erabiltzaileari erantzuten
Tax liabilities are the people’s debt to the government.
😉
Warren Mosler: Zerga-betebeharrak
(Tax Liabilities)
(http://www.collectedworksofwarrenmosler.com / —> Tax Liabilities)
Comment: The “inventor” of modern money (MMT) @wbmosler: Federal gov does not need to tax anybody, sovereign countries issue own money.
Mosler: Tax liabilities are required to create sellers of goods and services desiring that currency in exchange thanks.
Comment: What prices are government agents setting, exactly?
Mosler: With every purchase govt. defines the value of its currency whether it knows it or not. The econ needs govt spending to comply with coercive tax liabilities. It’s about who’s pitching and who’s catching. It’s a simple case of monopoly. Elementary game theory / disparity of power.
Mosler: The MMT insight – which is literally what created it as a body of theory – is that a JG can be used as a buffer stock approach to stabilise wages. Saying the JG is not part of the theory just says that you don’t understand the theory.
Mosler: The MMT insight (and a contribution to the economic history of thought) is that tax liabilities are the cause of unemployment as defined=unemployment is a monetary phenomena caused by gov by design to hire the unemployed to provision the gov with its otherwise worthless currency.
Comment: Pitch your best short idea and in one tweet (no threads) explain exactly why you hate money.
Mosler: Monetary tax liabilities– the continuous requisite coercion that supports highly beneficial and desired collective action- instils a permanent, pervasive, fundamental insecurity of running out of tax credits (money) that brings out the worst in people.
Posts in chronological order
Mosler: The tax liability is the arm of today’s ‘invisible hand’ 😉
Comment: That’s not what MMT says. Tax has many purposes. As @RichardJMurphy would say. But financing spending is not one of them. Thus, Speaking of the need to tax to finance the NHS is hugely damaging. #MMT takes a lot from Keynes. More so than most orthodox economists today
Mosler: I say it this way: tax liabilities, and not tax revenues per se, function to create sellers of goods and services in exchange for the state’s currency, which the state can then buy.
Mosler: That is, there is a distinction between tax liabilities and tax revenues.
Comment: Former ICE Gov Dir. Tom Homan shows no respect to Rep Jayapal during a House hearing today after going over his time, shouting out, “I’m a taxpayer, you work for me!”
Mosler: More nearly correct would have been ‘I have tax liabilities, I’m working for you.’
Comment: Issue 1: Debt is a stock (a total you have at one time) and GDP is a flow (the total over a period of time). Better to compare stocks to stocks (or flows to flows). Not hard to pay off $20T of debt when US GDP totals about $4 quadrillion going forward.
Mosler: That debt already is the money- $ in cash+ reserves+ securities accounts, all Fed liabilities (functionally) = net financial assets of the economy= equity that supports the entire private credit structure=net money supply.
Comment: Perhaps you, or @AlanKohler could elaborate as to what happens when people lose trust in the underlying value of the infinite fiat that is issued for them to store/exchange, um, value?
Mosler: If it was about trust it would have collapsed a long time ago. It’s a tax credit needed to satisfy coercive tax liabilities.
oooooo
Warren Mosler: Kapotaren azpian
(Warren Mosler: Under the Bonnet: Tax liabilities)
Warren Mosler: Under the Bonnet
(https://www.google.es/books/edition/Warren_Mosler/DgN2EQAAQBAJ?hl=eu&gbpv=1&dq=inauthor:%22Phil+Armstrong%22&printsec=frontcover)
Warren Mosler: Under the Bonnet
By Phil Armstrong
… tax payment , the government is not only the price – setter for the policy rate but also for the price level as well … liabilities was the sole cause of unemployment , by design , with the further purpose of facilitating …
ooo
… tax liabilities, not the extensive range of other factors pointed to by economists, that are the cause of unemployment. Unemployment in the economy is evidence that the state’s spending is insufficient to allow the non-government sector …
ooo
… tax liability , a requirement which creates sellers of real goods and services looking for that currency in exchange . This gives value to the state’s currency ; it can then spend its otherwise worthless currency to buy what its tax …
ooo
… taxation, by design, is the cause of unemployment – defined as people seeking work paid in that currency – presumably for the further purpose of the US Government hiring those that its tax liabilities caused to become unemployed. The …
ooo
… tax liabilities shifting people from one function to another , shifting income from one group to another , fiscal … taxation it is just a question of starting from a command economy . That command economy needs to adjust …
ooo
… tax liabilities in the currency it issues”. And that was my second paper. When I returned to Gettysburg college, I combined the two research papers: the theoretical review and the math model, into my college honors thesis. My …
ooo
… tax liabilities have caused to become unemployed. That is, it’s a case of a monopolist – the government – restricting supply, which in this case refers to net government spending. Current policy is to utilize unemployment as a counter …
oooooo
Warren Mosler: Hiru lan
erabiltzaileari erantzuten
That was the beginning of MMT in 1993. Tsy secs function to support rates, not fund expenditure:
moslereconomics.com
Soft Currency Economics – Mosler Economics / Modern Monetary Theory
Soft Currency Economics – updated March 2025
Soft Currency Economics
by Warren B. Mosler
Introduction
In the midst of great abundance, our leaders promote privation. We are told that national health
care is unaffordable, while hospital beds are empty. We are told that we cannot afford to hire
more teachers, while many teachers are unemployed. And we are told that we cannot afford to
give away school lunches, while surplus food goes to waste.
When people and physical capital are employed productively, government spending that shifts
those resources to alternative use forces a trade-off. For example, if thousands of young men
and women were conscripted into the armed forces the country would receive the benefit of a
stronger military force. However, if the new soldiers had been home builders, the nation may
suffer a shortage of new homes. This trade-off may reduce the general welfare of the nation if
Americans place a greater value on new homes than additional military protection. If, however,
the new military manpower comes not from home builders but from individuals who were
unemployed, there is no trade-off. The real cost of conscripting home builders for military
service is high; the real cost of employing the unemployed is negligible.
The essence of the political process is coming to terms with the inherent tradeoffs we face in a
world of limited resources and unlimited wants. The idea that people can improve their lives by
depriving themselves of surplus goods and services contradicts both common sense and any
respectable economic theory. When there are widespread unemployed resources as there are
today in the United States, the trade-off costs are often minimal, yet mistakenly deemed
unaffordable.
When a member of Congress reviews a list of legislative proposals, he currently determines
affordability based on how much revenue the federal government wishes to raise, either through
taxes or spending cuts. Money is considered an economic resource. Budget deficits and the
federal debt have been the focal point of fiscal policy, not real economic costs and benefits. The
prevailing view of federal spending as reckless, disastrous and irresponsible, simply because it
increases the deficit, prevails.
Interest groups from both ends of the political spectrum have rallied around various plans
designed to reduce the deficit. Popular opinion takes for granted that a balanced budget yields
net economic benefits only to be exceeded by paying off the debt. The Clinton administration
claims a lower 1994 deficit as one of its highest achievements. All new programs must be paid
for with either tax revenue or spending cuts. Revenue neutral has become synonymous with
fiscal responsibility.
The deficit doves and deficit hawks who debate the consequences of fiscal policy both accept
traditional perceptions of federal borrowing. Both sides of the argument accept the premise that
the federal government borrows money to fund expenditures. They differ only in their analysis of
the deficit’s effects. For example, doves may argue that since the budget does not discern
between capital investment and consumption expenditures, the deficit is overstated. Or, that
since we are primarily borrowing from ourselves, the burden is overstated. But even if policy
makers are convinced that the current deficit is a relatively minor problem, the possibility that a
certain fiscal policy initiative might inadvertently result in a high deficit, or that we may owe the
money to foreigners, imposes a high risk. It is believed that federal deficits undermine the
financial integrity of the nation.
Policy makers have been grossly misled by an obsolete and non-applicable fiscal and monetary
understanding. Consequently, we face continued economic under-performance.
Statement of Purpose
The purpose of this work is to clearly demonstrate, through pure force of logic, that much of the
public debate on many of today’s economic issues is invalid, often going so far as to confuse
costs with benefits. This is not an effort to change the financial system. It is an effort to provide
insight into the fiat monetary system, a very effective system that is currently in place.
The validity of the current thinking about the federal budget deficit and the federal debt will be
challenged in a way that supersedes both the hawks and the doves. Once we realize that the
deficit can present no financial risk, it will be evident that spending programs should be
evaluated on their real economic benefits, and weighed against their real economic costs.
Similarly, a meaningful analysis of tax changes evaluates their impact on the economy, not the
impact on the deficit. It will also be shown that taxed advantaged savings incentives are creating
a need for deficit spending.
The discussion will begin with an explanation of fiat money, and outline key elements of the
operation of the banking system. The following points will be brought into focus:
➢ Monetary policy sets the price of money, which only indirectly determines the quantity. It
will be shown that the overnight interest rate is the primary tool of monetary policy. The
Federal Reserve sets the overnight interest rate, the price of money, by adding and
draining reserves. Government spending, taxation, and borrowing can also add and
drain reserves from the banking system and, therefore, are part of that process.
➢ The money multiplier concept is backwards. Changes in what is casually called the
money supply cause changes in bank reserves and the monetary base, not vice versa.
➢ Debt monetization cannot and does not take place.
➢ The imperative behind federal borrowing is to drain excess reserves from the banking
system, to support the overnight interest rate. It is not to fund untaxed spending.
Untaxed government spending (deficit spending) as a matter of course creates an equal
amount of excess reserves in the banking system. Government borrowing is a reserve
drain, which functions to support the fed funds rate mandated by The Federal Reserve
Board of Governors. The federal debt is actually an interest rate maintenance account
(IRMA).
➢ Fiscal policy determines the amount of new money -bank balances- directly created by
the federal government. Briefly, deficit spending is the direct creation of new money.
When the federal government spends and borrows, what is functionally a deposit at The
Federal Reserve Bank in the form of a treasury security is created. The national debt is
therefore equal to all of the new money directly created by fiscal policy.
➢ Options over spending, taxation, and borrowing are not limited by the process itself but
by the desirability of the economic outcomes. The amount and nature of federal
spending as well as the structure of the tax code and interest rate maintenance
(borrowing) have major economic ramifications. The decision of how much money to
borrow and how much to tax can be based on the economic effect of varying the mix,
and need not focus solely on the mix itself (such as balancing the budget).
Finally, the conclusion will incorporate five additional discussions:
➢ What if no one buys the debt?
➢ How the government manages to spend as much as it does and not cause
hyper-inflation
➢ Full employment AND price stability
➢ Taxation
➢ A discussion of foreign trade
Fiat Money
Historically, there have been three categories of money: commodity, credit, and fiat. Commodity
money consists of some durable material of intrinsic value, typically gold or silver coin, which
has some value other than as a medium of exchange. Gold and silver have industrial uses as
well as an aesthetic value as jewelry. Credit money refers to the liability of some individual or
firm, usually a checkable bank deposit. Fiat money is a tax credit not backed by any tangible
asset.
In 1971 the Nixon administration abandoned the gold standard and adopted a fiat monetary
system, substantially altering what looked like the same currency. Under a fiat monetary system,
money is an accepted medium of exchange because the government requires it for tax
payments, and the government, through its agents, is the single supplier of that which it
demands in payment of taxes. That is the government is the source of the funds used to pay
taxes and to buy government securities.
Government fiat money necessarily means that federal spending is not constrained by revenue.
In fact, spending necessarily precedes revenue as a point of logic. Therefore the federal
government has no more money at its disposal when the federal budget is in surplus, than when
the budget is in deficit. Total federal expense is whatever the federal government chooses it to
be. There is no inherent financial limit, but instead is limited by whatever is offered for sale in
exchange for that currency.
The amount of federal spending, taxing and borrowing influence inflation, interest rates, capital
formation, and other real economic phenomena, but the amount of money available to the
federal government is independent of tax revenues and independent of federal debt.
Consequently, for example, the concept of a federal trust fund under a fiat monetary system is
an anachronism. The government is no more able to spend money when there is a trust fund
than when no such fund exists. The only financial constraints, under a fiat monetary system, are
self-imposed.
The concept of fiat money can be illuminated by a simple model:
Assume a world of a parent and several children. One day the parent announces that the
children may earn Mom or Dad’s business cards by completing various household chores. At
this point the children won’t care a bit about accumulating their parent’s business cards because
the cards are virtually worthless. But when the parent also announces that any child who wants
to eat and live in the house must pay a tax to the parents of, say, 200 business cards each
month, the cards are instantly given value and chores begin to get done. Value has been given
to the business cards by requiring them to be used to fulfill a tax obligation. The tax created
unemployment- in this case children looking for paid work. Taxes function to create the demand
for federal expenditures of fiat money, not to raise revenue per se. In fact, a tax will create a
demand for at least that amount of federal spending. A balanced budget is, from inception, the
minimum that can be spent, without creating a default condition and a continuous deflation.
Furthermore, The children will likely desire to earn a few more cards than they need for the
immediate tax bill, so the parent can expect to spend more cards than the children pay in taxes
-run a deficit- as a matter of course.
To illustrate the nature of federal debt under a fiat monetary system, the model of family
currency can be taken a step further. Suppose the parent offers to pay overnight interest on the
outstanding business cards (payable in more business cards). The children might want to hold
on to some cards to use among themselves for convenience. Extra cards not needed overnight
for intersibling transactions would probably be deposited with the parent. That is, the parent
would have borrowed back some of the business cards from the children. The business card
deposits are the national debt that the parent owes. The reason for the borrowing is to support a
minimum overnight lending rate by giving the holders of the business cards a place to earn
interest. The parent might decide to pay (support) a high rate of interest to encourage saving.
Conversely, a low rate may discourage saving. In any case, the amount of cards lent to the
parent each night will generally equal the number of cards the parent has spent, but not taxed
-the parents’ deficit.
Notice that the parent is not borrowing to fund expenditures, and that offering to pay interest
(funding the deficit) does not reduce the wealth (measured by the number of cards) of each
child. And also note that earning interest would also allow the children to earn the cards they
need to pay their taxes without doing their chores. When I did this with my children, I saw no
reason to ever pay interest on the cards, and likewise, with an understanding of monetary
operations, I see no reason for a government not to have a permanent 0% interest rate policy.
In the U. S., the 12 members of The Federal Open Market Committee decide on the overnight
interest rate. That, along with what Congress decides to spend, tax, and borrow (that is, pay
interest on the untaxed spending), determines the value of the currency and, in general,
regulates the economy.
Federal borrowing and taxation were once part of the process of managing the Treasury’s gold
reserves. Unfortunately, discussions about monetary economics and the U. S. banking system
still rely on many of the relationships observed and understood during the time when the U. S.
monetary regime operated under a gold standard, a system in which arguably the government
was required to tax or borrow sufficient revenue to fund government spending. Some of the old
models are still useful in accurately explaining the mechanics of the banking system. Others
have outlived their usefulness and have led to misleading constructs. Two such vestiges of the
gold standard are the role of bank reserves (including the money multiplier) and the concept of
monetization. An examination of the workings of the market for bank reserves reveals the
essential concepts. (Additional monetary history and a more detailed explanation is provided in
the appendix.)
The Inelasticity of the Reserve Market: Lagged versus Contemporaneous Accounting
The Fed defines the method that banks are required to use in computing deposits and reserve
requirements. The period in which a depository institution’s average daily reserves must meet or
exceed its specified required reserves is called the reserve maintenance period. The period in
which the deposits on which reserves are based are measured is the reserve computation
period. The reserve accounting method was amended in 1968 and again in 1984 but neither
change altered The Fed’s role in the market for reserves.
Before 1968 banks were required to meet reserve requirements contemporaneously: reserves
for a week had to equal the required percentage for that week. Banks estimated what their
average deposits would be for the week and applied the appropriate required reserve ratio to
determine their reserve requirement. The reserve requirement was an obligation each bank was
legally required to meet. Bank reserves and deposits, of course, continually change as funds
are deposited and withdrawn which was problematic for the bank manager’s task of managing
reserve balances. AS neither the average deposits for a week nor the average amount of
required reserves could be known with any degree of certainty until after the close of the last
day it was “like trying to hit a moving target with a shaky rifle.” Therefore, in September 1968,
lagged reserve accounting (LRA) replaced contemporaneous reserve accounting (CRA). Under
LRA the reserve maintenance period was seven days ending each Wednesday (see Figure 1a).
Required reserves for a maintenance period were based on the average daily reservable
deposits in the reserve computation period ending on a Wednesday two weeks earlier. The total
amount of required reserves for each bank and for the banking system as a whole was known in
advance. Actual reserves could vary, but at least the target was stable.
In 1984, however, the Board of Governors of The Federal Reserve System reinstated CRA. The
reserve accounting period remained two weeks (see Figure 1b). Reserves on the last day of the
accounting period are one-fourteenth of the total to be averaged. For example, if a bank
borrowed $7 billion for one day it would currently add 1/14 of $7 billion, or $500 million, to the
average level of reserves for the maintenance period. And although this system was called
contemporaneous it was, in practice, a lagged system because there was still a two day lag:
reserve periods ended on Wednesday while deposit periods ended on the preceding Monday.
Thus even under CRA the banking system is faced with a fixed reserve requirement as it nears
the end of each accounting period.
The 1984 adoption of CRA occurred as federal officials, economists, and bankers debated
whether shortening the reserve accounting lag could give The Fed control of reserve balances.
The change was consciously designed to give The Fed direct control over reserves and
changes in deposits. Federal Reserve Chairman Volcker favored the change to CRA in the
errant belief that a shorter lag in reserve accounting would give The Fed greater control over
reserves and hence the money supply. Chairman Volcker was mistaken. The shorter accounting
lag did not (and could not) increase The Fed’s control over the money supply because
depository institution’s reserve requirements were based on total deposits from the previous
accounting period. Banks for all practical purposes could not change their current reserve
requirements after they were calculated.
Under both CRA and LRA The Fed necessarily provides enough reserves to meet the known
requirements, either through open market operations or through the discount window, as the
reserve requirement itself is, functionally, in the first instance, an overdraft.
If banks were left on their own to obtain more reserves no amount of interbank lending would be
able to create the necessary reserves. Interbank lending changes the location of the reserves
but the amount of reserves in the entire banking system remains the same. For example,
suppose the total reserve requirement for the banking system was $60 billion at the close of
business today but only $55 billion of reserves were held by the entire banking system. Unless
The Fed provideD the additional $5 billion in reserves, at least one bank would fail to meet its
reserve requirement.
The Federal Reserve is, and can only be, the follower, not the leader when it adjusts reserve
balances in the banking system.
The role of reserves may be widely misunderstood because it is confused with the role of capital
requirements. The Fed addresses the quantity and risk of loans through capital requirements, it
addresses the overnight interest rate by setting the price of reserves. Capital requirements set
standards for the quality and quantity of assets which banks hold on the quality of its loans.
Capital requirements are designed to insure a minimum level of financial integrity. Reserve
requirements, on the other hand, are a means by which The Federal Reserve controls the
bank’s cost of funds and thereby the price of funds when lending.
In 2008, The Fed began buying treasury securities in an initiative known as Quantitative Easing
(QE). The securities were paid for by crediting appropriate bank reserve accounts. To support
their policy rate, The Fed received approval to begin paying interest on reserve balances (which
had long been standard procedure at other central banks) as an alternative to selling securities
outright or borrowing the reserves with reverse repurchase agreements, which would have been
problematic due to the magnitude of the reserve balances generated by QE. And, subsequently,
to accommodate fed depositors that were prohibited from earning interest on their fed balances
and thereby influencing the fed funds rate, The Fed began offering open-ended reverse
repurchase accounts to help ensure fed funds would trade within The Fed’s policy rate bands.
The Myth of the Money Multiplier
Everyone who has studied money and banking has been introduced to the concept of the
money multiplier. The multiplier is a factor which links a change in the monetary base (reserves
+ currency) to a change in the money supply. The multiplier presumably tells us what multiple of
the monetary base is transformed into the money supply (M = m x MB). Since George
Washington’s portrait first graced the one dollar bill students have listened to the same
explanation of the process. No matter what the legally required reserve ratio was, the standard
example always assumed 10 percent so that the math was simple enough for college
professors. What joy must have spread through the entire financial community when, on April
12, 1992, The Fed, for the first time, set the required reserve ratio at the magical 10 percent.
Given the simplicity and widespread understanding of the money multiplier it is a shame that the
myth must be laid to rest.
The truth is the opposite of the textbook model. In the real world banks make loans independent
of reserve positions, then during the next accounting period borrow any needed reserves. The
imperatives of the accounting system, as previously discussed, require The Fed to lend the
banks whatever needed.
Bank managers generally neither know nor care about the aggregate level of reserves in the
banking system. Bank lending decisions are affected by the price of reserves, not by reserve
positions. If the spread between the rate of return on an asset and the fed funds rate is wide
enough, even a bank deficient in reserves will purchase the asset and cover the cash needed
by purchasing (borrowing) money in the funds market. This fact clearly demonstrated by many
large banks, before QE, when they consistently purchaseD more money in the fed funds market
than their entire level of required reserves. These banks would actually have negative reserve
levels if not for fed funds purchases i.e. borrowing money to be held as reserves.
If The Fed should want to increase the money supply, devotees of the money multiplier model
(including numerous Nobel Prize winners) would have The Fed purchase securities. When The
Fed buys securities reserves are added to the system. However, before 2008 when The Fed
began to pay interest on reserves, the money multiplier model failed to recognize that the added
reserves in excess of required reserves drove the funds rate to zero, since reserve requirements
dId not change until the following accounting period. That forced The Fed to sell securities, i.e.,
‘drain’ the excess reserves just added, to maintain the funds rate above zero.
If, on the other hand, The Fed wants to decrease money supply, taking reserves out of the
system when there are no excess reserves places some banks at risk of not meeting their
reserve requirements. The Fed has no choice but to add reserves back into the banking system,
to keep the funds rate from going, theoretically, to infinity. In either case, the money supply
remains unchanged by The Fed’s action. The multiplier is properly thought of as simply the ratio
of the money supply to the monetary base (m = M/MB). Changes in the money supply cause
changes in the monetary base, not vice versa. The money multiplier is more accurately thought
of as a divisor (MB = M/m). Failure to recognize the fallacy of the money-multiplier model has
led even some of the most well- respected experts astray. The following points should be
obvious, but are rarely understood: 1. The inelastic nature of the demand for bank reserves
leaves The Fed no control over the quantity of money. The Fed controls only the price. 2. The
market participants who have a direct and immediate effect on the money supply include
everyone except The Fed.
After The Fed was paying interest on reserves, The Fed could indeed buy treasury
securities and add reserves without altering the fed funds rate. Reserve balances that pay
interest, however, are functionally identical to treasury securities that are also balances at
The Fed that pay interest. The only difference is maturity, which is of no material difference
to the macroeconomy. Therefore buying securities merely shifts balances at The Fed from
securities accounts to reserve accounts. That said, buying securities does increase narrow
monetary aggregates that do not include treasury securities, and so for those who define
“money” as not including treasury securities, The Fed buying treasury securities does add
to their narrowly defined “money supply” while broad aggregates that include treasury
securities remain unchanged, as do the net financial assets in the macroeconomy.
The Myth of Debt Monetization
The subject of debt monetization frequently enters discussions of monetary policy. Debt
monetization is usually referred to as a process whereby the Fed buys government bonds
directly from the Treasury. In other words, the federal government borrows money from the
Central Bank rather than the public. Debt monetization is the process usually implied when a
government is said to be printing money. Debt monetization, all else equal, is said to increase
the money supply and can lead to severe inflation.
However, before interest on reserves was permitted, fear of debt monetization was unfounded,
since the Federal Reserve did not even have the option to monetize any of the outstanding
federal debt or newly issued federal debt.
As long as The Fed had a mandate to maintain a target fed funds rate, the size of its purchases
and sales of government debt were not discretionary. Once the Federal Reserve Board of
Governors set a fed funds rate, the Fed’s portfolio of government securities changed only
because of the transactions required to support the funds rate. The Fed’s lack of control over
the quantity of reserves underscored the impossibility of debt monetization. The Fed was unable
to monetize the federal debt by purchasing government securities at will because, unable to pay
interest on reserves, to do so would have caused the funds rate to fall to zero. If the Fed
purchased securities directly from the Treasury and the Treasury then spent the money, the
expenditures would be excess reserves in the banking system and The Fed would be forced to
sell an equal amount of securities to support the fed funds target rate. The Fed would act only
as an intermediary. The Fed would be buying securities from the Treasury and selling them to
the public. No monetization would occur.
To monetize means to convert to money. Gold used to be monetized when the government
issued new gold certificates to purchase gold. In a broad sense, federal debt is money, and
deficit spending is the process of monetizing whatever the government purchases. Monetizing
does occur when the Fed buys foreign currency. Purchasing foreign currency converts, or
monetizes, that currency to dollars. Before interest on reserves, The Fed then offered U.S.
Government securities for sale to offer the new dollars just added to the banking system a place
to earn interest. This often misunderstood process is referred to as sterilization.
With The Fed able to pay interest on reserves, it can simply buy treasury securities and allow
reserve balances to accumulate. And for those who do not include treasury securities in their
definition of “money”, The Fed buying securities, also known as quantitative easing when done
as a policy, does increase the quantity of “money” as narrowly defined without putting
downward pressure on the fed funds rate. Furthermore, the economy’s net financial assets are
unchanged by this shifting of balances from securities accounts at The Fed to reserve accounts
at The Fed. And further note that the large fluctuations in the narrow monetary aggregates
caused by QE have no detectable macroeconomic consequences
Operating Procedure for the Federal Reserve: How Fed Funds Targeting Fits Into Overall Monetary
Policy
The Federal Reserve is presumed to conduct monetary policy with the ultimate goal of a low
inflation and a monetary and financial environment conducive to real economic growth. The Fed
attempts to manage money and interest rates to achieve its goals. It selects one or more
intermediate targets, because it believes they have significant effects on the money supply and
the price level.
Whatever the intermediate targets of monetary policy may be, the Fed’s primary instrument for
implementing policy is the federal funds rate. The fed funds rate is influenced by open market
operations. It is maintained or adjusted in order to guide the intermediate target variable. If the
Fed is using a quantity rule (i.e., trying to determine the quantity of money), the intermediate
target is a monetary aggregate such as M1 or M2. For instance, if M2 grows faster than its
target rate the Fed may raise the fed funds rate in an effort to slow the growth rate of M2. If M2
grows too slowly the Fed may lower the fed funds rate. If the Fed chooses to use the value of
money as its intermediate target then the fed funds target will be set based on a price level
indicator such as the price of gold or the Spot Commodities Index. Under a price rule the price
of gold, for example, is targeted within a narrow band. The Fed raises the fed funds rate when
the price exceeds its upper limit and lowers the rate when the price falls below its lower limit in
hopes that a change in the fed funds rate returns the price of gold into the target range.
Open market operations offset changes in reserves caused by the various factors which affect
the monetary base, such as changes in Treasury deposits with The Fed, float, changes in
currency holdings, or changes in private borrowing. Open market operations act as buffers
around the target fed funds rate. The target fed funds rate may go unchanged for months. In
1993, the target rate was held at 3 percent without a single change. In other years the rate was
changed several times.
Mechanics of Federal Spending
The federal government maintains a cash operating balance for the same reason individuals
and businesses do; current receipts seldom match disbursements in timing and amount. The U.
S. Treasury holds its working balances in the 12 Federal Reserve Banks and pays for goods
and services by drawing down these accounts. Deposits are also held in thousands of
commercial banks and savings institutions across the country. Government accounts at
commercial banks are called Tax and Loan accounts because funds flow into them from
individual and business tax payments and proceeds from the sale of government bonds. Banks
often pay for their purchases of U. S. Treasury securities or purchases on behalf of their
customers by crediting their Tax and Loan accounts.
The Treasury draws all of its checks from accounts at The Fed. The funds are transferred from
the Tax and Loan accounts to The Fed then drawn from the Fed account to purchase goods and services or make transfer payments. Suppose the Treasury intends to pay $500 million for a B-2 stealth bomber. The Treasury transfers $500 million from its Tax and Loan accounts to its account at The Fed. The commercial banks now have $500 million less in deposits and hence $500 million less reserves. At The Fed, reserves decrease by $500 million while Treasury deposits have increased by $500 million. At this instant the increase in U. S. Treasury deposits reduces reserves and the monetary base but when the Treasury pays for the bomber the preceding process is reversed. U. S. Treasury deposits at The Fed fall by $500 million and the defense contractor deposits the check received from the Treasury in its bank, whose reserves rise by $500 million. Government spending does not change the monetary base when reserves move simultaneously in equal amounts and opposite directions.
Figure 2 compares the T-accounts of the banking system, the Treasury and the Federal
Reserve for a $100 million expenditure. Figure 2a shows the net change for an expenditure
offset by tax receipts. Figure 2b shows the net change when the expenditure is offset by
borrowing. In either case reserve balances are left unchanged. There is no net change in the
banking system when the bomber is paid for with tax receipts. When the Treasury issues
securities to pay for the bomber, deposits in the banking system increase by $100 million. The
Federal Reserve’s use of offsetting open market operations to keep the funds rate within its
prescribed range is primarily applied to changes in government deposit balances.
Federal Government Spending, Borrowing, and Debt
The Fed’s desire to maintain the target fed funds rate links government spending, which adds
reserves to the banking system, and government taxation and borrowing, which drain reserves from the banking system. Under a fiat monetary system, The government spends money and then borrows what it does not tax, because deficit spending, not offset by borrowing, would cause the fed funds rate to fall.
The Federal Reserve does not have exclusive control of reserve balances. Reserve balances
can be affected by the Treasury itself. For example, if the Treasury sells $100 of securities,
thereby increasing the balance of its checking account at The Fed by $100, reserves decline
just as if The Fed had sold the securities. When either government entity sells government
securities reserve balances decline. When either buys government securities (in this case the
Treasury would be retiring debt) reserves in the banking system increase. The monetary
constraints of a fed funds target dictate that the government cannot spend money without
borrowing (or taxing), nor can the government borrow (or tax) without spending. The financial imperative is to keep the reserve market in balance, not to acquire money to spend.
The Interest Rate Maintenance Account (IRMA)
Over the course of time the total number of dollars that have been drained from the banking
system to maintain the fed funds rate is called the federal debt. A more appropriate name would be the Interest Rate Maintenance Account (IRMA). The IRMA is simply an accounting of the total amount of securities issued to pay interest on untaxed money spent by the government. Consider the rationale behind adjusting the maturities of government securities. Since the purpose of government securities is to drain reserves from the banking system and support an interest rate, the length, or maturity, of the securities is irrelevant for credit and rollover purposes. In fact, the IRMA could consist entirely of overnight deposits by member banks of The Fed, and The Fed could support the fed funds rate by paying interest on all excess reserves. One reason for selling long-term securities might be to support long-term interest rates.
Fiscal Policy Options
The act of government spending and concurrent taxation gives the illusion that the two are
inextricably linked. The illusion is strengthened by the analogy of government as a business or
government as a household. Businesses and households in the private sector are limited in how much they may borrow by the market’s willingness to extend credit. They must borrow to fund expenditures. The federal government, on the other hand, is able to spend a virtually unlimited amount first, adding reserves to the banking system, and then borrow, if it wishes to conduct a reserve drain.
Each year Congress approves a budget outlining federal expenditures. Congress also decides
how to finance those expenditures; in fiscal 1993 for example, government expenditures were $1.5 trillion. The financing was made up of $1.3 trillion in tax receipts and $0.2 trillion in
borrowing. The total revenue must equal total expenditures to maintain control of the fed funds rate. The composition of the total revenue between taxes and borrowing is at the discretion of Congress. The economic impact of varying the composition of government financing between taxes and borrowing is worthy of much research, discussion and debate. Unfortunately, sober discussion of the deficit’s economic implications have been dominated by apocalyptic sermons on the evils of deficit spending per se.
Since the federal budget deficit became an issue in the early eighties the warnings abound over the severe consequences of partaking in the supposedly sinister practice of borrowing money from the private sector. Enough warnings about the federal deficit have been made by
Democrats, Republicans and other patriotic Americans to fill a new wing in the Smithsonian.
The following is but a small sample:
“The national deficit is like cancer. The sooner we act to restrict it the healthier our fiscal body will be and the more promising our future.” Senator Paul Simon (D-IL)
“…because of the manner in which our debt has been financed, we are at great risk if interest
rates rise dramatically, or even moderately. The reason is that over 70 percent of the publicly-
held debt is financed for less that five years. That’s suicide in business, that’s suicide in your
personal life, and that’s suicide in your government.” Ross Perot
“Our nation’s wealth is being drained drop by drop, because our government continues to mount record deficits…The security of our country depends on the fiscal integrity of our government, and we’re throwing it away.” Senator Warren Rudman
“…a blow to our children’s living standards.” The New York Times
“…this great nation can no longer tolerate running runaway deficits and exorbitant annual
interest payments…” Senator Howell T. Heflin, (D-AL)
“The federal deficit…will continue to erode our capacity to respond to the economic and social challenges of the 21st century.” “…we are broke when we have to borrow to pay interest on the debt.” Senator Frank Murkowski, (RAK)
“…fiscal child abuse.” Senator William H. Cohen, (R-ME)
“This problem [government debt]…will precipitate an economic nightmare that will dwarf the
Great Depression.” “The country’s impending financial crisis is nearly upon us. The time for
polite debate has passed. Our national debt crisis can and will bring the United States to its
knees…” Harry E. Figgie, Bankruptcy 1995
All of this over a simple reserve drain! Real economic consequences, like inflation, are generally never even mentioned. The concerns are financial. Many of the drastic comments made about the deficit come from intelligent, competent, well-accomplished citizens. The concern for the welfare of America and for the nation’s future is genuine. However, in their haste to renounce financing decisions which would, in fact, be very harmful if not impossible for a private business or a household, they overlook the important differences between private finance and public finance. If you refer back to the parent child analogy, it is the difference between spending your own business cards and spending someone else’s.
ADDITIONAL DISCUSSIONS
What if No One Buys the Debt?
It is not possible to adequately address every question raised by debtphobes. One of the most common concerns, however, clearly illustrates the unfounded fear that arises from confusing private borrowing with public borrowing. The question is based on an image of Uncle Sam being turned away by lenders and being stuck without financing.
Fear the government will be unable to sell securities overlooks the mechanics of the process
itself. The imperative of borrowing is interest rate support. By issuing government securities, the government offers banks an opportunity to exchange non-interest bearing reserves for interest bearing securities. If all banks would rather earn zero interest on their assets than accept interest payments from the government, the refusal to accept interest becomes a de facto tax on the banking system. From the Treasury’s point of view the government’s inability to attract any lenders would actually be a benefit. Imagine, the government spends money and the banking system, in a sense, lends the money at zero interest by refusing to accept interest on the new deposits which the government spending created. Instead, the banking system is content to leave the money in a non-interest bearing account at The Fed. The money is held at The Fed either way – it has no other existence. If the money is left as excess reserves it sits in an non-interest bearing account at The Fed. If the money is loaned to the government by purchasing government securities it again is held at the government’s account at The Fed.
Savings and Investment:
How the Government Spends and Borrows As Much As It Does Without Causing Hyperinflation
Most people are accustomed to viewing savings from their own individual point of view. It can be difficult to think of savings on the national level. Putting part of one’s salary into a savings account means only that an individual has not spent all of his income. The effect of not spending as such is to reduce the demand for consumption below what would have been if the income which is saved had been spent. The act of saving will reduce effective demand for current production without necessarily bringing about any compensating increase in the demand for investment. In fact, a decrease in effective demand most likely reduces employment and income. Attempts to increase individual savings may actually cause a decrease in national income, a reduction in investment, and a decrease in total national savings. One person’s savings can become another’s pay cut. Savings equals investment. If investment doesn’t change, one person’s savings will necessarily be matched by another’s dissavings. Every credit has an offsetting debit. As one firm’s expenses are another person’s income, spending equal to a firm’s expenses is necessary to purchase its output. A shortfall of consumption results in an increase of unsold inventories. When business inventories accumulate because of poor sales: 1) businesses may lower their production and employment and 2) business may invest in less new capital. Businesses often invest in order to increase their productive capacity and meet greater demand for their goods. Chronically low demand for consumer goods and services may depress investment and leaves businesses with over capacity and reduce investment expenditures. Low spending can put the economy in the doldrums: low sales, low income, low investment, and low savings. When demand is strong and sales are high businesses normally respond by increasing output. They may also invest in additional capital equipment. Investment in new capacity is automatically an increase in savings. Savings rises because workers are paid to produce capital goods they cannot buy and consume. The only other choice left is for individuals to “invest” in capital goods, either directly or through an intermediary. An increase in investment for whatever reason is an increase in savings; a decrease in individual spending, however, does not cause an increase in overall investment. Savings equals investment, but the act of investment must occur to have real savings.
The relationship between individual spending decisions and national income is illustrated by
assuming the flow of money is through the banking system. The money businesses pay their
workers may either be used to buy their output or deposited in a bank. A bank bank has two
basic lending options. Money can be loaned to: 1) someone else who wishes to purchase the
output (including the government), or 2) to businesses who paid the individuals in the first place for the purpose of financing the unsold output. If the general demand for goods declines the demand for loans to finance inventories rises. If, on the other hand, individuals spent money at a high rate the demand for purchase loans would rise, inventories would decline and the level of loans to finance business inventories would fall. The structural situation in the U. S. is one in which individuals are given powerful incentives not to spend. This has allowed the government, in a sense, to spend people’s money for them. The reason that government deficit spending has not resulted in more inflation is that it has offset a structurally reduced rate of private spending. A large portion of personal income consists of IRA contributions, Keoghs, life insurance reserves, pension fund income, and other money that compounds continuously and is not spent. Similarly, a significant portion of business income is also low velocity; it accumulates in corporate savings accounts of various types. Dollars earned by foreign central banks are also not likely to be spent. The root of this paradox is the mistaken notion that savings is needed to provide money for investment. This is not true. In the banking system, loans, including those for business investments, create equal deposits, obviating the need for savings as a source of money. Investment creates its own money. Once we recognize that savings does not cause investment it follows that the solution to high unemployment and low capacity utilization is not necessarily to encourage more savings. In fact, taxed advantaged savings has probably caused the private sector to desire to be a NET saver. This condition requires the public sector to run a deficit, or face deflation.
Full Employment AND Price Stability
There is a very interesting fiscal policy option that is not under consideration, because it may
result in a larger budget deficit. The Federal government could offer a job to anyone who
applies, at a fixed rate of pay, and let the deficit float. This would result in full employment, by
definition. It would also eliminate the need for such legislation as unemployment compensation
and a minimum wage.
This new class of government employees, which could be called supplementary, would function
as an automatic stabilizer, the way unemployment currently does. A strong economy with rising
labor costs would result in supplementary employees leaving their government jobs, as the
private sector lures them with higher wages. (The government must allow this to happen, and
not increase wages to compete.) This reduction of government expenditures is a
contractionary fiscal bias. If the economy slows, and workers are laid off from the private sector,
they will immediately assume supplementary government employment. The resulting increase in
government expenditures is an expansionary bias. As long as the government does not change
the supplementary wage, it becomes the defining factor for the currency- the price around which
free market prices in the private sector evolve.
A government using fiat money has pricing power that it may not understand. Once the
government levies a tax, the private sector needs the government’s money so it can pay the tax.
The conventional understanding that the government must tax so it can get money to spend
does not apply to a fiat currency. Because the private sector needs the government’s money to
meet its tax obligations, the government can literally name its price for the money it spends. In a
market economy it is only necessary to define one price and let the market establish the rest.
For this example I am proposing to set the price of the supplementary government workers.
This is not meant to be a complete analysis. It is meant to illustrate the point that there are fiscal
options that are not under consideration because of the fear of deficits.
Taxation
Taxation is part of the process of obtaining the resources needed by the government. The
government has an infinite amount of its fiat currency to spend. Taxes are needed to get the
private sector to trade real goods and services in return for the fiat money it needs to pay taxes.From the government’s point of view, it is a matter of price times quantity equals revenue.
Given this, the secondary effects of taxes can now be considered before deciding on the tax
structure. A sales tax will inhibit transactions, as will an income tax. This tendency to restrict
trade and transactions is generally considered a detriment. It reduces the tendency to realize
the benefits of specialization of labor and comparative advantage. Furthermore, transaction
taxes offer large rewards for successful evasion, and therefore require powerful enforcement
agencies and severe penalties. They also result in massive legal efforts to transact without
being subject to the taxes as defined by the law. Add the this the cost of all of the record
keeping necessary to be in compliance. All of these are real economic costs of transactions
taxes.
A real estate tax is an interesting alternative. It is much easier to enforce, provides a more
stable demand for government spending, and does not discourage transactions. It can be made progressive, if the democracy desires.
How much money one has may be less important than how much one spends. This not a
common consideration. But having money does not consume real resources. Nor does one
person’s accumulation of nominal wealth preclude another’s, since the quantity of money
available is infinite. Fiat money is only a tax credit.
Perhaps those in favor of a progressive tax system should instead be concerned over the
disproportionate consumption of real resources. Rather than attempting to tax away one’s
money at source, luxury taxes could be levied to prevent excess consumption (not to raise
revenue). The success of the luxury tax should be measured by how little money it raises.
Foreign Trade
By the tenor of recent trade discussions it is apparent that the modern world has forgotten that exports are the cost of imports. Under a gold standard, each transaction was more clearly defined. If one imported cars, and paid in currency, the cars had been exchanged for gold. Cars were imported and gold was exported. Fiat money changed this. If a nation imports cars, and pays in its own fiat currency, cars are still imported but no commodity is exported. The holder of that money has a very loosely defined currency. In fact, the holder of currency is only guaranteed to be able to buy something from a willing seller at the seller’s offered price. Any country running a trade surplus is taking risk inherent in accumulating fiat foreign currency. Real goods and services are leaving the country running a surplus, in return for an uncertain ability to import in the future. The importing country is getting real goods and services, and agreeing only to later export at whatever price it pleases to other countries holding its currency. That means that if the United States suddenly put a tax on exports, Japan’s purchasing power would be reduced.
Inflation vs. Price Increases
Little or no consideration has been given to the possibility that higher prices may simply be the market allocating resources and not inflation.
Prices reflect the indifference levels where buyers and sellers meet. The market mechanism
allows the participants to make their purchases and sales at any price on which they mutually
agree. Market prices tend to change continuously. If, for example, there is a freeze in Brazil, the price of coffee may go up. The higher price accommodates the transfer of the remaining supply of coffee from the sellers to the buyers.
Prices going up and down can be the market allocating resources, not a problem of inflation.
The textbook definition of inflation is the process whereby the government causes higher prices by creating more money either directly through deficit spending, or indirectly by lowering interest rates or otherwise encouraging borrowing. For example, when a shortage of goods and services causes higher prices, a government may attempt to help its constituents to buy more by giving them more money. Of course, a shortage means that the desired products don’t exist. More money just raises the price. When that, in turn, causes the government to further increase the money available, an inflationary spiral has been created. The institutionalization of this process is called indexing.
Left alone, the price of coffee, gold, or just about anything may go up, down, or sideways.
Goods and services go through cycles. One year, there may be a record harvest, and the next a disaster. Oil can be in shortage one decade, and then in surplus the next. There could,
conceivably, be years, or even decades when the CPI grows at, say, 5% without any real
inflation. There may be fewer things to go around, with the market allocating them to the highest bidder.
As the economy expands and the population increases, some items in relatively fixed supply are bound to gain value relative to items in general supply. Specifically, gold, waterfront property, and movie star retainers will likely increase relative to computers, watches, and other electronics.
If The Fed should decide to manage the economy by targeting the price of gold, they would
respond to an increase in the price of gold with higher interest rates. The purpose would be to discourage lending, thereby reducing money creation. In effect, The Fed would try to reduce the amount of money we all have in order to keep the price of gold down. That may then depress the demand for all other goods and services, even though they may be in surplus. By raising rates, The Fed is saying that there is too much money in the economy, and it is causing a problem.
Presumably there is some advantage to targeting gold, the CPI, or any other index, rather than leaving the money alone and letting the market adjust prices. Interest rates can be too low and lead to excess money creation relative to the goods and services available for sale. On the other hand, higher commodity prices may represent the normal ebbs and flows in the markets for these items.
If there are indeed price increases due to changing supply dynamics, Fed policy of restricting
money may result in a slowdown of serious proportions which would not have occurred if they had left interest rates alone.
Conclusion
The supposed technical and financial limits imposed by the federal budget deficit and federal
debt are a vestige of commodity money. Today’s fiat currency system has no such restrictions.
The concept of a financial limit to the level of untaxed federal spending (money creation/deficit spending) is erroneous. The former constraints imposed by the gold standard have been gone since 1971. This is not to say that deficit spending does not have economic consequences. It is to say that the full range of fiscal policy options should be considered and evaluated based on their economic impacts rather than imaginary financial restraints. Current macroeconomic policy can center around how to more fully utilize the nation’s productive resources. True overcapacity is an easy problem to solve. We can afford to employ idle resources.
Obsolete economic models have hindered our ability to properly address real issues. Our
attention has been directed away from issues which have real economic effects to meaningless issues of accounting. Discussions of income, inflation, and unemployment have been overshadowed by the national debt and deficit. The range of possible policy actions has been needlessly restricted. Errant thinking about the federal deficit has left policy makers unwilling to discuss any measures which might risk an increase in the amount of federal borrowing. At the same time they are increasing savings incentives, which create further need for those unwanted deficits.
The major economic problems facing the United States today are not extreme. Only a misunderstanding of money and accounting prevents Americans from achieving a higher quality of life that is readily available.
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A Framework for the Analysis of Price and Inflation
(https://warrenmosler.com/aframeworkfortheanalysisofpriceandinflation/)
Introduction
The purpose of this chapter is to present a framework for the analysis of the price level and inflation. MMT (Modern Monetary Theory) is currently the only school of economic thought that, in direct contrast to other schools of thought, specifically identifies and models both the source of the price level and the dynamics behind changes in the price level with MMT offering a unique understanding of inflation as academically defined as part of its general framework for analysis that applies to all currency regimes.
I was asked to do a chapter on ‘inflation’ under the textbook definition which is ‘a continuous increase in the price level.’ However, under close examination this turns out to be elusive at best. At any point in time the price level is presumably both static and quantitatively undefinable. That’s why even the most sophisticated central bank research uses abstractions, the most familiar being the Consumer Price Index (CPI) which consists of selected goods and services designed to reflect a cost of living rather than ‘the price level.’ Nor can central banks determine a continuous rate of change of this abstraction. They can only tell you how the CPI has changed in the past, and they can attempt to forecast future changes. Even worse, they assume the source of the price level to be entirely historic, derived from an infinite regression into the past that, in theory, predates the birth of the universe.
I. The MMT Money Story
The MMT money story presumes a state that desires to provision itself via a monetary system sequenced as follows:
- Imposition of coercive tax liabilities
- State spending
- Payment of taxes and purchase of state securities
Again, with a more extended narrative:
1. The state imposes tax liabilities with penalties for non-payment. The tax credits required for the payment of taxes are units of the state’s currency, issued only by the state.
2. The tax liabilities, by design, create sellers of goods and services seeking the appropriate tax credits in exchange, the latter by definition being unemployment.
3. The state then provisions itself by spending its currency to purchase the goods and services it desires.
4. Taxes can then be paid and, if offered for sale by the state, state securities can then be purchased.
5. State spending in excess of tax receipts remains outstanding as the net financial assets in the economy that fulfill savings desires until used to pay taxes.
II. The MMT Micro Foundation- The Currency as a Public Monopoly
The MMT money story begins with the imposition of coercive tax liabilities to create a notional demand for that currency. That notional demand is the sum of units of the currency needed to pay taxes and fund residual savings desires, as evidenced by what is offered for sale by agents seeking that currency in exchange for their goods and services. With today’s state currencies, for example, the non-government sectors offer goods and services for sale until they have satisfied their need to pay taxes and their desires to net save.
The state monetary system is a public monopoly with the state the sole supplier of that which it requires for the payment of taxes. The state therefore necessarily dictates terms of exchange when spending to purchase goods and services, with the quantity that it can buy inversely related to the prices it pays. For example, if the tax liabilities are $100 and savings desires are $20, and the state offers to pay $1 per day for labor, the state will be able to obtain 120 days of labor. If instead the state pays $2 per day for labor, it will obtain only 60 days of labor. In both examples the non-government sectors are selling labor at the state’s price to the point where agents of those sectors have sufficient funds to comply with their tax liabilities and to net save as desired.
For a given fixed nominal tax liability and savings desire, when paying higher prices the state both redefines the value of the currency downward and purchases less in real terms. Therefore, the state can, as a matter of arithmetic, when paying higher prices only buy more real goods and services by increasing tax liabilities or through increased savings desires. That is, to return to the prior example where tax liabilities were $100, savings desires $20, and the labor wage was increased from $1 per day to $2 per day, a tax increase to $200 or an increase of savings desires to $140 would result in the state obtaining the same 120 days of labor as it received with the $1 wage.
In the US, tax liabilities tend to increase as the US government pays higher prices due to federal, state, and local transactions taxes that are based on prices. These include income taxes where higher nominal incomes result in higher tax liabilities, and sales taxes where higher prices also result in higher tax liabilities.
Additionally, savings desires are based on real rather than nominal considerations. Retirement savings desires, for example, are based on the presumed cost of living during retirement years. As prices rise, those nominal savings desires rise accordingly. Business liquidity needs and inventory and receivables financing needs also rise as prices rise.
Therefore, in general, an economy experiencing a continuous increase in prices requires a continuous nominal increase in what is casually called ‘the money supply’ that constitutes the economy’s net savings of financial assets. Without this increase, real savings desires cannot be achieved, as then evidenced by unemployment and excess capacity in general. This, in fact, is my narrative for the 1979 recession. Fiscal balance tightened as tax liabilities increased faster than government spending, and the real public debt growth further decelerated due to the increases in the price level, with the combination driving the economy into a severe recession.
III. The Source of the Price Level
With the state the sole supplier of that which it demands for payment of taxes, the economy needs the state’s currency and therefore state spending sets the terms of exchange; the price level is a function of prices paid by the state when it spends.
There are two primary dynamics involved in the determination of the price level. The first is the introduction of absolute value of the state’s numeraire, which takes place by the prices the state pays when it spends. Moreover, the only information with regard to absolute value as measured in units of the state’s currency is the information transmitted by state spending. Therefore, all nominal prices can necessarily be traced back to prices the state pays when spending its currency.
The second dynamic is the transmission of this information by markets allocating by price as they express indifference levels between buyers and sellers, and all in the context of the state’s institutional structure.
The price level, therefore, consists of prices dictated by government spending policy along with all other prices subsequently derived by market forces operating within government institutional structure.
IV. Agents of the State
The US Congress has designated agents to work on its behalf. These include the Federal Reserve Bank which operates the monetary system, commercial bank members of the Federal Reserve System that are federally regulated and supervised, and the US Treasury which executes purchases and sales as directed by legislation, by instructing the Federal Reserve Bank to debit or credit appropriate accounts.
Commercial bank Fed members have demand accounts at the Fed called reserve accounts. Federal tax liabilities are discharged by either the payment of Federal Reserve Notes (cash) or by the Fed debiting a member bank reserve account, and, if it is a bank client initiating the payment, by the member bank simultaneously debiting the bank account of the client making the payment. Non-bank entities can only make payments to the Fed indirectly through a Fed member bank as a correspondent, or by using cash.
Banks, as agents of the government, likewise influence the price level, as bank lending supports client borrowing to spend on goods and services. Government regulation and supervision controls the prices paid with funds borrowed from the commercial banks. And, with the unlimited liquidity inherent in a floating exchange rate policy, without regulation banks could lend without limit and without collateral requirements or other means of controlling the prices paid by borrowers, which could quickly impair the government’s ability to provision itself and catastrophically devalue the currency.
V. The Determination of the Price Level
The state sets the terms of exchange for its currency with the prices it pays when it spends, and not per se by the quantity of currency that it spends. For example, if the state has an open-ended offer to hire soldiers at $50,000 per year, the price level as thereby defined will remain constant regardless of how many soldiers are hired and regardless of the state’s total spending. The state has set the value of its numeraire exogenously, providing that information of absolute value that market forces then utilize to allocate by price with exchange values of other goods and services determined in the marketplace. Without the state supplied information, however, there would be no expression of relative value in terms of that currency.
Should the state decide, for example, to increase the price it pays for its soldiers to $55,000 per year, it would be redefining the value of its currency downward and increasing the general price level by 10%, as market forces reflect that increase in the normal course of allocating by price and determining relative value. And for as long as the state continues to pay soldiers $55,000 per year, assuming constant relative values, the price level will remain unchanged. And, for example, the state would have to continually increase the rate of pay by 10% annually to support a continuous annual increase of the price level of 10%.
VI. Inflation Dynamics
I begin with an academic definition of the rate of inflation:
“The continuous increase in the term structure of prices faced by economic agents today for purchases and sales for future delivery dates.”
This can also be referred to as forward pricing, and it’s an expression of the policy rate of interest determined by central bank policy.
MMT makes a distinction between changes over time of the price level, vs the rate of inflation which is expressed by the current term structure of prices.
The price level changes with prices paid by the state when it spends (fiscal policy) while changes in the term structure of policy interest rates (monetary policy) alter the term structure of prices. And while the term structure of prices is not a forecast of changes in the price level, that is not to say it doesn’t influence the future direction of the price level.
Interest rate policy also functions as a fiscal transfer as the state is a net payer of interest to the other sectors of the economy. With public debt levels in excess of 100% of GDP, for example, a 1% rate hike, ultimately adds interest income payments of over 1% of GDP to the economy. This increase in state spending directly increases nominal incomes, and, to the extent agents receiving the interest payments increase their spending, state interest payments support sales, output, and employment.
State interest expense also reduces fiscal space as it partially satisfies the need to pay taxes and to net save that is created by state tax liabilities, which means there will be that many fewer goods and services offered for sale to comply with the remaining tax liabilities. This means the state’s real purchases of goods and services are reduced by interest payments as per the same framework for analysis discussed in the previous examples.
Therefore, as described above, I conclude that the state’s payment of interest, implemented by the state to slow the rate of growth and work to counter price increases, is far more likely to do the reverse.
Also of note is that interest payments are necessarily to those who already have money, and are also paid proportionately to the amount of money one has. In prior publications, I’ve labeled a positive interest rate policy ‘basic income for those who already have money’ which, when stated as such, has no political support whatsoever. Yet, as monetary policy that, presumably, fights inflation, central bank rate increases receive widespread support.
To summarize, I see interest rate policy as both backwards and confused. First, the rate of inflation academically defined is an expression of the central bank’s policy rates, so rate hikes directly increase that measure of inflation.
Second, rate hikes constitute additional state deficit spending, which tends to also be an inflationary bias given currency institutional structure.
And third, for me the payment of funds only to those who already have money as a cure for what’s believed is inflation does not serve public purpose.
VII. Interest Rates and Wages
An increase in the Central Bank’s policy rate in the first instance increases state deficit spending and total income in the economy. This means wages are then a smaller percentage of total income which to some degree, depending on propensities to spend, implies that the relative value of wages has decreased.
This further implies that if wages are indexed to the general price level in the context of a positive policy interest rate, an increase in the wage will cause a larger increase in the general price level, which will then trigger a higher wage, in an accelerating spiral.
However, in the context of a 0% rate policy, a wage increase would not be magnified by this process.
What I’m suggesting is that this combination of wage indexation and high policy rates of interest selectively observed in nations experiencing undesired increases in the price level ironically contributes to accelerating rates of increase the interest rate policy is meant to contain.
VIII. The Hierarchy of Demand
Demand originates with the state. Without state spending the value of the currency is unspecified and there is no aggregate demand. Only subsequent to state spending can the currency obtain absolute value and non-government spending take place.
IX. Conclusion
This chapter provides a framework for the analysis of the price level and inflation. The framework is that of the currency itself as a public monopoly, with the state setting nominal demand with its tax liabilities, as well as providing the tax credits that allow compliance with those tax liabilities.
This understanding entirely explains the source of the absolute nominal value price level over time. Also implied is the role of interest rates with regard to the academic definition of inflation and the influence of policy rates on market-determined expressions of relative value.
References
Armstrong, P. and Mosler, W. B. (2020), ‘Weimar Republic Hyperinflation through a Modern Monetary Theory Lens’, Weimar-Republic-Hyperinflation-through-a-Modern-Monetary-Theory-Lens.pdf
(moslereconomics.com) accessed 25/10/2021.
Forstater. M. and Mosler, W. B. (2005),’The Natural rate of Interest is Zero’, Journal of Economic Issues, Vol. XXXIX, No. 2, June.
Mosler, W. B. (1993), ‘Soft Currency Economics’, Soft-Curency-
Economics-paper.pdf (moslereconomics.com) accessed 25/10/2021.
Mosler, W. B. (2010), The Seven Deadly Innocent Frauds of Economic Policy, US Virgin Islands: Valance.
Mosler, W.B. (2020), ‘MMT White Paper’ MMT White Paper – Mosler Economics / Modern Monetary Theory accessed 25/10/2021.
Forstater. M. and Mosler, W. B. ‘A General Analytical Framework for the Analysis of Currencies and Other Commodities’
oooooo
erabiltzaileari erantzuten
It’s just the yuan they spent that haven’t yet been used to pay taxes. They know they spend first, then some is used to pay taxes, and what remains outstanding is called the public debt. Another case of ‘knowledge is power’ that we could learn from. 😉
moslereconomics.com
MMT White Paper – Mosler Economics / Modern Monetary Theory
Click Here for the White Paper on Modern Money Theory Italian Version Español
11/03/24 (additional link added)
White Paper: Modern Monetary Theory (MMT)
(https://docs.google.com/document/d/1gvDcMU_ko1h5TeVjQL8UMJW9gmKY1x0zcqKIRTZQDAQ/edit?tab=t.0)
The purpose of this white paper is to publicly present the fundamentals of MMT.
*What is MMT?
MMT began as a description of Federal Reserve Bank monetary operations and accounting, which are best thought of as debits and credits to accounts as kept by banks, businesses, and individuals.
In 1992 Warren Mosler independently originated what has been popularized as MMT. In 1996 he introduced it to the academic community through an internet discussion group, and while subsequent research has revealed writings of authors who had similar thoughts on some of MMT’s monetary understandings and insights, including Abba Lerner, George Knapp, Mitchell Innes, Adam Smith, and former NY Fed chief Beardsley Ruml, MMT is unique in its analysis of monetary economies, and therefore best considered as its own school of thought.
https://www.scribd.com/document/35432615/Soft-Currency-Economics
http://moslereconomics.com/mandatory-readings/what-is-money/
*What is the Relevance of MMT Today?
The MMT understandings put policy options on the table that were not previously considered viable.
*What’s different about MMT:
SEQUENCE:
MMT alone recognizes that the US Government and its agents, including its regulated commercial banks, are the sole supplier of that which it demands for payment of taxes
That is, the currency itself is a simple public monopoly.
The US government levies taxes payable in US dollars.
The US dollars to pay those taxes or purchase US Treasury securities can only originate from the US government and its agents.
The economy has to sell goods, services or assets to the US government (or borrow from the US government, which is functionally a financial asset sale) to be able to pay its taxes or purchase US Treasury securities.
Ramifications:
1. The US government and its agents, from inception, necessarily spend (or lend) first, and only then can taxes be paid or US Treasury securities purchased.
This is in direct contrast with mainstream economic models and the rhetoric that states the US government must tax to get US dollars to spend, and what it doesn’t tax it must borrow from the likes of China and leave the debt to our grandchildren.
MMT therefore recognizes that it’s not the US government that needs to get dollars to spend, but instead, the driving force is that taxpayers need the US government’s dollars to be able to pay taxes and purchase US Treasury securities.
2. Crowding out private spending or private borrowing, driving up interest rates, federal funding requirements and solvency issues are not applicable for a government that, like the US, from inception spends first, and then borrows.
How are you going to pay for it?
The US government, for all practical purposes, spends as follows:
After spending is authorized by Congress, the Treasury instructs the Federal Reserve Bank to credit the recipient’s bank account (change the number to a higher number) on the Fed’s books. <Note: The accounts of Fed member banks are called reserve accounts and balances in those accounts are called reserves.>
How is the Public Debt Repaid?
When US Treasury securities mature, the Fed debits the securities accounts and credits the appropriate reserve accounts. Interest on the public debt accrues to the securities accounts and the Fed credits reserve accounts to pay that interest.
There are no taxpayers or grandchildren in sight when that happens.
THE CAUSE OF UNEMPLOYMENT:
MMT recognizes that taxation, by design, is the cause of unemployment-defined as people seeking work paid in that currency- presumably for the further purpose of the US Government hiring those that its tax liabilities caused to become unemployed.
THE MMT ‘MONEY STORY’- A STATE DESIRING TO PROVISION ITSELF:
1. The US Government by vote of Congress imposes tax obligations payable in US dollars.
2. Consequently goods, services and assets are offered for sale to get the US dollars required to pay the taxes.
3. The state can then buy those goods and services.
4. Taxes can then be paid.
5. If people, on average, want to earn more than what’s required to pay taxes, goods, services and assets will be offered for sale in sufficient quantity to obtain those extra dollars.
6. State spending in excess of taxes- deficit spending- provides the dollars desired to be saved.
7. After the state has spent those extra dollars, Treasury bills, notes, and bonds can then be purchased, which depletes the accounts containing the dollars the state has already spent.
Note: The public debt equals the dollars spent by the state that haven’t yet been used to pay taxes.
8. Payments by the US government are added to reserve accounts of Fed member banks.
9. When securities are purchased, the Fed debits reserve accounts and credits securities accounts which are also at the Fed.
INTEREST RATES:
MMT recognizes that a positive policy rate results in a payment of interest that can be understood as “basic income for those who already have money.”
MMT recognizes that with the government a net payer of interest, higher interest rates can impart an expansionary, inflationary (and regressive) bias through two types of channels — interest income channels and forward pricing channels. This means that what’s called Fed “tightening” by increasing rates may increase total spending and foster price increases, contrary to the advertised intended effects of reducing demand and bringing down inflation.
Likewise, lowering rates removes interest income from the economy which works to reduce demand and bring down inflation, again contrary to advertised intended effects.
The higher the debt/gdp, the larger the fiscal impact of rate policy.
Furthermore, forward pricing is a direct function of the Fed’s policy rate, and with a policy of a positive term structure of interest rates, the forward price level increases continuously at the policy rate, which is the academic definition of inflation.
MMT understands that a permanent 0% policy rate is the base case for analysis for a floating exchange rate policy.
MMT understands that with a permanent 0% policy rate asset prices reflect risk adjusted valuations, and do not “continuously accelerate” as presumed by the term “asset price inflation.”
The MMT understanding of interest rates is at times in direct conflict with the understandings of central banks and the large majority of academics. We see those “mainstream” views as at best applicable to fixed exchange rate regimes, but in any case not applicable to today’s floating exchange rate regimes.
http://moslereconomics.com/wp-content/graphs/2009/07/natural-rate-is-zero.PDF
http://moslereconomics.com/wp-content/uploads/2007/12/Exchange-Rate-Policy-and-Full-Employment.htm
INFLATION:
Only MMT recognizes the source of the price level: the currency itself is a public monopoly and monopolists are necessarily “price setters.”
Market forces determine relative prices. Their only information with regard to the absolute value of the currency comes from the state through its policies and institutional structure.
Therefore:
The price level is necessarily a function of prices paid by the government’s agents when it spends, or collateral demanded when it lends.
In what’s called a market economy, the government need only set only one price, as market forces continuously determine all other prices as expressions of relative value, as further influenced by institutional structure.
Monopoly Money: The State as a Price Setter by Pavlina R. Tcherneva
http://www.levyinstitute.org/pubs/wp_864.pdf
https://docs.google.com/document/d/1sySbx6EHOAYpAjE4FGnYApdZNyY6rh79KzajZxSU884
The Job Guarantee
Residual unemployment is caused by the government not hiring all of those that its tax liabilities have caused to become unemployed. That is, it’s a case of a monopolist- the government- restricting supply, which in this case refers to net government spending.
Current policy is to utilize unemployment as a counter-cyclical buffer stock to promote price stability. Another policy option is for the government to use an employed buffer stock, rather than an unemployed buffer stock, to promote price stability.
The Job Guarantee is a proposal for the US Government to use an employed buffer stock policy by funding a full time job for anyone willing and able to work at a fixed rate of pay. A $15 per hour wage has currently been proposed. This wage becomes the numeraire for the currency- the price set by the monopolist that defines the value of the currency while allowing other prices to express relative value as further influenced by the institutional structure.
The Job Guarantee works to promote price stability more effectively than the current policy of using unemployment, by better facilitating the transition from unemployment to private sector employment, as private employers don’t like to hire the unemployed.
It also provides for a form of full employment, and at the same time is a means to introduce minimum compensation and benefits “from the bottom up,” as private sector employers compete for Job Guarantee workers.
Full Employment AND Price Stability
“The 7 Deadly Innocent Frauds of Economic Policy”
oooooo
A US Centered Analysis of the Price Level, Inflation and the Neutral Rate ofInterest
Warren Mosler1
Phil Armstrong2
In this paper we develop a Federal Reserve Bank centered framework for the analysis
of the price level and inflation first presented by Mosler (2023). Both the source of the
price level and the dynamics behind changes in the price level are identified and
inflation, as academically defined, is shown to be a direct function of the central bank
policy rate. The neutral rate, as currently defined by central banks, is then analyzed and
revealed as an anachronistic narrative that echoes analyses of convertible currency
fixed exchange rate regimes, which are inapplicable to the US non-convertible currency
floating exchange rate regime.
Price level, Inflation, Interest rates, Monetary Policy, Neutral rate (R*), fiscal policy
In this paper, we further develop the Framework for the Analysis of the Price Level and
Inflation presented by Mosler (2023) in the context of the Federal Reserve monetary
policy.
In section 1. we identify the currency itself, the $US, as a case of a public monopoly,
which is thereby the source of the price level.
In section 2. we identify and analyze the sequence of monetary operations.
Section 3. is a discussion of inflation.
Section 4. introduces the commercial banking system and critiques current central bank
monetary policy.
Section 5. concludes.
1. The Source of the Price Level: The Currency as a Public Monopoly
The analysis of the origin of a non-convertible currency like the $US begins with the
imposition of coercive tax liabilities that both identifies the $US as the tax credit and
contains information regarding the quantity of $US required to satisfy the tax liabilities.
These requirements create a notional demand for $US, evidenced by sellers of goods
and services seeking $US in exchange. That total notional demand is the sum of both
the $US needed to pay taxes and $US denominated net savings desires. Stylized, the
non-government sector offers goods and services for sale to satisfy their need to pay
taxes and their desires to net save (Mosler, 1993).
The Federal Reserve Bank (Fed)3, as with any bank, is the single source of credit
balances in client accounts on its balance sheet. The $US credit balances of
commercial bank members at the Fed are called reserves. As the single supplier of
reserves, the Fed necessarily sets the rate of interest it pays on reserves as well as the
rate of interest it charges the commercial banks to borrow $US. Fed operations staff
implement a politically determined policy rate either by the rate of interest paid on
reserves or the interest charged for reserve deficiencies. The interest paid on US
Treasury bills- short term discount notes sold by the US Treasury, as well as the rate of
interest paid on longer term US Treasury notes and bonds, is determined by market
forces, and is largely a function of the Fed’s overnight policy rate along with
expectations of changes in the policy rate.
US Treasury securities are, functionally, $US balances in time deposits, known as
securities accounts, that are serviced by the Fed. The purchase and sale of US
Treasury securities is evidenced by $US balances shifting between reserve accounts
and securities accounts. The purchase of US Treasury securities is settled by debiting
reserve accounts and crediting securities accounts, and at maturity, the securities
accounts are debited and reserve accounts are credited.
Single suppliers (monopolists) set two rates. The first is known as the “own” rate, which
is how the item controlled by the monopolist exchanges for itself. For a currency
monopolist, like the Fed, the own rate is the policy determined $US interest rate.
Additionally, monopolists set terms of exchange for how their item exchanges for other
items. For a currency that is called the price level, which is necessarily a function of
prices paid by the currency monopolist.
With the US government (through agents) the sole supplier of the $US that it requires
for the payment of taxes, the US monetary system is a public monopoly. Government
spending is settled by the crediting of reserve accounts, which only the Fed can do, and
tax payments are settled by debiting reserve account balances credited by the Fed4.
The government, as a single supplier, is thereby (de facto) setting terms of exchange
when spending $US to purchase goods and services5.
Market forces only determine relative value, expressed by how quantities of various
goods and services exchange for each other. Absolute value in terms of the conversion
rate of a numeraire is necessarily introduced to a market exogenously. To express
absolute value in terms of a numeraire, markets require information as to the conversion
rate between the numeraire and at least one of the goods and services exchanged in
the market. For example, markets need to know the price in $US of at least one item
before the market prices all other items in $US.
The prices paid by the state, as single supplier of $US needed to satisfy coercive tax
liabilities, exogenously transmit the value of the $US6, thereby providing the information6 Increases in the price level are not per se a result of increases in the quantity of spending (or increases in the money supply), rather they are about the prices paid by the government. The value of the currency
is defined by what a given amount of it buys. So, for example, if the government increases purchases at
current prices, regardless of the quantity of money spent, that additional (price constrained) spending has
not driven up prices, and the value of the currency has not been altered.
However, if the government instead pays more for the same items purchased, the value of the currency,
by definition, has become lower, as it takes more of it to buy the same quantity than was previously the case.
Of further note is the following inverse relationship. For a given fixed nominal tax liability and savings desire, when paying higher prices the state both redefines the value of the currency downward and purchases less in real terms. Therefore, the state can, as a matter of arithmetic, when paying higher of nominal value that market forces then incorporate as they continuously allocate resources by price. Without that information there could be no $US denominated expression of relative value. The nominal value of the $US would be unspecified, and there would not be effective $US denominated aggregate demand. Only with state spending can the $US express a nominal exchange value, and non-government $US
denominated spending take place. As all nominal prices can necessarily be traced back
to prices the state pays when spending its currency, the price level therefore consists of
prices dictated by government spending policy along with all other prices subsequently
derived by market forces, all of which operate within the government’s institutional
structure.
With a convertible currency fixed exchange rate policy such as a gold standard, the
government sets the price of gold and allows all other prices to adjust and express
value relative to gold. The US government, for example, has previously fixed the $US to
gold by standing by to buy or sell $US at the conversion rate, and allow market forces to
set all other $US prices7.
With the US’s current floating exchange rate policy, the prices paid by government, in
general, continuously send pricing information to the private sector, with the only open
ended spending at the margin being unemployment compensation.
In the US, tax liabilities tend to increase as the US government pays higher prices, due
to transaction taxes that are a function of prices. These include income taxes where
higher nominal incomes result in higher tax liabilities, and sales taxes where higher
prices also result in higher tax liabilities. Additionally, nominal savings desires are also a
function of prices, as they are grounded on real rather than nominal considerations. So
as prices rise, nominal savings desires rise accordingly. Business liquidity needs and
inventory and receivables financing needs also rise as prices rise. Therefore, in general,
in an economy experiencing a continuous increase in prices there is an increasing
demand for $US denominated net financial assets8 which are a direct consequence of
US government deficit spending. Without this increase, real savings desires cannot be
achieved, as then evidenced by unemployment and excess capacity in general9.
The US Congress has designated agents to act on its behalf. These include the Fed
which operates the monetary system, the Treasury which executes purchases and sales
as directed by legislation by instructing the Fed to debit or credit appropriate accounts,
and the commercial bank members of the Federal Reserve System that are regulated
and supervised.
US commercial banks, as agents of the US government, have a direct influence on the
price level. Bank lending supports private sector deficit spending that purchases goods
and services. Through regulation and supervision, the scope of government policy
includes the establishment of terms and conditions of bank lending, including the size of
the loans and prices paid by those who borrow from the commercial banks. Without
regulation restricting bank lending, the inherent unlimited liquidity of a floating exchange
rate policy could result in accelerating, inflationary private sector deficit spending that
could also undermine the government’s ability to provision itself (see below).
Analysis of The Sequence of Monetary Operations
The following is the causal sequence of events for the US monetary system:
1. Establish tax liabilities with the $US as the tax credit
2. Government spending of $US
3. $US tax payments and payments for securities purchased from government
The process of government provision begins with $US denominated tax liabilities that
result in goods and services being offered for sale in exchange for $US. The US
government can then spend $US to provision itself. After receiving payment in $US,
taxpayers can then pay their $US denominated tax requirements and buy government
securities from the government10. It is inherent in Fed monetary operations that, from
inception, government spending precedes and thus provides the funds for payments to the government. At the Fed, crediting of reserve accounts necessarily takes place prior to debiting reserve accounts. Fed monetary operations staff say it this way: “You can’t conduct a reserve drain without a prior reserve add.” They have to credit member bank reserve accounts before they can debit them11.
To this point, the Fed stands by continuously to engage in what are referred to as open market operations in order to carry out what they call a “reserve add” to facilitate both
tax payments and securities purchases. This includes what are called repurchase
agreements whereby the Fed lends the banks the needed $US and accepts the newly
purchased Treasury securities as collateral for the loans. Monetary operations
personnel call this process, which is their prime responsibility, offsetting operating
factors. The critical micro foundation of the monetary system is that the $US required to
pay taxes and purchase government securities originate from the government through
its agent, the Fed.
From the understanding of the sequence, what is called the public debt is best
described as the $US spent by the government that have not yet been used to pay
taxes. And those $US remain outstanding until used to pay taxes. They take the form of
$US balances in reserve accounts at the Fed, $US balances in securities accounts at
the Fed, or physical cash, all of which are liabilities of the Fed. The sequence is:
1) the government (viewed on a consolidated basis) spends first, crediting reserve
accounts and, subsequently,
2) Reserve accounts are debited for the payment of taxes and for the purchase of
securities12.
3. Inflation
The standard textbook definition of inflation, in the context of floating exchange rate
policy, is “a continuous increase in the price level.” The price level, however, is
indeterminate, resulting in the use of inflation indicators such as the Consumer Price
Index (CPI), which contains prices of selected goods and services for the politically
determined purpose of identifying the cost of living. The continuous rate of change of
the CPI, however, is also indeterminate. Central banks can only calculate, for example,
how the CPI has changed in the past, and they can forecast subsequent rates of
change, but the current rate of change does not lend itself to calculation. Nor, after
decades of research, do central banks have a theory as to the source of the price level.
By default, the source of the price level is assumed to be entirely historic, derived from
an infinite regression of the current CPI into the past.
For purposes of this analysis, the definition of inflation and the term price level are from
the reference point of today’s decision making agents. While those agents don’t know
what prices may be in the future, current prices for immediate delivery and prices for
those same items purchased today for delivery at a future point in time can be
calculated.
From this understanding we deduce the determinate academic definition of inflation to
be: “The continuous increase in the term structure of prices faced by economic agents
today for purchases and sales for future delivery dates.” This concept is also known as
forward pricing, which also happens to be a direct function of the policy rate of interest
administered by the central bank. And it also remains consistent with the standard
textbook definition of inflation as a continuous increase in the price level. 13
There is a critical distinction between changes in the price level over time, and the rate
of inflation expressed by the current term structure of prices. The price level changes
over time as a function of prices paid by the US government when it spends (fiscal
policy), while changes in the term structure of policy interest rates (monetary policy as
decreed by the Fed) directly alter the term structure of prices. And while the term
structure of prices is not a forecast of changes in the price level, that is not to say it
does not influence the future direction of the price level.
With the rate of inflation academically defined as an expression of the central bank’s
policy rates, increases in policy interest rates directly increase that measure of the rate
of inflation. Additionally, monetary policy directly alters the fiscal balance. Increases in
the policy rate of interest cause government interest expense to increase which is also
an inflationary bias given current institutional structure. Of further note is that the
payment of interest is a distribution only to savers, and in proportion to the size of their
savings. Therefore, while a positive rate of interest constitutes expansionary fiscal
policy, it is an entirely regressive public policy (Armstrong and Mosler, 2020).
4. The Commercial Banking System and Monetary Policy
The Fed is a public bank that maintains reserve accounts for its member commercial
banks. This allows the commercial banks to transfer funds to each other by instructing
the Fed to debit their reserve account and credit a recipient bank’s reserve account, in
the same way as the commercial banks effect transfers between client accounts within
their banks.
Commercial bank purchases are paid for by crediting client accounts on their balance
sheet, which constitute new assets of those clients and new liabilities of the bank. Bank13
Ironically, while the term structure of forward prices is a direct function of the policy rate, we have found
no evidence of discussion at any central bank meeting in this regard.
lending is a subset of bank spending. It is the purchase of financial assets (loans,
securities, etc.) which the bank pays for by crediting client accounts, as is the case for
the purchase of non-financial assets. Bank assets and liabilities are increased when the
bank purchases assets from its depositors.
The US follows the standard approach to monetary policy employed by central bankers
including a Fed monetary policy committee that decides the policy rate of interest for the
$US. The underlying assumption is that inflation (as they define it) is indirectly a function
of the policy rate, through several listed channels. Increasing the policy rate is
understood to reduce inflationary pressures by reducing aggregate demand.
Accordingly, rate increases are referred to as ‘tightening’ monetary policy to make it
more ‘restrictive.’
The monetary policy model also assumes a neutral rate that is not a policy choice, so
named because it is consistent with desired price stability as mandated by the
legislature:
“The neutral rate of interest, which we call interchangeably natural interest rate14,
neutral rate, or simply r*, can be defined as the level of the short-run real interest rate
that is consistent with output near its potential, and stable inflation near its target (see
Laubach and Williams, 2003). The neutral rate is determined in the domestic market of
loanable funds, so factors that affect this market prompt changes in the neutral rate. We
can classify these factors into structural (such as potential growth, demographics,
financial-markets development, etc.) and transitory (such as macroeconomic shocks…).
Since these factors are exogenous to central banks, r* is not a policy choice” (Carrilo et
al. 2018, parentheses in the original).
We raise two issues with this model, one tactical and the other strategic. Our tactical
issue is in regards to the monetary influence of interest rates of the private sector
lending channel, as it directly influences fiscal policy. Within the commercial banking
system and for the non-government sector in general, interest rates are entirely
distributional. For every interest payer, there is an interest earner. Changes in rates only
shift income between borrowers and lenders so any macro effect is a result of differing
propensities to spend. Central Banks agree, and assume that when rates rise, for
example, borrowers decrease their (deficit) spending to a greater degree than savers
increase their spending, and vice versa, concluding that increasing rates is
contractionary and lowerer rates expansionary15.
Although the propensity estimates of the central bankers may be accurate, the US, with
a $US denominated public debt held by the public of approximately 100% of GDP and a
4.5% policy rate, is a substantial net payer of $US interest to the economy. This results
in government deficit spending for interest payments to the economy approaching 4% of
GDP. The macro data for the US indicates the expansionary effect of this deficit
spending for interest payments far exceeds any contractionary effects of the differing
propensities to consume between private sector borrowers and lenders (savers). That
is, higher rates may discourage borrowers, but the total addition to the income of
lenders more than makes up for it. Thus higher rates act as a net expansionary fiscal
force rather than the net contractionary monetary force assumed by central bankers.
Global central bankers have it backwards, easing when they believe they are tightening,
and tightening when they believe they are easing.
Evidence shows that high nominal rates, often as required by IMF terms and conditions
requiring the policy rate to be set above the inflation rate, have not been successful in
bringing down inflation, and instead are associated with increasing rates of inflation.
Likewise data from Japan, the eurozone, and the US indicate that decades of 0 and
near 0 rates did not increase aggregate demand or inflation from private sector credit
expansions, and, to the contrary, seem to have promoted low inflation and low demand
(Mosler and Armstrong, 2019).
Our second point of concern is that the concept of the neutral rate in the context of
floating exchange rate policy is an anachronism, the result of echoes of analysis done in
the context of fixed exchange rate regimes. Historically, the neutral rate literature arose
in the context of fixed exchange rate, convertible currency policy, and has merit in that
context, but is not applicable to non-convertible, floating exchange rate policy. And yet it
is at the core of current central bank monetary policy with floating exchange rate
regimes.
Amato (2005, p.9) concludes, “The natural rate has figured prominently in the academic
literature for many decades, and, in particular, the focus has shifted towards it again
with the recent development of New Keynesian models. Given the current mandates of
most central banks, we have argued that the natural rate automatically assumes a
central role in monetary policy, whether explicitly or implicitly.”
Interestingly, note this statement from the above referenced passages: “The neutral rate
is determined in the domestic market of loanable funds, so factors that affect this market
prompt changes in the neutral rate.”
What is called loanable funds theory applies to reserve constrained, fixed exchange rate
convertible currency policy, and not to floating exchange rate policy, where the currency
is not reserve constrained and “endogenous money” theory applies16. This failure to
recognize the core, fundamental distinctions between fixed vs floating exchange rate
policy is a fundamental error in central bank analysis of the neutral rate of interest and
monetary policy in general.
With convertible currency, interest rates are market determined. The $HK, for example,
is convertible into $US with the HK Monetary Authority which continuously intervenes as
both buyer and seller of $US at the decreed exchange rate. This intervention is the point
of contact where information of the absolute value of the $HK is transferred to the
marketplace, which is the price paid for $US reserves held by the HK Monetary
Authority.
The 90 day $HK interest rate is expressed by the difference between the spot price
which is fixed by the HK monetary authority, and the price 90 days forward which is
market determined. Owners of $HK have the option to convert to $US, and the term
structure of interest rates – as expressed by price differentials of the forward market –
expresses indifference levels between holding $HK vis-a-vis converting to $US. The
interest rate that clears the market is the rate at which the foreign exchange reserves
backing the convertible currency are stable, hence the term neutral rate. And this
neutral rate changes as a function of perceptions of holders of $HK. A seller of $HK
versus $US 90 days forward can, for example, drive down the forward price to a price
that attracts a buyer, and thereby increase the 90 day $HK interest rate to the level
deemed attractive to the buyer.
Furthermore, with fixed exchange rate policy, where foreign exchange reserves are
obtained by the state purchasing those reserves and paying for them with additional
convertible currency17, and with the price level expressing relative value in relation to
the fixed price of the monetized foreign exchange reserves, changes in the quantity of
monetized reserves at the given fixed price is defined as changes in the general price
level, as described in the Quantity Theory of Money18. Consequently, state efforts to
support an interest rate that differs from the neutral rate results in a change in the
quantity of monetized foreign exchange reserves, which, per definition, is a change in
the price level. Therefore, with fixed exchange rate policy, inflation is a function of
interest rates, and the zero inflation rate of interest is the continuously changing neutral
rate, as determined by market forces, which is coincident with foreign exchange reserve
stability.
1 Warren Mosler originated and began publicizing what has come to be known as Modern Monetary
theory in 1993 which he developed from his capital markets experience that began in 1973.
2 Phil Armstrong has taught economics for more than forty years. He is an Associate at the Gower
Initiative for Modern Money Studies (GIMMS). parmstrong@yorkcollege.ac.uk
3 Congress sets the operating procedures for the Fed and the US banking system, including regulations
regarding overdrafts (negative balances), which are accounted for as loans from the Fed. The Fed itself
neither has, nor does not have, $US. Rather, it acts as the “scorekeeper” for the members, crediting and
debiting their accounts as per their instructions, and accounting for what it does with debits and credits in
accounts on the Fed’s balance sheet.
The Fed also keeps accounts for the Treasury and for foreign central banks, and marks balances in the
various accounts up and down- credits and debits- on instructions from those entities with accounts
(Mosler and Armstrong, 2019).
4 Commercial banks act as agents for their depositors. Fed credits to commercial bank reserve accounts
as instructed by the Treasury are most often for what is called “further credit” to the commercial bank
account of the recipient depositor’s account. And when a commercial bank depositor instructs his bank to
make a tax payment, the commercial bank instructs the Fed to debit its reserve account on behalf of the
taxpayer.
5 US government spending is through its agents, which include the Treasury, the FEd, and other agents
that conduct government spending, including those receiving transfer payments.
6 Increases in the price level are not per se a result of increases in the quantity of spending (or increases
in the money supply), rather they are about the prices paid by the government. The value of the currency
is defined by what a given amount of it buys. So, for example, if the government increases purchases at
current prices, regardless of the quantity of money spent, that additional (price constrained) spending has
not driven up prices, and the value of the currency has not been altered.
However, if the government instead pays more for the same items purchased, the value of the currency,
by definition, has become lower, as it takes more of it to buy the same quantity than was previously the
case.
Of further note is the following inverse relationship. For a given fixed nominal tax liability and savings
desire, when paying higher prices the state both redefines the value of the currency downward and
purchases less in real terms. Therefore, the state can, as a matter of arithmetic, when paying higher
prices only buy more real goods and services by increasing tax liabilities or through increased savings
desires (Tcherneva, 2002).
7 “If the fixed link between national currencies and gold is preserved, stability of exchange between such
is ensured, and a broadly based community of interest is created for keeping the purchasing power of
gold itself stable and free from violent fluctuation. Expressed in simplest terms, the necessary
requirement for the maintenance of the established ratio between a currency and gold consists in the
obligation of the Government, or the currency authority, to buy and sell gold at a fixed parity on
demand…” (Kisch and Elkin, 1928).
8 Such a view is consistent with the endogenous money approach (Wray, 2015)
9 Mosler’s explanation of the 1979 recession in the US follows from this point. The US fiscal balance
adjusted for inflation tightened as the inflation indicators increased faster than government spending,
resulting in a contraction of the real public debt that caused a severe recession (Mosler, 2023).
10 The driving force of the monetary system is the private sector’s need for the government’s spending of
$US to pay its taxes, and not the widely assumed government’s need of $US to be able to spend.
11 Furthermore, an overdraft should be understood as, functionally, a loan to the commercial bank that
functions as a credit to its reserve account.
12 Note that the ability of the Fed to make payments is not revenue constrained. The willingness of the US
government to instruct the Fed to execute timely payments is the sole variable of credit worthiness.
13 Ironically, while the term structure of forward prices is a direct function of the policy rate, we have found
no evidence of discussion at any central bank meeting in this regard.
14 See Wicksell (1898); See Amato (2005) for discussion of the historic role of the natural or neutral rate in
the conduct of monetary policy.
15 See Andolfatto (2021), who notes, “A tighter monetary policy ends up increasing the interest expense
of debt issuance. And if the fiscal authority is unwilling to curtail the rate of debt issuance, the added
interest expense must be monetized—at least if outright default is to be avoided.”
16 See, for example, Wray (2015).
17 See Kisch and Elkin (1928).
18 This study of fixed exchange rate policy, and the gold standard in particular, is called the Quantity Theory of Money. See, for example, Hawtrey (1927) and Bordo (1981).
