Some Unpleasant Monetary Arithmetic

November 17th, 2013
in Op Ed

by Dirk Ehnts, Econoblog101

Editor's note: This discussion is a follow-on from Thomas Sargent on Sovereign Debt.

Sargent and Wallace in their seminal 1981 paper Some Unpleasant Monetarist Arithmetic describe a monetary system which is very different from what we see today. On page 1 the authors write:

The public demand for interest-rate bearing government debt constraints the government of a monetarist economy in at least two ways [...] upper limit on the real stock of government bonds [...]

Follow up:

The problem with this is that the Federal Reserve Bank holds US treasury securities outright, as data from the FED shows:

FEDERAL RESERVE statistical release


Factors Affecting Reserve Balances of Depository Institutions and     
Condition Statement of Federal Reserve Banks                        November 14,2013

1. Factors Affecting Reserve Balances of Depository Institutions
Millions of dollars
Reserve Bank credit, related items,         Averages of daily figures     Wednesday  
and  reserve balances of depository     Week ended Change from week ended Nov13,2013 
institutions at Federal Reserve Banks   Nov 13, 2013  Nov 6, 2013 Nov 14, 2012              

Reserve Bank credit                     3,822,130  + 19,225   +1,029,811  3,863,922  
Securities held outright (1)            3,590,340  + 17,049   +1,000,240  3,630,670  
U.S. Treasury securities                2,131,729  + 11,211   +  480,874  2,137,037  
Bills (2)                                       0         0            0          0  
Notes and bonds, nominal (2)            2,029,515  + 11,181   +  461,558  2,034,815  
Notes and bonds, inflation-indexed (2)     88,589         0   +   16,245     88,589  
Inflation compensation (3)                 13,624  +     29   +    3,069     13,633  
Federal agency debt securities (2)         59,080         0   -   22,822       59,0

So, the public demand for interest-bearing government debt does not constrain the government by setting an upper limit on the real stock of government bonds. Why? Because the central bank demands interest-bearing government debt. This is called quantitative easing (QE) and has happened during the financial crisis. Here is how that developed exactly:


Which means that whatever is happening in reality now, looking at it through a Sargent/Wallace lens will not show you what is going on.

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