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.

  1. The Treasury market is fully liquid
  2. Anyone who wanted to buy a T-Bill could.
  3. Yet, people are not choosing spend all of their funds on T-Bills
  4. They are not doing so because at the current interest rate their holdings of T-Bills are optimal
  5. If the interest rate on T-Bills does not change private parties buying behavior will not change
  6. 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
  7. Banks will continue to do this until the price of T-Bills falls to the interest rate on excess reserves
  8. Once Banks have achieved this the interest on T-Bills will be once again equal to the interest rate on reserves
  9. The incentives for non-banks buyers will not have changed
  10. 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:

FRED Graph


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.