By Dan Kervick
Imagine this: In a burst of manic, public-spirited zeal and budgetary enthusiasm, the US Congress passes, and the President signs, the following law. (Lawyers, forgive my poor mastery of legalese and feel free to translate the sense of what follows into the appropriate terminology):
L.1 The Secretary of the Treasury shall by a date no later than September 30, 2013 consolidate all United States Treasury accounts into a single account, to be called the “General Account”, and to be held at the Federal Reserve Bank of New York.
L.2 The General Account shall be used to settle and record all payments to and from the US Treasury.
L.3 The Federal Reserve Bank of New York shall on midnight, October 1, 2013 credit the General Account with an initial balance of $1,000,000,000,000,000.00
That’s one quadrillion dollars, about 263 times the current US annual budget, and about 63 times the current US Gross Domestic Product.
There is no question that Congress has the authority to do this. Constitutionally, the monetary authority of the United States rests with Congress. The Federal Reserve was created by an act of Congress, the Federal Reserve Act, and exercises its powers under that act. The Fed operates according to congressionally assigned mandates and regulations, and those governing rules can be changed any time Congress so desires. Congress also possesses the power of the purse; that is, it controls the US Treasury subject only to the possibility of a Presidential veto – which it can override.
So suppose it passed such a law. What would change?
Note that nothing important would change automatically. Congress could go right on spending exactly what it spends now and taxing exactly what it taxes now. It could even direct the Treasury to issue the existing forms of Treasury securities – notes, bills, bonds and TIPS – in exactly the quantities and denominations it currently does : about a trillion dollars net increase in debt a year. Business in the non-governmental sector would therefore go on more or less just as it does now, wouldn’t it? And so long as people were convinced the government was resolved to continue on as before, expectations of growth, employment, inflation and the rest should be unaltered.
So nothing important would have to change. But what would change and what should change? What would responsible fiscal and monetary policy look like in this new world of the gargantuan balance? What kinds of changes would the public call for? What expectations would people have about what the government’s policies would look like in the future? And how would those expectations influence their current behavior?
Now suppose Congress decides it doesn’t like the new law as originally written. They vote again, and section L.3 is replaced by:
L.3a The Federal Reserve shall on midnight, October 1, 2013 credit the General Account with a negative balance of minus $1,000,000,000,000,000.00.
L.3b The Federal Reserve shall clear all authorized payments by the Treasury, and adjust the General Account balance accordingly, permitting overdrafts when necessary without penalty to the General Account.
That’s minus one quadrillion dollars. Oh no! The government is out of money!
But wait: since the Fed is now required to permit overdrafts, it really doesn’t matter, does it? The balance in the account is just a convenient way of measuring the size of the Federal government’s transactions with the non-governmental sector. The absolute size of the balance doesn’t matter. If the Treasury has $1,000,000,000,000,000 in the account at the opening of business on October 1st 2013 and $999,000,000,000,000 in the account at the close of business on September 30th 2014, then its combined outlays and tax receipts amount to a transactional deficit with the non-governmental sector of $1 trillion. But the same is true if it begins with a minus $1,000,000,000,000,000 balance and ends with a minus $1,001,000,000,000,000 balance.
What if the account balance were $0? Or $1,000,000,000,000,000,000,000,000,000? Or minus $761,006,525,819.82? It seems obvious now that it doesn’t matter.
Unlike the rest of us, the government doesn’t need an account balance to spend. The balance is ultimately there for bookkeeping purposes. As the issuer of the dollar the government doesn’t fundamentally need to keep track of the money it has, but only needs to keep track of its taxing and spending. All it really needs is a sort of in-meter and out-meter. The economic impact of $3 trillion going in and $4 trillion going out is exactly the same, no matter what quantity happens to be in the account. In fact, so long as the government has a well-functioning and well-governed in-meter and a similarly well-functioning and well-governed out-meter, it really doesn’t matter whether the Treasury has an account balance at all. The incoming transactions from tax payments could be re-classified as “deletions”, since they just delete private sector balances without moving those balances to a government account. Similarly, the outlays could be re-classified as “creations” since they just create private sector balances without moving those balances from a government account.
But there are a number of questions we can then ask, once we have moved to this picture of the irrelevance of the absolute size of the government balance:
- Would the government still tax? How much? And from whom? And what purposes would the taxes serve?
- What about government spending? How would we direct our spending? And with the new accounting system in place, would the public change its perspective on how, and for what purposes, the government should spend?
- What about government securities? Would any purpose still be served by issuing securities? Who would be permitted to buy them? How would we conduct the sales? How should the rates be set?
- Would the government buy securities from others? And if so, then again, for what purpose?
- And once the psychological link between taxing and spending were broken, how would we understand the nature of our social contract in the economic sphere and the sphere of public finance?
This is just a thought experiment about an imaginary world and system of public finance that doesn’t exist. But thinking about this imaginary world seems to tell us something about the world that does exist. How should we think about the fact that both Republicans and Democrats in Washington are currently preparing to negotiate the details of a $1.1 trillion deficit reduction package due to reduce this year’s deficit by $110 billion dollars and reduce our GDP by 1.5% – all while the country is enduring a staggering 7.8% unemployment rate and a disturbing intensification and institutionalization of economic inequality? And how should we respond when both our President and the leadership in Congress tell us we are “out of money”?