National Debt and Monetary Policy

I'm not an economist but a lawyer but here goes.

If you extend that logic a little further, you might ask, “Well, don’t we pay taxes and buy bonds so that the government can spend?” Well, you first have to ask yourself the question, “Where do you get the money to pay taxes and buy bonds?” And the answer is that we can’t get our hands on the currency until the national government spends it. Spending is the prior act in a fiat monetary system; taxing and borrowing are following acts. In effect, the government is only taxing what it has already spent, and it’s only borrowing back money that it has already spent. Once you start pursuing this logic, you realize that most of the propositions that are occupying the current debate around the world are based upon false premises.

This is false. Money is often brought into circulation by banks through fractional reserve banking (but he deals with this later, so baffled he states it like this). This is why fiddling with the interest rate is considered to have an effect on the rate of inflation. The lower the rate, the more banks lend out, the more money they inject in the economy.

Additionally, a government can tax historic wealth, which doesn't require it to first spend either. Finally, a government can (and does!) spend and can create a by and large profit for society. Large-data review suggests the optimum balance between debt-to-GDP ratio is somewhere between 50% and 60%, where government borrowing and expenditure lead to economic positives - e.g. it's leveraging its investment paid for with borrowed money. It turns south quickly above 90%.

If you extend that logic a little further, you might ask, “Well, don’t we pay taxes and buy bonds so that the government can spend?” Well, you first have to ask yourself the question, “Where do you get the money to pay taxes and buy bonds?” And the answer is that we can’t get our hands on the currency until the national government spends it. Spending is the prior act in a fiat monetary system; taxing and borrowing are following acts. In effect, the government is only taxing what it has already spent, and it’s only borrowing back money that it has already spent. Once you start pursuing this logic, you realize that most of the propositions that are occupying the current debate around the world are based upon false premises.

This is worded a bit strangely. Yes, if I introduce an imbalance due to government action currency exchange rates will find a new equilibrium. So I can pursue a low interest rate domestically, curbing possible inflation, which probably strengthens my currency versus other countries, making imports cheaper and your exports for your foreign buyers more expensive, causing capital to flow out of the country (it's spend abroad), lowering circulation of your currency in your own country ultimately causing inflation. So yes, you can pursue "pure" domestic policy but that would be stupid as these "foreign" effects have domestic effects - they're not separate systems.

If you extend that logic a little further, you might ask, “Well, don’t we pay taxes and buy bonds so that the government can spend?” Well, you first have to ask yourself the question, “Where do you get the money to pay taxes and buy bonds?” And the answer is that we can’t get our hands on the currency until the national government spends it. Spending is the prior act in a fiat monetary system; taxing and borrowing are following acts. In effect, the government is only taxing what it has already spent, and it’s only borrowing back money that it has already spent. Once you start pursuing this logic, you realize that most of the propositions that are occupying the current debate around the world are based upon false premises.

Rating agencies are concerned with credit risk. Is a given sovereign capable of paying off its debt? If a country doesn't have revenue through taxes it won't be able to pay its debt so any bonds it issues will be rated as junk. In other words, nobody is going to buy your shitty bonds especially if you've shown a willingness in the past to create (severe) inflation to diminish your debt thereby screwing over investors and the general population at the same time.

The mainstream believes that taxation distorts individual incentives, that government borrowing pushes interest rates up and thereby undermines private sector investment, and that ultimately the danger of government spending is hyperinflation.

Hmmm... Taxation might make certain business with small margins unprofitable to continue, this might be true in a small number of cases but it isn't true across the board. So, mostly false. Government borrowing can push interest rates up but only if it crowds out other market participants. I refer to my earlier percentages as to "healthy" ratios. Hyperinflation is again, only an issue when dealing with excessive debt.

Well, there is certainly a mischaracterization among mainstream economists about how the modern monetary system operates. In mainstream textbooks you’ll find a chapter about the role of the central bank, and that chapter will describe how the central bank’s main function is to control the supply of money through open market operations—that is, buying and selling government bonds to regulate the demand of money relative to the supply. Through this process, the story goes, the central bank is able to target interest rates.

That textbook explanation is quite wrong. Central banks cannot control the money supply. And not many central banks past the mid-1980s gave any credibility to monetary targeting. They realized that central banks can control only interest rates, not the money supply. After this realization, monetary policy became expressed through setting a short-term interest rate by managing the liquidity in the overnight cash markets.

Central banks' influence on the money supply by just increasing base money is very limited. Due to the fractional reserve banking system, short-term interest rate changes are much more effective. The textbook explanation is still correct, it's just that broadening the money base isn't the preferred method any more. Even so, a large increase in the money supply without circulation, regardless of whether its caused by an increase in base money or through changes in the interest rate, will be ineffective. In other words, "money supply" is the wrong thing to look at from the start.

In the US and Japan, for example, there has historically been zero return on those reserves. So banks will try to lend out excess reserves to other banks that may be deficient in reserves. The competition in this market, called the interbank market, starts to drive interest rates down, because the banks will take any return instead of zero. If the central bank allows that process to continue, it loses control of monetary policy.

The way the central bank can maintain control of its target interest rate is to manage that liquidity that’s embodied in these reserves. So if the central bank perceives that the banks consider their reserves to be excessive on any particular day, it drains those reserves out of the system by offering an interest-bearing asset in the form of a government bond. The role of government bonds, then, is to provide the central bank with the capacity to ensure that there is no competitive pressure on the target interest rate. So you can see that the function of government bonds is something quite other than to lend the government money.

Yeah... but no. This will only result in a substitution on the balance sheet of the banks. Cash is exchanged for bonds. Bonds can still be used as a basis for their fractional reserve banking. So the reserves aren't drained because the cash they used for it is the cash that is part of their capital requirements and not what they actually lend out to their customers or on the interbank market. This will have no effect on the interest rates (but crowding out, which he rejected earlier, can!).

The only issues a progressive person might have with public debt would be the equity considerations of who owns the debt and whether there an equitable provision of private wealth coming from the deficits. There is a debate to be had about that, but there is no reason to obsess over the level of outstanding public debt. The government can always honor its debt; it can never go bankrupt. There’s no question that the debt obligations will be met. There’s no risk. What’s more, this debt provides firms, households, and others in the private sector a vehicle to park their saved wealth in a risk-free form.

There is plenty of reason to obsess over the level of outstanding public debt. At certain levels it is unsustainable and becomes a drag on economic activity. Plenty of data in that respect. And no, governments do not always honour their debt, we've had plenty of restructurings triggered because countries could not or were about to be unable to meet their payment obligations. So there's plenty of risk because you could be confronted with a serious haircut on your bond leading to an effective loss for bond holders.

I don't have time for more unfortunately. It might be the format of the article that causes a lot of inaccuracies/mistakes but it doesn't seem very convincing to me.

I agree with his basic premise. Government has to start somewhere, and the difficulty is that we are in the midst of it. If you start a Bank or any business you need to capitalize it first, which means that if you are a government you must print money to get the ball rolling to capitalize it. There was a bench mark for doing this, which was the gold standard, which was exchanged back in 1971 for the value of a dollar at that time, and now currencies float relative to each other. In principal the only restraint on a government printing as much currency as it wants (and some have tried) is the exchange rate or how much a 1971 dollar is effectively (vs nominally) worth relative to their currency today. If you print too much money interest rates drop and so does the relative value of a particular currency to other competitive currencies.

He suggests that the Central Bank controls interest rates by buying or selling bonds, which is right, and he dismisses the explanation that their use as public project financing tool which I am not sure about, but it kinda makes sense. If the government can print as much money as it wants, and assuming that it's able to keep to its inflation targets then why issue bonds, why not just print the money? The apparent answer is that the issuance of bonds enables the Central Bank to adjust for market fluctuations,to keep currency values, inflation rates with its targets.

Quoting Sam26

Here's an interesting article about about monetary policy. I'd be interested in those of you who have an economics background to get your thoughts. My feeling is that the national debt crisis may be blown somewhat out of proportion, but this subject is much more complicated than saying, "The sky is falling because of our debt."

The US is a sovereign nation and could half national debt simply by printing half the amount of that debt. Monetary sovereignty before "Reaganomics", "Thatcheromics" and all that, was employed to keep the economy moving onwards against the onslaught of inequality, off-shore accounts, and CEO bonus culture. The reason they decide not to do that is that those in power are the rich and do not want their savings to be devalued (all debt is held by someone). They also think it ideologically sound to keep large sections of the population in austerity and poverty.
The sky is not falling. "Our debt" is another's wealth.

MMT is a fine example of why economics is not a science. MMT is an ideology that attempts to "justify" rampant government spending. Now, while it is more historically accurate than the competing ideology of Austrian economics, when it comes to the origin of currency, it is still historically inaccurate. Just go back to England centuries ago? How did England establish currency? Did it just initially spend money it made up out of thin air as MMT claims? Not at all. People who already held gold turned it in to receive back from the government less gold, but in the form of a coin that could be used to buy things. So, while MMT is correct that all currency is based on a political organization that legalizes the use of a currency for the payment of debts, goods and services, it is wrong when it claims money originated by governments making it up out of thin air. The historical reality is that currency started off by governments confiscating wealth from private people.

This is also what would happen if the federal government in the USA started spending like crazy. Inflation will result, which is nothing less than a tax on people's savings.

MMT is an ideology not merely because it rewrites actual history, but because it ignores one of the most basic concepts of all in economics ---- the problem of scarcity. If the federal government prints up money and spends it, all it does is take resources that exist. It's not getting around the problem that in the end resources used for one purpose cannot be used for another.

Reply to LD Saunders I found your comments usefully explanatory. There is something fishy about the Harvard International Review article. It seems to fly in the face of what I have always taken to be a common sense view of income, taxes, government spending, inflation, and so on.

Debt usually is a problem eventually. Most people carry more debt than they can reasonably pay off quickly (it amounts to too large a share of their income and assets) for ordinary goods, autos, college education, and so forth. There are various schemes for banks to extract the value of houses (the home equity loan). Some corporations have quite a bit of debt (maybe not Apple, but Apple isn't everybody), and the there is the federal debt.

Governments shouldn't be free of the discipline of debt payment, balanced budgets, and so forth, because a lack of discipline disables any capacity to make intelligent decisions. Spend a trillion on this war, that tax cut, whatever... Great. It will play well on Main Street, Wall Street, or Dead End Street.

Debt and balance of payment deficits should alert us to failures in our economy -- that we are not utilizing all our economic resources--that we are wasting lives, rather than the greatness of paper money to waive away all problems.

A very good article about MMT, thanks!

Yet MMT is a perfect example of economists making a theory of how the present is totally different from the past and that this is the way how the economy will function from here onwards. MMT is like the idea that the economy has matured away from a boom-bust cycle, when the economy has just had a very long boom (and likely faces an imminent crash). Hence MMT works perfectly... until it doesn't.

Of course, there has been the hyperinflation in Zimbabwe, extremely high inflation in Belarus or Ukraine and in many other countries. But those countries seem not to matter. On a positive note (thanks to the article), seems that the MMT developers do understand this on some level:

(from the article)

None of this is to say that budget deficits don’t matter at all. The fundamental point that the original developers of MMT would make—myself or Randall Wray or Warren Mosler— is that the risk of budget deficits is not insolvency but inflation. In saying that, however, we would also stress that inflation is the risk of any kind of overspending, whether investment, consumption, export, or government spending. Any component of aggregate demand could push the economy to that point where we get inflation. Excessive government spending is not always to blame.

I think that Japan is the case experiment for the MMT. If it gets into trouble with it's huge domestically owned debt and Abenomics sometime in the future, that's bad for MMT.

Quoting ssu

I think that Japan is the case experiment for the MMT. If it gets into trouble with it's huge domestically owned debt and Abenomics sometime in the future, that's bad for MMT.

Yes, I think many economists keep an eye on Japan. Many predictions about what would happen when carrying as much debt as Japan didn't happen. Many of the past economic models probably need to be re-thought. People compare the debt of a country with household debt, but there is a vast difference, especially given fiat currencies. Sometimes I wonder whether a country might be able to have unlimited spending power in some sense. Not sure, just thinking outloud.

You are correct, Sam26.

You can have a lot of views about MMT, but the theory's existence itself tells that the World has indeed changed. Just how much it has changed, that's the big question. The fact is that the fiat system is, well, younger than me and hence still is a new thing from the historical perspective. It likely isn't a perpetual machine, that we can just go from trillions of debt to quadrillions, quintillions and so on without anything happening with prices and it's nice to see that even the MMT people understand this.

The real difference is that inflation has been contained, or basically it has gone into asset inflation. Yet one has to understand that the whole idea of functioning "free" markets is quite dubious as central banks not only intervene in the currency market, but even in the stock market. Everything is actually quite controlled.

And we usually forget just how close to a huge collapse of the entire system came to during the last financial crisis just a decade ago. A lot of things are still there even today.

Quoting LD Saunders

Not at all. People who already held gold turned it in to receive back from the government less gold, but in the form of a coin that could be used to buy things. So, while MMT is correct that all currency is based on a political organization that legalizes the use of a currency for the payment of debts, goods and services, it is wrong when it claims money originated by governments making it up out of thin air.

You can't eat gold. Gold is as arbitrary as any medium of exchange. You make the usual mistake of thinking that money is the same as wealth, when it is far from it.
The myth you carry around has always served the rich and greedy. The promise that gold has a magical value has simply been transferred to a paper promise.

Reply to charleton Ya, I think the idea that money has to be backed by gold is incorrect. Trust in a currency is probably more important than anything else. If trust is undermined, then all bets are off.

..

Charleton: There you go again, completely engaging in a strawman with respect to my actual comment. I never stated that gold was the equivalent of wealth. Wealth would be a borader classification; nevertheless, some wealth is in the form of gold. That was true centuries ago and is also true today. Gold did represent wealth for people, which is why the government confiscated it in producing gold coins.

Should one remind that if we could have as much gold we could have, the soft, malleable inert metal resistant to nearly all acids would be used in a lot of places starting from coating the plastic pipes used in plumbing? But as we can make artificial gold only extremely tiny amounts at CERN in the On-line Isotope Mass Separator the rareness of the metal is a reality. Yet surely there would be a demand for the metal if it would be as common as iron or copper. (Or if it actually wouldn't be mainly concentrated at the center of the Earth on this planet.)

The idea of thinking of a metal based monetary system seems to be an "old relic" as Keynes put it, but if the trust that we now have in the fiat monetary system collapses, it could be as realistic as it was in the past. Then our trust in the present system would seem naive and absurd. Who knows...

Reply to ssu My guess, and it's only a guess, is that money will morph into something completely different at some point, ala some kind of cryptocurrency, which will be a worldwide currency. Of course this may take some time because governments are wedded to paper money.

I don't recognize the debt as rational. Fiat currency creates a greater number of lesser value dollars. If the beneficiary of fiat currency paid for the full consequence out of his/her benefit there would be no benefit. And besides, the government exists to serve the people. Charging interest is one thing. Call it a fee for a service (i.e., the promotion of the economy.) However, payment upon something essentially paid for via devaluation with an interest on top I reckon is a bit too much. It puts a lien on everything. Does this go again inalienable or unalienable right? Just asking.