The Fed-Treasury Relationship
To Consolidate or Not To Consolidate, that Is the Question (or Maybe It Isn’t)
by L. Randall Wray, New Economic Perspectives
This is another short post on MMT, a sort of follow-up to my post from a couple of days ago. There was an interesting response to various comments on my piece, which was posted up on Mike Norman’s website.
We got the typical: “oh you MMTers always want to consolidate the Fed and Treasury, but really the Fed is a private institution that is not a part of government”, and “in reality the Treasury cannot spend unless the Fed will allow it to spend, otherwise it must get tax revenue before it can spend”, and hence “really government spending is constrained by its revenue, just like a household or firm”.
In reality, what MMT has shown — from the very beginning of the creation of the approach — that you can consolidate or deconsolidate and the balance sheets end up in exactly the same place. The MMT logic holds no matter how you do it: government creates a money of account, imposes a tax in that unit, spends currency denominated in the unit, and collects taxes paid in its own currency.
And, of course, the Fed is not a private institution but rather is a creature of Congress and no more independent of government than is the Treasury, the DOD, the DOT, or the IRS. The Fed is normally allowed to set the overnight interest rate target free from the everyday kind of politics — but all of these other branches of government also have some independence from party politics. Well, the IRS right now is being subjected to some of that.
Anyway, the response was by someone called Calgacus, who often makes quite interesting and thoughtful comments. I thought it would be worthwhile to repost the response here, along with a few comments of my own. The angle taken here on the “consolidation issue” is pretty novel.
[NOTE: In the quotes from Calgacus here, the comment by someone else is in italics, and the response by Calgacus is in normal font. (My comments below are in bold.)]
The second reason is that Congress does not trust itself to preserve price stability if it avails itself of its inherent authority to issue money directly. So it has accepted a more complex and convoluted system in which only the central bank is permitted to issue dollars, and in which the US Treasury is required to obtain dollar balances by issuing debt instruments and exchanging them for central-bank issued dollars.
That is not how it works. Not that it matters, but most state money, reserves is or was issued by the Treasury, not the Fed. There’s some old MMT paper that says 60% or so IIRC. The “money” in the Treasury’s account is not money at all, but the result of a delusion – the delusion of the nonexistent “constraint” that is only said to exist. This “money” is just “one pocket owing another pocket” in Abba Lerner’s words. Nothing would change if a trillion were added to it. The meaningful constraint is the informal upper one on the Treasury account – sopmething like $5B, not the lower one.
The general drift of some further comments is based on this too-usual unconscious construction of money as a thing, rather than a relationship. This results, as usual, in ascribing magical power to the Fed, the supposed magical maker of this magical “thing” – one sort of the nation’s money/debt – the less important sort – reserves. There is even the suggestion that the Fed could win in a showdown with the US Treasury, who makes the more important sort of money – bond debt – or even the Congress, which created and empowered the Fed. What is done here, the common logical error is dissociating the Fed from the Treasury – the left pocket and the right pocket – in one place, but not another. Consolidate or deconsolidate, but decide on which, and then do the accounting. Of course if you change your decision in the middle you can arrive at nonsensical conclusions.
Wray: Exactly right. Choose to consolidate or to deconsolidate and then do your T-accounts and you will reach exactly the same endpoint as long as you stick to one or the other. Not surprising, since Treasury “deposits” at the Fed are internal government record keeping.
It is like you owing your spouse. Your spouse took out the garbage yesterday, so you are in debt. Doesn’t matter to anyone outside your family. Won’t show up on your bank’s balance sheet.
There are all sorts of internal debts and credits within the household, the individual firm, or the federal government. They are of no concern to anyone outside that household, firm or government.
You can deconsolidate the internal accounts of the wife and husband. Wow, the wife is rich — lots of claims on the husband! Their bank won’t be impressed — it will consolidate the accounts and wipe out all the internal credits and debits, which will not show up on their joint account at the bank.
But wait, the husband must get “permission” from the wife before he can write a check on their joint banking account! The bank doesn’t want to hear about that, presuming the husband and wife can work it out.
Internal affairs, similar to the pirouette that the Secretary of the Treasury and the Chairman of the Federal Reserve must engage in to implement Congressionally mandated spending. This should be of no more interest to you, the general public, than whatever it is the one spouse must do to get the other to agree to take the checkbook on a shopping spree.
It amazes me that otherwise sentient economists can get worked up about this.
So the Treasury needs to get “money” – “reserves” from the Fed. Fine, we have deconsolidated them. But why is the Fed’s money worth anything at all to anyone? Answer – because the Treasury makes it so. The Treasury exchanges the ready money it invisibly issues for this and only this purpose – and exchanges it at par for the Fed’s reserves. That is one way of thinking of what is going on when the Treasury accepts dollars in its FR account as tax payments terminating debts owed it. That is where the Treasury gets its otherwise worthless reserve balances at the Fed, which are only valuable because they are so backed by the Treasury. Remember, we have deconsolidated. The Fed might as well be the FR Bank of Weimar Zimbabwe, issuing WZFR notes/ reserves. The Fed acts only as a fiscal agent for taxes owed to the Treasury, not it, and when a bank puts tax money in a Fed account, extinguishes its liability to the state by giving money to / drawing down its account at the government’s bank, the Fed, then the bank’s liability to the Treasury is terminated, but the Fed’s liability to the Treasury remains. It needs to be terminated by issuance of Treasury dollars, Treasury credits, the truer money, which the Fed- fiscal-agent can only obtain by putting some Fed funny money in the TGA. In the real world, Treasury debt, US Treasury checks, Treasury money back Fed reserves, NOT vice versa. Fine, if the Fed refuses to cash gubmint checks – then the gubmint sez – I don’t accept FR notes/reserves (at par) for taxes, only direct Treasury debt. Again, consolidate or separate, but do it consistently. Money is a relationship – and who would you like to be in a good odor with, have a positive relationship with, be a creditor, rather than a debtor of – Uncle Sam in DC with his legion of revenooers & henchpeople – or a bunch of snobs educated into ignorance sitting in the Eccles building?
Wray: Nice deconstruction here by Calgacus. The Fed can only issue “fiat money”; the Treasury issues “tax driven money”. Which would you rather tie your fate to?
The Fed is just a bank. It lends its IOUs into existence. Its stand-alone IOUs are desirable only to those who owe the Fed. They can use the Fed’s IOUs to pay down their own IOUs to the Fed. But the Fed cannot force anyone to become a debtor to itself.
The Treasury is the branch of government that is responsible for levying and collecting taxes that Congress has mandated in its legislation. (Technically, yes I know, the IRS is the Treasury’s agent that does this.) Those taxes drive the Treasury’s currency. The Treasury gives value to the Fed’s IOUs (reserves and FRnotes) because it is willing to accept those in tax payment. If the Treasury refused to do so, the Fed’s liabilities would be no better than those of the Bank of Podunk. Without the Treasury standing behind the Fed Bank of Podunk, we’d be back in the 19th century where bank notes did not clear at par.
Our deconsolidators love to believe that it is the Fed that is all-powerful and the poor little Treasury (and by extension Uncle Sam) is subject to the whims of our unelected “private” Fed.
What a load of Malarkey. The Fed is legally a creature of Congress. In times of war or crisis, the Fed is explicitly subjugated to the Treasury. In other times, the Fed serves at the pleasure of Congress and the Treasury albeit with little oversight. While I think that is a mistake, it doesn’t make the Fed either independent or dominant.
What I was trying to do in my own piece was to show that there is a symmetry between the way government spends and the way banks lend. Government needs to spend currency before taxpayers can use currency to pay taxes. Banks need to lend deposits before debtors to banks can repay loans using deposits.
In the past, the government’s treasury alone handled the operations associated with fiscal policy. It literally spent currency and then collected it in taxes. Modern governments have divided responsibilities between the treasury and the government’s bank, the central bank. The government’s bank makes and receives payments for government. Treasury still issues some of the currency, but most of it comes from the central bank (FRnotes).
Most Treasury payments are made by checks or by credits to bank accounts — just like firms and households make most payments by check (or direct deductions).
Central banks have a second function that has come to dominate the thinking of most observers: they are the bank for banks — running the payments system and maintaining par clearing.
These two functions are linked on the balance sheet of the central bank. We could separate out the fiscal policy operations and have the treasury do all of them. The complication is that then private banks would need to have accounts at the treasury—so that treasury could make payments directly to their accounts, and deduct those accounts when taxes are paid.
Banks would still need accounts at the central bank for clearing with each other.
So if we really did “deconsolidate” the Fed and Treasury, banks would have to have accounts at both. It would “work”, but why bother? Why not continue with the Fed acting as the Treasury’s bank, and also as the bankers’ bank?
Oh, but it is just so confusing! You mean the Fed serves two functions? It is the bankers’ bank and the government’s bank?
If economists could get their minds around this, they’d stop worrying about the internal record keeping between the Fed and Treasury. The Fed and Treasury know what they’re doing.
How do we know? Checks are not bouncing and the Fed is hitting its rate target.
If the Treasury’s checks start bouncing, we’ll know it is time for Congress to step in and give Janet a good talking-to.
Until then, I guess the deconsolidators will just need to hold their breath.