People are finally starting to catch on as to why the Federal Reserve's quantitative-easing program never brought about the inflation that many people expected. I've been writing about this for the past five months, ever since I came on board here at Real Money, and even before.
All this was predicted by Modern Monetary Theory, a school of economics that has been around for about 20 years but which is only now catching on. Modern Monetary Theory or, MMT, describes the workings of an economy under a fiat money system. That's a system where the money is not backed by gold or some commodity or somebody else's currency, and where the government issues the only money that is acceptable for the payment of tax liabilities.
Under such a system, the currency issuer, in this case the federal government of the United States, is not revenue constrained. It issues its own money and needn't collect taxes in order to spend or invest. Taxes function merely to regulate demand. Nor does the government "borrow," in the classic sense. The sale of Treasuries or other government securities is nothing more than a reserve drain.
The central bank is the agent of the government, debiting and crediting bank accounts, according to instructions from the Treasury. The Fed sets interest rates by manipulating the level of reserves in the banking system, and it has the power to set rates anywhere along the term structure. In 2008, the Fed was granted permission by Congress to pay interest on reserves, so reserve drains have even become unnecessary, but they continue to go on.
Under a fiat money system where the central bank pays interest on reserves, there is no reason for the government to sell Treasuries. Moreover, paying interest on its own money that it has the monopoly power to issue is nothing more than a fiscal transfer -- this is something I have pointed out many times. Furthermore it's a fiscal transfer that goes primarily to wealthy people, which means it's totally unnecessary and unjust in my opinion, particularly at a time when fiscal transfers to the truly needy are being reduced.
When the Fed conducts monetary operations, such as quantitative easing, it is not printing money. It is simply changing the composition of financial assets held by the public and most likely changing the duration of those assets. In the specific case of QE, it is exchanging reserves (dollars that have zero duration) for Treasury securities (dollars that have some duration). The bottom line is that no net new financial assets (money) have been created. No money has been printed. This is where many people got it wrong.
The federal government has the power to create money, and it does so when it deficit-spends. Deficit spending, by definition, means that the government is creating more money than it is collecting in the form of taxes. Deficits, therefore, leave the private sector with a surplus of dollars that are exactly equal to the size of the government's deficit. Moreover, the payment of taxes cannot occur unless the government deficit-spends, because that is the only way that the private sector will have the dollars to settle tax liabilities.
It's all pretty simple. We just need to rid ourselves of the myths and misconceptions that bind us.
