Yves here. One quibble with an otherwise very informative post. Tymoigne claims that informed commentators understood that S&P’s threat to downgrade the US credit rating, which it delivered on, would be a nothingburger. That’s false. The business and even political press had leading stories virtually daily that a downgrade would be a meteor wiping out the dinosaurs level event, with famous deficit hawks leading the hysteria. This site was virtually alone in arguing otherwise. I had to be more cautious that I liked at the time because I thought it was possible that there might be a short-lived downdraft.
By Eric Tymoigne, Ph.D., Associate Professor of Economics at Lewis and Clark College and Research Associate at The Levy Economics Institute. His research expertise is in: central banking, monetary economics, and macroeconomics. Originally published at New Economic Perspectives
On one side, critics argued that MMTers say nothing new when MMTers emphasize US government’s monetary sovereignty; “everybody knows this” is a common refrain. On the other side, critics argue that MMT incorrectly merges the US Treasury and Fed into a US government, which ignores the fact that the US Treasury can run out of money because it needs to tax and issue bonds first before it can spend.
Something is amiss. This post shows that MMT can be understood from two viewpoints. One is the consolidation viewpoint and another is the coordination viewpoint. Both lead to the same conclusion; money is never an issue. US government can’t run out of money, US Treasury can’t run out of money. They are other implications in terms of public finances (the role of taxes, the role of Treasury issuances, debt sustainability, etc.) and monetary policy but the post does not address these issues.
The Consolidation Viewpoint
In 2005, while testifying in front of the House Budget Committee about the solvency of Social Security, Greenspan noted:
I wouldn’t say that the pay-as-you-go benefits are insecure, in the sense that there is nothing to prevent the federal government from creating as much money as it wants and paying it to somebody. The question is, how do you set up a system which assures that the real assets are created which those benefits are employed to purchase. (Greenspan in House of Representative 2005, 43)
Social security can’t be insolvent; there is a potential resource problem, there is never a financial problem. When Standard & Poor’s downgraded US Treasuries in 2011, the hysteria about the debt reached a new peak, and yet again all informed pundits understood that a credit rating for the US public debt is irrelevant:
As the sole manufacturer of dollars, whose debt is denominated in dollars, the U.S. government can never become insolvent, i.e., unable to pay its bills. In this sense, the government is not dependent on credit markets to remain operational. Moreover, there will always be a market for U.S. government debt at home because the U.S. government has the only means of creating risk-free dollar-denominated assets (Fawley and Juvenal 2011)
This is not an issue of credit rating, the United States can pay any debt it has because we can always print the money to do that. So, there is zero probability of default (Greenspan 2011)
We’ve got the right to print our own money that’s the key. Greece lost their power to print their money. If they could print drachmas they would not have this problem. They’d have other problems, but they would not have a debt problem. Seventeen countries in Europe gave up their right to print their own money, that’s enormously important. We’ve got the right to print our own money so our credit is good (Buffet 2011)
Interest rates on US Treasuries proceeded to fall further after the downgrade as the Federal Reserve kept its course of pushing down rates. Once again, everybody was reminded that the financials are irrelevant for a monetarily sovereign government. In 2014, Larry Summers nodded by noting that: “We have a currency we print ourselves, and that fundamentally changes the macroeconomic dynamics in our country.”
In all these cases, the authors use a rhetorical strategy that recognized the logical implications of monetary sovereign. This strategy cuts to the chase by pointing to the fact that that money is never an issue for “the US government/the United States.” Everyone nodes in agreement until someone in the room raises his hand and says: “Hey! But hold on a second! This is not how things work, the Treasury needs to tax and issue bonds first before it spends, it can’t print money at will.”
The Coordination Viewpoint
Answering that query involves changing the rhetoric to include the institutional features involved in the implementation of monetary sovereignty. Instead of saying that the US government can’t run out of dollars because it is the issuer of the dollar, one just needs to state that the Fed and Treasury coordinate to ensure that monetary and fiscal policies are implemented smoothly. Once again, money is not an issue for fiscal operations. The Fed always accommodates the financial needs of the Treasury, either directly or indirectly, in order to ensure that the payment system is not disrupted. The coordination has allowed the Treasury to meet all its obligations.
The Fed is the fiscal agent of the Treasury, the underwriter of Treasuries, and a guarantor of the stability of the payment system. While a lot is made about the independence of the Fed, full independence is a veil. MacLaury at the Minneapolis Fed put it this way:
First, let’s be clear on what independence does not mean. It does not mean […] that the Fed is independent of the government. Although closely interfaced with commercial banking, the Fed is clearly a public institution, functioning within a discipline of responsibility to the “public interest.” […] Monetary judgments must be able to weigh as objectively as possible the merit of short-term expedients against long-term consequences—in the on-going public interest. (MacLaury 1977)
Chairman Eccles again provides further insights on the financing of the Treasury:
“[In past Congressional hearings] there was a feeling that […] Government [borrowing] directly from the Federal Reserve bank […] took off any restraint toward getting a balanced budget. Of course, in my opinion, that really had no relationship to budgetary deficits, for the reason that it is the Congress which decides on the deficits or the surpluses, and not the Treasury. If Congress appropriates more money than Congress levies taxes to pay, then, there is naturally a deficit, and the Treasury is obligated to borrow. The fact that they cannot go directly to the Federal Reserve bank to borrow does not mean that they cannot go indirectly to the Federal Reserve bank, for the very reason that there is no limit to the amount that the Federal Reserve System can buy in the market. […] Therefore, if the Treasury has to finance a heavy deficit, the Reserve System creates the condition in the money market to enable the borrowing to be done, so that, in effect, the Reserve System indirectly finances the Treasury through the money market, and that is how the interest rates were stabilized as they were during the war, and as they will have to continue to be in the future. So it is an illusion to think that to eliminate or to restrict the direct borrowing privilege reduces the amount of deficit financing. Or that the market controls the interest rate. Neither is true. (Eccles in U.S. House, 1947, p. 8)
The fear that the Treasury could run out of money because a Treasury-security auction could fail is unwarranted. The Fed makes sure Treasury-security auctions are always successful:
Now today in pricing a new Treasury issue, the Federal is in the position of underwriter. During the period of the offering the Federal tries to see to it that the Treasury’s issue is successful […] It stabilizes the market just the way any underwriter does. (Martin in U.S. Senate, 1952A, p. 96)
Throughout the past decades the Fed has done so in many different ways such as buying whatever was leftover in the auction, providing a dependable refinancing channel to the Treasury by replacing its maturing treasuries, and financing primary dealers that must bid at Treasury auctions. For example during World War Two:
It was evident that all funds needed for financing the war which were not raised by taxation or by the sale of Government securities to nonbank investors would need to be raised by the sale of securities to the banking system. At first commercial banks were able to draw down excess reserves by several billion dollars, but later they had to be supplied with a considerable amount of additional reserve funds in order to purchase the necessary securities […] In general, further reserve funds were supplied by Federal Reserve purchases of short-term Government securities. (Martin in U.S. Senate, 1952B, p. 288))
Bruce K. MacLaury summarizes all these points quite nicely:
The central bank is in constant contact with the Treasury Department which, among other things, is responsible for the management of the public debt and its various cash accounts. Prior to the existence of the Federal Reserve System, the Treasury actually carried out many monetary functions. And even since, the Treasury has often been deeply involved in monetary functions, especially during the earlier years … Following the 1951 accord between the Treasury and the Federal Reserve System, the central bank was no longer required to support the securities market at any particular level. In effect, the accord established that the central bank would act independently and exercise its own judgment as to the most appropriate monetary policy. But it would also work closely with the Treasury and would be fully informed of and sympathetic to the Treasury’s needs in managing and financing the public debt … The Treasury and the central bank also work closely in the Treasury’s management of its substantial cash payments and withdrawals of Treasury Tax and Loan account balances deposited in commercial banks, since these cash flows affect bank reserves. (MacLaury 1977)
The Federal Reserve and the Treasury must work together to support the financial system because they are ultimately two sides of the same coin—the US government. The Fed cannot be fully independent from the Treasury:
the history of central banking, as was brought out earlier by the chairman, is that central banking cannot get too far away from the policies of Government too long; and that while central banks historically have won battles against the Government, they have always lost the war. (Wiggins in U.S. Senate, 1952A, p. 235)
The central bank has independence of tools (interest-rate setting) and goals (inflation, etc.) but must work fiscal operations into its daily activities. It has done so through multiple means that have varied overtime such as direct financing, allowing intraday overdraft, and supporting primarily dealers. If the Fed does not play ball to meet the needs of the legislative and executive branches, there will be major disruption to the payment system and democratic system, and Congress can always take back the monetary powers it granted to the Fed. As Bernanke put it: “The Fed will do whatever Congress tells us to do.” The ball is in the hands of Congress and, at times, it has dropped the ball by political games surrounding the debt ceiling.