By L. Randall Wray

*The title of this post was inspired from a post by Mike Sax.

First an admission. I’m not really a blogger. I occasionally write pieces that somehow find their way onto blogs, but I rarely read or respond to blogs. I have no idea who is who in the blogosphere. For example, I do not know someone named Scott Sumner, who is apparently a Very Important Person in blogoland.

I note that he’s associated with the proposal that the Fed target nominal GDP. When I first heard about this, I thought it was a joke. Yeah, right, might as well have the Fed target the Earth’s Wobble. Gee, I’d really like the Fed to stabilize the tilt, to achieve San Diego’s invariantly moderate climate in upstate NY where I spend much of my time!

You see, the Fed has tried and failed to target Bank Reserves, Money Supply, and Inflation. So, what the heck, let’s have the Fed try and fail to hit Nominal GDP. As if the Fed has any tool that would allow it to do that. Anyone who understands central banking knows that central banks have one tool in their tool kit, and it is not a Hammer. It is the overnight interest rate—the rate at which it lends to banks, and at which banks lend to each other against the safest collateral. That target, in turn, impacts other short rates on other very safe lending and on Treasury Bills. Most bets are off once we move beyond that, however. The Fed has been trying for years to get the mortgage rates low enough to stimulate home buying—using ZIRP and QE1, QE2, and QE3 up the ying-yang to very little effect.

So, I still laugh anytime I hear anyone suggest that the Fed target NGDP. Good luck with that.

In any case, Sumner claims to have found MMT’s Achilles’ Heel. He sets up a hypothetical example.  Presume GDP is growing at 5%, unemployment is 5%, and the nominal interest rate is 5%.

An Aside: I can recall when I visited the Mayor’s office in Istanbul where it was reported that national inflation was about 29%, the nominal interest rate was about 29%, and the government’s budget deficit was about 29%–whereupon I told the Mayor that Turkey had hit the perfectly sustainable Trifecta! (See below for more discussion.)

But, Sumner interjects: suppose the central bank lowers the nominal rate to a big fat Zero. He predicts that GDP would DOUBLE and the price level would DOUBLE!

And somehow that proves MMT is wrong? Here’s his argument as well as his claim.

“Suppose we pick a fairly “normal” year, when NGDP growth and nominal interest rates and unemployment are all around 5%. It might be 2005, 1995, 1985, whatever. The exact numbers aren’t important. Now the Fed does an OMP and doubles the monetary base by purchasing T-securities. They announce it’s permanent. What happens? One MMT answer is that the Fed can’t do this. It would cause interest rates to change, and they peg interest rates. But the more thoughtful MMTers seem to be willing to let me do this thought experiment, as long as I acknowledge that interest rates would change and that it’s not consistent with actual central bank practices. I’m fine with that. So let’s say they double the base and let rates go where ever they want. I claim this action doubles NGDP and nearly doubles the price level. MMTers seem to disagree, as I haven’t changed the amount of net financial assets (NFA) at all. But here’s the Achilles heel of MMT. Neither banks nor the public particularly wants to hold twice as much base money when interest rates are 5%, as that’s a high opportunity cost. So they claim this action would drive nominal rates to zero, at which level people and/or banks would be willing to hold the extra base money. Fair enough. But then what? You’ve got an economy far outside its Wicksellian equilibrium.” http://www.themoneyillusion.com/?p=10238

Now, my own projection (and what I told the Turks) is that bringing down the interest rate will simultaneously reduce the budget deficit and nominal GDP growth—with falling inflation accounting for most of that. So, lowering Turkey’s interest rate from 29% to 0% would have eliminated most of the budget deficit (since government would spend far less on the Trillions of Turkish Lira debt it had to roll-over every month) and also inflation. So Turkey might have managed to bring interest rates, nominal growth, and budget deficits all down to the sustainable Trifecta of Zero! (By the way, Italy ran that experiment before joining the EMU—her interest rate and budget deficit were double digits, and after Warren Mosler talked to the Treasury to convince them that Italy would not default on Lira debt, rates were reduced, deficits came down, and inflation also fell.)

But let us ignore for a moment the possibility that lowering interest rates actually reduces budget deficits and growth, while raising unemployment. How does Sumner get from a 500 basis point reduction in overnight interest rates to a GDP that DOUBLES? Really?

Let’s give him the benefit of the doubt, and ignore the usual impact of Fed reduction of rates of 300 or 400 bp—which historically has had an impact of just about nil, nada, zip. Sumner argues we must ignore all the previous cases of interest rate reductions, because these occurred outside “normal” times. So let us say we are in a “normal” time, where the economy is humming, in conditions where the Fed would normally begin to think about raise rates because unemployment is already down to 5% and GDP growth is at 5%.  So the Fed instead tries Sumner’s experiment, reducing them by 500 bp. Sumner claims GDP will DOUBLE and prices will DOUBLE. Just how plausible is that? What kind of interest rate spending elasticities are required? And what is the time period required?

Some time ago my colleague Linwood Tauheed and I surveyed the orthodox literature to obtain estimates of interest rate elasticities. You need to remember that the Fed only directly controls the fed funds (and discount) rate, so lowering that rate by 500 bp is not going to lower the rates that really matter for private spending—longer term rates—by nearly so much. Indeed, operation QE has been relatively impotent—in the Fed’s own reckoning—even as it tried to directly lower longer-term interest rates. As the following graph shows, interest rate spreads over 10 year treasuries (which track the Fed’s policy rate reasonably well) are no where near constant. Indeed they vary by 200 bp to 300 bp–which is as much of the maximum “umph” that we could expect from Sumner’s experiment.

Lowering the fed funds rate also won’t necessarily lower the risk premium—overnight interbank borrowing is collateralized by safe treasuries, so firms and households are not going to get anything like zero rates since their borrowing is riskier. Let us be generous and presume that Sumner’s scenario can lower rates to actual borrowers by 200 or 300 bp—which would be quite a feat, far exceeding QE’s impact on loan rates. How much would private borrowing and spending rise? In Sumner’s view, they would rise sufficiently to DOUBLE GDP—ie from approximately 15 Trillion to 30 Trillion dollars. That is a big impact.

Real world, mainstream, estimates of the interest rate effects on spending are orders of magnitude lower than Sumner’s claim.

However, let us say that Sumner’s own fairly outrageous presumptions turn out to be correct. Would that invalidate MMT? Is a substantial impact of interest rate changes on aggregate spending a refutation of MMT?

I cannot see how. All that MMT claims is that if the Base is doubled, increasing banking system excess reserves, then the overnight rate will fall towards zero or the support rate paid by the central bank on reserves (presumably above zero). While MMT is skeptical that this would simulate spending, no part of MMT stands or falls due to an inverse and substantial interest rate elasticity of spending. If monetary policy is potent in that respect, so be it. Use it if it works, when it works. If it doesn’t work, then use fiscal policy. Our bet is that it won’t work. But that is a projection that can be decided by experiment. So far, it has failed handily—monkeying around with interest rate hikes and cuts have had no discernible stabilizing influence on the economy. But we can pretend the Jury is still out.

Nay, Sumner’s battle is with economics—both mainstream and heterodox. There isn’t any theory or evidence in support of his claim that a 500bp reduction of the overnight rate would lead to a doubling of GDP and the price level. It is the claim of the unschooled or the ideologue.

In short, Sumner’s thought experiment does not expose any weakness of MMT. If anything, it exposes a weakness in his thinking. He invokes Wicksell in his argument that doubling the monetary base would double GDP because neither banks nor the public will want to hold twice the base—hence they lend and spend until the cows come home and NGDP doubles. For those who do not know, Wicksell was a pre-Keynesian economist who had some interesting ideas. But drawing on Wicksell when you’ve got Keynes would be like an astronomer going back to Copernicus when you’ve got Galileo.

He concludes:

“That’s the flaw with MMT; it’s not net financial assets that matters, it’s currency…. It was hard sifting through all the comments, which were often on side issues, but it seems they regard base money as just another financial asset. But it’s not, which is why their view of monetary policy is wrong. Indeed in a sense they don’t even have a theory of monetary policy, they have a fiscal theory that implies open market operations don’t matter.”

That looks confused to me. By definition, net financial assets in the private sector = government liabilities. These are Treasuries (bills and bonds) plus Base (currency and reserves). Budget deficits, for example, lead to nongovernment surpluses, accumulated as either Treasuries or Base. Open market operations change the composition of NFA held: a purchase of Treasuries by the Fed reduces Treasuries and increases Base held by the nongovernment sector—but does not affect NFA. (A sale has the opposite impact.) Monetary policy is about liquidity—reducing or increasing the liquidity of private portfolios. Rates will adjust to balance portfolio composition with desires. But since the Fed targets the overnight rate, it needs to prevent movement of rates away from target—and does that by accommodating desires.

Fiscal policy is about spending—reducing or increasing NFA. These are statements of fact, not theory. MMT certainly would not say that OMOs “don’t matter”—they affect liquidity, which can be very important when the Fed stops a run on financial institutions by lending reserves or providing them in OMPs. Sumner is just plain wrong if he thinks that simply buying Treasuries in “normal” times causes banks to increase lending, which is transmitted to more spending, more NGDP and more inflation. All it does is to substitute Reserves for Treasuries. Again, Fact, not Theory.

Some years ago I co-authored a paper with my colleague Linwood Tauheed, titled SYSTEM DYNAMICS OF INTEREST RATE EFFECTS ON AGGREGATE DEMAND, that investigated the likely impacts of interest rate changes on aggregate demand. We used conventional estimates of interest rate elasticities for investment spending, as well as for parameters like the marginal propensity to consume. Unlike most conventional studies, however, we included the effect of rate hikes on government spending on interest—hence the interest income channel. As rates rise, the nongovernment sector earns more interest income, of which some is spent on consumption. We tried different government debt ratios and found that with a high enough debt ratio, raising rates would indeed stimulate spending. We can call that a “perverse” effect of monetary policy. Let me provide a few paragraphs from that paper to give you a flavor of the analysis. (Note this is from around the year 2000.) In particular, pay attention to the discussion of conventional estimates of interest rate elasticities—which are surprisingly small, and far too small for Sumner to get the results he wants.

However, note that validity of MMT does not hang on these results—even if monetary policy is as powerful as he believes, and the interest rate elasticities are much higher than those found in the literature, this is not inconsistent with MMT.

Heterodox economics has always been skeptical of the Fed’s ability to “fine-tune” the economy, in spite of the long-running Monetarist claims about the efficacy of monetary policy (even if orthodox wisdom used to disdain discretion). The canonization of Chairman Greenspan over the past decade and a half has eliminated most orthodox squeamishness about a discretionary Fed, while currently fashionable theory based on the “new monetary consensus” has pushed monetary policy front and center. As John Kenneth Galbraith argues, lack of empirical support for such beliefs has not dampened enthusiasm. Like Galbraith, the followers of Keynes have always insisted that “[b]usiness firms borrow when they can make money and not because interest rates are low”.  Even orthodox estimates of the interest rate elasticity of investment are so low that the typical rate adjustments used by the Fed cannot have much effect.

Conventional belief can still point to interest rate effects on consumption, with two main channels. Consumer durables consumption, and increasingly even consumption of services and nondurables rely on credit and, thus, might be interest-sensitive. Second, falling mortgage rates lead to refinancing, freeing up disposable income for additional consumption. Ultimately, however, whether falling interest rates might stimulate consumption must depend on different marginal propensities to consume between creditors and debtors. In reality, many consumers are simultaneously debtors and creditors, making analysis difficult because a reduction of rates lowers both debt payments and interest income. If we can assume that these do not have asymmetric effects (a highly implausible assumption), we can focus only on net debtors and creditors. The conventional wisdom has always been that net creditors have lower MPCs than do net debtors, so we can assume that lower rates stimulate consumption by redistributing after interest income to debtors.

Still, the consumer lives in the same business climate as firms, and if the central bank lowers rates in recession, the beneficial impacts can be overwhelmed by employment and wage and profit income effects. Further, as society ages and net financial wealth becomes increasingly concentrated in the hands of the elderly whose consumption is largely financed out of interest income, it becomes less reasonable to assume a low MPC for net creditors. Perhaps the MPC of creditors is not much different from that of debtors—which makes the impact of rising rates on consumption all the more ambiguous. This does not mean that lowering rates in recession (or raising them in expansion) is bad policy, but it could account for the observation made by Galbraith and others before him that monetary policy is ineffectual.

Most conventional and even unconventional explorations of interest rate effects have focused on demand-side effects. It is also possible that raising interest rates can have a perverse impact on prices coming from the supply side. Interest is a business cost much like energy costs that will be passed along if competitive pressures permit. The impact on aggregate demand arising from this might be minimal or ambiguous, but it is conceivable that tight monetary policy might add to cost-push inflationary pressures while easy policy would reduce them. For monetary policy to work in the conventional manner on constraining inflation, interest rate effects on aggregate demand would have to dominate such supply-side impacts. This seems ambiguous at best, given the uncertain impacts of interest rates on demand.

What has been largely ignored is the impact that interest rate changes have on government spending, and hence on aggregate demand through the “multiplier” channel. In a somewhat different context to the issue to be pursued here, some Post Keynesian authors have recognized that rising rates tend to increase the size of government budget deficits. Indeed, in the late 1980s, a number of countries with large budget deficits would have had balanced budgets if not for interest payments on outstanding debt—Italy was a prime example, with government interest payments amounting to more than 10% of GDP (Brazil was another). It was recognized at the time by a few analysts that lowering rates was probably the only way to reduce the government’s deficit—a path later successfully followed. However, conventional wisdom holds that high deficits cause high interest rates, hence, government can quickly find itself in an “unsustainable” situation (rising rates increase deficits that cause markets to raise rates even higher) that can be remedied only through “austerity”—raising taxes and cutting non-interest spending. In truth, for countries on a floating exchange rate, the overnight interbank lending rate (fed funds rate in the US) is set by the central bank, and government “borrowing” rates are determined relative to this by arbitragers mostly in anticipation of future overnight rate targets.

The heterodox literature on rate-setting by the central bank is large and the arguments need not be repeated here. What is important is to recognize the government’s ability to reduce its deficit spending by lowering interest rates.

What we want to investigate is the nearly ignored possibility that lowering/raising interest rates will lower/raise aggregate demand in a manner opposite to normal expectations. This would occur if lowering rates lowered government deficits by reducing interest payments—which are essentially the same as any other transfer payments from government to the private sector. Assume an economy in which private debt is small relative to GDP, and in which the interest elasticity of private investment (and other private spending) is small. By contrast, government debt is assumed to be large with holdings distributed across “widows and orphans” with high spending propensities. Raising interest rates will have little direct effect on the private sector, which carries a low debt load and whose spending is not interest sensitive, in any case. However, rising interest rates increase government interest payments; to the extent that the debt is short-term or at variable interest rates, the simulative impact on private sector incomes and spending is hastened.

This is, of course, the most favorable case. However, on not implausible assumptions about private and public debt ratios and interest rate elasticities, it is possible for the government interest payment channel to overcome the negative impact that rising rates have on private demand. We will proceed as follows. First, we will briefly introduce the methodology to be used, System Dynamics modeling. We then set out the model and explain the variables and parameters. For the first part of our analysis, we will use historical US data to set most parameters. We will determine given those parameters (debt ratios and interest elasticities), at what level of interest rates can we begin to obtain “perverse” results—where further increases actually stimulate demand. For the final part of the analysis, we will determine values for government debt ratios at which “perverse” results can be obtained, for different levels of interest rates.

Throughout we will assume uniform MPCs, and so leave for further research the questions about distribution effects. Further, we will not include interest rate effects on consumer borrowing—this is equivalent to assuming that consumer borrowing is not interest sensitive, or that any interest rate effects on net (private) debtors is exactly offset by effects on net (private) creditors. Finally, as we will briefly mention below, further research will be needed to explore implications arising from international debtor/creditor relations (Americans hold foreign liabilities, while foreigners hold American liabilities—both private and public—and even if domestic MPCs are the same across debtors and creditors, the MPCs of foreigner creditors and debtors could be different).

A cursory review of the literature on interest rate elasticity found a fairly wide range of estimates, with most below -0.25, although a few were substantially larger. We also found that setting ε = -.25, the investment function approximates the 2000 value for Gross Private Domestic Investment (Ig = 1,832.7) when α = 1 and rIg =.09 — (Ig = 1.8257). Hence, we use -0.25 as the interest rate elasticity of investment for this analysis.

For plausible “real world” prime rates in the range of 10% to 12%, and for a “real world” GDP of just under $10 trillion, government debt ratios well under 50% of GDP are sufficient to obtain perverse monetary policy results. Results for ‘Equilibrium’ Public Debt (Dp) for mpc = .9, ε = -.25, and Investment interest rates of 3% to 20% are shown in Table 5 and Figure 11. With an interest rate of 10%, if the public debt is $4.94 trillion—or about 50% of GDP, interest rate hikes can stimulate aggregate demand.

This exercise has demonstrated that under not-too-implausible conditions, raising interest rates could actually stimulate aggregate demand through debt service payments made by government on its outstanding debt. This is more likely if private sector indebtedness is small, if private spending is not interest-rate elastic, if interest rates are high, and if government debt is large (above 50%) relative to GDP. In addition, the reset period of the government’s debt affects the rapidity with which interest rate changes are transmitted to spending. Our analysis used fairly simple models and hence represents a first attempt at modeling these impacts.


  1. Golden.

    • I agree. Golden. Thank you for writing this, Randy. You cleared up so many things with simple statements about how things work. So many of us out here are trying to get it right by understanding the process correctly. Really appreciate your efforts to help us do so.

  2. tldr version: Scott Sumner reveals MMT’s Achille’s Heel: replace MMT with a straw horse version of the theory, and then drop it into an economic theory with no empirical support for the cause and effect relationships that it is built upon, and things will not work the way that MMT claims that they will.

    Why this amounts to an Achilles Heel is an exercise left to the overactive imaginations of Scott Sumner’s fans.

  3. Currently, interest rates are low (not high), and private sector indebtedness is high (not low – at least as compared to government). What does the model predict under 2013 conditions vs 2000?

  4. Sumner doesn’t understand the Fed Funds market. It is not necessary to double the monetary base to get the overnight rate to zero. Mathematically, $1 of excess reserves would do it, although in practice it might take a few $million; certainly not a doubling. Even the strictest monetarists would not say that such a small change could wreak large changes in prices or NGDP.

    Never mind that the Fed has tripled the monetary base, all of the increase being excess reserves that drove the rate to zero, and there has been no such effect. Whatever value monetarism may have in explaining the economy, changes in the monetary base have nothing to do with it.

  5. Jose Guilherme

    Great article!

    I just have a question on a technical point.

    In the text, one can read that “overnight interbank borrowing is collateralized by safe treasuries”.

    However, Stigum (and Perry Mehrling, who uses her book for teaching his money and banking course at Columbia) says otherwise.

    Here’s Stigum, page 540, Fourth edition of “Money Market”: “…a repo transaction is in essence a secured loan, whereas the sale of fed funds is an unsecured loan”.

    So, my question is: do banks ask for collateral to lend reserves to one another or is it all based on trust?

    • financial matters

      Repo transactions are based on cotton candy and will likely be the cause of the next credit crunch as this leverage unwinds in the search for real underlying collateral. Treasuries are currently the safest but they need to start backing the real economy instead of this cotton candy. Repo is essentially money market funds lent money to financial institutions that engage in this derivative trading (cotton candy) rather than real factories, living wage, infrastructure, education, health care…

      I think the ‘Liquidity Factory’ is linked to the Reserve Currency

      In his book ‘Extreme Money: Masters of the Universe and the Cult of Risk’ (2011) Satyajit Das talks about the ‘Liquidity Factory’.

      On an inverse pyramid at the bottom little pinnacle are the central banks, 2%, then there are bank loans, 19%, then securitized debt, 38% and then derivatives 41%.

      This is all considered liquidity ie the lubricant that allows the global economy to run. And 79% of it is derivatives and securitized debt which are largely unregulated and full of fraud. And the $16 trillion of US Treasuries used as collateral to back it all up is a small little fraction.

      This is financialization run amok and what he calls ‘cotton candy’ which is spun sugar composed mostly of air.

      No wonder Draghi doesn’t want us to be able to examine bank balance sheets but just have the taxpayer continue to bail them out while imposing austerity measures.

      This mountain of debt being supported by this little pyramid needs to be dismantled before the right grain of sand causes it to crumble.

      Countries shouldn’t have to pay back loans that their former dictators stashed away for themselves in off shore accounts. Students shouldn’t be indebted for most of their lives by college loans, medical bills shouldn’t be the major cause of household bankruptcy, homeowner’s who were given predatory loans so that the banks could repossess their house should have principal reductions to reflect actual value.

      If US Treasuries continue to support cotton candy they will lose their validity as a global reserve currency.

  6. Scott Sumner:

    “Now the Fed does an OMP and doubles the monetary base by purchasing T-securities. They announce it’s permanent.”

    What he means by ‘permanent’ is that the monetary base will be at least that size for ever. He would probably argue that even with zero government deficits, private spending and bank lending would expand over time, and then eventually GDP would be twice what it was before. So then you could claim that doubling the monetary base doubled GDP. Who knows how long it might take though..

    • No, the average temperature of the earth will rise by 1/2 degree centigrade over the next 24 years. Also the GDP will double over that same time. The causality is clear.

  7. Sumner said a while back that asset prices would probably rise first, and then prices of goods and services a bit later.

  8. Good piece Mr. Wray. Sumner has some evenhanded criticism:

    My rebuttal is that whoever wrote that nonsense is a liar, a moron, and a jerk, all wrapped up in one. Life’s too short to respond to someone who claims I asserted that lowering interest rates to zero would cause NGDP to double. (It’s got several names attached, so I don’t know who wrote it.)

    Rates just fell to zero in 2008 and I don’t see NGDP doubling.


    I do have one observation of my own however. You didn’t leave any links for where you were quoting Sumner from. It seems pretty clear that my piece yesterday at least had some inspiration for this one so why not give the link so people have a background for it?


    Mike Norman afterwards linked it on his blog as well.

  9. > Monetary policy is about liquidity—reducing or increasing the liquidity of private portfolios

    What about permanent open market operations (POMO)? That’s a permanent add/drain of liquidity, and seems a bit outside the Fed’s purview. Have we entered a new era where the Fed does all the money creation (and banks just gamble for a living) ? I’m sure it’s beside the point of the article, but I’m still curious how MMTers view these extraordinary measures.

    • financial matters

      I think that’s a very good point. QE might not have had the effect of lowering long term rates but it has caused the Fed to make money good fraudulently created securities like MBS thus sanitizing and enabling bank gambling. And it is standing ready to perform the same function for the money market/repo gambling. As when we used FDIC type guarantees for awhile at the height of the credit crunch.

      Part of this is no doubt due to a lack of fiscal and regulatory responsibility in taking on these issues.

      • @financial matters,

        Could you recast this sentence? I don’t understand what you’re saying.

        QE might not have had the effect of lowering long term rates but it has caused the Fed to make money good fraudulently created securities like MBS thus sanitizing and enabling bank gambling.

        • financial matters

          The Fed is supposed to buy AAA rated assets such as Treasuries. When they ventured into MBS this was unconventional territory. They were taking toxic assets off the banks balance sheets and exchanging them for US Treasuries. Two different animals. US Treasuries are backed by the US government and should ultimately be backed by productive labor and a real functioning economy. MBS are home loans that should be backed by good underwriting and the ability of the person to pay back the loan. Bill Black has gone into the huge amount of fraud that was used to create these securities and the Fed shouldn’t be absorbing them and treating them as equivalent to US Treasuries.

          As well as being a misuse of US Treasuries it doesn’t allow for true price discovery of the MBS and enables this asset bubble to continue. As a corollary I don’t think a lot of people realize how their ‘safe’ money market funds are being used to finance the repo market which can quickly become a game of musical chairs. And as people have found out with MF Global, Crete and Detroit not everyone is going to get their money back. The super-priority of derivatives even above bankruptcy stays also plays a role here.

        • I think he means that banks created pile-of-turd “assets” which they were then able to sell to the Fed, making those crappy “assets” “money good”.

  10. Randall – Although I’m more sympathetic to MMT than to Sumner’s market monetarism, I think you’ve misrepresented his position. Throughout your piece, you talk of the effects of changes in interest rates, but Sumner doesn’t make any claim about the effects of interest rates. In fact, one of his methodological principles is “Never reason from a rate change.” So when you say “But, Sumner interjects: suppose the central bank lowers the nominal rate to a big fat Zero. He predicts that GDP would DOUBLE and the price level would DOUBLE!,” that’s not something Sumner would say. In fact, he doesn’t say that in the passage you quote from him. Instead, he says, “let’s say they double the base and LET RATES GO WHERE EVER THEY WANT. I claim this action doubles NGDP and nearly doubles the price level.” As you can see from his statement, rates are not important to him; he considers rates epiphenomenal (non-causal). For Sumner the important thing is the supply of AND demand for base money. More accurately, its the EXPECTATION OF THE FUTURE amount of base money that drives the price level. This is why, for Sumner, an increase in the base must be permanent for it to have any effect on inflation or NGDP. And that’s why it’s unfair to use the failure of QE against him. He’s not happy with QE either, but his reasons are because the Fed is constantly signaling that the increase in the base will NOT be permanent. When Fed regional Presidents give speeches about raising rates and unwinding QE; or when Bernanke talks of tapering; or even the presence of 0.25% IOR, these are all signals that the Fed plans to reduce the amount of base money in the near future. Because it’s the future that markets react to.

    So I would love to see more discussion between you and Sumner about this (because I think his position is definitely worth taking seriously), but you’ll need to spend some more time gaining an understanding of his position. Likewise, he certainly needs to spend more time trying to understand MMT. Although, the more I try to understand Sumner, the more similarities I see between his position and MMT, but the vocabulary (fiscal vs monetary) and the roles of democracy vs technocracy keep getting in the way.

    • More accurately, its the EXPECTATION OF THE FUTURE amount of base money that drives the price level.

      What empirical evidence exists for that claim?

      • Dan – I was not arguing that position. I was just trying to explain Sumner’s position. But to play devil’s advocate, could we say that the taper talk serves as evidence? There was no actual change in the monetary base, nor in rates, but the Fed signaled that they were planning on pulling back in the near future. This had a clear impact on long terms rates. As for its impact on inflation, I guess it’s too soon as the data is not yet out, and the taper talk period was probably too short-lived to have much of an effect. But if we were still talking taper and long term rates were still elevated, it’s not unreasonable to expect some disinflation. Although, contrary to Sumner, I would argue that the taper caused the markets to fear future short term rate hikes, not a decreased monetary base, which caused long term rates to spike.

        • There was no actual change in the monetary base, nor in rates, but the Fed signaled that they were planning on pulling back in the near future. This had a clear impact on long terms rates.

          Jared, it seems to me that the most commonsensical interpretation of the impact of the taper talk is that people in the markets believe, quite appropriately, that aggressive Fed purchases of long-term debt increases the price (and thus, reduces the yield) on long-term debt. That’s a basic supply and demand issue. They thus believe that when the Fed backs off on these purchases, prices will fall and yields will rise. Naturally then, when the market begins to suspect that the withdrawal of Fed purchases is about to occur, they will begin to bid up toward a higher price. If this is what is going on, it is plausible to say that QE has whatever affects it has through the interest rate channel.

          It doesn’t seem to me that this offers any evidence at all that substantial numbers of market participants have expectations about the size of the monetary base, or that, if they do have such expectations, that they have significant and settled beliefs about the connections between the monetary base and other economic parameters. Some monetarist economists have such beliefs, but I don’t know that there is any empirical evidence that a preponderance of market participants share those beliefs. How many people are really looking at data on the monetary base?

          And it is a huge leap to go from expectations about long-term interest rates among people who participate in the debt markets to expectations and beliefs about the general price level. The general price level is a function of the behavior of millions of economic actors. How many of those people have beliefs about the monetary base? How many could even tell you what the monetary base is?

          The MMers seem to project their own theoretical beliefs, beliefs characterizing a very small proportion of the total population of economic actors, onto the entire population.

          • I certainly don’t have much time for Sumner’s approach, but even I can see a realistic link via expectations between the quantity of base money and the price level.

            As I understand it, the scenario Sumner is envisaging is one where the quantity of reserves is increased well beyond the normal requirement and, critically, anyone who cares believes that it will stay there. For as long as reserves exceed the normal requirement, the overnight rate will remain at its floor. If the excess reserves are not withdrawn, the only thing that will get the rate of the floor is when bank balance sheets expand enough that the actual reserves are no longer in excess. This could come about through growth in real bank lending or, more likely, a rise in the price level.

            So market participants who believe that the stock of reserves is going to stay at that high level for ever must either belief that the price level is going to go up, or they must believe that rates will stay near zero indefinitely. Or some combination. Either way, this presents a very good reason for shorting the domestic currency. So there will be downwards pressure on the exchange rate.

            A fall in the exchange rate will affect the price level even without taking into account expectations. Consumer prices are affected directly, but there are knock-on effects on nominal wages and prices of goods that compete with foreign goods (both exports and import -substitutes). So you’re going to get some upward pressure on prices, even if the economy is operating below capacity.

            This to me is a plausible story. Now, I don’t get from this the Sumner idea that to double NGDP you just double the base. I think there are all sorts of problems with that. But in the situation I think he is imagining, I would be surprised if there were no effect on the general price level.

            • So market participants who believe that the stock of reserves is going to stay at that high level for ever must either belief that the price level is going to go up, or they must believe that rates will stay near zero indefinitely.

              Nick, suppose total reserves are currently at $X dollars, and that the ratio of total reserves to required reserves is Y. When you talk about “market participants who believe that the stock of reserves is going to stay at that high level”, are you talking about market participants who believe that total reserves will remain near $X indefinitely, or those who believe that the ratio of total reserves to required reserves will stay near Y?

              Also, what percentage do you believe fall into either category? If you polled market participants, what percentage could tell you what the total level of reserves is currently? What percentage could tell you what the ratio of total reserves to required reserves is currently?

              Also, you mentioned the possibility of a growth in lending in the second paragraph, but then seemed to eliminate that option. A well-informed market participant might anticipate a growth in lending and a consequent reduction in the ratio that currently stands at Y, but without any reduction in X, and without any change in the price level. Unless these market participants adhere a rigid form of the quantity theory, they will be aware that if bank lending increases to finance a growth in production and consumption, prices need not change.

              Also, a lot of the reasoning I run into in these expectations-management analyses seems to rely on arguments of the following schematic form:

              1. Economic theory T says that P will occur if and only Q will occur.

              2. Market participant A believes P will occur.


              3. Market participant A believe Q will occur.

              But this is an invalid inference. It assumes that market participant A has internalized the assertions of theory T, and that A performs all of the deductions that are warranted by the true material biconditionals of that theory.

              I assume market participants are a varied lot, and rely on all sorts of economic theories of various degrees of sophistication and accuracy. Just because some schools economists are convinced by a theory that holds that two macroeconomic quantities co-vary in some particular way does not mean that market participants, or “the market” in general, behaves in the way an ideal believer in that theory would behave.

              • Dan,

                I was thinking of the $X being constant – again, just because this is what I understand to be the way Sumner sees it.

                I’m not sure it requires people to have precise knowledge of reserve requirements or the actual size of the base. As it is, I think “the market” probably understands that rates being near the floor is connected with there being excess reserves. So if they really believed that there would be no action taken to drain the reserves, come what may, I think they would expect rates to stay low for a long time. (Whether anyone would really believe that is another matter)

                I agree that many expectations theories don’t stack up, but I don’t think what I’m talking about here requires very strong assumptions. As it is, even vague hints of taper or not is enough to have some impact on the exchange rate. A general belief in a very strong policy action one way or another would likely have a stronger effect. (At least, I think so, but maybe I’m wrong. The markets can behave very oddly sometimes). But it doesn’t really require anybody to get the theory it right – just to have a general sense that very loose monetary means it makes sense to short the currency.

                You’re right I didn’t talk about the possibility of loan expansion – I didn’t want anyone getting the impression I thought excess reserves would drive more lending!

            • Nick,

              hasn’t the dollar index appreciated since before QE? Seems to pose a bit of a problem for Sumner’s argument, as you present it here.

              • Well, there’s a lot of things that affect the exchange rate, so it’s difficult to pick out cause and effect. As an empirical test, I think you would need to try and identify specific dates on which a surprise announcement was made and then see if it was immediately followed by an exchange rate movement. But, I am pretty sure that if you asked a number of currency traders which way they would expect the exchange rate to move if, for example, there was an announcement that the asset purchase programme was to increased, you would get a consensus that this would push the rate down.

                However, it does highlight that it is a very vague process. It depends on what all the other economies are doing and, particularly for the US, whether those other economies will change their own policy in response. And Sumner’s line of reasoning depends on convincing the market that a particular monetary position will be adhered to forever, something that seems to me rather implausible. So whilst I do see the possibility of super-loose monetary policy being inflationary, even when an economy continues to operate under capacity, I don’t think it has anywhere near the strong effects he claims.

        • I honestly don’t think anyone can ascribe logical actions to the “market”. That doesn’t mean I am criticising your assertion that the taper caused markets to fear short term rate hikes etc. It’s merely an observation as in theory, (aka the classroom) markets and their prices are driven by expected future events. If we accept that, then should we also not recognize that no one can foretell future events?

          The dot.com era was a classic example of the fallacy of the market logic as the final arbitrator. The market invested trillions into companies that had no viable business model — was that rational?

          The QE undertaken by the Fed on the open market involves a preference change by portfolio managers, they are choosing to sell their holdings. These are large organizations who, by trading their treasuries for bank reserves/cash are not about to spend that money on white goods or cars, items that drive aggregate demand. The only possible (afaik) impact on aggregate demand is the net change in private sector interest receipts. I may be mistaken, however, I doubt that there is any material impact on inflation/deflation.

          Likewise, if the monetary base is increased, doesn’t the ownership of that base in light of the gross income / wealth inequality that exists become a critical metric in understanding the impact?

      • Dan – Mark Sadowski addresses your question in depth over at The Money Illusion. I hope the discussion can continue.


    • What Sumner is arguing is that only changes in money holdings affect aggregate demand. Let’s not forget that QE takes away as much assets from from the private sector than it gives to it. He just claims that taking away those other sort of assets is of no consequence, only increase in monetary holdings is consequential.

      To give you an extreme example, let’s say there is a wealthy man who has all his assets in gold, except for 50 bugs in his pocket. Now the goverment comes in, confiscates gold fort hundreds of thousands of dollars, but gives him 50 bugs. Now, just because he has more money, he will increase his consumption argues Sumner. Government increased monetary base, increased monetary holdings in the economy and this must lead to more consumption. Even though person supposed to do consumption is now poor. I think that is crazy.

  11. Thank you Mr. Wray for attribution-I figured it was just an oversight. As for Sumner’s response, he’s claiming you got him wrong as he wasn’t saying that cutting rates from 5% to 0% would double NGDP-and almost double prices-but a doubling of the MB.

    I think the difference is that you presume that in such a scenario the FF rate would in fact drop to 0%? In any case Sumner’s whole premise was based on a healthy economy with no IRR. As we have neither of these things and have seen the Fed close to triple the MB with no such effect it’s not clear what use his ‘thought experiment’ is in any case.

  12. “But drawing on Wicksell when you’ve got Keynes would be like an astronomer going back to Copernicus when you’ve got Galileo.”

    Well, actually, Galileo performed very poorly on that regards. Copernic’s was much alike Ptolemean thinking, and he stuck to its many epicycles (circles upon circles approximating ellipses) so obviously irrealistic, he only reverses the centre of some (three planets : Mercury, Venus and Earth) from Earth, or itself, to the Sun. Anything else was left still. Only Kepler did get rid of all the epicycle, and a feud took place right after the one about Copernic. And… Galileo fought staunchly for Copernic’s orthodoxy against Kepler. Making it an embarrassment for every historian fond of Galileo having to talk about his view on Kepler.

    You may get a very simple correct statement with “But drawing on Wicksell when you’ve got Keynes would be like an astronomer going back to Copernicus(/Galileo) when you’ve got Kepler.”, yet, it doesn’t recall in common people’s minds quite the same legend…

    I highly recommend to you the reading of Koestler’s The Sleepwalkers. One of my favourite books.

    Best regards,

    Jean-Baptiste Bersac

  13. I am a little confused about the theory in general.

    Not sure this is the best place to ask this, but here is my question:

    If bank loans = deposits, and deposits can be used by the banks as reserves, don’t loans increase the reserves of the banks? Can’t banks then essentially give themselves more reserves, instead of having to fulfill reserve requirements in more traditional ways?

    • Deposits aren’t reserves. A deposit account balance at a commercial bank is a liability of the bank and an asset of the bank’s customer. A commercial bank’s reserve account balance at a Federal Reserve bank is a liability of the Fed and an asset of the commercial bank.There is no way of simply converting a deposit account balance into a reserve account balance. Banks don’t manufacture their own reserve account balances.

      • Then, if deposits are not reserves, why do banks want your money in their checking accounts? I thought that deposits could be used to fulfill reserve requirements.

        When government runs a deficit, I thought they simply credited the accounts of individuals. Deposits go up by the amount of the deficit. Reserves go up by that amount. Government then issues bonds in order to soak up those reserves from the system.

        Are you saying that instead, banks credit the customers, and government then credits the banks via the account at the fed? And then, that is how total reserves go up?

        • They don’t want what is in the checking account, John. What is in the checking account is what they owe you. What they want is your promissory note to repay a loan, because that is what you owe them. And when you do pay them, one of two things happens: either (i) their total liabilities to their depositors decreases by the amount you pay them, if you pay them by drawing on an account at the same bank, or (ii) they receive a payment from another bank, if you pay them by drawing on an account at that other bank. In either case, their balance sheet position is improved by the same amount, either because their liabilities have been reduced by that amount, or their assets have been increased by that amount.

          The central bank doesn’t just credit banks in some automatic way. Banks have to acquire those central bank liabilities. They can acquire them in various ways such as by (i) lending to the treasury or the central bank, which then pays them back more than the amount loaned, (ii) borrowing the reserves from another bank, in which case they have to pay back that other bank with interest, (iii) borrowing them directly from the central bank, in which case they have to pay back the central bank, (iv) selling stock, (v) receiving interest payments on its reserve accounts, or (vi) earning money from loans and other investments, which will either draw reserve balances in from payments from the reserve accounts of other banks, or reduce its liabilities to its depositors in the manner described above.

          Under current procedures, the government runs fiscal deficits by issuing and selling securities. Those sales result in dollar payments from commercial bank reserve accounts into the treasury’s general fund (its account held at the Fed). In exchange the payer receives a credit to its securities account. The treasury then issues payment orders which draw on the dollar balances in the general fund. Total US government liabilities to the non-government sector are increased because both the dollars and the treasuries are liabilities of the US government.

          • Thanks for the clarification, that helps. I would add, can’t banks also gain reserves by adding new depositors? Unless that falls under one of your seven points. When a bank adds new depositors, and they get paid by people with accounts at other banks, those banks have to transfer reserves. If a bank can get a positive flow of transfers, they can get a bigger share of the reserve pool. They get increased liquidity, possible $$$ from the Fed in terms of a support rate, and the ability to invest those reserves in an interest-bearing asset.

            Also, I wanted to clarify. When the government spends money, here is how I think the process goes:

            Government, let us say, pays person A his wage of 100,000. Person A has a bank account at Chase. Government credits Bank A with 100,000 in *new* reserves. Bank A then credits Person A’s bank account 100,000. Presumably, sometime down the row the government charges Person A a fee or a tax. Person A “writes” a check to the federal government for 35,000. Bank A reduces Person A’s account by 35,000. It then transfers 35,000 to the federal government by reducing its account of reserves at the Fed by 35,000. In order to manage the reserve supply, government issues bonds to soak up 75,000 (or close to that number) of the unallocated reserves. When government pays interest on that debt, it again adds *new* reserves to the banks that own the debt.

            Is this accurate?

            • John,

              I might be able to help out here. I know you are correct up to just before this point “In order to manage the reserve supply, government issues bonds to soak up 75,000” because the government issues bonds to soak up the 100,000, the amount before taxes.

              Here is Frank Newman, the former Deputy Secretary of the US Treasury explaining it in his recent book (Newman in his book recommends that people read Warren Mosler, Randy Wray, Scott Fullwiler, etc for how the system works).

              When the Treasury distributes funds, the nation’s deposits are initially increased. Where can the bank money go? Let’s look at an example, excluding the portion covered by taxes. Typically, before the Treasury issues $ 20 billion of securities, the government has distributed $ 20 billion to the public from its account at the Fed: redeeming maturing Treasuries, paying companies that provide goods and services for the government, for payments to individuals, etc. Many investors simply “roll over” their Treasury securities, replacing maturing ones with newly issued ones, and taking just the interest. For example, perhaps $ 10 billion of the $ 20 billion issue might be in that category. The Treasury pays out the other $ 10 billion to the private sector. At that point, a set of participants in the U.S. financial system will have the extra $ 10 billion in their bank accounts and will look to place those funds.

              The money supply has been increased by $10 billion [JOHN: in this example, the $10 billion not spent on replacing treasuries or paying interest], and the new dollars move around within the overall US financial system. All the Treasuries previously available are already owned by investors, and prior auctions had demand that exceeded the amount offered. As the new Treasuries are auctioned, the demand is filled by exactly the $ 10 billion offered, and the money supply returns to its prior level. In the whole of the U.S. financial system, the only place to put the money is into the new Treasuries that are being auctioned— or otherwise just leave the funds in banks. If some investors choose to buy other financial assets with those new funds, such as corporate bonds or stocks, then someone else— the sellers of those assets— will end up with the bank deposits, and will be looking for a place to invest them. There are no other USD financial assets to invest in that are not already owned by someone. And the dollars cannot go to another country; an individual investor can choose to invest some dollars in assets in another country, but then the foreigners who sold those assets would just own the same dollars in U.S. banks. The aggregate of all investors have, in the end, two choices: leaving the extra $ 10 billion of cash in bank deposits, which earn very little, if any, interest, and are not guaranteed by the government beyond $ 250,0001; or exchanging some of their bank money for the new Treasuries, which pay interest and have the “full faith and credit” of the United States.

              Newman, Frank N. (2013-04-22). Freedom from National Debt, Chapter 2.2 (Kindle Locations 255-271). Two Harbors Press. Kindle Edition.

        • I just switched a fairly significant sum of money from Bank of America to Chase because Chase is offering $500 in free money with a minimum amount of CC purchases. They offer the promotion obviously because they want the deposits, as you mentioned. Here is why:

          When I deposited my personal BofA check at Chase into my new account, BofA had to wire over the $20K in reserves to Chase for my check to “clear”. Chase is paying me .02% interest on my checking account balance. If Chase does nothing more than leave those excess reserves at the Fed sitting there idle (remember they are only required to hold ~10% reserves or $2000 for my $20,000 deposit account), they will earn .25% interest from the Fed (because the Fed is currently paying interest on reserves). So that .23% interest spread is pure risk free profit for Chase. Mind you this is only the most simple example, they could buy T-bonds, lend them out in the interbank market, they could make more loans to people and get even more interest.

          And this is why banks want to try and attract deposits from other banks. It is the cheapest way to get reserves.

          MMT = Reality

          • Ah, OK. So what you are saying is, is that banks compete with with each other for my deposit, because when the deposit gets transferred from bank A to bank B, reserves have to be transferred accordingly. So a certain bank can gain a larger share of reserves.

            Also, I am gathering that in this kind of system, if, let us say, there is some kind of imbalance where Bank A is overwhelmingly issuing new loans that are being credited to accounts in Bank B, and/or if Bank B is successful at getting Bank A depositors to move assets to Bank B. If Bank B (or obviously Banks C, D, E, etc.) does not reciprocate by issuing loans that are credited to Bank A, and/or Bank A does not succeed in wooing more depositors, over time, Bank A will find itself reserve constrained….because they’re constantly transferring a large amount of reserves to Bank B.

            At that point, assuming that Bank B does not then lend out its reserves, I presume that the Federal Reserve would provide the reserves with a cost to Bank A. Once Bank B started lending, and A got a bigger share of reserves, the Federal Reserve would then “destroy” those reserves.

            So over time, with the absence of a support rate, and assuming that government issues a nice interest-bearing asset for bank reserves, bank reserves will never arise much over the bare minimum necessary by law and general liquidity. Also, presuming a large number of banks, you will never get this kind of glut of reserves.

            Is that right?

        • John,

          If you’re not familiar with the lingo of the accounting profession, and double-entry bookkeeping, this stuff can be easily misunderstood.

          When you go to the bank and put a $20 bill in your account, your deposit balance goes up $20 and the bank’s vault cash goes up $20. So, the bank’s reserves go up, but the deposit is not reserves, the cash is reserves. They are the opposite sides of the transaction. The bank cannot use deposits as reserves, but some of the transactions that increase their deposits also increases their reserves, either as vault cash or as a balance in their account at the Fed, through the clearing process.

          “Loans create deposits” means that when the bank makes a loan to you, they create some money and it ends up in someone’s bank account as a deposit, perhaps yours until you spend it, or perhaps someone else’s right away. But no new net reserves are created. The bank acquires reserves by having people open accounts with them, or by borrowing them, or by issuing capital stock.

          Banks must keep some minimum amount of reserves in order to support the clearing process. If they don’t have enough, they borrow them. If they have more than enough, they lend them to other banks. The Fed keeps the right amount of reserves in the system by buying or selling Treasuries, except when they’re doing QE or other unnatural acts to inject lots of excess reserves.

          The important things about all this is not the technical details, but a few points:

          The Fed has no options about supplying reserves when needed. If the banks as a whole are short, the Fed must lend reserves in order to maintain their overnight Fed Funds rate target. If they don’t supply enough, the rate would go above their target. If they supply too much, it would go below.

          Banks are not reserve-constrained when they lend. They lend first, and acquire reserves later if necessary. Their lending may be capital-constrained.

          From this it follows that the Fed supplying more reserves, or excess reserves, by QE for instance, does nothing to increase banks’ ability to lend.

          • “The Fed keeps the right amount of reserves in the system by buying or selling Treasuries, except when they’re doing QE or other unnatural acts to inject lots of excess reserves.”

            Why should it be assumed that QE is not producing the “right” amount of reserves? Suppose the law changes to increase reserve requirements. Where is the financial sector in the aggregate supposed to find these extra reserves when other sectors also seek to maintain their reserves? Any individual bank can sell assets to obtain reserves, but that just reduces the buyer’s reserves and leaves the aggregate unchanged. In that situation QE is producing the new legally “right” amount of reserves. Even without such a legal change, a mere increase in demand for reserve balances, perhaps due to an increase in economic activity or the price level or the opening of new reserve accounts (new banks), creates a need for an increase in reserves. If QE is the available tool to accomplish such an adjustment in reserves, does that make it “unnatural”?

            • What I meant by the “right” amount of reserves is the amount needed to hit their Fed Funds Rate target – the market-clearing amount for that price. If the reserve requirement changes, then the Fed would have to adjust to it – but cannot anticipate it. That would not be called QE, it would be normal Fed rate management. If the demand (requirement) for reserves changes, due to increased lending, then the Fed would adjust to it, again by its normal operations – not QE.

              QE, adding more reserves than that, drives the Fed Funds rate below the target, except if (as now) the Fed also pays interest on reserves, which sets a non-zero floor under the Fed Funds rate. Interest on reserves is also an unusual (if not unique) Fed policy.

              I don’t know what you mean by other sectors needing reserves. In the context of the Fed providing reserves, it only pertains to banks, to the financial sector. Nobody else is required to maintain reserve accounts at the Fed.

      • @Dan,

        Why was the system set up that way? Do you know? I mean, what’s the logic in it? Is it just where the commercial bank parks its money, or banks its profits? This is the one thing I don’t get; why does a commercial bank need to keep a reserve account if there are, say, no creditworthy customers coming through the door? Frank Newman writes, and I’m probably getting it wrong, that banks must keep reserves equal to new deposits created by the commercial banks, which is why people perceive QE such a piggybank for commercial banks freed of the necessity of scrounging for reserves as they supposedly increase loans. I guess I want to know who the hell set this system up this way.

        A commercial bank’s reserve account balance at a Federal Reserve bank is a liability of the Fed and an asset of the commercial bank.

        • Even if during the course of a given time period a bank made no new loans, it would still be liable for all of its existing obligations to its existing depositors. Depositors draw on their accounts all the time to make payments to people who bank at other banks, or to demand withdrawals, and when that happens a bank has to have some asset with which it can make the payment and fulfill the obligation. The payment assets that are used in the centralized US banking system are the non-interest-bearing liabilities of the US government, issued by its central bank, either in the form of physical currency or reserve account balances. If banks had none of these assets, they wouldn’t be reliably able to pay other banks or pay their depositors.

          We don’t have a free banking system in which each bank issues its own form of money, backed by some commodity like gold or some other non-monetary assets and by customer trust in that bank alone and its promises. We had such a system in the 19th century and its was a mess. Bank currency values floated against the values of other bank currencies. Some banks and their currencies could go belly up, etc.

          We now have a system with a single, fundamental form of money – government liabilities issued by the central bank. The money issued by banks, on the other hand, consists in IOUs for that central bank money. That money is all that the US government will accept in payment for its taxes. (You personally can pay the government by issuing a draft on your commercial bank deposit balance, but the government only accepts that form of payment because it requires the bank in turn to make a payment out of its reserve funds to the government. The government wants its own liabilities back when it collects taxes. If you tried to pay the government with some kind of IOU that wasn’t backed by government reserves, the government wouldn’t accept it.)

          Because the system is highly centralized, regulated and guaranteed in various ways by the US government, bank liabilities in the form of deposit account balances are universally accepted in our economy. Other people’s IOUs, while negotiable, are not so universally accepted.

          • Thanks, Dan. I need constant reminders, it seems, of what I’ve read and forgotten to get the whole picture. Appreciate the time you took to answer me. It may seem like endless repetition to you (and the rest of the MMT crew), but it is deeply appreciated by me.

            • You’re welcome. I need to try to be more patient.

              • I understand. But more and more people are really tuning into MMT these days. You’re seeing it all over. And, unfortunately, you’re in the same position as Bill Black who must endlessly repeat what happened in the subprime crisis by repeating what happened in the S&L crisis. And he seems to do it happily in every article, never assuming that his readers have been with him since the flood. 😉 It helps new readers, and older ones as well who may have forgotten the particulars.

                Repeating yourself over and over and over again must just exhaust you, and Randy, and Stephanie, and Michael Hudson. God, Warren Mosler must want to down a tank of whisky at the amount of time he’s spent repeating himself. But don’t let the ennui get the better of you. Because you guys are getting through. You are making a difference. You’re educating the public, not the politicians, and that takes longer and has to be said more simply. But the impact down the road is going to be revolutionary.

  14. L. Randall Wray

    I provided all the relevant quotes from Sumner. He agrees that doubling Base will drive overnight rate to zero. Then NGDP doubles and prices double. Very clear. He might want to argue that doubling Base would double NGDP EVEN IF RATES DO NOT FALL. Fine. That just puts him even farther from every modern school of thought, out farther into a never never land of magic, with lending and spending magically increasing WITHOUT INTEREST RATES FALLING.

  15. What is so hard for people to understand about the overnight interest rate and the level of reserves? If the Fed doubled the level of reserves, then by definition there would be excess reserves and thus the interest rate would fall to zero. They are equivalent statements. How do you set a ZIRP? By adding excess reserves. What happens if you add excess reserves? You get a ZIRP. Its not that complicated.

    The Fed can either set the quantity of reserves or the price of them. Its impossible to set both.

    And another thing, why is it so hard for people to understand that bank lending is not reserve constrained? This is tied directly in with the price vs quantity tautology.

    Lets say on day 1, there are $100B in outstanding loans on the books of commercial banks. The Govt’s budget is perpetually balanced. The net rate of loan growth is constant at 1% net growth per day. The Fed has set a reserve requirement of 10%, has chosen to set the quantity of reserves at $10B and doesn’t wish to target a particular interest rate.

    What happens on day 2?

    There would be $1B in net loan growth for $101B in outstanding loans. $10.1 B in reserves required yet there would be only the same $10B in reserves in existence. Banks would have to try and attract new net cash deposits, but quickly the supply of cash would dry up as a means of increasing the number of reserves as there is no way for net new cash to enter the world. Banks would try and sell T-bonds to the Fed in exchange for reserves but tthe Fed would just say no because they are only targeting the quantity of the monetary base and not the price.

    As we can see, immediately the system fails without elasticity in the number of reserves. This is not a complicated thought experiment, how seemingly intelligent people who study these issues for a living can’t grasp such basics is beyond me. Its akin to try to be a physicist and not understand arithmetic.

    MMT = Reality

    • You say that lending is not revenue-based; meaning banks are not revenue-constrained.

      But, there are reserve requirements. If the banks don’t have these reserves, the central bank can supply them, but the bank has a cost. Plus, aren’t there capital requirements? Again, I am sure the bank could acquire these things, but at a cost…so in a way, there is some revenue constraint.

  16. “I’ve done Granger causality tests on the monetary base over the period since December 2008 and find that the monetary base Granger causes the real broad dollar index, the S&P 500, the DJIA, commercial bank deposits, commercial bank loans and leases, the PCEPI, and 5-year inflation expectations as measured by TIPS.”

    “The empirical fact that QE has an effect on the exchange rate of the dollar means that the Exchange Rate Channel is effective. (It’s always been curious to me how people can believe in the liquidity trap when Bulgaria, Denmark and Switzerland all successfully control their exchange rates despite being at the zero lower bound.) Does MMT address how exchange rates are set? (I honestly don’t know.)”

    “The empirical fact that QE has an effect on stock prices (something which is obvious to nearly everybody) means that the Tobin Q Channel, the Wealth Effects Channel, the Balance Sheet Channel and the Household Liquidity Effects Channel are all effective. The usual MMT response is that “the markets are irrational”.”

    “The empirical fact that QE has an effect on inflation expectations and the PCEPI means that the Unexpected Price Level Channel is effective. The effect on the PCEPI is not easy to observe, but most people acknowledge that QE has an effect on inflation expectations. Again the usual MMT response is that “the markets are irrational”.”

    “The empirical fact that QE has an effect on commercial bank deposits, and loans and leases, means that the Bank Lending Channel is effective. This is particularly significant in debunking MMT (as well as Accomodative Endogeneity) since they claim that this is completely impossible.”


    It’s clear that whatever Sadowski knows he doesn’t seem to know much about MMT as they’re always saying that expanding the MB will drive stocks, commodities, and other assess way up.

    Also one has to be careful with that phrase ‘granger causality’ as it can mean many things.

    • financial matters

      To refer to an excellent recent podcast, I liked Randy Wray’s discussion of a liquidity trap. He describes it from a somewhat different angle and in terms of what he thinks was the essence of Keynes thinking on the matter.

      He describes it as ‘marginal efficiency of capital’ or easiest for me to understand ‘profit expectations’ which can actually turn negative making producers not want to invest in production as there are not enough people to buy their product (demand) so they would lose their money. (negative profit). The variable is not interest rates but profit expectations.

      I like this reframing of a ‘liquidity trap’ as a ‘demand trap’. Even if several million dollars are available at low interest producers aren’t going to put that money into production unless there are enough employed people to buy the product. And this takes fiscal policy. (and we have a Congress that is out to lunch)

      He also sees the commodity bubble as not being due to QE but due to a large amount of this money that isn’t being spent on production instead chasing a limited amount of commodities.

      Some companies are starting to understand that federal deficits can correlate positively with company profits. The key is for these deficits to stimulate real demand rather than try and stimulate borrowing using the confidence fairy.



      He also sees this productive capacity as the most useful thing for retirement security. The three legs of retirement can be seen as private savings, pensions and social security.

      As pensions have moved from defined benefit to defined contribution they have become much less reliable. They depend on proper management and there is no guarantee that any money will actually be there when you retire. Private savings are subject to very disruptive boom/bust cycles.

      As a society, just saving money doesn’t really do the trick as that money has to be able to buy something. Reflecting Keynes, Wray thinks the best method for retirement security as a nation is investing in plant and equipment and a skilled, trained and educated workforce. This produces a healthy functioning economy rather than a financialized one where there is no there there.

      • To refer to an excellent recent podcast, I liked Randy Wray’s discussion of a liquidity trap.

        Agree. It’s superior. Available at the upper right panel of this blog. I wish Drs. Kelton and Wray would post a copy of the Fidelity newsletter they refer to in the podcast. I searched high and low for it. Couldn’t find it.

  17. L. Randall Wray

    Dan and others (sorry I skimmed over and cannot remember names of those discussing this topic): Makes no difference how many trillions of excess reserves are in the system. Anytime the Fed wants to quit ZIRP and raise rates, it can. All it does is raise its target. End of Story. It starts to pay 10.25% on reserves and charges 10.50% to lend reserves and BINGO the overnight rate will stay between that ceiling and floor. Regardless of the number of trillions. And if you understand that, you understand why there is no longer any operational reason to issue Treasury bonds.

    • If the Fed did decide to raise the rate, it would be because of high employment and accelerating inflation, no? If they were to do it by raising the IOR rate to 10.25%, would that not be a massive pro-cyclical injection of money into the banking sector? Would it not be better for them to first drain the excess reserves from the system?

  18. Randy,
    I agree in theory with your 10.25% precise example, and in practice for the most part. However, I still sense from senior bank management at major banks a hesitancy to borrow from central bank facility, e.g. Fed discount window because, as several have told me, “it makes us look illiquid”. These managers have argued they would pay up a few basis points over the Discount Rate to access money interbank or through repo. How much more they would be willing to pay is not clear, but I would suggest that makes your upper rate fixing boundary a bit fuzzy. Of course, that is not a problem for most banks today with excess reserves. At the opposite end of the spectrum, we have been seeing overnight fed funds trading below the IOER lower bound because of the peculiar treatment of Fannie and Freddie in the interbank market.

    Excellent post by the way. Thanks for writing it.