A plain-language guide (with all the jargon explained) to what government bond sales really do — and why it’s not about raising money. A Modern Monetary Theory (MMT) perspective.
Hi Jim - you mention that T-Bills are “traded” on a secondary market but I don’t think that’s strictly the case, ie as it is with gilts. There are “Primary participant” banks who buy them from the DMO and they will sell them on to holders but I don’t think they are traded. Similarly, are you sure the BoE sells T-Bills to commercial banks, do they not get them as Primary participants, directly from the DMO? I’m confused.
With regard to the ways & means account, I understood that was the primary overdraft facility with the BoE but, as you say, it’s pretty much only been used as such in the past 20 years in times of emergency, eg the crash & Covid. Today wouldn’t the daily equivalent be the Consolidated Fund facility which is akin to an overdraft and records all gov’t spending, tax receipts, bond sales and redemptions?
Thanks Paul. Thanks for pointing that out to me. I will update my article. I noticed that GIMMs wrote the following "The Bank of England would manage the cash requirements of the government and geared them toward managing the Monetary Policy Committee’s decisions on the level of short-term interest rates. If the government’s short term cash transactions didn’t create a daily shortage in the money markets (in order for the CB to enact monetary policy), then the Bank created a shortage by draining reserves through the sale of Treasury Bills.” Those reserves are commercial bank reserves - GIMMs is talking about exchanging Treasury Bills for reserves - which I mistakenly interpreted as being part of the secondary market: my revised understanding is that this is an 'open market operation' and the secondary market is confined only to trades that involve investors alone. I must have read something in the past about the central bank participating in the secondary market - which stuck in my head and predisposed me to interpret this in a particular way.
I'm not an economist, So there is stuff I might misunderstand. but with that said, I have some thoughts:
1. In a technical sense, for a currency-issuing government (like the UK), bonds are not necessary to fund spending because the government can create money. However, bonds are still issued to manage reserves and interest rates, and their sale does absorb liquidity from the system. The phrasing "no money is raised" could be misleading. It’s more accurate to say that bond sales are not required to fund spending but are part of monetary operations.
2. You are correct that T-bills don’t carry an interest rate but are sold at a discount. But the implied yield is still an interest rate in economic terms (the discount reflects the interest). The distinction is semantic, but important for clarity.
3. Modern central banks often use a "corridor system" where the rate is set by the central bank’s lending/deposit facilities, not just reserve scarcity. The Bank of England uses a "floor system" where reserves are abundant, and the rate is set by the interest paid on reserves.
4. OMF is not standard policy. It’s a theoretical proposal, not current UK practice (unless I have missed some change in the last year.
Thanks Anarcasper, you make good points. OMF is, of course, only theoretical when it's not being used. It was used during Covid - so at that point it wasn't theoretical. Whether it gets used or not doesn't change my point that it is a fallacy to say that bond sales and tax revenues are the methods the UK Government uses to fund services. Both are incorrect. 100% of UK Government spending is new money. There's no stash of cash that gets used up as the government pays for services. :-)
I am familiar with MMT, and I agree with it’s descriptive side (I have many quibbles with the prescriptive policy suggestion side, but that’s neither here nor there in terms of this article)
My comment was merely to point out nuance so that nobody can accuse you of presenting misleading information
I am aware of the 'corridor' system of the central bank and other points you make. I completed the 'Foundations of Modern Money, Institutions and Markets' at the Modern Money Lab - by Steven Hail and his colleagues. So, yes I agree I could have mentioned these things: but I guess I didn't feel they were essential for the story I was trying to tell in this newsletter. It's a balance between lots of things: keeping the readers attention, making it easy to consume while still understandable: including what is needed to make the point I want to make but not leaving things out that are essential and so on. Your comments are valid and welcomed. Thanks.
Hi Jim, you could consider including a section on how the primary and secondary gilt markets operate. It could be argued that the primary market is not really a market; the GEMMs are essentially obliged to buy all the gilts auctioned by the DMO. The secondary market, involving pension funds and other financial operators, is where the real jiggery-pokery operates and gives rise to what the mainstream thinks of as market power.
"Obliged" is an interesting word. Even though it is the floor rate, it is still "free money". Still, those GEMM criteria are pretty funny. It reads to me like, "What a hassle to have to agree to all that to get my basic income from the State!" If the primary dealers enter secondary markets and make mark-to-market losses that's nothing but re-arranging government scorepoints among already wealthy people. Those who complain about it are laughable. To all primary dealers I'd say, "Get a real job mate."
The jiggery-pockery should just be stopped at the source. Stop issuing gilts and bonds. Pay pensioners a decent pension to obviate the need for retirement savings schemes (It is not "tax payer funded"). The retirement savings schemes, just like tax evasion, are economic overhead (a lot of people tied up in otherwise needless activity).
There so much in this post that doesn't match the observable facts found on published balance sheets and normal public sector accounting standards and the documented processes I'm unsure where to start and I had to give up reading.
Take this: "Government bonds are something different..they are not used to raise funds and are not used to provide the government with spending money. They are...used to manage interest rates."
You are conflating open market operations with government funding. The central bank executes its sterling monetary framework remit by selling / buying securities it holds in its portfolio. Its portfolio are the assets of the central bank - listed as such in the balance sheet. This is a daily event. Government bond auctions are much less frequent and only affect the liability side of the central bank balance sheet. A successful auction will see a debit to a bank reserve account (liability) and a credit to the government bank account (liability). A bond auction can only ever drain reserves available to banks - it cannot increase them and is not frequent enough to be considered an OMO operation.
A bond auction may also require the central bank to execute its OMO function to ensure the correct levels of reserves available to banks. The OMO is an executive and supervisory function. Bond auctions are an operational function.
And this: "The only thing the government will accept in payment for the bonds that it issues is its own debt, its own IOUs.".
This is clearly wrong. What a government accepts into the government bank account held at the central bank is central bank IOUs (a credit) - which is a claim on the central bank. The central bank is indebted to the government. You can find the record of these accounts on the central bank balance sheet on the liability side - and also on the government balance sheet on the asset side. You can also find the flows into and out of these banks accounts using the cash flow statement in the government annual report. The bank balances will match the cash flow statement.
Government spends the balance from its bank account providing its services and thereby reducing the balance (debits). What prevents the balance on this account from going into an overdraft (debit balance) are the taxes it receives as credits from commercial bank reserve accounts. When taxes are not enough to cover spending the bond auctions taking place cause a commercial bank reserve account to be debited and the government bank account to be credited - moving the government account back towards to an acceptable balance.
Why does the government set out to maintain a zero or credit balance on this account? Because the market demands it. Government spending increases the size of the balance sheets of commercial banks - and bond auctions to third-parties (i.e. not member banks) reduce those same balance sheets. It dampens inflation expectations in the market and gives upward pressure on bond prices trading on the secondary market and therefore imputed yields low.
MMT seems to have created a convoluted, wordy, abstraction of what is going on - when what is going is easily discernable from the accounting and requires no "theory". Simply put, all MMT is asking for is to just run an overdraft on the government's bank account at 0% interest. That is it.
The problem with that is it creates an inflation expectation in the secondary bond market where prices drop and hence imputed yields rise. This creates a future problem when you decide, due to inflation pressures, you need to conduct a bond auction to reduce the size of 1. the government bank account overdraft and 2. commercial bank balance sheets. The problem you have now is that you need to compete with the secondary bond market and provide competitive yields. Your bond auctions are more expensive if you want to actually want to get a buyer.
If you make the mistake of not having bond auctions and just running the overdraft then you create inflation pressure, which only increases your spend each and every month in an exponential way if you want to maintain services.
There's no need for creative abstractions and theories - you can play the consequence of MMT using the existing accounting and standards which are widely documented. You are just asking for a 0% overdraft at the central bank which requires no special funding or accounting tricks. I understand MMT views the central bank and government as the same thing - but there's nothing to be gained in communicating MMT to the wider world by doing this - when you can just say "overdraft". It almost seems you are trying to make MMT a revolutionary paradigm when really it isn't.
Every I say can be found in the documentation on government and central bank document libraries.
Jim, we both agree that doing away with bond sales is possible. You go on to say that government would need to provide alternative funding for pension funds. Well, couldn't the government just offer pension funds managers a deposit account at the CB (which would pay interest)? National disaster averted 😉 and you're removing the complicated and unnecessary sale of bonds. Traders could do something useful instead like becoming doctors, nurses, teachers etc! I also don't believe that banks now need to do any overnight borrowing as they're awash with reserves since QE.
George, we mostly agree, with some critical specifics that I believe you should incorporate.
“when the government pays out to (say) a firm that has a bank account at NatWest, the reserve balance of NatWest at the Bank of England increases by the amount paid.”
Forensically, the UK revenue account at the CB is debited, and the receiving entity or payee’s bank is credited. Forensically, the debiting reduces CB liabilities, and the crediting increases them. In sum, the total supply of reserves from before and after does not change, the original value held by the public is transferred over to the Gov revenue account.
The Gov cannot spend without a positive balance, so they borrow that value from the public or CB via bond sale or CL then bond sale, and must repay.
I agree that tax payments from NatWest customers reduces the supply of deposits and transfers reserves to the Gov, and Gov spending reduces reserves in the Gov revenue account and increases reserves at NatWest, but the sum total is reserves did not change.
Under a Consolidated Balance Sheet CBS, it ‘appears’ tax receipts reduces Gov liabilities, and Gov spending creases them, because they do not recognize liabilities to the Gov that is value transferred from the private sector to the Gov.
And agreed, none of this has anything to do with MMT., except they make the mistake of failing to differentiate between the borrowing of assets and the transfer of value from the public, which is what mostly happens, versus the creation of new assets and money by the CB. They are not the same, and the CB mostly does not buy bonds, but MMT sees the world as if every reserve account credit is new money. Forensically, it is! But there is a major difference between existing assets and value being borrowed snd transferred, vs creating new assets by the CB.
Yes, we agree banks create deposits Andre oand the Monty supply when They create loans, they are not lending out the deposits of other customers.
“Governments also create deposits when they run budget deficits because they are putting more money into the public's bank accounts than they are taking out.”
This is the tricky part, and what we are really discussing. Only banks can create deposits, as they are liabilities in a banks ledger, so let’s not confuse things by saying the Gov creates deposits.
Only the CB can create reserves, and most deficits are financed by the Gov borrowing reserves from banks or the public, to which they have to repay, so this is existing assets transferred to the Gov prior to spending. This is not new reserve creation by the CB for the government to spend to pay their bills. This can happen if the CB buys the bonds to fund the deficit, then banks receive new reserves, and increases in the supply of reserves, along with new and expanded deposits.
This net inflow of reserves creates new deposits in the banking system, which has its counterpart on the bank's balance sheet as an increase in total reserves, expanding the supply of reserves. We can grant you this ‘convoluted’ process if the Gov selling bonds to the CB, and when it repays the CB transfers back to the Gov as printing new money, but in reality this rarely ever happens.
Here are some numbers from a different post in case you missed it:
~80–90% (~$18.4–$20.7 trillion) of money used to purchase Treasury securities at 2024 auctions originated in the private sector (deposits, capital, borrowed funds), and the TGA increases regardless of accounting entries. The remaining ~10–20% (~$2.3–$4.6 trillion) comes from non-private sector sources, primarily foreign central banks/governments (using reserves from trade or foreign central bank money) and marginally U.S. government entities (tax revenues).
Hi Jim, you wrote: ‘The UK Government issues currency without ‘borrowing’ via the OMF.’
When the BoE credits the accounts of Gov payees, does the Gov have to pay them back? Are those amounts placed on a BoE credit line that the Gov has to repay?
If so, that’s borrowing, not issuing or printing. And the reality is, no CB issues to pay bills, they sell bonds for that, a long term Liability.
Today the BoE only issues new reserves to lend reserves against assets, or issues new reserves to buy assets, they do not issue to pay gov bills.
If the CB starts issuing new Liabilities/reserves to pay Gov bills, they are spending CB equity.
E=A-L
E+L = A
If assets remain the same, an increase in Liabilities must result in an equal reduction in Equity.
Bonds are negative Gov equity. If the CB issues money for anything other than buying assets or lending, they are spending their equity.
If you really want to understand bonds, I can take the time to make it plain as day for you, but I think you really want to believe MMT so you are skipping over facts. The hard reality is:
1. There is not a Gov in the world that can spend unless they have reserves on their asst account.
2. If they are short, they have to borrow.
3. They borrow by selling bonds, and there are three potential buyers.The non-bank public, banks, or the CB.
When the public buys, deposits are reduced fir payment, the Gov spends back, so the net result is no change to the supply of deposits, but, a bond now exists, the public swapped assets, deposits for bonds, an asset swap, but, the payees have new deposits and new assets, so public equity increased. Gov negative equity from the bond.
When banks buy bonds, and then the Gov spends those reserves, there is an increase in the supply of deposits, increasing the money supply. Banks swapped for reserves, asset swap, but the Gov spending increases private wealth with new deposits and new assets.
When the CB buys, they issue new reserves so increase the supply of reserves, and the bank of the payee credits the payees account so new deposits as well, and since the Cb returns the profits to Treasury, no negative equity.
3 different outcomes.
The only way for Gov to deficit spend is to sell bonds to secure new reserves so the asset account can spend. Or, they can borrow short term on a credit line, but if they can’t repay they must sell bonds and use the proceeds to repay.
Completely false that bond revenue is used for anything other than to spend, as no revenue, no spending. Completely false the CB issues money for the Gov to spend, the CB only issues when buying assets or lending against assets. What you are saying is not true my friend.
You will find in this article that I mention the phrase ‘debt-free Sterling', refers to money the government spends without issuing bonds, i.e. were was no ‘borrowing’ involved in that transaction. This is done via Overt Monetary Financing (OMF). Economists Bill Mitchell put it this way, “Overt Monetary Financing (OMF), which simply means that all of the unnecessary hoopla of governments matching their deficit spending with bond-issuance to the private bond markets, as if the latter are funding the former, is dispensed with.” Bill Mitchell
This appears to contradict your claim.
Also in more normal circumstances bond sales come after spending not before. And the bond sales are a convention rather than a necessity. The UK Government issues its own currency - it does not need to find it from somewhere else. All UK Government could just as well be ‘debt-free Sterling'. However, there are practical implications that would create difficulties under the current system. For example, pensions are reliant on the money they get via government bonds. So if bonds sales stopped that money would have to be replaced. What MMT would say about that is that the government could pay for pensions directly.
As a more general comment - when the UK Government, which is a currency issuing government spends the non-government sector gets real money and the government adds an entry to its spreadsheet. Certainly the government now has a debt - but it's of no consequence in term of any further spending in the future. That's why I included the graph showing 300 years of mostly deficits spending. The governments debts aren't like household debs: they are just the balance (an accounting record) of how much has been spent into the non-government sector. If the UK Government did not issue its own currency then it would have real debts that it has to pay back and the country could go bankrupt. But the UK Government is not a user of currency it is an issuer of currency.
Thx Jim, I really appreciate your thoughtfulness and preparation, it’s not often I get to have an ‘expert’ conversation, so I am enjoying your work and this exchange of ideas.
Our differences stem mostly from using a Consolidated Balance Sheet vs standard accounting, but the good news is we are using the same numbers so we should be able to arrive at the same set of facts.
You wrote: “Overt Monetary Financing (OMF), which simply means that all of the unnecessary hoopla of governments matching their deficit spending with bond-issuance to the private bond markets, as if the latter are funding the former, is dispensed with.” Bill Mitchell This appears to contradict your claim.”
The ‘appearance’ of a contradiction boils down to this, there are three scenarios for bond sales, not one. When Mitchell says ‘all the hoopla,’ he is only describing one scenario but the entire range of possibilities is not visible to him because he is using a Consolidated Balance Sheet CBS. I will grant you that if and when the CB buys bonds to fund deficits, the CB is creating new reserves, and when the gov spends those new reserves the banks have an increase in reserves and then create new deposits, so your argument that the gov creates new money (reserves) and this then forces banks to increase deposits is accurate. In this scenario, the issuing of new reserves results in new deposits, and since the reserves were ‘borrowed from the CB, right hand borrowing from the left hand, as long as the CB Holds To Maturity HTM, the principal and interest are returned to the Gov, so no negative equity, for all intents and purposes the convoluted process simulates the Gov printing money to spend. Thot means new reserves = an increase in CB/Gov liability on the CB balance sheet.
If new reserves do not result in an increase in reserves from prior to the transaction, then it means those reserves existed prior to the transaction and were transferred to the receiving party. This is tricky because EVERY CB ledger entry either adds or reduces reserves, every transaction is 1:1 with a bank and the CB, so forensically, every credit of every reserve account is new reserves. However, we are only counting issuing as an increase in reserves starting from prior to the transaction, which allows existing value to be transferred among account holders, so -reserves when a bank buys a Gov bond, then + reserves Gov revenue account, then when the Gov spends -Reserves, so Gov account is net zero after spending. That means the reserves the Govvtecrived from selling bonds is either transferred from another reserve account holder, the public or their bank, OR the reserves are new and the supply is expanded because the CB bought the bond and created new reserves. Under CBS all crediting of reserve account appears as new reserves, when in reality most crediting is transferring value from reserves already issued and held by the public or their banks.
That said, I hope you will agree on these facts:
1. The Gov cannot and does not create new money to ‘spend’ and pay gov debts. Reserves needed for the Gov to deficit spend are always borrowed.
2. The CB only creates reserves in the process of buying assets, to pay for them, the seller is doing an asset swap, Reserves for bonds.
3. The Gov borrowing is not swapping assets, they are swapping liabilities short term for long term, Gov Balance Sheet -Bonds (+Liabilities) + Reserves (+Assets), -R to pay bills -L from bills paid, net result: no change in the size of the Gov balance sheet, but short term liabilities retired, new long term liabilities (bonds) incurred.
4. Your explanation is dependent upon the CB first buying Gov bonds, AND then HTM, otherwise if the CB sells the bond and retires the reserves, the argument the Gov is printing money does not hold.
5. This means our differences are including the reality that most bonds are purchased by the private market, ie public or their banks, not the CB.
6. In those scenarios, the Gov is borrowing existing reserves that are in the hands of the private sector, then spending, but promising to repay them later via bond.
7. Although this makes the story more complicated, it is more accurate, and often hidden from view using a Consolidated Balance Sheet. Same numbers, same transactions, but you are not including the majority of scenarios because you are only representing when the CB buys the bond. When they don’t, the Gov is borrowing from the private sector.
8. If we agree the Gov cannot spend until the revenue account is positive, and must ‘borrow’ short term from the CB if they are short, and the Gov then sells a bond to the public or banks to repay that BoE credit line, then the gov is not issuing new reserves to pay gov bills, they are borrowing existing reserves held by the practice . The reality is the CB does not buy many Gov bonds at auction, so what mostly happens does not resemble what you are saying. What mostly happens if the Gov borrows from the private sector to spend.
9. It is not currently possible for any major CB to spend prior to having a positive balance in their revenue account, and that deficit is mostly coveted by selling bonds to the private sector. The Gov sometimes sells to the CB, but the CB NEVER issue to pay Gov bills, only to buy that bond, which they may in the future sell.
You seem to be saying here that reserves are not involved in government spending -
"Today the BoE only issues new reserves to lend reserves against assets, or issues new reserves to buy assets, they do not issue to pay gov bills."
In reality, when the government pays out to (say) a firm that has a bank account at NatWest, the reserve balance of NatWest at the Bank of England increases by the amount paid. When the firm pays a tax liability, the reserve balance of NatWest at the Bank of England decreases by the amount paid. If (as is usual) the government runs a deficit, the net effect on NatWest's reserve balance is that it increases - and that has nothing to do with MMT.
Here's Standard & Poors on the Harvard University website saying the same thing, and they are not advocates for MMT -
"Banks create deposits when they create loans, as explained above. Governments also create deposits when they run budget deficits because they are putting more money into the public's bank accounts than they are taking out. This net flow creates new deposits in the banking system, which has its counterpart on the bank's balance sheet as an increase in reserves" -
You wrote: “You seem to be saying here that reserves are not involved in government spending -“
Not at all, the bond sale clearly results in a reserve account debit to the buying bank’s reserve account, and a credit in the Gov asset account. When the Gov spends those reserve account credits, the Gov asset account is debited, -Reserves, and the payee’s bank or receiving bank has their reserve account at the CB credited +Reserves. When the public buys new bonds at auction, and then spends the proceeds, Reserve account balances at banks are returned to where they were prior to the bond sale.
If a bank was the buyer, it’s an asset swap, -R + Bond. When the Gov spends, they return the reserves to the same level as prior to the sale, so banking sector -R +R = 0. But, the banking sector also owns a bond, so the reserves the Gov spent create new assets at the receiving bank, +R, who then credits their customer’s deposit account +D = new deposits and new assets for the public, and increase in public equity.
If the public was the original buyer, deposits are returned to where they were prior to the sale, -D +D, plus the public owns a bond, so Gov negative equity -Bond, and the public positive equity in the new deposits +from the reserves the Gov received from the bond sale and then spent.
Reserves or more accurately reserve account credits and debits are always involved in the settlement of payment at the CB, as they are ledger entries on the CB ledger.
Forensically, every debit of a bank reserve account reduces CB liabilities, and every credit of a bank reserve account is an increase in CB liabilities, so technically new ledger entries are always new, so always new reserves, but we are trying to differentiate between A) no net increase in total supply of reserves from before bond sales to after proceeds are spent, which we will say means new new reserves created by the CB, from B) a net increase in supply of reserves issued by the CB, creating new money from before the bond sale to after the the bond sale proceeds are spent.
-R (bank) + R (TGA) -R(TGA) +R (bank) = 0 no increase in the total supply of reserves
MMT using a Consolidated Balance Sheet CBS: -R(bank) +R(bank) = 0 no new net reserves or no increase in CB liabilities from where they were prior to the bond sale.
Contrast this to when the Fed buys:
+R TGA +Bond. -R TGA +R bank + Deposits. =
+R +B -R +R +D = +B +R +D
The result when the Fed buys is an increase in total reserves or CB liabilities, the CB created new money to buy Assets. The CB also owns a bond, and if they Hold To Maturity the principal and interest is returned to the Treasury (less expenses which were going to be incurred either way). Profits are returned, so no negative Gov equity, and the public has positive equity from new deposits receive when the Gov deficit spends.
In this scenario, the Fed buys AND HTM, the Fed created new money to buy assets, the gov spent the proceeds and there is no negative equity to free money to pay bills. This is what MMT promotes as always happens, but in reality only partly happens, and not very often, only in emergencies like COVID or during QE. But, if the CB sells the asset prior to maturity then the Gov has negative equity as they have to pay the private sector for the bond.
"Today the BoE only issues new reserves to lend reserves against assets, or issues new reserves to buy assets, they do not issue to pay gov bills."
The CB NEVER creates new reserves to pay Gov bills, meaning the CB NEVER credits the payees reserve account directly, without lending those reserves to the Gov, which means the Gov must repay. The CB never credits a reserve account for Gov payment to a payee and then does not also put that charge on a short term Credit Line (UK). The CB never issues new liabilities (new reserve account credits) without securing an asset (bond or Credit Line balance)
If the CB did, they would be spending their equity.
asssts = equity + liabilities
If assts remain the same, then new liabilities must result in an equal decrease in equity.
If the CB were to credit the reserve account of Gov payee’s banks, the CB would be spending their equity and wound be bankrupt within the month.
MMT imagines this happens, but it NEVER happens, instead the Gov MUST borrow prior to spending either by selling a long term liability (bond) or by securing a loan via Credit Line to pay off short term Gov liabilities, which then by law must be retired by selling a bond. The Gov ALWAYS must borrow if they are short, prior to spending. No wiggle room. It is impossible for the Gov to spend unless they have a positive balance in their asset account, and if the Gov is short it must borrow the needed reserves. The CB NEVER issues payment on behalf of the Gov and credits the reserve account of payees without also debiting the reserve account of the Gov, and if the Gov is short the payment will not be competed (US) or the amount is placed on a Gov CL (UK).
“In reality, when the government pays out to (say) a firm that has a bank account at NatWest, the reserve balance of NatWest at the Bank of England increases by the amount paid..”
Yes, but the asset account of the Gov is also debited. Gov reduces their Balance Sheet:
-A (-reserves)
-Liabilities (-bills)
If the Gov does not have enough assets to complete payment, they MUST borrow, which increases their BS:
+A (+reserves)
+L (+bonds or CL)
The net result if borrowing to pay bills is:
+R (+A) -Bonds(+L) -R (-A) -Bills (-L) = -Bond or CL, which is negative Gov equity.
“When the firm pays a tax liability, the reserve balance of NatWest at the Bank of England decreases by the amount paid.”
Yes.
“ If (as is usual) the government runs a deficit, the net effect on NatWest's reserve balance is that it increases - and that has nothing to do with MMT.”
Yes, but that has nothing to do with deficits spending v non-deficit spending. It is clearer to separate deficit spending from non-deficit Gov spending of tax receipts.
ALL Gov spending results in an increase in reserves in the banking sector, but not a change in total reserves or total CB liabilities. If the Gov is paying the public, all Gov spending results in new deposits.
When the Gov spends:
-R (TGA) +R NatWest, which increases NatWest assets. NatWest then credits their customer’s deposit account +Deposits = +L, so Gov paying the public results in an increase in reserves for banks and an increase in deposits for the public, a transfer of equity from the Gov to the private sector.
If that spending was financed by selling a bond, if a bank was the buyer of that bond, the reserves are first debited then credited to the banking sector, an asset swap reserves for bonds, but which now also receives the reserves back while owning a bond. +equity.
If the buyer of that bond was the public, deposits were first reduced then returned when the Gov spent those bond sale proceeds, plus the public own a bond. + equity.
“Banks create deposits when they create loans, as explained above. Governments also create deposits when they run budget deficits because they are putting more money into the public's bank accounts than they are taking out. This net flow creates new deposits in the banking system, which has its counterpart on the bank's balance sheet as an increase in reserves"
We agree on this.
But I am also saying when the Gov is short, it must ALWAYS borrow prior to spending, and the source of funds when borrowing effects the monetary system and equity differently depending upon who the buyer if bonds is. That’s not well known or well understood, but empirically you can work it out for yourself as I have just showed you.
Your analysis says that the government spends from assets - it does not. To put it simply, new money is created every time the government spends. Bank money is a zero sum game, government money is not.
George, I have pointed out that the ONLY time new money is created, so an increase in the total supply of reserves meaning an increase in CB liabilities over and above what they were prior to the bond sale, is when the CB buys the bond. And, this results in a bond, the Gov borrows first, so only holds true if the CB Holds To Maturity HTM.
You like MMT are making a mistake not differentiating between the CB buying, which is rare, and between when banks or the public buy that bond, which is what mostly happens. In those cases, no new money is created, reserves are borrowed then spent, and the Gov has negative equity, public positive equity.
In no case does the CB credit a receiving bank to pay Gov bills, as you imagine and state, without the Gov borrowing those reserve account credits first. The formative accounting shows this clearly, you can work through what I wrote further yourself.
There is zero instances of debt free money being created on the spot to pay Gov bills. New CB Liabilities +L without the CB receiving assets +A FIRST!
The CB issuing new money (+L) without first securing an asset (+A) ABSOLUTELY POSITIVELY NEVER happens.
Your analysis says that the government spends from assets - it does not. To put it simply, new money is created every time the government spends. Bank money is a zero sum game, government money is not.
Look at what happens to CB equity if the CB issues new liabilities +reserves without securing new assets. They would be spending their equity, and they would spend 100% of their equity and be bankrupt within a month.
E= A -L
E+ L = A
Assuming the CB does not secure new assets, and just credits the Gov payee’s bank’s reserve account as you imagine, the CB issuing new reserves and increasing their liabilities +L with no new Assets means Equity must decrease 1:1 with new Liabilities. The CB would literally be spending their equity, which they never do.
This business of issuing bonds etc seems a very convoluted mechanism for controlling the interest rate...if its not needed to raise funds...can we do away with it? And if Liz Truss had understood MMT might she have survived longer and not been freaked out by the bond markets?
Liz Truss could have easily have survived if she had understood the role of the Central Bank and understood the power of Parliament over the Central Bank. The Bond market only has power because politicians let it have power. Truss and indeed all UK politicians are ignorant of the fact that the Central Bank can protect the price of government bonds and defend the exchange rate (i.e., set it at whatever rate it wants it to be): Parliament has the power to tell the Central Bank what it wants it to do: not the other way around. When you issue your own currency - you can buy anything in that currency. Doing away with bond sales is certainly possible: but first the government would have to provide alternative funding for pensions funds: otherwise there would be a national disaster.
Hi Jim - having stated that T-bills do not pay interest but are sold at a discount, you then say "The commercial banks are keen to get them because they pay more interest than they get from their reserves". Do you in fact mean that the profit from the discount is higher than the interest paid on reserves?
Hi Jim - you mention that T-Bills are “traded” on a secondary market but I don’t think that’s strictly the case, ie as it is with gilts. There are “Primary participant” banks who buy them from the DMO and they will sell them on to holders but I don’t think they are traded. Similarly, are you sure the BoE sells T-Bills to commercial banks, do they not get them as Primary participants, directly from the DMO? I’m confused.
With regard to the ways & means account, I understood that was the primary overdraft facility with the BoE but, as you say, it’s pretty much only been used as such in the past 20 years in times of emergency, eg the crash & Covid. Today wouldn’t the daily equivalent be the Consolidated Fund facility which is akin to an overdraft and records all gov’t spending, tax receipts, bond sales and redemptions?
Cheers
Thanks Paul. Thanks for pointing that out to me. I will update my article. I noticed that GIMMs wrote the following "The Bank of England would manage the cash requirements of the government and geared them toward managing the Monetary Policy Committee’s decisions on the level of short-term interest rates. If the government’s short term cash transactions didn’t create a daily shortage in the money markets (in order for the CB to enact monetary policy), then the Bank created a shortage by draining reserves through the sale of Treasury Bills.” Those reserves are commercial bank reserves - GIMMs is talking about exchanging Treasury Bills for reserves - which I mistakenly interpreted as being part of the secondary market: my revised understanding is that this is an 'open market operation' and the secondary market is confined only to trades that involve investors alone. I must have read something in the past about the central bank participating in the secondary market - which stuck in my head and predisposed me to interpret this in a particular way.
I'm not an economist, So there is stuff I might misunderstand. but with that said, I have some thoughts:
1. In a technical sense, for a currency-issuing government (like the UK), bonds are not necessary to fund spending because the government can create money. However, bonds are still issued to manage reserves and interest rates, and their sale does absorb liquidity from the system. The phrasing "no money is raised" could be misleading. It’s more accurate to say that bond sales are not required to fund spending but are part of monetary operations.
2. You are correct that T-bills don’t carry an interest rate but are sold at a discount. But the implied yield is still an interest rate in economic terms (the discount reflects the interest). The distinction is semantic, but important for clarity.
3. Modern central banks often use a "corridor system" where the rate is set by the central bank’s lending/deposit facilities, not just reserve scarcity. The Bank of England uses a "floor system" where reserves are abundant, and the rate is set by the interest paid on reserves.
4. OMF is not standard policy. It’s a theoretical proposal, not current UK practice (unless I have missed some change in the last year.
Thanks Anarcasper, you make good points. OMF is, of course, only theoretical when it's not being used. It was used during Covid - so at that point it wasn't theoretical. Whether it gets used or not doesn't change my point that it is a fallacy to say that bond sales and tax revenues are the methods the UK Government uses to fund services. Both are incorrect. 100% of UK Government spending is new money. There's no stash of cash that gets used up as the government pays for services. :-)
I am familiar with MMT, and I agree with it’s descriptive side (I have many quibbles with the prescriptive policy suggestion side, but that’s neither here nor there in terms of this article)
My comment was merely to point out nuance so that nobody can accuse you of presenting misleading information
I am aware of the 'corridor' system of the central bank and other points you make. I completed the 'Foundations of Modern Money, Institutions and Markets' at the Modern Money Lab - by Steven Hail and his colleagues. So, yes I agree I could have mentioned these things: but I guess I didn't feel they were essential for the story I was trying to tell in this newsletter. It's a balance between lots of things: keeping the readers attention, making it easy to consume while still understandable: including what is needed to make the point I want to make but not leaving things out that are essential and so on. Your comments are valid and welcomed. Thanks.
Hi Jim, you could consider including a section on how the primary and secondary gilt markets operate. It could be argued that the primary market is not really a market; the GEMMs are essentially obliged to buy all the gilts auctioned by the DMO. The secondary market, involving pension funds and other financial operators, is where the real jiggery-pokery operates and gives rise to what the mainstream thinks of as market power.
GEMMs guidebook - https://dmo.gov.uk/media/koqlfuai/guidebook181024a.pdf
GEMMs - https://www.dmo.gov.uk/responsibilities/gilt-market/market-participants/
"Obliged" is an interesting word. Even though it is the floor rate, it is still "free money". Still, those GEMM criteria are pretty funny. It reads to me like, "What a hassle to have to agree to all that to get my basic income from the State!" If the primary dealers enter secondary markets and make mark-to-market losses that's nothing but re-arranging government scorepoints among already wealthy people. Those who complain about it are laughable. To all primary dealers I'd say, "Get a real job mate."
The jiggery-pockery should just be stopped at the source. Stop issuing gilts and bonds. Pay pensioners a decent pension to obviate the need for retirement savings schemes (It is not "tax payer funded"). The retirement savings schemes, just like tax evasion, are economic overhead (a lot of people tied up in otherwise needless activity).
Thanks George, I will check out your links. :-)
There so much in this post that doesn't match the observable facts found on published balance sheets and normal public sector accounting standards and the documented processes I'm unsure where to start and I had to give up reading.
Take this: "Government bonds are something different..they are not used to raise funds and are not used to provide the government with spending money. They are...used to manage interest rates."
You are conflating open market operations with government funding. The central bank executes its sterling monetary framework remit by selling / buying securities it holds in its portfolio. Its portfolio are the assets of the central bank - listed as such in the balance sheet. This is a daily event. Government bond auctions are much less frequent and only affect the liability side of the central bank balance sheet. A successful auction will see a debit to a bank reserve account (liability) and a credit to the government bank account (liability). A bond auction can only ever drain reserves available to banks - it cannot increase them and is not frequent enough to be considered an OMO operation.
A bond auction may also require the central bank to execute its OMO function to ensure the correct levels of reserves available to banks. The OMO is an executive and supervisory function. Bond auctions are an operational function.
And this: "The only thing the government will accept in payment for the bonds that it issues is its own debt, its own IOUs.".
This is clearly wrong. What a government accepts into the government bank account held at the central bank is central bank IOUs (a credit) - which is a claim on the central bank. The central bank is indebted to the government. You can find the record of these accounts on the central bank balance sheet on the liability side - and also on the government balance sheet on the asset side. You can also find the flows into and out of these banks accounts using the cash flow statement in the government annual report. The bank balances will match the cash flow statement.
Government spends the balance from its bank account providing its services and thereby reducing the balance (debits). What prevents the balance on this account from going into an overdraft (debit balance) are the taxes it receives as credits from commercial bank reserve accounts. When taxes are not enough to cover spending the bond auctions taking place cause a commercial bank reserve account to be debited and the government bank account to be credited - moving the government account back towards to an acceptable balance.
Why does the government set out to maintain a zero or credit balance on this account? Because the market demands it. Government spending increases the size of the balance sheets of commercial banks - and bond auctions to third-parties (i.e. not member banks) reduce those same balance sheets. It dampens inflation expectations in the market and gives upward pressure on bond prices trading on the secondary market and therefore imputed yields low.
MMT seems to have created a convoluted, wordy, abstraction of what is going on - when what is going is easily discernable from the accounting and requires no "theory". Simply put, all MMT is asking for is to just run an overdraft on the government's bank account at 0% interest. That is it.
The problem with that is it creates an inflation expectation in the secondary bond market where prices drop and hence imputed yields rise. This creates a future problem when you decide, due to inflation pressures, you need to conduct a bond auction to reduce the size of 1. the government bank account overdraft and 2. commercial bank balance sheets. The problem you have now is that you need to compete with the secondary bond market and provide competitive yields. Your bond auctions are more expensive if you want to actually want to get a buyer.
If you make the mistake of not having bond auctions and just running the overdraft then you create inflation pressure, which only increases your spend each and every month in an exponential way if you want to maintain services.
There's no need for creative abstractions and theories - you can play the consequence of MMT using the existing accounting and standards which are widely documented. You are just asking for a 0% overdraft at the central bank which requires no special funding or accounting tricks. I understand MMT views the central bank and government as the same thing - but there's nothing to be gained in communicating MMT to the wider world by doing this - when you can just say "overdraft". It almost seems you are trying to make MMT a revolutionary paradigm when really it isn't.
Every I say can be found in the documentation on government and central bank document libraries.
Jim, we both agree that doing away with bond sales is possible. You go on to say that government would need to provide alternative funding for pension funds. Well, couldn't the government just offer pension funds managers a deposit account at the CB (which would pay interest)? National disaster averted 😉 and you're removing the complicated and unnecessary sale of bonds. Traders could do something useful instead like becoming doctors, nurses, teachers etc! I also don't believe that banks now need to do any overnight borrowing as they're awash with reserves since QE.
George, we mostly agree, with some critical specifics that I believe you should incorporate.
“when the government pays out to (say) a firm that has a bank account at NatWest, the reserve balance of NatWest at the Bank of England increases by the amount paid.”
Forensically, the UK revenue account at the CB is debited, and the receiving entity or payee’s bank is credited. Forensically, the debiting reduces CB liabilities, and the crediting increases them. In sum, the total supply of reserves from before and after does not change, the original value held by the public is transferred over to the Gov revenue account.
The Gov cannot spend without a positive balance, so they borrow that value from the public or CB via bond sale or CL then bond sale, and must repay.
I agree that tax payments from NatWest customers reduces the supply of deposits and transfers reserves to the Gov, and Gov spending reduces reserves in the Gov revenue account and increases reserves at NatWest, but the sum total is reserves did not change.
Under a Consolidated Balance Sheet CBS, it ‘appears’ tax receipts reduces Gov liabilities, and Gov spending creases them, because they do not recognize liabilities to the Gov that is value transferred from the private sector to the Gov.
And agreed, none of this has anything to do with MMT., except they make the mistake of failing to differentiate between the borrowing of assets and the transfer of value from the public, which is what mostly happens, versus the creation of new assets and money by the CB. They are not the same, and the CB mostly does not buy bonds, but MMT sees the world as if every reserve account credit is new money. Forensically, it is! But there is a major difference between existing assets and value being borrowed snd transferred, vs creating new assets by the CB.
Yes, we agree banks create deposits Andre oand the Monty supply when They create loans, they are not lending out the deposits of other customers.
“Governments also create deposits when they run budget deficits because they are putting more money into the public's bank accounts than they are taking out.”
This is the tricky part, and what we are really discussing. Only banks can create deposits, as they are liabilities in a banks ledger, so let’s not confuse things by saying the Gov creates deposits.
Only the CB can create reserves, and most deficits are financed by the Gov borrowing reserves from banks or the public, to which they have to repay, so this is existing assets transferred to the Gov prior to spending. This is not new reserve creation by the CB for the government to spend to pay their bills. This can happen if the CB buys the bonds to fund the deficit, then banks receive new reserves, and increases in the supply of reserves, along with new and expanded deposits.
This net inflow of reserves creates new deposits in the banking system, which has its counterpart on the bank's balance sheet as an increase in total reserves, expanding the supply of reserves. We can grant you this ‘convoluted’ process if the Gov selling bonds to the CB, and when it repays the CB transfers back to the Gov as printing new money, but in reality this rarely ever happens.
Here are some numbers from a different post in case you missed it:
~80–90% (~$18.4–$20.7 trillion) of money used to purchase Treasury securities at 2024 auctions originated in the private sector (deposits, capital, borrowed funds), and the TGA increases regardless of accounting entries. The remaining ~10–20% (~$2.3–$4.6 trillion) comes from non-private sector sources, primarily foreign central banks/governments (using reserves from trade or foreign central bank money) and marginally U.S. government entities (tax revenues).
Hi Jim, you wrote: ‘The UK Government issues currency without ‘borrowing’ via the OMF.’
When the BoE credits the accounts of Gov payees, does the Gov have to pay them back? Are those amounts placed on a BoE credit line that the Gov has to repay?
If so, that’s borrowing, not issuing or printing. And the reality is, no CB issues to pay bills, they sell bonds for that, a long term Liability.
Today the BoE only issues new reserves to lend reserves against assets, or issues new reserves to buy assets, they do not issue to pay gov bills.
If the CB starts issuing new Liabilities/reserves to pay Gov bills, they are spending CB equity.
E=A-L
E+L = A
If assets remain the same, an increase in Liabilities must result in an equal reduction in Equity.
Bonds are negative Gov equity. If the CB issues money for anything other than buying assets or lending, they are spending their equity.
If you really want to understand bonds, I can take the time to make it plain as day for you, but I think you really want to believe MMT so you are skipping over facts. The hard reality is:
1. There is not a Gov in the world that can spend unless they have reserves on their asst account.
2. If they are short, they have to borrow.
3. They borrow by selling bonds, and there are three potential buyers.The non-bank public, banks, or the CB.
When the public buys, deposits are reduced fir payment, the Gov spends back, so the net result is no change to the supply of deposits, but, a bond now exists, the public swapped assets, deposits for bonds, an asset swap, but, the payees have new deposits and new assets, so public equity increased. Gov negative equity from the bond.
When banks buy bonds, and then the Gov spends those reserves, there is an increase in the supply of deposits, increasing the money supply. Banks swapped for reserves, asset swap, but the Gov spending increases private wealth with new deposits and new assets.
When the CB buys, they issue new reserves so increase the supply of reserves, and the bank of the payee credits the payees account so new deposits as well, and since the Cb returns the profits to Treasury, no negative equity.
3 different outcomes.
The only way for Gov to deficit spend is to sell bonds to secure new reserves so the asset account can spend. Or, they can borrow short term on a credit line, but if they can’t repay they must sell bonds and use the proceeds to repay.
Completely false that bond revenue is used for anything other than to spend, as no revenue, no spending. Completely false the CB issues money for the Gov to spend, the CB only issues when buying assets or lending against assets. What you are saying is not true my friend.
Thanks for your input Jon,
You will find in this article that I mention the phrase ‘debt-free Sterling', refers to money the government spends without issuing bonds, i.e. were was no ‘borrowing’ involved in that transaction. This is done via Overt Monetary Financing (OMF). Economists Bill Mitchell put it this way, “Overt Monetary Financing (OMF), which simply means that all of the unnecessary hoopla of governments matching their deficit spending with bond-issuance to the private bond markets, as if the latter are funding the former, is dispensed with.” Bill Mitchell
This appears to contradict your claim.
Also in more normal circumstances bond sales come after spending not before. And the bond sales are a convention rather than a necessity. The UK Government issues its own currency - it does not need to find it from somewhere else. All UK Government could just as well be ‘debt-free Sterling'. However, there are practical implications that would create difficulties under the current system. For example, pensions are reliant on the money they get via government bonds. So if bonds sales stopped that money would have to be replaced. What MMT would say about that is that the government could pay for pensions directly.
As a more general comment - when the UK Government, which is a currency issuing government spends the non-government sector gets real money and the government adds an entry to its spreadsheet. Certainly the government now has a debt - but it's of no consequence in term of any further spending in the future. That's why I included the graph showing 300 years of mostly deficits spending. The governments debts aren't like household debs: they are just the balance (an accounting record) of how much has been spent into the non-government sector. If the UK Government did not issue its own currency then it would have real debts that it has to pay back and the country could go bankrupt. But the UK Government is not a user of currency it is an issuer of currency.
Thx Jim, I really appreciate your thoughtfulness and preparation, it’s not often I get to have an ‘expert’ conversation, so I am enjoying your work and this exchange of ideas.
Our differences stem mostly from using a Consolidated Balance Sheet vs standard accounting, but the good news is we are using the same numbers so we should be able to arrive at the same set of facts.
You wrote: “Overt Monetary Financing (OMF), which simply means that all of the unnecessary hoopla of governments matching their deficit spending with bond-issuance to the private bond markets, as if the latter are funding the former, is dispensed with.” Bill Mitchell This appears to contradict your claim.”
The ‘appearance’ of a contradiction boils down to this, there are three scenarios for bond sales, not one. When Mitchell says ‘all the hoopla,’ he is only describing one scenario but the entire range of possibilities is not visible to him because he is using a Consolidated Balance Sheet CBS. I will grant you that if and when the CB buys bonds to fund deficits, the CB is creating new reserves, and when the gov spends those new reserves the banks have an increase in reserves and then create new deposits, so your argument that the gov creates new money (reserves) and this then forces banks to increase deposits is accurate. In this scenario, the issuing of new reserves results in new deposits, and since the reserves were ‘borrowed from the CB, right hand borrowing from the left hand, as long as the CB Holds To Maturity HTM, the principal and interest are returned to the Gov, so no negative equity, for all intents and purposes the convoluted process simulates the Gov printing money to spend. Thot means new reserves = an increase in CB/Gov liability on the CB balance sheet.
If new reserves do not result in an increase in reserves from prior to the transaction, then it means those reserves existed prior to the transaction and were transferred to the receiving party. This is tricky because EVERY CB ledger entry either adds or reduces reserves, every transaction is 1:1 with a bank and the CB, so forensically, every credit of every reserve account is new reserves. However, we are only counting issuing as an increase in reserves starting from prior to the transaction, which allows existing value to be transferred among account holders, so -reserves when a bank buys a Gov bond, then + reserves Gov revenue account, then when the Gov spends -Reserves, so Gov account is net zero after spending. That means the reserves the Govvtecrived from selling bonds is either transferred from another reserve account holder, the public or their bank, OR the reserves are new and the supply is expanded because the CB bought the bond and created new reserves. Under CBS all crediting of reserve account appears as new reserves, when in reality most crediting is transferring value from reserves already issued and held by the public or their banks.
That said, I hope you will agree on these facts:
1. The Gov cannot and does not create new money to ‘spend’ and pay gov debts. Reserves needed for the Gov to deficit spend are always borrowed.
2. The CB only creates reserves in the process of buying assets, to pay for them, the seller is doing an asset swap, Reserves for bonds.
3. The Gov borrowing is not swapping assets, they are swapping liabilities short term for long term, Gov Balance Sheet -Bonds (+Liabilities) + Reserves (+Assets), -R to pay bills -L from bills paid, net result: no change in the size of the Gov balance sheet, but short term liabilities retired, new long term liabilities (bonds) incurred.
4. Your explanation is dependent upon the CB first buying Gov bonds, AND then HTM, otherwise if the CB sells the bond and retires the reserves, the argument the Gov is printing money does not hold.
5. This means our differences are including the reality that most bonds are purchased by the private market, ie public or their banks, not the CB.
6. In those scenarios, the Gov is borrowing existing reserves that are in the hands of the private sector, then spending, but promising to repay them later via bond.
7. Although this makes the story more complicated, it is more accurate, and often hidden from view using a Consolidated Balance Sheet. Same numbers, same transactions, but you are not including the majority of scenarios because you are only representing when the CB buys the bond. When they don’t, the Gov is borrowing from the private sector.
8. If we agree the Gov cannot spend until the revenue account is positive, and must ‘borrow’ short term from the CB if they are short, and the Gov then sells a bond to the public or banks to repay that BoE credit line, then the gov is not issuing new reserves to pay gov bills, they are borrowing existing reserves held by the practice . The reality is the CB does not buy many Gov bonds at auction, so what mostly happens does not resemble what you are saying. What mostly happens if the Gov borrows from the private sector to spend.
9. It is not currently possible for any major CB to spend prior to having a positive balance in their revenue account, and that deficit is mostly coveted by selling bonds to the private sector. The Gov sometimes sells to the CB, but the CB NEVER issue to pay Gov bills, only to buy that bond, which they may in the future sell.
Hi Jon,
You seem to be saying here that reserves are not involved in government spending -
"Today the BoE only issues new reserves to lend reserves against assets, or issues new reserves to buy assets, they do not issue to pay gov bills."
In reality, when the government pays out to (say) a firm that has a bank account at NatWest, the reserve balance of NatWest at the Bank of England increases by the amount paid. When the firm pays a tax liability, the reserve balance of NatWest at the Bank of England decreases by the amount paid. If (as is usual) the government runs a deficit, the net effect on NatWest's reserve balance is that it increases - and that has nothing to do with MMT.
Here's Standard & Poors on the Harvard University website saying the same thing, and they are not advocates for MMT -
"Banks create deposits when they create loans, as explained above. Governments also create deposits when they run budget deficits because they are putting more money into the public's bank accounts than they are taking out. This net flow creates new deposits in the banking system, which has its counterpart on the bank's balance sheet as an increase in reserves" -
https://www.hks.harvard.edu/sites/default/files/centers/mrcbg/programs/senior.fellows/2019-20%20fellows/BanksCannotLendOutReservesAug2013_%20(002).pdf
You wrote: “You seem to be saying here that reserves are not involved in government spending -“
Not at all, the bond sale clearly results in a reserve account debit to the buying bank’s reserve account, and a credit in the Gov asset account. When the Gov spends those reserve account credits, the Gov asset account is debited, -Reserves, and the payee’s bank or receiving bank has their reserve account at the CB credited +Reserves. When the public buys new bonds at auction, and then spends the proceeds, Reserve account balances at banks are returned to where they were prior to the bond sale.
If a bank was the buyer, it’s an asset swap, -R + Bond. When the Gov spends, they return the reserves to the same level as prior to the sale, so banking sector -R +R = 0. But, the banking sector also owns a bond, so the reserves the Gov spent create new assets at the receiving bank, +R, who then credits their customer’s deposit account +D = new deposits and new assets for the public, and increase in public equity.
If the public was the original buyer, deposits are returned to where they were prior to the sale, -D +D, plus the public owns a bond, so Gov negative equity -Bond, and the public positive equity in the new deposits +from the reserves the Gov received from the bond sale and then spent.
Reserves or more accurately reserve account credits and debits are always involved in the settlement of payment at the CB, as they are ledger entries on the CB ledger.
Forensically, every debit of a bank reserve account reduces CB liabilities, and every credit of a bank reserve account is an increase in CB liabilities, so technically new ledger entries are always new, so always new reserves, but we are trying to differentiate between A) no net increase in total supply of reserves from before bond sales to after proceeds are spent, which we will say means new new reserves created by the CB, from B) a net increase in supply of reserves issued by the CB, creating new money from before the bond sale to after the the bond sale proceeds are spent.
-R (bank) + R (TGA) -R(TGA) +R (bank) = 0 no increase in the total supply of reserves
MMT using a Consolidated Balance Sheet CBS: -R(bank) +R(bank) = 0 no new net reserves or no increase in CB liabilities from where they were prior to the bond sale.
Contrast this to when the Fed buys:
+R TGA +Bond. -R TGA +R bank + Deposits. =
+R +B -R +R +D = +B +R +D
The result when the Fed buys is an increase in total reserves or CB liabilities, the CB created new money to buy Assets. The CB also owns a bond, and if they Hold To Maturity the principal and interest is returned to the Treasury (less expenses which were going to be incurred either way). Profits are returned, so no negative Gov equity, and the public has positive equity from new deposits receive when the Gov deficit spends.
In this scenario, the Fed buys AND HTM, the Fed created new money to buy assets, the gov spent the proceeds and there is no negative equity to free money to pay bills. This is what MMT promotes as always happens, but in reality only partly happens, and not very often, only in emergencies like COVID or during QE. But, if the CB sells the asset prior to maturity then the Gov has negative equity as they have to pay the private sector for the bond.
"Today the BoE only issues new reserves to lend reserves against assets, or issues new reserves to buy assets, they do not issue to pay gov bills."
The CB NEVER creates new reserves to pay Gov bills, meaning the CB NEVER credits the payees reserve account directly, without lending those reserves to the Gov, which means the Gov must repay. The CB never credits a reserve account for Gov payment to a payee and then does not also put that charge on a short term Credit Line (UK). The CB never issues new liabilities (new reserve account credits) without securing an asset (bond or Credit Line balance)
If the CB did, they would be spending their equity.
asssts = equity + liabilities
If assts remain the same, then new liabilities must result in an equal decrease in equity.
If the CB were to credit the reserve account of Gov payee’s banks, the CB would be spending their equity and wound be bankrupt within the month.
MMT imagines this happens, but it NEVER happens, instead the Gov MUST borrow prior to spending either by selling a long term liability (bond) or by securing a loan via Credit Line to pay off short term Gov liabilities, which then by law must be retired by selling a bond. The Gov ALWAYS must borrow if they are short, prior to spending. No wiggle room. It is impossible for the Gov to spend unless they have a positive balance in their asset account, and if the Gov is short it must borrow the needed reserves. The CB NEVER issues payment on behalf of the Gov and credits the reserve account of payees without also debiting the reserve account of the Gov, and if the Gov is short the payment will not be competed (US) or the amount is placed on a Gov CL (UK).
“In reality, when the government pays out to (say) a firm that has a bank account at NatWest, the reserve balance of NatWest at the Bank of England increases by the amount paid..”
Yes, but the asset account of the Gov is also debited. Gov reduces their Balance Sheet:
-A (-reserves)
-Liabilities (-bills)
If the Gov does not have enough assets to complete payment, they MUST borrow, which increases their BS:
+A (+reserves)
+L (+bonds or CL)
The net result if borrowing to pay bills is:
+R (+A) -Bonds(+L) -R (-A) -Bills (-L) = -Bond or CL, which is negative Gov equity.
“When the firm pays a tax liability, the reserve balance of NatWest at the Bank of England decreases by the amount paid.”
Yes.
“ If (as is usual) the government runs a deficit, the net effect on NatWest's reserve balance is that it increases - and that has nothing to do with MMT.”
Yes, but that has nothing to do with deficits spending v non-deficit spending. It is clearer to separate deficit spending from non-deficit Gov spending of tax receipts.
ALL Gov spending results in an increase in reserves in the banking sector, but not a change in total reserves or total CB liabilities. If the Gov is paying the public, all Gov spending results in new deposits.
When the Gov spends:
-R (TGA) +R NatWest, which increases NatWest assets. NatWest then credits their customer’s deposit account +Deposits = +L, so Gov paying the public results in an increase in reserves for banks and an increase in deposits for the public, a transfer of equity from the Gov to the private sector.
If that spending was financed by selling a bond, if a bank was the buyer of that bond, the reserves are first debited then credited to the banking sector, an asset swap reserves for bonds, but which now also receives the reserves back while owning a bond. +equity.
If the buyer of that bond was the public, deposits were first reduced then returned when the Gov spent those bond sale proceeds, plus the public own a bond. + equity.
“Banks create deposits when they create loans, as explained above. Governments also create deposits when they run budget deficits because they are putting more money into the public's bank accounts than they are taking out. This net flow creates new deposits in the banking system, which has its counterpart on the bank's balance sheet as an increase in reserves"
We agree on this.
But I am also saying when the Gov is short, it must ALWAYS borrow prior to spending, and the source of funds when borrowing effects the monetary system and equity differently depending upon who the buyer if bonds is. That’s not well known or well understood, but empirically you can work it out for yourself as I have just showed you.
Your analysis says that the government spends from assets - it does not. To put it simply, new money is created every time the government spends. Bank money is a zero sum game, government money is not.
George, I have pointed out that the ONLY time new money is created, so an increase in the total supply of reserves meaning an increase in CB liabilities over and above what they were prior to the bond sale, is when the CB buys the bond. And, this results in a bond, the Gov borrows first, so only holds true if the CB Holds To Maturity HTM.
You like MMT are making a mistake not differentiating between the CB buying, which is rare, and between when banks or the public buy that bond, which is what mostly happens. In those cases, no new money is created, reserves are borrowed then spent, and the Gov has negative equity, public positive equity.
In no case does the CB credit a receiving bank to pay Gov bills, as you imagine and state, without the Gov borrowing those reserve account credits first. The formative accounting shows this clearly, you can work through what I wrote further yourself.
There is zero instances of debt free money being created on the spot to pay Gov bills. New CB Liabilities +L without the CB receiving assets +A FIRST!
The CB issuing new money (+L) without first securing an asset (+A) ABSOLUTELY POSITIVELY NEVER happens.
Your analysis says that the government spends from assets - it does not. To put it simply, new money is created every time the government spends. Bank money is a zero sum game, government money is not.
Look at what happens to CB equity if the CB issues new liabilities +reserves without securing new assets. They would be spending their equity, and they would spend 100% of their equity and be bankrupt within a month.
E= A -L
E+ L = A
Assuming the CB does not secure new assets, and just credits the Gov payee’s bank’s reserve account as you imagine, the CB issuing new reserves and increasing their liabilities +L with no new Assets means Equity must decrease 1:1 with new Liabilities. The CB would literally be spending their equity, which they never do.
@george, I thought I responded but don’t see it, so maybe I did not press enter at the end???
I don't see it either.
This business of issuing bonds etc seems a very convoluted mechanism for controlling the interest rate...if its not needed to raise funds...can we do away with it? And if Liz Truss had understood MMT might she have survived longer and not been freaked out by the bond markets?
Liz Truss could have easily have survived if she had understood the role of the Central Bank and understood the power of Parliament over the Central Bank. The Bond market only has power because politicians let it have power. Truss and indeed all UK politicians are ignorant of the fact that the Central Bank can protect the price of government bonds and defend the exchange rate (i.e., set it at whatever rate it wants it to be): Parliament has the power to tell the Central Bank what it wants it to do: not the other way around. When you issue your own currency - you can buy anything in that currency. Doing away with bond sales is certainly possible: but first the government would have to provide alternative funding for pensions funds: otherwise there would be a national disaster.
Hi Jim - having stated that T-bills do not pay interest but are sold at a discount, you then say "The commercial banks are keen to get them because they pay more interest than they get from their reserves". Do you in fact mean that the profit from the discount is higher than the interest paid on reserves?
Updating it now Rick. Thanks for pointing it out. Brain fade?
🙂
Whatever you do, don't get old. LOL