Friday, May 6, 2011

Matt Rognlie Asks A Question

Matt: By the way, I would like to extend an invitation for anyone here to explain to me why the ability to issue debt in the form of base money is so fiscally beneficial. I agree (as I have stated at length in the comment section of the original post) that it is theoretically possible for the government to issue all of its debt in the form of interest-paying bank reserves, but I don't see how this justifies claims that the government can act freely of any budget constraint. If it's paying interest on reserves, there's a still a cost to financing its debt! (And there will still be limits to how much investors are willing to hold, much as these limits exist for debt in the form of bonds.)

Even if the government pays a very low nominal rate of interest of reserves, this doesn't mean that the real costs are any lower. Economists almost universally agree that the real interest rate, in the long term, is pinned down by real factors like investors' preferences for intertemporal substitution and opportunities for capital investment. If you disagree with this, and you have some competing theory by which the Fed can change the long-term real interest rate through purely nominal manipulations, then I'm happy to hear your case. Otherwise, a decrease in the nominal interest rate (enacted via a decrease in interest paid on reserves) will simply manifest itself as a decline in the long-term rate of inflation, with no fiscal benefits whatsoever.

15 comments:

Matt Franko said...

Tom,
I think ultimately the Congress would have to appropriate the funds to pay the IOR?

But without Treasuries being issued the Fed I dont think would balloon its balance sheet like they have now causing this huge amount of excess/reserves in the first place.

Before the GFC, I think reserves were like $10B or so. So if conditions went back to that type of scenario, if you had to pay IOR on 10B @ 0.25% that only comes to $25M per year, I dont think Congress would squawk too much about that.... it's peanuts.

But it would cut off the Feds gravy train of the interest it gets on the Treasuries it owns... which even before the GFC I think was around $800B?

I sometimes think this is one reason the Fed has loaded up on Treasuries in the QE2: The interest they receive from the Treasuries they use to pay IOR (and their boondogles). Without having to go to Congress for a separate appropriation to pay the IOR... and the charade can continue.

Resp,

apj said...

Matt, required reserves were more like 40bn fyi (43 rings a bell), and had been on a constant downtrend....excess reserves were a couple yards only

RR now are ~74bn

Mike Norman said...

"And there will still be limits to how much investors are willing to hold, much as these limits exist for debt in the form of bonds"

Yes, the limits are determined by the non-government's savings desire and need for gov't fiat for the settlement of tax liabilities. The level of debt is therefore determined endogenously.

"If you disagree with this, and you have some competing theory by which the Fed can change the long-term real interest rate through purely nominal manipulations, then I'm happy to hear your case"

The consolidated government (fiscal authority and Fed) can certainly set rates all along the term structure and keep them anchored via monetary operations and control of inflation via taxation, spending reductions or other means to tamp down demand.

Tom Hickey said...

Matt F, I think ultimately the Congress would have to appropriate the funds to pay the IOR?

IOR is paid by the Fed (as now) rather than the Treasury, so I don't believe that appropriation would be required.

Conversely, Tsys are issued by the Treasury, so interest goes on the deficit.

The Fed is Congress's "off the hook" deus ex machina.

Matt Franko said...

Tom, I was thinking if the Fed did not have a portfolio of USTs, what other interest yielding assets would they have to generate the balances to pay the IOR to the banks?

And I thnk my first comment is a bit off as I guess with no bonds, there would by definition be a lot of reserves excess if the govt ran a deficit. then if no treasuries would be sold to "sop up" the reserves if the IOR rate was positive, where would the Fed get the balances?

Now they buy treasuires that yield say 1% with interest bearing reserves that they pay only 0.25% on so no worries for them currently... but what if there were no USTs as Rognlie says "If it's paying interest on reserves, there's a still a cost to financing its debt!" Where does the Fed get the balances?

Andrew Rogers said...

@Matt

I was under the impression that the Fed has freewill to simply "change numbers in accounts up and down." When they engage in OMO, this is what they do- they just purchase treasuries by changing reserves up. They don't get those reserves from anywhere.

Andrew Rogers said...

BTW, I was hoping some of the official MMTers would stop by here to directly address Matt's question, given we have his attention. It appears Scott Fullwiler has recently added some comments at Matt's blog that should hopefully move the discussion forward. I have refrained from commenting since I did not want to muck up the debate with "unofficial" opinions.

However, Matt (R), have you read "Interest Rates and Fiscal Sustainability" by Scott Fullwiler ( http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1722986 ). This is likely to address some of your questions.

Tom Hickey said...

Andrew, Scott Fullwiler informed me that he wrote a long comment early this AM but it got lost when he tried to post it here, and it had not saved a copy. He said he'd get back to it when he had time.

Tom Hickey said...

Matt F, is there a rule against the Fed running negative equity? All that is actually required is to balance the books. JKH has suggested that negative equity is the way to do it simply and cleanly. Basically, the government negative equity is nongovernment's NFA anyway. Why not just book it that way instead of going through the present kabuki it create the illusion of a gold standard when it does not exist?

Matt Franko said...

Andrew/Tom,

I was just trying to understand how it would be accounted for, ie this is an accounting exercise. The way the Fed does it now it creates a liability ( right side, credit reserve balances +) , and takes possession of an asset (left side, debit USTs held +) so you have a dual entry accounting.

Tom has mentioned the possibility of "negative equity". This I believe would be similar to the accounting from above, but instead of debiting assets (by purchasing USTs), they would credit the equity account with a negative number (right side, - equity & right side, + liabilities) as I see that to offset the liability increase in the reserves. This could go on for eternity with no worries and they could just do this to pay IOR to banks if that was necessary looks to me....

Please post questions if you have any.

Andrew Rogers said...

As an update, the discussion has reached this point (nicely done by Scott to identify the crux, which Scott claims is common but not realized in most debates between MMTers and non MMTers):

"Matt,

You write:

“Sure. I agree that the government could conceivably issue all its debt in the form of reserves, and then pay whatever nominal interest rate on these reserves is jointly consistent with (1) the real interest rate that investors demand to hold that amount of debt and (2) the long-term target inflation rate. ”

This shows that you are conflating two separate issues within MMT. I think that’s what several have attempted to explain to you already.

Issue 1: Your first part ” I agree that the government could conceivably issue all its debt in the form of reserves, and then pay whatever nominal interest rate on these reserves” is what we agree with and we should stop debating this point because everyone’s basically talking past each other. In other words, we agree that the central bank at the very worst can set the nominal interest rate on the national debt.

Issue 2: Your second part–”then pay whatever nominal interest rate on these reserves is jointly consistent with (1) the real interest rate that investors demand to hold that amount of debt and (2) the long-term target inflation rate”–is where we disagree. MMT’ers, as I explained above, reject the idea of an equilibrium real rate. We see it, instead, within the context of a desire by the non-govt sector to net save out of current income relative to the govt’s deficit.

I think that all the other issues here–for instance, whether fiscal constraints should be seen as a tightrope versus a winding road–are secondary to this issue (though I am not implying in the least that these issues aren’t important), at least as regards the debate between MMT and other economists.

Best,
Scott (Fullwiler)"

Andrew Rogers said...

As an update, the discussion has boiled down to the following point, which has been astutely identified by Scott Fullwiler (he claims in a previous post this crux is the most common amongst debates between MMTers and non MMTers, yet seldom recognized and addressed). Matt R has not yet replied.

"Matt,

You write:

“Sure. I agree that the government could conceivably issue all its debt in the form of reserves, and then pay whatever nominal interest rate on these reserves is jointly consistent with (1) the real interest rate that investors demand to hold that amount of debt and (2) the long-term target inflation rate. ”

This shows that you are conflating two separate issues within MMT. I think that’s what several have attempted to explain to you already.

Issue 1: Your first part ” I agree that the government could conceivably issue all its debt in the form of reserves, and then pay whatever nominal interest rate on these reserves” is what we agree with and we should stop debating this point because everyone’s basically talking past each other. In other words, we agree that the central bank at the very worst can set the nominal interest rate on the national debt.

Issue 2: Your second part–”then pay whatever nominal interest rate on these reserves is jointly consistent with (1) the real interest rate that investors demand to hold that amount of debt and (2) the long-term target inflation rate”–is where we disagree. MMT’ers, as I explained above, reject the idea of an equilibrium real rate. We see it, instead, within the context of a desire by the non-govt sector to net save out of current income relative to the govt’s deficit.

I think that all the other issues here–for instance, whether fiscal constraints should be seen as a tightrope versus a winding road–are secondary to this issue (though I am not implying in the least that these issues aren’t important), at least as regards the debate between MMT and other economists.

Best,
Scott"

modernmoney said...

Scott Fullwiler seems to answered the question satisfactorily to me - http://mattrognlie.com/2011/04/29/mmt-fallacie/#comment-181

Detroit Dan said...

Thanks for the link, modernmoney...

Andrew Rogers said...

Matt continues to respond engaged and respectfully -

http://mattrognlie.com/2011/04/29/mmt-fallacie/