Open Discussion on MMT III

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12 responses to “Open Discussion on MMT III

  1. Just a few questions I hope someone could help me out with:

    1) If bank reserves are not required to create loans, what is their purpose? As I understand it, they are required for collateral against bad loans and bank runs, giving enough time for the central bank to react. Is this correct?

    To further this if a bank doesn’t have reserves sufficient for their needs, are their options either to borrow money from other banks, or borrow from the central bank? If so, how do banks decided which to do?

    2) When banks charge interest on loans repayments, does that result in a net decrease in the money supply, seeing as the debtor must repay more than they are able to spend?

    3) If debt monetisation (selling bonds for cash) is not necessary to finance the deficit, how is it accounted for? Or is it better to think of the deficit as the net injection of money into the economy (the diagram of the vertical and horizontal ways money can move comes to mind here) so essentially all that the government has done by spending more than it taxes is increase the supply and thus potential size of the economy provided output increases to match the increase in the money supply?

    I will probably come up with some more questions at some point…

    Many thanks.

  2. “1) If bank reserves are not required to create loans, what is their purpose? ”

    Banks reserves include settlement balances in the banks’ reserve accounts (deposit accounts) at the central bank and vault cash for settlement with customers requesting cash at the window. Banks obtain vault cash by exchanging settlement balances for notes and coin at the central bank.

    “As I understand it, they are required for collateral against bad loans and bank runs, giving enough time for the central bank to react. Is this correct?”

    Not correct. Banks are required to hold capital in reserve to default by customers. Bank runs are obviated buy government deposit insurance and the central bank acting as lender of last resort.

    “To further this if a bank doesn’t have reserves sufficient for their needs, are their options either to borrow money from other banks, or borrow from the central bank? If so, how do banks decided which to do?”

    Banks need reserve balances, which are more properly called settlement balances to settle accounts with other banks after interbank netting. Banks have asset & liability management (ALM) departments to handle this. The ALM department obtains needed settlement balances in the most cost-effective way consistent with the individual bank’s policy. Banks have the option of borrowing from the central bank at a penalty rate. That is the least desirable option but it ensures that the banking system always has enough settlement balances to clear.

  3. “2) When banks charge interest on loans repayments, does that result in a net decrease in the money supply, seeing as the debtor must repay more than they are able to spend?”

    Those interest payments don’t disappear down a black hole. They are bank revenue that banks use (spend) to cover salaries and expenses, invest in expansion, and pay dividends.

  4. “3) If debt monetisation (selling bonds for cash) is not necessary to finance the deficit, how is it accounted for?”

    The central bank credits the seller’s of the bonds bank’s deposit accounts at the cb in the amount of the sale and debits its asset account. The banks then credit sellers’ deposit accounts if the sellers are non-banks.

    There are three sets of books involves — the central bank, the banks, and the non-bank sellers of the bonds. In the end all accounts balance as a result of the respective credits and debits.

    Bonds are actually time deposits held at the central bank. So what happens is that time deposits at the central bank are decreased and deposit accounts there are increased. The end result is that liquidity is increased, that is, the monetary base increases.

    “Or is it better to think of the deficit as the net injection of money into the economy (the diagram of the vertical and horizontal ways money can move comes to mind here) so essentially all that the government has done by spending more than it taxes is increase the supply and thus potential size of the economy provided output increases to match the increase in the money supply?”

    When government spends, banks’ reserve accounts are credited with settlement balances and the banks make appropriate entries on their books by crediting customer accounts as directed. When government taxes, banks’ reserve accounts are debited settlement balances and banks mark down tax payers’ deposit accounts as appropriate.

    If spending exceeds taxation, then the total amount of reserve balances increase in that amount. In order for the central bank to target a policy rate, the excess reserves created (injected) by deficit spending are drained into securities removing them from the monetary base. The total amount of aggregate non-government net financial assets remains the same. What was previously held as entries in customers’ deposit accounts and settlement balances in banks’ reserve accounts decreases and the amount held at the central banks in time accounts increases.

    The stimulus to the economy comes from government spending. It’s the top line spending that initiates the flow. Taxation withdraws some of this along the path of the flow, and bond issuance drains settlement balances from the monetary base to facilitate central bank monetary operations. Bond issuance provides nongovernment with interest bearing default-free assets (“save assets”) which reduces systemic risk, since at least some of those funds would likely have been saved in riskier assets.

  5. Tom, I am still dubious about your claim that Treasury only sells securities to cover the national debt. Looking at the growth of tsys sold in any year, it seems to grow much faster than accounted for by the federal budget’s deficit. The annual deficits run on the order of $500 B but the annual
    amount of securities sold is much higher, so much as to be even higher
    than interest borrowing using securities would account for. In other words,
    about 85% of the national debt is to investors and not banks, and investors dollars are sequestered somewhere to be returned plus interest to their holders. The investors’ treasuries are like bank CD’s–time deposits.

  6. Can correspondent banks exchange reserve balance dollars for private bank dollars? They often engage in foreign exchange, so why not with reserve balances exchanged for private bank dollars?

  7. I was thinking that reserve balance dollars could remain constant over the
    entire banking system, if exchanges of private bank dollars for reserve balance dollars was conducted by correspondent banks. Once within the arena of federal funds, the same reserve balance dollars would just circulate around within the banking system, but never into circulation. When in deficit spending the Fed takes reserve balance dollars from Treasury it draws those dollars out of a reserve balance account of the Treasury. Then the correspondent bank of the vendors whose goods and services are bought by the Federal government is credited with those reserve balance dollars. The
    private bank’s vendor account is then credited while the correspondent account is debted accordingly. In other words the private bank creates the dollars to match the amount credited to vendor in its reserve accounts. No reserve balances pass through into circulation from the private bank. Once
    the private bank dollars are made, the reserve balance dollars can be used again elsewhere in the banking system.

    Does this make sense?

    • I’m relatively new to MMT so please correct me if I’m wrong, but the way I understand it is that what is referred to as our “debt” is simply the number of bonds purchased. When the government deficit spends, they are using the revenue from those bonds.

      • When the government deficit spends, all it’s doing is reating new high powered money, which in turn creates deposits for the end recipient in their private banking institution.

        This paper explains how “revenue” cannot finance government spending: http://www.levyinstitute.org/pubs/wp244.pdf

        When the government sells bonds, it actually reduces the amount of reserves in the banking system, so selling bonds doesn’t create any money for the government to spend, but in a sense it does create “room” in the reserve system that the government can spend into … it’s in no sense a way for the government to fund it’s operations though.

        Bonds are just a liability swap, like a term deposit. I discuss this here: https://www.youtube.com/watch?v=lr6heZubkL4

  8. Hi there, we’re starting a political party with MMT as the core economic framework and the main policy platform being a job guarantee.

    http://www.australianemploymentparty.org/

    We’re doing a YouTube channel/podcast as well as a Facebook group to get the word out:

    https://www.youtube.com/channel/UCt3B5PX86GE_IXgZtar8xXw

    https://www.facebook.com/groups/520023444868205/

    Would love to get your opinions on the content!

  9. Paul Keating and the “Banana Republic”
    The economic issues outlined by PJK himself in discussions with Kerry O’Brian in the book “Keating” make an interesting MMT case study. Earlier when first in his job as treasurer he had been accused by his colleagues of being a captive of Treasury – remarking that “Treasury has got it right”. He had said that “… (Wills) would have supported and expansionary budget with the effect of crowding out private investment.” Then going on “… You couldn’t bring the Australian economy back to growth off the back of public investment and public employment.”
    With that understanding of economics in PJK’s arsenal, the way he intended to deal with the 1986 “Banana Republic” issues now sound insane to any student of MMT – the result being a the “Recession we had to have” caused by PJK himself and made considerably worse by the ’87 crash that followed soon after. Subsequent to the float of the dollar and “freeing up the economy” a perceived crisis arose, that neither PJK or his advisors in Treasury/RB knew how to deal with – the worsening of the terms of trade and the declining value of the Au$. Cheap imports were seen to be feeding inflation – foreign countries were seen to be paying for our lifestyle that was out of control. On reading this stuff my reaction is WTF is going on here? Housing mortgage rates were pushing the then prescribed limit of 13.5% and were predicted to get a lot worse by PJK himself when he deregulated the rates.
    PJK then outlines how via the Expenditure Review Committee he and his ministerial colleagues spent long hours and months of work cutting expenditure on a “line-by-line” review of the budgets of every department – cutting billions off the deficit – eventually arriving at a surplus. The reward came as “the dollar surged back to six-month high of 67cents US (Hooray!). We now hear of the Reserve Bank’s efforts to do everything it can, but failing, to keep the dollar as low as possible.
    I hope someone can explain the thinking at the time – how a drastic cutting of government expenditure was seen to be the way to fix the matter of a negative current account balance. At the time rising interest rates were seen to be the remedy for inflationary pressures – which weren’t having any effect on inflation itself. It seems that neither Keating, the Cabinet (cowed by PJK himself) nor Treasury or the RB knew what they were doing.

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