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The problem is never the amount of debt, but the backing of that debt. It is true that government debt is useful: money is a government liability (zero coupon, infinite maturity for cash) and treasuries are a safe security (until we default) in a world where safe securities are scarce. In the 90s, people were worried that by lowering deficits we would create a shortage of government debt and safe assets. This was completely misguided because we can always issue more debt and use the proceeds to buy valuable assets to finance the repayment.
When people say that they are worried about government debt, they mean relative to the ability to repay. Since we see that increases in debt don’t go towards increasing our ability to repay it but rather decrease it, it is natural to say that we want government debt to stop increasing.
I actually think that there is not enough Treasuries around as we can see by the convenience yield that they have. This convenience yield says that we could profit by issuing debt and investing in real assets, turning the federal government into a massive bank (which it kind of is). Yet issuing more Treasuries and then wasting the proceeds is not sustainable.
But what are the 'proceeds' in your formulation? They issue a government liability that pays the policy rate, swap it for a different government liability that pays the policy rate (central bank reserves), and then spend it. There is no difference between reserves and treasuries, so calling one 'money' and calling the other 'debt that requires backing and an ability to repay' is only serving to confuse your thinking.
It's akin to printing up a new $5 bill, then exchanging it for quarters because that's what the arcade takes. No more or less money in any form. They can print as many central bank reserves or treasury securities as they want, so 'repayment' is a non issue. Inflation is the only relevant concern.
When the government issues treasuries and receives money, it can spend that money. When the federal reserve “issues securities” (more accurately, the ON RRP), it withdraws that money from circulation.
If the government were to just take the money from the issued bonds and just sit on it, then there would be no effects (except those via the relative supply of money and treasuries). But it issues debt to get money to spend, so after issuance, the amount of things the government can afford at that moment has increased.
The point is that issuing debt gives you resources now that you have to repay later. Money or nominal versus real does not change that.
My thinking is not confused because I admit that money and treasuries are (consolidated) government liabilities, both of which need backing and ability to repay. People get confused with “fiat money” and think that it doesn’t require any backing. But the value of fiat money today depends on the expectations of its value in the future; that value depends on the demand and supply of money then. If the federal reserve has no assets, then it cannot react to a lower demand for money by withdrawing the money from circulation so the value of money would be lower. Therefore, if you don’t have “ability to repay”, your currency in aggregate and in real terms cannot be too valuable.
The usefulness of money allows you to get some value without any backing (for a different example of that look at Bitcoin). But at the margin, if you want an economy with enough money in real terms you must have backing.
Finally, repayment in real terms is the concern. Inflation is default. No serious monetary economist will ever tell you that a central bank has no meaningful budget constraint (but you might read that in a paper in the AER).
I don't know what you would mean by "backing" in this context. The treasury issues IOUs that pay interest (bonds/bills/etc), and they make those interest payments by issuing more of the same IOUs in the future: they indefinitely roll over. The central bank issues IOUs that pay interest (reserves), and they make those interest payments by issuing more of the same IOUs in the future: it indefinitely rolls over. There is no promised future real 'value', it is what it is, and if there's inflation, so be it (other than the inflation-indexed bonds). And the only thing any of these government IOUs can be redeemed for when returned to their issuer is tax relief (or you can freely swap them for other different types of government IOUs).
They are the monopoly issuer of the currency, and thus can either control price or quantity. There was a bit of a monetarist experiment with Volcker where they tried to control quantity and let price float, but that just caused the price (interest rate) to keep ratcheting up, because commercial bank lending creates deposits endogenously. They have since recognized that they just have to fix price and let quantity float, to run the system properly. So they just set the interest rate and do not care about 'demand for money' - it's infinitely available at some price. We're simply talking about numbers in account balances.
Whose concern? The government doesn't care. And no one else's opinion matters. They are not beholden to the market. If inflation ticks up, that is definitely not the same as defaulting on the debt. We still need the government's IOUs to pay taxes, so they will perpetually be valuable to that extent.
Not sure what you mean by a central bank budget constraint. They have various expenses each year, but any preparation of a formal budget is to make their case to congress that they're behaving well and shouldn't be slapped on the wrist. It's not an economic constraint. They tend to end up in profit every year and just dump that amount into the treasury's account.
Bitcoin has no issuer offering a redemption value, and thus is a commodity rather than money. As an economic instrument, the fair value is $0. Any valuation above that might be a small amount for the utility of making transactions (would work if each btc were 1 cent or something), and otherwise just speculative (don't get caught holding the bag).
If you're saying that bitcoin has no 'backing', but US dollars have 'backing', maybe you're using that term for what I'm calling IOU 'redemption'? (returning an IOU to its issuer, to get what is 'owed')
Yes, there is. It made somewhat explicit by inflation targets. I don't understand at all what you mean by "if there is inflation, so be it."
Sure, they set a price but how is that implemented? It is implemented by changes in the quantities. Yes, the rule says adjust the quantity as much as needed to get to the price. But to do that quantity adjustment sometimes you need to reduce the quantity in the market (OMOs sometimes require 'buying back' money) and for that you need assets that the market values.
This is my point about budget constraints. The central bank supplies money which, to think clearly, we should measure in real terms. The amount of money in real terms that a central bank can supply is limited by the assets that they hold because otherwise the bank cannot maintain the real value of money in the face of demand shocks. Demand matters because it is obviously easier to maintain the value of your currency when its demand is growing than when its demand is declining. I don't see how this point is hard to understand, but it is easy to show in a very simple model.
The difference between defaulting on debt and defaulting on money (inflation) is who gets to bear the losses of the default. This is easy to see if you think of money as an infinite-maturity bond with zero coupon (for currency) or some coupon (for reserves). Your argument proves too much: if it were true, there would be no issues with the monetary crises in the late 20th century. Taxes are set in nominal terms, but they are set with a delay so the government will lose in real terms with inflation (after we are all bumped up to higher brackets).
In monetary economics, commodity money means an asset or durable good that has intrinsic value. That is, value for non-monetary uses. In this sense, Bitcoin is not commodity money. Backing need not be about redemption. Think of stock buybacks, stocks are backed by the companies cash flows. You can't show up with one share and demand a payment from the company, but there is an implicit expected future value of the stock and the buybacks help maintain it. Bitcoin doesn't have that and the dollar could work without that, but it would mean a low aggregate stock of money in real terms which is bad because we need money valuable in real terms to make transactions.
This was the old rate maintenance regime, but unfortunately you're almost 20 years out of date here. The way they implement the policy rate is by simply paying that chosen rate of interest on reserves directly. They absolutely flooded the banking system with excess reserves, in order for the interbank lending rates to get pinned to that same 'floor' rate. For those entities holding reserves which aren't legally allowed to be paid interest directly, the Fed pays them interest anyway, using overnight reverse-repos that you mentioned before.
I believe basically all central banks switched to this approach rather than OMOs with 0 excess reserves (it's way easier this way).
And with this regime, there's basically no difference to the banks whether they're holding reserves or short-term securities, so the Fed's balance sheet composition and size can be changed at will.
I can't exactly tell, but it kind of sounds like you're describing some kind of conception of banking like they're storing real objects. Like you 'deposit' some gold bars and your jewelry, and they issue you an account balance and/or a paper money receipt for it? In that kind of idea, I can see how you would be talking about the bank's assets and how they 'back' the value of the credit money. And that kind of story is like where the 'fractional reserve -> money multiplier' ideas came from.
That just has nothing to do with how modern banking actually works (nor even really past banking apparently, the goldsmith idea was basically always a misconception or story for convenience). The Fed's balance sheet assets are almost entirely just treasury securities, which they 'bought' by creating their own liabilities (reserves). It was just a pure balance sheet expansion, which is how modern banks work. Maybe the terminology here is that banks in the real world use 'finance' model of banking while some dated textbooks discuss hypothetical 'intermediation' models.
You're basically just referring to things having value for various reasons. 'Backing' means there's a subject behind it, guaranteeing a value (or trying to). It's just going to serve to confuse thinking to bring out 'backed by' when it's not an actual strong case. Does a government want their currency to be more valuable than less, like a company wants their stock price to be higher rather than lower (because look at our great cash flow this quarter)? Yeah, but those are categorically different than an IOU that promises some redemption value like gold or PS5s. Now if a company has a standing offer to buy back any existing stock at some price, that is more of a real backing.
I didn't follow this part, can you mention the crises you're referring to?
You should be more charitable than this. How do you think the level of reserves changes over time, simply from the payment of interest on reserves? How do they go down then? You can check the NY Fed for this; there is also data.
Perhaps I wasn't clear enough. The point is that the amount of money in nominal terms is not economically relevant. (If you search for the "most valuable currencies," you will encounter articles like this one in Forbes that are completely useless). The economically relevant quantity is the "real value" of the stock of money or the market(!) value of money in terms of other goods and services. You can do this without 'backing' as in Bitcoin or monetary models where money is inherently useless and the aggregate nominal stock of money is held constant; so it is a separate concept from backing. As a follow-up point, I mentioned that if you want to increase the real value of the total stock of money, you need more backing.
Here we have a strong disagreement. In my view (which I believe is in line with theoretical models of money), a key component of money is simply asset pricing with a 'convenience yield' or non-dividend uses. Of course, there is more to it, but understanding that gets you a long way. The 'convenience yield', which is the spread in return between money and the risk-adjusted market portfolio, is like a (rental) price for money (in real terms) and it is lower when the central bank supplies more money (in real terms) as the central bank simply works its way down a demand curve. So money is just a security, a very special one for sure, so the same ideas of 'backing' for stocks and bonds apply to it.
I was referring to episodes like the ones explored in The Monetary and Fiscal History of Latin America. I might be able to understand your argument better if you tell me how it is consistent with these episodes.
The level of reserves definitely changes over time, and they can buy & sell at will. But that's irrelevant to the interest rate maintenance after 2008, because the system is absolutely flooded with excess reserves. You just linked to the OMO page where they said it:
The old system was that they had to mop up any excess reserves to keep them at 0, using OMOs, or else commercial banks would have a race to the bottom of trying to lend them to each other accepting lower & lower rates, and the central bank wouldn't maintain their target rate.
The new system is that they swapped billions/trillions of treasury securities into excess reserves, and then just directly pay the policy interest rate on those reserve balances. As of 2006, they were already planning on making this change to the interest rate maintenance regime in 2011 (because it's a much better system and makes everything easier), but moved it up to 2008 during the crisis to have the better tools at that time.
The currency is infinitely elastic: always more available to be created at a given price (at commercial banks and up at the central bank). These are simply expanding balance sheets of credit-debt relationships, rather than a relatively fixed quantity of things. When people still have the 'money as a thing' mindset, they get hopelessly confused in the modern financial reality, trying to track nominal & real stocks of money and switching between a dozen different monetary aggregates, trying to make any sense of it in the face of QE & such. Chosen nominal rates, floating quantity stock, dynamic real price level not in anyone's direct control.
OK yeah the concept of inflation being "what one dollar buys", whereas a different concept is "what all the dollars buy". But this isn't like some kind of main policy concern where everyone is trying to rank highly on that kind of list, with Kuwait currently winning. Countries are trying to run their economies well, aiming for a balance between low unemployment and low inflation. The currency is merely a tool, and outside of any exchange pegs or various temporary gold standards, they aren't backed by anything. They're valuable because each country taxes its citizens and only accepts their own currency in payment.
That might be a "sufficient but not necessary" kind of point. The price level is totally dynamic so you could get deflation out of nowhere just from the "animal spirits" changing and everyone trying to save monetarily, increasing the real value of money. Or you can keep the economy running and extremely productive and end up with the money stock more valuable even with some inflation, being nominally larger. You can implement policies that incentivize saving for retirement in regular bank account balances and move the needle quite a bit.
Now maybe we could announce that we were foolish not to "back" the currency with anything of value in the central bank, and that we're reimplementing a gold standard, going back to the wisdom of the 19th century. And it could be sufficient to get people to immediately value money slightly more in comparison to stocks or something. But certainly not necessary.
I don't know, looking up convience yield briefly, it doesn't appear to have anything to do with currency. It kind of seems like getting tied in knots without realizing the basic chartalist logic about taxes being the driver. Meanwhile none of that suggested anything about the subject of backing.
Wow yeah that is a pretty big set of examples. The entire late 20th century history of a ton of different developing nations with all kinds of various macroeconomic paths pursued. I mean, multiple countries have literally switched on & off of simply using USD as their currency. I have no expertise to weigh in very deeply, but these aren't exactly examples of well-run macroeconomies just getting tripped up.
I think the original point of contention was about "the ability to repay" government debt. Where the relevant context was the US, but generally countries that have their own floating currency. In this context, government debt is just money & currency in a different form, and it just rolls over indefinitely, so there's no "repayment" really. As for the 'inflation = default basically' angle, the US offers some limited inflation-indexed securities as a nice thing for people who want it, but otherwise makes absolutely no promise of bonds/reserves/notes/coins holding their value.
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The damage isn't done by money simply being created or spent. It's done when it's used to Dig Up and Fill Holes Again, or worse, paid to my political enemies to actively undermine my interests. The money is then "backed" by holes dug up and filled again, or hit pieces against Twitter nobodies.
These things probably don't generate as much real wealth as what the private sector would back it with instead, if it was allowed to create the money instead.
Well the private sector definitely creates money and real wealth as well, so it's not a competition for any kind of limited quantity of financing. But it does so pro-cyclically: when times are good there's lending & investments everywhere, but everyone clams up when times are bad. The government can be the counter-cyclical engine, stopping the paradox of thrift.
If you would have otherwise had high unemployment, then creating money and paying those unemployed people to dig holes is at least better than letting them atrophy away, in terms of "damage done", because at least they go on to spend that money and generate more demand. But yeah it would always be a better idea to put people to work generating some kind of base-level valued output (goods/services). Ideally the government catches people at the bottom unemployment end, and they can as quickly as possible transfer back into the private sector to make more money and do something valuable.
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