Casey Mulligan writes
I agree that unemployment benefits and other safety net benefit payments are many times financed with taxes in the future or taxes in the past. But that “financing channel” still does not make the payments free from the perspective of today’s economy.
Suppose the government has been borrowing the money to pay for unemployment benefits. It borrows money by selling bonds. The purchasers of those bonds have less to spend on something else.As I explained last week, government borrowing to pay for safety net benefits may increase consumer spending and reduce investment spending, because it does put money in the hands of consumers.
Lets try it this way. I am going to number each statement so anyone can point out the number where they think we disagree.
- The Treasury market is fully liquid
- Anyone who wanted to buy a T-Bill could.
- Yet, people are not choosing spend all of their funds on T-Bills
- They are not doing so because at the current interest rate their holdings of T-Bills are optimal
- If the interest rate on T-Bills does not change private parties buying behavior will not change
- If the interest rate on T-Bills rises above the interest rate paid on excess reserves then banks will use excess reserves to buy T-Bills
- Banks will continue to do this until the price of T-Bills falls to the interest rate on excess reserves
- Once Banks have achieved this the interest on T-Bills will be once again equal to the interest rate on reserves
- The incentives for non-banks buyers will not have changed
- Thus all the funds to pay for T-Bills are drawn from excess reserves
Where will the money come from?
It will come from here:
To be clear for this example there is nothing special about the excess reserve set up, apart from the way the Fed has always worked. However, it should be abundantly clear where the money comes from now that there is a huge pile of money and not simply the daily creation and destruction of reserves to make the excess equal zero.
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Wednesday ~ February 22nd, 2012 at 11:07 am
Alex Godofsky
Isn’t the problem with step 4? Because we’re at the ZLB – and presumably the natural nominal rate on T-Bills would be negative, if that were possible – bonds are underpriced and so in some sense the market isn’t actually clearing. Right?
Wednesday ~ February 22nd, 2012 at 11:39 am
RickR
The question that the chart raises in my mind is why do the banks accept the 0.25% yield on excess reserves rather use these reserves on other higher yield assets? 20 year home mortgages are around 3.25%. Twenty year AAA corporate bonds are around 4.5%. Are these really so risky that their effective yields drop to below a quarter percent? There seems to be a large risk-aversion going on here.
This raises a question as to you point 5. If the private parties come to accept a bit more risk, then the private parties buying behavior will change even if If the interest rate on T-Bills does not change.
Wednesday ~ February 22nd, 2012 at 1:08 pm
Greg Ransom
Except this isn’t an “Austrian” argument and Casey Mulligan isn’t an Austrian economists.
Other than that, Brad DeLong is right on spot. Brilliant man. Honest as the day is long …
Wednesday ~ February 22nd, 2012 at 3:34 pm
Wonks Anonymous
Karl doesn’t mention the word “Austrian” anywhere here. Checking Delong’s blog I find this, but that also links to a separate post on Hayek.
Wednesday ~ February 22nd, 2012 at 7:51 pm
Greg Ransom
Is DeLong wrong that the “Brad” in the title is one “Brad DeLong”.
I don’t know.
DeLong is spreading bunkum regardless.
Wednesday ~ February 22nd, 2012 at 5:02 pm
Lord
Resistance is futile!
Wednesday ~ February 22nd, 2012 at 10:07 pm
Doc at the Radar Station
Wow! This is good stuff, and I think you are right 100% on this one. No worries about bond vigilantes. Glad my mortgage is tied to the 1-year treasury.
Thursday ~ February 23rd, 2012 at 12:01 pm
Andy
A big fallacy in the argument is that banks buying T-bills does NOT change the amount of reserves in the banking system.
1. If one bank buys T-bills from another private party on the secondary market, then reserves just switch hands.
2. If a bank buys newly issued T-bills directly from the Treasury, the reserves go to the Treasury’s account at the Fed. But the Treasury issues bonds exactly to finance the deficit. And when it finances the deficit (pays for stuff and workers etc), it uses these reserves for payment. So the reserves flow back to the banking system.
The accounting is pretty simple. Once reserves are created, only a central bank action can withdraw them from the market. The Fed has to sell something or conduct reverse repos or any other transaction in which it “gets reserves back”.