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.

Advice to video producers and lecturers.

The basic advice is this. Arguments in economics, as in other subjects can be presented in video form or lectures to an audience in a lecture theater or via the written word. But when going for video or lectures, make a transcript available at the same time or refer to an article which makes the same points as the video or lecture. Reason is that if you want to get your message across to brainy people then make a “written word” version available because that’s what brainy people prefer.

The written word is a much more efficient way of getting ideas across for the following reasons.

1. Most people can read faster than a speaker can speak, and some people can read TEN TIMES faster.

2.  With the written word, you can go back over a paragraph you didn’t understand very quickly. The same process with a video, i.e. winding back, is more difficult and time consuming.

3. If you suspect the presenter is talking BS or saying something which is not of interest to you, you can skim thru with the written word just to make sure. That’s much more difficult with video. For that reason, many intelligent people simply ignore most videos.

4. As for lectures, if you find the lecture is not of interest, it’s a bit difficult to walk out ten minutes after it has begun, plus the time spent travelling to the lecture has been wasted.

In short, and to be thoroughly cruel, the intelligentsia reads stuff, while simple folk like videos or lectures. So if you’re a video producer or lecturer and want intelligent people to get your message, produce a transcript at the same time, or refer to an article which has the same message as your video or lecture.

So whence the popularity of video and lectures? Well most adults are much like babies: they like a human face. Plus they like things that move, particularly coloured things that move: e.g. a rattle in the case of babies or a video presenter’s face and hands.

They also like emotion: if you do a video presentation and talk total BS or just talk about the weather, your audience will be captivated long as you put on a variety of facial expressions, wave your arms around, look sincere, get excited, etc etc.

Random charts - 52.

Pink text on the charts below was added by me.

The fact that stricter bank regulations raise interest rates does not mean GDP is reduced as a result.

It’s obviously tempting to think that if stricter bank regulations raise interest rates, that’s an additional cost for mortgagors and businesses which need to borrow. Thus it would seem we’re all worse off. The UK’s  “Vickers Commission” fell hook,  line and sinker for that argument. So too does Congressman Keith Rothfus: see the second para of this recent “Money and Banking” article (entitled “Money Funds – The Empire Strikes Back”).

Of course I’m aware that Rothfus’s motives for wanting to get back to the old “heads the banks win and tails the taxpayer loses” arrangement is possibly not entirely altruistic: he may have had wads of $100 stuffed into his back pocket by banks. But corruption is not the central issue I’m addressing here.

I’ve been thru the flaws in the above “higher interest rates makes us worse off” argument at least once before in this blog, but I’ll run thru them again.

The first obvious flaw in that argument is that every additional pound or dollar of interest paid is an additional pound or dollar for creditors, thus to that extent interest rate changes have no effect on GDP.

However it is widely accepted that a rise in interest rates does have a deflationary effect: indeed interest rate adjustments are one of the main weapons used to regulate aggregate demand. Thus a rise in rates stemming from stricter bank regulations would indeed cut demand and thus GDP. But that effect is very easily countered by standard stimulatory measures, monetary and/or fiscal and the latter measures cost nothing in real terms. As Milton Friedman and others have pointed out ad nausiam (figuratively), having the state print money and spend it and/or cut taxes costs nothing.

To summarise so far, the fact that stricter bank regulation cuts GDP via the above “higher interest rates cuts GDP” channel is completely irrelevant.

The really important question is whether the higher rates that stem from stricter regulations give us something nearer the genuine free market rate of interest. If they do, then GDP will rise: reason being that, as is widely accepted in economics, GDP is maximised when prices are at free market prices, unless there are good social reasons for thinking free market prices should not prevail: i.e. where there is “market failure” to use the jargon.

Now it might seem that conventional or “fractional reserve” banking under which loans are largely funded via deposits and under which those deposits are insured by government (with banks being charged an insurance premium by government) is very much a free market system: at least it seems to be free market in that all costs, in particular the cost of insuring banks seem to charged to banks.

But there’s just one problem: the only reason government can afford to insure dozens of banks with assets and liabilities running to hundreds of billions is that government has access to two near infinitely large sources of cash: first the taxpayer and second the right to print money. Normal, or “free market / commercial” insurers do not enjoy the latter two luxuries.

Indeed, in the US, large banks are not insured via FDIC: what happened during the crisis was that the Fed rescued large banks with loans totaling billions at derisory rates of interest: an obvious subsidy or “non free market” ploy.

In contrast, a system under which bank loans are funded via equity or “floating net asset value” stakes in banks is entirely subsidy free: if a bank makes silly loans, all that happens is the value of its shares or “net asset value stakes” falls. There is no danger of the bank collapsing and no need for taxpayer funded rescues.

And a further point is that funding private banks via deposits actually enables private banks to create or “print” money. That is, private banks can use the profits of seigniorage to subsidise the lending process, as I explained here recently.*

And finally, if the widespread belief that there is  too much debt is valid, then a rise in interest rates would cut the total amount of lending and debt, which according to the latter “too much debt” theory would be beneficial.


* Article title:  "Why private banks are counterfeiters in 300 words."

Large pink text on the charts below was added by me.

You’ll get a job at a central bank – if you’re seriously stupid.

This article in the Wall Street Journal is a laugh. It’s by Neel Kashkari (president and CEO of the Federal Reserve Bank of Minneapolis and participant in the Federal Open Market Committee.) Article title: “Immigration Is Practically a Free Lunch for America.”

He argues, first, that immigration raises GDP (as distinct from GDP per head). Well that’s pretty obvious: the more people there are in a country, the larger will its GDP be all else equal. In fact even if all else is not equal (e.g. if immigrants are all unproductive, lay-abouts) GDP will STILL RISE. As long as a bunch of immigrants produce at least SOMETHING, however little, then the effect of their arrival will be to raise GDP.

Kashkari then says “Legislators of both parties, policy makers and families all want faster economic growth because it produces more resources to fund national priorities and raise living standards.” He doesn’t tell us what “national priorities” are, but I assume he’s referring to infrastructure, schools, hospitals, etc.

Now assuming you have more brain than Kashkari, you ought to have spotted the flaw there: it’s that the larger the population, the more infrastructure, schools etc are needed!! Thus immigrants have no effect whatever on a country’s ability to afford those items unless the effect of immigration is to raise GDP per head. But Kashkari doesn’t address the question as to whether immigrants increase GDP per head!



Kashkari also trotts out the old canard about stimulus not being possible without increasing the national debt (3rd para). In fact as Keynes pointed out almost 100 years ago, stimulus can be funded either by more debt or by new money created by the central bank. Indeed that’s exactly what numerous countries have done over the last five years or so. That is, their governments have borrowed and spent more, with their central banks then printing money and buying back almost all that new debt. The net effect of that is: “the state prints money and spends it and/or cuts taxes”. Seems Kashkari is not aware of what has been going on. Evidently studying economics is not a requirement when seeking a nice well paid job at the Fed.

Why do I have to waste my time combating this nonsense?

Why private banks are counterfeiters in 300 words.

Take a country which switches from barter to using money for the first time. It has the choice between state issued money, which I’ll call base money, and money issued by commercial / private banks. Base money is cheaper – indeed it’s costless as Milton Friedman and others pointed out. In contrast, when a private bank supplies money to a customer, the bank has to check up on the customer’s creditworthiness, perhaps take security off the customer, allow for bad debts, etc etc. Those are very real costs.

Having supplied the economy with enough base money to ensure full employment, people and employers would lend to each other, either direct (person to person) or via commercial banks. However, there is then a trick which private banks can pull: supply money to customers WITHOUT first having obtained necessary funds from saver / depositors. I.e. private banks could (as in the real world) in effect just print money. And printing money is clearly a cheaper way of obtaining money than borrowing or earning it. Thus private banks in our hypothetical economy are able to undercut the free market rate of interest. And that would reduce GDP because the GDP maximizing price for anything, including the price of borrowed money, is the free market rate (absent what economists call “market failure”).

But that extra lending would raise demand to above the above mentioned full employment level: excess inflation would ensue. Thus government would have to impose some sort of deflationary measure, like raising taxes and confiscating base money from citizens.

Now that’s exactly what happens when traditional backstreet counterfeiters print and spend $Xmillion of forged dollar bills: government has to confiscate about $Xmillion from citizens. QED.