Thursday, February 19, 2009

Deficit spending *enables* private savings

It's worth reiterating Mosler's explanation of how Federal deficit spending enables private savings.

1. The Treasury sells $100B of government bonds.

2. Private sector bank balances go down by $100B to pay for those bonds.

3. Private sector holdings of government bonds go up by $100B.

4. The Treasury now spends the $100B it just raised by issuing debt

5. Private sector bank balances go up by the $100B the Treasury just spent.

So, net net, bank balances are exactly where they were before. The private sector holds $100B new Treasury debt, and the Government has funded $100B of public works (or whatever). The Treasury debt the private sector now holds is savings which pay interest, higher interest, than the bank liabilities (deposits) they held earlier. So private sector savings has gone up by exactly the amount the deficit has increased.

When the Treasury issues debt, it does not finance the deficit, it just alters the term structure of money that's out there, because you can either have the Government hold one of your dollars in an FDIC insured account, or you can have the Government hold one of your dollars in an equally zero-default treasury security. No difference, just a new term structure. The term structure is important in that bank deposits can sit at the Federal Reserve account and Treasuries cannot, so the Government issues Treasuries to drain reserves, and thus maintain a positive interbank overnight lending market. In a ZIRP situation (which we are currently in) I don't see why the Government needs to issue any Treasuries at all, nor do I see why the Government cannot simply ran an overdraft at the Fed.


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