In a recent blog post, I explained that government deficits increase the private sector’s holding of net financial assets. And this led to the following question from one reader:
And to the following command from another:
Below, I show why this is wrong. And note that I am showing that it is wrong. I am not cutting any corners, committing any economic sleight of hand or glossing over any institutional detail. I’m tracing through the actual balance sheet entries that reflect the government’s fiscal operations.
Before we begin, let’s make sure we understand what actually happens when the Treasury issues debt in anticipation of running a deficit. In the U.S. this involves a debt auction. So let’s suppose that the Treasury plans to spend $100 and anticipates tax payments in the amount of $90. If it did not sell bonds to coordinate its fiscal operations, the private sector would end up with a $10 net addition to its financial holdings. On this point, there appears to be general agreement. But what happens when the Treasury auctions off $10 of new debt in order to offset the “reserve add” that would otherwise result from this deficit spending?
This involves the use of what are known as Treasury Tax & Loan Accounts (TT&L). These accounts are held by thousands of private banks – known as Special Depositories – across the country. When one of these banks wishes to purchase government debt, it acquires the debt (Treasury bonds) by crediting the Treasury’s TT&L account. (Note that this is exactly how a commercial banks acquires a loan – i.e. it credits the bank account of the borrower and adds the loan to its books.)
In stage 2, the Treasury sells $10 of debt to BoA, and BoA pays for these bonds by crediting the Treasury’s TT&L account. (Again, this is analogous to a bank acquiring a loan by crediting the borrower’s account.) It does not “cost” the bank anything. No existing resources (reserves) are spent when the bond is acquired. BoA gets the bonds (assets) and the Treasury gets a credit to its account at BoA.
** One caveat: I did something here that adherents to MMT may wish I had not done – I began with the payment of taxes rather than with government spending. As we in the MMT tradition consistently insist, spending must, as a matter of logic, precede taxation in the first instance (for it would be impossible to collect dollars from the private sector unless they had first been spent into existence by the public sector). But in the real world, the Treasury receives tax payments on a daily basis, and government checks are clearing bank accounts on a daily basis as well. So there is really no objective beginning point or ending point. You can begin with spending if you prefer. But it will not alter the result.