mmt knows the fed sets rates

8/12/2019 MMT Knows the Fed Sets Rates

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MMT Knows:Interest Rates are Set Bythe US Federal Reserve


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All rates on US TreasurySecurities, regardless ofmaturity, are indirectly setby the Federal Reserve

While not its explicit policy,by setting the overnight rateand various direct lending

rates, the Fed determinesthe nominal yields on all USTreasury Securities


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Quick Lesson: We use what are calledPrimary Dealer Banks as middlemen

between two branches of government: theFederal Reserve, and the US Treasury.

These PD banks can borrow from the Fedat one rate, and lend to the Treasury at a

higher rate. This is silly and totally unnecessary, and

represents yet another form of Wall StreetWelfare (Marriner Eccles called it hocus

pocus back in the 1940s!) Nevertheless, as long as you understand

this arrangement, you can understandthat the Treasurys account can never be

short of funds


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Lets start by looking at two base rates from the Fed:

The Effective Federal Funds Rate, which the Fed sets indirectly throughOpen Market Operations, and

The Discount Rate, the rate at which the Fed will lend directly to itsmember banks, which the Fed entirely controls (hence the even lines)


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As we can see, the two track each other pretty closely.


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The Fed generally likes to make direct borrowing a littlemore expensive than borrowing in the funds market,especially recently

Starting in 2008, Interest on Excess Reserves (IOER)changed the game in the fed funds market, while thediscount process remained similar

Some spread remains due to counterparty friction andbecause FHLBs cant get IOER

Since 2003, financially strong and well-capitalized bankscan borrow under the Discount Window primary creditprogram at a penalty rate above the target fed fundsrate (rather than a subsidized rate, as in the past). Forbanks eligible for primary credit, the newDW is a no-

questions-asked facility. Namely, the Fed no longerestablishes a banks possible sources and needs forfunding to lend under the primary credit program.Instead, primary credit for overnight maturity isallocated with minimal administrative burden on theborrower.


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Comparing Rates

So lets compare rates that we know the Federal

Reserve controls directly, with interest rates onUS government debt, known as TreasurySecurities

Both the Treasury and the Federal Reserve create

liabilities:

Fed liabilities are called reserves, and can be withdrawn fromthe banking system as Federal Reserve Notes (cash). They donot bear interest

Treasury liabilities are Treasury securities, and do bear interest

All that monetary policy involves is swapping one liability foranother

The US Treasury issues several types of thesesecurities, with varying maturities and coupons.


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Comparing Rates

As we will see, both types of government liabilities

are closely related Think of it this way: Treasury Securities are to

reserves, what ice is to water

A security, like ice is a less liquid form of the samething

Just as water expands when it freezes, dollars intreasuries expand through coupon and interestpayments

For this exercise, well take a look at the 1-month,

3-month, 6-month, 5-year, 10-year, and 30-yearsecurities

Keep a close eye on how rates on these Treasurysecurities compares to the Federal Funds rate


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Example #1 Lets start with a short term security, such as the 1-month note:


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What do you notice?

The FF acts as ceilingto the 1 month rate, since Fed Funds are uncollateralized


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Ok, how about a 3-month note?

Oh look, its the same damn line (basically)


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6 Month Note with shorter time period:

If I had not used different colors, you probably

could not have seen the difference


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Ok fine, how about a 5 year bill?

Here, we can see some pricing of 5 years worth of inflation riskagainst an overnight rate, but the price still follows the funds rateneatly


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The benchmark 10-year bill, same story

A little more risk, a little more expensive. But still, follows the Fed!

However, there is enough daily noise to lead people to miss thiscrucial fact. This is why the long picture is so important!


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And finally the 30 year Bond:

Weakest correlation thus far, but still obvious


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Put it all together..

All of these nominal yields follow the Federal Funds Rate

Markets do a little pricing, but the Fed is always in thedrivers seat


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Think of it this way: Treasury Securities arejust time deposits at the Fed, like a Certificateof Deposit is a time deposit at your bank.

Just as longer CDs have higher rates; longer

Treasuries have higher rates Federal Funds are like a checking account

(demand deposit) at your bank. Since it is themost liquid, it has the lowest yield.

All Treasury Securities are just priced out ofthat overnight rate.

The longer the term, the higher the yield(FF rate+time)

An everyday comparison


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A Treasury Security is just a CD at the Fed

When you buy a CD, do you think of yourselfas lending to the bank? Not really. But this iswhat you are doing without realizing it. You

probably think of it as just a safe, interestbearing place to put your money

Treasury Securities are similar. While we thinkof buying them as lending to the USTreasury, we are really just putting money

into a safe, interest bearing account, whichfunctions as a CD/savings account at the Fed


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The Fed always buys bonds to hit its targetrate, whatever that may be

The rate is voted on by the FOMC, themembers of which are appointed by the USPresident and confirmed by the US Senate-not markets, bond vigilantes, the Chinese, or

whatever

How does this work into normal Fed operations?


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How does this work into normal Fed operations?

That the target rate now happens to benear zero doesnt matter. The Fed alwayshas to set some rate! This rate haschanged over time, as we have seen

Money market conditions are based on

whatever the Fed wants them to be Therefore, bond buys are not and cannot

be discretionary! If the Fed buys too manybonds, the funds rate would sink below itstarget rate, forcing it to sell back thesame amount of bonds just to raise therate back up its target again


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This means there are no suchthings as

helicopter drops

printing money

debt monetizationinterest rate suppression

loanable funds


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Quick note on Quantitative Easing (QE)

There has been an enormous amount of confusion andhyperbole surrounding the recent unconventional monetaryoperations used since the crisis

Many (now-discredited) economists, operating withoutdated ideas, were predicting hyperinflation and disaster

But QE is just one big FF operation. There is littleprocedural difference between QE and everyday Fedoperations.

The only thing that differs is the targeted metric. In QE, theFed directly seeks to affect Treasury and MBS rates, insteadof indirectly through an overnight rate, as described in

previous slides

The Fed does this by executing a certain quantity of bondpurchases- $X per month.


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No correlation between debt and rates

See how the rising debt affects interest rates?

Me neither

Debt

Rates


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And its not just the United States.

Look at Japan:


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Implications for the US Congress

So now it should be obvious- The Fed sets

all rates! Why?

Because WEissue our own fiat currency,WE get to decide how much interest, ifany, to pay on it

Not Wall St., not foreigners, not markets,not bond vigilantes

Thats what it means to be a monetarilysovereign government

Say it with me:Uncle Sams a moneysovereign, markets dont tell him what hecan spend!Congress does!

Th t h t thi


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Thats how you get this:

A government that adds, not subtracts to the wealth of its

citizens when it deficit spends.


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You still think the Federal Government canrun out of money?

Really?


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Youve made Marriner Eccles mad!


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Who was Marriner Eccles?

The original MMTer, Marriner S. Eccles was thearchitect of the Banking Act of 1935, whichrestructured the Federal Reserve System into itscurrent form. He was heavily involved in the BrettonWoods negotiations that created the World Bank andInternational Monetary Fund, and he served as a keyeconomic policy advisor to President Franklin D.Roosevelt.

Chairman of the Federal Reserve System, during the

1930s and 1940s

Played a huge role in monetary and fiscal systems ofthe United States during those years.


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This building

is named after him (the Fed Board of

Governors building on Constitution Ave)

70 ld i d f M E l


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Interest rates ongovernment securitieshave been and willcontinue to bedetermined by theOpen Market

Committee it isunrealistic to presume,that if Congress votesfor expenditures butdoes not vote forsufficient taxes to

cover theexpenditures, themoney market shoulderect barriers todiscourage the

practice

The fact that they[Congress] cannot

go directly to theFederal ReserveBank to borrowdoes not mean thatthey cannot goindirectly to theFed, for the veryreason that there isno limit to theamount that theFederal Reserve

System can buy inthe market. This isthe way the warwas financed.

70-year-old wisdom from Mr. Eccles


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So it is illusion to think that to eliminate or to restrict thedirect borrowing privileges reduces the amount of deficit

financing. Or that the market controls the interest rate.Neither is true.

The facts of the matter are that the Federal ReserveSystem gets practically all of those bills every week,through an arrangement with the Government bonddealers, to put bids in at 3/8ths, with complete protectionby the Reserve banks to take them off their hands beforethey even pay for them. This is what we call hocus-pocus,and we are of the opinion that we could exchange directlywith the Treasury


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More evidence

Further argument form Beardsly Ruml, Chairman of the New YorkFed in 1946:


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Eccles laid all this out during his tenureat the Fed. Unfortunately, most of hiswords have long since been forgotten.

For more Eccles documents, go to fraser.stlouisfed.org/eccles


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The Federal Reserve is independent in the

government, not of the government

There is no reason to pay banks a commission

to serve as middlemen between inter-agency,intra-governmental transactions.

While statutory changes would be ideal (i.e.

HVPCS, direct unlimited overdraft authority),we feel that in the short term, mere rhetoricalchanges could suffice.


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The word deficit is itself very prejudicial.Americans have been trained, like Pavlovssalivating dogs, to elicit fear at the mere mention of

the word. It implies some sort of lacking or runningout of things, which as we know has no relevance tofederal finance, so

We strongly suggest using these terminologyupdates:

Instead of deficits or borrowing, saynet financial injection or net financialassets

Instead of spending say federaldeposits

Instead of debt say risk free savingsaccounts or simply Treasury Securities

l d


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Terminology Updates

So lets stop using self-defeating, fearful rhetoric like

out of control debt

skyrocketing debt

crushing debt

Pay China First

Only fires, wars, climate change can get out ofcontrol. Digital balance sheets cannot get out ofcontrol!

We need to use MMT to deploy a fierce practicality onfiscal issues to counter all the right-wing deception

Right-wingers feed on fear and confusion, so we haveto stop using confusing terms ourselves


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Bond markets do not get to discipline our US government;the Chinese to not get to discipline our US government;Wall Street banksters do not get to discipline our

government. Only we the voters get to do that. Thanks tothe genius of the founding fathers, our participatorydemocratic form of government has been Constitutionallyvested with the monopoly power of currency issuance.

No Chinese Shylock is going to sail across the Pacificdemanding a trillion pounds of American flesh. It justdoesn't work that way. We are Americans, and only wecan control our economic destinies.

The Chinese dont command the US Treasury anymorethan Chinese generals command the US Pentagon. Do USsoldiers take orders from Chinese military leaders? Ofcourse not, and the Treasury/Congress does not takeorders from Chinese bankers.


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Therefore, for the purposes of clarity, we believe that there is noreason why any supreme, sovereign government should be issuingdebt at all. Instead, such governments should be issuing debt freecurrency, that could be identified, or at least thought of, as equity.

The US government did this previously during the Civil War, whenAbraham Lincoln ordered the Treasury to issue its own, debt freecurrency known as United States Notes. The Treasury continues todo this in limited form every time it mints coins and assigns themvalue.

Thomas Edison in 1921: If our nation can issue a dollar bond, itcan issue a dollar bill. Both are promises to pay, but one promisesto fatten the usurers and the other helps the people.


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Nearly every publicly traded corporation fundsitself through a mix of debt and equity

issuance; why should the federal governmentnot do the same? US dollars could be referredto as American Equity, and would represent anominal claim to the massive productionpower of the United States economy.

Further, direct creation of reserve balanceswould actually be less inflationary than thecurrent system of security issuance. Reservebalances, unlike securities, are inert forms ofgovernment liabilities, because they do notcontinuously pump coupon or interestpayments into the economy.


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So how could we go about doing this? Well the answer is, wealready have, during World War II. Along with other NewDealers, Federal Reserve Chairman Mariner Eccles ushered in theera of modern public finance

Due to emancipation from the gold standard and Mr. Ecclesleadership, this was one of the first times in human historywhere a nation at war ran out of real resources before it ran outof money. Finally freed from self-imposed financial constraints,this new approach to public finance allowed the allies to produce

a war machine of unprecedented size and strength:

http://youtu.be/l2ECyYHPnhg?t=2m43s
http://youtu.be/l2ECyYHPnhg?t=2m43shttp://youtu.be/l2ECyYHPnhg?t=2m43shttp://youtu.be/l2ECyYHPnhg?t=2m43s


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We strongly feel that the enormous 21stcentury challenges of income inequality,middle class collapse, and global climatechange cannot be sufficiently tackled until thehow do we pay for it question has been fully

answered, and only MMT has that answer.

We can both succinctly describe theoperational realities of the current system,and suggest updates; we can provide both

short term patches, and long term paradigmchanges, and we have the academic backingand persuasive materials to make abulletproof argument.


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Sources Federal Reserve Economic Data (FRED), Federal Reserve Banks

of St. Louis

Recent Developments in Monetary Policy ImplementationbySimon Potter, Executive Vice President, Remarks before theMoney Marketeers of New York

Marriner Eccles Testimony- Direct Purchases of GovernmentSecurities By Federal Reserve Banks. Hearing before theCommittee on Banging and Currency, House of Representatives(1947)

Can Taxes and Bonds Finance Government Spending? ByStephanie Bell, July 1998

The Greatest Myth Propagated About The Fed: Central BankIndependence (Part 2), L. Randall Wray, January 2014

Soft Currency Economics II, Warren Mosler, October 2012

Liberty Street Economics, Blog from the FRBNY

mmt knows the fed sets rates

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