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Paying for public services, in a monetary sovereign state

December 5, 2016

If our national Government was to spend more than the currently budgeted amount on your health care system next year, it would be good to know how they would finance that spending. It is a question that advocates of more health spending are always likely to be asked. More generally, exactly how is the total public spending which is currently budgeted for across the next year going to be funded? Do the various charts you see, linking the total tax take and government borrowing to items of government expenditure make any sense? If not, then why not?

The conventional view

This is that public spending must be paid for through taxation, government sales of assets, or issuing government bonds – in other words, through taxes now, ‘selling off the family silver’ now, or borrowing at interest now money which will have to be repaid in the future, and presumably setting up a burden of additional taxation for future generations.

Your reaction to this conventional answer might be a “conservative” one, which is to say, austerity to keep government spending down and privatisation, in order to keep taxes low: or a “progressive one”, which is to say, tax the rich and the multinationals much more highly, because the Government needs more money from rich people so it can pay for our public services.

Both of these reactions are wrong, or at least misleading, because they are based on that conventional view of public sector finance which I mentioned above. It is a conventional view which suits many conservatives, but is also (wrongly) accepted as being valid by many progressive people. It is – and this might surprise you – a view which the majority of highly credentialed economists, including Nobel Prize winners, know to be incorrect, but which many of them justify as a mechanism for imposing some restraint on politicians. They believe that if politicians only knew the financial options which are actually available to them, they would abuse these freedoms, ‘spend like drunken sailors’, wreck the economy.

Laws of Public Finance

I don’t believe there is ever a good reason for remaining in ignorance about something this important, and I think we have other ways of restricting what politicians do than telling blatant lies to the public, so I want to share the truth with you.

To keep this as brief and as straight-forward as I can, I am not going to dwell on the current institutional practices, conventions and rules, as they are applied in 2017. Current practices are very different indeed from how things were done before 1979. All the sets of conventions and rules which have been applied down the years have, to a greater or lesser extent, obscured the truth about public finance, which I can summarise in two sentences. Let’s call them two ‘laws’ of public finance (based on Lerner’s laws of functional finance, from the 1940s).

1 A government with its own currency (like the dollar), its own central bank (like the Reserve Bank), a floating exchange rate, and no foreign currency debt, faces no financial budget constraint at all.

2 Such a government faces real and ecological constraints, but no financial constraint.

Let’s be clear what we are talking about here. We are not talking about Greece. We are not talking about an independent Scotland, if Scotland were to keep the pound or join the euro (which I have recently advised a Scottish political party to stop saying they would do). We are talking about a genuine ‘monetary sovereign’. We are talking about the USA, Japan, Australia and the UK, among many others.

Monetary Sovereignty

The Australian Government is a monetary sovereign. Every time the Australian Government spends a dollar, it does so by crediting the reserves of a commercial bank which are held at the RBA (Australia’s central bank) by that dollar, and having the commercial bank credit the bank account of whoever has been the beneficiary of that spending. In other words, every time the Government spends, it creates money. Not some of the time – every time. All of the Governments spending creates money, and all this money is created using the equivalent of keystrokes on a computer.

The Government does not need to receive your money in taxes, or borrow your money by selling bonds, or raise money from you by selling you shares in government owned utilities …. before it spends. Think about it for a moment. It isn’t, in a literal sense, your money in the first place. Who issues the nation’s currency? The RBA. And who owns the RBA? The Australian Government. The Government doesn’t need to collect its money, which it creates, from you before it can spend.

Every time our national Government spends, it creates some of its money for the purpose. I know commercial banks create a great deal of deposits for themselves, and a great deal of what is normally defined to be ‘the money supply’ by lending to their customers, but they can only do this because they have access to Government money, in the form of their reserves at the RBA. There are two ways for this money to be created. One is the Government spending this money (permanently) into existence, and the other is the RBA lending this money (temporarily) into existence.

We have come to the answer to our initial question. How can we pay for an increase in health spending? The same way that we pay for all public spending. The Government will spend the money into existence. The way the accounting is done these days, and current institutional practices, obscure this truth, but they do not change the fact that it is a truth. It is not a theory. It is a plain fact.

Let me put it more simply. Money does not grow on trees. It is easier than that. Money comes from nowhere. It exists mainly in the form of electronic entries on spreadsheets (these days), and you can say it is typed into existence. Our Government can no more run out of dollars than the scorer at a cricket ground can run out of runs, perhaps something to remember the next time our Australian boys go over to England to win the Lords’ test match. In this sense, the Government really does have a ‘magic pudding’.

You might ask me whether I am talking about ‘printing money’ to pay for the Government’s spending. You might conjure up visions of Zimbabwe or Weimar Germany. I’ll deal with those briefly in a footnote below, but let us be clear – in a sense, all of Government’s spending always involves ‘printing money’. Except, I hate using that term, because of its associations, and because it is a little misleading. Very little modern money is actually printed, remember – it is nearly all electronic.

The Purpose of Taxation

The question is, then, why do governments tax people at all? Taxes do not ‘pay for government spending’, after all. Taxes do not pay for the education service. Taxes do not pay for Medicare. It might make you feel better to know that your taxes are not paying for military weapons. They really aren’t. The Government doesn’t need to get money from rich people before it can spend. Your taxes, in a literal sense, do not pay for anything. Taxes, at least in a monetary sovereign state, pay for nothing at all. 

So, why do we pay taxes? There are many distributional, or microeconomic, functions which the tax system fulfils. However, at the macroeconomic level, the purpose of taxation is very simple. It is necessary for people to pay taxes to destroy (to use a provocative word) some private sector spending power, to make room within the economy for the government to conduct its desired spending on public goods and services, without pushing total spending in the economy beyond the productive capacity of the economy and causing inflation. Taxes limit inflation, helping us to maintain the spending power of money, so that people maintain their confidence in the value of money.

Deficit Budgeting

We have reached the second law I wrote down above. As a society, we cannot run out of dollars, but we can run out of people, skills, technology, infrastructure, natural and ecological resources. There are limits – but the limits are ‘real’ and not financial. When planning for the future, governments should use their freedom from financial constraints to plan wisely to manage the real and ecological constraints which will always be with us.

The Government, then, cannot spend without limit, because it would push total (private sector plus public sector) spending beyond the current capacity of the economy, and be inflationary. So we have to pay taxes.

This does not, however, mean that governments need to ‘balance the budget’, or should ever attempt to balance the budget, or limit its deficit to a specific proportion of GDP. In fact, most Governments (including Australia) have hardly ever run balanced budgets or budget surpluses in modern times, and when they occurred they tended to be just prior to economic downturns. For example, there were very small and very temporary fiscal surpluses in the UK in the late 60s, the late 80s and the late 90s. The rest of the time, the UK Government has been in continuous fiscal deficit, since the early 1950s.

This is true almost everywhere, with almost all the exceptions being relatively small and oil rich countries, like Norway. In the case of Norway, what makes it possible for the government to run fiscal surpluses is not the ‘sovereign wealth fund’ you may have heard about. It is simply Norway’s consistently large trade surplus with the rest of the world.

Most governments most of the time historically have run budget deficits. This is essential, because if the rest of us want to build up our savings in dollars (including foreigners in ‘the rest of us’) it turns out the Government will be forced, one way or another, to run a deficit. A good deficit will prevent a recession from happening, and a bad deficit would be the consequence of a recession happening and tax receipts crashing while welfare payments rise, when everyone wants to save and not spend. To explain the logic properly would mean going into too much detail here, but believe me it is a mathematical (or accounting) fact of life.

Sovereign Government Debt is Different

Doesn’t all this mean the Government getting further and further into a burdensome ‘debt’, which future generations will have to repay, so that government borrowing is somehow immoral, and especially so if it isn’t to pay for investments in the future?

Not once you understand that monetarily sovereign governments don’t and can’t really borrow in their own currencies, at all, in the conventional sense of the term. If you or I, or a business, or a local authority, borrow in dollars, then later on we will have to repay that debt and the interest on it, or we will go broke. We are (obviously) not monetary sovereigns. We face a financing constraint.

It is different for our national Government. I have already said that the Government spends new money into circulation, and then uses taxes to destroy some of that money so that there won’t be rising inflation. Ideally, the Government should spend more than it taxes, when it is running a deficit, to ensure that total spending in the economy is at the right level to maintain full employment. The total level of public spending, how it is divided up between public goods, and the structure of the taxation necessary to limit inflation, are then political issues.

Until the Global Financial Crisis, and before some central banks started doing quantitative easing, it was necessary for their governments to sell government bonds to more or less match government spending net of taxes, in order to keep control of interest rates. The reasons are a bit dull, but if you bear with me I will try to explain.

Interest rates in general depend on the interest rate banks charge each other when they lend each other money for liquidity management purposes for very short periods of time. A fiscal deficit effectively feeds cash reserves, or liquidity, into the banking system. In the past, it was necessary to remove those reserves again by selling government bonds, or this interest rate would fall below the level the central bank wanted it to be at. Banks with plenty of reserves of cash don’t need to borrow from other banks. Sales of government bonds were about keeping the supply of cash to the banking system limited to the right level to stop interest rates falling.

That’s all changed now – at least in the UK, the USA, Japan and the Eurozone. The central banks of all those countries first cut interest rates to virtually zero, after the Financial Crisis, and then used quantitative easing to deliberately flood the banks with cash reserves, by purchasing large amounts of (mainly govern-ment) bonds from the private sector. The so-called ‘bank rate’ is now not a rate of interest at which private banks lend to each other – it is now the rate of interest that central banks pay on the huge amount of reserves the commercial banks have on deposit with it. Rather than seeking to limit those reserves, the central banks have been deliberately increasing them.

Yet the old practice of each government selling its bonds goes on. It is rather ridiculous at the moment, because as the governments concerned are selling new government bonds – in a conventional view, to raise money – their own central banks (which are owned by each government, remember) are kept busy buying those same government bonds second hand from the private sector, in order to increase the amount of money in bank reserve accounts. It’s very strange and anachronistic. Economists like me view it as something of a muddle.

We have learned in recent years that there is no genuinely good reason for selling government bonds at all, if you are a monetary sovereign government. Indeed, it would be better to convert them into term deposits at the central bank, and to regard them as a form of money. 

After all, at the moment bank reserves held at the central bank are (in an accounting sense) Government liabilities, on which the central bank as part of the Government pays interest, but are not seen as Government debt: government bonds are also government liabilities, on which the central bank on behalf of the Government also pays interest, but they are seen as Government debt.

Moreover, if the central bank, as a part of QE, buys Government bonds from the private sector, it is just swapping one interest bearing government liability for another. No wonder QE doesn’t work! It isn’t ‘free money’ at all. It is basically swapping two very similar assets for each other. The private sector used to own Government bonds and receive interest. The private sector now owns reserves at the central bank, and still received interest.

Summary

Why would that arrangement act as much of a ‘stimulus’ for the economy? Why, indeed? To cut a very long story quite short:

1 When the Government spends it creates money.

2 When the Government taxes it destroys money.

3 Government ‘debt’ should not be thought of as ‘debt’ in the conventional sense at all. It is better thought of as a form of money.

4 The Government cannot run out of money, and as long as it doesn’t guarantee to convert its money at a fixed rate into anything it could run out of, it faces no financial constraints at all.

5 However it faces real and ecological constraints, because we can run out of people, skills, technology, equipment, infrastructure, natural resources, and ecological space.

6 The Government is NOT a household and NOT a business, and has nothing at all in common with a household or a business, where financial matters are concerned.

7 When progressives understand this and start framing their arguments in this light, I believe they will be able to argue their points far more effectively and persuasively, and free themselves from what are sometimes called ‘neoliberal dogmas’ (i.e. conservative and ‘new labour’ nonsense).

Understand all of this, and I think that it will change your perspective on many things. And ought to make you a great deal more confident when dealing with interviewers. If they approach you using the conventional view as a framework, remember that it is either because they have never really thought these issues through or because they are being dishonest for some reason (sometimes it is a mix of the two, and people can, of course, be dishonest with themselves, or at least suffer from cognitive dissonance). 

Footnote: Mugabe’s Zimbabwe and Weimar Germany 

Zimbabwe 2008  If you engage in a poorly planned and violent land reform, regardless of your motivation, there will be consequences. Zimbabwe’s govern-ment managed to wipe out its vital agri-cultural system, while at the same time alienating most high income country governments, and facing sanctions. The supply of food failed. The Government then (literally) printed vast amounts of money to buy non-existent food, and inevitably the price level sky-rocketed. Ever higher prices then led to ever more money being printed, so that at least the friends of the government and the army could be provided for. The result was hyperinflation. The lesson is that if you destroy the supply side of your economy and try to make up for it by printing loads of money, you will be able to create hyperinflation. Zimbabwe 2008 has no lessons for Australia 2016.

Germany 1923  Germany’s productive capacity had been destroyed by war and by the resolution of that war. In addition, Germany had been required to pay vast amounts of gold to its former enemies. The only way to obtain the gold was to buy it, using marks which could then only be spent into a German economy already on the brink of famine. There were some other issues, but it’s basically similar to Zimbabwe 2008. If you destroy the supply side of an economy and then print loads of money, you will push spending far beyond the productive capacity of the economy and create inflation.

Steven Hail

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23 Comments
  1. Thank you steven Hail for that – a very rare and constructive explanation, i will now re-read both Johns piece and his reply.

    perhaps my idea can be summarised as Regulating privately-created Money into Existence and paying your Share (banks, that is, to “reduce deficits”) – if Governments played its part getting interest rates on “borrowed” money down to payments being the equivalent to the savings on fossil fuel [and cancellation at end of term] – and put the initiative out for home and building owners. Much more efficient approval than grants – Do you think they (govt) could cope with more efficiency if it meant a shorter working week for those fewer officials earning less in doing their job? for example ultra-insulating means less fossil fuel but a new industry for in Australia’s case lasting maybe 30 years, eco-enveloping?

    the private sector in WA did something similar by simplifying construction of houses – brick and tile with raft foundations… Please let me explain on the phone +44 7702 569 077 – 8 am to 8 pm GMT

  2. Reblogged this on unionsnswinfo and commented:
    An excellent explanation by Stephen Hail of how our modern monetary system really works. Read this to help understand the false impressions created by just about all the press, all the politicians and most economists

  3. jonpatterns permalink

    Brilliant post. I think part of the problem is it seems hard to believe the governments spends money into existence – as you mentioned cognitive dissonance. It is far from people’s everyday experience with money.

  4. Dear Steven,

    Enlightening piece, thanks. Why are Conservatives Government economists and ministers arguing for austerity in the UK? Is it a political move to privatise public services to make their friends rich as the Labour Party claim?

    Thanks

  5. JohnB permalink

    Dear Steven,
    Love your work.
    A query:
    The govt is paid an equivalent amount of currency in circulation (pre-existing govt. liability) in exchange for the issuance of CGS security ‘paper’ – but the transaction is recorded on national fiscal balance sheets as an increase in govt. liabilities.

    When that same transaction is recorded on the private investor’s balance sheet, the purchase of that ‘security’ would be recorded as:
    1) A reduction in available ‘Current assets’ equal to the amount of money spent to acquire the purchased bond/s;
    2) An increased in the value of set term/interest bearing ‘Investments’ held – an equal amount to the reduction recorded in ‘current assets’.

    In other words, the transaction (at the time of purchase) represented a transfer of money from a readily convertible ‘liquid’ form (cash) to a (interest earning) not so readily convertible investment form (ie security contract).
    At that instant in time, there has been no increase in the net wealth of the investor, though ‘interest’ dividends will be received per agreed investment terms.

    However, when that same transaction is recorded on the National Governments balance sheet, the transaction reflects only an increase in govt liabilities.
    e.g. If cash received ‘x$’ was recorded as a reduction in ‘currency in circulation’ liability, the entry would then be countered by a corresponding value ‘x$’ of issued security ‘paper’ liability – thus recording zero net change in govt. net worth – as it would be recorded (in reverse) on an investors balance sheet.

    I have been unable to locate in budget documents a counter entry to reflect the decrease in govt. liabilities through receipt of an equal amount of currency (govt. debt) in circulation as payment for the bond/security issued.
    I presently believe that no such ‘credit’ entry exists due ‘special accountancy rules’ for national accounting – but have been so far unable to conclusively prove it.

    My question is:
    As one familiar with ‘budget papers’, are you able to locate/identify a ‘balancing’ cash credit in budget papers that corresponds to the issuance of a CGS, and if not explain why such an entry is not required to be present.

    • The decreased liability is a liability of the Reserve Bank of Australia, the balance sheet of which ought to be incorporated into the balance sheet of the Commonwealth Government, since it is wholly owned by the Commonwealth Government. So of course no such entry exists. This is a problem with the accounting though, and irrelevant to the facts. While I admire your tenacity, it is a waste of time, really, studying the budget papers for something that won’t be there.

      Moreover, worrying about a distinction between currency as a current asset and government securities as capital assets is again a waste of time. Government bonds markets are highly liquid, so that investments in government bonds are effectively investments in current assets. They are safe and easily convertible into cash with very little risk instantaneously. They are best thought of as tradable term deposits at the RBA.

      Steven Hail

      • JohnB permalink

        Thanks Steve for your reply – it concurs with my understanding of the so called national ‘debt’.

        In conversing with those unfamiliar with the intricacies of federal finance I represent it in simple terms like this:
        One must start with incontrovertible fact 1)
        1) to the currency issuer all ‘money things’ are the debt of the issuer.
        “Australian currency issued represents a liability of the Reserve Bank of Australia in favour of the holder….” – http://www.finance.gov.au/sites/default/files/11_Notes-8A-to-8G.doc (Page 6)
        2) a) therefore, since money in circulation is already govt debt, the ‘swap’ of ‘circulating currency’ for an interest bearing deed/contract/certificate of the same monetary value represents no change to the currency issuers net liability at that instant of time.
        b) It is merely a swap in the form of an existing (continuing) liability – however, since the interest accrual under the issued ‘contract’ changes the liability value over time, the ‘debt’ is therefore recorded on the govt budget papers.

        Point 2b above is mirrored on an investors balance sheet; i.e. It is merely a form swap of an existing (continuing) asset.
        Just as an investor incurs no gain in net worth at that instant of purchase, the Fed govt incurs no net worth loss – no principal debt exists.

        The only additional ‘cost’ to a currency issuer is the interest cost associated with locking the money out of general circulation for the duration of the contract.
        Since the interest ‘cost’ is paid (in the issuers own currency) via keystrokes it is an almost insignificant burden.

        In my opinion the scare tactics used by neoliberal economist (and most politicians) in negatively framing the national debt, and demonising essential nation building fiscal deficits constitutes vandalous debilitation of our nation .

    • David permalink

      Enjoyed reading the explanations and clarifications. Interesting aspect regarding proportions of real resources consumed that are attributable to private versus public spending, and the role of taxation to limit inflation, along with balancing act to “optimally” engage or utilize real economic resources. It seems that there is a concern to the extent that public spending crowds out private, where centralized decision-making by government on resource allocation increasingly dominates private sector decisioning. A balancing act I presume, but am biased that more effective price discovery and wealth creation (and more fair distribution) would come from private markets than from government spending. A big issue when taxation levels on middle class removes 50% or more of respective income. The level of this wealth redistribution creates a lot of frustration / anger, and certainly drives efforts to investigate and create new forms of money. Also, would be important to include impacts of international trade and debt obligations in the analysis, introducing “currency wars” implcations.

  6. steve13565 permalink

    A very good explanation of the subject that I will share with readers of my blog. Of course, I have some minor quibbles with some of your wording. You do eventually get to mention that the Fed buys a lot of bonds. This explanation mitigates some of my quibbles about previous statements.

    One of the things I have come to quibble with about MMT explanations is that MMT uses accounting balances in sectors to come to certain conclusions that are overstated. To say that fractional reserve banking in the private sector does not produce high powered money because for every dollar given out as a loan the books also carry a counterbalancing accounting entry of the borrowers promis to repay the loan. In a static accounting sense this balance is certainly true. However, the static accounting balance does seem to blind MMT to the dynamic impact of giving out spending money immediately and the counter balancing transaction is to repay that money later, sometimes much later.

    That lent money has tremendous economic impact in the time between the giving out of the money and when it has to be paid back. Your statement that government bonds that pay interest are the equivalent of deposits at the Fed is one of those instance where you ignore the time shift factor. To get cash for a bond that has not matured, the owner has to get someone to buy that bond back. If the Fed buys it, then it is similar to the reserve account at the Fed. If someone in the private sector has to put up the money to buy the bond, then it has a different impact than if the Fed buys it.

  7. There appears to be misconceptions here Steve13565.

    Firstly, MMT is not blind to the dynamics of bank credit money creation or any transactions involving it. Credit money created by a bank certainly impacts the real economy but has no direct impact on the bank’s net worth (capital, equity). Putting it another way, banks do not create net financial assets, but governments do.

    Secondly, not all bank credit money is created by bank lending, as there are many other mechanisms by which this form of money comes into existence. So it does not necessarily need to be paid back.

    The point you are making about Treasury bonds is unclear. Treasury bonds may be thought of as a form of “broad” state fiat money, while banking reserves may be thought of as a form of “narrow” state fiat money. If broad money is traded for narrow money before its term has expired, then there is a price to be paid in terms of interest foregone. This is analogous to the broad money (term deposits) and narrow money (demand deposits) created by commercial banks.

    • steve13565 permalink

      Economicreform, thanks for addressing my issues.

      “Credit money created by a bank certainly impacts the real economy but has no direct impact on the bank’s net worth (capital, equity).”

      In looking at inflation and deflation or economic growth, concentrating on a banks net worth is somewhat of a distraction. Concentrating on creating only net assets also distracts from looking at the impact on the behavior of the economy. The fact that the Fed created trillions of dollars to keep the economy from collapsing in 2008/2009, but no inflation occurred requires answering the question of why it did not. The fact that the private sector did not put that money to work, but just used it to inflate the stock market and buy Treasury securities or just keep the cash and the banks did not make loans to multiply the cash had to do with the economic situation. We have to ask the question of what happens when the economic situation changes so that the private sector decides to put that money to work. Does the Fed have a plan to sop up the excess liquidity? Does the Fed account for the fact that even if they pull some liquidity out of the private sector, the banks will multiply what is left by making loans in sufficient quantity to cancel out some of the Fed’s actions.

      I fear that all the talk of sector balance being an accounting identity and banks not creating net assets will lull economists into thinking that keeping the balance in the economy is wholly in the control of the Fed. The tax structure may also need to adapt to the changing economic conditions, and getting Congress to make those changes in a timely manner is probably impossible.

      Yes, I know the banks aren’t the only ones doing this, but I use them as one example of how it is done. Any act of lending money has the potential of doing what the banks do. I am also worried about the impact of mark-to-market valuation of assets. The Fed and the taxes have trouble controlling that as we saw in the dot com bubble.

      MMT would gain a lot of credibility in the world if it were to explicitly deal with these topics in a forum where the public could see the answers.

  8. I agree that the Fed’s monetary policy exercise known as quantitative easing has been a failure. However that exercise did not create net financial assets — it was an exchange of one form of financial asset for another form.

    Only the government alone (i.e. not the Fed) can create net financial assets and inject them into the real economy, using fiscal policy and operating through Treasury.

    • steve13565 permalink

      John Maynard Keynes explained in the 1930s why monetary policy cannot stimulate the economy when there is a shortage of consumer demand. That is about the only thing we can agree on. The Fed is part of the government. The difference between the Treasury and the Fed is irrelevant when the legislative branch refuses to authorize fiscal stimulus.

  9. The Fed is semi-independent. However I agree that ultimately the Fed cannot operate independently of the will of the legislature, administration and Treasury.

    I would ask: when was the last time that the legislature refused to allow the debt ceiling to increase? The reality is that it cannot refuse to do so without crashing the economy, and I would suggest that there would be a heavy political price to be paid for that eventuality at the next election. I would also suggest that most of the objections to doing so by elected members of the legislature are little more than political posturing and grandstanding.

    • steve13565 permalink

      According to the Federal Reserve Banl in the article “Who Owns the Federal Rserve ?” http://www.federalreserve.gov/faqs/about_14986.htm

      ===== quote =====
      The Federal Reserve System fulfills its public mission as an independent entity within government. It is not “owned” by anyone and is not a private, profit-making institution.
      ===== /quote =====

  10. In practice the Fed and Treasury work cooperatively. The Fed knows that Treasury has the ultimate whip hand if it ever chose to use it. For example, Treasury could arrange for bonds to be sold to the private sector and not match this with commensurate spending, or simply delay such spending. In order to retain control of the federal funds interest rate the Fed would then be forced to buy bonds from the private sector. The net result of such operations is that Treasury has effectively sold bonds to the Fed. And notwithstanding that there is a legislative prohibition in the U.S. for Treasury to directly borrow from the Fed.

    • steve13565 permalink

      If the Treasury sells bonds to the private sector (which is the only place it can sell them), The Fed would not be “forced” to buy them. The sale of bonds might not push the interest rates out of the bounds that the Fed is aiming for. On the other hand, the Fed might decide to let the interest rates move. As far as the decisions of the Federal Reserve Open Market Committee is concerned, they are free to make thier own decisions, independent of what the Treasury does.

  11. It obviously depends on the volume of Treasuries sold to the private sector.

    And in an endogenously operated financial system, the Fed conducts its monetary policy in a reactive manner. This is because its prime mission, indeed the main reason for its existence, is to target interest rates and keep them within prescribed bounds. It cannot afford to lose control of interest rates.

    Therefore my point stands, that the Fed cannot operate in an entirely independent manner from the operations of Treasury or the will of the government. In other words, the story that the Fed operates as a fully independent entity is a myth.

    • steve13565 permalink

      Using circular logic to “prove” your point just has you spinning around in circles. The Fed is the one that decided to focus on interest rate control rather than employment levels. Nothing that Congress did made them change their focus. It is wrong to imply that the main reason for the existence of the Fed is interest rate control.

      The actual main reason for the Fed started out to be the prevention of bank failures that would take down the entire economy. Since the end of the gold standard, again in 1972, the Fed has had more policy choices to get its job done.

  12. I see no circular logic. It is irrelevant who decided what the focus of the Fed should be. It is simply a fact that interest rate control is their modus operandi in regard to conducting monetary policy, and has been for a long time. It is also a fact that the financial system operates endogenously and that the Fed operates reactively, not proactively, in that context. And because this is their focus, they need to be aware of and take account of the government’s fiscal operations. Fiscal policy and monetary policy cannot operate in an entirely independent manner without serious consequences arising for the economy. This is why, in the wake of the global financial crisis, and in response to the need to keep the economy from becoming seriously depressed, the Fed and Treasury worked together in a cooperative manner. The Fed did not operate independently of the will of the Secretary of Treasury. Lastly, the Fed was created by government and its officials are well aware that it can be uncreated by government if a perceived need to do so arises.

    • steve13565 permalink

      The Fed may target interest rates now, but they have had other targets in the past, and they could revert to those targets whenever they wish. The Fed reacts to how they think the economy will go. If that is reactive instead of proactive, that is mostly about how you define the words. Of course the Fed and the Treasury work together when they have to and when they are permitted to. When the Fed created $29 Trillion to stop the crash of 2008/2009, I don’t see how the treasury was involved. The Fed’s policy of quantitative easing doesn’t concern the Treasury either as far as I can tell. I think the Secretary of the Treasury had little legally mandated or authorized role in the way the Fed created $29 Trillion. The Fed could be uncreated by Congress, but in the current political environment the Congress cannot bring itself to agree on much. The Fed has a lot of political backing from the people who have bought the Congress. I wouldn’t think there is much fear of Congress at the Fed.

      You can argue whether the chicken came before the egg forever. You can focus on certain aspects of the economy while ignoring other aspects to seem to prove your point. You can ignore John Maynard Keynes’ explanation that monetary policy is a weak tool when there is lack of consumer demand. The Fed can certainly be a hindrance to the economy, but once it has let out all the stops and it hasn’t helped, there isn’t much more the Fed can do. It is up to Congress to stop conning us, and time to start to care about the bottom 90% of us.

      Have you driven on the US roads lately? That is an example of how our infrastructure is crumbling, but Congress would rather pay for bombs rather than roads. The Fed has little to no influence on these matters. When the Fed chief testifies before Congress, I don’t think I have ever heard her or him tell Congress to get off their asses, and do what needs to be done that the Fed does not have the power to do. I have never heard the Fed chief tell Congress that they are undermining what the Fed is trying to do.

  13. Part of the government’s strategy for handling the crisis was TARP, administered by Treasury, not the Fed. The activities of Fed and Treasury needed to be coordinated in that context. Unfortunately the Fed’s exercises in QE have failed to achieve their objectives.

    The government (under advice from the secretary of Treasury) appoints the Fed chairman, and requires accountability from that person in regard to the Fed’s activities at regular congressional hearings. The Fed exists and operates at the pleasure of Congress. And I realize that Congress has also failed the nation, but that is not the issue at hand.

    I am not really interested in proving a point with you, and you are entitled to your own views. You seem to have made up your mind, so I see no point in continuing this discussion.

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