling bonds if it wants to deficit spend. However, like you mention, bonds are an interest-earning alternative to reserves. So: 1) If bonds are an interest-earning alternative to reserves, is there an economic reason why the ultimate holder of reserves (whether it’s China or whoever China sells dollars to) would not place their reserves into US debt and at an interest rate consistent with the future pathof FFRs? In other words, it’s generally understood interest rates on US debt follow the expected future path of FFRs. Why would this change if foreigners hold the debt (even a majority portion of the debt)? 2) Let’s assume foreigners arbitrarily abstain from buying the debt. Could the US and its holding of reserves as well as credit creation abilities still fund the US debt at rates consistent with the path of expected FFRs
A: First, sovereign government can target any interest rate it wants—overnight, short-term, long-term. It can refuse to offer long-term debt and instead stay at short end of market. Thus it can offer Chinese 0.50% on 30 days, or 0% on overnight. Period. They’ll take the 30 days, but if they decide not to, so what? And in any case, all the monetary ops undertaken to let the Treasury spend have nothing to do with Chinese—it is the special banks in the US.
Q3: wh10 It seems if we take foreigners out of the picture, then there is a smaller amount of reserves/treasury debt with which to buy/rollover into new debt. However, in sort of a reversal from my alien scenario, why couldn’t the US just hold smaller but more frequent auctions to overcome any ‘funding’ issues?
A: It is not a funding issue and yes, the US can do whatever it wants. The foreigners are never in the “funding” part—it is special domestic banks.
Q4: Paul Krueger Thanks, this is a nice exposition of the (at least partial) equivalence of different views of the process. To really prove a complete functional equivalence it seems to me that you would need to show that the interest rate paid on government bonds was the same in any of the cases. Is that a correct assumption or does that not matter for some reason?
Q5: wh10 I believe at the end of Fullwiler’s paper, he also comments that bank primary dealers can take on the govt’s tsys in a manner similar to your case 3 (as opposed to non-bank primary dealers having to engage in repos to obtain the deposits to purchase the tsy). Is there a practical difference between these two types of primary dealers? Can bank primary dealers handle a greater govt debt load or do it more easily? What is the ratio of these bank primary dealers to non-bank primary dealers? Secondly, Fullwiler has commented to me that it is possible that a tsy auction could fail if the govt conducted a tsy auction, say, 2-3x the size of what it normally does (or some conceivable size). This is because investors do have to secure financing to participate in the auction, and they might not be able to do it readily enough with such a large issuance. Although, he says, the next time around, they’d likely have no problem getting things together. Though this doesn’t present an issue to a govt normally, I think it does underscore a real difference between a govt being able to simply spend first whatever it pleases (e.g. if it had overdrafts from the Fed) and a govt needing to tax/sell debt to the private sector in order to spend. That is, the private does have to secure financing for a govt debt auction to succeed. So just because the final balance sheet position is the same, the path to get there may be more obstructive in the real world. Usually, it is not an issue at all, but it seems it could conceivably be. I just think these types of qualifiers are worth mentioning when teaching MMT to others who may be skeptical about ‘govt spends first,’ since it paints a more accurate picture and clarifies why the real world doesn’t operate exactly like the general case of a consolidated Fed/Tsy.
Q6: Neil Wilson is there any benefit from all those extra transactions? Or is this, like allegedly private pensions that ‘invest’ in Treasuries, simply a Job Guarantee scheme for financial sector workers?
Paul: A treasury that understands what bonds are would only sell bills and so would have no impact on interest rates; that said, there might be an impact if treasury tries to sell too many long term bonds into mkts. Solution: don’t sell long term bonds.
WH: Scott is the expert and I won’t disagree. And aliens might explode a supernova at some distant place in the universe precisely when the treasury tries to auction, causing a temporary hiccup. We cannot possibly deal with every unlikely event. Treas and Fed converse every morning to go over plans.
They aren’t going to try to auction of 3x what the mkt can handle. In any case, the primary dealers are “banks” so not sure what you are getting at. While the path could be more difficult in practice it is not. Except when Congress refuses to raise debt limit!
And that leads to Neil: NO, obviously all the intermediate transactions just introduce the possibility that something could possibly go wrong. You can be a much better boxer if you do not tie your hands behind your back and your shoes together. These constraints arise because Congress doesn’t understand monetary operations.