Episode 242 – Monetary Operations: Coordinated vs. Consolidated with Eric Tymoigne

Macro N Cheese – Episode 242
Monetary Operations: Coordinated vs. Cosolidated with Eric Tymoigne
September 16, 2023

[00:00:00] Eric Tymoigne [Intro/Music]: Hyman Minsky always said that if you cannot put your reasoning in a balance sheet, then there’s something wrong with your reasoning. So balance sheets provide you a rigid framework that if you can’t put your reasoning in there, you’re missing something. And so it’s a good tool for analyzing any financial operations.

The Central Bank makes sure that Treasury auctions are successful either by directly buying or by financing the main buyers of Treasury securities.

[00:01:35] Geoff Ginter [Intro/Music]: Now, let’s see if we can avoid the apocalypse all together. Here’s another episode of Macro N Cheese with your host, Steve Grumbine.

[00:01:43] Steven Grumbine: All right, this is Steve with Macro N Cheese. Today’s guest is a returning guest, Eric Tymoigne. He’s an Associate Professor of Economics at Lewis and Clark College, Portland, Oregon, and a Research Associate at the Levy Economics Institute of Bard College. His areas of teaching and research include macroeconomics, money and banking, and monetary economics.

My discussion with Eric today is as much for me as it is for you, because this is probably one of the most frustrating dialectical perspectives you will experience. And that is, how does a monetarily sovereign government spend? In particular, when we’re talking about a government that creates its own currency and we have two different angles, we’re going to look at this through the consolidated Federal Reserve-Treasury approach.

And then we’re going to look at the collaborative, cooperative version of the Treasury and the Federal Reserve. I know a lot of you out there have these questions, and it’s a fair question because they make this as murky as you can get. And so in an absolute effort to try to explain, simplify, and give you guys tools to use in your evangelism, in your activities, in terms of explaining modern monetary theory to your friends and your political figures, etc.

We’re going to do more of this, by the way, we’re going to try and have Eric back to help us with a visual representation of this, but for today, we’re going to go with the narrative version. So with that, Eric, thank you so much for joining me today, sir.

[00:03:20] Eric Tymoigne: Thank you for having me, Steve.

[00:03:22] Grumbine: Absolutely. I’m very happy to have you on because for as long as I’ve been trying to be an activist in this space, this subject is the one that trips more people up than almost anything short of inflation.

And when I think about trying to explain to people, ‘do federal taxes fund spending’ and the answer is no. Stephanie Kelton’s 1998 paper, can taxes and bonds finance government spending, and the answer came out to an unequivocal no. And that served as my viewpoint and how I frame this. And I’ve heard Warren Mosler explain it in his own unique way.

You’ve heard Randy and you’ve heard all the other developers, and when you come to your banking primer, that was in New Economic Perspectives, it still leaves me scratching my head. So why don’t you start off with explaining, at least at a high level, the two different approaches, and then we can dive down into each one separately.

[00:04:23] Tymoigne: Okay. So I guess one of the main confusions in all of these discussions is ‘what do we mean by government?’ And a lot of people, when they think about government spending and taxes, they focus on ‘government means the U. S. Treasury.’

MMT – and not only MMT, actually, if you look at academic work, it’s quite a widespread technique – we don’t mean U. S. Treasury. When we look at government, we mean U. S. Treasury and the Central Bank together as a single entity. So with that, we’ll look at the implications of the merging of these two entities into one, in terms of public finance and in terms of its impact on the rest of the economy.

Now, a lot of people are going to say “well, that’s not realistic, that’s confusing, that’s not how people think about it”… and it leads to results that are counter-intuitive. And so again, it’s not merely an MMT way of looking at things. And second of all, if you do not like the way of looking at government financial operations through this technique, it’s possible to separate the two entities, the U. S. Treasury and the Federal Reserve. But in that case, what you have to do is look at how they interact with each other, how they work together.

Clearly, a lot of people think that the U. S. Treasury and the Central Bank are completely independent from each other, and they don’t talk to each other. And the Central Bank is supposed to be independent. The Treasury is not supposed to be able to create money. And so it has to look for the money somewhere.

And unfortunately, this is not a correct way of understanding how the Treasury and the Central Bank operate. Every day, every month, every week, every year, they are always heavily in relations with each other. To help fiscal policy. To help the Treasury finance itself. And also to help monetary policy, that is, to help the Central Bank meet its policy objective in terms of interest rate target, for example.

And so ,when you move to a coordination of the two entities and analyze these two entities, what you find is that the results or the conclusions that you have in the consolidated case, come back. You’ll find similar results.

Although you’ll also find things that are different. And so what we can do is move to an analysis of each of them if you want.

[00:07:38] Grumbine: Let’s start with the consolidated one, because that’s the one that I’m most familiar with.

[00:07:43] Tymoigne: So, to really do that properly, we would need to go to a drawing board and look at balance sheets. But first of all, I guess I would say that if you look at rhetorical arguments made by Alan Greenspan, Warren Buffet, even the Federal Reserve, we talk about the United States cannot run out of money. The Federal Government cannot run out of money.

So, In all these discussions, clearly, they are merging together, the Federal Reserve and the Treasury. So, it’s a common rhetorical tool used by a wide range of people. And again, as I said, at the theoretical level, it’s also a common way to analyze government financial operations. Not only by MMT, of course, but also outside MMT.

Where MMT goes further, is in understanding the impact of merging these two entities on the role of taxes and issuance of government securities. I think that’s something others do not do. And others also tend to say that ‘the U. S. government can always “print” the money, it’s always an option.’ When you actually look at the accounting and do the accounting, you’ll see that issuing money to spend is the only option. There is no other option.

And so I think the contribution of MMT at that level, has been to really straighten up the accounting and the logic at play. When you consolidate the governments and make sure that we understand well, that there is only one way for the government to spend, which is by crediting accounts. And it’s impossible for taxes and government securities to fund the government.

And of course, the other conclusion is that you need to spend first, or if you don’t spend, you need to provide credit first, or make a gift through grants, whatever it is.You have to inject the money first, before taxes can be implemented and before you can issue government securities.

[00:10:21] Grumbine: I say in shorthand: ‘printing money is government spending, government spending is new money creation, and taxation is money destruction.’

[00:10:31] Tymoigne: That’s right.

[00:10:32] Grumbine: So, printing of money is spending money. Then it’s unprinting money on the back end. These are just shorthand, quick ways for regular people to capture these things.

[00:10:42] Tymoigne: That’s correct. And that’s the perspective of Stephanie Bell at the time, now Stephanie Kelton’s, paper. She looks at a consolidated government. And so she analyzed things that way. On its own term, it’s perfectly fine. I think the main contribution of doing that is to, again, clear the rhetorical argument and theoretical argument that is used quite widely, to push the logical conclusion to its end by looking at the accounting.

And what does that mean, practically, to merge the two things together, in terms of balance sheet operations. And what does that mean when the government spends, in terms of balance sheet operation? What does it mean when the government taxes, again, in terms of balance sheet operations?

So, it’s Hyman Minsky that always say that “if you cannot put your reasoning in a balance sheet, then there’s something wrong with your reasoning.”

So, balance sheets provide you a rigid framework… that if you can’t put your reasoning in there, you’re missing something. And so, it’s a good tool for analyzing, basically any financial operations.

[00:12:02] Grumbine: So, when you say ‘balance sheets’, I took Perry Mehrling’s course on Coursera and it showed us the balance sheet back and forth. It also talked about crediting accounts with reserves, inside the banking system. When the government spends, reserves are created. Help me understand where ‘reserves’ come into this

[00:12:26] Tymoigne: Yeah. So, when you look at the consolidated government, on the liability side of the government balance sheet, you’ll have the monetary base. Part of which is composed of reserves, and reserves are accounts. Mostly today, at least, they are accounts. Banks – in this case, it would be at the government if you go more to the institutional details, it’s accounts at the Federal Reserve. But if you move to a consolidated case, again, we’re merging the Fed and the Treasury together, there would be an account at the government.

And so, when the government needs to spend – say you need to spend $20 to buy pizzas – what’s going to happen is, of course the pizza shop doesn’t have an account directly at the government, on the balance sheet of the government. The bank of the pizza shop, THAT has an account there. To to pay the pizza shop, the government is going to pay the bank, and that bank will pay the pizza shop. And so to pay the bank, the government credits the reserve account of the bank by $20. And in turn, the bank will credit the account of the pizza shop by $20.

[00:13:56] Grumbine: Pretty simple sounding. It doesn’t sound terribly complex at all so far. So far. Help me understand then when we say, and I don’t want to jump around too much, I want to let you go through this logically. But from the shorthand that is frequently uttered by us activists. When we say that taxes drain reserves people only think of spending and taxing. They don’t think of all those micro operations in between. What does it mean to drain a reserve? What is happening there? What is the point of a reserve? Is it just simply to facilitate transactions between banks?

[00:14:42] Tymoigne: So first of all, when we drain reserves, taxes, what they do is debit accounts. Again, think of when we pay our taxes, we have to write a check to the US Treasury. Now, again, we’re not looking at the U. S. Treasury here, we’re looking at the US government entity that is composed of the Fed and the Treasury.

So there you would be writing a check to the US government, the United States. When you write that check, say it’s a $10 tax. Well, you write a $10 check to the US government, and what’s going to happen is your account will be debited by $10. Now again, you don’t have a direct financial relation with the US government, you work through the banking system. So the banking system will debit your account by $10 and in turn will also on the asset side of its balance sheet, the bank will debit $10 of reserves. And then the question is, where do these reserves go? Do they provide funds for the U. S. government? And the answer is no.

The only thing on the balance sheet of the U. S. government, reserves fall by 10. And here after that, you have several ways to go, but one is to have net worth going up by 10. Could go that way. Or another one, it would be government tax dues fall by 10 on the asset side. The idea being that again, taxes debit accounts, they debit your accounts and they debit the account of the banks at the government, and that’s it. The government is not going to gain any money. When you merge the Fed and the Treasury together, what you find is that the government has no money that is on the asset side of the U. S. government. There is no domestic monetary instrument.

There is no. US dollars that it spends because the US dollars in this context are the monetary base, which are the cash and the accounts of banks, and those are the liability of the US government, not its assets. So when you tax, you reduce the amount of monetary base and the government doesn’t gain any asset.

[00:17:26] Grumbine: Ah, let’s step back just for a second. We often hear people talking about how the US isn’t going to be able to spend all this money when these other countries drop the dollar, and I know we’re not going to go into BRICS. But in particular, I wanted to understand when a country holds dollar denominated debt, or it’s currency is pegged to the U S dollar, frequently they need to have dollar reserves. And speaking with another one of our MMT friends from Pakistan, Aqdas Afzal, he said basically you can run out of reserves. We don’t have enough US reserves. We don’t have enough to facilitate the transactions between our country and your country. What is the role of reserves on the international stage? And why does that matter?

[00:18:23] Tymoigne: So it’s not only banks that have accounts. So let’s move away from the US government technique first and look at the Central Bank’s Fed balance sheet. On this balance sheet, you’ll see that not only banks that have accounts there, there’s also the US Treasury. Of course, we’ll get to that in a second step. But there are also foreign Central Banks among many other financial market participants that have access to an account at the Federal Reserve. So many other financial institutions besides banks have access to the Federal Reserve. And so like you and I, we have an account at banks. They have an account at the Federal Reserve Bank, and they use this account to make payments with each other.

So a foreign country has an account at the Federal Reserve through its Central Bank. And so for that country or for that Central Bank here, it’s an asset. And of course, given that it’s an asset, you can run out of assets. And so you can run out of funds in your account at the Federal Reserve. So if you move that to the US government consolidated case, again, you could add other accounts in there, then run through the logic. The idea again is that for the US government, it will be a liability. The account of the Bank of England, at the US government or the UK in that case, if you want. And so for the UK, that account would be an asset. Like you and I, we have a bank account and that’s an asset for us.

And we can run out of money on that account. The same thing for other countries. It can run out of money in there. The US government itself cannot run out of money because again, for the US government, these accounts are not its assets, they’re its liabilities. That’s just a matter of typing more numbers in a computer, that’s it.

[00:21:00] Grumbine: Interesting. So when we’re talking about the consolidated approach and we see our government spend money into existence, let’s say Congress writes a bill. We are going to spend 500 million dollars on providing some service to the American people. Take me from the signing of that bill to the disbursement of payments for that.

And where does the money come from? It doesn’t come from taxes, correct?

[00:21:37] Tymoigne: So again, if we’re going to use the consolidated government, no. So in that case, what happens first is Congress meets and decides whatever they want to do. You took the case of $500 billion. I took the case of buying $20 worth of pizzas. And that’s one of the point of MMT is to try to move the debate away from financial debates, more toward this kind of debate.

And what do we want the government to do for us? What kind of society do we want to have and how can the government be involved in such a society? And of course, different countries have very different response. But that’s the way you ought to look at the problems of government involvement, not through the financial side, but more through the political and resource side.

But we’ll leave that to the side. So for us, we have decided, well, I’ll go with the pizzas. We decided to spend $20 on pizzas because we think that this serves the public purpose. And so we vote on that. The government signs it. And then it’s just a matter of implementing that by buying the pizzas. And again, to buy the pizzas, the way it’s going to work is government is going to credit the accounts of banks by $20.

And the way you do that is you type plus 20 in the account of banks on the computer. And so the liability side of the US government goes up by plus 20. And of course, the banks themselves then use these funds to pay the pizza shops. So the pizza shop will receive 20 on their accounts at the private banks.

And in return, of course, they make a pizza. And so the government will receive on its asset side pizzas. That’s it.

[00:23:54] Grumbine: Okay.

[00:23:55] Tymoigne: And then after that, what it does with pizzas, probably eats them. If you want to do art. Now you have a art going on with nailing a banana to a wall. Maybe you want to do that with the pizzas too.

[00:24:10] Grumbine: Well, one of the concerns that always comes back during this portion of the conversation, when you’re creating the reserves within the spending. The bank, the federal reserve, the Treasury, the government, someone pays interest on reserves. And they say that this is a really bad thing. And so we got to do everything in our power to prevent interest accumulating on reserves.

Can you help me understand?

[00:24:40] Tymoigne: I would have to know what bad means here.

[00:24:43] Grumbine: That is never specified. This is always a boogeyman.

[00:24:47] Tymoigne: Okay.

[00:24:48] Grumbine: This is the standard pushback in the world for activists when they’re explaining and me stumbling through this with you. I have an idea, but some of these questions, I couldn’t answer that very well.

[00:25:03] Tymoigne: Interest on the reserve for the United States is something quite new and the goal of that is to make sure that the Central Bank can meet its interest rate target. And again, to pay interests on the reserve account. So now the banks have $20 in reserves there, there is a certain interest rate on this reserves.

And let’s say after a year, you have to pay $2 of interest service on the reserves. Well, the way you do that is just add two to the account either by doing it through the computers in modern days. In the past it was writing on the ledger. Plus we had two. So now you have 22, and there is nothing bad. The government cannot run out of money to pay those things.

Banks themselves cannot do much with the reserve they have because again, Reserves are accounts at the government. And banks can only make payments with each other, they cannot buy anything from the private sector with those reserves. So they’re just laying around there.

[00:26:26] Grumbine: Banks can’t lend reserves and don’t spend reserves. Reserves stay within the banking system.

[00:26:33] Tymoigne: That’s right. It’s like, again, let’s say you want to buy a car from your friend Andy and you have a bank account, but Andy doesn’t have one. Well, in that case. He can’t pay you by using a bank account. It’s going to have to find another mean. I guess it’s going to be a cash transaction in this case. But the point is that if someone doesn’t have a bank account, you cannot transact with that person through the banking system.

And so the same way. You and I don’t have a reserve account, so we cannot transact with banks and banks cannot transact with us through reserve accounts.

[00:27:21] Grumbine: Okay. Very good. We’ve covered the consolidated balance sheet. And let me ask you, is there anything about the consolidated balance sheet? We’re talking about consolidation of the Federal Reserve and the Treasury. It has one mirror image, one sides pluses, the other sides minus, and they mirror exactly correct.

[00:27:43] Tymoigne: We’re saying that we’re merging the two entities into one. It’s a bit like getting married. So you are merging all your assets together. You’re merging all your liabilities together. And if for some reason, Mr. X owed $10 to Mrs. Y and Mrs. Y also owed $10 to Mrs. X, when they meet together, they basically write off these inter-debts that they have with each other. So there are things canceling out. So that’s what consolidating means. And of course the implications are first, as we saw that the government spends by crediting an account that taxes do not fund the US government. Same thing with government securities. Okay. They don’t do that.

Again, if you want the detail, we’ll have to run through the accounting. It’s not possible that they fund. And the last conclusion is that you have to find a way to inject reserves in the economy first before you can tax or issue government securities. And so that means that the role of taxes and government securities is no longer linked to financing the government.

They have a purpose. So you still need those things. But you don’t look at them from a financial perspective, which has quite significant implications for how and why you tax and how and why you issue public debt. Some of these things we’ll retrieve in step two.

[00:29:31] Grumbine: Every year, the federal reserve tallies up its expenses, pays its expenses, and then it gives the Treasury a huge amount of money. It doesn’t keep any of the profits for itself, but ultimately the federal reserve remits it back to the Treasury. And then I assume that goes into the Treasury’s general account, which is a point of great consternation for some. Can you explain that process?

[00:30:02] Tymoigne: So the idea is that the Federal Reserve, when it makes a profit… and recently it has not made a profit, and so it has not remitted any funds to the Treasury… after distribution of dividends to member banks, it basically moves all that profit to the account of the Treasury. Again, to do it well, we would have to do it through an account,

[00:30:32] Grumbine: balance sheet?

[00:30:33] Tymoigne: yeah, it’s hard to do that this way, but that’s the general idea.

[00:30:39] Grumbine: Okay,

[00:30:51] Intermission: You are listening to Macro N Cheese, a podcast brought to you by Real Progressives, a non profit organization dedicated to teaching the masses about MMT or Modern Monetary Theory. Please help our efforts and become a monthly donor at PayPal or Patreon, like and follow our pages on Facebook and YouTube, and follow us on TikTok, Twitter, Twitch, Rokfin, and Instagram.

[00:31:42] Grumbine: now let’s go with the coordinated versus consolidated walk us through this process.

[00:31:50] Tymoigne: Again, a lot of people are going to say, well, when you talk about the US government this way it’s confusing. It’s not how people think about it. And that leads to strange results. Taxes don’t fund government, government securities don’t fund the government. So if we don’t want to do that, we’re going to look at the coordination.

The idea here is that again, the consolidation case is a theoretical tool to use to understand public finance. And it’s backed by extensive institutional details that you observe by looking at the coordination.

So it’s not like we’re doing that just for fun, this analysis, this consolidation case is grounded in detailed analysis of how the Central Bank and the Treasury interact with each other, not only in the United States, but abroad too, in many countries. So, If you look at the interaction between the Treasury and the Central Bank, the first thing you’ll note, it’s very extensive and it’s not exceptional.

It’s routine and it occurs daily and it goes on several levels. The first level is in terms of making sure that the Central Bank can implement monetary policies smoothly. What that means in practice is that the Central Bank is able to meet its interest rate target because monetary policy is about setting a price.

In this case, the price is an interest rate. And so as a Central Bank, your role is to dictate what the specific interest rate, we’re not going to go into detail of which one, but a specific interest rate should be. We’ll generalize and say, we’ll set interest rate. The Treasury has a role to play here in helping the Central Bank maintain its interest rate target.

The second is in terms of fiscal policy. Now that we have separated the two entities and we have decided to transfer most monetary powers to the Fed, we have a Treasury that now needs to fund itself. And the way the Treasury funds itself is through tax revenues and through the issuance of government securities.

So with the trillion dollar coin that you can also do monetary financing by the U S Treasury, the U S Treasury coins, the standard denomination it used to issue also United States notes that there were called before. So Treasury, if it wanted, could use its monetary power and finance itself that way. But today we have decided that the financing, the bulk of it has to go through taxes and the issuance of government securities.

However, in these financial operations, the Treasury department is not left hanging. The Central Bank is there to make sure that Treasury can always get the funding it needs to implement the budget that was passed by Congress. So that’s the second level through which you have coordination. A third one is to promote financial stability, and it’s linked to Monetary policy, but it’s also broader than that.

The US Treasury securities and Treasury securities of other countries are usually seen as very safe securities, at least for developed countries that are monetarily sovereign. And they are also liquid. So the financial sector likes to hold treasuries and it used these treasuries as a foundation for their financial strategies, for pricing securities, for regulatory purposes.

And so they have a large role to play in the financial sector. As a consequence that leads the US Treasury and other treasuries again to issue treasuries for broader purposes than merely budgetary needs. So we’re going to run through all three. The main conclusions we’re going to reach is that the public debt, that is the dollar amount of all US Treasuries, is managed in a way that is not necessarily consistent with budgetary needs. And the second conclusion we’ll reach is that the US Treasury will always be able to fund itself. Because it has the backing of the Federal Reserve and that backing comes through several methods. And at the same time, the Treasury also has the back of the Federal Reserve and helps the Federal Reserve to implement its policies.

So broadly, government financial operations through monetary policy, through fiscal policies, through management of the public debt, involve heavy coordination between the two entities to make sure that you have a smooth functioning of the economy and ensuring that we have smooth financial operations of the government in general. So I guess we can start with monetary policy. In terms of monetary policy, the Central Bank, and again, other Central Banks throughout the world, use US Treasuries to manage interest rates. Now we have moved recently to additional techniques to manage interest rates. We talked about interest rate on reserve and all of this.

Again, US Treasuries can help maintain interest on reserve. And the way it works is the Central Bank basically wants to buy or sell U. S. treasuries to and from banks, and to try to impact the amount of reserves in the system. Because the interest rate the Central Bank targets It’s basically the interest rate at which banks lend and borrow reserve among each other.

So the interest rate target is basically the price of reserves, if you want. And to make sure that the price of reserves stays on target, the Central Bank has to manage the amount of reserve in the system. Now it gets really esoteric here. So the way I do it usually to bring it back to earth is use the case of potato farmer.

So let’s say we have a potato farmer in Idaho that decides that he wants to fix the price of a bag of potatoes everywhere in the United States. He has this idea that I’m going to make sure that when people go to the supermarket, the price of a bag of potatoes is going to be $5. Everywhere in all supermarkets, it has to be $5.

Now, how are we going to do this? Well, first of all, you have to see what the market price is currently. So he wants the market price of a bag of potatoes, supermarket to be five. What if currently the price of a bag of potato is $3, what will he have to do? What he’ll have to do is buy potatoes from other farmers.

The idea being, farmers now have two choices. They can sell to the supermarket for $3, or they can sell to that farmer, we’ll call it farmer or John, at $5. 3 at the supermarket, 5 to John, they’re going to sell their potatoes to John. John is going to accumulate tons and tons of potatoes on its fields. He’s going to have pyramids of potatoes coming in.

And of course that means that the supermarket will say, “Hey. You used to sell potatoes to us. How come you’re not selling?” The farmers are going to say, well, John here is buying from us at five. You only buy from us at three. If you want us to sell you potatoes, you’re going to have to at least raise your price to $5.

And so then supermarkets are going to have to raise the price at which they sell their bag of potatoes. Otherwise they won’t have any potatoes. So that’s the first side. And so the price of a bag of potatoes in the supermarket will rise until it’ll reach $5. What if the price of a bag of potato now goes up above that, goes to $7?

Well, John says, no, no, no, that’s not good either. It’s too high. Prior it was too low. Now it’s too high. So I want again the bag of potatoes to be at 5. So how is he going to do that? In that case. You have a supermarket that have two choices. They can buy a bag of potatoes for 7 from other farmers, or they can buy from John at five, which one they’re going to choose.

They’re going to choose buying from John, of course. And so John is going to release all the potatoes he’d had accumulated in his fields there, and he’s going to sell them at 5 to the supermarket. So that means that farmers now are left hanging and they say hey, why aren’t you buying potatoes from us, supermarkets?

And supermarkets are going to say well, there is John here selling to us for five and you’re selling it to us for seven. We’re not going to buy from you, you’re too expensive compared to John. So farmers are going to have to lower the price of their potatoes to five. And then the supermarkets are going to start buying from them.

So by buying and selling potatoes at $5, Farmer John is able to set the price of potatoes everywhere. Of course, to be able to do that, he has to be able to buy as many potatoes as needed to make sure the price goes to five and he has to sell as many potatoes as needed to make sure that again, the price is at five.

So he loses control over the amount of potatoes he’s receiving and the amount of potatoes he’s selling. He has to do whatever it takes in terms of quantity of potatoes to meet the $5 price at the supermarket. Well, the same thing basically is going on with the Federal Reserve. The main difference with the Federal Reserve is that contrary to John, the Federal Reserve is a monopoly supplier of reserves.

John has lots of other people supplying reserves. The Fed is the only one that creates reserves. And the Fed wants to set the price at which reserves are borrowed and lent among banks. Same way John wanted to set the price at which potatoes were trading in supermarkets. Well, to do that, you’re going to have to add as much reserve as needed or remove as much reserve as needed to make sure that the interest rate on reserve stays on target. And the way you add and remove reserves is by buying and selling US Treasuries. So that’s what monetary policy is all about.

[00:45:27] Grumbine: When you were explaining this, it sounded very much like the nominal price anchor of a job guarantee where you can buy up as much buffer stock of unused labor as you want. But in order to get it back, you got to pay the price that the job guarantees paying. I just felt very similar. Are they similar?

[00:45:45] Tymoigne: Yeah, they are. It’s a buffer stock approach for reserves.

[00:45:50] Grumbine: Very good. Okay.

[00:45:52] Tymoigne: The main issue, of course, for the Central Bank is that again, to be able to add and remove reserve, he has to buy and sell US Treasuries. Again, we have moved to new operating procedures that have limited the need to do that recently, but historically that’s the way the Central Bank has done it.

Now what if the Central Bank runs out of treasuries and it needs to sell more treasuries, it doesn’t have any more. Well, what’s going to happen is going to go knock at the door of the US treasury and say, knock knock. Could you please issue more U. S. treasuries? I need you to help me drain more reserves.

So this kind of issuance of US treasuries for monetary policy purposes has occurred several times through US history. World War II was one, a more recent case was 2008 financial crisis. So the Treasury will issue US treasuries for other reasons than financing itself. That’s one. Now, I guess we can skip directly to number three here, which is financial stability.

As I said, the Treasury securities are used by private financial institutions for many reasons and the Treasury tries to accommodate their needs as much as possible. First of all, it’s going to ask the financial market participants, what do they like? So it’s going to say, do you prefer short term, do you prefer long term?

So it gets to query financial market participants about what they want. And second of all, it always makes sure that the US treasury market or Treasury markets in general stay liquid. And where you can start to have problems with that is if the US Treasury start to run surpluses. So when the US Treasury runs surpluses, they usually use the surplus to repay the public debt.

That means that now the amount of US Treasuries circulating in the economy goes down, and that’s usually seen as a noble. Policy goal to try to reduce public debt. The problem is that reducing the public debt means you reduce the amount of Treasuries and that lowers the liquidity of US Treasuries markets in addition to create a headache for monetary policy purposes. So if you look at the experience of US Treasuries throughout the world, when they have been running consistent surpluses. They have also, at the same time, continued to issue US Treasuries or Treasuries in general. They don’t need to issue them because they have a financing need.

Again, they are running surpluses. The amount of funds in their account is going up and they can repay the public debt. They do it because they want to maintain the stability of the financial system. So again, an example that Bill Mitchell has nicely analyzed was the case of the Australian government, where that has run fiscal surpluses for a decade and continued to issue Australian treasuries because it was seen as a means to preserve the stability of the financial system by preserving the liquidity of the Treasury market. Clearly here, there is a reason to issue US Treasuries or Treasuries in general, that is not linked to financial needs and run counter to a budgetary logic. And especially if you look at it from a point of view of household finance, why would you grow the amount of debt you have if you have the financial means to not use debt?

It would seem imprudent to do that. But again, the public debt is not managed in a similar way as private finance. Because public debt has broader purposes than just financing the US Treasury. It has these macro purposes. So that’s the second layer. Third layer, which I put in second previously, was fiscal policy.

In terms of fiscal policy, the US Treasury, when it receives less money from taxes than it spends, that is when it runs a fiscal deficit, issues US Treasuries to fund the difference. And the question becomes, well, are we sure we’re going to get the money? Maybe China will not buy the US Treasuries and we’re going to be in trouble or people are going to refuse somehow to buy them.

And so then the Treasury won’t be able to spend. Well, again, if you look at the coordination between the Central Bank and the Federal Reserve, you’ll see that the Fed is always either directly there or behind the curtain during Treasury auctions. The US Treasury can directly buy US Treasuries at auction. Until the early 80s it could do that to add to the amount of US Treasuries it had on its balance sheet. Today, we have restricted the ability to buy new US Treasuries to replace those that are maturing on the balance sheet of the Fed. So it provides a stable refinancing source for the US Treasury. So that’s the first way that the Central Bank is directly involved in financing the Treasury.

And the second one is the fact that one of the main participants in Treasury auctions are called primary dealers in the United States. They are called gilt edge market makers in the UK. And what’s special about primary dealers is that they are required to bid at every auction at a reasonable price. So that creates a stable demand for US Treasuries.

[00:53:18] Grumbine: People say, what happens when nobody wants to buy your treasuries anymore? After talking to Bill Mitchell, how Japan frequently buys its own bonds. There’s always someone, whether it be the state itself or primary dealer, or someone will always buy these bonds. Is that correct statement?

That’s

[00:53:39] Tymoigne: right. If you look at the auction techniques of us treasuries, it took a while to create techniques that are successful. And so for quite a while, there was what we’ll call undersubscription that is. The Treasury were trying to issue treasuries, sell them, and there was not enough demand. So what happened in that case is the Fed bought the rest, basically.

But today the auctions are usually oversubscribed. That is, there is always way more demand than what the US Treasury wants to sell. And going back to the primary dealers, they are one of the main buyers. The Fed financed primary dealers. And remember, primary dealers are required to bid, okay, they must bid.

And if they don’t have enough funding, they can get funding to buy the treasuries. The Fed will provide them funding. So we have put an intermediary between here, the Fed and the Treasury in the form of primary dealers. But the Fed is there in the background helping. So one way or another, the Central Bank makes sure that Treasury auctions are successful either by directly buying or by financing the main buyers of Treasury securities.

[00:55:12] Grumbine: When someone says you’re wrong, that the taxes really do fund spending. What is that all about? Because it seems to be the semantic game. Is this just fundamentally the difference between seeing the consolidated balance sheet versus the cooperative one?

[00:55:32] Tymoigne: No, there is more to that here.

[00:55:34] Grumbine: So break it down.

[00:55:35] Tymoigne: So first of all, in terms of consolidation, it’s not funding, period. Now, if you look at the coordination, yes, there is funding. Where that becomes then important is people are going to say, well, then that means we have to make sure that taxes are enough to meet government spending.

And so we’re going to have to think of being careful in terms of spending and making sure that we can pay for the spending by raising taxes, because we don’t want to run fiscal deficits. Because in that case, it’s a road to ruin. What MMT is saying is that again, no, you don’t want to think of public finance in that way, because you’re going to have the federal reserve that will be helping.

So if you run fiscal deficits, you won’t have what is usually seen as the bad outcome that will come up. You don’t see raising interest rates. Because the Fed targets rates is that’s a Fed that control interest rate, not fiscal policy. The Fed will help to make sure that auctions are successful. Rising public debt does not lead to higher taxes in the future.

Otherwise we would have much higher tax rate right now. You don’t want to eliminate the public debt. The public debt has a public purpose. We just explained what those public purposes are. So you don’t want to make policy to reduce the public debt. It doesn’t mean that you are pro fiscal deficits. What that means is that you have to think of public finance in different ways.

You want to make sure that you spend and tax to meet specific goals that you have. So if you want to tax, you tax with a goal of achieving whatever goals you have, which are relevant goals would be reducing income inequality. Let’s say you want to fight climate change, things like that. So you can set up the tax system to meet that goal.

Spending the same way. You look at it from the goal you want to achieve, full employment and others, price stability for the tax system too. So. What you do here is you decouple tax and spending. You don’t look at them as if we’re going to raise government spending by $5 billion, we have to make sure that we find an extra $5 billion because taxes fund the US Treasury, and so we have to make sure that the US Treasury doesn’t run a deficit because it’s bad. No, what you do is you have decided to raise government spending by $5 billion. The next step is to see, well, do we have enough resources, labor resources, material to meet the $5 billion of extra expenses we want to make?

And if we do fine, we don’t have to do anything on the tax side. If we don’t, well, we may have to raise taxes to drain purchasing power out of the private sector and release some resources from the private sector. So for example, let’s say the government wants to buy $5 billion of chocolate croissant and there’s not enough supply of chocolate croissant to meet that extra demand, at least at the current level of demand in the private sector.

So what you could do is tax the private sector to reduce their demand for chocolate croissant. They’re going to spend less. That’s the only thing you can buy in that econ, chocolate croissant. Now the question is, do you have to raise taxes by five billion dollars? Maybe, maybe not. Maybe you have to raise them by more.

Maybe you have to raise them by less. But the way you’re going to look at how much you’re going to have to raise taxes is, what do you think the effect is going to be on the economy and the ability then to meet the increase in demand for chocolate croissant without raising the price of chocolate croissant.

And so you have to look at what tax rates you want to put in, the elasticity of demand, the income, so things like that. And you may end up having to raise taxes only by, let’s say, a billion dollars. Or you may have to raise taxes by 10 billion dollars. The point is, you don’t immediately say, we raise government spending by 5 billion, we’re gonna have to raise taxes by 5 billion.

Why? Why do you want to do that? Well… Usually the fear here is that if we don’t raise by 5 billion taxes, we’re going to have to have a deficit and this is going to create some instability. And it’s going to be bad, bad for interest rate, bad for economic growth, bad in terms of tax rate, whatever, name it.

And what we see is that empirically, there is no relationship between fiscal deficits and inflation and interest rates and things like that.

[01:01:26] Grumbine: Very good, Eric. I really appreciate you taking the time to walk us through this. Some of this stuff was said differently than I’ve heard and it’s helped me put some stuff together. I guess my final question to you, Eric, is October 1st, people’s student debt comes back into play. It wouldn’t be paid for by your taxes or anything like that to allow everyone to cancel the student debt.

[01:01:53] Tymoigne: Okay.

[01:01:54] Grumbine: And as far as monetary operations go within the federal reserve, the institutions have already been paid. They’ve already received the money for the goods and services they sell. What happens to that money within this framework that we just discussed in this podcast? What does that transaction look like based on what we’ve just said?

[01:02:16] Tymoigne: So in terms of the consolidated case, what’s going to happen is you’re going to destroy a bunch of reserves and the government is going to gain a net worth. In terms of the coordinated case, the reserves are going to fall and Treasury account is going to rise. That’s it. Again, if we want to do that, we’re going to have to do the accounting on the board.

[01:02:44] Grumbine: The point I’m making here is no tax dollars were spent. Nobody didn’t get paid

[01:02:51] Tymoigne: No, again, it’s the same as chocolate croissant. You don’t need taxes to be able to do the spending you need. At least you don’t need to raise taxes by the same amount. You may need to raise them, but not necessarily by the same amount. You may need to raise them again by more or by less. You look at taxes from the point of view of trying to manage the economic system, not from the point of view of financing the Treasury and ensuring that you have a balanced budget.

That’s not how you look at them.

[01:03:29] Grumbine: instead of transactional on one side. It’s more like an EQ on a stereo. We’re trying to tune the economy.

[01:03:36] Tymoigne: That’s right.

[01:03:37] Grumbine: All right, Eric, thank you so much for joining us. And again, I’m really looking forward to being able to see you actually draw this stuff out and walk us through the balance sheet transactions. I know that that’s where the money is.

So

[01:03:49] Tymoigne: When I was in France studying economics, In France, you are required to take two and a half years of accounting for your economy degree. Some of it is national income accounting and the rest is private accounting. And that was so boring. But in the end, with insight, it’s actually very useful.

[01:04:14] Grumbine: So boring that you decided to specialize in it! Eric, I really appreciate this. And I can’t wait for us to have you on to do the webinar, to walk us through the stuff. This is really important and I want to be precise, but I also want to be effective in explaining things. I’m hoping that by understanding the way these systems operate, that we can demand better from our governments.

And if our governments don’t respond, we understand how it really works. And then we can make different decisions as activists. Let us all know where we can find more of your work. And also, by the way, tell Yan I said hello.

[01:04:54] Tymoigne: All right, I will. So you can go to my webpage. Usually the drafts of all the papers that I wrote are there and freely accessible. And to find my webpage, you just type my last name and usually it gets there. That’s the first page, usually first link. I’m on Twitter. Not as much as I used to be. I have other things to do.

So don’t have as much time for this as I used to have even there. I didn’t have that much time, but I have moved Twitter in the background.

[01:05:29] Grumbine: understood. Believe me, I would love to move it way in the background, but it’s the only way we can reach out to people. So with that, Eric, thank you so much for joining us today. And please remember Macro N Cheese is in fact part of the Real Progressives network. Real Progressives is a nonprofit. We live and die by your financial donations.

And if you want to get involved, please come to our website, Realprogressives.Org. Go to get involved and come volunteer. Eric, thank you so much, sir. My name is Steve Grumbine. I’m the host of Macro N Cheese. And for my guests and I, we are out of here.

[01:06:11] End Credits: Macro N Cheese is produced by Andy Kennedy, descriptive writing by Virginia Cotts and promotional artwork by Andy Kennedy. Macro N Cheese is publicly funded by our Real Progressives Patreon account. If you would like to donate to Macro N Cheese, please visit patreon.com/realprogressives.