Federal Reserve should run an overdraft
Arnold's academic career didn't pan out, and his internet startup didn't make him a millionaire either. He writes bitter posts about no one reading his book, so I guess author/pundit isn't quite working out so far. I'm sure his high-school student appreciate him though. Either way, the car wreck that is this post represents everything that is wrong with macroeconomics. Be sure to check out the comments where the horror show continues.
Here is the basics for how the banking system works in reality, and therefore what "quantitative easing" actually means.
The Federal Reserve Bank is a bank, just like BofA or Wells Fargo. The Treasury has an account at the bank, just as you or I have a checking account at our local bank. Other banks, like BofA and Wells Fargo have accounts at the Fed as well, and they are called reserve accounts.
So, that's the first thing you need to know -- reserve accounts are not made up of money held in reserve in case a loan goes bad, they are money held at the Federal Reserve for payment settlement. The reserves of money held in case loans go bad are capital. Reserves are held as assets at the bank and liabilities at the Fed. Capital is held as an equity liability at the bank, and does not exist at the Fed at all.
Misunderstanding what reserves and capital are and how they are accounted for is a fundamental error in macroeconomics. It also explains why banks aren't making loans, nor is there any inflation, even though reserve accounts are so swollen. Reserves are for payment settlement, not loan enablement, so excess reserves have no impact on anything (except letting banks really really settle payments).
When the US Government buys something, say a TV from China, the Treasury writes a cheque to the Chinese manufacturer in US$. The Chinese manufacturer then deposits the cheque in some bank that is linked to the Federal Reserve -- because all dollar accounts ultimately must tie back to the Fed. So the Treasury's reserve account is debited, and the Chinese manufacturers reserve account is credited. The total number of outstanding dollars has not changed.
When the Chinese manufacturer then buys a Treasury bill, it writes a cheque to the Treasury and the Treasury's account is credited, while the Chinese manufacturers account is debited. Again, the total number of outstanding dollars has not changed.
It's interesting to note here that the US "borrowing" from China turns out to be nothing more than a number moving from one account at the Fed to another account at the Fed. When the private sector borrows money, the total quantity of gross outstanding financial assets increases, as balance sheets get larger (a receivable asset is credited, and deposit liability is credited as well). But, when the Govt borrows, the total quantity of gross and net financial assets does not change, all that changes is their term structure.
So, suppose the Treasury account hits zero, and it writes yet another check. Will the check bounce?
Back in the days of the gold standard, the Treasury account hitting zero would mean there was no gold left in the vault. If the Treasury promised someone more gold, it could not deliver. The check would, indeed bounce.
But we are no longer on a gold standard, and for the Treasury to clear its check, all it needs is for the Fed to process the payment, and let the Treasury account go into the negative (overdraft). The Fed would need to let the Treasury account have a "-" in the spreadsheet cell that tracks its number.
Currently, this is illegal. However, the one time it happened, there was an obscure clause that let the Treasury go into overdraft temporarily until some bill was authorized and it moved back into the black. If the Fed decides to toe the line, and Congress does not change the law, it means that the US Govt will have decided to bounce its own checks. Its next decision, one presumes, will be to dissolve itself entirely.
MMT elides this point by combining the Treasury and the Fed into a single entity. It is reasonable for it to do this, as they are both part of the Government. Nevertheless, in reality they are separate, and although this law will be waived or changed when the time comes, it still exists right now.
In QE2, the Fed buys Treasury bills at longer durations, which means it changes the composition of its balance sheet. You are correct in noticing that this will have no economic consequence of note.
Here is the basics for how the banking system works in reality, and therefore what "quantitative easing" actually means.
The Federal Reserve Bank is a bank, just like BofA or Wells Fargo. The Treasury has an account at the bank, just as you or I have a checking account at our local bank. Other banks, like BofA and Wells Fargo have accounts at the Fed as well, and they are called reserve accounts.
So, that's the first thing you need to know -- reserve accounts are not made up of money held in reserve in case a loan goes bad, they are money held at the Federal Reserve for payment settlement. The reserves of money held in case loans go bad are capital. Reserves are held as assets at the bank and liabilities at the Fed. Capital is held as an equity liability at the bank, and does not exist at the Fed at all.
Misunderstanding what reserves and capital are and how they are accounted for is a fundamental error in macroeconomics. It also explains why banks aren't making loans, nor is there any inflation, even though reserve accounts are so swollen. Reserves are for payment settlement, not loan enablement, so excess reserves have no impact on anything (except letting banks really really settle payments).
When the US Government buys something, say a TV from China, the Treasury writes a cheque to the Chinese manufacturer in US$. The Chinese manufacturer then deposits the cheque in some bank that is linked to the Federal Reserve -- because all dollar accounts ultimately must tie back to the Fed. So the Treasury's reserve account is debited, and the Chinese manufacturers reserve account is credited. The total number of outstanding dollars has not changed.
When the Chinese manufacturer then buys a Treasury bill, it writes a cheque to the Treasury and the Treasury's account is credited, while the Chinese manufacturers account is debited. Again, the total number of outstanding dollars has not changed.
It's interesting to note here that the US "borrowing" from China turns out to be nothing more than a number moving from one account at the Fed to another account at the Fed. When the private sector borrows money, the total quantity of gross outstanding financial assets increases, as balance sheets get larger (a receivable asset is credited, and deposit liability is credited as well). But, when the Govt borrows, the total quantity of gross and net financial assets does not change, all that changes is their term structure.
So, suppose the Treasury account hits zero, and it writes yet another check. Will the check bounce?
Back in the days of the gold standard, the Treasury account hitting zero would mean there was no gold left in the vault. If the Treasury promised someone more gold, it could not deliver. The check would, indeed bounce.
But we are no longer on a gold standard, and for the Treasury to clear its check, all it needs is for the Fed to process the payment, and let the Treasury account go into the negative (overdraft). The Fed would need to let the Treasury account have a "-" in the spreadsheet cell that tracks its number.
Currently, this is illegal. However, the one time it happened, there was an obscure clause that let the Treasury go into overdraft temporarily until some bill was authorized and it moved back into the black. If the Fed decides to toe the line, and Congress does not change the law, it means that the US Govt will have decided to bounce its own checks. Its next decision, one presumes, will be to dissolve itself entirely.
MMT elides this point by combining the Treasury and the Fed into a single entity. It is reasonable for it to do this, as they are both part of the Government. Nevertheless, in reality they are separate, and although this law will be waived or changed when the time comes, it still exists right now.
In QE2, the Fed buys Treasury bills at longer durations, which means it changes the composition of its balance sheet. You are correct in noticing that this will have no economic consequence of note.
posted by winterspeak at
9:48 PM
50 Comments:
This comment has been removed by the author.
FYI, I dealt with much of the Fed/Treasury stuff in my post to Naked Capitalism a few months ago. The combining of the Fed/Treasury in MMT should be seen as the general case--there has never been a suggestion that this is the actual case. The point is to demonstrate how the general case and special case have been confused. http://www.nakedcapitalism.com/2010/08/guest-post-modern-monetary-theory-%E2%80%94-a-primer-on-the-operational-realities-of-the-monetary-system.html
Scott Fullwiler
"the car wreck that is this post"
including the comments, a gathering of the high priests of misinformation on monetary operations
nice post btw (i.e. yours)
JKH, can you please elaborate?
There are three possibilities of what can happen when a treasury bond is sold:
(1) A TT&L bank credits an account and buys the bond.
(2) An existing deposit is used by the bank or non-bank private sector to buy a bond
(3) The central bank buys the treasury - although rules don't allow this now
The fed will have to offset any changes in reserve balances due to fiscal operations via open market operations or using the discount window if it is to maintain it's target rate. To think there wouldn't be a market for treasury bonds is to think that there are no excess reserves or banks prefer to hold lower interest earning reserves to treasury bonds.
Wray and Bell separate the treasury and fed in this paper "Fiscal effects on reserves and the independence of the Fed"
Dear Sir running the blog,
You are wrong, QE1 had $1.7T in asset purchases and ONLY $1T became excess reserves(check the numbers) $700B became broad money. QE2 will have a similar thing occur. This means that the Fed essentially has M2 at its control and if they inflate that by 1000% inflation is not a probability but a sure thing(of course they wont go that far)
I suggest you drop your view on how the Fed is impotent and think about the effects of helicopters drop of money which the Fed can EASLY replicate through massive asset purchases from primary dealers(who quite often are selling CLIENT assets to the Fed, this means M2 rises buddy)
Cordially,
Someone
Please forgive my ignorance...
"So, that's the first thing you need to know -- reserve accounts are not made up of money held in reserve in case a loan goes bad, they are money held at the Federal Reserve for payment settlement."
I can see this is true as the general rule. But surely if a private bank needs funds to cover the situation where "a loan goes bad," they would withdraw from their reserve account, no? Or if their "capital" runs low for whatever reason, they would replenish it from their reserve account??
Aren't you ignoring the unusual circumstance, and generalizing from the common circumstance? And isn't that a dangerous thing to do?
Art
Art,
You are completely confusing capital and reserves. Reserves settle payments and meet reserve requirements. That's it. Capital is marked down when there is a loss, but cannot settle payments.
Best,
Scott Fullwiler
Scott: Thanks for the link.
Tschäff: Yes -- Fed manages reserves to try and hit it's target ON rate. Having the Fed extend overdraft privileges to the Treasury may also require then to set their target rate to zero.
Fernando: In a helicopter drop, the money goes to households who pick it up off the Street. In QE2, or QE1, the Fed shuffles assets around in a way that does not impact lending.
In an environment where the household sector is looking to save, I do not see how this will have any potency.
If you can describe a mechanism by which shuffling around a fixed quantity of money re-capitalizes households, I will change my position.
Art: No. If a private bank writes down a loan (asset) it needs to write down a liability. Their Reserve account is also an asset. They need to write down their equity.
If a private bank runs low of capital, it needs more capital from equity investors. Reserves are only for payment settlement.
Winterspeak-- Everything you write is true, but I wonder if you understand where the confusion comes from. "Reserves" as commonly referred to in bank analysis are loan loss reserves, and if we're being picky they are not purely a liability but rather a contra-asset. I think that the confusion intensifies when the layperson, seeing "reserves", conflates "loan loss reserves" and "deposits held at the central bank".
Peter: You've certainly identified one source of confusion, there are others as well.
I didn't pick the terms. I think Canada uses more transparent terminology. But when economists talk about "fractional reserve banking" and the "money multiplier" they are talking about reserve accounts held at the Federal Reserve, not "loan loss reserves". Economists are not "lay people" -- they just don't know what they are talking about.
The terminology of choice in the Great White North is PCL or provision for credit losses in the case of the income statement charge, and ACL or allowance for credit losses in the case of the cumulative provision that appears on the balance sheet.
http://rbc.com/investorrelations/pdf/glossary_01_e.pdf
so there, you hosers - we don't confuse central bank reserves with pcls or capital
http://en.wikipedia.org/wiki/Hoser
:)
Peter,
I second what Winterspeak said. Also note, this is a discussion about QE, and it would seem rather obvious that any discussion of reserves in that context would be in regard to central bank reserves, not loan loss provisions.
Best,
Scott Fullwiler
"JKH, can you please elaborate?"
In addition to Winterspeak's very capable and concise summary, please read the following pieces by Scott Fullwiler for a more detailed description of modern monetary operations, including central bank and commercial bank involvement, as they happen in fact:
http://www.cfeps.org/pubs/wp-pdf/WP53-Fullwiler.pdf
http://www.nakedcapitalism.com/2010/08/guest-post-modern-monetary-theory-%E2%80%94-a-primer-on-the-operational-realities-of-the-monetary-system.html
(the second already referenced above by Scott)
Then go to any monetarist blog and see if you can find anything remotely resembling the descriptive material in Scott’s pieces, notwithstanding that this operational subject matter should be the very life blood of the monetarist occupation.
You won't. They're not intellectually curious enough to move outside the comfort zone of their academic theoretical models to investigate how the system actually works.
I don’t know what service they’re providing, but it certainly doesn’t include accurate information on how the monetary system actually works.
@JKH ah ok, I was frightened that you were saying STF's and my comments:
"a gathering of the high priests of misinformation on monetary operations"
I thought your comment here was a great summary of how government deficit = private savings with real world numbers. Although when you started to add household and business investment in the second comment it became quite a bit less clear.
QE1 WAS a helicopter drop, how come you didnt comment on my numbers. $1.7T of assets purchased. $1T of excess reserves, it wasnt a big helicopter but the fed could have turned these numbers into $10T purchased and $6T in excess reserves, with $4T added to the money supply. Which would send M2 to the moon.
Maybe you havent realized that when primary dealers sell assets to the fed sometimes they are doing in the name of CLIENTS, who dont have reserve accounts at the Fed. Also sometimes the dealers need to renew their stock that they sold which means they will turn over their reserves to non-banks, which raises M2
The money supply(the broader measures) is whatever the fed wants it to be. Whether banks lend or not is irrelevant. Again check out the numbers from QE1
Fernando
I agree that QE does not have much effect. That being the case, there is an easy way to dramatically reduce the national debt. 1. QE a chunk of the debt. 2. That would be mildly stimulatory. 3. So counteract that with a deflationary method of debt reduction: get the money for some for some of the debt reduction from increased taxes and/or spending cuts. 4. Assuming the stimulatory effect of the QE equals the deflationary effect of the extra tax, AD remains the same. The only net effects are that the debt declines and the monetary base rises. Anyone see any snags?
Fernando: None of the Fed's actions had any impact on the net financial assets (equity) held by the non-Govt sector. Whether done by primary dealers for themselves or their clients, it's just shuffling extant assets around, not creation of new NFA(E) and therefore impotent.
The definitions of money supply used by economists are based on the money multiplier, which is a fallacy, and ignorant of basic double entry book keeping. They are just different cataloging of asset classes as if moving a number from a reserve account to a Treasury account has any economic impact beyond the double-edged sword that is interest rates.
None of this has any impact on the overleveraged, undercapitalized household. A true helicopter drop has a simple and obvious impact on that household. The difference is clear to everyone except monetarists.
you know my bogey -- if you can show me a mechanism I'll change my mind.
MUSGRAVE: Why do you want to reduce the national debt? It's just paid-in capital, and right now it's too small.
About 90% of the population (politicians in particular) think the debt is too large, rather than, to use your words, “too small”. This makes the debt the big obstacle to more stimulus. So reduce it, or even keep it constant, and more stimulus might become politically easier.
Second, in that the stabilisers and deliberate stimulus have been funded by extra national debt, the actual stimulatory effect is uncertain because of the disagreements over crowding out. In contrast if govt spending is funded by plain old money printing, the effect is more certain. And since debt funded govt spending plus quantitatively easing govt bonds equals plain old money printing, I favour quantitatively easing govt bonds, and the national debt reduction that results from it.
Third, a large part of the problem is deleveraging, i.e. a perceived shortage of cash (particularly by households). If it’s zero interest bonds they want, i.e. cash, it is illogical issuing interest paying bonds (i.e. national debt).
The above “national debt reduction” policy is actually just a move towards a regime favoured by Warren Mosler and Milton Friedman which involves no national debt at all, and where all stimulus (or deflationary policy) is effected by having govt print and spend money (or raise taxes and rein in money).
Dude,
are you saying that if the Fed were to purchase all outstanding USTs that are traded plus all GSE MBSs plus all muni bonds in existence(all assets mostly non-bank owned) which would send M2 soaring that would have no impact on inflation and nominal GDP?
The 10 year correlation between M2 and those stats would disagree with you
Fernando,
If the Fed were to purchase everything in that way, it could affect interest rates and thus encourage greater borrowing/economic activity, and so could be inflationary eventually. Further, it could encourage borrowing by easing other terms of credit creation in that market.
But, the act of purchasing MBS and creating a deposit doesn't help a bank create money. Banks can already create as much as they want even without the Fed doing this.
And the act of purchasing MBS and creating a deposit in the process doesn't force anyone to spend. The deposits created could go into bank cd's for instance, destroying the deposits. It could be used to pay down bank debt, again destroying the deposits. It could be used to purchase Tsy's from the Tsy, again, destroying the deposits. And even if the deposits aren't destroyed, this doesn't mean they will be spent--i.e., velocity. Those holding MBS were savers/investors, after all, not spenders. Why would they all of a sudden become spenders, particularly in this economy?
Best,
Scott Fullwiler
Musgrave: LOL! I doubt that Warren and Friedman would agree on much. And I don't believe that Warren would support a regime that has no national debt.
But maybe this is semantics. When the Government spends, and then taxes, it injects money into the private sector, and then withdraws it. If it spends more than it taxes, it leaves the residual in the private sector, where it is called the "deficit". The sum of all period deficits is called the "national debt". This "national debt" is also the savings of that sector.
The only question is what form this "national debt" takes. It could all live in checking accounts, where it would show up as reserves, and the Treasury would run an overdraft at the Fed. Or it could exist in some mix of checking accounts and Treasury accounts. Quantitative Easing just means that the mix of checking accounts and Treasury accounts changing. If this sounds profoundly underwhelming to you, you're right.
Fernando/Scott: Lower interest rates have a deflationary impact as well (google "pensioners"). Net net, it's hard to say what they might do in a given context. M2 can get very high -- it's a gross and not a net number after all -- and could easily have no impact on prices (as you say, Scott).
Finally, I would add that if the Fed starts overpaying for credit risk (GSE MBS, munis) then we're firmly in the realm of fiscal policy. BOC does this a lot, btw., and I am more ambivalent about state directed bank lending and industrial policy that people may think.
Either way, if that's where Fernando is going he is reaching the last refuge of monetarists and scoundrels, which is to reclassify fiscal policy and monetary policy. It makes sense though as monetarism is irredeemable to anyone who understands the difference between an asset and a liability.
Don't mean to interrupt, but thank you Wintergreen, thank you STF, for the clarifications.
Fernando, enable access to your profile so i can get to your blog.
Art
And while we're piling on, let's look at how financially illiterate M2 is as a measure. IIRC, M2 counts hard cash, demand deposits, savings, and some time deposits.
So, whether $100 in a checking account comes from someone going $100 in debt, or from the Government create a private sector net financial asset, makes no difference! The problem is not that these guys don't know what a balance sheet is (although that is a problem), it's that they can't even figure out why it's important.
Macroeconomics is truly ignorant about debt because they do not see how it is created through balance sheet expansion -- their mental model is someone taking a $10 bill out of their wallet and saying "pay me back on Tuesday".
Winter,
Mosler’s advocacy of a zero national debt regime is here (see 2nd last para):
http://www.huffingtonpost.com/warren-mosler/proposals-for-the-banking_b_432105.html
Friedman’s advocacy of much the same thing is here:
http://nb.vse.cz/~BARTONP/mae911/friedman.pdf
Winterspeak @9:16,
I completely agree with all points you made there.
Musgrave: Thanks for the links. Warren and Friedman are not on the same page at all.
Warren's suggestion is not for there to be zero national debt, it is for the national debt to be booked as a negative Treasury balance at the Fed. The US would deficit spend as it does not, and those period deficits would sum to a "national debt". This is what I advocate here, and merely make explicit the rule change that would allow it.
Friedman is your typically confused monetarist nonsense in which he advocates 100% reserve banking as if this means banks can't lend through balance sheet expansion. Once again, you get the "money multiplier" myth as an economist who doesn't understand a balance sheet starts talking about finance.
Friedman isn't ground zero for this nonsense, it goes way back, and actually makes sense in a gold standard world.
What Friedman wants is no debt. And in this zero debt world, you get a Government that is a currency user just like the rest of us, and ideally is more responsible about how it spends as a consequence. Maybe this is a worthy goal, but it's not what Warren is saying.
"And the act of purchasing MBS and creating a deposit in the process doesn't force anyone to spend. The deposits created could go into bank cd's for instance, destroying the deposits. It could be used to pay down bank debt, again destroying the deposits. It could be used to purchase Tsy's from the Tsy, again, destroying the deposits. And even if the deposits aren't destroyed, this doesn't mean they will be spent--i.e., velocity. Those holding MBS were savers/investors, after all, not spenders. Why would they all of a sudden become spenders, particularly in this economy?"
Dude thats when expectations come in, the fed just HINTED at QE and the dollar plunged, commodities soared. Thats is because people expect inflation tomorrow therefore they buy it today. If the Fed launches a campaign of 'we will destroy the dollar', velocity WILL rise, so will the money supply. This will create inflation, that is unless you dont understand basic economics
Also besides the decline in the dollar and commodity mini-boom, the QE hint lead to an increase in inflation expectations(a run on tips). Those are all signs of a DECLINE in MONEY DEMAND(read velocity is rising). Which means that the M2 that QE2 will generate(40% of the program using QE1 history as an guide) will be circulated in all likelyhood because people are getting more afraid of future inflation
Whether they should or not is irrelevant, this is a self-fulling prophecy
Rising money supply + rising velocity = inflation, it doesnt matter if balance sheets are damaged. If you think the Fed will destroy your M2, people will spend it, whether its prudent or not
Fernando: Ah yes, the tinkerbell mechanism. "It works because people believe it will work". I actually think that this is the only real mechanism for monetary transmission, and it is purely a psychological one based on superstition. So this is what monetarism comes down to -- voodoo.
I'm not even sure the psychology is right though. You're a cash strapped business owner whose sales are down. You suspect that the value of your too-small nest egg is going to be eroded by Bernanke. You may save more, or you may move your savings to Gold or other currencies. You are not going to hire an extra worker, or buy a new car. Nor are you going to stock up on canned goods to see you through your retirement years.
It is like real return on assets -- if those go down are you going to save more or less? Once again, I think the standard models have it backwards.
In practice it is actually very difficult to bring real consumption forward. I can only think of 2-3 categories where it may be possible.
I can see a lot of trading and positioning over QE2, and yes this may count as velocity, but I don't see AD rising.
"I can see a lot of trading and positioning over QE2, and yes this may count as velocity, but I don't see AD rising."
If velocity is rising and the Fed boosts M2, Nominal GDP will rise. I'm not sure how you cant count that as AD rising
"Ah yes, the tinkerbell mechanism. 'It works because people believe it will work'.
Winter, did you get "Tinkerbell" from Krugman or did he get it from you??
"You're a cash strapped business owner whose sales are down. You suspect that the value of your too-small nest egg is going to be eroded by Bernanke. You may save more, or you may move your savings to Gold..."
And you may raise your prices!!
Nobody needs an excuse to look for increased income, and everyone will use an opportunity.
Art
Fernando: If my wife and I write a bunch of checks to each other, depending on how it's booked it would count as velocity and raise NGDP. Yet it would not impact prices or count as AD.
A flurry of traders swap Treasury liabilities -- they impact on AD will be......?
Arthur: I'm sure Krugman didn't get it from me. I don't think I got it from him either.
I'm not sure a cash strapped businessman with weak sales is going to raise his prices and thus depress sales even more.
It really is very difficult to move consumption forward. If you think your currency is going to be inflated away, you'll move to another financial store of value, or maybe one or two other goods that function in similar ways. Every third world country operates this way -- examine how they hedge against inflation and you will see that it is not the flurry of consumption you see in (bogus) economic models.
Winter,
I'm not talking about traders swapping USTs. Inflation expectations ROSE due the QE hint, this means money demand will/is declining(since the cost of holding cash is higher) so velocity is higher, NGDP is higher, by definition inflation will be higher(although some of it could temporarily boost real growth most will be inflation)
M2 will also rise(Primary dealers have an arbitrage profit to make by selling USTs from non-willing non-bank sellers to the aggressive buyer that the Fed is, M2 rises in the process). My whole point is that the Fed CAN avoid the japanese disease by doing what they have been doing, boosting both M and V
The helicopter drop can be implemented and the Fed is WAY more aggressive than the BOJ ever was, the BOJ is run by incompetents anyway
Fernando:
Please, I am not your professor, and I am not going to award you an "A" because you parrot the nonsense written in Mankiw's textbook.
M2 as a measure doesn't even distinguish between assets and liabilities. Don't you think this is important? Don't you think this might just have some bearing on what's been going on in Japan since 1985, or why Fed policies to date have been ineffectual? At this stage in the game, aren't you at all curious about how money is actually supplied before using the term "money supply"?
I actually understand textbook macro perfectly well. I have simply realized that it is garbage. I have told you what will change my mind.
You can have the last word. But it isn't a good use of anyone's time for you to type in paragraphs from college textbooks. So unless I see progress, I'll end this thread after your next post. You may also want to visit moslereconomics.com and go through the required readings for a more robust treatment of actual real life bank and monetary operations. There are other MMT resources out there too if you want to learn something new.
"M2 as a measure doesn't even distinguish between assets and liabilities. Don't you think this is important? "
No, its not a matter of opinion, is a matter of what the data says
http://www.econbrowser.com/archives/2006/05/m2_and_inflatio.html
Historically pumps in the M2 numbers have been followed by increases in inflation and NGDP. And i have never read any Mankiw. The onus is on your to show how a increases in both M and V wont lead to increases in NGDP and inflation
Increasing velocity in asset markets is not equivalent to increasing spending.
Spending is a broad category that is generally intended to mean expenditures that generate final consumption - not exchanges of assets.
QE generates transactions in asset markets that prop up (or slow the decline) of pricing and bend the interest rate curve. These price "increases" are not inflation - they are an attempt to avoid collapse of poorly performing assets (not a policy I agree with, but I believe I understand the intent).
Instead of a single big asset bubble - we have a pot of mini-bubbles - from equities to corporate debt to foreign exchange to commodities - a time-buying exercise which - left on its own - cannot be successful.
Aggregate demand needs income to increase - in a deflationary condition incomes need to increase dramatically, because a higher proportion of income will go to debt reduction, extinguishing supply and velocity. Income will not increase via QE - investment generated will be monopoly-intended acquisition activity.
The historical correlation of M2 with GDP and inflation is interesting - but it is hard to determine cause and effect. Any even so, there has been no recent "hockey stick" increase in M2 - it is basically on trend with a slight bump in 2008/2009.
http://research.stlouisfed.org/fred2/series/M2?cid=29
And certainly from 1995 to 2009, there is an uptrend in M2 without a corresponding increase of inflation.
So, we are in different times and those historical correlations no longer apply.
"Increasing velocity in asset markets is not equivalent to increasing spending."
I didnt even mention asset markets. I'm referring to INFLATION EXPECTATIONS. When people expect more inflation they tend to spend more today, velocity rises
And with regards to M2 and GDP. Again, I'm referring to nominal GDP, of course there is a correlation given that the definition of NGDP is M2*Velocity. Not to use you guys favorite catch phrase but 'its an accounting identity'
Good discussion (other than Fernando's unfortunate knuckleheadedness). Thanks...
Fernando
IF your fairy tale was even remotely true we would already see more spending because all I hear everywhere is that there is going to be inflation. "Its not here yet but just you wait". That is the mantra of everyone outside the MMT camp. How many times does it need to be repeated before its believed 2,345,731 times? Or is it 2,345,732?
Wait, wait ,wait I know ....... Bernanke just has to say it with the right amount of conviction!!
One of these days there will be some inflation and sure enough those knuckleheads will be standing there pointing at everyone "SEE I TOLD YOU SO!!"
The Fed should be allowed to run an overdraft? Well... luckily for the world you're a blogger and not in charge of the monetary plumbing.
"However, the one time it happened, there was an obscure clause that let the Treasury go into overdraft temporarily until some bill was authorized and it moved back into the black."
C'mon winterspeak, if your going to call for an overdraft facility, at least get your facts right. The Fed has granted the Treasury an overdraft some 45 times since it was granted that power during WWII.
JP Koning: Really? Learn something new every day. Can you provide a link?
I think I saved the relevant document in my why-mmt-is wrong file. Might be hard to find, its a pretty thick file... how badly do you want it? Gonna take me some time & energy.
How many times the Fed has extended overdraft facilities to the treasury has nothing to do with MMT. It's officially not allowed, but I know of only one temporary exception, made under unusual circumstances
If you have another two or three examples I'd be interested. Shouldnt be hard if there are as many instances as you say
C'mon, Winter, that was funny!!
Beautiful work, Koning, at your site.
"How many times the Fed has extended overdraft facilities to the treasury has nothing to do with MMT."
I think it does. MMT theorizes as if the central bank and executive were one. In reality, laws sever this linkage. Since MMT doesn't conform to reality, the inevitable fall back for MMTers is to attack the laws. But this is a political battle, as such any sort of precedent that can be used to justify overturning the laws is valuable to MMTers. Therefore, how many times the Fed has extended overdraft is probably important.
I'm going to do this properly and do a full length treatment of the Fed overdraft facility on my blog. Um, unfortunately I don't have a blog yet. But plans are in place... you will be the first to be notified when it is up. Fair?
LOL -- JP, I am fully aware that MMT combines the Fed and the Treasury into one, and this is not how it works in real life. That's why this post is entitled the "Federal Reserve /should/ run an overdraft".
And if the law ever is changed it won't be on precedent, there are much better reasons to do it.
I just know of a single occasion when the Fed had the opportunity to bounce a Treasury cheque and they didn't take it. The situation was also unusual, and doesn't set a precedent of any sort.
I'm beginning to suspect you don't have 44 other incidences of this.
Winterspeak: I'll bring the rabbit out of the hat. Will get back to you.
Arthurian: Thanks.
Ahoy Winterspeak.
I'm about to order some books from Amazon.
What are the seminal works in "Modern Monetary Theory?" Might pick up a few.
Thanks.
A few years later, as promised:
http://jpkoning.blogspot.ca/2012/12/the-final-draft-on-fed-treasury.html
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