Tag Archives: QE

Quantitative Easing in Australia (Wonkish)

For the first time in our country’s history, Australia has embarked on Quantitative Easing (QE). On Thursday, the Reserve Bank of Australia (RBA) slashed the Cash Rate to 0.25%, which is effectively the floor of the Cash Rate before hitting negative interest rate territory [1]. With QE, the RBA will purchase government bonds to drive up their prices and hence lower their yields to lower interest rates throughout the economy, particularly longer-term interest rates [2]. Some tabloid journalists have referred to this as ‘money printing’ or ‘monetising debt,’ but neither of these claims are true. QE, like other monetary policy operations [3], does not create what we call net financial assets. If the RBA purchases a government bond, it sells reserves in return. The commercial bank holds fewer bonds, more returns, but their net financial assets are unchanged. What changes instead are yields as the decrease in the supply of bonds pushes up their price.

What about claims surrounding ‘monetising the deficit.’ Usually what people mean by this is creating ‘new money’ to finance a budget deficit, which is inapplicable for a few reasons. First, if the RBA has a positive Cash Rate target, its supplying of reserves is non-discretionary and will increase or decrease when the demand for reserves changes so that the overnight interest rate aligns with the Cash Rate [4]. In other words, if we run through the scenario of the RBA directly purchasing public bonds as the government runs a budget deficit, the excess of spending over taxation would generate excess reserves in the commercial banking system. Such an excess would cause the overnight interest rate to fall to zero. In order to make the overnight interest rate match the Cash Rate target, the RBA would need to sell an equivalent amount of bonds (the RBA buys reserves in exchange) as it had purchased so that it eliminates the excess supply of reserves that it had initially created.

Second, the money (here I mean net financial assets) used to purchase public bonds is the result of deficit spending in the first place, which raises an interesting question of why we have a ‘public debt’ if the government is the issuer of Australian Dollars (AUD). Well, as part of the emergency response to the coronavirus, we have seen the ‘debt ceiling’ raised to about $850 billion [5], which makes it sound fairly arbitrary. The functional purpose of the public debt is not to raise revenue through borrowing from the public (people would have no net financial assets with which to purchase government bonds if those net financial assets did not exist in the first place through deficit spending on part of the treasury or ‘fiscal policy’ [6]) but, rather, to control interest rates. If there is deficit spending, there is a surplus on part of the recipients of the deficit spending. This means that commercial banks will have more reserves than before, putting downward pressure on their price (their overnight interest rate). To maintain a particular Cash Rate, government bonds are sold to the private sector to drain the excess reserves and so to prevent the overnight interest rate from falling. This happens to be equivalent to QE in not issuing bonds in the first place.

Will QE do much? I have my doubts. The idea of lowering longer-term interest rates is to raise the demand for credit to finance real investment on part of the business sector. The problem is that in a downturn, businesses will not invest if they do not expect to make money in doing so. Will refinancing effects allow for higher disposable incomes on part of households? Not if the assets that are the collateral backing the debt plunge in value (people will struggle to refinance if they are in negative equity).

In other words, shifting interest rates becomes akin to pushing on a string. As much as borrowing can be made cheaper through lower interest rates, the demand for loans must exist for credit to be created. During a downturn, people are less creditworthy as unemployment spikes and job hours are slashed, reducing the capacity for people to borrow. Businesses with fewer sales also have less creditworthiness. In this sense, credit expansion follows rather than leads the business cycle, intensifying booms and busts rather than stabilising the boom-bust cycle.

 

[1]. The way the RBA makes the overnight interest rate – the rate at which commercial banks lend to one another – align with its Cash Rate is through a ‘corridor’ system. In effect, because the RBA (usually) pays commercial banks 0.25% below the Cash Rate on their exchange settlement (ES) balances (the reserves that commercial banks have with the RBA), commercial banks with a surplus of ES balances have an incentive to lend them to other commercial banks at the Cash Rate because that yields more interest. By the same token, if a commercial bank wishes to borrow reserves directly from the RBA, they will pay a premium interest rate 0.25% above the Cash Rate, which provides them with an incentive to borrow at the Cash Rate from another commercial bank. This time, with the Cash Rate at 0.25%, the RBA has decided to pay commercial banks an interest rate of 0.10% on their ES balances rather than 0.00%.

[2]. https://www.abc.net.au/news/2020-03-19/rba-cuts-interest-rates-coronavirus-covid-19/12070494

[3]. Monetary policy is basically what the Central Bank does. The other arm of economic policy decision-making is called fiscal policy, which concerns government spending and taxation.

[4]. http://bilbo.economicoutlook.net/blog/?p=2943

[5]. https://www.fxstreet.com/news/australian-treasurer-frydenberg-will-lift-debt-ceiling-to-a850-billion-202003200630

[6]. The private sector can create ‘money’ in the form of credit but this is not a net financial asset because private-sector lending to itself creates a financial liability. In other words, as part of an endogenous money supply, this is called ‘horizontal money.’ Vertical money creation is sourced through deficit spending as it creates net financial assets.

As another point, to avoid confusion, public bonds and net financial assets are not equivalents per se. Public bonds can be a component of one’s net financial wealth, but this is a portfolio choice. In other words, if the government did not issue public bonds, the recipients would still see their net financial assets rise when there is deficit spending. To make this point in another way, if a private agent used private credit to buy a government bond, it would not have net financial assets. While the government bond is an asset, the loan used to purchase the bond is a liability that must be paid back. As explained before, why public borrowing tends to coincide with deficit spending is to maintain control over interest rates as an instrument of monetary policy. With QE, this function is obsolete because QE floods the commercial banks with reserves.

The Weasel Word: Seigniorage

Like many words in economics, seigniorage is a bit of a weasel word as it depends on the context it is used.

In a commodity currency, the authority would produce coinage with face-value exceeding commodity value. Seigniorage was the difference between those values. That is simple enough.

What does it mean in a fiat economy though?

John Quiggin provides us with an answer:

 …the value of the net increase in money issue is referred to as seigniorage. To the extent that seigniorage is consistent with stable inflation, it is achieved by mobilising previously unemployed resources.

Now putting that in Modern Money terms, all that says is that the creations all net financial assets are seigniorage.  That is all.  Pretty fancy word to say nothing at all.  Only public spending can create net financial assets.

It renders the question asked by Labor Advisor Richard Holden moot.

So here’s my challenge to the modern monetary theory crowd. Please state a formal, precise, economic model in which a monetary authority can extract an infinite amount of real resources through seigniorage. Or be quiet.

He was thoroughly schooled in the comments in the article and at no point has anyone said extract infinite resources.  Modern Money has always said resources or if you prefer inflation is the constraint.

So in the end, seigniorage is a pretty meaningless Humpty-dumpty word.  All it means is spending capacity moderated by inflation.

So what amount of real resources can be extracted through seigniorage (spending)? What is the scope for seigniorage?

As much as desired, as long as you have access to the resources and are creating productive capacity.


Related questions are:

Is MMT just printing (spending) money?
Is MMT just quantitative easing? (also known as printing money)
Is MMT just monetary policy as it refers to QE and ‘monetary’ is in the name?

The answer to all the above is no.

QE is just a financial asset swap (bonds for cash) and the rest has been addressed by Scott Fullwiler and in our 5 things to read.

These questions often come up (as statements) consistently so there may be a post to address them in the future.

Meanwhile, recently Bill Mitchell, modern money economist, has had words about seigniorage.

How MMT is NOT Printing Money!

This is a guest/adapted post from a series of tweets by Scott Fullwiler.

From the very beginning, in the 1990’s, MMT has NEVER argued that ‘printing money’ was necessary. Anyone saying MMT = “print money,” even if they (correctly) incorporate an inflation constraint, is getting MMT dead wrong.

The argument from the earliest days in Warren Mosler’s “Soft Currency Economics,” Wray’s “Understanding Modern Money,” or Stephanie Kelton’s “Can Taxes & Bonds Finance Government Spending?“–the MMT argument is that ALL government deficits are ‘printing money’ ALREADY (!).

These and other early foundational pieces on MMT argue that the choice to issue bonds or not is about monetary policy – how to set the CB’s interest rate target, not whether to ‘finance’ a deficit or ‘print money.’

The argument across literally dozens of publications is consistent–whether or not government issues bonds when it runs a deficit, the macroeconomic impact of ‘bonds vs. money’ is nil.

What matters for macro impact is the deficit itself, and how it is created (spending/taxing priorities), since the deficit is creating net financial wealth in the private sector (note I did NOT say ‘real‘ wealth (!)).

The choice to issue bonds or not in the face of a deficit is simply about 1 risk-free government asset (say, T-bills) vs. another risk-free government asset of perhaps slightly longer maturity (but that’s also a policy choice).

This is also partly why we predicted back in the 2001 that Japan’s QE (Quantitative Easing) wouldn’t be inflationary, and predicted the same for the US in 2008. QE & ‘monetization’ of government debt is about an asset swap–it’s the deficit itself that has the ‘quantity’ effect, not the financing.

Similarly, in the real world, Central Banks (CB) are defending their national payments systems every minute of every day. This means they accommodate banks’ demand for CB liabilities always at or near their current interest rate target.

From an MMT perspective, it’s really weird that people believe a government running a deficit via overdraft at the CB is inherently inflationary, but the current system, where government runs a deficit while CB guarantees market liquidity for bond dealers to buy government bonds, isn’t.

So, from the beginning 20+ years ago, MMT said the ‘choice’ to issue bonds when running a deficit was about how to set CB’s interest rate target. With bond sales, CB accommodates banks at its target rate. Without bond sales, CB sets rate at ZIRP (0%) or uses interest on reserves – IOR=target rate to set target rate <> 0.

This is just supply and demand from ECON 101. If you push out the supply curve beyond the entire demand curve, either the price falls to 0 or you have a price floor set at <> 0. Those are the only 2 possibilities when ‘printing money’ to run a deficit.

Neoclassicals actually agree with this for different reasons. For them, if we ‘monetize’ government debt & CB rate = 0, ‘monetization’ isn’t inflationary. Or, if CB sets rate <> 0 via IOR=target rate, still not inflationary.

In both cases, CB’s reserves are considered effectively equivalent to holding, say, T-bills. So, ‘monetization’ or ‘printing money’ is effectively equivalent to ‘printing’ T-bills. In other words, if you blend neoclassical model w/ actual CB ops, ‘printing money’ isn’t inflationary.

Putting this all together . . . MMT has NEVER argued that ‘printing money’ as conventionally interpreted is necessary to carry out MMT policy proposals. All deficits create net financial wealth for private sector, regardless of ‘finance’ method.

Choice to issue bonds or not when running a deficit is about how to set CB’s target rate, not ‘financing’ a deficit. This means that interest on national debt is a policy variable, or at least can be (for monetary sovereign, of course).

So, choice to issue bonds or not is not about ‘quantity’ impact of a deficit, but about ‘how’ CB chooses to achieve its target rate. Hitting interest rate target by overdraft to government & pay IOR=target rate=2% has no difference of macro significance from hitting interest rate target by government instead issuing T-bills while CB ensures market liquidity at target rate = 2% to banks & bond dealers.

Now, there are places where MMT scholars argued for no bond issuance, government gets CB overdraft, & CB sets target rate= 0 (permanent ZIRP).

Note, though, that this is:

(a) not arguing in favor of ‘printing money’ even in neoclassical view

(b) and is therefore, simply a policy proposal for low interest rates on government debt.

It is also NOT arguing for ZIRP in a neoclassical world–Wray did his Ph.D. under Minsky. Minsky was against manipulating short term rates; instead favored credit regulations/margins of safety.

That is, when MMT proposes ZIRP, it is proposing it for ONLY the government debt, NOT for the economy overall as in a New Keynesian model. There are dozens of MMT publications on regulating credit, and more on the way. MMT was about macroprudential before that was a thing.

Minsky was adamant that manipulating short-term interest rates was actually destabilizing (he blamed the rise of money manager capitalism on Volcker’s high rates). Raise margins of safety to slow credit rather than raising the overnight, risk-free rate.

A benefit of margins of safety is that raising interest rates to slow credit leads to higher hurdle rates that can only be met by riskier projects, while raising margins of safety slows credit by favoring the LESS risky loans.

Particularly given that the problem of a debt bubble is that credit QUALITY is bad, it’s really weird from an MMT perspective that it’s mostly MMT arguing in favor of macro policy that target credit quality while neoclassicals go to lengths to NOT talk about credit quality–use a Taylor rule to manipulate short-term rates, increase liquidity requirements, increase capital, but little to nothing about underwriting. (Shocker–we now have a corporate debt bubble.)

So, MMT is NOT arguing for ‘printing money’ and ‘ZIRP’ in the conventional, neoclassical world. MMT is arguing for stabilizing demand side of the economy with a mix of government’s budget position (at low rates, however ‘financed’) & credit quality/margins of safety.