Responses to Blog #31: Functional Finance

By L. Randall Wray

All: thanks to some for attempts to come up with some real world JG jobs suggestions in answer to my challenge last week. We will move on to the JG after dealing with a few more issues related to JG. Keep thinking! I also saw that Neil has done a good job around the blogosphere defending JG. Keep it up!

We are more than half-way through the MMP. My responses to questions/comments are going to become more focused. In part because many questions concern issues we already covered, or those we will cover. But more importantly, I’ve put a lot of work to the side to do the Primer over the past 6+months and now must catch up with a variety of other work and deadlines. So, the Primer will continue, maybe with fewer side issues, but my responses will be more focused on those questions/comments that respond to the current week’s blog.

So just a few responses today.

Q1: I thought it was the MMT position that adjustments to the interest rate are not and cannot be matters of open market purchases, which are only used defensively to maintain the target rate.  Instead, the Fed changes interest rates by announcing the new rate (it's unclear to me what the actual threat is for the rate to change) or paying IOR at the target rate (unless this is the threat???).

A: That is pretty much what the blog says and what Lerner thought. If banks are short reserves, they drive fed funds rate (in US) above target, Fed buys bonds (OMP), provides reserves, increases the ratio of reserves/bonds. Just like Lerner (and I) said. On the other hand, when Fed announces new interest rate target (say, increase from 1% to 2%) it does not need to change Res/Bonds ratio at all since it is likely banks have the ratio they want and the demand for reserves is not interest elastic. So I think you've confused two different things—using bond sales/purchases to satisfy private sector demands for high powered money (to hit a rate target), versus announcing a new interest rate target (which normally does not require any open market sales or purchases).

Q2: What is the government budget constraint?

A: OK this is the idea that even sovereign currency-issuing government is subject to a spending constraint. I’m sure BillyBlog has written on this. It came to life in the late 1960s—government is like a household and must “finance” its spending: taxes, borrowing, or (unlike households) printing money. But that is false. Government spends through keystrokes. Yes it can self-impose budget constraints (ie in the US we pass a budget and we also impose a debt limit). But this is nothing like a household, that faces a market imposed constraint.

Q3: What drove inflation?

A: This is not the time for that. We already talked about hyperinflation and a bit about CPI inflation. We might return to it again later; and note that the JG is a price stabilizer. We can have full employment without stoking inflation pressure—a topic for later.

Q4: Can the Euro nations create net financial assets?

A: I already discussed this. Domestically, yes, in the sense that claims on the Greek government are net financial assets for the nongovernment sector. But I do take the point that ultimately Greece (etc) are users of the currency so it all depends on the ECB to create true NFA for the system as a whole. (or the US which can create NFA in dollars for Eurolanders to hold)