Thinking About the Fed

JKH has magisterial post up on the recent dust-up over Saving as perceived in various sectoral models — one-sector (global, for instance, or government- and trade-balanced domestic private sector); two-sector (government and private including international); the most common MMT construct, the three-sector model (government, domestic private, and international); the rather uncommon four-sector model (government, international, domestic household, and domestic business); or even a seven-billion-plus-sector model, in which each individual (and business, and government) is represented as a sector.

His key point, I think — one I agree with profoundly — is that people need to be very clear on which model they’re assuming when they use the word Saving, or the construct “S.” (People sometimes use those two differently, with different implied sectoral models, sometimes within a single discussion or even a single sentence.) In most cases the different constructs of saving and S that people throw around are absolutely valid within their (implicit) sectoral models. The problem arises when people are talking about different sectoral consolidations within the same discussion, without themselves and/or their interlocutors being (fully) aware of it.

I’ve left a few glancing comments over there, but it’s prompted me to write up some thinking here that’s conceptually related.

How do we think about the central bank, and actually the nature of money and the monetary system? I see a lot of people talking past each other because they’re talking about different levels of accounting consolidation. Here are four ways to look at the Fed:

1. It’s an independent institution, separate from Treasury and the reserve-holding banks.

2. It’s part of “government” — a consolidated entity comprised of Treasury and the Fed.

3. It’s part of the private sector monetary system — a consolidated entity consisting of the Fed and all the banks holding reserves at the Fed.

4. It’s part of a fully consolidated monetary system consisting of Treasury, the Fed, and all the reserve-holding banks.

I’m not going to explore all these fully — there’s a book (or several) there — but here are some thoughts on each that might illuminate how the thinking is very different depending on which you adopt, perhaps showing how quite a lot of unecessary confusion and cross-discussion might be avoided.

1. It’s an independent institution, separate from Treasury and the reserve-holding banks.

Even though this is the “reality” of our monetary system (as a result of legislative diktat), thinking about it this way results in an odd conceptual situation. We end up with a sovereign currency issuer (Treasury) that (like a household or business) has to borrow in order to spend, and a bank (the Fed) that can issue unlimited funds ex nihilo to purchase assets. This seems exactly the opposite of how one would imagine things would work.

2. It’s part of “government” — a consolidated entity comprised of Treasury and the Fed.

This is a preferred MMT construct, and it has much conceptual appeal. “Government” issues new money through Treasury spending, and Fed open-market and QE operations are basically fiddling around the edges of the money “supply,” largely for the purpose of interest-rate management. Yes, the Fed actually issues the money, but in this consolidated view “government” is doing the issuing through deficit spending, crediting people’s bank accounts with newly-created money.

3. It’s part of the private sector monetary system — a consolidated entity consisting of the Fed and all the banks holding reserves at the fed.

This makes conceptual sense, because all deposits ultimately resolve, consolidate, back to reserves at the Fed. In this construct, all the banks (including the Fed) are issuing private money as licensees of of the Fed, which ultimately derives its licensing authority from “government” (Treasury).

4. It’s part of a consolidated monetary system consisting of Treasury, the Fed, and all the reserve-holding banks.

Looked at this way, we could conceive of it all as a single big national bank, with deposits resolving back to reserves, which ultimately resolve back to the full faith and credit of the government (Treasury).

These are fairly sloppy characterizations. I know the JKHs and SRWs, Ramanans, Vimothys et. al could (and I hope will) express them more cogently and accurately. But I wanted to keep them brief to highlight my central point:

Different views, consolidations, of these entitites result if very different understandings of “how the monetary system works.” Each (properly presented, unlike here) is valid within its own construction, and each imparts an important understanding of how things work. The problem arises, as with Saving and “S,” when a person, or people in discussion, confute and confuse these different views, or switch among them during thinking and discussions.

Cross-posted at Asymptosis.

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