Monetary policy through the looking glass

Many have noted that central bank lowering of short-term interest rates is running up against its limits, and  we are hearing calls for major fiscal stimulus, i.e. large deficits. In a normal world, this raises the spectre of the government having to sell bonds to the private sector to get the funds, which could actually increase long-term interest rates and partially undo the stimulus. But in our potentially deflationary situation there is an important monetary connection that recommends going out on a ledge and not issuing public debt but still running the deficits.

I have been influenced here by some Post-Keynesians, notably Randall Wray of University of Kansas City Missouri, taking the position that government can just write cheques, it does not need the tax revenues to come back to it to balance a budget; the deficit is just an addition to the money in circulation. Alternatively, it can be constructed as the central bank buying up the government bonds that finance the deficit. The effect is essentially the same.

Two recent posts go into the mechanics of how this might work. William Buiter at the London School of Economics walks through this in an extended blog post for the Financial Times. Carleton’s Nick Rowe at Worthwhile Canadian Initiative puts additional central bank options beyond interest rate cuts into the Canadian context. These are last resort options, to be sure, but worth thinking through now that the spectre of deflation has raised its ugly head.

Minimally, we need to think about really large government deficits over the next couple years, and I’ve been pressing for shoring up income support programs to get money into the hands of those who will spend it, plus a green retrofit of our infrastructure that would create new jobs. We should be biased towards excess, and if we go to far then the central bank can raise rates, so that we are shifting to fiscal policy as the first mover but they will ultimately have to be coordinated. Paul Krugman’s latest oped makes this argument.


  • On the Wray distinction between buying the central bank buying bonds, and writing cheques. This may be an institutional issue having to do with the Federal Reserve, which is privately owned (or was until recently!). In Canada printing money occurs when the central bank buys government debt, and credits government accounts in the chartered banks. This was how we financed World War II. It does still happen here, but since the 81-82 period my sense is that the central bank monetization (taking on government debt in this way) is about equal to the currency in circulation i.e. there has been no credit creation in favour of the federal government. Writing cheques would amount to cash advances (loans) from the central bank, and corresponding government deposits being created on the books of the central bank.
    For years William Krehm and the Monetary Reform group pleaded for restrictions on private bank lending and opening up the credit spout for the federal government. They look very good today. Going back even further, William Irvine of the ginger group/CCF called for the socialization of credit. Unfortunately that got confused with Social Credit which is something else.

  • The CDN government is already writing blank cheques. Notice that the 50 the billion in IOUs the gov has already written to the CDN banks in mortgages have already been sopped-up! And still the spread remains. This bear is much bigger than the Jaques-de-derrière assume.

    Good thing that through the enabling legislation of finance the 250 billion of IOUs they spent did not have to be declared as an expenditure: a money bill as it were (clean that observation up and run with it).

  • Hey Marc,

    Nice post. On the Wray business, a small nuance — Wray and the rest of the Post Keynesians at UMKC argue that in the U.S. at least (and I’m sure this is equally true in Canada), every act of spending — in normal and abnormal times — entails by definition money creation in the sense that new reserves are added to the banking system. Bond sales are merely reserve draining operations designed to help the central bank hit its target for the overnight rate and hence its inflation target.

    This is of course controversial stuff with huge implications for how we think of monetary and fiscal policy (hence the rather radical policy recommendations that we tend to get from UMKC and Warren Mosler types). For anyone interested in understanding the argument in its details, I strongly recommend reading Stephanie Bell’s JEI piece from 2000 (Do Taxes and Bonds Finance Government Spending). Bell is a colleague of Wray’s at UMKC professor and fellow traveler down the Chartalist road. Here’s a reference to a more easily accessible version (Levy Working Paper I think) :



  • Hi Marc:

    Governments running deficits is going to do nothing about the long-term unsustainability of the present financial system. Deficit spending is going to increase taxes at a later date, and thus, reduce consumer’s incomes.

    The government needs to issue credits directly to consumers in the form of a price rebate and a dividend. This is the only solution to the fact that prices rise faster than incomes when regarded as a flow. The consequence of this flaw is ever increasing debt and business cycles. Periods of increasing investment, where incomes are disbursed prior to costs for the investment showing up in the price of consumer goods leads to economic “booms”, but they are followed by periods of contraction as those costs make their way into the price of consumer goods, but the income necessary to defray those costs is gone, as it was spent on consumer goods in the past.

    All of these proposals are merely bandaid solutions. Keynes recognized the gap between incomes and prices, but thought that the problem could be fixed by “priming the pump”. This “fix” only leads to inflation and debt. The only real fix is the issuance of credits directly to consumers which have not run through the productive system, and consequently, do not have a cost associated with them.

  • I don’t really agree with Marc Lee when he credits Randall Wray with the idea that governments can “just write cheques” without bothering to collect tax (or borrowed funds) to cover the cheques. I suggest Mugabwe plus and a large number of third world dictators worked this one out for themselves long ago without any help from academic economists (not that I’m suggesting a small amount of controlled “cheque writing” is a bad idea in a recession.)

    Re Arun Dubois’s claim that we ought to pay attention to Randall Wray’s ideas on Chartalism, I totally disagree. Chartalism strikes me as a load of nonsense and for reasons I spell out at

    Jim claims “Governments running deficits is going to do nothing about the long-term unsustainability of the present financial system.” I don’t think anyone is saying deficits ARE a solution to “unsustainability”. The solution to unsustainability is better bank regulation.

    Jim also claims “Deficit spending is going to increase taxes at a later date, and thus, reduce consumer’s incomes.” I suggest there is a flaw in this sentence as follows. It is generally agreed that we need to boost economies (and there are a variety of ways of doing it). It is also generally agreed that some of the money used to do the boosting will have to be withdrawn at a later date so as to avoid inflationary effects. This “withdrawal of money” will show up as for example tax increases. But these tax increases, ironically, will not make anyone any worse off. Indeed in the absence of these tax increases people would be worse off because of the resulting inflation. So we have “tax increases that make people better off” – bizarre, but true.

  • Re my point about Mugabwe above, possibly I’m being too flippant. To put the above point more seriously, I think it has long been recognised that a really quick “high octane” way of boosting economies is for government or central bank to spend without collecting the relevant sums in tax or borrowing. This has always
    been known as an “unfunded budget deficit”, as far as I know. Take the process too far too quickly, and you end up with a Zimbabwe, of course.

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