New MMTer on the Block

Luke Williams, another Australian MMT proponent blogs at Shmookey.net/blog and draws my attention to his flow of funds model.

Flow of funds

There’s not much on Luke’s blog at the moment but blogging is a slow process when you’re attempting to be factually correct.  Check it out at Shmookey.net/blog.  Nice to have more locals on the scene.

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19 responses to “New MMTer on the Block

  1. what i don’t understand is the, ‘they can’t lend them [excess reserves] to other banks because they also have excess reserves’. if this were true, why can european banks not borrow in the interbank market? also, banks regularly decline to make loans on credit or price decisions ie they decline the loan because it is viewed as too risky or because the return is insufficient.

    • ‘they can’t lend them [excess reserves] to other banks because they also have excess reserves’.

      I think he means that there are no SOUND banks (meaning banks likely to repay the loans) that don’t already have excess reserves.

  2. What I read from Cullen Roche is that Banks first Spend money, i.e., do the electronic transfers to the accounts of the recipients and *then* drains the excess reserves via treasury auctions…

  3. Hi,
    I read pragcap.com that govt first spends and credits the recipient’s bank accounts with electronic transfer of money and *then* it sells treasuries via auctions to drain excess reserves…

  4. While this post says govt first sells treasuries and then spends money.. Which one is true.

  5. According to MMT, what happens logically is that government deficit spends and then issues tsys to drain excess reserves created by deficits if the cb wishes to set a non-zero overnight rate and doesn’t pay IOR. This is more complicated than this simple example since the Treasury and cb coordinate their operations, and the Treasury uses special accounts in banks for its management.

    Govt expenditure is a fiscal operation and issuance of tsys is a monetary operation. In actual practice, due to the political prohibition on the Treasury running an overdraft at the Fed, the Treasury has to obtain reserves through issuance of tsys before deficit spending. This gives the appearance of borrowing to finance, but that is not the case operationally.

    The private sector can only create credit money that nets to zero, since the asset and liability are both in the private sector. Government can create non-govt net financial assets (NFA) by deficit spending since the asset is in the private sector and the liability on the side of govt. Govt withdraws NFA from non-govt through taxation.

  6. Thanks Tom,
    “In actual practice, due to the political prohibition on the Treasury running an overdraft at the Fed, the Treasury has to obtain reserves through issuance of tsys before deficit spending.”
    Does it mean Treasury sells treasuries directly to CB? I read somewhere that treasury can’t see treasuries directly to Fed by law? How does it actually works? And if treasury sells treasuries in Open market where does the private sector gets *New* dollars to fund these *New* treasuries, since private sector can’t create new dollars?

    -RB

  7. Fed cannot buy tsys directly from the Treasury in the US. Treasury issues the securities in coordination with the Fed to provide the various maturities as appropriate to market desires. Then the Treasury has the Fed auction the tsys on its behalf. Primary dealers are the chief participants in these auctions. The Fed then credits the reserves it receives in exchange for the tsys to the Treasury account at the Fed so that expenditures will clear.

    Although this resembles borrowing before spending, the NFA are issued as non-zero maturity assets (tsys) which the Fed converts to zero maturity assets (reserves). So there is no actual borrowing. It is an asset swap that’s a wash. It just changes the composition and term of non-government NFA.

    What happens is that the reserves that get credited to a non-govt account though spending or transfer payments gets saved by someone else as tsys, extracting those newly injected reserves from the interbank market. At the aggregate level it is an asset swap.

    Again, when the Fed buys or sells tsys in OMO, there is no “new money” involved. It’s an asset swap that leaves total non-government NFA unchanged in amount. Only the asset form and term change.

  8. Thanks Tom. I understand parts of it however one question is still in my mind… You say “US. Treasury issues the securities in coordination with the Fed to provide the various maturities as appropriate to market desires. Then the Treasury has the Fed auction the tsys on its behalf. Primary dealers are the chief participants in these auctions. The Fed then credits the reserves it receives in exchange for the tsys to the Treasury account at the Fed so that expenditures will clear. ”

    Question is when govt has to spend more it has to create new money. Treasury creates a non-zero maturity asset called treasury, it is effectively creating new money out of nothing. Say it created 100 Billions worth of treasuries. Now treasury account at Fed has 100 billion dollars worth of treasuries sitting there. It is fresh money. After this they have an auction. Who ever buys these treasuries in the auction has to give 100 Billion dollars in exchange for these treasuries. Where is that money coming from? Is this the money already in the system? If so what treasury just created isn’t the new money. It just took the money which was already in the system. So that sounds like borrowing! But if it is borrowing it is not new money so no increase in the money in the system.

  9. In shorter form my question is that in the statement : “The Fed then credits the reserves it receives in exchange for the tsys to the Treasury account at the Fed so that expenditures will clear.”
    From where is the Fed getting reserves in exchange for treasuries?

  10. “From where is the Fed getting reserves in exchange for treasuries?”

    The government is the sole provider of its currency. Under a central banking system which most countries use today, the Treasury and central bank work together reciprocally to issue government money. Banks have government franchise to create credit money denominated in the currency as unit of account established by the the government, but they cannot create currency. They have to get reserves and cash from the cb as needed.

    The Treasury issues non-zero government money in the form of tsy securities and the cb issues reserves. When the Treasury issues tsys that are then auctioned by the Fed, the Fed receives reserves in exchange in an asset swap. Total NFA does not change. The Fed then credits the Treasury’s reserve account by creating reserves, increasing govt money of zero maturity that is used to settle the deposits created by Treasury spending and transfers. This means that there is an increase in NFA in the system, in that non-government now holds more tsys than previously with the excess reserves added by the fiscal deficit drained off to allow the cb to hit its target rate. The “national debt” increases, representing increased saving of non-govt NFA. So the total national debt is the net savings of non-govt in NFA in that the liability is on side of government, tsys being liability of Treasury and reserves being a liability of the cb, within the assets in the hands of non-govt.

    Banks have a government franchise (charter) to create credit money denominated in the currency as unit of account established by the government, but they cannot issue currency. They have to get reserves and cash from the cb as needed, but loans (bank asset, customer liability) creating deposits (bank liability, customer asset) nets to zero.

    The cb then adds and drains reserves by purchase and sale of tys to manage the quantity of reserves so that it can hit its target rate, unless it chooses to set the rate to zero or pay IOR.

  11. Thanks a lot Tom for taking time to answer my novice questions. I will have more questions for sure but first I have to read your posts a few times more to grasp the concept. :) No wonder economics is called the toughest subject on earth!

    regards

  12. Rajeev:
    Say it created 100 Billions worth of treasuries. Now treasury account at Fed has 100 billion dollars worth of treasuries sitting there. It is fresh money. After this they have an auction. Who ever buys these treasuries in the auction has to give 100 Billion dollars in exchange for these treasuries. Where is that money coming from? Is this the money already in the system? If so what treasury just created isn’t the new money. It just took the money which was already in the system.
    Excellent questions. I’ll repeat Tom’s answers in different words. As you observe, you can think of the cycle of reserve drain /bond issuance / auction–>government spending–> rd / bi /a as starting at any point. That money that the Treasury gets in return for the $100B bonds is “already in the system”, true.

    But the “if so” is wrong in essence. You are forgetting what the Treasury does with the money in the Treasury General Account. It spends it, and puts it back in the economy. So the economy has no less currency/reserves/money than before, and has lots of shiny new T-bonds. But if it is borrowing it is not new money so no increase in the money in the system. To repeat, this is false. There is “new money” (new NFA) – currency/reserves stay the same & the national debt/ bonds increases.

    Not only is there a requirement (due to misunderstanding of economics) that the TGA have a positive balance, there is one in practice that its balance doesn’t goes above $5 billion – which means it isn’t supposed to suck more than that amount of currency/reserves out of the economy by its monetary games – and this latter requirement is probably the more important one. As soon as the reserves / money comes in the Treasury’s front door, it’s gotta go out the back door.

    MMTers usually say it is better to think of “government spends first” – and that is true, ultimately, must be true logically. But again, you can think of it starting anywhere. These silly games & their pointless requirements could conceivably have some effect in ultra-extreme, academic situations, but never in practice. (never in 200+ years). The real effect of these silly games is in confusing everyone about what the hell is going on, which is truly so simple it repels the mind. And this “WTF-I’m so confused effect” dwarfs the economic effect on interest rates, the direct effect.

  13. Calgacus,
    Thanks a lot.
    >> You are forgetting what the Treasury does with the money in the
    >> Treasury General Account. It spends it, and puts it back in the economy.
    >> So the economy has no less currency/reserves/money than before, and
    >> has lots of shiny new T-bonds.

    You are right. I was forgetting this very fact that the money acquired by treasury department in exchange for the bonds will be pumped back into the system.. So net reserves are same but there are new treasury bonds injected into the system (which is the new money just created).
    Until this is what I have understood after reading here and some other places, about treasury bond auctions (and money creation by govt) Please let me know if my understanding is correct.

    1. Treasury department needs money so it plans a bond auction.
    2. Central bank/Treasury/Primary dealers work together and determine how many bonds worth how many dollars need to be sold.
    3. Fed ‘makes money available’ for the bonds by buying existing bonds from the banks via REPO. Now banks have enough reserves to buy new bonds.
    4. Auctions are held. Primary dealers participate. Banks already have the reserves created via repo. They buy the bonds with these reserves.
    5. Treasury’s account at Fed has cash to spend.
    6. Banks buy back the bonds from Fed as per the REPO agreement in step three above.
    7. After step 6 above, private sector (banks) have new set of bonds they just bought in the auction. Treasury account has reserves they got in exchange.
    8. Money in Treasury department’s account is spent back into the private sector.

    Now after step 8, I see that Treasury department created a liability for itself (bond) for each dollar it spent. It has pumped new reserves it got into the system via govt spending plus it has created equal amount of bonds. Is this understanding correct? If so then treasury department is creating 2 times the money it needs. i.e., if it had to spend say 1 billion, it spent 1 billion in cash and created 1 Billion worth of bonds which banks are holding! Isn’t it?

  14. As Calgacus said, the reserves that come out of deposit account to pay for the tys are a specific amount of NFA. This is a simple asset swap of reserves for the tys. No change in NFA.

    Then the Fed credits the Treasury reserves account with the same amount of reserves has now resides in the economy as tys. The Treasury then uses those reserves to credit deposit accounts for its expenditure into the economy, leaving the economy with the same amount of reserves as it had.

    End result X dollars in reserves as at beginning of process plus X dollars in tys at the end of the process = 2X.

    What is usually not noticed is that the reserves that came out of the economy to pay for the tys are actually an asset swap and remain in the system in another form. Composition of NFA has changed, but not the total amount. Then the cb credits the Treasury in the same amount of new reserves, which the Treasury then injects into the economy through expenditure.

    Instead people think that the reserves were “borrowed” and then spent, leaving NFA the same. That is incorrect.

  15. I should make this a bit clearer. The way the public thinks is that the Treasury is borrowing dollars on a promise to pay later and then spending those dollars. The amount of dollars remains the same plus a promise to repay that is essentially worthless until payment.

    That is of course, wrong. The tys are not just promises to pay (IOU’s) that are filed away somewhere until they come due. They are an asset form just like currency (reserves and cash) and due to their high liquidity, they can be converted into currency virtually immediately.

    The way Warren Mosler explains it metaphorically is that reserves accounts are deposit accounts at the cb that are like bank deposit account and tsys are savings accounts at the cb are like savings accounts at the banks. Just as funds get switched back and forth from deposit account to saving accounts at banks, so too with reserves and tsys in the cb accounts.

  16. Tom,
    Thanks.
    I understand it quite well now (or I think I understand it :) ). One more question:
    I am thinking that all this jugglery and complexity is due to the fact that by law Central bank can’t buy the treasuries directly from the department of treasury and also there is some outdated law due to which Treasuries have to “raise money before spending” (or look like it is borrowing money) before spending… If we did not have these laws, the process would have been much simpler. Is that understanding correct?

  17. @ Rajeev

    Yes, that is correct. The roundaboutness is the result of voluntary political choices not operational constraint. Treasury could either just issue currency directly as President Lincoln directed it to do with “greenbacks” to fund the Civil War, or Treasury could still issue interest-bearing tsys exchanged directly with the Fed for reserves for its payments account if it wanted to subsidize default risk-free assets for non-government. However, there is no operational need for currency soverigns to issue Treasury securities under the existing system.

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