Wednesday, May 30, 2012

Stephanie Kelton on why the US doesn't borrow to spend


Excerpt from Stephanie Kelton
"Can Taxes and Bonds Finance Government Spending?" (1998)
(h/t y in the comments)
Federal Reserves notes (and reserves) are booked as liabilities on the Fed's balance sheet and these liabilities are extinguished/discharged when they are offered in payment to the State. It must be recognised that when currency or reserves return to the State, the liabilities of the State are reduced and high-powered money is destroyed. 
The destruction of these promises is no different from the private destruction of a promise once it has been fulfilled. In other words, when an individual takes out a loan, she issues a promise to a bank. Once she 'makes good' on that promise (i.e. repays the loan), she may 'destroy' that loan debt (liability) by eliminating it from her balance sheet. 
Thus, while bank money (M1) is destroyed when demand deposits are used to pay taxes, the government's money, HPM, is destroyed as the funds are placed into the Treasury's account at the Fed. Viewed this way, it can be convincingly argued that the money collected from taxation and bond sales cannot possibly finance the government's spending. This is because in order to 'get its hands on' the proceeds from taxation and bond sales, the government must destroy the money it has collected. Clearly, government spending cannot be financed by money that is destroyed when received in payment to the State! [This may be intended meaning of Warren Mosler's metaphor that tax dollars are destroyed when the tax liability has been removed from the record, rather than being used to fund future spending as most assume — th.]
How, if not by using the money received in payment of taxes and bond sales, does the government finance its spending? Notice that the government writes checks on an account that does not comprise part of the money supply or HPM but that as it does, the funds become part of the money supply (M1 if deposited into checking accounts, M2 if savings accounts, etc.) and part of HPM. It is therefore apparent that while the payment of taxes destroys an equivalent amount of money (M1 immediately and HPM as the proceeds go into the Treasury's account at the Fed), spending from this account creates an equivalent amount of new money - both bank money and HPM. Modern governments, then, finance all of their spending through the direct creation of new (high-powered) money.

40 comments:

Ramanan said...

Early debates [Modigliani 1961; Blinder and Solow 1973, 1976; Barro 1974; Buiter 1977; Lerner 1973; Tobin 1961] over the optimal method by which to finance deficit spending remain a controversial topic today [Trostel 1993; Ludvigson 1996; Smith and Villamil 1998]. Despite differing beliefs about the macroeconomic consequences of, say, borrowing vs. "printing money," economists on both sides of these debates clearly accept that the purpose of collecting taxes and selling bonds is to secure funds that are then respent by the government. In other words, it is generally agreed that the role of taxation and bond sales is to transfer financial resources from households and businesses (as if transferring actual dollar bills or coins) to the government, where they are respent (i.e., in some real sense "used" to finance government spending). This erroneous view follows from an implicit treatment of money in its physical form and can be avoided by considering the balance sheet and reserve effects of taxation and bond sales. This, in short, is the purpose of this paper.

[Italics in original]

- that's from the endnote 1 of the paper.

Now, I don't know why she thinks that the view is erroneous. The Treasury actually respends the funds it gets in its account unlike what is claimed by Stephanie Bell Kelton.

Ramanan said...

oops italics missing.

italics appear in

- consequences
-purpose
-respent
-respent

Tom Hickey said...

Ramanan: "The Treasury actually respends the funds it gets in its account unlike what is claimed by Stephanie Bell Kelton"

I take it you mean that the rb transferred by taxpayers banks to satisfy tax obligations get credited to the TGA and are used for future spending or to redeem maturing tsys. That would seem to me to be the accounting.

y said...

"I don't know why she thinks that the view is erroneous"

She explains why she thinks it is in the paper, surely.

The quote posted by Tom above explains one aspect of her argument. Basically a govt liability (money) is extinguished when money is transferred to the Treasury. A govt liability is created when money is transferred from the Treasury. The govt spends by issuing/creating govt liabilities.

Ramanan said...

y,

"She explains why she thinks it is in the paper, surely. "

Her claim is incorrect.

The Treasury actually spends the funds it raises.

y said...

If someone gives me my IOU, my IOU (liability) is extinguished, deleted, no longer an IOU or a liability.

If I give an IOU to someone, my IOU (liability) is created at that point.

That's my understanding of the point she's making in the quote above.

Ramanan said...

y,

There is no extinguishing of funds with the US Treasury.

Stephanie claims that the view that the funds raised out of collecting taxes and bond sales are respent is incorrect by actually going through monetary operations.

Funnily, the Treasury actually spends the funds raised out of taxes and bond sales. If it does not have funds in its accounts, it cannot "simply credit bank accounts"

The central bank is not the fiscal arm of the government.

The overkill is counterproductive.

Dan Kervick said...

Ramanan, re: your first comment, while that is certainly the current practice, there is no obvious reason why that particular practice must be adopted or maintained. For example, we could have a system in which central bank macroeconomists decided each year on the appropriate size of the pure deficit for the upcoming year, and then simply credited that amount to the treasury account, debt-free.

We could even imagine a country with a sufficiently small government in which the entire sum that is spent in each year is created in this way by the CB.

The only reason that the same method would not be advisable for larger governments whose spending was a sizable portion of GDP is due to price stability concerns. The reason the government then needs to tax is not to get the money which they could equally well "print" and spend directly into existence, but to carry out spending priorities in a way that preserves price stability at the same time. While current practice might be to require the spending arm of the government to acquire account balances equal to its expenditures, this practice is a price stabilizing measure and could be replaced by alternative measures.

Tom Hickey said...

But the fact is that now the Treasury needs reserves to settle when it credits accounts and it gets those reserves either through tax credits that go into its account at the Fed (actually its more complicated than that due to the TTL accounts and Treasury Fed coordination), or else it issues tsys that are sold at auction and reserves paid go to its account for expenditure in excess of taxation, i.e., "deficit spending."

Ramanan said...

Dan,

"Ramanan, re: your first comment, while that is certainly the current practice, there is no obvious reason why that particular practice must be adopted or maintained."

Well yeah but the point is that one shouldn't mix reality with what happens. I see this a lot here and JKH has been quite accurate in pointing this out.

Instead you could just say, we want the Treasury to run with an open line of credit or whatever. (Which of course I do not think will ever happen, topic for a different day).

Even in the present arrangement you could say that fiscal policy can be considered exogenous but it doesn't appeal to everyone.

It is not even true that the government doesn't tax to not get revenue. Fiscal policy has a direct effect on demand but in my opinion it is silly to say taxes is not for the purpose of revenues. Consider the case for example of the recent struggle of the Indian government to tax Vodafone. (too many links, don't know which one is the best to link here).

To try to prove it MMTers even go to the extent of regularly showing that all taxes are actually destroyed but a careful look shows they aren't!

Of course there are conceptual advantages of thinking taxes are destroyed but these don't happen in real life. Consider for example the Moslerism that taxes paid by cash notes are shredded as soon s the person leaves the room.

Ramanan said...

"Well yeah but the point is that one shouldn't mix reality with what happens"

Oops - infectious? ... shouldn't mix reality with proposed scenario I meant!

Ramanan said...

[sorry if it appears twice]

Dan,

"Ramanan, re: your first comment, while that is certainly the current practice, there is no obvious reason why that particular practice must be adopted or maintained."

Well yeah but the point is that one shouldn't mix reality with what happens. I see this a lot here and JKH has been quite accurate in pointing this out.

Instead you could just say, we want the Treasury to run with an open line of credit or whatever. (Which of course I do not think will ever happen, topic for a different day).

Even in the present arrangement you could say that fiscal policy can be considered exogenous but it doesn't appeal to everyone.

It is not even true that the government doesn't tax to not get revenue. Fiscal policy has a direct effect on demand but in my opinion it is silly to say taxes is not for the purpose of revenues. Consider the case for example of the recent struggle of the Indian government to tax Vodafone. (too many links, don't know which one is the best to link here).

To try to prove it MMTers even go to the extent of regularly showing that all taxes are actually destroyed but a careful look shows they aren't!

Of course there are conceptual advantages of thinking taxes are destroyed but these don't happen in real life. Consider for example the Moslerism that taxes paid by cash notes are shredded as soon s the person leaves the room.

paul said...

Is anyone claiming that the Treasury can't spend funds into the non-government without selling bonds to the non-government?

Because clearly this has been done in the past so it must be possible.

Tom Hickey said...

paul, at present the US Treasury cannot run and overdraft at the Fed, so it has to get the reserves to clear deposits it makes by issuing tsys along the yield curve in denominations desired by purchases. Most tsys are at the shorter end of the curve.

Issuing tsys with the Fed correspondingly issuing reserves is the way that the Treasury funds deficit expenditure instead of issuing currency directly, as it did with greenbacks, which are not allowed under current law. Could be by changing a word or two.

Similarly, the Fed is prohibited from purchasing tsys directly, so the tsys have to be auctioned into non-govt.

Treasury can issue coin and as beowulf pointed out, there is leeway to issue a platinum coin with huge "seignorage," i.e., face value much greater than the metal value.

paul said...

"…the Fed is prohibited from purchasing tsys directly, so the tsys have to be auctioned into non-govt."

So they say, but it's been done more than once (even since WWII) so how did that come about?

When was th elaw enacted. I've always understood it was part of the Federal Reserve Act of 1913.

Is that wrong?

y said...

I think the point she was making is that, under current institutional arrangements, the whole business of government selling and buying of bonds is simply an interest rate maintenance operation.

The Treasury does not store "funds" which are then spent at a later date (although this is how it tends to be conceptualized).

When the Treasury receives money (its own IOUs), this money is "deleted" (i.e. Treasury liabilities are "extinguished").

When the Treasury spends, money is "created" - given that "money" is ultimately a Treasury IOU or Treasury liability) - see my comment above.

The Fed issues IOUs on behalf of the Treasury, but these IOUs are only "extinguished" when they are transferred (paid) to the Treasury.

Given that the Fed's job is to control interest rates and manage inflation, the process of selling and buying government bonds is simply a convoluted way of achieving those aims.

It's not about placing "funds" in the Treasury's account which can then be spent.

When the Treasury issues bonds, it's not desperately worrying about whether anyone will buy them. They will be bought. Their only purpose is to provide a mechanism by which the government can control interest rates and manage inflation.

I'm sure Ramanan will disagree with this.

Anonymous said...

"The overkill is counterproductive."

I'm sorry, are you a political consultant, or some sort of PR person? How do you define overkill? How do you define counterproductive?

Ramanan said...

Damn one of my comments has disappeared.

y,

"I think the point she was making is that, under current institutional arrangements, the whole business of government selling and buying of bonds is simply an interest rate maintenance operation."

Under the alternative arrangement.

Under the current setup, the "purpose" of issuing bonds is to get funds so that the government expenditure can be higher than taxes.

As long as the Treasury lives with a no overdraft facility at the Federal Reserve, it has no choice but to issue bonds.

"The Treasury does not store "funds" which are then spent at a later date (although this is how it tends to be conceptualized). "

Yes the Treasury stores funds in TGA and TTL and lends some out for short term. Why do you think the accounts exists?

"When the Treasury receives money (its own IOUs), this money is "deleted" (i.e. Treasury liabilities are "extinguished"). "

When the Treasury receives funds, its balance at TGA/TTL increases.

"When the Treasury spends, money is "created" - given that "money" is ultimately a Treasury IOU or Treasury liability) - see my comment above."

When the Treasury makes an expenditure, the assets of the other sectors increases. Money - if it is deposits is not the government's liability. It is a bank's liability.

"It's not about placing "funds" in the Treasury's account which can then be spent."

It is about it.

"When the Treasury issues bonds, it's not desperately worrying about whether anyone will buy them. They will be bought. "

Yes it isn't because the markets love Treasuries. But while I do not worry about an imminent auction failure, telling thee worrier "the treasury simply credits bank accounts" is not a sufficient explanation.

y said...

"Under the alternative arrangement."

Under current arrangements bond selling and buying by the government serves to maintain interest rates and manage inflation.

Given that there is necessarily always a buyer for Treasury bonds under current arrangements - at some price - bonds are not "funding" instruments but interest rate and inflation management instruments.

As I argued above, if someone hands me MY own IOU, that IOU ceases to exist as such (when it is in my possession).

My IOU is only an IOU when it is held by someone else. When I hold it, it is nothing. I don't have to hold my own IOU as a "fund" for future expenditure.

When my IOUs are handed back to me, they are "extinguished". When I give someone else my IOUs they are "created".

I can't owe myself my own promise to pay myself with my own promise to pay myself... etc.

As such, money essentially ceases to exist when it is placed in the Treasury's account. It comes into being when it leaves the Treasury's account.

Agreed, Bank deposits are bank liabilities and not govt liabilities (though perhaps this isn't so clear cut when deposits are guaranteed by the government?).

Tom Hickey said...

"Damn one of my comments has disappeared."

Sorry. I've been remiss in checking the spam filter. I just fished out a number of them that have gone missing recently.

Ryan Harris said...

This Ramananistic discussion got me curious about actual US Government procedures on handling cash. It is kind of complicated as there is a large bureaucracy of people with tiny slivers of responsibility for each part of the minutia.


This describes an overview of how cash is handled at the IRS

This is the US Code Relevant


Who collects the cash and how much is collected determines how the cash is handled.

The cash generally gets deposited in a “lock box” (a private banking institution) that provides treasury services, such as JP Morgan or US Bank or any number of other banks. See this

In other instances cash will be converted to a Money Order at a private bank by an IRS agent, and then the agent mails the bank draft with their payment report to a processing center.

If the cash money is sent to an “ IRS campus” – gov. speak for a big processing center, the cash after being accounted for gets exchanged for a money order at the IRS employee credit union on the campus, if there is one. Otherwise it goes to a regular private bank as above for conversion to a money order. See this

For MMT amusement, this bit is particularly odd:
5.1.2.6.1 (01-24-2012)
Large Dollar Remittances

A large-dollar remittance requires special handling to ensure the earliest deposit to the Treasury so the government will enjoy the maximum availability of funds and earn interest at the earliest opportunity

miller B said...

I thought this debate was settled long ago. Government liabilities[GL] (cash or other) are what circulate as money. GL are created when Gov. spends and when any liabilities are returned to their originator, the liability no longer exists. A new liability must be issued. If reserves get added when Gov. spends and reserves disappear when taxes are paid. how can it be any other way

y said...

If you have a $10 deposit in a bank, and then pay the $10 to that bank in fees, the bank doesn't store that $10 as "funds" for future deposit creation, does it?

money4nothingchicks4free said...

Ramanan said: "The central bank is not the fiscal arm of the government."

Bernanke says Fed is government's fiscal agent(starts at 19:00).
http://www.federalreserve.gov/newsevents/lectures/the-aftermath-of-the-crisis.htm

It seems you are arguing sometimes for the purpose of arguing.

money4nothingchicks4free said...

I am sorry, Bernanke said "we act as government's fiscal agent"

I am sure It must matter to you Ramanan. Bernanke is not saying that Fed is acting as my fiscal agent, not yours either. Obviously there must be difference there.

paul said...
This comment has been removed by the author.
paul said...

"It seems you are arguing sometimes for the purpose of arguing."

Nice to see others are beginning to figure that out.

money4nothingchicks4free said...

Bernanke: Then there are other liabilities including Treasury accounts and a variety of other things that the Fed does – we act as the fiscal agent of the Treasury. But the two main items, you can see, are the notes in circulation and the reserves held by the banks.”

Ramanan said:The central bank is not the fiscal arm of the government.

It turns out it is!

Leverage said...

Someone should post the famous list of "what the FED could do in case of deflation" by Bernanke in 2002 (I think?).

There seems 'operations' really don't matter in that case, when you have to save the system, the list was monstrous and helicopter drops and fiscal operations ('monetary financing' as ECB hawks would say) were in the list.

Operations change to fit the environment, period. There is nothing sacred about them.

Ramanan said...

Keep confusing the principal and agent!

paul said...

"Keep confusing the principal and agent!"

Alas, you are the one who is confused.

Ramanan said...

Yeah. Right.

According to the Second Law of Thermodynamics, na?

paul said...

"According to the Second Law of Thermodynamics, na?"

Partly. More a general observation that you don't understand systems, even simple ones, and thus have no idea how to apply the underlying math principles.

From that perspective you're in over your head.

You're a bulldog when it comes to reading and storing information. It's amazing and impressive how much stuff you have stored in that brain of yours. Way more than I.

It's going to waste.

Not an indictment as The President of the United States as well as most other so-called world leaders and their advisors are in over their heads too.

In their case though there may be evil involved.

Matt Franko said...

Paul,

"The President of the United States as well as most other so-called world leaders and their advisors "

They are mostly lawyers and MBA types....

Resp,

geerussell said...

If you have a $10 deposit in a bank, and then pay the $10 to that bank in fees, the bank doesn't store that $10 as "funds" for future deposit creation, does it?

If I understand it correctly, fees feed into bank earnings. The bank can opt to retain some or all of those earnings on the asset side of its balance sheet where they will improve its capital position. Or they can distribute those earnings (bonuses for all, hooray!).

Matt Franko said...

Lev,

I think in 2002 Bernanke would have thought QE1, QE2, and Twist would have qualified as "helicopter drops".

They have done nothing.

He is scared, you can see it in his face when he appears. He's got nothing.

For "deflation", now, I think something has to happen with petroleum prices, ie petro has to fall then prices in general will start to fall (housing, food, etc..).

Bernanke will then shit in his pants...

THE LAST THING HE WILL DO ABOUT IT IS RAISE INTEREST RATES. I dont see him raising rates. TPTB will have to get rid of him if they want higher rates at this point...

IF HE WOULD RAISE RATES IN THE FACE OF CURRENT OUTPUT GAP AND UE, IT WOULD BE ADMITTING MONETARISM IS A COMPLETE FANTASY.

I dont see Bernanke doing this under current economic conditions for ANY reason.... He's trapped by his academic frame of reference (monetarism)...

Resp,

Tom Hickey said...

Ramanan: Keep confusing the principal and agent!

The crux of the issue. While theoretically the cb is the agent of the govt, the reality that the financial sector wants to see is the cb as principal and govt as agent. The centuries-old struggle of finance capital to dominate.

Leverage said...

Matt, QE/Twist type operations where around the middle of the list. He has been working down the list.

True helicopter drops became later, he hasn't implemented any. But I think he now is concerned about 'credibility' and the political situation ('end the FED'/'change the FED' by both conservatives and progressives). Hence he has changed discourse and talks about 'worrisome deficits', I also think he may be worried about trade deficits, but does not know how to solve it.

Helicopter drops were some things like buying equities/debt directly from the market. Buying muni bonds from local governments, implementing fiscal stimulus plans and financing them through the FED, etc.

Apparently there were no 'operational impediments' then hehe. MMR guys are completely missing the point: all this operational nuances will fade compared to gold-buggery or progressives assaulting the FED; or will fade against a collapsing demand and deflationary economy; or will fade compare to blowing up the gold-standard, just like has happened in the past etc.

THESE are the real sort of constraints about operations of basically the government printing money and financing itself (something most market participants seem to get directly or indirectly). Not the functioning of daily operations, where you can look for loopholes or bypass them if necessary.

But 'technicians' usually obsess over technicalities, and miss the picture. Happens in every field.

Matt Franko said...

" Hence he has changed discourse and talks about 'worrisome deficits',"

Good point, that may be a mis-direction play... he's impotent so he deflects attention onto the "deficit" and the moron legislators buy it...

Takes the heat off of him and monetary policy...

Resp,

y said...

"fees feed into bank earnings. The bank can opt to retain some or all of those earnings on the asset side of its balance sheet where they will improve its capital position. Or they can distribute those earnings (bonuses for all, hooray!)."

The $10 deposit is a bank liability. Paying that $10 to the bank simply eliminates the liability. How does the bank retain a zero?