It had to happen.
Once Alan Kohler was talking up the wonders of Magic Money on national television, it was only a matter of time before the RBA would strike back….hard. After all the RBA has a state / private bank monetary cartel and the interests of very large wealthy corporate stakeholders to defend.
Sith Lord Governor Philip Lowe chose the annual Anika foundation speech as the opportunity to instruct the assembled young banking industry Padawans on the importance of remaining loyal to the dark side of the monetary force.
The speech opened with some “looking on the brighter side” and “looking on the gloomy side” statistics about the labour market during COVID-19. On balance the RBA is a bit worried. But the fun really started when Governor Lowe reached the section of his speech entitled Public Sector Balance Sheets. A hush fell over the room.
Governor Phil explained that in response to COVID-19 the RBA had announced a “comprehensive monetary policy package” (CMPP) that was designed to ensure that oodles of cheap debt could be peddled by the private banks in these dark economic hours. Implementing the CMPP has resulted in the RBA balance sheet expanding, like a Work From Home belly, from $180 billion to $280 billion.
What Phil did not spell out but the audience implicitly understood is that expanding the RBA balance sheet is a good thing provided it is to support the debt peddling business models of private banks. After all, surely we are all agreed by now that a monetary system built around interest accruing debt contracts purchased by private banks (by creating credit liabilities on their balance sheets) is what powerful sky gods intended for their beloved sapiens.
But Alan Kohler’s prime time challenge required a response and so Phil continued.
“..I would now like to address one idea for the use of the central bank’s balance sheet that I sometimes hear – that is, we should use it to create money to finance the government. A variant on this idea is that the central bank should just deposit money in every bank account in the country – this is sometimes known as ‘helicopter money’ because, before we had an electronic payments system the idea was that banknotes could simply be dropped by helicopter.
For some, this idea is seen as a way of avoiding financing constraints – it is seen as holding out the offer of a free lunch of sorts. The central bank, unlike any other institution, is able to create money and the resource cost of creating that money is negligible. So the argument goes, if the government needs money to stimulate the economy, the central bank should simply create it in the public interest.
The reality, though, is there is no free lunch. The tab always has to be paid and it is paid out of taxes and government revenues in one form or another. I would like to explain why.
Phil’s explanation of why there is no free lunch was strange although entirely predictable having regard to the importance the RBA places on protecting the interests of the private banks and its preference for pea soup obsfucation when doing so.
Unfortunately this ‘explanation’ by the Governor will require a paragraph by paragraph review.
“….I will start with some central bank accounting. When a central bank creates money to finance government spending it does so by crediting the government’s deposit account with it. These extra deposits represent a liability of the central bank. And on the asset side of the balance sheet, the central bank might have an IOU from the government to be paid in the future…”
So far so good. Governor Phil explains that the RBA can provide the government with money to spend into the economy by a simple accounting entry. A credit into the government’s deposit account at the RBA and a debit on the asset side of the balance sheet… which might be nothing more than a simple IOU that the government owes the RBA. It is important to note that this IOU need NOT accrue any interest as it is hardly of importance whether the public in the form of the government pays interest to the publicly owned RBA.
The next paragraph is interesting.
“..Now suppose that the additional government spending is successful in stimulating the economy and this starts to push inflation up. At some point, interest rates would need to be increased to avoid inflation rising too far. If this lift in interest rates did not occur, inflation would rise, perhaps to a very high level. In this case, it would be through the inflation tax that the community pays for the extra government spending. So there is no free lunch – the spending is just paid for in a different way…”
Governor Phil paints a picture where the additional government spending resulting from the interest free IOU starts to push up inflation and as a result interest rates would need to rise. Hmmm, let’s take that one step at a time.
First, in order for inflation to start rising as a result of the additional government spending, the economy would need to be hitting resource constraints such that suppliers of goods and services find they are able to increase the prices of their goods and services and persuade customers to pay the higher prices. With unemployment before COVID-19 stagnant at 5% and high levels of underemployment and unemployment during the COVID-19 pandemic now significantly higher, and businesses competing fiercely on-line, just how likely is it that suppliers will be able to increase the prices for their goods and services any time soon.
If anything there are deflationary forces building in the economy and it would take a lot of additional government spending to prevent that. Even with the government pumping many billions into the economy over the last few months via JobKeeper and increased JobSeeker there is little sign of any inflationary twitches.
Second, let’s assume that the government does go spring break wild and manages to spend so much money that inflation stirs across the economy. Phil reckons in that event the only solution would be to crank up interest rates.
The more likely response by the government would be to reduce the amount of additional spending into the economy. As a very last resort it might need to run a balanced budget or surplus.
But the reference by Phil to raising interest rates is interesting because “raising interest rates” would have ZERO impact on the government’s capacity to spend into the economy because the additional credits the government is spending are funded by issuing zero interest IOUs to the RBA.
The reference to “raising interest rates” is a reference to the part of the story that Governor Phil has not mentioned or more accurately is trying to conceal. This part of the story is the money creation activities of the private banks which he anticipates will be occurring at the same time as the government is spending. Private banks rapidly expanding their loan books as the government spends into the economy and in doing so rapidly expanding the overall money supply is a much more likely driver of inflation than the government spending a few more billions after issuing some zero percent IOUs to the RBA.
Isn’t it interesting how the Governor of the Reserve Bank manages to avoid discussing the largely unregulated money creation powers of the private banks in our monetary system when issuing homilies about the dangers of the government spending funded by money created by the RBA.
Interesting but entirely predictable.
Money creation by private banks to blow the mother of all bubbles in stock prices, commercial property and residential housing is NEVER the problem. Money creation by the publicly owned central bank to support the operations of the government is always a danger.
But let us return to the spooky ghost story being spun by Governor Phil
Now instead suppose that interest rates are increased to avoid high inflation successfully. Even then, there is still no free lunch. How the tab is paid though depends on the nature of the arrangements that are in place.
One possibility would be for the government to pay back the IOU along with any accumulated interest at some point down the track. This repayment would need to be funded by future taxes.
If instead the IOU was not interest-bearing and was not repaid, the central bank would start accumulating losses as the interest rate it paid on its deposit liabilities increased and there was no offsetting income. This would lead to a decline in dividends to the government and possibly a future recapitalisation of the central bank. Both have to be funded through tax revenue.
Another possibility would be to increase the general level of interest rates to deal with inflation, but to maintain the low interest rate on deposit balances held at the central bank. This approach would limit losses at the central bank even if the IOU was not interest bearing. But it would effectively amount to a tax on the banking system, as it is the banks that would hold these low-interest balances once the government has spent the money. In this case, it is this tax that would help finance the extra spending.
How the tab is paid? What tab Phil?
So far all you have done is describe interest free money creation by the RBA that is used by a government to fund some additional spending into an economy during a recession or that is not at full capacity and when there is little or no inflation. Why would the government want to “repay” the RBA and remove that additional spending from the economy. Keeping in mind that after being spent that additional money is now sloshing around the bank accounts of the general public who are using it to engage in economic activity. Until there is a need to remove money from the economy there is no need to pay any tab.
Phil then describes “one possibility” being the government paying back the IOU (along with any interest) out of taxes. As noted above there is no interest to be paid and the only circumstances in which a government might be motivated to pay back some of the money created by the RBA by running a fiscal surplus is in the very unlikely circumstances that the economy is over heating. But if that is happening the more likely explanation is that the private banks are expanding their loan books with unproductive and reckless lending and regulating that behaviour is likely to be a much more effective response to any inflationary pressures.
Phil then considers the option of a government IOU that was not interest bearing and claims the central bank would start accumulating losses because it is would be paying interest on its “deposit liabilities” but not receiving any income. Phil doesn’t spell out what he is referring to (for good reason because people will be outraged) but what he means is that currently the RBA is paying interest to the private banks on their balances in their 100% risk free ES accounts (deposit accounts).
Yep – the deposit accounts at the RBA which the private banks are allowed to operate but the general public are prohibited from operating pay interest.
Yes – the deposit accounts at the RBA, which are 100% risk free, pay interest.
Why on earth the RBA is paying interest on deposits which are entirely risk free is one of the world’s great mysteries and also one of the world’s great scams.
Dear Phil, a simple solution to this problem is to stop paying the banks interest on their privileged and risk free deposits at the RBA. Even better Phil, is to allow the general public the right to open and operate their own 100% risk free deposit account at the RBA. For more discussion of MyRBA click here.
Phil anticipated this solution and claimed that paying little or no interest on risk free deposit balances at the RBA would amount to a “tax on the banking system“.
But it would effectively amount to a tax on the banking system, as it is the banks that would hold these low-interest balances once the government has spent the money.
Good grief. It is almost as though the Governor of the Reserve Bank does not understand what the risk free balances of the ES accounts are used for by the banking industry. If the banks don’t want to use ES accounts to settle their interbank transactions let them close them and go back to settling their debts to each other in smokey bars with bags of $US dollars or armoured trucks full of gold. We dare them.
Perhaps if the RBA wasn’t so busy paying the private banks interest on their risk free ES account balances the RBA might have some time to install some off the shelf software to allow the general public to open and operate risk free RBA deposit accounts.
If Governor Phil’s dodgy logic did not persuade you at least it persuaded him and he ended on a defiant note.
So I want to make it very clear that monetary financing of fiscal policy is not an option under consideration in Australia, nor does it need to be. The Australian Government is able to finance itself in the bond market, and it can do so on very favourable terms.
The Government will continue to sell bonds to the private banks so they can clip a few basis points and have interest accruing wealth assets to add to their “investors” portfolios.
After dismissing negative interest rates and intervening in the FX markets Governor Phil then concluded by looking at the government’s balance sheet and by singing a very different tune.
Apparently when the government is borrowing from the banks (i.e. rich people) and incurring truckloads of debt, additional spending into the economy by the government is a fantastic thing to do.
Debt across all levels of government in Australia, relative to the size of our economy, is much lower than in many other countries and it is likely to remain so (Graph 8). As I said before, the Australian governments can borrow at the lowest rates since Federation.
According to Governor Phil, the government has an important role to play in the economy but ONLY if it is funded by selling interest accruing bonds to banks and the wealthy (both domestically and overseas) and the private banks are left to expand the money supply with their debt peddling business operations.
Government activity funded by selling a zero interest bonds to the RBA with the RBA balance sheet allowed to grow (with appropriate regulation of money creation by the private banks) is simply not compatible with the kind of privatised public monetary system that Governor Phil likes so much.
I’m just a layperson in this space, so in this respect my questions are more for understanding and clarification than for the purpose of argument.
It seems to me that the biggest risk of printing lots of extra money (as opposed to issuing bonds) is that it can lead to a complete breakdown of discipline when it comes to borrowing money. We can obviously hope that governments will invest this extra money in productive assets (i.e. new infrastructure, health and education, etc.), but past experience would suggest that governments will throw money at any and all rubbish projects to hold onto power. Whereas in terms of government bonds, discipline is instilled because of the interest payments governments have to pay out to bondholders. Issue too many bonds and the repayment burden becomes a hindrance, so governments need to be more prudent about what they’re spending this money on.
At least, this is how I’m currently viewing this issue – am I missing something obvious, or is there a lot of technical jargon that I need to understand in order to see the MMT perspective?
As a side comment, it seems that a lot of these discussions are theoretical and aren’t linked to any research that attempts to forecast the impact of an MMT-style system. I’d love to see the following two questions answered by people in the know – whether they’re in favour of printing money or not, it would be a starting point at least:
1) How much cheaper is debt if the government funds our current spend versus current bond market prices?
2) What impact would cost-free debt have on productivity in the long-run?
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Your concerns are valid. There is nothing wrong with having concerns about unproductive government spending as there are legitimate risks of that happening just as there is a legitimate risk of unproductive lending by banks (e.g. lending that does little more than inflate the prices of existing assets).
And we don’t really need any empirical studies to assess whether or not the deregulation, over the last 40 years, of money creation / printing by banks has resulted in a lot more unproductive activity. The massive asset bubbles (aka inflation in asset prices.. houses, shares etc) we have seen demonstrates that bank money printing is a real thing and causes plenty of inflation. Inflation in asset prices is as damaging as inflation in everyday goods and services.
Politicians love doling out pork whenever they can as that increases their chances of re-election and they generally don’t care whether the the pork is productive and expands the productive capacity of the economy. So they certainly need to be kept on a short lead.
At the risk of upsetting the often passionate MMT supporters, that is one of my concerns with MMT as MMT promoters tend to focus on how MMT will allow increased “government spending” on government programs when there is less than full employment or other spare capacity in the economy. In other words while MMT does not require a Big Government approach, most of the time that is what the supporters of MMT seem to prefer and there is inevitably a risk that the spending will be on political pork.
I think it would be preferable that when there is a concern about a lack of demand in the economy (high unemployment and underemployment) that demand be stimulated in the most democratic way possible and in a way least likely to enrich pork doling politicians or bonus chasing bankers.
I think the simplest way of doing this is to deposit an equal amount into the MyRBA accounts of each citizen and allow them to choose what goods and services they would find most useful (aka productive) to themselves or their families. And if they would prefer to save the deposit or to apply to paying debts and bills they should be free to do that as well. We might call it a dividend of citizenship or of the public monetary system. Money has to be created as the economy grows to avoid deflation so why not distribute it in a democratic and equitable way. Banks creating money to pump up the assets of rich people is just as unfair as a politicians putting pork on the forks of some mates or a select section of the population.
The decision as to when such deposits should be made should take into account things like unemployment, spare capacity in the economy and whether there are inflationary pressures. This would be no different to the current situation where the press constantly reports on inflationary pressures and rising prices in the economy. This would ensure that only responsible decisions as to the amount and timing of this national deposits are made.
Deposits to the MyRBA accounts of the type outlined above are NOT UBI (Universal Basic Income) as UBI is more like a social security ration that is doled out on a regular basis with few other changes to the status quo.
Permitting all citizens and non-banks to operate deposit accounts at the RBA is a fundamental reform of the status quo.
As for bonds maintaining discipline, I think that is one of the great myths. If anything allowing politicians to issue interest bearing IOUs to banks and foreigners and to be paid by later generations encourages irresponsible spending decisions as the cost is not borne by present generations and the decisions of foreigners (both governments and banks) to buy Australian government bonds may be driven by considerations that are not in the national interest.
Came here via your MB comment
“It had to happen” indeed; the MMT meme is spreading like a virus, even in the US. Time for some “hammer and dance” control.
I suspect that US will be forced to openly adopt MMT and UBI for domestic social stability (probably post-Trump). Fed is already doing MMT for US Govt., but errs in bailing the corporate sector at the demand of the Wall St Banks. Atm its explained as a temporary crisis measure, but on the evidence since 2008/9 will never be wound back. Eventually, it will reduce the USD status as the world’s reserve currency. This will be gradual unless US anarchy &/or military defeat, requires a reset. For any other country, MMT will cause its currency to rapidly reset relative to USD. Lowe would want to avoid that!
I agree that it is likely that we are going to see a lot of money creation by central banks and most of it will not be helpful or productive and it is likely to benefit the big end of town much more than main street.
I am reluctant to describe that as MMT as pining down what MMT is can be a challenge and I will leave that to others to argue endlessly about.
The version of QE I think is most likely is some form of QE for Debtors as finding a way for debtors to keep paying off their loans and keeping the banking system alive is likely to be given the highest priority by our current crop of pollies and central bankers.
Tks for yr response, and the link to your earlier post of May 2015.
You rightly mock the idea of “QE for debtors” as another prop for the Bankers, and it is probably unacceptable post-Haynes.
UBI can achieve the same result in the present recession, and surely is “QE for the People” in its purest form. It exists now as “Job-keeper/seeker”, albeit temporary. While UBI has a socialist conotation it could be relabelled in Oz as a “national prosperity dividend” and pegged to Government receipts from export activities (licences, royalties etc). As such, it might give voters cause to engage with new revenue suggestions like your idea for a National Export Licence Auction system.
MMT is presently a malleable concept circulating in social media. The virus analogy is apt with respect to its current propagation and mutation. However, “pinning down what MMT is” is possible if Bill Mitchell’s textbook is read (and understood) by the commentariat. Even tho’ Lowe did not use the words “modern monetary theory” in his speech, your 1st quote from him (above), can be taken as one of MMT’s main mechanisms “use of the central bank’s balance sheet…… to create money to finance the government” As such, Lowe doesn’t dismiss MMT entirely, but argues that it’s not necessary in Oz at present, explaining that “Australian Government is able to finance itself in the bond market, and it can do so on very favourable terms.”
I believe it is remiss of Lowe to not address the impact of MMT on AUD exchange rate, as I suspect it is his underlying reason for dismissing MMT. To look at the exchange rate question only through the lens of the RBA’s currently available powers (over-night inter-bank rates and FX interventions) is to neglect the seriousness of the present COVID-19 crisis, as it is almost universally agreed that the past economic paradigms of capitalism are unlikely to see us through it equitably, or even peacefully.
Great article. Is there anywhere specifically I can read more about the ‘deposit liabilities’ referred to here? I’m one of those average mugs that had no idea this was a thing.
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Have a look at this
But it is difficult finding any solid articulation of the logic for paying interest on ES balances which the banks need in order to settle their inter-bank transactions conveniently.
If you can find a clear articulation of the reasoning let me know. The reason is likely to be that given in the article above, i.e. the RBA needs to pay interest on bank deposit balances at the RBA in order to keep its centralised money “price fixing” regime operational.
Why otherwise would the RBA need to pay interest on deposit balances that are 100% risk free?
After all we keep being told that in a free market, returns require the acceptance of risk and logically if there is zero risk there should be zero return.
Especially when the banks need the ES accounts for settling their interbank transactions.
An article on ES accounts.
The easiest way to start reforming the RBA is to require it to allow all Australians to open and operate deposit accounts at the RBA. Those accounts would not pay interest but they are by definition risk free. Why force Australians into business relationships with private banks when the RBA is perfectly capable of providing them with a means of conveniently saving in liabilities of the publicly owned central bank.
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Thank you GP