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Fiscal and Monetary Policy in a Sovereign Nation: Responses to Blog #18

Posted on October 6, 2011 by | Comments Off on Fiscal and Monetary Policy in a Sovereign Nation: Responses to Blog #18

By L. Randall Wray

Thanks for comments. Let me provide a dozen responses, by topic.

Q: What about interest on reserves?

A: Chairman Bernanke moved to pay interest on reserves a couple of years ago, joining other countries (like Canada) that do so. Does that make any difference? Yes and no. First it simplifies operations and renders Treasury bond sales superfluous. Since the purpose of bond sales is to provide an interest-earning alternative to non-interest paying reserves, once you pay interest on reserves that is effectively the same thing as a bond. Ergo, you can stop selling bonds.

Now, why do you sell bonds when reserves don’t pay interest? Because excess reserves in the system drive overnight rates below the central bank’s target. It then sells bonds to offer the alternative.

But the easiest way to hit a target interest rate is to charge—say—50 basis points (100 bp = one percentage point) on loans at the discount window then to pay 25 bp on reserves held at the central bank. The overnight market rate on interbank lending (fed funds in the US) cannot deviate from the 25 to 50 bp range. (These are the ceilings and floors—you can do the same thing with sheep wool: government pays $25 to buy wool and sells at $50 so wool never rises above $50 nor falls below $25). The narrower that range, the smaller the flux of overnight rates.

Now as we know the US (and Canada) still sells bonds. This mostly has to do with the maturity structure: reserves are close substitutes for very short term bonds (ie: 30 day bills), and the central bank normally stays at the very short end.

Not that Treasuries understand any of this: when rates on 30 year maturity bonds are low, they issue lots of those thinking they’ll save on interest payments. But any Central bank with a floating rate can set the overnight rate anywhere it wants, and then just pay interest on reserves—no need to ever issue long maturity debt. Call your Treasury official and explain this. Stop issuing bonds = never run up against debt limits = never have kindergarten level debates in congress about debt limits.

Q2: In real terms, do government deficits take away “real saving”?

A: At full employment, government deficits move resources away from other uses to the public purpose. That might be good; it might be bad. With fewer resources available for private use, private investment might be lower. In that sense, “private real saving” is less. Fewer shopping malls, more schools and museums. Less investment in producing social life-altering underarm sprays, and more investment in bridges that do not collapse into rivers. I don’t know which to choose. But I’ve been flying a lot, avoiding bridges but sitting next to passengers who could use the spray.

Judge that for yourself. In nominal terms, however, government deficits create equivalent private savings—dollar for dollar. (Full disclosure, some can leak out to imports from Mars, etc.)

Q3: How does the central bank (CB) affect interest rates? Using open market operations (OMO)? Does it use the fed funds rate or discount rate? Is the 10 year bond rate set by the CB or by the market?

A: From above, we know CBs target overnight interest rates, and can use the ceilings and floors approach: lend at the discount window at 50bp and pay 25bp on reserve balances. In which case the “market rate” will flux between the two. Is this done through OMO? Not really. If the CB announces it will move its target rate from the range of 25-50bp to 50-75bp it does not need to engage in any OMO. All it does is to increase its rate paid on reserves to 50, and increase its discount rate charged to 75. And then “presto-change-o” market rates move. So you can see it uses both the fed funds rate (target) and the discount rate (rate charged), as well as the “support rate” paid on reserves.

What about longer maturities like the 10 year? It could do the same in that maturity—offer to buy at an interest rate equivalent of 200 bp and to sell at 150bp and you can bet your bottom dollar that the 10 year will trade in that range. But normally central banks do not do that. (QE tried a backassward way to do it: using quantity rather than price to try to get long rates down. Didn’t work—but who says Bernanke knows what he’s doing?)

Q4: What is endogenous vs exogenous?

A: It is somewhat arbitrary; and these terms are used in different senses (for the truly wonky: statistical, theoretical, or control senses). To keep it simple, most people use these to refer to the policy sense: does the government control the variable? For example, does the CB control the “money supply” or the “interest rate”. Well, it clearly cannot control the money supply—however measured except in the sense that it can do a Bernanke and fill banks full of excess reserves (that cannot get out). But it clearly can set overnight interest rates—all of them do—so that is called “exogenous” control of interest rates.

Q5: If the deficit gets bigger and bigger, doesn’t it have to get repaid later out of savings?

A: No. The US government debt was only “repaid” once in our nation’s history: 1837. That will never happen again. Bet on it.

Q6: In a fixed exchange rate system does govt really “choose” to spend less (or raise its interest rate target) to protect currency?

A: Yes. In the sense that it can “choose” not to do so, and then deal with the consequences. You can “choose” not to drive on the right (or left) side of the road. You might not enjoy the outcome. I’ve done it. You probably have, too. You might even “choose” to drive above the speed limit, too. There are consequences, and we all deal with them.

Q7: Does it matter if govt spends money into existence for interest payments rather than wages (as in ELR program)?

A: Yes. It can also spend money into existence to support fat cat Wall Street fraudsters. Good idea? Maybe not. Will it run out of funds? No.

Q8: Use GDP income measure rather than GDP expenditure measure.

A: Well, by identity they are identical. But, yes, it does matter that the wage share in the US has dropped toward third world status (about 50% of national income; vs 25% in Mexico). And so for consumption to grow Americans had to borrow heavily. Bad idea.

Q9: MMT has an unwarranted fixation on nominal vs real.

A: Give me a break, Neil. I guess you slept all through last week (see Blog 17). If anyone suffers from a fixation it is our Austrian brethren who are so fixated on “real” that they cannot understand that we live in a monetary economy.

 Thanks, Eric and Calgacus.

Q10: Can the CB compel banks to support higher reserve levels; can the CB control interest rates without issuing reserves?

A: CB can raise required reserve ratios, and banks (magically!) will hold more! That acts like a tax on banks, increasing their cost of doing business as reserves pay very little, ie 25 bp. Banks are less profitable. Not sure why we want that. In the Canadian system, bank holdings are right about zero—since the Bank of Canada requires zero and operates with a ceiling and floor interest rate as described above. Nice system. Sometimes those Canadians surprise you with how clever they can be! So, yes, they hit their interest rate targets even as banks essentially hold no reserves. But they do use them for clearing—which is all that matters.

Q11: How are government bonds issued?

A: By Treasury, to special banks, that use reserves to buy them. The CB supplies the reserves the banks need. We’ll do more of this later.

Q12: I go to a bank and it creates a loan; does it create money out of thin air? Is this disreputable?

A: Yes. And No. It takes your IOU, and creates its own IOU (your demand deposit). Out of a keystroke to a computer tape. Sounds a bit sexy but not at all pornographic. It is the bank’s IOU. It gets your IOU (“loan”) and goes into debt (demand deposit). It does not “get something for nothing”. If it eventually earns profits on the deal, that is a reward for “underwriting”: determining that you are no scumbag deadbeat borrower who will default.

I think that’s the nicest thing I’ve ever said about a banker. Made her sound almost like Jimmy Stewart. On that note I should stop.

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Who Will Win This Year’s Nobel Prize in Economics?

Posted on October 5, 2011 by | Comments Off on Who Will Win This Year’s Nobel Prize in Economics?

By Stephanie Kelton

On Tuesday, October 4, the Royal Swedish Academy of Sciences awarded the Nobel Prize in Physics to three US-born scientists who discovered that the universe is expanding at an accelerating rate. On Monday, October 10, they’ll award the Prize to Robert J. Shiller for recognizing that the housing market can’t do the same. Or, maybe not . . . the polls are still open. Who do you think they’ll choose? Care to wager? It turns out, you can!

Since 2009, some economists at Harvard have been running a prediction market. For the price of $1.00, you can submit your pick. And, if you’re right, you get to share in the jackpot. But remember, this isn’t about picking the the economist whom you believe to be the most “worthy” recipient. This is about trying to figure out whose contributions the Academy will decide to honor. So it’s really more like Keynes’ beauty contest. 

The Rules

  • Nominate who you think will win.
  • Each name that you enter costs $1.
  • You can also guess that no entrant will correctly guess the recipient(s).
  • You can enter as many times for as many names you’d like.
  • Entries and payments must be RECEIVED BEFORE 11:59 PM EST ON SUNDAY, OCTOBER 9.
  • All of the money collected will be divided between the winners of the pool. 

And, yes, we’re aware that its called the Memorial Prize in Economics, but c’mon — it sounds so much more prestigious to call it the Nobel.

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A Suggested Theme for the Occupation of Wall Street

Posted on October 4, 2011 by | 5 comments

By William K. Black

The systemically dangerous institutions (SDIs) are inaccurately called “too big to fail” banks.  The administration calls them “systemically important,” and acts as if they deserve a gold star.  The ugly truth, however, is what Wall Street and each administration screams when the SDIs get in trouble.  They warn us that if a single SDI fails it will cause a global financial crisis.  There are roughly 20 U.S. SDIs and about the same number abroad.  That means that we roll the dice 40 times a day to see which SDI will blow up next and drag the world economy into crisis.  Economists agree that the SDIs are so large that they are grotesquely inefficient.  In “good times,” therefore, they harm our economy.  It is insane not to shrink the SDIs to the point that they no longer hold the global economy hostage.  The ability — and willingness — of the CEOs that control SDIs to hold our economy hostage makes the SDIs too big to regulate and prosecute.  It also allows them to extort, dominate, and degrade our democracies.  The SDIs pose a clear and present danger to the U.S. and the world.




It takes a global effort against the SDIs because they constantly put nations in competition with each other in order to generate a “race to the bottom.”  We are always being warned that if the U.S. adopts even minimal regulation of its SDIs they will flee to the City of London or be unable to compete with Germany’s “universal” banks.  The result of the race to the bottom, however, as Ireland, Iceland, the UK, and U.S. all experienced is that we create intensely criminogenic environment that creates epidemics of “control fraud.”  Control fraud — frauds led by CEOs who use seemingly legitimate entities as “weapons” to defraud — cause greater financial losses than all other forms of property crime — combined.  Because of the political power of the SDIs and the destruction of effective regulation these fraudulent SDIs now commit endemic fraud with impunity.


Effective financial regulation is essential if markets are to work.  Regulators have to serve as the “cops on the beat” to keep the fraudsters from gaining a competitive advantage over honest firms.  George Akerlof, the economist who identified and labeled this perverse (“Gresham’s”) dynamic was awarded the Nobel Prize in 2001 for his insight about how control fraud makes market forces perverse.

“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”  George Akerlof (1970).

One of the most perceptive observers of humanity recognized this same dynamic two centuries before Akerlof.

“The Lilliputians look upon fraud as a greater crime than theft.  For, they allege, care and vigilance, with a very common understanding, can protect a man’s goods from thieves, but honesty hath no fence against superior cunning. . . where fraud is permitted or connived at, or hath no law to punish it, the honest dealer is always undone, and the knave gets the advantage.”  Swift, J. Gulliver’s Travels

We are the allies of honest banks and bankers.  We are their essential allies, for only effective regulation permits them to exist and prosper.  Think of what would happen to banks if we took the regular cops off the beat and stopped prosecuting bank robbers.  That’s what happens when we take the regulatory cops off the beat.  The only difference is that it is the controlling officers who loot the bank in the absence of the regulatory cops on the beat.  It is the anti-regulators who are the enemy of honest banks and bankers.

Top criminologists, effective financial regulators, and Nobel Laureates in economics have confirmed that epidemics of control fraud, such as the FBI warned of in September 2004, can cause financial bubbles to hyper-inflate and drive catastrophic financial crises.  Indeed, the FBI predicted in September 2004 that the developing “epidemic” of mortgage fraud would cause a financial “crisis” if it were not stopped.  It grew massively after 2004.  The fraudulent SDIs (who were far broader than Fannie and Freddie, indeed, they only began to dominate the secondary market in sales of fraudulent loans after 2005) ignored the FBI and industry fraud warnings for the most obvious of reasons — they were leaders the frauds.  The ongoing U.S. crisis was driven overwhelmingly by fraudulent “liar’s” loans.  Studies have shown that the incidence of fraud in liar’s loans is 90% (MBA/MARI 2006) and that by 2006 roughly one-third of all mortgage loans were liar’s loans (Credit Suisse 2007).  Rajdeep Sengupta, an economist at the Federal Reserve Bank of St. Louis, reported in 2010 in an article entitled “Alt-A: The Forgotten Segment of the Mortgage Market” that:

“[B]etween 2003 and 2006 … subprime and Alt-A [loans grew] 94 and 340 percent, respectively.  The higher levels of originations after 2003 were largely sustained by the growth of the nonprime (both the subprime and Alt-A) segment of the mortgage market.”

Sengupta’s data greatly understate the role of “Alt-A” loans (the euphemism for “liar’s loans”) for they ignore the fact that by 2006 half of the loans called “subprime” were also liar’s loans (Credit Suisse: 2007).  It was the massive growth in fraudulent liar’s loans that hyper-inflated and greatly extended the life of the bubble, producing the Great Recession.  The growth of fraudulent loans rapidly increased, rather than decreased, after government and industry anti-fraud specialists warned that liar’s loans were endemically fraudulent.  No one in the government ever told a bank that it had to make or purchase a “liar’s” loan.  No honest mortgage lender would make liar’s loans because doing so must cause severe losses.  Criminologists, economists aware of the relevant criminological and economics literature on control fraud, and a host of investigations have confirmed the endemic nature of control fraud in the ongoing U.S. crisis.

But the banking elites that led these frauds have been able to do so with impunity from prosecution.  Take on federal agency, the Office of Thrift Supervision (OTS).  During the S&L debacle, the OTS made well over 10,000 criminal referrals and made the removal of control frauds from the industry and their prosecution its top two priorities.  The agency’s support and the provision of 1000 FBI agents to investigate the cases led to the felony conviction of over 1,000 S&L frauds.  The bulk of those convictions came from the “Top 100” list that OTS and the FBI created to prioritize the investigation of the worst failed S&Ls.  In the ongoing crisis — which caused losses 40 times larger than the S&L debacle, the OTS made zero criminal referrals, the FBI (as recently as FY 2007) assigned only 120 agents nationally to respond to the well over one million cases of mortgage fraud that occurred annually, and the OTS’ non-effort produced no convictions of any S&L control frauds.  OTS’ sister agencies, the Fed and the OCC, have the same record of not even attempting to identify and prosecute the frauds.  The FDIC was better, but still only a shadow of what it was in fighting fraud in the early 1990s.  If control frauds can operate with impunity from criminal prosecutions, then the perverse Gresham’s dynamic is maximized and market forces will increasingly drive honest banks and firms from the marketplace.

The Financial Crisis Inquiry Commission reported on the results of the Great Recession that was driven by this fraud epidemic:

“As this report goes to print, there are more than 26 million Americans who are out of work, cannot find full-time work, or have given up looking for work. About
four million families have lost their homes to foreclosure and another four and a half million have slipped into the foreclosure process or are seriously behind on their
mortgage payments. Nearly $11 trillion in household wealth has vanished, with retirement accounts and life savings swept away. Businesses, large and small, have felt the sting of a deep recession.”

It is the fraudulent SDIs that are the massive job killers and wealth destroyers.  It is the Great Recession that the fraudulent SDIs produced that caused most of the growth in the federal deficits and made the fiscal crises in our states and localities acute.  The senior officers that led the control frauds are the opposite of the “productive class.”  No one, without the aid of an army, has ever destroyed more wealth and dreams than the control frauds.  It is essential to hold them accountable, to help their victims recover, and to end their ongoing frauds and corruption that have crippled our economy, our democracy, and our nation.

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Core Europe Sitting Pretty in their PIIGS Drawn Chariot

Posted on October 3, 2011 by | 5 comments


By Marshall Auerback and Warren Mosler

The refusal to countenance a Greek default is now said to be dragging the euro zone toward even greater crisis.  Implicit in this view, of course, is the idea that the current “bailout” proposals are operationally unsustainable and will lead to a broader contagion which will ultimately afflict the pristine credit ratings of core countries such as Germany and France.

Well, we see a very different view emerging:  The “solution” currently on offer – i.e. the talk surrounding the European Financial Stability Fund (EFSF) now includes suggestions of ECB backing.  This makes eminent sense.  Let’s be honest: the EFSF is a political fig-leaf.  If 440 billion euros proves insufficient, as many now contend, the fund would have to be expanded and the money ultimately has to come from the ECB — the only entity that can create new net financial euro denominated assets — which means that Germany need no longer fret about being asked for ongoing lump sums to fund the EFSF in a way that would ultimately damage its triple AAA credit rating.

Despite public protestations to the contrary, it is beginning to look like the elders of the euro zone have begun to embrace the reality that, when push comes to shove, it is the ECB that must write the check, and that it can continue to do so indefinitely.

That means, for example, the ECB can buy sufficient quantities of Greek bonds in the secondary markets to allow Greece to fund itself in the short term markets at reasonable interest rates.  And it gets even better than that for the ECB, as the ECB also substantially enhances its profitability by continuing to buy deeply discounted Greek bonds and using Greece’s income stream to build the ECB’s stated capital.  As long as it continues to buy Greek debt, Greece remains solvent, and the ECB continues to increase its accrual of profits that flow to capital.


The logical conclusion of all of this is ECB ownership of most of Greece’s debt, with austerity measures imposed by the ECB steering the Greek budget to a primary surplus, along with sufficient taxation to keep the ECB’s capital on the rise, and help fund the ECB’s operating budget as well.  Now add to that similar arrangements with Ireland, Portugal, Spain and Italy and it’s Mission Accomplished!

Mission Accomplished?  Are we daring to suggest that the Fathers of the euro zone had exactly this in mind when they signed the Treaty of Maastricht? 

Or, put it another way: it’s all so obvious, so how could they not have this mind?

So let’s take a quick look at the central bank accounting to see if this seemingly outrageous thesis has merit. 

Here is what is actually happening. By design from inception, when the ECB undertakes its bond buying operation, the ECB debt purchases merely shift net financial assets held by the ‘economy’ from Greek government liabilities to ECB liabilities in the form of clearing balances at the ECB.  While the Greek government liabilities shift from ‘the economy’ to the ECB.  Note: this process does not alter any ‘flows’ or ‘net stocks of euros’ in the real economy. 

And so as long as the ECB imposes austerian terms and conditions, their bond buying will not be inflationary.  Inflation from this channel comes from spending.  However, in this case the ECB support comes only with reduced spending via its imposition of fiscal austerity.  And reduced spending means reduced aggregate demand, which therefore means reduced inflation and a stronger currency.  All stated objectives of the ECB.

We would stress that this is NOT our PROPOSED solution to the euro zone crisis (see here and here for our proposals), but it is clearly operationally sustainable, it addresses the solvency issues, and puts the PIIGS before the cart, which at least has the appearance of putting them right where the core nations of the euro zone want them to be.

Additionally, the ECB now officially has stated it will provide unlimited euro liquidity to its banks. This, too, is now widely recognized as non-inflationary.  Nor is it expansionary, as bank assets remain constrained by regulation including capital adequacy and asset eligibility, which is required for them to receive ECB support in the first place.   

To reiterate, it is becoming increasingly clear, crisis by crisis, that with ECB support, the current state of affairs can be operationally sustained.

The problem, then, shifts to political sustainability, which is a horse of a different color.  And here is where the Greeks (and the other PIIGS) paradoxically have the whip hand.  So long as the Greeks continue to accept the austerity, they wind up being burdened by virtue of their funding of the ECB.  The ECB takes in their income payments from the bonds, and the ECB alone ensures that Greece remains solvent.  It’s a great deal for the ECB and the core countries, such as Germany, France and the Netherlands, as it costs the core’s national taxpayers nothing.  And, as least so far, Greece thinks the ECB is doing them a favor by keeping them out of default.  The question remains as to whether the Greeks will continue to suffer from this odd variant of Stockholm (Berlin?) Syndrome.

Perhaps not if some of the more recent proposals make headway.  As an example of what might be in store for Greece, consider the “Eureca Project”, publicly mooted in the French press last week.  In essence, it aims to reduce “Greek debt from 145% to 88% of GDP in one step” without default (so protecting all northern European banks); reduce ECB exposure to Greek debt (that is, force Greece to pay the ECB for the bonds it has purchased in secondary bond markets) and it claims that it will “kick-start the Greek economy and revive growth and job creation” and promote “structural reform.”


So how is it going to do all of that?  Simple: engage in the biggest asset strip in history.  The proposal in essence calls for a non-sovereign entity to take all the public assets – hand them over to a holding company funded by the EU which pays Greece who then pay off all it debtors. End of process – except that if it is implemented, the Greeks could well say “Stuff it.  Let’s default and take our chances.  At least we get to keep our national assets.”  That’s the risk that is being run if the ECB and the economic moralists in Germany take this too far.  If this proposal were accepted, the eurocrats would in fact have a failed nation state on their hands in 3 months time — in the eurozone, not the Mideast or Africa.


By contrast, the current arrangements seem tame in comparison.  They obviate the solvency issue, but even here one wonders how much more can be inflicted on countries such as Greece.  We stress that the current arrangements have OPERATIONAL sustainability, not necessarily POLITICAL sustainability.  The near universally accepted austerity theme is likely to result in continuously elevated unemployment, and a large output gap in general characterized by a lagging standard of living and high personal stress in general. This creates huge systemic risk insofar as it might well make sense for Greece (and others) ultimately to reject this harsh imposition of austerity.  But, so far so good for the core nations, as there appears to be no movement in that directions (except on the streets of Athens, rather than in the Greek Parliament). 

By the ECB continuing to fund Greece, and not allowing Greece to default, but instead to continue to service its debt, the whole dynamic has changed from doing Greece a favor by not allowing Athens to default to disciplining Greece by not allowing the country to default.  And while that’s what the Germans SEEMINGLY haven’t yet figured out, if one is to judge from the current debate, particularly in Germany itself, at the same time they have approved the latest package and are quickly moving in the direction we are suggesting.  Note that Angela Merkel has been most adamant on the particular question of allowing Greece to default or allowing an “orderly restructuring.”  It’s also worth noting that when the ECB funds Greece, that funding facilitates Greek purchases of German goods and services, including military, at no cost to the German taxpayer.  In fact, Germany gets to run larger trade surpluses, which means by accounting identity it is able to run lower government budget deficits, which allows it to feel virtuous and continue its incessant economic moralizing. 

So what’s in it for Germany?  That should be obvious by now:  Germany gets to export to Greece, and to control/impose austerity on Greece, which keeps the euro strong, interest rates in Germany low, and FUNDS the ECB.  All in the name of punishing the Greeks for past sins.  It doesn’t get any better than that for the core nations.  It’s time for the Germans to stop pushing their luck.  Rather, they should embrace the genius of one of the so-called southern profligates, Italy, as they have surely created an operationally sustainable doomsday machine of which Machiavelli himself would be proud. How could this not be the Founding Fathers’ dream come true? 

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Today’s Modern Money Primer

Posted on October 3, 2011 by | Comments Off on Today’s Modern Money Primer

By L. Randall Wray


This week we will begin to examine our next topic: government spending, taxing, interest rate setting, and bond issue. We will examine fiscal and monetary policy formation by a government that issues its own currency. We will bear in mind that the exchange rate regime chosen does have implications for the operation of domestic policy. We will distinguish between operational procedures and constraints that apply to all currency-issuing governments and those that apply only to governments that allow their currency to float. Over the previous 17 (!) weeks we have touched on much of this, but now it is time to get down to “brass tacks” to look at some of the nitty-gritty.
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MMP Blog #18: Fiscal and Monetary Policy Operations in a Nation that Issues its Own Currency

Posted on October 2, 2011 by | 22 comments

By L. Randall Wray

This week we will begin to examine our next topic: government spending, taxing, interest rate setting, and bond issue. We will examine fiscal and monetary policy formation by a government that issues its own currency. We will bear in mind that the exchange rate regime chosen does have implications for the operation of domestic policy. We will distinguish between operational procedures and constraints that apply to all currency-issuing governments and those that apply only to governments that allow their currency to float. Over the previous 17 (!) weeks we have touched on much of this, but now it is time to get down to “brass tacks” to look at some of the nitty-gritty. As always, we are trying to stay true to the purposes of a “Primer”—a fairly general analysis that can be applied to all nations that issue their own currency. We will note where the results only apply to specific exchange rate regimes. And we will get into some of the procedures adopted that effectively “tie shoelaces together”—self-imposed constraints. This week we will provide a quick overview of general principles.

Statements that do not apply to a currency-issuer. Let us begin with some common beliefs that actually are false—that is to say, the following statements do NOT apply to a currency-issuing government.

  1. Governments have a budget constraint (like households and firms) and have to raise funds through taxing or borrowing 

  2. Budget deficits are evil, a burden on the economy except under some circumstances

  3. Government deficits drive interest rates up, crowd out the private sector…and necessarily lead to inflation

  4. Government deficits leave debt for future generations: government needs to cut spending or tax more today to diminish this burden 

  5. Government deficits take away savings that could be used for investment 

  6. We need savings to finance investment and the government’s deficit 

  7. Higher government deficits today imply higher taxes tomorrow, to pay interest and principle on the debt that results from deficits

While these statements are consistent with the conventional wisdom, and while they are more-or-less accurate if applied to the case of a government that does not issue its own currency, they do not apply to a currency issuer.

Principles that apply to a currency issuer. Let us replace these false statements with propositions that are true of any currency issuing government, even one that operates with a fixed exchange rate regime

  • The government names a unit of account and issues a currency denominated in that unit;

  • the government ensures a demand for its currency by imposing a tax liability that can be fulfilled by payment of its currency;

  • government spends by crediting bank reserves and taxes by debiting bank reserves; 

  • in this manner, banks act as intermediaries between government and the nongovernment sector, crediting depositor’s accounts as government spends and debiting them when taxes are paid; 

  • government deficits mean net credits to banking system reserves and also to nongovernment deposits at banks;

  • the central bank sets the overnight interest rate target; it adds/drains reserves as needed to hit its target rate; 

  • the overnight interest rate target is “exogenous”, set by the central bank; the quantity of reserves is “endogenous” determined by the needs and desires of private banks; and the “deposit multiplier” is simply an ex post ratio of reserves to deposits—it is best to think of deposits as expanding endogenously as they “leverage” reserves, but with no predetermined leverage ratio; 

  • the treasury cooperates with the central bank, providing new bond issues to drain excess reserves, or retiring bonds when banks are short of reserves; 

  • for this reason, bond sales are not a borrowing operation used by the sovereign government, instead they are a “reserve maintenance” tool that helps the central bank to hit interest rate targets; 

  • the treasury can always “afford” anything for sale in its own currency, although government always imposes constraints on its spending; and 

  • lending by the central bank is not constrained except through constraints imposed by government (including operational constraints adopted by the central bank itself). 

Some of these statements will seem cryptic at this point. We will clarify further in the following weeks. Here we are setting out the general principles that will be discussed later in order to contrast them with the “conventional wisdom” that likens a government’s budget to a household budget.

Let us be careful to acknowledge that these principles do not imply that government ought to spend without constraint. Nor does the statement that government can “afford” anything for sale in its own currency imply that government should buy everything for sale in its currency. Obviously, if things are for sale only in a foreign currency, then government cannot buy them directly using its own currency.

These principles also do not deny that too much spending by government would be inflationary. Further, there can be exchange rate implications: if government spends too much, or if it sets its interest rate target too low, this might set off pressure to depreciate the currency. This means that the government’s interest-setting policy as well as its budget policy will be mindful of possible impacts on exchange rates and/or inflation rates; in that sense, interest-setting and fiscal policy are “constrained” by government’s desire to control the exchange rate or the inflation rate.

This brings us to the exchange rate regime: while the principles above do apply to governments that peg their exchange rates, they must operate fiscal and monetary policy with a view to maintaining the peg. For this reason, while these governments can “afford” to spend more, they might be choose to spend less to protect their exchange rates. And while government can “exogenously” lower its interest rate target, this might conflict with its exchange rate target. For that reason, it might choose to keep its interest rate target high if it is pegging its exchange rate.

Next week we will begin to examine in more detail the government’s budget when it is the issuer of the currency.

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Say W-h-a-a-a-t?

Posted on September 30, 2011 by | 12 comments
Below are some of the wildest,boldest, and most surprising stories we ran across this week. Thanks toall who shared their favorites.  Keep them coming! This is a weeklyseries, so we’ll be back with more next Friday.

This piecefrom Forbes Magazine argues against Keynesian demand management and in favor of deflation as a cure for our ailing economy. The rationale?  Straight from the 19th century — Say’s Law of Markets.  The author argues:  “Right now there’slots of demand for Apple iPads and Amazon Kindles and Google Android phones, say, or for Katy Perry and Bruno Mars downloads. Lady Gaga’s “fame-monster” microeconomy thrives, needing no artificial boost. Even Britney Spears is back, with Ke$ha and Nicki Minaj.  Buton the other hand, there seem to be too many houses, Chevy Volts, BlackBerrys and Rihanna tour dates. Still, there is no general glut; everything has some market-clearing price. Instead there is relative overproduction in particular sectors to which pricesmust adjust.For housing and labor, say, to recover, some prices and wages must fall.  But policymakers face political difficulties by permitting prices to fall to the market-clearing levels that enable recovery. Nearly all policytries instead to hold prices at unsustainable levels and create still more “demand” in defiance of Say.”  

I hope his readers will remember that falling wages and asset prices didn’t help markets reach “equilibrium” during the Great Depression. Indeed,it made made conditions much worse.


Robert Reich, former secretary of labor under President Clinton, continues to make a strong case for infrastructure investment (the wise Homer in him), pointing out that, “unemployment in America remains sky-high” and “the nation’s infrastructure is crumbling.” But then, things go wrong. He says, “now connect the dots. Anyone with half a brain will see this is the ideal time to borrow money from the rest of the world to put Americans to work rebuilding the nation’s infrastructure.” As any MMTer knows, the US doesn’t need to “borrow money from the rest of the world to put Americans to work.” The government is the source of our money. It spends by crediting bank accounts. It is not revenue constrained.


US Congressman Dennis Kucinich (D-Ohio) has introduced legislationmodelled on a the kind of Job Guarantee (JG) or Employer of Last Resort (ELR) proposal that MMTers have been advocating for more than a decade. Unfortunately, the bill also advances the American Monetary Institute’s wrong-headed plan to fundamentally change the nature of our monetary system. The problem with the Kucinich legislation is that it views the JG as an employment creation scheme rather than a mechanism to promote macroeconomic stability (I.e. Full employmentand price stability).  As MMTers have explained, the JG buffer provides the nominal (price) anchor, and it is perfectly compatible with the monetary system we have in place right now.


In a recent post, Paul Krugman lashed out at Larry Kotlikoff for “dismissing Keynesian economics based on what they think they heard somebody say” instead of  taking “even a minute to see what those people have actuallybeen saying.” What’s Krugman’s beef?  Well, Kotlikoff misrepresented Jamie Galbraith and Paul Krugman, saying that, as Keynesians, they believe that unemployment exists because wages are too high, and thata decline in wages would increase employment.  Krugman points out that Jamie has “never claimed that a fall in wages would create jobs — nor can I see how anyone familiar with his work could imagine that this was his position.”  It reminded us of  some of Krguman’scritiques of MMT, especially the one in which he wrongly accused Jamie Galbraith (whom he considers a leading proponent of MMT) of taking the position that “deficits are never a problem.”  We hope that Professor Krugman remains interested in MMT and that he takes his own adviceand responds to what we’ve “actually been saying” and not some caricature of what others have said about us.

For the handful of readers who haven’t already seen this, here’s a BBC interview with market trader Alessio Rastani. We found it shocking, not because of its content but because of its candor.

Some shocking statsabout America’s food stamp recipients.  Whites make up the largest share of food stamp households, 70% have no earned income, 94% are US born citizens, etc.
What’s it like to work in one of Amazon’s warehouses in the USA?  Story here.

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Real vs. Financial Accounting: Responses to Blog #17

Posted on September 29, 2011 by | 4 comments

Ok this week we are detailing the difference between real and financial—both flows and stocks. Let me provide answers on seven points, and (sorry) postpone for a couple of days an answer to the eighth (which I have not had time to go through).

Q1 (Neil): What about a reserve currency? What about insufficient real investment—especially to deal with the extra demand of ELR?

A: All the real and financial accounting applies to any nation, any currency. No difference. But, OK, might be worthwhile to have a blog devoted to the international reserve currency. Will do.

On adopting ELR and capacity. Look, my belief is that capitalists are not (too) stupid. If there is demand, they will try to meet it. There can be bottlenecks, but those are temporary. We do not need to prod them to invest. If there are sales prospects they will add capacity. On ELR (a topic we have not covered yet), we increase employment and probably demand for consumer goods. By Okun’s law, reducing the unemployment rate by one percentage point raises output by three percentage points (GDP). The ratio could be considerably less for ELR. Note that conventional estimates of a universal ELR program are that wages and other costs would be about 1% of GDP, so by Okun’s law, reducing unemployment by 10 percentage points or so the extra output generated would be far more than enough (up to 30 percentage points of GDP, although probably less) to satisfy the demand. But—we’ll do this later.

Q2: (Tom): Doesn’t childcare (etc) increase value added as women (etc) are released to higher value work? And Austrians argue only real assets, not financial assets, constitute “the economy”.

A: Agreed on the first point, but “efficiency” is vastly overrated—see below. The second, Austrian, point might be OK as a prescription, but certainly not as a description of the real world (a point Dave makes, too). This is a “monetary production economy” where satisfying consumer demand (providing “utils”, raising living standards, reproducing labor power—whatever you want to call it) occurs only by coincidence. What matters is monetary profits. All the more important when Wall Street runs the economy.

Q3: (Geerussell): Does government need to tax all activity, including production for own use?

A: No. We need a broad-based tax that is hard to avoid. Cubic foot of dwelling space, or perhaps cubic inches of cranial space, will do it. (Everyone needs shelter and a brain.)That will drive money, allowing government to move resources to the public purpose.

Q4: (Rvm) Does MMT apply to communist society?

A: In theory, socialist society still uses money to motivate production, hence to move resources to public purpose. So, yes, taxes drive money and money motivates labor. From each according to ability to each according to contribution. In communist society, in theory, you no longer need money to motivate activity. From each according to ability to each according to need. No taxes, no money.

Q5: (Dave): Is drop-out hippiedom the future?

A: Well, a lot of people thought that back in 1965. We’re still waiting. Note, I do think that “slow” and “local” food is a good thing, with proper caveats.

Q6: (Forrest) Again, a question on efficiency vs independent food production.

A: Briefly, efficiency is vastly overrated as an overriding goal, and it often (maybe always) conflicts with sustainability. Without getting overly tree-huggy about this, if using a few more workers in agriculture instead of poisonous petrochemicals can help to save the globe, let’s give up some efficiency. It is not like we’ve run out of labor. And if we go a bit wonky, the economic definition of efficiency is only well-defined in a general equilibrium model with continuous full employment. That ain’t our real world. Most of the time we have massive amounts of unemployed resources, so putting them to work increases output without sacrificing any efficiency, no matter how inefficient the production process.

Q7: (Joe & Larry—I sure wish it had been Moe&Larry!): Money is the way to shift real production; money is not real stuff, but moves it.

A: Mostly agreed—from the perspective of government. Government creates a money of account, issues IOUs denominated in it, and imposes a tax to move real resources to the public sector to accomplish the public purpose (as it sees it). Unfortunately, in a capitalist economy, the captains of industry that control a huge portion of production do not see it that way. All they really care about is money.

Q8: (Mattay): Accounting example.

A: Sorry—will try to answer soon.

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The Solyndra Loans as Liar’s Loans

Posted on September 26, 2011 by | 8 comments

By William K. Black
(Cross-posted from Benzinga.com)

This column comments on Joe Nocera’s September 23, 2011 column entitled: The Phony Solyndra Scandal

Nocera’s column compares the statements of Solyndra’s controlling managers to Dick Fuld’s statements to the public about Lehman’s conditions and asserts with minimal explanation that neither could have been criminal. I have testified before the House Financial Services Committee at some length as to why Lehman was a “control fraud” so I disagree with Nocera. Lehman engaged in extensive accounting and securities fraud and caused massive losses by selling endemically fraudulent liar’s loans to the secondary market. It Soyndra’s controlling managers made false disclosures analogous to those made or permitted to go uncorrected by Fuld, then they too face a serious risk of criminal prosecution – it we ever replace Attorney General Holder with a prosecutor.

I also write to explain why Nocera is wrong to absolve the White House from scandal in the Solyndra matter. Nocera argues that it is inherently highly risky for the government to lend to companies the market will not loan to because their “green” projects are extremely risky commercial projects. He concludes that it is inevitable that many such loans will fail and that such failures do not demonstrate that the federally subsidized loan program for green energy companies is flawed. He concludes by warning that China dominates solar panel manufacture and that China will be the winner if the Republicans cut funding for the green energy programs.

Nocera is correct that the subsidized program is extremely risky. He identifies two of the risks. First, the technology developed may prove unmarketable. Second, entry by competitors may be so robust that the price of the relevant products (e.g., solar panels) suffer a “stunning collapse” and cause the U.S. Treasury-financed firm to fail even if the development of improved technology is modestly successful. 

There are obvious economic arguments against Nocera’s play of the Red Menace card. China heavily subsidizes solar panel manufacturing. Other nations (including the U.S.) subsidize solar panel manufacturing. Solar panels are still a specialty application that is not cost-effective in general usage absent public subsidies. The subsidies to the purchasers are not large enough to develop a market that has kept pace with the tremendous growth of solar panel production. The result has been a glut of solar panel production and a sharp drop in solar panel prices. In sum, the Chinese government is taking the very large financial risks of developing a new technology and the financial losses that come from selling us the solar panels at a low and sharply falling price that is inadequate to defray the costs of production and the risks of new product development. Nocera states that China has provide a $30 billion subsidy to solar panel producers purchasers, which has helped produce a glut of solar panels and caused a “stunning collapse” in their “market” price. That means that the great bulk of the Chinese subsidy has flowed to purchasers of solar panels, including Americans. Even if the Chinese develop a solar panel technology that is cost effective in general residential and commercial real estate usage there is no assurance that the Chinese government or public will find the production subsidies desirable. China may lose its solar panel production lead to a lower-cost producer or a higher quality producer. Other nations’ producers may be less than vigorous in enforcing the intellectual property rights of the Chinese producers, allowing domestic competitors to skip the large risks and costs of the research and development stage.

This column, however, generally emphasizes financial regulation, and there are reasons to use the word “scandal” to describe the administration’s treatment of its regulators in the Solyndra loan. Here is Nocera’s defense of the administration’s behavior:

 “Undoubtedly, the Solyndra “scandal” will draw a little blood: there are some embarrassing e-mails showing the White House pushing to get the deal done quickly so it could tout Solyndra’s green jobs as part of the stimulus package.

But if we could just stop playing gotcha for a second, we might realize that federal loan programs — especially loans for innovative energy technologies — virtually require the government to take risks the private sector won’t take. Indeed, risk-taking is what these programs are all about. Sometimes, the risks pay off. Other times, they don’t. It’s not a taxpayer ripoff if you don’t bat 1.000; on the contrary, a zero failure rate likely means that the program is too risk-averse. Thus, the real question the Solyndra case poses is this: Are the potential successes significant enough to negate the inevitable failures?”

Nocera’s effort to minimize the administration’s misconduct and his misstatements about risk are interrelated and they reprise the mistakes that the Bush administration made in its assault on financial regulation that led to the ongoing financial crisis. Life does not reward all risks. The quintessential risk that it does not reward in lending is failing to underwrite. A lender that fails to underwrite prudently is taking a severe risk, for the failure causes “adverse selection.” Lenders that make large loans (e.g., mortgages or loans to solar panel manufacturers) under conditions of adverse selection have a “negative expected value” – they are gambling against the house. Lenders that make loans with a negative expected value will suffer severe losses.

We are still suffering from a crisis driven by CEOs of lenders who deliberately destroyed essential underwriting in order to maximize the accounting control fraud “recipe” that I have explained many times. The result was “liar’s” loans. By 2006, roughly half of loans called “subprime” were also liar’s loans. Approximately one-third of U.S. mortgage loans made in 2006 were liar’s loans and the fraud incidence in studies of liar’s loans is 90 percent. Liar’s loans caused staggering direct losses and hyper-inflated and extended the residential real estate bubble, driving the Great Recession.

So the “real question” is not the one Nocera framed. The real question is why a lender (the U.S. government in this case) would gratuitously fail to underwrite a loan properly. The fact that the type of loan was inherently extremely risky makes it imperative that the lender engage is superb underwriting. The Obama administration, and Nocera, have failed to learn the most obvious and costly lesson of the ongoing U.S. crisis – liar’s loans cause catastrophic losses and failures and are “an open invitation to fraudsters” (quoting MIRA’s 2006 report to the members of the Mortgage Bankers Association).

Nocera does not explain what is embarrassing about the Obama emails. The government’s professional loan underwriters were worried about lending to Solyndra. They were warning the administration that they had not been able to complete the professional underwriting essential to making loans prudently. The Obama administration officials did not respond by backing their professional regulators. The administration did not stress that it was essential that the loan be approved only after it passed a rigorous underwriting process. The administration responded to the efforts of its professionals to protect the government from loss by abusing the regulators and pressuring them to approve the loans without completing the underwriting. The administration thought it was fine to make a liar’s loan to Solyndra. 

The administration exposed the government to a gratuitous risk of loss of hundreds of millions of dollars in order to achieve an overarching priority – they wanted a presidential photo op. If that isn’t a scandal, if Nocera thinks it is merely business as usual, then our failure to hold Dick Fuld, President Obama, and a host of other elites to a higher standard of accountability is the scandal that will generate repeated scandal.

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.


Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

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MMT in the Upper Midwest

Posted on September 26, 2011 by | 2 comments

Readers in the Rochester (Minn.), Waterloo (Iowa), and La Crosse (Wis.) area can attend a public lecture by Stephanie Kelton on Wednesday, September 28 at Luther College in Decorah, Iowa.  Stephanie’s talk is at 7:00 p.m. in the Center for Faith and Life Recital Hall.  For more information, visit the Luther College website.  http://www.luther.edu/publiclife/

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