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 [...]
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 H.4.1 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.