Yves here. Richard Murphy gives a straightforward explanation of why governments that issue their own currency and tax to assure its use do not need to borrow in order to spend. Borrowing is simply a political convention, plus public government bonds are useful, via providing a safe investment (absent large interest rate increases).
So why is there so little uptake of this message from Modern Monetary Theory? Recall that Stephanie Kelton was an economist to the Senate Budget Committee, yet I have yet to hear of any Senator advocate for MMT ideas.
Prototypical MMT discussions mention that currency issuers are not like households, that the only constraint they have on spending is real resources, as in inflation. So why is this message met with such resistance?
One is that, as Murphy’s title makes clear, that governments (or at least national governments in large nation states) wield more power than the private sector. Witness the post-crisis rescues of financial institutions as well as automakers, or how governments all over the world propped up spending during Covid. But if you are in the Anglospehere, you’ve been indoctrinated to regard government activity as crowding out commerce, or worst, that the private sector is more efficient than the state. Oh, and that taxes are theft.
Consider Mikhail Kalecki’s seminal article, The Political Obstacles to Achieving Full Employment. The impediment is that even though businessmen would make more money under full employment, they would also have less social/status difference with labor. On top of that, the state playing a more active role in the economy would additionally reduce the importance of the commercial sector and impair its claims to being indispensable.
The resistance to taking advantage of the flexibility of a fiat currency is in large measure due to campaigns to discredit the idea of government intervention, when oddly no one made much noise about the >$162 billion sent to the Project Ukraine burn pit.
However, MMT proponents, IMHO, do themselves a disservice by not mentioning the role of tax in draining demand/checking inflation often enough. That feeds into the “This sounds too much like a free lunch” reaction. Even the policies that broke the gold standard are not framed well. You often hear commentators casually say that in the 1960s, the Federal government “spent too much” between LBJ’s Great Society programs, the Man on the Moon, and the Vietnam War.
The more accurate formulation was that even members of LBJ’s economic team, such as Walter Heller, told LBJ he needed to raise taxes, that running deficits when the economy was at full employment was too stimulative and would produce inflation. LBJ refused because he believed the public would perceive that they were being hit with higher taxes to fund an unpopular war.
By Richard Murphy, Professor of Accounting Practice at Sheffield University Management School and a director of the Corporate Accountability Network. Originally published at Funding the Future
James Carville, adviser to Bill Clinton, once said that if there were reincarnation, he would like to come back as the bond market, because then he could “intimidate everybody”.
The Financial Times has repeated that line in an editorial, claiming that bond investors continue to exercise power over governments and that unless “government spending is brought under control”, financial markets will impose their will.
It will not surprise readers of this blog to know that I think this view is nonsense. It may suit bond dealers, bankers and financial journalists to repeat it, but it is built on a false premise about how governments work.
First, governments do not borrow in the way households or companies do. A household has to earn money before it can spend. A company has to make profits, or raise capital or debt, before it can invest. Governments with their own central banks do not face these constraints. When a government spends, it creates money. That is a simple fact of modern monetary systems. The Bank of England, the Federal Reserve, the Bank of Japan and most other central banks all issue the currency in which their government’s debts are denominated. They have acknowledged that fact. QE proved it. The FT and commentators deny that reality.
That fact is that reality shows that so-called “borrowing” is not a necessity. It is a policy choice. Governments issue bonds because they wish to offer safe assets to the financial system and because they want a mechanism for influencing and managing interest rates. But they never need to issue bonds to fund spending. That spending always happens first because only the state can create the money, which the private sector then, later, uses to buy government bonds.
Second, the FT’s narrative flips reality upside down. The article suggests that bond markets set the rules and that governments must cut spending or raise taxes to please them. In truth, bond markets only function because governments guarantee their existence. Without the state’s promise to stand behind its own currency, there would be no “safe asset” for investors to buy. Nor would there be the structures in which bond markets can operate. Bond dealers are not doing governments a favour. It is governments that create the conditions in which bond dealers profit. To suggest otherwise is to grant the City of London and Wall Street a veto over democracy.
Third, deficits are not a sign of weakness. In fact, they are the foundation of private wealth. The FT’s editorial bemoans rising government debt-to-GDP ratios since 2007. But what it ignores is the fact that these rising rates are a measure of the growing accumulated savings of the private sector, held safely in the form of government bonds. When governments run deficits, they are allowing households, businesses and pension funds to hold wealth in the safest form available. To call this a problem is to misunderstand the whole architecture of modern finance. It is also to ignore the real issue of growing inequality.
Cutting deficits, as the FT urges, would mean cutting private wealth. That would, unless properly planned, undermine, not stabilise, economies. It would appear that they have no comprehension of this issue, which I will be addressing in my series on quantum economics very soon.
Fourth, the idea of “bond vigilantes” is a myth. The FT might as well be reporting that the City’s high priests are demanding the sacrifice of virgins, so inaccurate is their portrayal of reality when they suggest that such fictional entities control what government might do.
That said, of course, bond prices go up and down, and yields fluctuate. But the idea that markets will “impose discipline” on governments is hollow. At any time, the Bank of England could step in to set yields where it wants them to be. It did precisely that during the 2010s, and again during the Liz Truss crisis in 2022, when pension funds faced meltdown. In a matter of days, the Bank bought gilts and restored calm.
That episode showed something vital: the bond market only exists at the grace of the central bank. Far from intimidating governments, bond traders live under their protection.
Fifth, the FT’s so-called “solutions” are dangerous nonsense. The article suggests governments must cut benefits, suppress public services, and avoid taxing wealth to appease markets. This is the politics of cruelty dressed up as financial wisdom. It amounts to saying democracy should be subservient to investors’ fears. In fact, the real task is the opposite:
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We need governments to guarantee public investment in housing, healthcare, education and the green transition.
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We need progressive tax systems not because they “fund” spending, but because they shape a fair society and tackle inflationary pressures when they arise.
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We need central banks to recognise their role as backstops to government policy, not as supposedly “independent” agents serving the City.
In summary, the FT’s editorial line gives the impression that elected governments are mere playthings of the bond market. That is not true. Governments make our money. They spend first. They guarantee the conditions within which bonds are traded. The danger is not that markets will impose their will. The danger is that politicians believe this myth and impose needless austerity on their own people to keep traders happy.
That is not an economic necessity. It is political cowardice. And it is time we called it out.
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“In summary, the FT’s editorial line gives the impression that elected governments are mere playthings of the bond market.”
What’s really going on is that the FT editors WISH elected governments were mere playthings of the bond market. They don’t really like democracy, unless it’s carefully boxed in to suit the desires of their social class.
These economic poison pills have been spread across the globe…wide and deep.
I remembered this:
https://www.reuters.com/article/business/japans-nikkei-buys-financial-times-in-13-billion-deal-idUSKCN0PX0YL/
Before changes with its central bank, Japan was talked about as an economic wonder. Lots of influence from the West.
This is a question as much as anything else.
Is it correct to say that the application of MMT works well in an autarky, with inflation the main constraint.
But if a country has a significant trade deficit, then the additional constraint is currency depreciation. So if debt (public or private) grows faster than GDP in a sustained manner, that means the country is simply printing money to import foreign goods. And foreigners who have the export surplus with that country need to park their money somewhere – which means govt bonds and equities. So in a sense, there is some validity to the bond vigilantes’ argument?
Not really, the inflation constraint and the depreciation constraint are the pretty much same thing. For instance, during the stagflationary 1970s, the US, which does not have a large trade sector, had a very weak dollar.
What has often happened with small or even large-ish open economies (see Russia through the mid 2010s) is that they were dollarized, which is a different issue. I was told banks would offer dual currency (ruble-dollar) accounts. Many countries had private companies and sometimes governments borrowing in dollars. So they lost monetary sovereignity that way. They would need to impose capital controls to get it back.
To elaborate, the causality often is: high domestic inflation leads companies and investors to use a foreign currency. Companies borrow in a foreign currency to get a nominally lower interest rate, overlooking the risk that the loan can and often will wind up being way more costly in the end due to currency depreciation. Local investors buy foreign currency as a store of value….when those buys help lower the value of their base currency.
“And foreigners who have the export surplus with that country need to park their money somewhere – which means govt bonds and equities. So in a sense, there is some validity to the bond vigilantes’ argument?”
Just because the foreigners have a surplus of currency from the importing country does not mean they have any power over the financing of that country’s government debt (assuming they are sovereign in their own currency & issuing debt denominated in that currency) – they are not bond vigilantes.
If foreigners do not want to hold the currency, they can exchange it in the FOREX market and yes this can cause currency depreciation. However, that is just another name for import inflation so again inflation is the constraint.
“If foreigners do not want to hold the currency, they can exchange it in the FOREX market and yes this can cause currency depreciation. However, that is just another name for import inflation so again inflation is the constraint.”
I would add that in the FOREX market in the end someone will have to hold the currency of the chronic trade deficit country in the example so, yes, the pressure will come first from currency depreciation but also the final “bag holder” will ask for a higher yield to hold on that currency denominated assets.
Did you mean bonds instead of bands?
Fixing….
> “why is there so little uptake of this message from Modern Monetary Theory?”
When I was learning about MMT in the teens it seemed always to be presented in two parts. I later came to see them as 1) an empirical, objective account of fiat money creation that I think can now be seen as a theory in the scientific sense, and 2) a discourse on policy about how to spend created fiat money and to what political goals.
L. Randall Wray was typical of those who would present both one after the other. His writing and lectures are excellent and I assume correct and I’m not leveling a criticism here. I’m just observing that a lot of people, including many friends and acquaintances I tried to explain MMT to, reacted with disbelief to the first part (shouts of “bulls-t” etc) and horror at the second, because, I guess, they have savings/investments and they fear their devaluation. Owing to the horror at the policy part, most of them never managed to understand the theory part and remained rigid in their opposition to any positive discussion of MMT as though it were a threat to the world order.
Years later the comments to Taibbi’s hit job on Kelton “Magic Monetary Theory Goes Primetime” shows how this became the standard response. I took part in the comments (I no longer have access as I quit my Taibbi sub soon after) and while a few commenters, judging from likes, got what I was saying the responses were overwhelmingly of the kind that conflate the theory with the usually leftish attendant policy proposals. And I don’t even agree with most common policies people tend to put forwards together with MMT. I have little attraction to full employment and see environmental protection as the top priority for government spending.
I recently adopted a different approach to discussing MMT. I start by saying that it tells us, first and foremost, that the only limit on a currency issuer’s spending is inflation. I don’t know if this will help because most everyone I might try it on is already hostile (reflecting what I suppose is now a widespread remediation problem). But I think a valid argument can be made this way and it adopts the primary counterargument as its own.
A problem I see with MMT is that the teachers of it are/have been heterodox economists and not essentially lay persons. I have come to the view that the order of teaching this stuff should be to explain money first, both commodity money and fiat as creatures of the law, then move on to banking and only finally macroeconomics.
It is only when macroeconomics is arrived at as the end stage of study that the distinction between Descriptive MMT (the science of double entry) and Prescriptive MMT (the choices that can be overlain on Descriptive MMT) contrast the differences in ideological choices, from far left progressive to extreme right wing, when applied to an operating system of Descriptive MMT.
Because of the order and manner in which the ideas of Descriptive and Prescriptive MMT have been presented it seems to me that the conflation between those opposite sides of the same coin has been an easy pickup for neoliberal neoclassicals to falsely present their counters to Descriptive MMT to an already indoctrinated masses captive to the idea of “household budgeting” fiat currency governments.
Questioning resistors about where they believe the unindebted money that they possess comes from to show them, by their own reasoning, that a belief that government as a household leads to an infinite regress. Such an understanding cannot be an explanation of the source of that money.
“…yet I have yet to hear of any Senator advocate for MMT ideas.”
In alignment with yesterday’s post on the state collapse, it’s more of the institutional decline. There used to be people in Congress who did understand how the system worked, but they’ve been ideologically drummed out of office over the past 45 years (from both parties).
As I’ve pointed out before, former FED Chairman Marriner Eccles told the House Committee on Banking & Currency how the FED indirectly funded deficit spending, and it was a system requirement (see page 8).
https://fraser.stlouisfed.org/files/docs/historical/house/1947hr_directpurchgov.pdf
A quote from former Congressman Wright Patman, “When our Federal Government, that has the exclusive power to create money, creates that money and then goes into the open market and borrows it and pays interest for the use of its own money, it occurs to me that that is going too far. I have never yet had anyone who could, through the use of logic and reason, justify the Federal Government borrowing the use of its own money… I am saying to you in all sincerity, and with all the earnestness that I possess, it is absolutely wrong for the Government to issue interest-bearing obligations. It is not only wrong: it is extravagant. It is not only extravagant, it is wasteful. It is absolutely unnecessary.”
I wish I had saved it, but there is a story about a US Senator in the early 1980’s (or late 1970’s) who was confronted by a reporter about the size of the US government debt (or deficit). As I recall, the senator first retorted that it was just the savings of Americans. When the reporter didn’t understand the senator then told they young reporter it wasn’t his job to educate him on the operations of debt and financing of the US government.
Dear Yve, You write:
„… governments in large nation states) wield more power than the private sector..“ So far so good, especially in countries where government spending amounts to more than 50% of total national spending, as in France for instance.
But the argument is moot when the government is not ruled by and accountable to the people, when a billionaire oligarch class has coopted government, administration and institutions as thoroughly as in the US. Then it is the “private sector” acting through government having more power.
Sorry, this is a category error. The billionaires here are not unified. You have crypto bros and oil and gas and the military industrial complex, the surveillance state (overlaps with but not the same as the MIC), the AI crowd, the other Silicon Valley mavens, Big Pharma, private equity…all have influence. None is in control.
Government is more powerful.
The bloom fades from the MMT rose when you no longer have reserve currency status. Also when your industrial base is no longer competitive. Also when you MIC doesn’t field forces that has unquestioned superiority. Also when your politicians have neither enough of a moral core, enough integrity, or enough intelligence to manage the colossal powers with which Murphy would endow them. For all the bleating by political scientists and economists about where we should be on the capitalist-socialist spectrum, such grand frameworks aren’t of any signifigance if at the end of the day you can’t come up with better politicians than the likes of Trump and Biden and the whole pathetic bunch of congress bumpkins.
Not true. Japan has for decades. The UK can act in accordance MMT principles. So can the Eurozone but they are so neoliberal that they’d all have their heads explode if the idea crossed their minds. And what about Russia, FFS?
“However, MMT proponents, IMHO, do themselves a disservice by not mentioning the role of tax in draining demand/checking inflation often enough.”
Funnily enough, Bill Mitchell returned to this theme, at least in part, in his blog post yesterday.
He also references a previous specific MMT view that confirms that…..
“Taxation is an indispensable anti-inflation policy tool in Modern Monetary Theory” in:-
Taxation is an indispensable anti-inflation policy tool in Modern Monetary Theory (June 23, 2022).
https://billmitchell.org/blog/?p=50005
I am yet to see a good justification how the government deficits create money ( by themselves, not when monetized by the central bank). All I have read so far amounts to statements of belief without proper justification ( including this article).
As to the suggestion to take out excessive money by taxing: may sound good on paper, but it is politically impossible. It amounts to the statement that a government will get some money from taxes and then will simply sit on it. And that in the middle of high inflation, when everybody asks for an increase of his pension/ social benefits/ etc. Basically: exactly when we need money the most we will not use it, although it is available.
In the MMT framework the Central Bank is part of the government (which it is in reality as well, for example in UK, Canada, Australia, Japan, etc.. explicitly so, in the US there is a grotesque hybrid structure that may obfuscate things but in the end the Fed is a creature of Congress and it does report to Congress) so, yes, the government deficit creates money.
You just confirmed that government deficits create money if and only if the central bank monetizes them. Is this what MMT contends officially or this is your personal opinion?
The government creates money every time it spends as per MMT framework and all accounting operational evidence,
In the MMT framework it may create money, but at present money gets created if and only if the debt gets monetized. Again: give me a proper explanation how the money creation happens at present, when the government deficit spends and the central bank does not monetized this debt. How does this happen?
I already did. Let’s say tomorrow the Treasury needs to spend $5 Billion for Social security, it instructs the Fed to send the payments to the banks reserve account which in turn mark up the bank account of the SS recipient. End of story, money are created on the fly by the Fed. If you say, “but the money come from the TGA”, the TGA is not money, it is not part of the money supply, it’s simply an internal accounting tracking between the Fed (part of the government) and the Treasury (another part of the government) so it’s meaningless, it’s like owning an asset which is your own liability. It is a left pocket/right pocket situation. It does not get more complicated than that.
What you describe amounts to direct monetary creation ( no debt issued). To the best of my knowledge this is forbidden by law in general ( I think in UK they could do that under extraordinary circumstances). The reason to be banned is that history has shown, that one cannot trust a politician with a printing press at hand not to abuse this opportunity.
Do not Make Shit Up. This happens ALL THE TIME. It has already been described that the Treasury spends by debiting its account at the Fed first, as in the Fed credits the Treasury checking account, and then issuing bonds later. I was just discussing this matter with a top tax expert last night, who pointed out that there are multiple instance of the government spending amounts not formally approved and therefore also not subject to Treasury bond issuance. One is the black budgets where no amount is authorized; the relevant agencies have an open checkbook. Another is the >$2 trillion the Pentagon has over recent years that it can’t account for. Yet another is Medicare, where the actual spending regularly exceeds the budgeted total.
“What you describe amounts to direct monetary creation ( no debt issued). To the best of my knowledge this is forbidden by law in general ( I think in UK they could do that under extraordinary circumstances). The reason to be banned is that history has shown, that one cannot trust a politician with a printing press at hand not to abuse this opportunity.”
In the US an intraday overdraft at the Fed is permitted by rules and regulations.
In the UK an overdraft at the BOE is the standard practice, such overdraft (the Consolidated Fund at the BOE starts every day at 0) is eventually closed by issuing bonds and with tax revenue under the “full funding” rule.
This is the document which describes in detail how the UK system works.
“The Self-Financing State: An Institutional Analysis of Government Expenditure, Revenue Collection and Debt Issuance Operations in the United Kingdom”
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4890683
As I indicated in a thread related to an earlier comment from you, the Treasury isn’t fettered by that rule. We have tons of black budget and military spending in excess of budgeted amounts, which means bond funded amounts.
It doesn’t take much for a modern government and central bank to create money. For example, it happens every month wiht my monthly pension payment.
The government/central-bank sends an electronic note to my credit union: “We have increased your reserve balance by $700. Credit that amount to your customer Mel.” The credit union increases my balance (their obligation to me) by $700, and their increased reserve balance means they can fund th checks I write when I spend the money.
Similarly at tax time I pay my taxes through the credit union. They send an electronic note to the treasury/central-bank. “Mel is paying $2000 in taxes owed.” The central bank reduces the credit union’s reserve balance by $2000, and Treasury notes that my taxes are paid for the year. The credit union deducts $2000 from my account balance.
When the government spent to pay my pension, the M0 money supply went up (the credit union’s reserve balance), and the M2 went up (my account balance.) Money went into circulation.
When the government taxed, the reserve balance that was part of the M0 (credit union’s reserves) and the M2 (my account balance) got reduced. Money went out of circulation.
But all that happened was that numbers were added to and subtracted from various account balances. HTH
It amounts to the statement that a government will get some money from taxes and then will simply sit on it.
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My understanding is that taxation destroys the money. If needed later new money can be created.
Taxation moves money from people/companies to the government. This money does not disappear, however. It stays with the government. I am not aware of any historical precedent, when a government taxed some money and destroyed it or simply never used it.
You must have missed this paper from 1998: Can Taxes and Bonds Finance Government Spending? by Stephanie Bell [Kelton]
Several historical examples of physical money destroyed by government after tax payments, The Tally Sticks in England or the Colonies Notes in early America.
When you pay taxes, your bank account gets marked down and the bank reserve account at the Fed gets marked down as well. The Fed internally marks up the treasury account at the (the TGA which is not part of the money supply) but in the consolidated MMT framework (the Central Bank is part of the government) if you think about it, the money is effectively destroyed. What is left is some government internal accounting (between the Central Bank and the Treasury) it’s like owing money to yourself, the left pocket owe the right pocket.
Mosler has already dealt with this canard. In the unlikely event that you pay your taxes with cash, the US Treasury will shred it upon receipt. It does NOT recirculate.
Fun fact — you can buy shredded currency as a souvenir …
Actually Mosler was forced to correct his statement which was an extreme simplification of the actual process.
The US Treasury will not shred any currency, if you pay your taxes with physical cash, it will be handed over to the banking system and swapped for reserves to be “returned” to the Fed on behalf of the IRS (via the TT&L accounts at commercial banks I presume, the experts can chime in), the bank will then use that physical notes, like any other cash in their vault, as needed, it may indeed send then to the proper channels for shredding if excessively worn out. Functionally, it does not make any difference, once you pay your taxes, money is destroyed, the Treasury gets an asset in the TGA (Treasury General Account at the Fed) which is another branch of government (the Fed) liability, so right pocket/left pocket situation.
I’m not fully literate in myths and truths about bonds, but if states have more power, then why the gilt meltdown over Liz Truss’ ‘Mini Budget’ in 2022, and why did bond reactions seemingly persuade Trump to dial back tariffs earlier this year?
Thanks if anyone can provide some clarity. Perhaps I’m missing some simple factors.
A large and politically influential institutional framework has been created around bonds. The most obvious are the insurance and pension funds which have to match liabilities over many decades and structure their portfolios accordingly.
Government issued bonds are seen as vital to the matching process because the payout period is clearly defined both in terms of the timing of interest payments and the payment at maturity – or the realisation of payment through the market prior to maturity.
In a sense, with this combination of liquidity and predictability, government bonds insure the insurers if – but only if – the value of those bonds remains relatively stable, usually within the declared policy aims of the government over the horizon term which is appropriate to the needs of the fund – usually at a given percentage of inflation per annum.
Playing about with that matching process without warning means that a particular government may be forced out of office el quicko à la Truss, but the bond market will not result in the collapse of the state simply because of the economic and coercive powers of the modern state. To bring about the downfall of the state, many more factors beyond the bond market have to be brought into play
Anyway, that’s a very basic outline of the relevance or the bond market to government as opposed to the state.
Because politicians are macroeconomic illiterates (or trade in homespun economic “wisdumb”).
In the Truss incident what you actually had was a case of inaction by the Bank of England — arguably a political action by a supposedly apolitical, technocratic institution. You could make an argument for treason.
RE: “Recall that Stephanie Kelton was an economist to the Senate Budget Committee, yet I have yet to hear of any Senator advocate for MMT ideas.”
I recently spoke with a friend who was a longtime employee at Treasury and now works for the Congressional Budget Office. I brought up MMT with him and he told me that the CBO had invited Stephanie Kelton in for a meeting recently and she declined to attend. Whether she has attended other meetings previously or since, or what the purpose was of the meeting she declined, I don’t know. Just figured I’d pass along that anecdotal detail for what it’s worth.
I’ve been recommending her book The Deficit Myth to anyone I can convince to read it.
There is an important difference between governments getting their revenue from taxation and creating money to spend. Taxation means that goods or services have already been supplied to the economy. For example, I work at a company that sells a service, they pay me an income and the government taxes a share of it. The government then uses that amount to provide services to the country. When money is created, nothing has been provided, the money is an IOU, a financial claim on the country the country that created it and can be used to buy goods, services or assets like debt. At the end of any exchange whoever is holding the money has a claim on the country. For an economic actor In the taxation instance, money is a medium of exchange and in the money creation situation it is a creation of a liability for the country – it is debt. I don’t see the MMT people recognizing the distinction between the two forms of money or recognizing that creating money is creating debt.
From an MMT standpoint, governments create money through spending. Taxation does not provide the government with revenue, as the government can create and spend whatever money it needs. Taxation is the destruction of money to keep everything in balance.
An example – the government spends let’s say $50 billion on health care and everyone working in the industry gets paid a decent wage, but at the end of the year it’s determined that a few corporate healthcare execs have given themselves $2 billion bonuses. This would be an indication that the government created too much money relative to the goods and services being provided. If left unchecked, the recipients who accrued all the money to themselves would be able to overpay for all kinds of things, leading to inflation. This is what we’re seeing play out today with massive wealth disparities. But if you tax those executives at 90% (which used to be the going rate around the Eisenhower years), that money is destroyed and the playing field is leveled.
My understanding of the creation of money, at least US dollars, is not that government creates money through spending. The government creates a deficit and borrows the money to cover it with the sale of treasuries. That is a circular transaction. The government has the power to create money but has, so far, restrained the impulse. I have a suspicion the some covert money is created for secret operations that is not reported. When governments create money directly it can enable hyper-inflation. The US government facilitates the creation of money but has wisely awarded the actuality of that to the banking industry through the creation of loans. That is, bank loans are the creation of money in the US system. When a bank makes a loan they create a deposit ex nihilo (out of nothing)
When a private sector, a loan officer, makes a loan they really don’t want to lose money. So, for the most part, it is good productive dept. When the government spends it is quite often unproductive bad dept. This works to keep the dollar honest and facilitates economic expansion.
The government can and does facilitate liquidity through programs and the Fed but the Fed does not print money. However, create enough liquidity and it is the same thing.
The US Treasury accepts only bank reserves for the purchase of bonds at auction and such reserves can be created only by the Fed, a de facto government agency so by definition, the government creates money through spending. Primary Dealers are obliged to submit meaningful bids at Treasury bond auctions penalty the loss of Primary Dealer status. The Fed will also always make sure that enough reserves are in the system to clear a bond auctions (outright purchase of securities in the secondary market, Repos, etc…) If you look at “the machine” randomly in the middle of the cycle you may think that the public “fund” the deficit (previously spent money in private bank accounts are used to buy these bonds) in reality you need to always keep in mind that the money to purchase government securities can come only from the government itself.
My understanding is bank reserves (by definition) are deposited at the Fed by banks. It is not Fed money but bank money. Please cite a source for your comment.
Bank reserves are created by the Central Bank, always. Private Banks cannot create reserves and they cannot destroy them as well, all they can do is generate credit, bank money, a liability in their balance sheet. The only thing Private Banks can do with reserves is asking the payment system (Fedwire I guess, the experts can chip in) to shuffle them around from one bank account at the Fed to an other when they make a payment (for example, a money transfer) to another commercial bank. Reserves are created by the Central Bank when they buy an asset (for example, a government bond) and deposited at the original owner of the asset’s bank account at the Fed that private bank, in turn, will mark up the owner bank account on their liability side.
It’s been an education. Thanks Domenico.
Thanks for clarifying my sloppy definition. I should have said that governments can create money through direct spending.
Governments can create debt as long as someone is willing to hold it. When I borrow money from a bank, money is created and when I pay that money back, it is destroyed. That is just the normal functioning of an economy.
For your example, when the government spends $50 billion on healthcare, all the people who are involved in the transactions and end up with that money, have a claim on that country for $50 billion. If the government taxes to pay for the money it spent, that $50 billion claim is reduced. Why doesn’t the government just do that? Maybe it is not as sovereign as we think, it can create debt but it is worried that taxing the economy will result in lost investment and the economic growth that comes with it.
I strongly recommend that you investigate Steve Keen’s analysis of fiat monetary operations. Among other things, the Fed is your bank’s banker, so transactions between you, deposit holder at Bank X, and some other private sector entity (household, business, etc), deposit holder at Bank Y, results in multiple balance sheet entries. Let’s say you “pay” a local store $100 in the scenario above (you bank at X, they bank at Y). The multiple spreadsheet entries are:
Bank X debits your account $100
Bank X issues a transfer of $100 to Bank Y
The Fed debits $100 from Bank X’s account at the Fed and simultaneously credits $100 to Bank Y’s account at the Fed
Bank Y credits your local store’s account
The transaction has four essentially simultaneous debits/credits, which means in terms of assets and liabilities there are EIGHT entries.
No wonder it’s easy to confuse people who don’t aren’t fully aware of the plumbing …
Once the idea of the importance of small bank credit creation as being necessary for significant economic growth in the real economy is also allowed into the conversation, then there may be a worthwhile foundation for a hopefully productive discussion on the issue/role of centralized vs. decentralized creation and allocation of money in our economy.
From my perspective, small bank credit creation gives the average citizen more power, hence the plan of our central bank to eliminate as many small banks as possible.
I believe that MMT says that money is debt.
I’ve heard said that the FT is a rag of a failed empire, likewise the Economist.
Great article, thank you Mr Murphy.