Modern Money Theory Lecture 3 Campinas Aug 2018 Professor L.Randall Wray

Modern Money Theory Lecture 3 Campinas Aug 2018 Professor L.Randall Wray Reaction to MMT • Federal government spends through keystrokes that credit bank accounts so it can afford anything for sale in dollars. • The reaction typically goes through four stages: • 1. Incredulity: That’s Crazy! • 2. Fear: Zimbabwe! Weimar! • 3. Moral Indignation: You’d destroy our economy! • 4. Anger: You’re a Dirty Pinko Commie Fascist! Ingham: Money is an institution; record of a social relation • Money is social in 3 ways: -produced outside mkt; no ind is free to produce own M; must be legitimately sanctioned; counted by those who count -monetary exch consists in social relation; unlike barter; involves an IOU -today, money-stuff consists in symbol of state’s or bank’s promise to pay Alternative: Modern Money • Use of currency and value of M are based on the power of the issuing authority, not on intrinsic value. • State played central role in evolution of M. • From beginning monetary system mobilized resources • One Nation, One Currency Rule • Separate currencies not a coincidence. Tied up with sovereign power, political independence, fiscal authority. • TAXES DRIVE MONEY: • State chooses money of account, imposes obligation denominated in that unit, issues currency denominated in that unit, and accepts its own currency in payment of the obligations Fiscal Constraints • Economists: Unsustainable debt path! • 70% of Americans say progress on Deficit needed • Chinese might stop lending to us! • Zimbabwe and Weimar hyperinflation! • Burden our grandkids! • Look at Euroland! • Sovereign debt crisis • Default risk • Bond vigilantes Thomas Smith 1832 • Paper money has no intrinsic value; it is only an imputed one; and therefore, when issued, it is with a redeeming clause, that it shall be taken back, or otherwise withdrawn, at a future period. (Smith 1832, p. 49) • Value maintained by Redemption • Sin of Debt and Saintliness of Redemption Drive Money Govt Spends First, Then Collects Taxes • The BofE issues its notes to merchants upon bills of exchange… The advances to government are conducted in the same manner, the amount to be advanced is placed to the credit of the treasury, or of the particular department for which it is destined, and the officers in that department draw for it, from time to time, as may be required. When the bills discounted, or the taxes on which the advances have been made, become due, then the notes which have been advanced are returned in payment. (Smith 1832) The BofE issues the notes that will be used to pay taxes in Redemption Banks Advance Notes, Then Collect Them, TOO • This mode of issuing notes is not peculiar to the • bank of England, it is followed by every respectable Banks issue the and well regulated bank…A bank discounts a bill of notes that exchange…and gives its own notes, which are returned when the bill becomes due; but if, in the debtors will use interim, these notes are presented, and gold to make demanded and received for them when the bill comes due, there will be no notes to retire it with…. payments to the [B]anks always hold securities for a larger amount banks in than they have notes out. As they are not bound to take any thing except their own notes or specie; if Redemption they do not, or cannot, get the first, they must the last; and thus, not only the specie they have issued must revert to them, but, should they stop making fresh issues, a great deal more. We Cannot Run Out of Money Uncle Sam’s Money Tree The possible consequences are: • Over-Full Employment of Resources • Inflation Why Don’t Economists Get This? • It was more transparent when Treasury “raised a Tally” • Operational constraints on modern Central Banks • Economists don’t understand banks! • And don’t want to let the cat out of the bag Let That Cat Out of the Bag! • Lord Adair Turner: within limits financing government spending by printing money “absolutely, definitively” does not lead to inflation. • “I accept entirely that this is a very dangerous thing to let out of the bag, that this is a medicine in small quantities but a poison in large quantities but that there exist some circumstances, in which it is appropriate to take that risk.” But Is that True? • “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” Mark Twain • Is there evidence of run-away, Weimar/Zimbabwe Deficit Spending? • Is debt at historic high? • Is govt spending out of control? • Have we hocked ourselves to China? • Does debt burden our grandkids? • Will Entitlements (ie Social Security) bankrupt our grandkids? Modern Money: Fiscal Policy • Modern govt spends by crediting bank accounts, and reserves of those banks • Fed and special banks help facilitate process • Sovereign govt can “afford” to buy anything for sale in its currency • Taxes by debiting bank accts • Net creditsdeficitsnet financial assets • Govt does not, cannot “borrow” its own currency Modern Money: monetary policy summary • Central bank sets overnight rate • Accommodates demand for reserves • Coordinates with Treas to supply/drain reserves The Central Bank • The Government’s bank: Makes and receives all payments for Treasury • Empowered to set target overnight (interbank) interest rate • While most claim to be targeting inflation, little evidence they control inflation • Fed dual mandate (high employment, price stability, and growth) prevents it from specifically targeting inflation • Usually has some bank regulation responsibility • Lender of Last Resort • Fed is “Creature of Congress” • Claims that Fed is “independent” or controlled by banks are overstated • While banks “own shares”, cannot buy/sell them, and receive no voting rights • Always subject to regulation by elected representatives • In war or crisis, subjected to closer regulation • Its operations are largely accommodating so as to hit rate target (explained below) Payments system, Reserves, Interbank market • Interbank/fed funds rate: main policy target—a “market” rate • Discount rate: rate central bank charges at Discount Window • Interest rate paid on reserves (historically zero in US, now positive) • Maintains narrow band between discount rate and rate paid on balances— to hit fed funds rate target • Banks DO NOT lend out reserves to customers; they can only lend to one another. Used to meet req’d reserve ratio (if it exists) and for interbank payments • Central bank ACCOMMODATES demand. Otherwise it has trouble hitting target, and ultimately, maintaining stability in payments system The Treasury • Fiscal agent of govt; charged to make budgeted payments, and receive taxes imposed by representatives • Authorized to issue currency and other debt (bills, bonds) • Coins (including platinum!) • Historically, issued paper notes; now only Fed does so • Congress and President determine how much to spend and set tax law; Treasury is only the agent that spends budgeted amount • Deficit is known only ex post: total spending (including transfers and interest) less taxes (and other revenues) • Generally, new bond issues approximately equal deficit (ex post) • Government’s deficit = nongovernment’s surplus (Sectoral Balances) • Nongovernment net financial assets accumulated = government debt issued • Sovereign govt cannot run out of money Myths Surrounding CB Independence • Main argument: Fed is, and should be, independent to fight inflation: • Perceived threat: financing Treasury deficits inflation; insolvency • But operational realities ensure Fed cooperates • Limited independence: selects overnight rate target accommodates reserve demand. • In times of stress, voluntarily cooperates, or Congress mandates cooperation • Chairman Mariner Eccles: independence is pragmatic, not universal law Place of Fed in Government • Currie 1935: “The Federal Reserve is a creation of Congress and not of the Constitution, and its duty is to carry out the will of Congress. It is necessary, therefore, that Congress retain some degree of control over the money issuing authority.” • US Congress 1952:“The Board of Governors, like all other parts of Government, must play as part of a team, not as an outside umpire, and must ultimately abide by the decisions that are made by Congress” …“This formal independence of the Board of Governors from the president is inevitably limited by the hard fact that fiscal and monetary policy must be coordinated with each other and with the other policies and objectives of the Government” • Bruce K. MacLaury “First, let's be clear on what independence does not mean. It does not mean decisions and actions made without accountability. By law and by established procedures, the System is clearly accountable to congress—not only for its monetary policy actions, but also for its regulatory responsibilities and for services to banks and to the public… • Nor does it mean that the Fed is independent of the government. Although closely interfaced with commercial banking, the Fed is clearly a public institution, functioning within a discipline of responsibility to the “public-interest.” It has a degree of independence within the government—which is quite different from being independent of government. • Thus, the Federal Reserve System is more appropriately thought of as being “insulated” from, rather than independent of, political—government and banking—special interest pressures.” How Government Spends its Own Currency Today: Keystrokes • Spending credits • Government credits bank’s reserves; bank credits account of recipient • Taxes debits • Government debits bank’s reserves; bank debits account of taxpayer • Deficits net credits • Government net credits bank’s reserves; bank net credits account of recipient Simple Model: Sovereign Currency Issuer Spends Sovereign Subject Taxes Sovereign Currency w/CB and Banks Treasury CB Taxpayer Bank Bank Contractor 1 2 Money as Scorekeeping Budget “constraint” or Accounting Identity? • Orthodox believe government “chooses” bond-finance or money-finance • Govt Budget Constraint, similar to that of household or firm • G + iB - T ≡ ΔB + ΔMh • iB is interest on bonds, T is taxes, ΔB is bond issues, high powered money issued is ΔMh • This is just an accounting identity, ex post.

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