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Friday, July 31, 2020

Primer: MMT And Abolishing Government Bond Issuance

Proposals to abolish the (central) government bond market is one of the striking features of Modern Monetary Theory. In the current context, it is debatable how much difference that such a change would make. I avoid attempting to be a forecaster, but it is safe to say that it would not be a true “surprise” if developed economy policy rates remained below 1% for a good portion of the 2020s. (This observation is consistent with bond market pricing at the time of writing.). This is a basic extrapolation of behaviour of past cycles. This time could be different, but it is no surprise if it is not. Meanwhile, some neoclassical economists are agitating for negative policy rates, which makes the MMT proposal look much more sensible by contrast.

(Note: This is an unedited draft from my upcoming MMT primer. Most of the controversy around this subject is dealt with elsewhere in the text. I have kept this short, as it is covered already in "Understanding Government Finance".)

This ho-hum assessment does not align with popular discussion of MMT, with fears of “money printing” leading to hyperinflationary outcomes. For example, this is one of the suggested consequences within a resolution introduced by U.S. Senator David Purdue, partly based on the deep analysis of Lawrence Summers (URL: https://www.perdue.senate.gov/imo/media/doc/MMT%20Resolution.pdf).

As always, the euro area is an exception to the discussion here. The operations of the European central bank are enshrined in treaties, and the resulting dysfunction is a well-known problem.

Abolish (Central Government) Bonds!

My earlier book Understanding Government Finance covers the theoretical basis for the operations behind government bond issuance, and why it is possible to eliminate the issuance (Section 6.7). Most topics of interest were covered there, so I will keep the discussion here brief.

The starting point for MMT macroeconomics is to use the accounting procedure of consolidation – combining the balance sheets of the central bank and the fiscal arm of the government (the Treasury in the United States). Since the Treasury effectively owns the central bank in developed countries, this is entirely legitimate from an accounting perspective. Such ownership was typically not the case before World War II, and there are some privately-owned equity shares floating around for some central banks. (For conspiracy theory buffs, this does not include the U.S. Federal Reserve. Private banks are forced to buy preferred shares of the Federal reserve district banks. Preferred share ownership does not imply any form of control, rather it is a form of a capital requirement.) Nevertheless, some very tiresome people object to consolidation (see Section 5.8), but they are of course incorrect.

From this perspective, a government deficit implies that the government is emitting (central bank) settlement balances (“reserves” in American parlance) as the counterpart of the income flow imbalance. These settlement balances would pile up in the banking system (as is happening in the post-Quantitative Easing era). This has normally unwelcome side effects, so government bonds are issued to absorb the balances. This represents a transformation of governmental liabilities, from settlement balances to bonds/bills (the non-government balance sheet similarly shifts). By issuing bonds, the government creates a benchmark risk-free curve that is used in pricing private sector interest rates. This also allows the central bank the ability to attempt to steer the economy with interest rate policy (as noted in Section 2.5, MMT proponents are largely unconvinced by the effectiveness of interest rate policy).

This background leads to the proposal: stop issuing bonds, and let the risk-free curve disappear (other than settlement balances, which pay 0%).

Implementation Details

For good reasons, civil servants and elected politicians must follow procedural rules with regards to spending money. We would be stepping backwards to personal rule if this were not the case. As such, there is a web of laws and regulations that constrain governmental financial transactions. Under those regulations, the central bank and fiscal arm of government are distinct, and financial flows must follow certain forms.

This is normally the key argument of critics: we cannot consolidate the fiscal arm of government and the central bank because of the operations of those rules. This shows a complete lack of imagination: regulations were made by legislative bodies, and they can be changed in the same fashion.

The simplest work around is for the fiscal arm of government to be given an open-ended overdraft at the central bank. At one stroke, the problem disappears. Meanwhile, this is not novel: such overdraft facilities were common before superstitious beliefs about government finance led to their abolishment.

Consequences

I see two main consequences of such reforms.
  1. Since the fiscal arm of government has no debt instruments outstanding, default is no longer even a hypothetical possibility. Since there was no practical way of such a government to be forced into involuntary default, the practical effect of this is not large. However, it eliminates the possibility of using government debt worries as a political tactic.
  2. Interest rate policy no longer exists, and so cannot be used to control inflation. This is a source of obvious distress to conventional economists, while most MMT proponents view this to be a small loss. One way to avoid this outcome is for the central bank to issue its own bonds, and/or pay interest on settlement balances. This still leaves the fiscal agency immune to default, while interest rate policy might continue. However, it still leaves central bankers the ability to hijack fiscal policy discussions by making arbitrary threats about raising interest rates.
Given that I am not expecting rapid rises in interest rates in the absence of much looser fiscal policy, these changes might be viewed as cosmetic over a medium-term horizon. That assessment would not be shared be conventional economists. Much of the arguments about the effects of such a policy rely on beliefs about inflation and the behaviour of politicians, which is discussed in Chapter 5.

One Trillion Dollars!

(Note: this sub-section was published earlier within another article.)

One eye-catching financial reform for the U.S. Federal Government that was originally floated online by Carlos Mucha during one the periodic debt ceiling crises is the notion of minting a trillion-dollar coin. During the pandemic crisis of 2020, Congresswoman Rashida Tlaib introduced a motion to mint two trillion-dollar coins.

The trillion-dollar coin comes out of the legal details of monetary institutional arrangements in the United States. The U.S. Treasury (the fiscal arm of the government) issues coins. For other metals, coin denominations are fixed by law. However, the Treasury has the right to issue platinum coin in any denomination. (These are already issued for collectors.)

The Treasury pockets the profits on the difference between the face value of the coin and the cost to produce it. (It also eats the loss on pennies. Canada abolished pennies since nobody wants to deal with them, and they are produced at a loss.) This is the literal version of seigneurage (also spelled seigniorage) profits. (Economists also refer to the carry profits by the central bank as seigneurage, but that is a different concept. The profits made from minting coins is the traditional version of seigneurage.)

All the Treasury needs to do is take a small amount of platinum coin (with maybe $200 worth of the metal), and then mints into a coin with a $1 trillion face value. It then ships it to the Federal Reserve (like it does other coins) – under very close guard – and the Treasury just cleared a profit of close to $1 trillion. (The Fed would likely put it into Fort Knox, giving rise to future action movie plots.)
This eliminates two institutional barriers to Treasury spending – the need to replenish the Treasury’s balance at the Fed, and the debt limit (since coins do not count).

This procedure is economically equivalent to the Fed giving a $1 trillion overdraft in exchange for a token amount of platinum with somebody’s mug stamped on it. I am not a legal expert, but I have every reason to believe that it would pass all legal tests. The important thing to note that this possibility demonstrates how arbitrary the rules governing intra-governmental accounting are. (As Rohan Grey observed in response to an online draft of this text, the coin has some advantages over an overdraft. However, these refer to political/legal issues in the United States, while the economic outcome is normally the same.)

If we look at other countries, the rules are different, and so the means to bypass them correspondingly change.

Concluding Remarks

For online discussions, “money printing” is synonymous with MMT. The reality is that very few people who invoke “money printing” have any idea of the legal or operational framework behind government borrowing, so such discussions are often a waste of time. The issue of losing interest rate policy exists, but that would be a more complex debate. Once again, I refer the reader to Chapter 5 for coverage of these debates.

References and Further Reading





(c) Brian Romanchuk 2020

2 comments:

  1. "This has normally unwelcome side effects, so government bonds are issued to absorb the balances."

    My personal recommendation is that savings certificates or central bank CDs should be issued. Issuing bonds just encourages misunderstanding of what is actually going on and is complicit in the smoke and mirrors when discussions of the government's debt ensue.

    ReplyDelete
  2. The old fashion idea of money as a vehicle for an exchange of value disappears here. No longer is there a need to establish a value system symbolizing a fair exchange of labor, skill, and reward for ownership.

    Instead, government can simply, generously, issue money to accomplish the purposes of government.

    ReplyDelete

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