Tag Archives: Quantitative Easing

MMT Does Not Advocate (or mean) “Monetisation”

Modern Monetary Theory in no way endorses “monetisation.” To the extent monetization is simply a name for quantitative easing (roughly, RBA purchases of long-term bonds), we either oppose it or find it only mildly effective and sometimes propose alternatives.

Whether it comes from Catallaxy, Rabobank or Saul Eslake, these ideas run rampant amongst the economics community.  Allow me to repeat, Modern Monetary Theory in no way endorses “monetisation.” At best we only find it mildly effective and have proposed other ways of achieving the same goal.

An example of an early MMT work that specifically criticizes even the use of the word monetisation is Warren Mosler’s Soft Currency Economics II, a paperback that is not too expensive at used book sites.

First, we believe that entities other than Canberra choose the form of Australian government liabilities through their investment, saving, financial-trading, and other choices.

Regardless of the public’s choice of assets, our central bank, the RBA, buys and sells assets to get its chosen interest rate(s). Of course, interest rates other than the cash rate are determined by other actors. The action of “the markets” (including huge banks) for bonds and other debt securities most closely approximate an uncoordinated supply-demand process. Unless, of course, market manipulation dominates there.

Critics across the spectrum have been gathering that the unique idea of MMT (perhaps because of its name) involves attempts to “pump money” into the system. This process would then likely generate inflation but would allow higher federal spending without tax increases.

In fact, as former Bernie Sanders aide and MMTer Stephanie Kelton puts it in her terrific new popular book (for example, on p. 36), you might as well think of bonds and money as “yellow dollars” or “green dollars”—more or less the same, except one pays interest.

Another place to find a good critique of the idea that deficits “pump money” into the economy is The Scourge of Monetarism by Nicholas Kaldor. In the writings in that 1980s book, Kaldor sought to dissuade British policymakers from an earlier round of fiscal austerity.

What MMT does is explain how the federal spending process works always. It does not call for a change in a method of financing. Moreover, the always-existing method of increasing spending does not require tax increases unless there is a macroeconomic need for them—say to dampen aggregate spending and cool down the economy. Hence, there is nothing magical about the number zero for the federal deficit or deficit increases. The federal government indeed never “pays for” new spending the way households or Australian States or local councils do. Hence, worries about higher deficits as such should not slow our crises responses ever.

This is a remix of Greg Hannsgen, Ph. D, UMKC graduate, Levy Economics Institute Research Associate post.  The original can be seen here.

What MMT Is Not… What MMT is…

Normally at Australian real Progressives we remix for an Australian audience but as this is a recent repost from multiplier-effect from L. Randall Wray and Yeva Nersisyan we did not wish anything to be taken out of context as it refers to specific U.S. events. Just replace Fed with RBA, President with Governor-General and the gist remains. We have dealt with most of these misconceptions  previously.

As MMT has been thrust into the spotlight, misrepresentations and misunderstanding have followed. MMT supposedly calls for cranking up the printing press, engaging in helicopter drops of cash or having the Fed finance government spending by engaging in Quantitative Easing.

None of this is MMT.

Instead, MMT provides an analysis of fiscal and monetary policy applicable to national governments with sovereign, non-convertible currencies. It concludes that the sovereign currency issuer: i) does not face a “budget constraint” (as conventionally defined); ii) cannot “run out of money”; iii) meets its obligations by paying in its own currency; iv) can set the interest rate on any obligations it issues.

Current procedures adopted by the Treasury, the central bank, and private banks allow government to spend up to the budget approved by Congress and signed by the President. No change of procedures, no money printing, no helicopter drops are required.

In the old days, governments just notched tally sticks, minted coins, or printed paper money when they spent, then collected them in redemption taxes and burned or melted down all the revenue. Today all modern governments use central banks to make and receive all payments through private banks. Government spending is still financed by money creation, and taxes destroy money—but in the form of central bank reserves. Instead of wooden sticks, we use electronic keystrokes, which the government cannot run out of. Bond sales merely swap one government liability for another, while paying off bonds reverses the operation.

Critics make a big deal of the separation of the Treasury (the government’s spending arm) and the Central Bank (the issuer of currency), claiming the latter is independent and may refuse to “finance” Treasury spending. The separation of the Treasury and the Fed does not alter government’s ability to spend. The Fed is a creature of Congress and an agency of the U.S. government. Liabilities of the Fed (notes and reserves) are obligations of the United States just like Treasury securities. Yes, different arms of the government issue these, but it doesn’t change the fact that they are liabilities of the United States.

As MMT explains, since bonds can only be purchased with reserves (the government will take only its obligations in payments to itself), the reserves must be supplied first before bonds can be purchased. It demonstrates how the Fed provides the reserves needed to buy the Treasuries even as it never violates the prohibition against “lending” to the Treasury by buying the bonds directly. The Fed has to ensure that funds to buy the bonds are available to safeguard the payments system, to achieve its interest rate targets and for financial stability considerations.

None of this is optional for the Fed. It cannot refuse to clear government checks. It is the government’s bank, after all, and is focused on the stability in the payments system.

Case in point: the Fed engaged in repo operations last September to add reserves to the system when Treasury bond sales and corporate tax payments left the market without its desired level of liquidity, pushing repo rates above the Fed’s desired levels. Any disturbance in the Treasury market will have ripple effects as many financial institutions have sizable holdings of Treasuries. Indeed, the Fed’s very first intervention during the pandemic was in the form of repo operations, citing “disturbances” in the Treasury market.

Government can make all payments as they come due. Bond vigilantes cannot force default. While their portfolio preferences could affect interest rates and exchange rates, the central bank’s interest rate target is the most important determinant of interest rates on the entire structure of bond rates. Bond vigilantes cannot hold the nation hostage—the central bank can always overrule them. In truth, the only bond vigilante we face is the Fed. And in recent years it has demonstrated a firm commitment to keep rates low. In any event, the Fed is a creature of Congress, and Congress can seize control of interest rates any time it wants.

Finally, even if the Fed abandons low rates, the Treasury can “afford” to make all payments on debt as they come due, no matter how high the Fed pushes rates. Affordability is not the issue. The issue will be over the desirability of making big interest payments to bond holders. If that’s seen as undesirable, Congress can always tax away whatever it deems as excessive.

We hope the Coronavirus will teach us that in normal times we must build up our supplies, our infrastructure and institutions to be able to deal with crises, whatever form they may take. We should not wait for the next national crisis to live up to our means.

In conclusion, MMT rejects the analogy that a sovereign government’s budget is just like a household’s. The difference between households and the sovereign holds true in times of crisis and also in normal times, regardless of the level of interest rates and existing levels of outstanding government bonds (i.e. national debt). The sovereign can never run out of finance. Period.

That doesn’t mean MMT advocates policy to ramp up deficits. For MMT a budget deficit is an outcome, not a goal or even a policy tool to be used in recession. There’s no such thing as “deficit spending” to be used in a downturn or even a crisis. Government uses the same procedures when spending no matter what the budgetary outcome turns out to be. We won’t know until the end of the fiscal year as the outcome will depend on the performance of the economy. And the spending will already have occurred before we even know the end-of-the-year budget balance.

MMT recognizes that the constraint faced by government is resource availability. Below full employment government spending creates “free lunches” as it utilizes resources which would otherwise be left idle. Unemployment is evidence that the country is living below its means. A country lives beyond its means only when it goes beyond full employment, when more government spending competes for resources already in use. Full employment means that the nation is living up to its means.

The most important lesson we must learn from this crisis is that the ability of the government to run deficits is not limited to times of crisis. Indeed, it was a policy error to keep the economy below full employment before this crisis hit in the belief that government spending was limited by financial constraints. Ironically, the real limits faced by government before the pandemic hit were far less constraining than the limits faced after the virus had brought a huge part of our productive capacity to a halt!

We hope the Coronavirus will teach us that in normal times we must build up our supplies, our infrastructure and institutions to be able to deal with crises, whatever form they may take. We should not wait for the next national crisis to live up to our means.

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.