Since the beginning of the corona virus Governments around the world have began to spend huge sums without a call from anyone on ‘How are you going to pay for it?’ In a recent 730 interview the reporter asked the question on how a sovereign currency issuing government would ‘pay for’ its spending down the track.
LEIGH SALES: Has any thought been given yet as to how Australia will ultimately pay for this or is that to be worked out down the track?
JOSH FRYDENBERG: This will be paid back for years to come. There’s no secret in that and of course, we will enter into discussions with the credit rating agencies over due course.https://www.abc.net.au/7.30/josh-frydenberg-on-the-$130-billion-wage-subsidy/12104458
When I’ve publicly stated currency issuing governments have no intrinsic financial constraint the retort back is usually something like ‘if you print money you just get inflation’
This post will look at the way in which currency issuing governments spend, how ‘printing money’ does not apply to any spending operation, look at what government debt is.
The first thing to note is that there is a difference between a currency issuer and a currency user.
- The Australian Government is a currency issuer. It is a monopolist of the Australian dollar – It faces no insolvency risk
- As a monopolist over the currency it always has the capacity to spend (that is not a call for unlimited spending)
- Regardless of past deficits or surpluses the Australian Government spends in the same way every time. – There is an appropriation bill that passes through the legislature, Treasury instructs the Australian Office of Financial Management to give the Reserve Bank an instruction to credit the relevant bank account(s)
The very concept of saving for an issuer of a currency is ridiculous. Savings are the act of forgoing current expenditure and are used to spend at a later date. When you issue a currency you always have the ability to spend.
We can conceptualise the process from the above figure. Like you have an account with your bank, your bank referred to as, Authorised Deposit Taking Institute (ADI) has an account with the Reserve Bank of Australia. They care called Exchange Settlement Accounts (ESA). All Federal Government spending marks up reserve levels of ADIs and those ADIs credit the relevant account holder.
Taxation has the opposite effect. Demand deposits decline and Reserve levels also decline. It means less spending power for currency users.
There are institutionalised arrangements where The Australian Government holds an Offical Public Account with the RBA, however this is merely an accounting arrangement and the numbers within the OPA are not included in the money supply. The image below is a screenshot from the notes of the RBAs data on the financial aggregates of the Australian economy.
There are two options for a Government to adjust aggregate spending levels. Fiscal Policy (Spending and Taxing) and Monetary Policy (Interest Rates)
We have seen how Government spending adds to reserve levels and taxation does the opposite. What Government spending also does is effect the RBAs target rate. This is the interest rate that you hear about on the first Tuesday of every month and it is the rate ‘targeted’ for ADIs to loan to each other using their Exchange Settlement Accounts (ESA)
One of the purposes of bond issuance is to defend an interest rate. As noted above all Federal Government spending increases reserves with ADIs.
As government spending adds to reserves and increases their level it pushes interest rates down and as taxation removes reserves it pushes rates up.
Obviously fiscal policy can not be used to defend a particular target rate as it would cause all sorts of havoc. It is the RBAs job to ensure the levels of reserves are right so banks lend to each other at the target rate.
Bonds are used to drain and add liquidity. When a bond is issued (sold) it drains reserves. It is the equivalent of an ADI moving dollars from their ESA (The account used to pay other ADIs) to a securities account, an account which earns interest.
The opposite happens when bonds are purchased by the RBA. It moves dollars from the ADIs security account to their ESA. Bond issuance doesn’t alter the supply of funds but merely the portfolio mix.
The activities of Treasury and The RBA need to be very closely co-ordinated to ensure the payment systems functions.
The RBA needs to ensure sufficient reserve levels so ADIs can pay each other. Remember loans create deposits and spending and taxing by the treasury can have huge fluctuations in the levels of reserves.
Rather than relying on bond issuance to ensure a particular target rate is achieved the RBA uses what is called the corridor system. You can watch this video of Katherine from the Domestic Market Operations department at the RBA to understand how it works. Thank you Katherine.
Once you take into consideration the corridor system, bond issuance becomes about liquidity management and ensuring there are sufficient reserves so ADIs can pay each other and our payment system functions.
The RBA will always have an option for an ADI to ensure their ESAs are positive. If they are short of reserves they can borrow from the ‘penalty window’. This is where the RBA acts as a Lender of Last Resort and loans the required reserves to the ADI.
In no way does the bond issuance ‘fund’ the ability of a currency issuer. There isn’t really a reason for treasury to match deficit spending with bonds either. It just means the RBA may have to enter into more repurchase agreements to ensure there are sufficient reserves in the system. Because bond issuance moves dollars into securities accounts, draining reserves, the RBA then enters into what is called repurchase agreements (repos) where it issues bonds and then buys them back the next day with an interest rate to add to reserve levels.
What does all this have to do with ‘printing’ money. I am never too sure what people mean when they use this term.
- Governments spend by marking up the appropriate account
- Bonds are issued voluntarily to match deficit spending changing the portfolio mixture.
- The RBA uses its Domestic Market Operations to ensure there is liquidity in the system so ADIs can pay each other.
- The RBA uses a corridor system to defend an interest rate.
The very concept of borrowing for a currency issuer or using ‘this record period of low rates’ to invest is non-sensical. There is no borrowing or debt in the same way it applies to a household. Deficit spending adds to reserves and that deficit spending is what gives ADIs the ability to purchase bonds and that is what we refer to as Government debt!
In The Canberra Times Adam Triggs wrote an article Before anyone asks: no, Australia does not have a debt problem. It starts with an incorrect understanding of macro and uses neoliberal or fake knowledge.
The article states that the increased costs of government spending in normal times don’t apply to these pandemic times. That’s ridiculous, there is no real cost to government spending, it marks up accounts using a computer. Costs are real resources. Environmental damage, loss of habitat, climate change, individual hardships, unemployment, mental and physical health etc…
The author outlines three reasons in the risk of this ‘pandemic’ spending.
“The first is the potential for increased government spending to “crowd out” the private sector. When governments run budget deficits they are borrowing money from investors, money which is no longer going to other worthy investments. Increased demand on the limited pool of savings, in normal times, means higher interest rates”
The above quote is straight out of the loanable funds theory that states there is a limited pool of savings that banks loan from and Government spending in excess of taxation then uses that limited pool and pushes rates up. That is simply not true. I outlined in a previous post on how loans create deposits and above have described the process of how the RBA ensures sufficient reserves to ensure ADIs have sufficient reserves to pay each other. The loanable funds theory is on of those neoliberal myths that is used to demonise public spending. I like to use this thing called observation of reality. We can very clearly see through the GFC and now this crisis, deficit spending has increased and we have record low interest rates. You can see central banks around the world set interest rates every month, there is no natural reason they will suddenly increase and governments will be powerless to stop it.
“The second potential cost of increased government spending is the future cost of paying interest on that debt.“
The ‘debt’ are securities account that ADIs hold at the RBA. If you don’t like Government debt, don’t issue it.
Furthermore, the RBA announced it will engage in Quantitate Easing – a process where it chooses a particular treasury maturity (say three year bonds) chooses a yield it desires and begins purchasing those bonds from the market. Central Banks around the world have engaged in this practice since the GFC. Many central banks now hold treasury bonds. It is the treasury choosing to issue a bond, an investor buys that bond, it is then purchased by the central bank (with a capital gain for the investor) and the interest payment is then paid from treasury to the central bank who then credits the treasury account.
“The third cost of increased government spending is that it can be unsustainable (meaning it can cause problems if that level of spending continues) or can destabilise financial markets.“
Government spending can never become unsustainable. It is a currency issuer and literally as infinite financial capacity. Why are financial markets an indicator of sustainability? Fiscal policy shouldn’t be there to appease financial markets, who desire less public expenditure and the ability to make more profits, it should be there to ensure our own well being. You judge fiscal policy based on how well the bottom of the income spectrum is doing and whether we have our desired levels of public services and are reaching our goals to mitigate against climate change.
It is pathetic that the vast majority of financial journalists/commentators get the very fundamentals of the way government spending works wrong.
Adam Triggs in The Canberra Times, Leigh Sales in her interview with the Treasurer, Jessica Irvine in the Sydney Morning Herald who said “These surplus funds can then be used to pay down any existing debt.,”
No, currency issuers can always spend regardless of past deficits or surpluses. Government Debt are bonds purchased by Financial institutions who obtain Australian dollars from Federal Government deficit spending. Surpluses are not savings. It is the government spending less than taxing and removing reserves.
Lenore Taylor of The Guardian who wrote “The country will be deeply in debt, as will many households.” The Taylor article makes an argument “Having seen the life-saving benefit of our public health system, there will surely be enormous pressure to fund it better in the future.” I agree with the overall spirit of the article. However, we won’t achieve greater levels of public services and spending, if we continue to frame economics using a neoliberal perspective.
For an accurate discussion of how our monetary system operates listen to this discussion between financial journalist, Alan Kohler and Emeritus Professor Bill Mitchell.
In term of the term ‘printing money’. It doesn’t apply to any spending operation.
- All spending by a currency issuer is an authorisation bill through the relevant legislature.
- There is then an instruction from somewhere within treasury to the central bank to mark up the relevant account.
- ‘Government debt’ or treasury bonds are then issued.
- Taxes are there to remove spending power and create non-inflationary space for public expenditure as well as creating a demand for a currency. See The Story of Money and Money is a creature of The State
© Jengis 2020