The 30 years non-war over the debt burden. Plus Samuelsonian NGDP bonds.

I thought we all had this debt burden stuff sorted out 30 years ago. Obviously we didn't.

We should have had a bigger argument about it 30 years ago, which would have sorted it all out. But we didn't. Maybe because we spent all our time arguing about other stuff 30 years ago, and didn't have time to argue about this stuff as well. Or maybe because most of us were too embarrassed to mention we had totally changed our minds on this, and that the views we used to say were uneducated views were in fact right after all. So we silently changed our beliefs, and tried to forget we had ever believed anything different. But not all of us noticed this change in beliefs, and still thought everybody else believed what we all used to. So now we are re-fighting the old ground we should have fought properly 30 years ago.

There are 4 possible positions to take on the debt. One of them doesn't make sense; the other 3 do. Which of those 3 is right is an empirical question.

Here are the 4 positions. I gave each one a name. I made up the quotes.

1. Abba Lerner. 'The national debt is not a first-order burden on future generations. We owe it to ourselves. The sum of the IOU's must equal the sum of the UOMe's. You can't make real goods and services travel back in time, out of the mouths of our grandkids and into our mouths. The possible second-order exceptions are: if we owe it to foreigners; the disincentive effects of distortionary future taxes; the lower marginal product of future labour if the future capital stock is smaller.'

2. James Buchanan/uneducated person on the street. 'The national debt is a burden on future generations of taxpayers. Foreigners are basically irrelevant. Any second order effects of distortionary taxes and lower capital stock are over and above that first order effects of the taxes themselves.'

3. Robert Barro/Ricardian Equivalence. 'The national debt is not a burden on future taxpayers (except for the deadweight costs of distortionary taxation) but only because ordinary people take steps to fully offset the burden on future generations by increasing private saving to offset government dissaving and increasing bequests to their heirs to offset the debt burden.'

4. Samuelson 1958. 'If the rate of interest on government bonds is forever less than the growth rate of the economy, the government can run a sustainable Ponzi finance of deficits, where it rolls over the debt plus interest forever and never needs to increase taxes, so there is no burden on future generations.'

I personally was taught 1 as an undergraduate. And I believed in 1 until about 1980, when I spent some time reading Buchanan and Barro arguing with each other. And I worked 4 into my own beliefs soon after.

And now, I believe 1 is false. The truth is some sort of mixture of 2,3, and 4. What precise mixture of 2,3,4 is true is an empirical question. My prior is one third-one third-one third.

Until last week, I thought that almost every macroeconomist had now realised that 1 was false. And I wrote a post arguing 1 is false. My post was triggered by Paul Krugman's recent post, which I interpret as saying that 1 is true. Paul wrote two later posts too, which I interpret as also saying that 1 is true.

Many other bloggers have now waded into this debate. Good! Finally (I was scared we were going to keep on ignoring this question)! Bill Woolsey. Greg Mankiw. Don Boudreaux. Karl Smith. Daniel Kuehn. Jim Hamilton. Noah Smith. (I must have missed some. Sorry.)

And look, just because deficits have costs doesn't mean we shouldn't do them. Like a lot of things, deficits have benefits too, and sometimes the benefits are bigger than the costs. But we shouldn't ignore those costs, just because we think the benefits are bigger than the costs.

And what we need to do more work on is this: we know Samuelson is right, if we know for sure that the interest rate on bonds is less than the growth rate of GDP forever. That is a sufficient condition for Samuelson being right, but I rather doubt it's a necessary condition. What if the interest rate will probably be less than the growth rate part of the time for a rather long time? Could Samuelson still be right, or at least partly right?

I really wish I could get my head around that question, but I can't. My hunch is that NGDP bonds would play a role in the solution, because a bond indexed to nominal GDP would resolve the uncertainty of whether the interest rate would be above or below the growth rate of GDP. And if we got the duration of those NGDP bonds right, we ought to be able to get around the problem of r being sometimes greater and sometimes less than g. Somehow, it just must be possible to eat the Samuelsonian free lunch, even if it's only a temporary and uncertain free lunch. And NGDP bonds just must be the way to eat it, somehow.

And if I could only get my head around that question, I might come up with something that would make both Scott Sumner and the MMT guys very happy indeed. Which would be neat. Plus, as a side-benefit to making both those guys happy, it might be very good for the poor ignorant uneducated slob on the street too.

But my brain just can't figure it out, yet. Maybe some of you younger, keener, brighter, people could work on this?

Comments

[wh10]

Are there other kinds of PhD degrees that would allow me to learn what's important to what we all care about without the superfluous stuff AND still be a credible voice?

[Nick Rowe]

wh10: "Nick, your thoughts?"

I'm biased. I'm biased because I'm crap at math, so want to think it's not all it's cracked up to be. I'm biased because I'm an economics prof employed by a department with a strong grad school that wants to attract good grad students. And I'm pissed off that the only non-mathy grad schools, AFAIK, are more extreme heterodoxy. So don't trust me.

[vimothy]

I love it really. I think of it as being like bootcamp for nerds. While the rest of the social science losers are strolling in for a couple of classes a week on how to use SPSS or administer a survey, we're up at dawn learning to programme MATLAB or working though textbooks on real analysis.

(Just kidding, social science types).

I’ve certainly no regrets (so far!). If you're interested in economics and don't mind doing a lot of sums and having the odd feverish dream about envelope theorems, I can definitely recommend it. You'll eat it up.

Vimothy, consumers don't have to lend their apples or savings as in the loanable funds model. Again, credit is made out of thin air and defended at a certain price by the Fed. This I think is our disconnect.

I’m not sure I follow you, but think of this—why is credit required? It's clear that the govt wants to consume or invest some output. So ultimately, someone is going to have to, effectively, lend it some "apples". If it doesn’t want apples, it certainly doesn’t need any credit made out of thin air. And why would anyone lend the govt apples? It must be that they expect apples in return in the future (it’s apples all the way out in this economy). When they want them, and how many they want back are like the terms of the loan. It’s hard to see how the govt could control this, because it seems like it should be down to the individual consumer.

[wh10]

Vimothy, I'll post this again (you might not have seen it yet):

"First, there are these things called primary dealers, who can borrow at the repo rate and fix their costs for any maturity in forwards and buy any Tsy issue that goes above the borrowing costs. And the repo rate--created out of thin air with just a previously issued security as collateral--always arbitrages with the overnight target rate.

Second, there are these things called hedge funds--like 100s of Warren Moslers--who can (and in the case of Mosler, have and will continue to) borrow at LIBOR and fix this rate at any maturity in swaps or forwards. And LIBOR arbitrages at the overnight target rate, while eurodollars are created out of thin air like any bank loan."

Pretend you're an investor, and the govt is announcing a tsy auction. If you can make a risk-free return higher than your borrowing costs, then you will buy that tsy! It's free money that requires nothing of your own. It would make no sense for anyone not to do that. It's like someone refusing to take $20 dollars for nothing. The Fed determines that borrowing cost, and the market will (essentially) arbitrage away the profit that can be made from doing this.

I don't see how there is any escaping this.

[vimothy]

wh10,

Thanks, I hadn't seen that.

I still don't follow you, though. Could you explain how it is relevant? At the end of the day, the govt will have more apples, and everyone else will have less. How is it that the govt can determine the terms at which people are prepared to lend it apples in the long run?

[wh10]

Vimothy, can you give me a more real-world example of what you think people are lending to the govt and what they have less of?

We agree the Fed sets interest rates. Investors then use credit to secure free profit when the govt auctions bonds, the price of which is determined by the rates the Fed sets. This raises the govt's bank account. The govt then transfers those deposits to Grandma's bank account.

Where, in the real world, is this lending of apples occurring, where the govt has to convince anyone to give something up?

[vimothy]

I'm using "apples" to designate output more generally. The govt transfers, consumes and invests output. It funds some of this through taxes and some through borrowing. For example, say that the govt wants to transfer consumption from one group to another. It could do this by taxing some consumers and transfering the proceeds to some others. This intervention would reduce group A's consumption and raise group B's consumption, just like if the govt had physically taken possession of the output and handed it over itself.

[wh10]

(I think) the difference with your/Nick's model is that you're imagining fixed loanable funds and someone actually having to give up something up. In my model, that doesn't have to happen because I introduce a free flow of credit from the govt which goes through the banking system. So instead of a person giving the govt their money, they go to the govt (Fed/banking system) to borrow money and then give it right back to the govt for a free profit (the tsy, which returns more than their borrowing costs).

[wh10]

Can you provide an example with deficits, so that you have to think about bonds and what determines their interest rate?

[wh10]

I mean we could use your example, but pretend it was a deficit. For the govt to raise their bank account to do this, there is no pulling teeth. Anyone from Group A or Group B will recognize the arbitrage opportunity on govt bonds and fund them according to the price of credit. If Group A doesn't like the govt's policies, then they'll vote for someone else in the next election. In the meantime, they might as well take advantage of the arbitrage before someone else does.

I've never heard of the mkt abstaining from govt bond auctions and deliberately avoiding costless profit because they aren't in agreement with how the govt is going to spend the money. No, the investors are profit maximizers. They look at the risks and payoffs they can make from investing in the tsys, and they see the arbitrage.

[vimothy]

Think of why the govt might want to create that money or credit in the first place: becauase it wants to use it to consume, invest or redistribute some output.

[wh10]

Vimothy, that doesn't change the process by which primary dealers and investors actually think about bonds as I have laid it out! If I am laying out that process incorrectly, I am happy to listen.

What would any profit maximizer do if the following deal was offered, guaranteed: "take this $20, give it back, and then receive $25?"

[vimothy]

Okay, so assume arguendo that you are correct. Nevertheless, it must still be the case that the value of govt expenditure plus transfers is higher than its take from taxes. In other words, it must still be borrowing apples from the private sector.

[vimothy]

So that whatever else is going on, the govt is borrowing apples. You appear to be saying that the govt can determine the price at which it borrows apples by offering to first lend money to the private sector, and then borrow it back at a higher rate. Is that right?

[Winslow R.]

"4. Samuelson 1958. 'If the rate of interest on government bonds is forever less than the growth rate of the economy, the government can run a sustainable Ponzi finance of deficits, where it rolls over the debt plus interest forever and never needs to increase taxes, so there is no burden on future generations.'"

I'd just add this ignores the not insignificant continuous growth in saving desires.

If the economy grows by 2% and the interest on government bonds is 2%, and the savings rate is 5% (foreigner and domestic) where is the 'extra' money for savings going to come from?

[wh10]

If you assume I am correct, then we agree the govt determines the interest rate on govt bonds. But then I don't understand what 'borrowing apples' means in this context. What govt spending, which is a net add of financial assets to the private sector, will do is affect private sector output, prices, or distribution of wealth. That impact though doesn't change why the govt determines the interest rate on govt bonds. Govt policy could be really poor, but that's not a good enough reason for investors not to take advantage of the arbitrage, unless you reach a point where the arbitrage is worthless because of hyperinflation. BTW all of this of course assumes zero govt default risk.

[wh10]

"So that whatever else is going on, the govt is borrowing apples. You appear to be saying that the govt can determine the price at which it borrows apples by offering to first lend money to the private sector, and then borrow it back at a higher rate. Is that right?"

The govt doesn't borrow in apples that the private sector creates. It borrows in money it first creates and then gives it right back and so on and so forth, which is why it is silly to think of govt borrowing like you or me borrowing. This is a sustainable as long as investors continue to believe the govt won't default.

[vimothy]

To be honest, I'm not really sure what process you're describing. Are you saying that when the govt sells a bond, it's borrowing from itself? And paying someone else for the priviledge of doing so?

[wh10]

The other problem here might be that you are thinking in terms of a barter economy, and I am thinking in terms of money as a creature of the state.

[wh10]

"To be honest, I'm not really sure what process you're describing. Are you saying that when the govt sells a bond, it's borrowing from itself? And paying someone else for the priviledge of doing so?"

Vimothy, yes. Like many others have observed before, including the MMTers, who I am sure you have read say how, in colloquial terms, a govt can't default on money it owes itself.

[vimothy]

Either way, I don't undersdtand how that enables the govt to determine the real rate at which investors are prepared to lend to it.

[wh10]

Probably because you're still thinking about loanable funds and a barter economy, which doesn't capture the dynamics of fiat and credit and a risk-free govt. It's about the existence of arbitrage which in a world of profit maximizers will necessarily be arbitraged away and then ensure the success of bond auctions in accordance with Fed rates. Again, I offer the example of exchanging a $20 for a $25.

We can leave at it there for now. I'll come back when I get my PhD, and we can re-evaluate :).

[wh10]

I wish JKH was stepping in here. He'd be a good mediator.

[vimothy]

Vimothy, yes. Like many others have observed before, including the MMTers, who I am sure you have read say how, in colloquial terms, a govt can't default on money it owes itself.

But you seem to be saying something different. It's not the MMT case, as I understand it, that the govt borrows from itself; rather it's that the govt doesn't need to borrow but does so anyway to keep control of the CB policy rate. And it doesn't follow from the fact that the govt can meet any nominal obligation that the govt borrows from itself.

I think you may be confusing monetary and fiscal arms of the govt here. If I want to buy a gilt, I tell my bank manager or stockbroker. The govt acquires a bank deposit; I acquire a bond. I'm not aware of a govt financing scheme for prospective investors. In the background, the CB is keeping the level of reserves wherever it needs to be—but this is distinct from govt borrowing.

[vimothy]

Or there's equivocation. Because the govt issues money, when it borrows money, it must be borrowing from itself. But this is incorrect.

Probably because you're still thinking about loanable funds and a barter economy, which doesn't capture the dynamics of fiat and credit and a risk-free govt.

Actually, I think it's more subtle than that. There's no strict dichotomy between the two approaches you describe here. In fact, they both have to hold. To properly understand what's going on, you need to reconcile your analysis of the monetary system with a model of the real economy.

We can leave at it there for now. I'll come back when I get my PhD, and we can re-evaluate :).

Hahaha--no worries.

[wh10]

"I think you may be confusing monetary and fiscal arms of the govt here. If I want to buy a gilt, I tell my bank manager or stockbroker. The govt acquires a bank deposit; I acquire a bond. I'm not aware of a govt financing scheme for prospective investors. In the background, the CB is keeping the level of reserves wherever it needs to be—but this is distinct from govt borrowing."

Vimothy, you're not thinking like a fancy hedge fund manager or a primary dealer utilizing debt market and forward markets to fund purchases of tsy debt.

'The six transactions for Treasury debt operations for the purpose of deficit spending in the base case conditions are the following:

"1)The Fed undertakes repurchase agreement operations with primary dealers (in which the Fed purchases Treasury securities from primary dealers with a promise to buy it back on a specific date) to ensure sufficient reserve balances are circulating for settlement of the Treasury’s auction (which will debit reserve balances in bank accounts as the Treasury’s account is credited) ******while also achieving the Fed’s target rate.******* (emphasis added) It is well-known that settlement of Treasury auctions are “high payment flow days” that necessitate a larger quantity of balances circulating than other days (Fullwiler 2003, 2009)...."

"Overall, adding the rule that the Treasury must finance its own operations in the open market to the need to achieve timeliness in the Fed’s operations results in the six transactions described above for the Treasury’s debt operations. The added complexity in the Treasury’s operations that results is unnecessary since it does not change the facts that (1) reserve balances must be provided via previous deficits or Fed loans to the private sector in order for Treasury auctions to settle, and (2) deficits accompanied by Treasury security issuance does not result in fewer deposits circulating than without such security issuance. Further, the rule itself and the added complexity can be counter-productive if they influence policy makers’ decisions regarding options available in times of macroeconomic difficulty......

I pulled that from here http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1825303

"But you seem to be saying something different. It's not the MMT case, as I understand it, that the govt borrows from itself; rather it's that the govt doesn't need to borrow but does so anyway to keep control of the CB policy rate. And it doesn't follow from the fact that the govt can meet any nominal obligation that the govt borrows from itself."

Vimothy, if the govt isn't paying interest on reserves and providing sufficient excess reserves at the target rate, then it has to sell bonds to maintain the rate. The US however is paying IOR now, and it wouldn't need bonds to maintain the rate. However it continues to sell them because it is a self-imposed constraint written in law.

The MMT position is much more nuanced, particularly if you read Fullwiler's work.

[wh10]

Gah, I added a comment responding to 12:31 but I think the spam ate it.

[wh10]

"I think you may be confusing monetary and fiscal arms of the govt here. If I want to buy a gilt, I tell my bank manager or stockbroker. The govt acquires a bank deposit; I acquire a bond. I'm not aware of a govt financing scheme for prospective investors. In the background, the CB is keeping the level of reserves wherever it needs to be—but this is distinct from govt borrowing."

You're not thinking like a hedge fund manager or primary dealers utilizing debt markets to fund purchases.

"The Fed undertakes repurchase agreement operations with primary dealers (in which the Fed purchases Treasury securities from primary dealers with a promise to buy it back on a specific date) to ensure sufficient reserve balances are circulating for settlement of the Treasury’s auction (which will debit reserve balances in bank accounts as the Treasury’s account is credited) while also achieving the Fed’s target rate. It is well-known that settlement of Treasury auctions are “high payment flow days” that necessitate a larger quantity of balances circulating than other days."

"Overall, adding the rule that the Treasury must finance its own operations in the open market to the need to achieve timeliness in the Fed’s operations results in the six transactions described above for the Treasury’s debt operations. The added complexity in the Treasury’s operations that results is unnecessary since it does not change the facts that (1) reserve balances must be provided via previous deficits or Fed loans to the private sector in order for Treasury auctions to settle, and (2) deficits accompanied by Treasury security issuance does not result in fewer deposits circulating than without such security issuance. Further, the rule itself and the added complexity can be counter-productive if they influence policy makers’ decisions regarding options available in times of macroeconomic difficulty."

That's from Fullwiler's "Treasury Debt Operations—An Analysis Integrating Social Fabric Matrix and Social Accounting Matrix Methodologies." You can get it on SSRN.

"But you seem to be saying something different. It's not the MMT case, as I understand it, that the govt borrows from itself; rather it's that the govt doesn't need to borrow but does so anyway to keep control of the CB policy rate. And it doesn't follow from the fact that the govt can meet any nominal obligation that the govt borrows from itself."

The MMT case is much more nuanced if you read Fullwiler's work IMO. If the govt is paying IOR at the target with sufficient excess reserves, then bond sales aren't needed to maintain control of the CB rate. However, in the US, we're doing that, but we still have bond sales since it is written into law (the self-imposed constraint).

[wh10]

Testing?

[wh10]

"I think you may be confusing monetary and fiscal arms of the govt here. If I want to buy a gilt, I tell my bank manager or stockbroker. The govt acquires a bank deposit; I acquire a bond. I'm not aware of a govt financing scheme for prospective investors. In the background, the CB is keeping the level of reserves wherever it needs to be—but this is distinct from govt borrowing."

You're not thinking like a hedge fund manager or primary dealers utilizing debt markets to fund purchases.

"The Fed undertakes repurchase agreement operations with primary dealers (in which the Fed purchases Treasury securities from primary dealers with a promise to buy it back on a specific date) to ensure sufficient reserve balances are circulating for settlement of the Treasury’s auction (which will debit reserve balances in bank accounts as the Treasury’s account is credited) while also achieving the Fed’s target rate. It is well-known that settlement of Treasury auctions are “high payment flow days” that necessitate a larger quantity of balances circulating than other days."

"Overall, adding the rule that the Treasury must finance its own operations in the open market to the need to achieve timeliness in the Fed’s operations results in the six transactions described above for the Treasury’s debt operations. The added complexity in the Treasury’s operations that results is unnecessary since it does not change the facts that (1) reserve balances must be provided via previous deficits or Fed loans to the private sector in order for Treasury auctions to settle, and (2) deficits accompanied by Treasury security issuance does not result in fewer deposits circulating than without such security issuance. Further, the rule itself and the added complexity can be counter-productive if they influence policy makers’ decisions regarding options available in times of macroeconomic difficulty."

[wh10]

That's from Fullwiler's "Treasury Debt Operations—An Analysis Integrating Social Fabric Matrix and Social Accounting Matrix Methodologies." You can get it on SSRN.

"But you seem to be saying something different. It's not the MMT case, as I understand it, that the govt borrows from itself; rather it's that the govt doesn't need to borrow but does so anyway to keep control of the CB policy rate. And it doesn't follow from the fact that the govt can meet any nominal obligation that the govt borrows from itself."

The MMT case is much more nuanced if you read Fullwiler's work IMO. If the govt is paying IOR at the target with sufficient excess reserves, then bond sales aren't needed to maintain control of the CB rate. However, in the US, we're doing that, but we still have bond sales since it is written into law (the self-imposed constraint).

[wh10]

Heh, got em to go in pieces.

[vimothy]

Right--if there is a “high payment flow day”, then the CB might need to take extra steps to ensure that there are sufficient reserve balances in there so that the RTGS system works as smoothly as it does on normal payment flow days.

That doesn't mean that when the govt issues bonds the CB is indirectly lending to the treasury, though, as far as I can see. Just consider the magnitudes involved. Since the crisis, the Fed's balance sheet has more than doubled, but even then the total base inc. cash held by the public is something like $2.5 trillion (all off the top of my head--I could be off here, but I think I'm in the right ball park). The gross national debt is about $14 trillion and public debt is something like $9 trillion. So it's clear from those figures that you can't explain govt borrowing with reference to the CB alone.

[wh10]

If a tsy is purchased, that necessarily means reserves are drained from the private sector to the govt. So if repos or loans are being used to fund the purchase, the CB is involved to the extent that it needs to provide enough reserves to maintain interest rates where it wants. All along, the cost of that debt to fund the purchases of tsys stays in line with where the Fed wants it. "(1) reserve balances must be provided via previous deficits or Fed loans to the private sector in order for Treasury auctions to settle."

I'm not following the implications of your math, might need to spell it out more for me, but I am sure there are lots of variables involved here. The operations and accounting though seem clear.

[wh10]

So it's not necessarily that the Fed is injecting the same amount of reserves as the amount of tsys that need to be purchased on auction day, but it is injecting whatever is needed to maintain interest rates where it wants. And it's the interest rate a primary dealer or hedge fund gets that matters to its investing decision. It's about the interest rate not quantity.

[vimothy]

The implcations of the math are just that it can't be the case that when the govt borrows, it necessarily borrows from the Fed because govt borrowing is much bigger than Fed lending. That is, even if all Fed assets are treasuries, $14 trillion and $9 trillion are both very clearly strictly greater than $2.5 trillion (or whatever the precise numbers are). I'm not sure if treasuries held by the Fed count as gross or public debt, but either way.

[wh10]

Okay yeah I hear you. See what I wrote above- the Fed isn't necessarily supplying the same quantity of reserves as debt, just whatever is needed to maintain interest rates. Fullwiler once replied to me: "The Fed’s repos here to PD’s are simply to make sure sufficient reserve balances circulate, and so these repos may not be the same size as the auction. The repo that funds the dealer is usually with another dealer or a bank. Then the dealer has sufficient deposits to buy the Tsy’s, and the dealer’s bank settles the transaction with the reserve balances."

Ultimately, it's the interest rate that funds PD repos or hedge fund borrowing that matters. If the transfer of reserves from private sector to govt is sufficient enough to alter interest rates, then the Fed will necessarily have to supply whatever amount is needed to keep rates where the Fed wants. I would like to understand the details behind the quant better along the lines of what you're asking, and it's a very interesting question IMO, but in any case, we seem to agree the Fed can do what is necessary to maintain interest rates- and that's what ultimately matters here.

[vimothy]

Previously, you seemed saying that when the govt borrows, the central bank lends the funds to the private sector, which the private sector then lends back to the govt at a nice spread. Perhaps I misunderstood you, but I think I've shown why that can't possibly be the case for the whole national debt.

But you may still be conflating a number of different things here. Whenever there's a lot of settlement activity (such as on treasury auction dates), the CB is going to need to ensure that there are sufficient reserve balances in the system to ensure real time gross settlement proceeds as usual. After this activity dies down, the CB can reverse its repo operations to withdraw the excess balances.

Institutional details like these are not so important, I would say, for what we are discussing. Instead, let me make the following distinction:

There is the question of the CB policy rate. I certainly agree that the CB can control this.

Then there is the real interest rate (or rates) at which investors lend to the govt, which is the point of debate. I don't see how this can be controlled by the CB. It seems to me that this should be down to intertemporal prefs, supply of investments, etc, etc. And I don't think control of the real interest rate on govt debt follows from the fact that the CB targets interest rates.

[wh10]

I don't think you showed anything. Sorry if I misspoke, but I clarified myself above, pretty clearly; there is no reason the money base needs to match outstanding govt debt. The whole point of ensuring sufficient reserves balances is to maintain the interest rate. Banks will minimize reserve balances to the point that is sufficient to settle transactions and meet RR. Reserve balances+cash will obviously be a small fraction of the nominal financial assets govt spending creates, which initially is a deposit (part of the reason why your outstanding debt to reserves+cash measure shows nothing surprising and is actually really high given all the excess reserve balances).

I don't understand why it comes down to that for you. If you can get a loan at the Fed's policy rate (which you agree the Fed controls) and earn more riskfree on a govt loan, then the rate on that govt loan will necessarily be bid down to the Fed's policy rate.

[wh10]

Wish I could use T accounts here. Go to page 18 here. The most basic example showing the Fed's balance sheet can be WAY smaller than outstanding debt. This accounting example involves a bank primary dealer as opposed to a primary dealer needing to raise deposits, but the point still stands. http://www.boeckler.de/pdf/v_2011_10_27_lavoie.pdf

[vimothy]

It can't be the case that govt debt wholly represents the Fed indirectly lending to the treasury, because treasury borrowing is much bigger than Fed lending. That's what the numbers I gave show. The reason I brought them up is that it seemed to me that you were claiming that the Fed lends the funds to the private sector and then the private sector lends them to the govt, so that the govt is effectively lending to itself. I tried to clarify this in a comment, which you reponded to at "Posted by: wh10 | January 06, 2012 at 12:14 PM".

Anyway, if you didn't mean this, then my apologies for the misunderstanding. It's easy to get lost in all the details.

[Winslow R.]

"If you can get a loan at the Fed's policy rate (which you agree the Fed controls) and earn more riskfree on a govt loan, then the rate on that govt loan will necessarily be bid down to the Fed's policy rate."

Mosler says something like the long-term tsy rate is based on expectations of current and future fed funds rates and the natural rate is zero.

[vimothy]

Mosler says something like the long-term tsy rate is based on expectations of current and future fed funds rates

That's based on a theory of the term structure known as the expectations hypothesis. According to this theory, bonds of different maturities are perfect substitutues and long term rates average expected short term rates, plus some risk premium. If you have access to a uni library, there is a very basic/accessible intro to some competing theories of the term structure and the standard "stylized facts" they try to explain in Mishkin's textbook.

[wh10]

It would help me if you could respond to this: "I don't understand why it comes down to that for you. If you can get a loan at the Fed's policy rate (which you agree the Fed controls) and earn more riskfree on a govt loan, then the rate on that govt loan will necessarily be bid down to the Fed's policy rate."

Vim, I added some clarifying thoughts since the 12:14 post. I referenced a paper, and I just posted a paper with some accounting showing why your numbers aren't illuminating to this point. Banks will necessarily minimize base money to only what is required, which shrinks the Fed's balance sheet to a size OBVIOUSLY much smaller than the tsy issuance.

I think we agree the only way tsy auctions can settle is with reserves. And there is only one place reserves come from, and it's not apples: "it does not change the facts that (1) reserve balances must be provided via previous deficits or Fed loans to the private sector in order for Treasury auctions to settle, and (2) deficits accompanied by Treasury security issuance does not result in fewer deposits circulating than without such security issuance. " There is no getting around that.

[wh10]

well you also need to be able to fix your rollover costs in forward markets

[wh10]

"Mosler says something like the long-term tsy rate is based on expectations of current and future fed funds rates."

Vim, that's interesting. In response, this is also from Fullwiler:

"if long-term rates are much higher than market expectations of short-term rates...Borrow short-term, invest long-term at higher rate, and then take futures short position on expected rates to cover your need to roll over short-term debt in spot markets. If you’re right and short-term rates remain low, you refinance your short-term debt at low rates. If you’re wrong and short-term rates rise, you refinance your short-term debt at higher rates, but the $ earned on short futures position offsets these higher borrowing costs, so you make a profit here, too. This arbitrage opportunity is why long-term rates WON’T deviate much from expected short-term rates (and it’s even easier with swaps!)."

[vimothy]

So what you are saying is not that the Fed lends funds to the private sector, which are then lent to the govt, but that the Fed determines the terms at which the private sector lends to the govt, via its policy rate?

I can see that nominal short term rates are heavily influenced by monetary policy, but I'm not sure that the long term real rate on govt debt is so easy to control. Can you explain how you get to control of LT real rate from control of the policy rate & ST nominal?

[wh10]

I gotta give up here. Too much time on this and need to learn more neoclassical econ. As far as LT rates, the Fed could just not issue LT in the first place, but if it wants to manipulate those rates, it could announce itself as a buyer of unlim. amt of LT tsys at its named price and the mkt should move to that price.

[vimothy]

wh10,

All good. I really oughta be revising myself. If you get time, look up "real vs nominal" and "real interest rates" on google or wikipedia. Might shed some light on where I'm coming from.

[wh10]

Funny thing is I learned that stuff in undergrad and had no problem with it, since I was just trying to get the A at the time. But yes, I owe it to myself to give it another shot.

[himaginary]

A sidenote: condition #4 (Samuelson 1958) is called "Domar condition" in Japan, based on Domar, Evsey D., (1944) "The Burden of the Debt and the National Income," American Economic Review, 34(4), pp.798-827. However, one Japanese economist pointed out that Domar actually didn't state such a condition in the paper. Nevertheless, the name has already acquired popularity in Japan. Another example of particular keyword gaining momentum of its own.

P.S. So-called "Bohn condition" is also popular in Japan, which states that the debt is sustainable even if "Domar condition" is not met, as long as the following rule is observed: improve primary balance even slightly whenever debt increased. In fact, I was referring to that rule here.

[Richard Lucas]

Please discuss whether what the government does with the money it is either printing, or borrowing and taxing. If it is not relevant at all then we can increase civil servant pensions, hire extra hookers for politician parties - it makes no difference. If the quality of government spending matters at all then we have to consider principle agent problems among civil servants and politicians. the golden rule of economics is surely to look for differences in behaviour when spending your own money or someone elses. The reason to limit ruthlessly the capability of governments to tax, print and/or borrow is that the best route from my wallet to that of others is when they sell me something I want, and if I don't spend today I (or my heirs) can spend even more tomorrow with no stress or need to make a return. The poor sod who borrows from me has to pay it back to me, and if he/she is the government then he has to take it away from someone else.
From a macro economic perspective: by ignoring the many inefficiencies, conflicts of interest and worse of government spending, we can conclude that printing and borrowing money may be OK or even desirable at different times and places. In countries run by people, its best to pre agree some limits and rules of thumb so that if they decide to increase their own pensions, at least they have to cut back on the hookers (just like the rest of us).
Technical progress, competition, capital mobility and the profit motive should lead to growth provided the place is reasonably governed. letting the central banks print like crazy except as a short term measure, to followed by currency bonfires to soak it up when things pick up, is risking too much.

[Michael Carroll]

Nick (also wh10),

After all isn't fiat money just debt with a zero interest rate? It seems like as long as the government has previously replaced barter with money they can drive the nominal interest rate to zero whenever they choose.

But... by introducing money did we go from a one good model to a two good model, stealthily?

Look at this net worth statement for each cohort (pardon my rounding):

A 1000 apples + 110 apple debt asset (incl. 10% interest)
B 1000 apples + 119 apple asset (incl. 8% interest) + 2.0 apple dollars
C 1000 apples + 126 apple asset (incl. 6% interest) + 4.5 apple dollars (note apple dollars, unlike apples can be inherited!!!)
D 1000 apples + 131 apple asset (incl. 4% interest) + 7.0 apple dollars
E 1000 apples + 133.5 apple asset (incl. 2% interest) + 8 apple dollars
F 1000 apples + 133.5 apple asset (incl. 0% interest) + 8 apple dollars

Which by is effectively the same as...

F 1000 apples + 141.5 apple dollars !

The original interest, which was a promise by the government to rob THE next generation by 10 percent more apples has been harmlessly (?) converted to a promise to rob SOME future generation by exactly 141.5 apples - and that can be put off perpetually.

[OliverD]

My hunch is, 1 and 4 are perfectly compatible, or rather 4 is a subset of 1, if one assumes the nominal interest rate (the one paid on the national debt) is a policy variable, which I think is the MMT position. But 1 is more flexible in tweaking the flow of real output, whereas 4 is 'playing it safe' at the expense of potential output at times when the interest paid on outstanding debt exceeds growth. That, and the different implied multipliers in the quotes should make at least those two add up. Not sure about the others.

Using your apples as money, here's how I would frame the exercise (assuming for a moment that interest rates are fully market determined, but constant - a silly assumption?):

Assume apples are money and oranges are goods an services.

There are 100 apples circulating in period 1.

Government sees new potential for creating oranges where none are being produced under current circumstances. It does the following:

It asks the people currently holding the apples under which conditions they would voluntarily give up the option of spending 20% of them on oranges for a while by having them locked up for 1 period. Several buyers agree to do so at 1 extra slices per year (10% interest).

So now, at the beginning of period 2 there are again 100 apples circulating (80 old and 20 new), plus 20 old ones locked up, yielding 2 extra whole apples at the end of the period, making the total 122 (= total deficit of 22 = 22%)

Period 3 sees the same thing happening. While the first locked up apples mature at the beginning of the period, that leaves 122 free apples (97.6 old, 24.4 new) + 24.4 locked up ones + 2.44 in slices = 148.84 (= total deficit of 26.84 = 22%)

Questions:

Is my account an accurate description of reality in your opinion?

At what rate does the amount of oranges grow? Can one tell by my example (or any of the above quotes, for that matter)?

Does it matter if there is a discrepancy in the respective growth rates of apples and oranges?

Which growth rate is more important?

My guess, as above, is it's all about the interest rate and multipliers and in the end, it's about oranges, not apples.

[mr miyagi]

wh10, where did you get the idea that HFs or BDs are infinite consumers of any asset with an interest rate greater than their borrowing costs? If you knew even one leveraged investor, you'd know why that isn't true.

[wh10]

Miyagi, in the real world it's not infinite, I'm not talking about all types of investors, default-free govt debt is different than all other assets, and the additional condition is that you need to be able to fix your debt roll over costs in forward markets.

[Art Patten]

Re Posted by: Winslow R. | January 06, 2012 at 03:58 PM

"Mosler says something like the long-term tsy rate is based on expectations of current and future fed funds rates and the natural rate is zero."

Important to note, especially since vimothy has mentioned it, that Wicksell and Forstater do not use the Wicksellian or successor definitions of natural rate:

http://moslereconomics.com/wp-content/graphs/2009/07/natural-rate-is-zero.PDF

"This paper argues that the natural, nominal, risk free rate of interest is zero under relevant contemporary institutional arrangements." (emph added)

Their point is that the nominal interbank target rate has to eventually fall to zero when a CB uses interest rate targeting in a soft (fiat) currency system (esp where balanced budgets or fiscal surpluses are seen as desirable objectives) because under such conditions, the sovereign govt sector is not supplying net financial assets (NFAs); and in the case of budget surpluses, it is subtracting from NFAs.

This would be analogous to a gold standard-era policy of shutting down mine production and even re-burying gold (b/c monetary gold constituted NFAs then). Things were bad enough when they couldn’t produce enough gold to support fixed nominal parity, i.e., even while adding NFAs, when insufficient, depression still resulted: http://en.wikipedia.org/wiki/Long_Depression.

And these are both similar to the assumption that govt debt, which constitutes a portion of NFAs in a soft currency system, will some day have to be repaid. And that’s the highly questionable assumption that Nick’s argument relies upon.

Granted, if under a gold std, gold were produced well in excess of demand, then it could make sense to rebury some as long as nominal parity was fixed (thank you very little Sir Isaac), ignoring the function of non-monetary gold. Likewise, if NFAs in a soft currency system are well in excess of a non-inflationary (or desired inflationary) level, then the removal of some of them via taxation and/or CB operations (or perhaps lessening their potency via other regulatory channels?) is necessary. But in both cases, it’s not so much about imposing a burden as pursuing an optimal policy course. Right?

[Art Patten]

The concept of NFAs seems to be the unmentioned elephant in this thread (though wh10 has mentioned them more than once, and Michael Carroll pointed out that both money and bonds are govt debt).

Going back to Wicksell and the concepts vimothy has invoked...

In his pure credit economy treatise, he hypothesized that if the banking sector set the marginal loan rate below the marginal return on productive investment, then a process of ongoing inflation would result, and vice-versa for deflation (some bizarre assumptions required, but he seemed aware of that). From there, it's implied (though I think he delved into this in other writings) that if the real lending rate is a function of additions to NFAs (monetary gold, in his time), then when those additions were excessive (low in relation to available returns on investment), overinvestment and inflation would occur, and when they were in short supply relative to marginal rtns on capital, deflation (as measured in and reflected by interest rates). People have argued over this stuff since he published it, so feel free to point out where I'm wrong.

From that, it seems rather apparent that:

* When transferred into the realm of real world operations, Wicksell's model absolutely required the support of the gold sector's ongoing additions to NFAs, whether one subscribes to a cumulative process or not (most economists do not).

* In a soft currency system, the issuing govt (typically a CB via monetary and/or fiscal operations) assumes that role from gold mines.

* Many tools in the macro toolbox have not been updated to reflect the reality of this post-1973 transition in the U.S. and many other places.

Key among the latter is the intertemporal govt budget constraint model, which assumes that (1) deficits cannot be run indefinitely, when in fact, under a soft currency system, they almost always must be, and (2) M and B are very different, when in fact, they are the same thing, liabilities of the sovereign issuing sector, and together net of all financial liabilities, the stock of NFAs. (h/t to Fullwiler: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1722986)

As just one result of applying this hammer of a model to the screw that is modern monetary systems, we get well-intended but absolutely dead-wrong warnings from folks like Paul O'Neil and Gokhale/Smetters, Larry Kotlikoff, Peterson/Walker, Concord, Tea Partiers, etc, re the USG going broke, intergenerational burdens, and the like. But once you get your head around NFAs in a soft currency system, it becomes apparent how nonsensical these arguments and analyses are.

Though to be fair, as long as politicians believe this nonsense, the Tea Partiers have a point, even though they're dead wrong themselves on budget deficits...