Tuesday, January 15, 2013

The Platinum Coin Debates

     On a political level I've argued that it's something of a red herring. While I have no problem with it economically or politically, it's unnecessary and falsely implies that the GOP has more leverage than it does.

     Far from it being too "undignified" my concern is that it dignifies the GOP threat way too much. Still, my analysis was political-economically there seemed to me to be no problem. In the last few days some interesting posts have come out by some econ guys that consider it more from the economic standpoint.

     Krugman has been a big proponent of the platinum coin-although he agrees it's not needed if Obama does stand his ground. Krugman has been very clear though that he sees the economics of the coin as impeccable.

     Yet an interesting debate has developed about what the economics of it really are. Krugman thinks it's fine right now with us up against the zero bound. Normally, however, he thinks it would be a problem.

      "Via Mark Thoma, I see that Steve Randy Waldman believes that the distinction between monetary base — the stuff only the central bank can create — and short-term debt in general has disappeared, not just for the moment, but permanently. It’s a point of view I hear fairly often, along with the view that in fact there never was a difference. But it’s a view based, I think, on a slip of the tongue.

       Tim Duy agrees with Krugman:

        "Ultimately, I don't believe deficit spending should be directly monetized as I believe that Paul Krugman is correct - at some point in the future, the US economy will hopefully exit the zero bound, and at that point cash and government debt will not longer be perfect substitutes. Note that Greg Ip disagreed with this point:
I disagree. The Fed does not have to sell its bonds, or the $1 trillion coin, to control inflation (though it may do so anyway). It only needs to retain control of interest rates, and that does not depend on the size of its balance sheet

        Yet, notice that Krugman was a proponent of the coin while Duy seems to think that the optics of the coin were too much for both the Fed and Treasury:

        "Apparently fiscal and monetary cooperation is alive and well - the US Treasury and the Federal Reserve conspired to kill the platnium coin idea. In retrospect, we should have seen this coming. As the debate continued, it became increasingly evident that the platinum coin threatened the conventional wisdom in very deep and profound ways. It was a threat that could not be endured by Washington."

          "This realization hit me this morning, working on my last piece. Begin with the effectiveness of monetary policy at the zero bound. Or, more accurately, the lack of effectiveness as the Federal Reserve is swapping one zero-interest asset for another. Rarely do we take this to its logical conclusion for fiscal policy: If there is no difference between cash and Treasury bonds, why should we issue bonds at all? Why not simply issue cash? In other words, at the zero bound, what is the argument against monetizing deficit spending?"

         "And then we come to the platinum coin, which threatened to expose the illusion that cash and debt are different at the zero bound. By extension, the platinum coin threatened to expose as folly any near-term deficit reduction plan. If you could issue a coin to support near term spending without inflationary consequences, what exactly is the rational for tighter policy now? There is none - but that would run directly contrary to the conventional wisdom among Very Serious People on both sides of the aisle that the debt needs to be addressed right now."

       "And just think about what it would mean for the Fed if it became evident that, even if only temporarily at the zero bound, deficit spending could be monetized with no impact on inflation. The lines between monetary and fiscal policy would blur further, threatening the existing state of affairs in Washington. Monetary policymakers would face an increasingly hard time defending their need for independence as akin to an Eleventh Commandment."

     Note that while Duy and Krugman agree that the debt should not be monetized Duy seems to be suggesting that the platinum coin was a problem because it would have led some people to wonder if maybe there isn't a problem with monetizing the debt. This is different than Krugman who doesn't see a problem with ir right now.

     It seems that Duy doesn't either but he thinks that we couldn't do it from a need to maintain the necessary illusions for people to continue to fear debt monetization.

     On the other side you have arguments from Steve Waldman, Greg IP and Woj who argue that even were we not at the zero bound, the platinum coin would not be a problem. Yet what the argument here seems to be is it's not a problem anymore-due to the Fed now paying interest on reserves.

     According to Waldman, There's no such thing as base money anymore:

     "What I am fairly sure won’t happen, even if interest rates are positive, is that “cash and government debt will no[] longer be perfect substitutes.” Cash and (short-term) government debt will continue to be near-perfect substitutes because, I expect, the Fed will continue to pay interest on reserves very close to the Federal Funds rate. (I’d be willing to make a Bryan-Caplan-style bet on that.) This represents a huge change from past practice — prior to 2008, the rate of interest paid on reserves was precisely zero, and the spread between the Federal Funds rate and zero was usually several hundred basis points. I believe that the Fed has moved permanently to a “floor” system (ht Aaron Krowne), under which there will always be substantial excess reserves in the banking system, on which interest will always be paid (while the Federal Funds target rate is positive)."
      "If Ip and I are right, Paul Krugman is wrong to say
It’s true that printing money isn’t at all inflationary under current conditions — that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end.
     "Printing money will always be exactly as inflationary as issuing short-term debt, because short-term government debt and reserves at the Fed will always be near-perfect substitutes. In the relevant sense, we will always be at the zero lower bound. Yes, there will remain an opportunity cost to holding literally printed money — bank notes, platinum coins, whatever — but holders of currency have the right to convert into Fed reserves at will (albeit with the unnecessary intermediation of the quasiprivate banking system), and will only bear that cost when the transactional convenience of dirty paper offsets it. In this brave new world, there is no Fed-created “hot potato”, no commodity the quantity of which is determined by the Fed that private holders seek to shed in order to escape an opportunity cost. It is incoherent to speak, as the market monetarists often do, of “demand for base money” as distinct from “demand for short-term government debt”. What used to be “monetary policy” is necessarily a joint venture of the central bank and the treasury. Both agencies, now and for the indefinite future, emit interchangeable obligations that are in every relevant sense money."

     Greg IP further elaborates on Duy's arguemnt that it was the politics of the coin-rather than the economics-that were problematic:

   "But while the economic consequences for the Fed are benign, the political consequences are not. As I noted earlier, the Fed buys coins in response to demand from commercial banks (the process is explained here). Banks won’t want a $1 trillion platinum coin, so the Fed will only buy the coin if Treasury forces it to. The Treasury, in “depositing” its coin at the Fed, is in reality ordering the Fed to print money. And if Treasury doesn't take the coin back, the money stays printed."

   "The economics may be the same as QE; as Mr Krugman notes, coins, like bonds, are liabilities of the central government. But the politics are utterly different. We have a central bank to separate fiscal from monetary policy. The Fed implements QE when it has decided that’s the best way to carry out its monetary policy objectives. Buying a coin solely to finance the deficit is monetizing the debt, precisely the sort of thing central bank independence was meant to prevent. How could any Federal Reserve chairman justify cooperating in such a scheme, in particular since the Fed would be taking the White House’s side in a fight with Congress over a matter of dubious legality?"

   "Yes, the Fed has sacrificed its independence for the sake of the national interest before, such as maintaining a ceiling on Treasury yields between 1942 and 1951; but that was (initially) in wartime, and it eventually led to inflation. Would avoiding the debt ceiling be important enough to compromise the Fed's independence? Perhaps not in this one case; but it would set a precedent future presidents will happily exploit and feed the perception that America’s economic institutions are in terminal decline. America has had debt ceiling crises before (in 1957, 1985, 1996 and 2011) and survived; are the unknown risks of the platinum coin option obviously preferable to the known risks of hitting the debt ceiling?"

    "There is a way around this problem that preserves the Fed’s independence. That would be for the Treasury to issue the coin to the public, instead of the Fed, thereby leaving the Fed’s balance sheet, and its control of monetary policy, alone. Of course, no one would want a $1 trillion coin. But Gary Gorton, an economist at Yale University, suggests there might be demand for a bunch of $50 million coins. He notes the financial system still craves safe, liquid assets. Corporations in particular are desperate for a safe place to park cash now that unlimited federal deposit insurance has expired. Including fees, many bank accounts now sport negative yields, as at times do Treasury bills. Money market mutual funds may float their asset values. Platinum coins would represent a risk-free, liquid way to store cash with no risk of negative yields."

     Note that these positions are all different shades of grey. As Krugman mentioned, there are those who think that there was never a problem  with the coin being inflationary even when not at the zero bound. The arguments here are that it's no longer a problem due to interest on reserves. Sumner on the other hand thinks that paying interest on reserves is "tight money"-ie, a big mistake.

    Woj agrees with Greg IP, Waldman, et al. and says that the Fed will never stop interest on reserves-as they recently did in the EU:

     " Changing
the Fed’s operating procedures to use interest-on-reserves in setting interest
rates, therefore allowed the Fed to engage in massive balance sheet expansion,
via QE, and to increase the size of Operation Twist. Through these
unconventional measures the Fed not only continues to increase liquidity and
“finance” the federal budget deficit, but also manages to lower long-term
interest rates."

the ECB’s decision to stop paying interest-on-reserves, proponents of monetary
stimulus within the US are calling for the Fed to adopt a similar stance or
potentially make the nominal rate negative. While I previously examined the
fallout from a negative IOER rate
, in light of the above information, a
reversion back to previous monetary policy procedures seems even less

Federal Reserve’s decision to implement an “interest-on-reserves regime” has
clearly been beneficial in permitting the use of previously conventional
measures for unconventional purposes, including the provision of liquidity and
“financing” of federal budget deficits. Eliminating the payment of
interest-on-reserves will not prevent the Fed from continuing to use open market
operations in this manner, as long as the Fed Funds rate remains at zero.
However, departing from this new regime will ensure that any future rate hikes
be preempted by a reversal of the balance sheet expansion (or excess sale of
Treasuries). Balance sheet contraction, through open market operations, could
very well depress asset values and raise long-term interest rates. If this
occurs, the Fed would be effectively causing a new crisis just as the economy is
becoming increasingly stable. Separately, a 25 basis point reduction in
short-term interest rates is unlikely to cause a noticeable rise in credit
demand but would reduce financial sector profits. Given that any decision to
cease paying interest-on-reserves would likely be temporary and the potential
benefit is limited, there is seemingly little reason for the Fed to change
course. An “interest-on-reserves regime” appears likely to rule monetary policy
for the foreseeable future."
    This is very different from the proponents he mentioned-Sumner, et. al-who believe that interest on reserves is "tight money."

     The only thing missing is the proper MMT position that there was never a problem with the coin being inflationary even prior to the coin. I see that some MMTers left Krguman links in his comments section.

     Here is a piece by Cullen Roche over at Monetary Realism-who is always at least refreshingly lacking in snark-compared with many of the MMers:

     "These ideas of “high powered money” and the “monetary base” are unfortunate terms that muddy the waters in understanding how money is created and how the monetary system works. In a world of endogenous money where almost all money is created by banks these concepts get large facets of the workings of the monetary system wrong. Now, I don’t doubt that monetary policy will become more effective outside of the balance sheet recession. But the end of the balance sheet recession won’t magically bring the money multiplier back to life. It’s dead. It’s always been dead and we should make sure this myth remains very dead.

      And yes, Stephen Williamson couldn't resist razzing Krugman and actually left his link in the comments section:

      "In a financial system, like the one we have in the US currently, in which there is a positive stock of deposits with the central bank overnight, and the interest rate on those deposits essentially determines the overnight interest rate, the central bank works within a floor system. I have discussed that in several blog posts, including this one. To quote myself:
A floor system is different. Under such a system, the central bank sets an interest rate on reserves and a central bank lending rate, and plans to have a positive supply of reserves in the system overnight. As a result, the overnight rate must be equal to the IROR, by arbitrage. An open market operation in short-term government debt in a floor system will have no effect, at the margin, as the central bank is simply swapping one interest-bearing short-term asset for another. The instrument of monetary policy in a floor system is the IROR, which determines short-term nominal interest rates.

Currently, the Fed operates under a floor system. The supply of excess reserves is enormous, and the IROR determines short-term interest rates. There are some weird features of the system, such as the fact that the GSEs receive no interest on their reserve accounts, and there is some lack of arbitrage which results in a fed funds rate less than the IROR, but I think those weird features are irrelevant to how monetary policy works.

Under a floor system, we are effectively in a perpetual liquidity trap. Conventional open market operations in short-term government debt do not matter, whether the IROR is 5%, 0.25%, 10%, or zero. But, not to worry, the central bank can always change the IROR except, of course, when it hits the zero lower bound (neglecting the possibility of taxation of reserve balances, which is another issue altogether).

     "Steve Randy Waldman seems to agree with that. Paul Krugman does not. Here's what Krugman says:
Now, under current conditions that doesn’t matter; dead presidents don’t pay interest, but neither do T-bills, so short term debt and currency form an aggregate (a Hicksian composite commodity, for the serious nerds out there), whose composition doesn’t matter. But interest rates won’t always be zero, and at that point the size of the monetary base — dead presidents plus a sliver of bank reserves that can be converted into dead presidents at will — will matter again.
     "That's incorrect. The nature of the liquidity trap does not change if the interest rate on reserves (IROR) rises. With a positive stock of reserves in the system, there's a liquidity trap no matter what the IROR is. If the Fed swaps short maturity debt for reserves it's essentially irrelevant - the two assets are roughly identical. It's not a big deal though, as the Fed would conduct monetary policy in exactly the way it did in 2007. The policy rate is the IROR (not the fed funds rate), and moving the policy rate will have essentially the same effects as targeting a particular fed funds rate through open market operations."

     "Addendum: Where I don't agree with Waldman is on this:
Consistent with the “Great Moderation” trend, the so-called “natural rate” of interest may be negative for the indefinite future, unless we do something to alter the underlying causes of that condition.
     "I haven't seen a convincing explanation for why the "natural rate of interest" is currently low, or worse still, persistently low. See this post."

      Ok, that's enough opinions to chew on I think!




  1. Mike,
    Thanks for including my thoughts in this discussion. It obviously feels nice to be included in such an esteemed group, although I certainly have plenty of learning left to do on these topics.

    Cullen had a really good post up earlier on the important of the platinum coin that I largely agree with. As I see it the platinum coin was abandoned because it reduces the power of the Fed and private banks, exposes the truth about the current fiat monetary system and was far too complex and crazy sounding to sell to the American people.

    I also think it's important to clarify the potential inflationary effects of the platinum coin. As I see it, the platinum coin is only inflationary to the degree the govt uses the funds for deficit spending.

  2. Would it have basically made the Fed redundant?

    Do you agree that IOR has somehow changed the monetary regime as much as Waldman and Greg IP think?

    1. Prior to the recent crisis, the Fed set/targeted short-term interest rates by adjusting the amount of reserves given required amounts and demand. The Fed primarily adjusted reserves through OMOs (purchasing Treasuries). Meanwhile, the Treasury spent reserves into the private sector and sold Treasury bonds/bills to reduce/eliminate the increase in reserves.

      Now a $1 trillion platinum coin gets created by the Treasury and deposited at the Fed, in return for $1 trillion reserves. Unlike in the above case, the Treasury could now spend the reserves into the private banking system without requiring new debt sales. Suddenly the Treasury has significant discretion over the supply of reserves (monetary base).

      In the case above, the Fed is not necessarily redundant but has lost a large chuck of its power in controlling the base money supply.

      I do agree with SRW and Ip that the change in monetary regime is extremely significant, although I expect it will take many years for most people to recognize this.

  3. It's not clear w

    here you are then in the debate in that you say it's inlfationary if it's used for deficit spending.

    Krugman's argument is that it's not inflationary-right now, because we're at the zero bound.

    Waldman thinks we are in a new monetary regime and it will never be inflationary anymore because we've moed to what he calls a "floor system'-it's all about IOR.

    If the platimum coin had been used it wouldn't have been for deficit spending but previous spending already authorized-the debt ceiling

    1. Apologies for the lack of clarity, let me try again...

      In my view, deficit spending is inflationary regardless of the ZLB or economic slack. That is not to say it will cause high or hyper-inflation, only that their will be more inflation (or less deflation) than would have otherwise been the case.

      The platinum coin, in itself, is not inflationary regardless of whether or not the economy is at the ZLB. When the coin is deposited at the Fed, it credits the Treasury's account (at the Fed) with reserves (which are not counted in the monetary base).

      Presumably due to seigniorage, the deposit reduces the public debt outstanding, permitting Congress to spend without exceeding the debt limit. As I mentioned above, Congressional spending (up to the coin's value) would then increase the base money supply. Under the old monetary regime, this would have put downward pressure on short-term interest rates, which may be inflationary. At the ZLB or under the new regime (which I discussed back in August), the increase in monetary base does not affect short-term interest rates. In that sense, it is not inflationary.

      There are many other aspects of this debate however which I'll just mention quickly as food for thought:
      1) Are higher or lower short-term interest rates inflationary? I've seen arguments made both ways.
      2) The platinum coin is interest free, while reserves under the current "floor system" are interest-bearing. As the reserves are spent, this is somewhat reversing QE, whereby the private sector gains interest-bearing assets and the Fed doesn't. This would increase interest income for the private sector, creating larger deficits (and possibly higher inflation).
      3) It's reasonable to expect that the platinum coin might alter debates within Congress over spending. To the degree it alters current/future deficits might be inflationary.

      (The ideas in this comment and the previous one are, to the best of my knowledge, correct. I'm not sure of all the legalities and may have made other errors, so I'm open to further debate/questioning.)

    2. Don't get me wrong Woj-I have no doubt that your comments are made in good faith and you are honest! Of course, honest people can have honest disagreements!

      You know a lot of this stuff much more than I do, I'm just picking your brain. When I comment or question something you said it doesn't at all necessarily I'm saying you're wrong or even thinking in those terms.

      Mostly, I'm trying to expand my own knowledge. You have to understand I'm must an interested layman. I consider myself lucky to be able to have a rap session with you.

      I actually found your 1) a very good question. Sumner is one who always says it's inlfationary. If you read him at all, this is something you come across again and again:

      "Let me repeat, higher interest rates are inflationary. They increase velocity. If you don’t believe me, check out interest rates and velocity during any extremely high inflation episode. When rates rise, inflation usually rises. Higher interest rates are inflationary. Repeat 100 times. But the thing the Fed uses to generate higher short term interest rates—a reduction in the money growth rate—is deflationary. To reduce inflation you must reduce money growth. Interest rate targeting (or exchange rate targeting) is simply a tool. It is changes in the money growth rate that actually drive macro nominal aggregates up and down."

      See now this is why I ask questions: I really don't know whether he's right or not about that.

      You have any thoughts?

    3. Thanks for the clarification and glad we're on the same page.

      As for the question, I think there are two many potential cross-currents to say it has a decisive effect one way or the other (ignoring questions of timing). Here's a quick list of my thoughts on higher rates:
      1) Increase interest income on federal debt; inflationary
      2) Imply increasing inflation expectations; correlation not causation
      3) Imply greater bank lending; correlation no causation
      4) Strengthen the currency; deflationary
      5) Raise interest costs to borrowers, especially those with floating-rate debt; deflationary

      I'm sure there are more factors, they're just not coming to mind at the moment. Anyways, depending on the time frame, I would certainly expect increasing interest rates to correlate with rising inflation. The portion of debt that is fixed vs floating and the dispersion of debt in society will play a large role. My best guess is that under current circumstances, higher interest rates would be deflationary especially after the short-run.

  4. Thanks Woj! This discussion is always tough for me to wrap my head around. Whats tough is to differntiate is like you said-causation as opposed to just correlation and also cause and effect.

    I think why I find it hard is because when the Fed wants to damp down on inflation it raises rates.

    So the rates raise because inflation is already high rather than rates causing inflation-or so it seems to me.

    I'm just thinking about the Fed here, but on the market, as inflation rises, creditors raise interst rates to mitigate what they lose from higher inflation.

    So you wouldn't raise rates to get higher inflation or higher output, etc.

    If you raise inflation and output then in time you would get higher rates.

    To get higher inflation you lower rates which lowers costs to borrowers which in time would lead to inlfation.