Saturday, 3 February 2018

The Fed’s “Tax and Loan Note Accounts”.

This is an interesting paper by Stephanie Kelton (or Stephanie Bell as she was when she published the paper).  She is a leading MMTer by the way.  Title of paper: “Do Taxes and Bonds Finance Government Spending?” (Journal of Economic Issues).

The basic point made in the paper is that there would be a problem if the Treasury just kept receipts from tax collected in a special “government” account and paid for government spending out of that account. There wouldn’t be a problem  if the amount of tax collected each day (and indeed receipts from government borrowing) exactly matched the amount of government spending each day. But the reality is that tax receipts and government spending thru the year is erratic. And that gives rise to a problem as follows.

The Fed controls interest rates by adjusting the total amount of reserves  in the hands of the commercial bank sector. So if for example the total amount of tax paid on a particular day exceeds public spending on that day, the commercial bank sector’s stock of reserves will fall, which in turn will raise interest rates.

So what the Fed and Treasury do is to temporarily deposit that excess back in accounts the Treasury has opened at sundry commercial banks. That way, commercial banks’ total stock of reserves remains constant.

Very neat trick. But that doesn’t mean there’s much wrong with regarding receipts from tax and government borrowing as all going into a piggy bank at the Fed, with government spending coming out of that piggy bank. The only slight inaccuracy with that “piggy bank” view is that, as just stated, the  money in the piggy bank is actually spread over several accounts rather than all being  in one account.

Bit like me taking some money out of my checking account (“current account” in UK parlance) at bank X and paying the money into newly opened checking accounts at banks Y and Z. The only net result is that I have three checking accounts instead of one. That has no effect at all on my income, what I can spend, what size mortgage I can get or anything else.

As the title of her paper implies, SK thinks this all of significance for the MMT claim that taxes and government borrowing do not fund government spending. Personally I don’t see the relevance. The latter “do not fund” point is simply this.

The conventional view of government income and spending is that it is similar to a household’s income and spending in that income and spending must be equal or nearly in the long run. That is certainly not the case with government spending.

To illustrate with an extreme example, given a very severe cut in spending by the private sector, the result would be a big fall in demand. Government would have to counter that with a large deficit (i.e. its expenditure would need to exceed its income from tax etc).

Thus it can be said that what government actually does is to simply print and spend whatever amount it wants, and then it collects enough tax to ensure that “print and spend” ploy does not cause excess inflation. That’s the sense in which tax does not fund government spending.

The latter is clearly just A WAY of looking at government income and expenditure. It does not make much sense to argue about whether it’s a REALISTIC view. It is simply a view which is not totally irrational.

However, and to repeat, I don’t see important connections between that very arcane or abstract argument and the “reserve smoothing” points several paragraphs above.

SK’s paper was published in 2000. Obviously since the crises banks are awash with reserves, so practice at the Fed may have changed substantially since the crisis. I haven’t caught up with what those changes are. Sorry…:-)

BTW, I was alerted to the above paper by Joseph Firestone.


  1. Funny but I was just wondering recently about a tax refund I was due. If HMRC just destroys money as MMT claims how can they pay me back overpaid tax?
    Your post answers that,there must be an HMRC commercial bank account with slush funds for such eventualities I guess. Last I checked Santander was the bank I pay my employer PAYE taxes to online.

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