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Some aspects of federal government finances – John Hermann

One reason why many find it difficult to believe that federal tax payment entails the destruction of money, while federal government spending entails money creation, is their failure to understand the difference between currency issuers and currency users. Currency users can run out of money, but currency issuers cannot. Another related reason is the common perception that tax payments entail the transfer of money from the payee – or perhaps from the payee’s bank – to a federal Treasury account at the central bank (in Australia, the RBA). They are encouraged to believe this because they know that the federal Treasury’s account with the central bank increases upon receipt of a tax payment and also decreases when the government spends. Notwithstanding that money appears to be transferred in these ways, the perception that it does so is a carefully cultivated illusion. Here is my justification for these assertions:

  1. A monetary sovereign government is one which is responsible for issuing the nation’s currency.
  2. The nation’s currency may be defined as the conjunction of (a) coins and banknotes that are used for the public’s buying and selling activities and (b) exchange settlement balances held at the central bank (banking reserves) – which can be used to acquire bank- notes and coins on demand.
  3. The national money supply may be defined as the conjunction of (a) retail deposits in commercial banking institutions and (b) coins and banknotes in the hands of non-banks.
  4. Unlike a currency user, a currency issuer has no need to save or store the currency that it issues (or its proxy — retail bank deposit money).
  5. When a monetary sovereign government spends, the money supply always increases and the supply of banking reserves increases. The part of spending that exceeds taxation receipts, over an accounting period, is often described as deficit spending.
  6. Such deficit spending entails the creation and distribution of net financial assets for the non-government sectors.
  7. There are two well understood mechanisms by which this deficit spending may occur: (a) The federal government may sell Treasury securities to the private sector, freeing up fiscal space for accommodating that spending, and(b) The federal government’s spending may be directly funded by the central bank (which sometimes happens in Australia and other countries, and is usually accounted as an “overdraft”, however the practice is discouraged on the grounds of “sound finance”).
  8. The instruments of federal government debt (Treasury securities) can be more usefully thought of as a component of broad state fiat money, rather than a form of debt.
  9. Where there are no legal restrictions on the operation of either 7(a) or 7(b) it may be said that the federal government is unconstrained in its ability to create net financial assets for the non- government sectors. In Australia the operation of both 7(a) and 7(b) is effectively unrestricted.
  10. By contrast, in the United States there are restrictions on both 7(a) and 7(b), that is, there are debt limits which can only be raised (or abolished) by the legislature. However this should not be interpreted to mean that the U.S. federal government cannot create net finan- cial assets for the non-governmentsectors, even if prohibitions on further borrowing by the federal government happen to be in operation. The reason for this has been explained in an article by John Carney [1].
  11. Historical evidence indicates that central banks always honour payments made by monetary sovereign governments (i.e. by transferring commensurately banking reserves as assets of the financial institution in which a payee’s account is held). We know this is true in Australia, because RBA officers said so in response to a carefully worded quest- ion forwarded to the RBA by Damian Penston [ERA Review, v9, n2, 2017].In regard to the U.S. economy, John Carney has argued [1] that even in the hypothetical situation where federal Treasury’s account with the Federal Reserve [Fed] happened to be zero, the Fed would honour Treasury payments in order to fulfil its duty to maintain an acceptable interest rate regime as well as its obligations to the nation in regard to price stability and employment.

    According to Carney: “.. overdrafts on the Fed wouldn’t be Treasury securities and they aren’t explicitly guaranteed by the U.S. government. They’re more like unilateral gifts from the Fed. And guess what? The federal Treasury is allowed to accept gifts that ‘reduce the public debt’. Since these overdraft gifts from the Fed would allow the government to spend without incurring additional debt,

    it seems very plausible to argue that this kind of extension of U.S. credit would be permitted under the debt ceiling.“

  12. It appears that Treasury’s general account with the central bank does not behave in every respect like a transact- ion account, implying that the credits within it are not a measure of any accepted form of money, notwithstand- ing that those credits are denominated in the national unit of account (i.e. the dollar). These creditary entities are neither currency nor any part of the money supply. They could only be banking reserves if Treasury was a type of bank, which clearly it is not because it does not take deposits. Some have argued that these credits are a form of transaction money because they are exchangeable with the accepted retail forms of money. However this argument is very weak because there exists a range of non-transactional financial entities that are exchangeable with transaction money (including Treasury securities, bank term deposits, stocks and shares). Consequently it may be held that Treasury’s general account should be regarded as an operating account (a record of the government’s fiscal operations) rather than a transact- ion account.

[1] Carney, John: Can the Treasury Department really run out of money?

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