Peter Stella on the Fiscal Theory of the Price Level

Peter Stella is the former Head of the IMF Central Banking division and has researched and written extensively on safe assets, collateral and central bank operations. Peter now hosts a website Central Banking Archeology. Peter joins David on Macro Musings to discuss the role of money and its relationship to inflation as well as its relationship to the payment system. Specifically, David and Peter discuss the fiscal theory of the price level, how rising indebtedness can signal higher inflation in the future, the implications of the fiscal theory for contemporary fiscal and monetary policy going forward, and much more.

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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to

David Beckworth: Peter, welcome back to the show.

Peter Stella: Thanks, David. It's great to be back with you again.

Beckworth: Yeah, it's great to have you on, and you've been requested multiple times by many listeners, so you're one of the favorites and it's always great to get a favorite back on the show. So I'm going to begin with a paper you've written and it really delves into this big theme of what is the relationship between money and inflation. And do we have a correct understanding the title of your paper is “Interpreting Modern Monetary Reality,” but maybe start us off with kind of the big picture here you're trying to paint for us.

Stella: So that paper is something that I wanted to do for a long time. And it really is my, you could say, I always did a lazy or patient, but in 1995, Robert Lucas gave his Nobel prize at us and it was all about monetary neutrality and so on. And he's a complete theoretical genius and deserving of the prize and all that. But one of the things that bothered me in that address and bothered me in some sense with the quantity theory of money is that some of its advocates looked to empirical data and basically made the claim, this theory works in every country, no matter what the exchange rate regime, no matter what the fiscal situation. It's basically the relationship between money growth and inflation is one to one over the long run. And Lucas in particular refers to some empirical work that he did not do.

Stella: It's not his own work, saying that this is completely the most valid economic theory in history. And so that the work that he cites, in particular, the one that I always wanted to redo, used IMF data actually, cross country data from 1960 to 1990. And it validates the claim that, yeah, there's this very tight relationship in all these countries. And so having been at the IMF and traveled to a lot of countries to have been the fiscal economist in Argentina in the 1980s, early 1990s, and seeing hyperinflation there, been there during hyperinflation. I was in Argentina in May, 1989 when the price level went up 198.5% in one month.

Stella: And I've also been in countries like Liberia, worked in Liberia where they didn't have their own currency, and yet they had quite a bit of inflation. So I was kind of accumulating observational facts that just didn't quite, weren't quite well explained by the theory. And there was kind of a joke in the IMF at that time, I was in the fiscal affairs department at the beginning. And that was that IMF, which stands for international monetary fund, really stood for it's mostly fiscal. So it was kind of a joke, but you know, I saw this in front of myself and I said there's some things going on here. It's not quite so easy to explain them because people in Argentina at the central bank, they weren't trying to create a hyperinflation. It's not like they were controlling the money supply to create hyperinflation, something underneath was driving this.

Stella: So for a long time, I kind of just wanted to do something very easy, which was to say, let me just rerun the same empirical work with the same countries over the last 30 years of data, or the last 20 years. And this is where either the patients or the laziness came in. So with a couple of former colleagues at the IMF, Maman Singh and someone else in his depart, kind of reproduced those results from the period 1990 to 2020. So it took us whatever it took me 20 years to get around to doing this, but we did it. And I was convinced that the numbers would not come out the way that they had come out in the earlier period and true enough, they didn't. So that was kind of that whole point of that IMF working paper, which came out in January. And then it was a bit like saying, "Okay, there's all these facts that we can't quite explain with this theory."

Stella: And that's the end of it. Now, someone got ahold of that paper and thought, "Oh, this is really good, but I have to read it twice." And so it's the editor of the journal of Fly Corporate Finance at Columbia. And he said, "Could you kind of rewrite this paper in a different context and make it straight forward?" So I did that and I thought I did a pretty good job of making it much, much clearer and not getting involved in all the econometrics. And so he said, "Yeah this is great, but I want the right theory. You've explained why that theory is failing. But now I want to know, what's the truth." And I'm thinking what you think I'm like Albert Einstein or something, I'm not the guy to ask me, what's the new theory, but I went ahead and I said, okay he's the one who asked me to write the paper, he's the boss, so to speak.

Stella: So I said, okay, I'll rewrite the paper and I'll work in what I think is the most plausible sort of explanation or the leading contender to advance economic science, which I would say is the fiscal theory of the price level. And I rewrote the paper pretty considerably with that in mind. It wasn't like I just added a paragraph at the end of the paper. And in writing the paper, I kind of convinced myself that we should look at the fiscal theory as a more general theory of the quantity theory. So the quantity theory is a special-

Beckworth: Is a special case of the-

Stella: Is a special case.

Beckworth: Okay.

Stella: Exactly right. So if you look at sort of the history of science, let's say real science, like physics, it's kind of around the term of the 20th century, the 1900s. People are doing experiments with new technologies and coming up with a lot of data that Newtonian mechanics, Newtonian physics cannot explain. It's very disconcerting, it's not like Newtonian physics is wrong. It's just, we're now generating a lot of data that just cannot be explained by it. And then at about 1905, Einstein comes up with the special theory of relativity and that explains a lot of stuff, but not everything. 10 years by later, he comes up with the general theory. That explains more stuff. But obviously, I don't think Einstein never ever sort of claimed that he had explained everything. Obviously he hadn't explained everything.

Stella: And that's the way kind of science moves ahead or doesn't move ahead. Is that the theories start failing to explain the new data and new theories have to come up, which not kind of reject the old theory, but simply say, "Okay, we need to have a more general explanation of phenomenon."

Beckworth: Well, how would you define the fiscal theory of the price level for our listeners?

Fiscal Theory of the Price Level

Stella: So I would say that, coming back to the quantity theory, so the quantity theory is basically saying a particular type of liability of the state, which is a monetary, we call it a monetary liability, which is bank reserves or physical currency let's say. Changes in that lead one to one to inflation. So that's the variable to keep an eye on. So it's basically the state is issuing liabilities and this is the part where the fiscal theory stresses, without any change in fiscal policy. It's not promising to raise taxes in the future. It's simply issuing more liabilities against itself, and it's not generating any revenue to redeem those liabilities. So kind of law of supply and demand if a company issues more debt, but just burns the money away, it doesn't generate in a project that generates the revenue to pay off that debt.

Stella: You're going to see the value of the firm fall. And if inflation is measured in the share price of the company, then inflation will go up, but our unit of account is the liability of the state, which is these monetary liabilities. So basically in a nutshell, what I think the fiscal theory is saying is it's not just the monetary liabilities of state, it's all the liabilities of the state. So if the state issues a trillion dollars, if the US issues a trillion dollars in Treasury bills, and there is no sort of fiscal future, fiscal effort to redeem those, that debt, it's going to be just as inflationary as if the Fed were issue, just give away a trillion dollars in bank notes.

Stella: So there's nothing... I would say that again, I can't claim to be at all, the author of the ideas behind the fiscal theory, but my simplistic understanding of it is to say, it's a question of not making such a huge deal between the monetary liabilities of the state and the debt liabilities of the state, or the, let's say the future entitlements that the state is committed to pay for like Medicare and so on and so on. So it's a broader concept. Now, if we want to come back to say, "Well, how did the quantity theory of money do such a good job of explaining inflation if I'm saying it's only a small piece of the pie that we should be paying attention to?" Here’s what I kind of come to in terms of the special case.

Stella: If you say, as I think is legitimate to have claimed say in the 1950s or the 1960s, that when the government says, "I'm going to spend more money," and finances it with money creation, that's a pretty clear signal they're not intending to raise taxes in the future. So it's basically a signal when I finance with money that means, "Hey I'm never going to raise taxes or cut expenditure in the future. This is a permanent increase in fiscal spending. And I'm not going to do anything about it." Whereas in the 1950s or 1960s, the government says, "I'm going to spend more money, but I'm going to issue bonds." Even though a bond is nothing more than a promise to pay money in the future. If you take that as a signal, Hey, this government is issuing a bond, they're going to raise taxes to pay the bond off.

Stella: So basically what I'm saying is when you see, let's say in the 1950s, when you see a government financing with money instead bonds, it's a signal that the fiscal effort that we expect in the future is very different than if they're financing with bonds. And of course, we can look back at cases of hyperinflation in those periods. And they're almost always cases where the bond market is not well developed. So there wasn't really a credible option for Argentina to issue domestic bonds in the 1980s. There was no market. So the way they had to finance, let's say a crisis, if they couldn't borrow externally, was to print money. It wasn't because they thought, "Oh, that's a great way to finance a deficit."

Beckworth: Yeah. So couple of elements you've outlined here. So one is fiscal policy and monetary policy are intricately linked in understanding this relationship up. So there is really no island of monetary policy that's truly independent of what fiscal policies is doing. That's the one thing you've mentioned. The other thing, and you highlight this in your paper, is the fiscal theory of the price level treats all these government liabilities as equivalent or substitutes to some degree. So the monetary base and bonds are substitutes in this theory, they're all government liabilities, you got to consider them. Now maybe they're not perfect substitutes on every margin, but they're, in terms of liabilities, you got to count both of them. And then the final thing you mentioned then is it's the expected future fiscal condition of the government that's going to be driving this process.

Beckworth: So if the government is not going to be running primary surpluses in the future, and if there's not a sufficient flow of seigniorage coming in, such that it leads to say permanently higher debt levels, is that the point where we see inflation begin to go up? Is it the concern about the future debt loads, future fiscal health that affects current inflation?

Stella: Yeah, I would say exactly. So that's exactly the notion. And if I could come back, I don't know your audience, how much they are into theory, but Neil Wallace, who's not as well known, but he's the Wallace in Sargent and Wallace, everyone knows Sargent and Wallace and Tom Sargent won the Nobel prize. And people probably don't know Neil Wallace, but he wrote a paper in 1981. It was called kind of, a Modigliani Miller theory of open market operations, which is a long title that if you don't know finance, probably means nothing to you. But basically what he was saying in a very theoretical model, he's saying, "Central bank issues money and blue government debt. I don't see any reason why that should change anything. It's simply one liability swap," and it's similar...

Stella: He didn't talk about it this way, but treasuries all the time, all over the world are making decisions, "Do I issue a Treasury bill? Do I issue a 30 year bond? A 10 year bond? A floating rate note?" And I've never heard anyone say that the choice between initially a Treasury bill versus a 30 year bond is somehow inflationary or terribly meaningful. On the margin, small changes in the government's debt strategy are just not talked about as meaningful economic factors in theory, or I would say in practice. Small changes. So what Wallace in my mind, and again, this is something that when I read the paper in the 1980s, I understood. But now in retrospect, you go back to that paper and say, "Well he's really asking a really hard question," saying, "Well, this is just a little liability management. Why should it matter?"

Stella: And he's saying it doesn't matter. Unless this is changing somehow fiscal policy. So there's a tiny little difference. Back in those days, the Fed is issuing non-interest bearing money and buying back treasuries, which are paying a little interest. So you could say, "Oh, this decreases the government's interest cost by a tiny little bit. So maybe that's what matters." But if there isn't that little fiscal thing going on, then it really shouldn't matter. Which of course causes all kinds of problems for people doing actual central banking because they think they are actually doing something right with the whole-

Beckworth: Yeah. So Wallace neutrality is a very powerful idea. And I remember having lots of conversations about it and it's the application of a Modigliani Miller theorem to public finance. It doesn't matter how you finance. It's the point. And I remember around QE3, maybe a little after that, we had these online conversations about, well, how affect have is QE3? Is it really making a difference> even Michael Woodford and Gauti Eggertsson's in their papers, they come up with something similar called the policy and effectiveness proposition of QE. And they make the same point that QE really doesn't make that much difference outside of market collapsing, market crashes. So maybe 2008, 2009, March, 2020, that's when large scale asset purchases can make a difference, they actually backed up a market. But in terms of normal market functioning periods, there really isn't a whole lot of bank for buck, other than maybe the signaling that you've mentioned, or it's some indication of the future health of fiscal policy. I want to come back to that in a minute, but let me just push this a little bit more with you.

Beckworth: So why would it be the case that even if we think government's going to run these bigger permanent deficits, so higher levels of debt in the future, why should it cause inflation? What is the actual mechanism or step that would imply more debt, higher inflation in the future?

More Debt Implies Higher Future Inflation?

Stella: Right. So the one who has, I think, the most extensive in articulating the fiscal theory is John Cochran. And he's working on a book, it's currently over 700 pages long. So I'll refer you to him for any details. But what troubles me a little bit about this, and it bothers me as well, personally very often, it's the notion that the government will have to monetize the debt eventually. Which is really the story behind Sargent and Wallace. So if you go back and read that paper, which I hadn't read for decades, I reread it and I said, "This is really kind of an artificial model." It's sort of like the government can issue so much debt and then it reaches this wall and then it has to issue all the money. And of course the world isn't like that. You don't just hit a finite well known barrier and then you flip from all bond finance to all money finance. But I think that's one way to think about it. I don't think that's the right way to think about it. But that's one way to think about it.

What troubles me a little bit about this, and it bothers me as well, personally very often, it's the notion that the government will have to monetize the debt eventually. Which is really the story behind Sargent and Wallace. So if you go back and read that paper, which I hadn't read for decades, I reread it and I said, "This is really kind of an artificial model." It's sort of like the government can issue so much debt and then it reaches this wall and then it has to issue all the money. And of course the world isn't like that.

Beckworth: Well, that's how I think about it.

Stella: The government will issue all this debt and it can't credibly raise the taxes to pay it off, it can't cut spending. So it's just going to print money and we get inflation. But I think that is missing something really important that has to do with the progress of financial markets in the last 50 years. And that is, it is more efficient, it is less costly to finance government deficits and debt. Sorry, government deficits with debt, than it is with money.

Stella: Okay. So this comes back to, you didn't raise this, but the whole idea of helicopter money. Okay. So helicopter money, this sort of drives me nuts, but we have to agree. Helicopter money is fiscal policy, and it's a permanent increase in the fiscal deficit. It is not a monetary policy. It is not something that central banks should do, should ever do. This is a political, Treasury, government decision. It is not a central bank policy. Okay. This is a permanent increase in the fiscal deficit. And why do we call it helicopter money? Because traditionally it was financed with money. But I've written several sort of blog posts, which I don't think are on my site anymore, but you can do helicopter money with bonds. You can give away bonds, and I can have a permanent increase in the fiscal deficit by running arrears or, and this is not a hypothetical example, during COVID some countries just had a state owned electricity company for example.

Stella: I think Bahrain, for example, did this. And they just said, during COVID, don't pay your electric bill for six months or three months. And we're never going to recover that money. I mean, we're never going to ask you to pay that electric bill. Permanent forever. And that didn't involve creating a creating money. But to me, that's a permanent increase in fiscal policy financed by a decline in the net equity of the state electricity company. And we never to, I say, we, the government never has to create money, it's just there are different ways to do this. It's not just money. And I think money is an inefficient way to do it because of what we're seeing right now in many, many countries, countries can issue debt, long-term debt at negative, real rights.

Stella: And in many cases, negative nominal rates. So why is that? It's because as my friend and colleague Maman Singh has talked for a long, long time securities have collateral value. They're really important in a modern financial system. Debt is much more important than money in modern financial systems. I mean the monetary base, so to speak. So if you're looking to finance a permanent increase in the fiscal deficit, to me it's much more credible to issue debt and roll over that debt forever.

Helicopter money is fiscal policy, and it's a permanent increase in the fiscal deficit. It is not a monetary policy. It is not something that central banks should do, should ever do. This is a political, Treasury, government decision. It is not a central bank policy.

Beckworth: Yeah.

Stella: At higher interest rates, but there will be higher inflation, you'll have to pay for it, but it's actually less costly than issuing money because who wants $4 trillion in excess reserves at the central?

Beckworth: Well, I guess that's the condition then is you can keep rolling over debt as long as it's cheaper, long as it's more efficient. But in the limit, I'm guessing the argument is that it may not always be that way. That the government may have to force reserves into the system, may have to force currency out into the public. And that's the certain. Let me push back a little bit on, on the fiscal theory of the price level for all my quantity theory fans out there. So I'm trying to imagine what they would say, and I want you to give answers to this. So let me first... So a couple of things. One, some might say, well, I think the quantity theory money is still valid if we expand the definition of money. And that's kind of what you were saying in your paper, and you just said as well, a few minutes ago, but in other words, think of money broadly as including Treasury securities.

Beckworth: And we include Treasury securities because they are highly liquid. Like your colleague, you just mentioned, said they're used as collateral. They have a convenience yield on them. And so for example, William Barnett does this divisia money aggregate measures that include treasuries. He has an M4 measure. And so if you look at M4, for example, during the great financial crisis, it actually collapsed. Once you account for institutional money asset, it collapses during this time. And so you could kind of point to something like that and say, "Hey from a broader perspective of money, quantity theory, still kind of loosely holds." How do you respond to that?

Stella: Sorry, I'm going to use the word that I don't like to use in a general population, but here we have difference between exogenous and endogenous.

Beckworth: Okay.

Stella: Okay. So when we talk about causality, the quantity theory of money... We can get into the weeds on this, which I don't want to do, but basically the quantity theory of money and all the theoretical models, money comes out of nowhere where it's created by the state. It is exogenous and people take it or leave it, basically that's it. In the real world the money supply that you're talking about, that in other words, all the monetary measures apart from that which is created by the state is endogenous, is determined by demand. So if we see a correlation between inflation and money growth, the correlation in my mind, and I know people hate this, is running the opposite way.

Stella: So money is going up, yes, but that's because banks are lending more, or incomes are going up. The demand for money is going up. The private sector is creating, if I put a number on it before the big blow up in central bank balance sheets, I would say 99.9% of all money was created by the private sector in response to demand or response to credit supply, what have you. So yeah, there's going to be a correlation, but it's running the causation. If there is a causation, it's running the other way. I mean, that's where I'm drawing the distinction between government debt again, is exogenous. So the US Treasury, doesn't say, "Hey come and buy as much debt as you want." No it's setting the amount of debt it's selling, and then the market's determining the price. So basically the sum of money, state liability, monetary liabilities, and other liabilities is determined exogenously. So if we're looking for a driving variable, a causation variable to me, it has to be that one, not the other way around.

Beckworth: Okay. Let me do a second objection from a quantity theory perspective. And it goes something like this, the proper view of the quantity theory would maybe be a little more nuanced than what you outlined earlier. And that is, it would be limited to government liabilities, actual government money. So the monetary base. It wouldn't include necessarily M1, M2. I know Robert Lucas looked at broader measures that included a lot of private money, but it would be limited to the monetary base. And it would be limited as well to injections of the monetary base that are with two conditions. One, it has to be greater than what's demanded by the public. And two, it has to be permanent or expected to be permanent. It's never going to be reversed. And I think probably one answer you're going to give to that objection is, well, what is a permanent increase in the monetary base? It's a helicopter drop.

The quantity theory of money and all the theoretical models, money comes out of nowhere where it's created by the state. It is exogenous and people take it or leave it, basically that's it. In the real world the money supply that you're talking about, that in other words, all the monetary measures apart from that which is created by the state is endogenous, is determined by demand. So if we see a correlation between inflation and money growth, the correlation in my mind, and I know people hate this, is running the opposite way.

Beckworth: Which gets us back to fiscal policy. But I think that's one of the views out there is that it's going to be permanent. It's not going to be reversed by future taxes, and it's going to be greater than what's actually wanted. And therefore it will be spent or put to use on spending. Any thoughts?

Stella: So I completely agree with that. But that's again, what I'm saying, that is the mechanism, but it applies equally to... Let's imagine a little piece of paper and we call that piece of paper, a bond. It applies to the bond. And it's kind of funny, you go back in US history the constitution, it was interpreted saying because of the experience of inflation during the revolutionary war plans, that Congress couldn't issue money, it could just issue bonds. Paper money, couldn't issue paper money. So money was gold or silver. That's what the traditional interpretation of the constitution was. Coin money. That's the base of constitution. So that's very clear. Put a stamp. This is a US dollar. It's a certain weight of gold, certain weight of silver. Now there were times of course, where the government needed money, well needed financing.

Stella: And they issued small denomination, bearer bonds that paid like one mil, which is like one 1000th of a percent, in six months or something. Basically the interest rounded to zero. Okay. So this was paper money, but it was authorized by Congress. It was a big controversy in the Congress about whether this was printing money, which it really was. Okay. It was. But technically legally, "Oh no, no, no. We're just issuing the bond." Okay. So what I like to say is, look, what is the difference between one piece of paper and the other piece of paper that makes it so different? I don't think it's the interest rate. I don't think it's what the bond promises, because the bond promises money. That's all. Promises the paper money. So what I'm saying is, it's all about fiscal policy. And like you say, if you are issuing more bonds or more money and people want in quotation marks, yeah.

Stella: The bond prices are going to go down, price level will go up. I mean, all this. The value of the government bonds will go down. How does that happen? Well, price level goes up and the real value of the debt goes down or the real value of the money goes down, which is what we call inflation. So I completely agree that that's the mechanism. And then I come back to the signaling issue and I want to bring another example from US history. So during the depression, a lot of people had really innovative ideas about, they didn't talk about helicopter money, but printing up greenbacks and giving them out. One was for civil war veterans to give them a bonus and cash, so on. And it's very interesting. If you look at some of the draft proposals and Irving Fisher was involved in some of these. For some of these, what we would call pure paper money, irredeemable paper money was a phrase that Irving Fisher used.

Stella: And I think it's very important that he used to irredeemable. So that's coming back to, okay, that's a permanent thing. This is not paper money that's redeemable and gold or silver. This is irredeemable. There's no promise to ever, ever give you something real for it. So that was the idea, we want to create inflation during the great depression. I think some people did. It's very interesting. Some of the proposals actually called for these money, these greenback issues to be redeemed over time to be redeemed over like 20 years, because people were afraid it would kind of get out of control. It would be too easy. And Roosevelt actually, as you probably know, didn't want, Congress gave him the power to print up greenbacks and give them away. And if you read some of his speeches, he was totally against that. Because it was talking about fiscal policy and he didn't think that's the way you did things.

What I like to say is, look, what is the difference between one piece of paper and the other piece of paper that makes it so different? I don't think it's the interest rate. I don't think it's what the bond promises, because the bond promises money. That's all. Promises the paper money. So what I'm saying is, it's all about fiscal policy.

Stella: In a crisis yes, you can do this, but he didn't want this idea. He talked about the veteran's funds. He vetoed the bill to pay the veterans bonuses in advance. And he said this is really bad, because everybody's going to start asking for this and this doesn't make sense. So I completely agree with the, let's say the validity of the quantity theory of money in the circumstances you described, if it is a verifiable or true signal of the future of fiscal intentions of the state. I absolutely agree with that. But all I'm saying is in, in modern times I would say the idea that you'll issue more government debt and then one day redeem it, I think people would laugh at you today. It's like, "Are you kidding me?" The debt that countries are issuing now, you think we're going to like reduce the nominal stock of bonds-

Beckworth: Let me push back a little bit on that point. I think the way I wrap my mind around this, and this is based off some work by Marcus Brunnermeier, he talks about fiscal theory of the price level with a bubble. So part of what he says supports your point. If you look at discounted present value of future primary surpluses, expected primary surpluses and seigniorage, it doesn't really add up to the real price of bonds today. There's not enough government fiscal resources in the future being collected that to justify, to warrant of value of government liabilities today in real terms. And so what's left? And that's this bubble term, which he and others are arguing comes from this convenience seal, this liquidity that government bonds provide as collateral, as well as the monetary base.

Beckworth: In other words, look at seigniorage broadly beyond just what the monetary base provides, but also what the bonds are providing. So if you look at all of those, in other words, there's a real service being provided by these assets and the government's tapping into the revenue that service provides, that there's a broad seigniorage flow, then there's some, hopefully some primary surpluses. And so from that perspective, there is a future flow of real claims against the economy the US government is taking in that keeps the price level low today.

Stella: Yeah. So I completely, I think I would be sympathetic to that view. But let me come back to something personal where I saw a bit of broader insight into this. And that is, as you might know, I got involved in the issue with central bank capital a long time ago, 30 years ago. And it was a bit controversial people weren't thinking, "Oh, central bank's not capital. Does it matter what the net worth of the central bank is ?" So I did I did a fair amount of work on that. I mean, I wasn't at the IMF, my job wasn't really to do research, but I did it because I'm curious and came across all these things that just didn't make sense to me. And I had to try to figure them out.

Stella: So basically I did a lot of research on central bank net worth and capital to this matter. And, and eventually I wrote a paper with a friend of mine, ex colleague Ulrich Clu at the IMF, and it was kind of an econometric look at this. And you know what, we found is that the, and I'm coming back to this consolidated government debt pricing equation. So where do we get the market value of bonds? And you say, "Gee, it doesn't seem to square with the present discount of value of future primary surpluses," so I'm coming back. I'm going to get to that point. But what we found was central bank negative equity, it's not a linear type problem. In other words, if your central bank net worth goes up by 1% of GDP, and it's 2% of GDP, it doesn't affect anything.

Stella: And if it's 1% of GDP and it goes to zero, that doesn't really affect anything. It's a very non-line relationship. So when it gets very negative, then that's a real problem. So it's a very non-linear thing. And it is very similar, I think to, if you look at Merton Miller, like distance to default with the corporation. So you have equity and you have debt, and basically you can have a lot of movements from AAA to...The probability of default does not rise linearally with distance to default. So you get downgraded from AAA to AAA plus it doesn't change probability by anything. But when you get close, it's very non-linear. So a small shock when you're on the verge, makes a big difference.

Stella: Okay. So that's the same thing with central bank equity in the sense that when your equity is deeply negative and it is in danger of getting more negative, then basically you're going to have a lot of inflation. You've got to finance your, you either have to default as a central bank, or you create a lot of inflation. So small changes are very important in that. So I would come back now, look at the sovereign. Look at the US sovereign. And in my sense, and I did a lot of work on measuring the fiscal deficit within IMF as well. So it's a very complicated thing, and it's much more complicated than any model. You've got two or three variables. In the real world, you've got present discount of value of social security obligations. Medicare is very, very complicated. I like to say in a model, there's one way to default on government debt. In the real world, there are 10,000 ways to default. The government can default in 10,000 ways. Break its promises, right?

I completely agree with the, let's say the validity of the quantity theory of money in the circumstances you described, if it is a verifiable or true signal of the future of fiscal intentions of the state. I absolutely agree with that. But all I'm saying is in, in modern times I would say the idea that you'll issue more government debt and then one day redeem it, I think people would laugh at you today.

Beckworth: Right.

Stella: Raise taxes, cuts spending, whatever. So it's very complicated. And I think in countries like the US, or let's call them Switzerland or call them the advance economies. They're not always so advanced. They have this equity or margin or left balance sheet resources, whether it's political determination or sensibility, or just if the US started charging entrance fees to the national parks, like Disneyland charges.

Stella: There are a lot of resources that a country like the US has that aren't on the balance sheet but they could be called upon. And when you look at countries like Argentina or Venezuela, I don't want to pick on them, but there are a lot of countries in that category that I've seen and I've been there. And they just don't have that.

Stella: So they're on that margin. So if they issue, if they have a... In COVID, let's say, they issue something people say no way in the world, these people are going to raise future primary surpluses. There's the track record of that. So if you look at, coming back to John Cochran's book, in terms of the general theory of the fiscal theory he says pretty clearly, or well, it's a presentation. That he says, he's in the US talking to a European and says, "In countries like ours, it seems like when we issue a lot of debt, which we have with COVID, people expect us to kind of generate higher primary surpluses." And he comes up with a general estimate, like two thirds. Two thirds of it will be covered with future primary surpluses. And a third will be covered by basically inflation.

Stella: And when I'm watching that, I'm thinking, "Oh yeah, in Argentina that happens." And basically people expect 0% to be covered. In other words, it's not even a negative correlation. It's like, if an as well starts doing something, you would expect even more, like get worse, for it to get worse, not for them to recover. So coming back to the fiscal theory. Yeah, there's a lot that is not necessarily obvious on the balance sheet. And we don't really... I mean, Larry Summers has talked about this and you had Jason Furman on and they wrote this paper about how to measure the debt. It's very interesting, these kinds of things, where in the US do we get a calculation?

Stella: What is the infinite horizon fiscal policy? Well of course we don't know that. It's uncertain. There would be 30 years of work to figure out, "Oh, how do we know that the US is issuing more that than it can?" It's not so simple. In other words, it's not a linear relationship. We're not on the margin. We can't tell. Now, it depends on all these things we don't know. But I guess what I conclude in the paper is to say, the only thing I'm pretty sure of is we should be looking at the total of the state's monetary plus securities, liabilities, not just at the expansion of the monetary liabilities to interpret modern monetary reality. It's not just money anymore. Maybe in the 1930s, it was just money. It was either money or taxes. And now we have to look at the sum of the two. But even then, it's not a linear relationship. I don't think we're ever going to get one equation that says, "Oh yes, all the time. There's going to be a one to one match."

Beckworth: So Peter, a fascinating conversation. I want to take what we've discussed and apply it to the current developments, what we've seen over the past year with Fed policy, with Treasury and what do you see as the implications of all this discussion we've had about the fiscal theory of the price level and such for the implementation of monetary policy and fiscal policy?

What is the infinite horizon fiscal policy? Well of course we don't know that. It's uncertain...the only thing I'm pretty sure of is we should be looking at the total of the state's monetary plus securities, liabilities, not just at the expansion of the monetary liabilities to interpret modern monetary reality. It's not just money anymore.

Implications for Fiscal and Monetary Policy

Stella: So one of the clear points coming out of the fiscal theory mileu if you will, Chris Sims has a nice address to when he was president of the American Economic Association, basically saying we need to rethink macro economics and look at the relation shift between monetary policy and fiscal policy and the relationship between central banks and treasuries. So to give one example of this, and it's a really big picture thing. And I think it's a very, very important thing from the political economy standpoint. So right now today... Well, let me take a step back. In 2007 in the old days, this is what the Fed was doing. This is how the Fed did monetary operations. It was lending through repo operations, 20 billion and banks were holding. All US banks were holding 16 billion at the Fed. So the Fed was a net lender to the US financial system of four billion, four billion.

Stella: That's nothing. When the Fed raises interest rates, raised interest rates in that scenario, it was successfully doing monetary operations policy, you'd say, "Oh, there was a fiscal impact." So the Fed was lending 20 billion. Let's say it was paying interest on reserves. Well, it wasn't paying interest on reserves. So it increases the rate effectively on its $20 billion loan by 25 basis points. Oh big deal. Who cares? Nobody cares except maybe Neil Wallace, right?

Beckworth: Right, right.

Stella: It's nothing. It has a fiscal impact. Yeah. But it's no fiscal impact. Zero. Now, today, right now, October 7th, the Fed is lending $60 billion to the banking system, which is a lot. And then these days, it's nothing. What is it borrowing? So we have to think of deposits at the Fed as lending to the Fed. Just like when you make a deposit at the bank, you're lending to the bank and the bank is lending your money out. So that's borrowing. So what is the Fed borrowing from the financial system? Well, it's borrowing for 4.2 trillion from US banks in terms of reserves and it's borrowing 1.7 trillion in overnight reverse repos from non-bank. Okay. So that's $6 trillion in borrowing, net borrowing. So it went from a net lender of $4 billion in 2007. It is now a net borrow of $6 trillion.

Stella: It is paying interest on that. That's 25% of GDP. Okay. 25% of GDP. So now let's say the Fed is managing 25% of GDP of the US debt. And now the Fed has to raise interest rates. So Fed raises interest rates by 25 basis points, 50 basis points, 1%, a hundred basis points. That has a real fiscal impact. The Fed is now paying 1% on $6 trillion and it's not doing it in a market determined way. It's doing it, let's say, arbitrarily. It's setting the rate. So this is what we call a floor system versus what the old system was. And I would say, forget about what the operational issues, if the floor system is 20, you're lending, or you're borrowing $20 billion, I don't care. But this is a system where you're borrowing $6 trillion. And imagine the political perspective on that.

Beckworth: Exactly.

Stella: If the US Treasury were to say, "Hey we've got $6 trillion of notes and bonds out there and all you people who are holding them, we're going to pay you another 50 basis points coupon on it. We're just going to give it away." You would say, "You're out of your mind." No Treasury would ever do that just out of nowhere, say, "Oh yeah, here's a gift." But that's essentially the political problem that the Fed could be getting into by having this huge balance sheet just from the optical standpoint. And it's not just me, who's raised this issue. It's come up in the UK where I think the bank of England is much closer to raising rates and people have, respected economists have said, "This might be a problem. Maybe you're not going to raise rates because of this sort of political problem or the fiscal impact of it."

Stella: So I think that's something that people are, are sort of missing because most people were, are still in that world where central banks were very small players in the financial market in terms of magnitudes and now you cannot ignore them.

Beckworth: Yeah. That's fascinating. So $6 trillion the Fed is financing, whereas normally it would be with Treasury. So you could argue financing costs one way or the other would occur, but the political economy, how it looks, the optics are just completely different. And it's arbitrary. As you said, the Fed sets an administrative rate, the Treasury takes it to auction. So there's big differences there. And what I see this leading to, I mean, maybe this is your point too, but is the Fed losing independence. If the Fed gets cut up in a political firestorm, because it's paying bankers and Wall Street, higher interest and Congress steps in and says, "No, you can't." Then the Fed can't respond to say inflationary pressures. And it loses its ability to fulfill its mandate of price stability. So I could see how this political consideration ultimately affects actual monetary policy.

Stella: Right. And as you acutely pointed out, from the US context, we went for decades without paying interest on reserves. So it's not so ingrained and obvious, why are we doing that? And I think when we started paying interest on reserve, there's a lot of confusion about that. And I think there remains a lot of confusion about that. And I might have said this before, but I was at Jackson Hall in 2016 and a board member from the ECB said, "I don't understand why negative rates are so on unpopular." And I was in the audience and I kind of raised my hand and I said, "Well negative rates would be a lot more popular if you were lending at them instead of borrowing at them." In other words, in 2007, yeah lower rates are always, everyone is happy. But you have to realize you're not a net borrower.

Stella: You're not a net lender anymore. You are a huge borrower, so of course people are unhappy at negative rates. People are lending $6 trillion. And if you put the rate negative, it's like taxes. Again, it's kind of a fiscal, it's almost like a tax. For central bankers not to have seen that this, in mathematical terms, the derivative, it's now on a negative number, it's not on a positive number anymore. So the derivative is negative. It's not positive anymore. So I'm really worried that people are underestimating this problem. And when we talk about, I guess the question going forward is, is this the future going forward? And we have to recognize that okay so that means the Treasury's got to take into account the Feds policy for its debt management strategy.

Stella: And we've delegated a huge amount of the sovereign debt to be set by an administrative rate for a different purpose. Except for a monetary policy purpose. And in let's call it the old days, the fiscal implications of that were nothing. Although of course, for decades, every time central banks raised rates, even though direct fiscal impact was not big, finance ministers jumped up and down because they knew they would have to sell in the market, their debt, and roll it over to high rates. So they would always complain. And when you come back to central bank independence, and in my mind, if I define central bank independence in one sentence, it's the ability to raise interest rates when the Treasury doesn't want you to. And the Treasury almost never wants you to, because of the cost of the debt.

Stella: And now we're putting it in the lap of the central bank and saying, "Okay, central bank, raise interest rates." And I think most central bankers would say, "Oh yeah, we're going to make a loss and da, da, da. Don't worry about it," and say, "Okay, yeah, I want to worry about it. If you're talking about like $10 million and your seigniorage is $100 billion." But now you're talking about raising rates on $6 trillion and people are going to start asking questions, what is going on? So to have it on this debts balance sheet, I think is extremely...

Stella: First of all, I don't think it makes sense because I think the Treasury's job is to manage the debt and to fit everything in the budget. It's not the job of the central bank to be doing that. But second, just from the political administrative and even economic aspect it's, let's face it, a floor system. It's an administered rate. It is not auctioning a Treasury bill, where there's an interaction of demand and supply. So I think that is very different than the way we used to think of things before the GFC. The US was trying to conduct monetary policy, which is a little impact on the yield curve as possible.

If the US Treasury were to say, "Hey we've got $6 trillion of notes and bonds out there and all you people who are holding them, we're going to pay you another 50 basis points coupon on it. We're just going to give it away." You would say, "You're out of your mind." No Treasury would ever do that just out of nowhere, say, "Oh yeah, here's a gift." But that's essentially the political problem that the Fed could be getting into by having this huge balance sheet just from the optical standpoint.

Beckworth: Let me ask you this, Peter, in the time we have left, you have a proposal. We talked about it, I believe on your first show, first appearance here on Macro Musings. But you have a proposal that would address this problem. And what it would do is it would transfer all those liabilities from the Feds balance sheet to Treasury's balance sheet. So tell us how that would actually operate. What would be the steps necessary to shrink the Fed’s balance sheet and have Treasury take over the liabilities?

How the Treasury Can Help Shrink the Fed’s Balance Sheet

Stella: Okay. Right. So I started proposing this to finance ministries in 2005. I won't mention the country, but basically this is not a new idea for me. And so basically the proposal is you say to the Treasury, "You've got to issue a ton more debt and keep it at the central bank” and what the Treasury, when I'm there in the office and this gentleman, the guy literally got so agitated that he said, "Excuse me I have to leave the office." He reached into his drawer and he took something out of the drawer and went out of the room. It was like he was going to have a heart attack. So the answer is very simple. But people immediately think I'm crazy. So the answer is US Treasury go out and issue $2 trillion more in debt and deposit that at the Fed.

Stella: And the Treasury is going to flip out. But what the treasuries don't kind of realize is when you've got $6 trillion in excess reserves at the Fed, well, the money is there. It's not like the old days where you have to go out and borrow it. All you're doing is, is doing a debt management operation. You're changing the issuance from issuing debt that you are very good at and retiring this overnight debt. Okay. So in very practical terms, if the US were to do this, I would say something like, look, you've just announced over the next 12 months, 24 months, the Fed is going to restrict the amount of excess reserves that it will pay interest on reserves. To say, "Okay, now we're paying it on all of it. We're going to reduce that by $100 billion dollars a month or a quarter." Well then the Treasury just comes in and scoops that money up. So eventually you get to a point where, and I think politically, it would look good because, oh yeah, we're going back to not paying interest on reserves, isn't that great? Well, that's kind of an illusion because the Treasury is paying interest on the debt.

Beckworth: Right. Banks still get the money.

Stella: But still you're doing it in a much more are sophisticated way. The Treasury is issuing floating rate now. It's for 30 years. It's issuing all these instruments. Instead, the Fed just issuing kind of one instrument, which is interest on reserve or overnight reverse repo. And other people, other countries have done it by the central bank issuing debt. Right. So you absorb all the excess reserve, but debt. I don't like that because it fragments the debt market. The US thought of doing that right at the beginning of the GFC, I think rightfully so there were discussions at the New York Fed but they decided not to do that. And I agree with that. But if you recall at that time, the Treasury went out and issued debt and did exactly what I'm talking about, and it was called the supplementary finance program. Went out and issued about $650 billion of short term cash management bills. Took that money at the Fed, placed that money at the Fed.

If you recall at that time, the Treasury went out and issued debt and did exactly what I'm talking about, and it was called the supplementary finance program. Went out and issued about $650 billion of short term cash management bills. Took that money at the Fed, placed that money at the Fed...It was not to finance the deficit. This was simply a debt management operation...that's the proposal. It's basically shrinking the, either you want to call it the floor, the amount of money that's at the floor or creating the reserve shortages like we had before.

Stella: It was not to finance the deficit. This was simply a debt management operation. And it happened. It's not a theoretical thing. They actually did this for a different reason. It was to keep the Fed funds rate above zero before it had the authority to pay interest on reserves. And before the target went down to zero. But that's the proposal. It's basically shrinking the, either you want to call it the floor, the amount of money that's at the floor or creating the reserve shortages like we had before.

Stella: I'm willing to be completely agnostic about if you want a floor system, fine, but have a floor system where it's $100 billion dollars or $20 billion, not $6 trillion. That's all I'm saying. You don't have to have $6 trillion there. And I really don't think it's efficient. The Treasury can finance at a lower cost. Right now, the Treasury can issue bills at a lower cost than the interest on reserve rate. So it would save the taxpayer money for the Treasury issued bills and deposit, take that reserves out of the system. It would be cheaper. That's just a micro example. So that's trying to bring in this thing, like fiscal theory of the price level saying, "Yeah, QE it doesn't really matter whether it's reserves or it's..."

Stella: From that perspective, yes. But from this other perspective of blurring the boundaries between fiscal responsibilities and central bank responsibilities, between what we understand to be monetary policy and what we understand to be fiscal policy, I think that's a real dilemma or a problem going forward. I don't think perpetuating this system makes sense for me. And as I've written elsewhere, other countries have solved this problem. I mean, they have put the genie back in the box, so to speak. Chile, Mexico, India, Israel.

Beckworth: Well, that is a great proposal. And we'll provide a link to your article where you outline that. But with that, our time is up. Our guest today has been Peter Stella. Peter, thank you so much for coming back on the show.

Stella: Thanks.

Photo by Alex Wong via Getty Images

David Beckworth
Calendar Date: 
Nov 8, 2021
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The relationships between monetary and fiscal policy, money, and inflation can be better understood in light of the fiscal theory of the price level.

Peter Stella on the Fed’s Off-Balance Sheet Transactions and Public Financing of the COVID-19 Crisis

Peter Stella is a former IMF official, where he led the Central Banking and Monetary and Foreign Exchange divisions, and he now hosts a webpage titled *Central Bank Archeology*. Peter is also a former guest of Macro Musings, and rejoins to talk about the COVID-19 crisis, central bank balance sheets, and more. David and Peter also discuss the dangers and challenges of the Fed’s off-balance sheet transactions, how the government should approach crisis financing, and who should be managing the country’s public debt.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to

David Beckworth: Peter, welcome back to the show.

Peter Stella: Thank you, David. It's great to be back.

Beckworth: Glad to have you on. As I mentioned in the email when I invited you back on, you were highly demanded by listeners. Many people reached out to me and said, "We want Peter back on the show. We want to know more about the monetary plumbing." So, all those monetary plumbing fans out there, you know who you are, Peter is now back by demand. So, welcome back to the show.

Beckworth: Peter, we are in the midst of the COVID-19 crisis and a lot has been going on. I want to talk to you about it and how you view the financing of it. I know you're going to walk us through some historical perspective on this. Before we do that though, I want to zero in on the Fed's balance sheet because a lot of people have been asking about it. I just want to run some numbers by you, just to put things in perspective, add some context. As of today, it's May 29th, the Fed's balance sheet is about $7.1 trillion. It was about $4 trillion before this whole crisis started. So it's risen about $3 trillion, about a little over one and a half trillion in treasuries and some additional assets, GSEs, securities have bought, repos have been purchased, temporary purchases.

Beckworth: So, we're getting near the 33, 34% of GDP mark, and forecasts have the Fed's balance sheet getting as high as 40% possibly, maybe getting 9-10 trillion in size. Most of it has been, again, from the revived large scale asset purchases, GSEs. There hasn't been a whole lot on these credit facilities. They've actually been surprisingly small. But, the Fed's balance sheet has grown bigger. Now, compared to the ECB in Japan, it isn't that big, but many people are wondering about it. I want to just get into it with you today, should we worry about it? Should we worry about public financing of this crisis in general?

Beckworth: I wanted to get a few questions on the Fed's balance sheet and then we'll step back and move into the more general discussion about public finance. One of the interesting observations about this crisis is the use of the Federal Reserve. There's a critique that's been going around and one we've discussed on this show, and that is that Congress and Treasury are effectively using the Fed as an off balance sheet way to finance this crisis. So, the Fed again, when the original CARES Act was passed, the idea was Treasury would leverage up and use the Fed balance sheet to get an extra $10 trillion of funding out there.

Beckworth: We've had people on the show talk about how this isn't really well thought out, because the Fed is limited in what it can do. It can only lend, it can't do grants. It has to participate with counterparties that are solvent, all kinds of legal hurdles that don't make it a very effective way to do off-balance sheet transactions. But nonetheless, that is the case. We brought this up and I've had some feedback from listeners who say, "Well, so what Beckworth. We have a rich history of this, the GSEs, the Resolution Trust Corporation for the savings and loan crisis. We have a tradition in the US of going off-balance sheet when we want to fund something that might be pretty pricey."

Beckworth: So, I want to ask you, is there a danger of going off-balance sheet like this? You've worked with other central banks, you've seen it overseas, what are some of the challenges of taking this approach to financing big public expenditures?

The Public Financing Infrastructure of the Crisis

Stella: Now, coming back to your original question, if you're not concerned about this, you're not paying attention. But, I'm not particularly worried about it at this time. We're actually in a very fortunate position from some sense technologically, in terms of the modern payment systems we have that allow us to get money out to people very quickly, that we didn't have in the Depression or other times in the past. We also have a very well developed, I'm talking about the United States and Europe, UK, very well developed securities markets that can handle enormous amounts of issuance in relatively short periods of time. Which again historically speaking, was not frequently the case or often the case.

Stella: I've actually encouraged by some of the changes that I've perceived in the way policymakers are thinking about this crisis, in particular the ECB and the Fed. So, the technology, a lot of people are using historical analogies naturally, but we have much a more advanced technology now than we did even in the 1960s or '70s, in terms of the debt market and payment system. It's not just payment systems are pretty dull, right? Even more dull are accounting systems, but the advent of straight through accounting processes, which means when you take your $100 out of the ATM, your account is immediately debited, the bank makes an adjustment. The thousands of pages of forms that banks have to submit to regulators, to shareholders, they're automatically all adjusted in real time.

Stella: So, can you imagine if we had to send out 50 million checks to people today and they had to go and present ID and wait in line and cash them at a Federal Reserve bank to get cash, bank notes? I did a back of the envelope calculation for that, and it would take about 51 years, okay?

Beckworth: Wow.

Stella: I'm talking about Great Depression, you were doing paper-based accounting for all of these things. I don't even know if people had photo IDs then. I grew up in New Jersey, we didn't have a photo ID for your driver's license until I don't know when. So, we take for granted, and people are complaining, somebody got a check that they shouldn't have gotten a check, it's really remarkable. Yeah, mistakes will be made because we're moving very fast, but the technology has enabled us to do the accounting and all of these things, it's really remarkable. So, the technology, fundamental technology has really enabled us to address very fast moving prices in historically a very, very fast way, and the way people are thinking I think has changed even since 2016, in terms of the policymakers’ response. We have fantastic debt markets compared to the 1960s, '70s, '80s. So yes, I'm concerned, but there are some strengths that I think people are overlooking.

Beckworth: That is an interesting observation about technology. So, is it the case then that even if policymakers during the Great Depression had figured out the perfect policy, it still would have taken time to implement it that we don't have to deal with today? So, maybe to some extent they were destined to some challenges, some hardships back then because they didn't have what we have. That's a pretty profound thought.

Stella: Yeah. People talk about helicopter money, right?

Beckworth: Yeah.

Stella: Let's think about what that literally is, and why it's was such a good analogy. You're literally dropping money out, physical cash out of helicopters. Nobody has to sign for it, register it, have a bank account. You just grab it, put it in your pocket. The nice thing about this, the government doesn't know who got it, so they can tax it away from you, and that's important. If you want people to say, "Oh, this is an increase in my wealth, I'm going to spend it," it's important that they know, "Hey, I'm not going to have to pay taxes on this."

Stella: I think the policymakers have realized this and they're saying, "Hey, you won't be taxed on your stimulus check and so forth, and so on."  But, when you think about that literally, and I don't know if I mentioned this in the previous show, but I was in Instanbul once, maybe 15 years ago, around the St. Sophia Mosque and the Blue Mosque. It's a big square. All of a sudden, I saw a helicopter coming low and hovering over this big open space. All of a sudden, things started falling out of the helicopter and I thought, "What is going on?" People were scrambling and grabbing them. They were blue jeans. They were designer jeans that were being dropped out of the helicopter as a publicity stunt. They were getting caught in trees and people were fighting each other and grabbing them out of trees.

Stella: So, it was real chaos. The mayor of Istanbul in the newspaper the next day said he really wasn't happy about this. But when you think about it, we take for granted in a theoretical model, oh, yeah, we just take a derivative or something, and everybody gets his money. It just doesn't work that way. Even in a helicopter drop, it's chaos, it would be chaos. In the Great Depression, how would you have done it? How would you have done it? In the United States, every month we send out about 60 million Social Security payments. This is a lot of money and it's happening every month automatically through the system, and all the records are being kept. Records that you were paid or not paid. So, we're really at a much stronger point. I'm not saying you want to give money away, but-

Beckworth: Yeah, I know it is profound.

Stella: ... You absolutely can't do it today. Think about, I don't know how old you are, but my father was born in 1919. So, you're just thinking, well how in the world would they do something like what they're doing now? There was no unemployment insurance, no deposit insurance, no old age and disability Insurance, what we call social security.

Beckworth: No record keeping to know who to send it to at that time.

Stella: No. People didn't have ID cards. One of my mother's uncles was a master plumber, and there was like a physical... Well actually, her father was, my grandfather was a master plumber. I guess there was some certificate or like paper based certificate that said Joseph O'Brien. In New York City at that time, there might have been a thousand Joseph O'Brien's, right? So, the story my mother used to tell was, somehow he lent his plumber's license to somebody, maybe a relative O'Brien, and he never got it back. That was a big deal, right? So, we just take it for granted that we can do these things and people complain, "Oh, why did it take a week to... Come on."

Beckworth: Right, right.

Stella: We just like you said, even if we said we want to give this money away, how do we do it? There was a very interesting, I don't want to go too long on this, but, during the Roosevelt administration, there was an issue called the Veterans Bonus. So in 1924, US World War One veterans were given a bonus depending on how long they served in the military during the First World War. In 1924, this was granted by congress but it was payable in 1945. In the midst of the Great Depression, there was a lot of political pressure to pay the bonus early. So, I believe people had received in 1924, a paper certificate which said what their service was and what they're entitled to, in 1945 20 years later. So, the idea was, it seemed pretty simple and I would think super politically popular, let's just pay the veterans their bonus now with print money, and give it to the veterans in 1935, instead of making them wait until 1945.

Stella: The interesting thing that might surprise some people is, Roosevelt was dead set against this. He vetoed the legislation, even though he knew it was going to be overridden, and it was overridden. His argument for not doing it... I mean, the argument for doing it was, "Well, this was one thing where we could kind of get the money out the door in a couple of months to a list of people who you might say sort of deserved it." But, Roosevelt said something like, "Well, we want to send the money to the needy. Just because someone wore a uniform doesn't mean they're needy." It's a remarkable political statement, because I can't think it was very popular to say something like that.

Beckworth: Right, right.

Stella: But, it comes back to this question of, how do you identify who the needy people are in 1934, 1935, and keep the accounts and track of, "Did I give this Joseph O'Brien 10 stimulus checks or not?"

Beckworth: That's interesting, and it's something we have talked about on the show before that, it has been difficult, at least from our modern perspective, to get payments to people because, we literally don't have the infrastructure in place. The IRS, it's tax season, people are working from home, we don't have a Small Business Administration that's really scaled to size to do the PPP effectively. But yet, it's much, much better than what they would have had in 1929, 1930, because they didn't have any of the infrastructure back then. They didn't have any of those new deal agencies, the byproduct of legislation, Social Security, for example, which would have been name names of people. So, that is an interesting thought.

Stella: Right. You recall the notion in 2008 of shovel ready infrastructure projects. If anybody's ever done an infrastructure projects or been involved with one, or even a home remodeling, there's no such thing as a shovel ready infrastructure project. These things take years to plan and design and bid, and so on and so forth. So, if you believe this crisis is a three month of a four month or five month crisis, that's not an option. It's really not an option. You need to get the money out fast. We have the capacity to do it.

So, if you believe this crisis is a three month of a four month or five month crisis, that's not an option. It's really not an option. You need to get the money out fast. We have the capacity to do it.

Stella: Let me also touch on this point about the Small Business Association, a Small Business Administration. People might have realized this, but I was aware very early on in the beginning of March, that this worldwide, this provision of assistance was going to be done through the banking system. It's impossible. I don't think anyone would argue that the Small Business Administration should have the staffing to administer a program like this. When you... I'm kind of a practical person. I've been around the world, I've seen things that other people haven't seen, and the model looks very clean. But Chile, when they imposed capital controls, which could have been a very good policy, basically they had to set up, devote an entire floor of the central bank and hire people to administer the capital controls. I mean, it's a huge, huge task.

Stella: So, I think people realized very early on in the US and Europe, that since the banks are not the problem this time, I hope, we hope, they're going to be part of the solution. We are going to work through the banks. In other words, unfortunately, if you don't have a relationship, you're a small business you don't have a relationship with a bank, it's unfortunate. That's the only way to get the money now, right?

Beckworth: Yeah.

Stella: The Small Business Administration can't hire 100,000, bank loan officers and assess collateral and all these things. So, you had to work through the banking system, I think, just from this mundane administrative reason. Of course, much better if you have your direct deposit information with the IRS, and if you need to get a check. But all of these things, we're working, we have to work through the financial system. That's why in a way, I'm not trying to sound like an apologist, but if you're in a real hurry, and you're the Treasury, you're saying, "Look, there's no way I could administer this in the relevant time period. I don't really even want to set up the infrastructure to administer this, because I'm hoping in six months time, I'm never going to have to do this again."

Stella: You just can't find the experienced people on the street anyway, to do it. So, you're going to work through the banks. Well, why not work through the Fed, which is working with banks in an indirect way?

Beckworth: That's a nice segue back to my question about using the Fed kind of in an off balance sheet way. I mean, that point there makes a good case for doing so, that the Fed has at least relative to Treasury and other government agencies, has a better apparatus set in place. But in general, should we be taking this approach? I mean again, it's a rich tradition in the US, the GSEs, Fannie and Freddie are off balance sheet, the savings and loan crisis was handled off balance sheet. So I mean, I guess there's maybe a long term question there versus the immediate one. Maybe these are two distinct issues, but what are your thoughts based on your work overseas and what you've seen?

The Fed's Off-Balance Sheet Approach

Stella: So let me say, I don't want this to be misinterpreted. There will be smoke and mirrors. There will be. There always will. What do I mean by that? We'll be arguing 10, well maybe not me, but other people will be arguing 10, 15, 20, 30 years from now, what really happened? What really happened, trying to sort out these accounting issues of what balance sheet was it on and what was the real cost of this and so forth and so on. The Fed, let me be critical here, in its defense of what it did in 2008, frequently claimed, "Well, we made money on all of this, so it doesn't matter."

Stella: Now, I started my career in the IMF in the Fiscal Affairs Department, and I wrote a lot about, let me quote Mark Twain, "There are lies, damned lies, and statistics." A lot about statistical manipulations of central bank balance sheets, government balance sheets, arguing that they should be both, you can't ignore one without looking at the other and so forth and so on. So believe me I know, I know almost anything is possible. It's not that I theoretically know it's possible, I've seen things that you would think are impossible, but I've seen them, they've been done and they've been published. It's not any different in this crisis.

Stella: So, let me come down to the economic aspect of this. The right way to have measured what the Fed did in 2008, 2009 with the Maiden Lane LLCs and so forth and so on, was to look at the risk adjusted return to the investment. Just because you wound up making money, still doesn't mean it was in expected value terms, not a subsidy, or you weren't potentially losing money, that it wasn't a quasi-fiscal expenditure. So, it's very difficult to properly sort out what is really going on in real time, in terms of, what is the risk adjusted capital at risk if you will.

Stella: So, coming down to a very practical question, it's common for treasuries to provide capital indemnity to public institutions, to the central banks. The question is, what's the right amount? What's the right amount? Is it completely open ended? We see that in the UK, but we tend not to usually see that. In the US Congressional Budget Office, since about the Reagan administration, I think it started around 1980, has been required to do fiscal scoring of all kinds of exposures to new credit programs. So, if you're asking me whatever the Treasury has I think paid in 45 or $50 billion to support some of these debt programs, are you telling me that was done in some super actuarially sound way? Probably, it's in a world where nobody knows what the numbers are. So, I'm trying to draw this distinction here between lies, damned lies, and statistics.

Stella: We're operating with statistics, forecasts that the variance in their reliability is so high you could justify almost anything. From saying, "Oh, we don't need to contribute. We don't have to pay any insurance premium to the Fed for this”, or “we should be guaranteeing the full amount." I think you could probably find some projection that would justify anything from one end to the other and anything in between. So, it's certainly from my standpoint of transparency and fiscal accountability and governance, it's not the right way to run things. But in a crisis, this is inevitable. Things are moving in real time, it's inevitable that this is very murky and obscure.

So, it's certainly from my standpoint of transparency and fiscal accountability and governance, it's not the right way to run things. But in a crisis, this is inevitable. Things are moving in real time, it's inevitable that this is very murky and obscure.

Stella: By the way, whether the Fed makes money or loses money in the end, again, it really has nothing to do with whether it was a good idea or not, in my mind, but, it really depends on the risk adjusted return.

Beckworth: So in a crisis, don't let perfect be the enemy of good. Maybe using the Fed is all we could do given our institutional capabilities in the US.

Stella: Right. We can talk about the budget process and all that.

Beckworth: I mean, just being pragmatic about it. Again, I think there are ways to address some of these problems before the next crisis so that in a bind, if we do rely on the Fed, we do it in a more thoughtful way.

Beckworth: Peter, let's move on to a broader issue here. We've been talking about central bank balance sheets, but let's step back and look at just the general public finance view of a crisis like this. So, in real time, this is huge. We think there's a huge collapse in the economy, all indicators point to that, lots of uncertainty, we're trying to throw everything we can at this given the political constraints. What is your view of how we should approach a crisis like this?

How Should the Government Approach Crisis Financing 

Stella: It might sound irresponsible, but basically you spend now and figure out how to finance it later. In looking for historical parallels, I'm reminded of the First World War. Now, why? First of all, it was a true surprise. World War Two, the Nazis, it was pretty clear something was happening. World War I, assassination in Sarajevo, maybe there's going to be a small difficulty between Austria-Hungary and Serbia. It wound up being absolutely global, at least European catastrophe. At the time, people thought, "Well yeah, this war will involve major combatants, but it's going to be over in a few months. It'll be over by the end of the year, maybe even over long enough to get the harvest in." So, I'm talking about assassination in late May or June. We think, "Okay, it will be over. It will be over in no time."

It might sound irresponsible, but basically you spend now and figure out how to finance it later.

Stella: So, there's a very interesting thing that immediately happened and that is, all the major European belligerence sent agents to the Americas, their equivalent of ventilators and medical equipment, and that was horses and mules. So, the military technology that at that time meant we would need a lot of horses and mules to conduct this war. We were on the gold standard. So basically, agents were sent out to the US West, Canada, Argentina, with cash, cash pay, "We need to get these horses and mules before the Germans do or the Belgians do." So basically, countries were running down their foreign exchange reserves, people were selling horses and mules knowing they had the buyers over a barrel so they were demanding cash payment.

Stella: Now that was okay if you think the war was going to last three or four months. A lot of the belligerents inconsistently, of course, we're thinking, "Well, reparations from the loser are going to pay our expenses. We're going to win and the loser is going to have to pay us off. So, we're not really worried about that."

Stella: The war continues. Of course, countries requisitioned horses from their own population, paid for those too. Just a number, the UK alone sourced over 600,000 horses and mules from North America during the First World War. So, time moves on and the war's carrying on. So, the UK Government says, "Well, we're running out of reserves. This is a little bit dangerous." So what they did was, they got together, the large investment houses in the UK and said, "You know, we would like your high grade foreign corporate bonds, railroad bonds, equities, and we'll give you UK government bonds and exchange."

Stella: So, it was basically agreed. The UK Government got all this denominated, foreign exchange claims, packed them up, sent them by boat let's say to Wall Street, and used those as collateral to borrow from JP Morgan or sold them, sold them in the New York Stock Exchange or sold them in the US foreign market. Argentina was in the same spot. Argentina was a real solid country back then.

Stella: Basically, that was the second round, kind of, I wouldn't say force, but let's say coerced debt exchange. We didn't have a well-developed debt market in any of these countries. So, this was the solution. Time goes on and the UK government needs more money, and everybody has surrendered their foreign exchange claims. They're running out of gold. So, they have to issue, let's call it a war bond. Here's where very interesting cases of smoke and mirrors comes up. In those days, again, all the bonds were paper-based. You were selling them by subscription, not by auction. So, subscription means the government sets the coupon and the maturity, let's say 4%, and then you come in and buy as much as you want whenever you want. So, you subscribe to them.

Stella: Now, if the government sets the interest rate too high, everybody subscribes. If they're paid too much, if they set it too low, people are done with the bond subscribing. They don't get them. Remember, this is not a time where you could raise taxes anyway. Probably most countries didn't even have an income tax, and taxes take time. So basically, you had this subscription going on, and typically what would happen, if the government needed the money and the private sector didn't come in and subscribe, the central bank would basically take a big chunk.

Stella: So what happened in the UK is very interesting, is that subscriptions, the interest rate was a bit too low. Of course, you're borrowing at a time where you're in distress now. If you had done this at the beginning, maybe people would have let you, but now you're in distress, you're having trouble. The war has not been won in three months. So basically, the Bank of England was faced with buying about three fourths of the offered amount. Everyone said, "Well, the optics of this would look really bad, because people would know, "Hey, wait a minute, I bought those bonds, but nobody else is buying them. I must be a fool. They're only being bought by the central bank, Bank of England."

Stella: So, the bank decided to subscribe to let's say, formally subscribe to let's say 30%. Then, essentially what they did was, they had the Chief Cashier of the Bank of England, subscribe to an enormous amount of bonds as a private person.

Beckworth: Wow.

Stella: Presumably, this was financed by a loan from the bank to this senior officer, so that when they published the statistics in the newspaper saying, "Oh, you know the bond, the subscription is going along very, very well. The private sector uptake has been whatever." But behind the curtain, this was absolutely smoke and mirrors, right? So, I'm giving you an example, pretty replicable. Let's say Treasury and in a crisis, things like that happen. Now, the story doesn't end there. There's a very interesting next stage because, of course that bond wasn't enough, so they had to introduce another bond. Let's call it the Second War Bond. Because they realized the interest rate in the First War Bond was too low, they were going to offer a much higher coupon, let's say 5% instead of 3%.

Stella: There was a bit of an uproar because the people who had bought the coupon at 3%, were going to take the big capital loss, right? Saying, "Oh, we were patriotic and we bought the bond. Now, the next bond is 5%." So, the Treasury decided to give the original bond holders the option to convert into the new bond, at par. So, it unexpectedly gave them the option to transform their 3% bond into a 5% bond with no cost. Now, the Economist Magazine and people were outraged. "This is crazy. Why would you give these people who they lent you in good faith at this rate, and now you're just giving them money? Giving them this? This is crazy. This is terrible."

Stella: On the one hand you could say, "Yeah, that makes sense." But, if you take a look at it from the games theory point of view, and you say, if this is churning from a onetime game into a repeated game, in other words, you have to keep going back to the market maybe again and again, and again, maybe it's not such a bad idea for the purposes of selling this bond, to just say, "Hey, you know you guys, we're going to give this option because we want to be known as a reliable partner so to speak, in financing." This has a parallel interestingly enough, when we come back to this central bank independence question. We all know about the Treasury Accord in 1951, where the Fed had been-

Beckworth: Yep.

Stella: ... [inaudible] interest rates, keeping Treasury bond rates up, fixed. Well, there's something very interesting, and I don't think this is widely known. But, there's a footnote in one of, I can bring these papers that alerted me to this, I can bring in Garber’s paper. the Treasury actually offered the same exact step up to holders of bonds at the time when the Treasury issued the first bond that had, let's say the higher coupon. Basically there was an offer, an exchange offer by the Treasury, right after the accord, to the existing holders of the Treasury bonds to swap them into the higher new coupon bonds at par. So, this idea isn't-

Beckworth: It's been done in the United States.

Stella: It's been done in the United States, it's been done in the UK. You might say, "Oh, this is outrageous," but if this is a repeated game, maybe this makes sense. Again, when we come back to what I was talking about at the beginning, the US Treasury now, and other countries, have a very regular and predictable strategy. That's what it's called. We don't take advantage of the markets for short term gain, because this is a repeated game. The Treasury's issuing debt this week, next week, the week after, not just in the US, basically all of these countries. So, there's this notion of a symbiotic relationship going on.

Stella: These markets have proven to be very, very successful in terms of funding expenditure over the long-term. You're talking about decades, but they come in awfully handy at times like this. So, if I could say, if the government had been perceived as having screwed the patriotic bond holders at the First World War, when Second World War rolls around, maybe you would have an even bigger problem. So, the financial markets are much more deep and fluid than they were before. I think again, coming back to our strengths today is that, because of regular and predictable, because many countries, even in emerging markets who absolutely couldn't have an issuing of bonds to finance their COVID-19 expenditures, they didn't have to issue money. They can issue bonds now because of the work they've done in the last 20 years.

Stella: I saw Israel issued 100 year bond recently. They were in basically hyperinflation in the 1980s. So, I think that's a strength that should be tapped now, in terms of the financing. So coming back to the original statement is, I can't tell you how much money to spend. I can't tell you where to spend it, but I know it needs to be spent now. We know enough about this crisis. Later is not working.

I can't tell you how much money to spend. I can't tell you where to spend it, but I know it needs to be spent now. We know enough about this crisis. Later is not working.

Beckworth: Spend now and worry about the financing arrangements later. That's your point?

Stella: Yeah. No, it's Congress or the parliaments should decide how much to spend and where to spend it. I think in terms of the financing aspect, we're in a really much, much stronger position than we were in the Depression, and even in the 1960s and '70s in terms of technology and the debt markets. If there's one big picture point I would make here is, the idea of financing with helicopter money, however you perceive that term, let's call it central bank money, which is floating rate debt, it's floating rate government debt, where you're adjusting the interest rate every day potentially right now, versus issuing long-term debt, which the US Treasury is issuing 10 year TIPS, which is an inflation index security, 10 years at a minus 47% basis points annual yield.

Stella: That means the US Treasury, I'm talking about last week, last week or two weeks ago. So you've locked in, and the Treasury just locked in a negative real yield for 10 years. US Treasury issued last week a 30 year bond at 1.32%. 30 years. So, if you think inflation might average 1.5 or 2% over the next 30 years, again, negative real yield. We care about the real yield. We don't care about the nominal, the real yield for 30 years. Why in the world would you want to finance... Why would you trade that for issuing central bank money, which is paying a floating rate? It just doesn't make any sense.

Beckworth: It goes back to what you mentioned earlier.

Stella: Given the technology we have now, this isn't the Great Depression where we had to basically hand out physical bank notes.

Beckworth: Well, going back to what you mentioned earlier though, maybe it's just expediency right now that the Fed is effectively financing a lot of this deficit. So, the Fed is buying up a lot of the debt this year. Just to be clear, what you're saying about the floating rate financing, you're talking about bank reserves, right?

Stella: Right.

Beckworth: Bank reserves and rates can change instantaneously, I know that it could change within the day. It's all up to the Federal reserve. So, your point is that could go up and we actually hope it would go up, because that means recovery is under way, we'd have higher rates versus locking in a long-term yield. So here's the pushback I've gotten on that point, because we've discussed this on the show before. So, here's the challenge. Could the Treasury finance its deficits without the Fed’s support? In other words, yes, the Treasury goes out and issues 30 year bonds, one and a quarter percent, but some of that's being bought up indirectly at least by the Fed, and in their large scale asset purchases.

Beckworth: So, could the Treasury finance it? If the answer is no, then ultimately, it's still going to be financed short term, right? The reserves are funding the purchase in the markets of these long-term treasuries. On the other hand, if there's still this big, safe asset shortage out there, people around the world are craving treasuries, and the Treasury could finance without reliance from the Fed without support from the Fed, then, I think the case could be made for that. So, does this really hinge upon how much financing comes from the bond market versus the Fed?

Treasury Financing: Bond Markets vs. the Fed

Stella: Let's talk about the timing again, just in terms of the mechanics. At the end of the day on Wednesday, the US Treasury had $1.3 trillion in its account at the New York Fed. That's the most shocking number on the Fed's balance sheet. Prior to this, prior to 2008, as I'm sure you know David, the Treasury managed its cash pretty carefully. It aimed to hold a balance of $5 billion at the New York Fed on average. If you look at the numbers for 2006, 2007, it held 5 billion on a daily basis. So, this number of 1.3 trillion is absolutely shocking. This is an example of one of these numbers that, what does it mean?

Beckworth: Right, it's so big.

Stella: It's not interpretable, right? Presuming the Treasury is going to spend that money very fast. But, why do I mention that? Let's just go through the mechanics. Suppose that Treasury stopped issuing debt and kept spending, it would by its own spending, create a trillion dollars in bank reserves. It would send a check to my children. They all got their stimulus checks. Send another check, they would deposit them, it would go into their bank account, that bank would have reserves at Fed. So, the Treasury would be in some sense printing money. So, that's nothing. That's just arithmetic. That's the mechanics of it. So your question is, how does the Treasury refill its bank accounts?

Beckworth: Yeah.

Stella: My answer, I'm putting this in simple terms and I tend to think of the simple terms. But, basically you would wake up the next week, the Treasury would wake up, and the banking system and wake up and say, "Gee, our excess reserves have gone up by $1 trillion. We're getting 10 basis points from the Fed. Hey, US Treasury is offering Treasury bills that at 50 basis, or more like 30 basis points. So, let me gobble them up. I mean, why not? Why not? I don't think the Fed is going to raise the interest rate on reserves anytime soon." I'm talking now as a bank. Well, why not?

Stella: So, I've run into this problem in many countries with debt managers all over the world. Because, whenever I tell them, "Oh, just issue another like trillion dollars of debt," and they're thinking in the old way like, "Well, how can we do that? The market isn't there for that." I say, "No. Yeah, the market is there for that because you just put a trillion dollars into the system and took it out." So, I think really what we want to do... Let me come back to that. In any crisis, every crisis, coming back to that First World War crisis, you finance by creating money in the short run, in some way. You liquidate your liquid assets, then you create money.

Stella: Then over time, as in the UK system, they stumbled upon, over time, what's the best way actually to issue bonds, not just an emergency, but over time? Believe me, I've seen this in dozens of countries. They have gone through financial crisis, and invariably let me just give you in a nutshell, the typical financial crisis is also a fiscal crisis. The central bank lends to banks, takes collateral, that's trash. Whether they call it trash on day 1, or it takes them 10 years to say this actually is trash, they take trash. So, they're basically creating money to support the banking system or to support the government. They're taking collateral, which is worth nothing.

Stella: We get back to this policy and insolvency problem. We've created all this money, the exchange rate starts depreciating because people want to convert that money into foreign exchange. If it's a real asset, you get inflation. So the central bank, let's say we're starting in a world where they have no domestic debt, where it's in Latin America or Asian countries in the 1980s. So what happens? The central bank says, "Well, we have to do something." So, they issue their own debt. But, they're issuing it in a crisis and they've never issued debt before. So, they issue really expensive debt in a very unprofessional ad hoc way.

Stella: But then, what you see as time passes, you get out of the crisis 10 years, 20 years later, and you look at what Brazil, Mexico, Chile, Peru, Israel, other countries, Thailand, have done. They've done a fantastic job of developing domestic debt markets.

Stella: So, if you look at the central balance sheets of those countries now, and you look at the consolidated balance sheets, they're financing themselves with domestic currency and local debt, plus foreign debt. But, they're not financing themselves with money. So, that's why I want to point people to, let's look at how countries who've navigated this in the past, what are those debt managers doing? They're not saying, "Oh, please central bank, issue a lot of money." No, no, no. They're issuing long-term bonds. They're to issue more obviously, but keeping within some sort of strategy. Over time, and I'm… sorry, this is taking me a long-

Beckworth: No, this is good, this is good.

Stella: …the original point. But at the beginning, yes, the central bank will just like the Bank of England did, it will buy a ton of the government debt. So, it will at the beginning finance with, let's call it money creation. No doubt about that. I've seen this, there's no problem. The Fed set interest rates as well in 2008, 2009 and other central banks have done it. The Swiss National Bank did this, the European Central Bank did this, right? Not everybody did this. Canada did not do this. Other countries survived the crisis without doing it. But, if you do it for a short period of time, I have absolutely no problem with it.

Stella: What I have a problem with is this notion of permanent monetary finance, the notion of helicopter money as a permanent solution. I think if you push that question back on those who advocate permanent monetary finance, they said we should have more. Okay, more than what please? More than what? So, the Fed has had permanent monetary finance for the last 75 years, but the amount has been constrained. What am I talking about? Well, if you look at the physical Federal Reserve notes outstanding in the US economy from 1957 to 2007, well, they've grown.

What I have a problem with is this notion of permanent monetary finance, the notion of helicopter money as a permanent solution.

Beckworth: Right.

Stella: Well, look on the other side of the balance sheet, Treasury securities, that's monetary finance. I think 50 years is a pretty long time. So, I consider that permanent. Well, why is that not a problem? It's not a problem because people wanted those bank notes.

Beckworth: Yeah, real money demand has grown with the economy.

Stella: Money demand has grown. My point is, if you're talking about helicopter money or permanent monetary finance, I think you must be saying that the proportion of US government finance that is accounted for by money, should grow from where it was in 2007, and I've done the calculation just so that you know. I looked at the total growth in US public debt from 1957 to 2007. I subtract the amount that the Fed bought over those 50 years. I add in the increase in central bank money, which is reserves plus bank notes over that time period.

Stella: So, 16% of US consolidated financing has been monetary finance. To be honest, it's a higher number than I thought it would be. It's 16%. So, I don't see any problem with us thinking, "Oh well, that proportion can continue forever over time." The only problem with that is, I think it's a very antiquated notion because, we come back to the technology question. I don't see a big demand for fiscal bank notes growing in the next 53 years. I know for sure that actually the demand for bank reserves from 1957 to 2007 fell in nominal terms, fell in NOMINAL terms.

Stella: So, I don't see a future for that personally, even if it were a good idea. Even if you thought it was cheap, I just don't see it saying, "Oh, that should go up from 16%." I don't know that the helicopter money people ever say it should go from 16% to 25% or whatever, but I think that's the way you have to look at it. So, the way I'm looking at it is saying, "Gee, I think there's a pretty strong demand for more government debt. If we're putting our eggs in one basket, it shouldn't be in the money basket. If we're talking about permanent reliance on something, we should be putting our money in the government debt basket."

Stella: Again, the way to properly develop that basket or not squeezed the golden goose too much, is to keep selling debt, not to make some sudden swerve of this idea, "Oh, helicopter money." I mean, the more I think about it, the more it seems to be exactly the wrong way to approach it, again, in the long run.

Beckworth: In a crisis maybe.

Stella: It is absolutely going to happen. We're going to see the Fed's balance sheet grow, absolutely no question, trillions more. But, when we're talking about thinking through the implications for the long run financing this, the debt markets are… and I'm encouraged by this, because the Treasury is continuing to issue debt, issuing the TIPS, issuing 30 year bonds. You look at the interest rates they're getting, I think it's great. I'm sure if you talk to the debt managers in Peru or Mexico, they're saying, "Yeah okay, we need to raise this money fast, and this is more than the market can absorb right now. So yes, central bank can help us out." But, I'm absolutely sure over time they'll want to do what they've been doing in the last couple of decades, and that's basically develop the domestic debt market even more.

Beckworth: Just to summarize, and if I've understood you correctly, what you're saying is, we've got to have the right time horizon when thinking through this process. So, the scenarios that I propose to you is really thinking short term. So short term, the Fed is buying up a lot of Treasury debt, but your point is, ultimately, it's going to be a temporary injection and therefore how we finance it over the long run... At some point, this huge increase might be reversed or refinanced in a different way. At that point, you refinance it with government debt locking in these low rates. Is that fair?

Stella: Absolutely. I want to clarify something for all the listeners, some of whom know this, but I think it's very important. If you look at the Treasury, it's a one page statement, the results of each auction. You look down and you'll see a line that says SOMA on there, which stands for the System Of Market Account, which is a weird, weird word for what the Fed is buying at the auction. You'll see it is on a separate line. So, it's what we would call an add on. So, the rates that I'm talking about are not literally being suppressed because the Fed is in there bidding at really low interest rates. The rates that we're seeing is the market bidding versus what the Treasury is offering. Now, how central banks typically do their buying at auction is, when they do buy at auction, some central banks are prohibited from buying other than from the market. But in many countries, there's ability for the central bank to roll over its maturity treasuries at the auction in a noncompetitive way.

Stella: So basically, and I believe that is still what is going on. In other words, what the Fed is buying right now is actually the reinvestment of maturing treasuries. It can be 30% of the amount that the Treasury has auctioned to the market. I'm not saying it's a small number, but, it's not directly influencing the market rates. So, that's why I'm confident. David, I don't know if you think our listeners have understood that point, but it's basically saying, the Fed calls up the Treasury two days before the auction and says, "You know, I've got 10 trillion of treasury securities maturing this week. So, I'm going to want so many of your three month bills and so many of your seven years and so on." The Treasury just makes a note of that and says, "Okay yeah. After the auction, we're going to give you that."

Beckworth: No. I think that-

Stella: So, when you look at so to speak, the demand curve at the Treasury auction, the Fed is not there. The Fed is what we call-

Beckworth: Right.

Stella: So, I'm pretty optimistic and I'm thinking, if the market is voluntarily sanguine enough to lend you 30 years at these rates, I say, go for it. If you start running into resistance, you back off, but talking with the market. This is not-

Beckworth: No, this is good. This really in my mind has clarified the issue. Because, I was thinking just in terms of the short term crisis, but ultimately from a consolidated balance sheet view and time-wise, the government can refinance how it does its operations after the crisis, and we can finance with long-term debt. So, that's a great point.

Stella: There was one thing I did want to say that I think maybe I've been avoiding in some sense the whole time, and this is your off balance sheet question. I've been talking mostly about the relations between the Fed and the Treasury and this kind of thing. It's very, very important to accept that, when the Fed is taking claims on the private sector, it is acquiring an asset and it is paying for that with reserves. If we consider that from a consolidated basis, which I think we should, as equivalent to a US Treasury debt, we're not capturing that in the statistics, okay?

Beckworth: Okay.

Stella: We count Fed reserves as part of US Treasury debt. That comes back a little bit, I think you mentioned at the beginning. When central banks issue debt, I saw this many times, going back in the 1980s, analysts would have a big kind of crimp in their brain, "Do we count the central bank's debt as part of public debt or not?" I think if you look at it properly, the answer is obviously yes. When you have the US Treasury buying mortgage backed securities in 2008, it was financing by issuing debt. It was under a program whose name escapes me at the moment, but Congress approved that program.

Beckworth: This is the Supplemental Financing Program?

Stella: No, this was under the Bush administration.

Beckworth: Oh, Bush administration, okay.

Stella: The titles of these laws are always politically nice, like supporting the US homeowner or something. But actually, what the Treasury was doing was buying agency debt, and mortgage backed security debt before the big crisis in 2008. But, this was under a law. Congress had to approve it. The Treasury secretary was under an obligation to report to Congress about using the money. There was a limit on it set in the law. You couldn't go out and buy as much as you wanted. Of course, the debt that Treasury was issuing was subject to the debt limit.

Stella: Now, the really bizarre thing if you put these two programs side by side is, then come to the end of 2008, or beginning of 2009, the Fed starts buying mortgage backed securities and agency debt. There's no law saying the Fed should do this. There's no real requirement that the Fed should report to the Treasury minute by minute on what it's doing. Eventually, Congress made the Fed do this, but not at the beginning. Absolutely, there was no limit on how much the Fed could buy. There was no limit on the amount of reserves the Fed could create. In other words, no subject to the law that governed.

Stella: To make it even more ironic, at the beginning, the Fed was actually absorbing the reserves that it was creating to buy mortgage backed securities, by selling treasuries to the market. But, when you think about it, this is exactly what the US Treasury was doing. Exactly. Selling treasuries to the market to finance the purchase disasters. So, all that activity, that was on budget under law subject to congressional approval, subject to the debt limit. When the Treasury does it, it was not approved by Congress, not subject to the appropriation process, the debt being issued wasn't subject to any kind of limit. Let's face it, that makes no sense in the end. So, this is... Dodd-Frank tried to limit what the Fed could do there, but you would need something more dramatic to really keep this very clear.

Stella: In other words, I'm not... When you do the consolidation of money creation by the Fed buying treasuries, this becomes an issue of debt management, how you do financing. I don't want anyone to think that I'm implying that's the same when the Fed is doing all these other things. That's really what we should be worried about in the long run. We don't have a good record on that, I'm speaking of the United States here, in that in 2009, the Fed and the Treasury issued a joint statement about how they should be doing their respective roles.

When you do the consolidation of money creation by the Fed buying treasuries, this becomes an issue of debt management, how you do financing. I don't want anyone to think that I'm implying that's the same when the Fed is doing all these other things. That's really what we should be worried about in the long run. We don't have a good record on that.

Stella: It's a one pager, the penultimate bullet point says the following. "When budgetary circumstances permit, the US Treasury will take the Maiden Lane facilities off the balance sheet of the Fed." That was the right thing to say, it's absolutely the right thing to do, but you know what? Never happens. That wasn't a big amount of money. The proper way, in other words going forward in my scenario is, "Okay Fed, you created these LLCs and da, da, da. You had to do it. But at some point, the Treasury buys them from you, takes it onto the Treasury balance sheet," which has happened in other countries. It's happened in Sweden, happens in the UK, other countries. The US said it, didn't do it-

Beckworth: This is the... Sorry.

Stella: That's coming back to this. It's a repeat game.

Beckworth: Yeah. This is also the-

Stella: There'll be another crisis and-

Beckworth: Yeah.

Stella: ... Hey, it's really important I think, that you do the right thing. Not immediately, at the right time. You do the right thing at the right time. Next time, people are going to remember. Maybe not too many people remember what I just told you, and maybe it wasn't good for me to remind people of that, but it's a fact. A lot of countries have promised to recapitalize their central bank, they haven't done it.

Beckworth: This was a big part of our discussion in the last podcast. So, I encourage listeners to check it out, where we spend a lot of time talking about who should be managing the public debt of the US. Should it be the US Treasury or the Fed. This really helps us see that the importance of the Treasury taking that responsibility. Well with that, our time is up. Our guest today has been Peter Stella. Peter, thank you so much for coming on the show.

Stella: Thank you David.

Photo by Karen Bleier via Getty Images

David Beckworth
Calendar Date: 
Jun 8, 2020
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COVID-19 has caused a massive economic collapse, and the response should be to spend now, and worry about financing later.

Peter Stella on Debt, Safe Assets, and Central Bank Operations

David Beckworth: Our guest today is Peter Stella. Peter is the managing director of Stellar Consulting and formerly an IMF official, where he led the central banking and monetary and foreign exchange divisions, among other things. Peter has researched and written extensively on safe assets, collateral, and central banking operations. Today, he joins us to discuss this work. Peter, welcome to the show. 

While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to

Peter Stella: Thank you. Thank you, David, for having me. 

David Beckworth: Oh, it's great to have you on. So back during the crisis and the years after that, those of us who were really into following what was going on, we became familiar with your work along with your co-author, Manmohan Singh. FT Alphaville highlighted a lot of your work. At least that's the medium that let me on to what you were doing. So it was real fun to follow it and to think about these issues. So it's neat to have you on as a guest, have a face to face conversation. I want to hear, what was it like during the crisis, and working at the IMF during this time? What was your experience? 

Peter Stella: So, you might say I was in the right place at the right time, or the wrong time, from the global economy standpoint. I was head of what's called the central banking division, and we were asked, or the IMF was asked to give some feedback or examine the reaction of the major central banks during the crisis. I was asked to head that team for institutional reasons. 

Peter Stella: So we visited some central banks and talked to them and were kind of pressed to think through what they were doing, so that was very interesting. At the same time, my 25 years at the IMF, I had been exposed to countries having banking crises. That's our kind of clientele that we work actively with. I've seen central banks with huge balance sheets, I've been in hyperinflations, I've been in Argentina when inflation was 198 and a half percent in a month. So it's not kind of something I'm reading about, it's something I'm looking at. Of course, I was trained as an economist, but it's another thing to go and be at the supermarket and get nervous because there are no prices anywhere. This was in the 1980s, by the way. 

David Beckworth: Interesting. 

Peter Stella: And you were wondering, do I have enough money to pay? I asked somebody in Spanish and they say, "Oh, well, nobody knows what the price is until you get to the cashier." 

Peter Stella: Literally. So, they would download, batch load different prices every hour or so. I got to see a lot of sort of macro phenomenon up close over 25 years that kind of came in handy when people in the US were saying, "Oh, you know, nobody's ever had to cope with this before. Nobody's ever seen this before." 

Peter Stella: Well, yeah, I mean, I can give you dozens of cases that are relevant for this. 

David Beckworth: So you were well prepared for all of the innovations that took place in the US and the ECB based on experience with these other countries. 

Peter Stella: Yeah, and just a framework of what's important and what's not important. Before I was head of the central banking division, I was head of the division called monetary and exchange operations division. There, I learned from people how monetary policy is executed, how the plumbing works. The FOMC says “raise interest rates by 25 basis points.” Well, how does that happen? Somebody in New York does something, and that's a common problem in many central banks around the world. The policy makers decide something based on their models, and then you've got to make it happen, and sometimes it's really difficult to make it happen because it's not the textbook. You don't just take a first derivative and everything works. 

David Beckworth: It's more than applied math. Well, we want to get into the plumbing and the operational details as we move forward in our conversation, but let me begin our talk today by going back to the pre-crisis period, and you and Manmohan did a number of articles highlighting the money creation process leading up into the crisis. And then we'll move into the crisis, but tell us about what we got wrong and what we got right about this plumbing, this execution of monetary policy, and how money was created. 

Peter Stella: Right. So, sometimes I give an analogy. On one side of my family, they are Irish plumbers in New York City. My mother had an uncle who installed the plumbing and was part of the team installing the plumbing in the Empire State Building. 

David Beckworth: Interesting. 

Peter Stella: So I think a lot of people don't think about plumbing, how it works, until something breaks. And when the plumbing breaks, you don't usually call the architect of the building, you call the plumber, right? Because they're the ones who actually know how to fix things and how they work. 

Peter Stella: And I think in normal times, you don't need the FOMC, you don't need the head of the Fed to understand exactly how the plumbing works. They have models. They can do their job and captain the ship without knowing how the boiler in the ship works, whether it's fueled by coal or oil or something like that. Until the plumbing breaks, and then suddenly, you can have a problem, because people have these mental models of how the world works and they're actually wrong. And it matters, because you're making policy decisions based on a false model. 

Peter Stella: So I think the most important thing, and if your listeners think at the end of this I'm a clown, I'll give them a few facts that they can check and they can contemplate, even if whatever I, however I interpret them you don't agree with. So let's talk about money and the payments system in any advanced country today, or in 2006 or 1996. 

Peter Stella: We're talking about, say, government created money, central bank created money. There's basically two kinds, the physical paper money and bank reserves. So if you look in the United States, we first use the one that we're familiar with, they have a retail analogy. So if the Fed surveys households, how much cash do you hold in your wallet? And the answer is, on last year's survey was $59. So, how often do you make a payment with cash in a day, on average? About one, 1.3 times a day. Obviously you're making cash payments for small amounts. Let's just say the average person holds $60 in their wallet, they spend $20 a day, which is on the high side. Let's say the average adult population in the US, something like 200 million, multiply that by 20, you're getting $4 billion of cash transactions a day. So that's one part of that money, used for payments, about $4 billion. 

Peter Stella: Now, how many gross payments, what's the value of gross payments in a day using bank reserves? I'll answer that question. Through Fedwire alone, $3.5 trillion a day. Okay? $3.5 trillion. If you add in chips, which is a kind of subset of Fedwire, it's the big banks and they make payments among themselves, and then at the end of the day they net everything out and settle through Fedwire. So that's another about $1.5 trillion a day. So we add just those two together, you're getting about $5 trillion of gross payments a day, electronically. 

Peter Stella: Now, you take that in a year, you're getting basically close to $1 quadrillion in payments. Quadrillion is a thousand trillion. 

David Beckworth: Blows the mind. 

Peter Stella: So when we talk about payments and money, it's all about bank reserves. The cash component. What did we say, $4 billion, compared to $4 trillion. Now, here's the other kind of crazy thing. So I'm saying, you're making five trillion payments electronically every day. And by the way, this is pretty similar to target, too, in the European union, it's about five trillion euro a day, and in the UK it's about five trillion pounds a day. Just coincidentally, it comes out to be five trillion. 

Peter Stella: So you say, okay, what is the value of bank reserves that's kind of being used to affect $5 trillion in payments a day? And before the crisis, which was normal time, and I'm talking about decades before the crisis, the average amount of all the US banks, the Federal Reserve banks, at the beginning of the day, be about $15 billion. And the amount at the end of the day, $15 billion. So JP Morgan, for example, in 2006 was holding $2 billion in all the federal reserve banks. Biggest US bank at L2, right? 

Peter Stella: So basically you're saying, how does that happen? Well, basically, banks are sending messages electronically at about 40 percent of the speed of light. They're netting out, it's a closed system, what they're transferring funds among each other. So it's just a fact, they were doing five trillion in gross transfers with basically zero balances at the Fed, and the system was working just fantastic. 

Peter Stella: As I say, it's not just the Fed, it's the UK, it's Europe, it's Japan. That's the way modern payments work. So when we think about money or kind of the quantity theory of money, it kind of doesn't resonate with the way the system works in practice. There's something else that's kind of interesting, and then we can move on, but I think it's important to know where I'm coming from. 

David Beckworth: Absolutely. 

Peter Stella: Because this completely changes what most people think, why money is important. It's very important, but you can do everything you need to do with a very small amount. If you look at the Canadian payment system, their balances, all the banks were less than a billion Canadian dollars. We're talking about millions of Canadian dollars. 

Peter Stella: So that sort of payment, that's actually how payments are made. They're made electronically. So we don't need any more money. We don't need more balances to make more payments. If you look at the correlation between balances at central banks in the US and Japan, over time, fact, US banks were holding more balances at Federal Reserve banks in 1951 than they were at the end of June 2008. Just a fact. 

David Beckworth: That's striking. 

Peter Stella: The payments have gone up by 10,000 times. GDP has gone up. So there's a correlation between the volume of payments, that's five trillion a day, and GDP. They move pretty much in unison. But there's absolutely no ... Well, there's actually a negative correlation between changes in bank reserves and any other kind of macro number like credit or GDP. 

Peter Stella: Now, another kind of interesting thing, surprising thing, I suppose, is that during the day in these payment systems, there's a lot of payments going back and forth, and basically they net out during the day. Because it's a closed system, all the banks are members of the Fed and they have to net net zero, essentially. So at the end of the day they're in balances and they have an overnight loan, and then they move on to the next day. But during the day, of course, banks need to make payments, and they haven't received payments. So if they need to do that, a client says, "Look, I need this payment made right now at 11:00 in the morning, I can't wait until 3:00 in the afternoon," so the bank can, and the Fed, it's different mechanisms in different central banks, basically have electronic collateral. You charge your bills and get what's known as a daylight overdraft. 

Peter Stella: So the Fed lends, creates reserves during the day against collateral, and then by the end of the day when that bank gets the payments, receives payments, it repays that daylight overdraft. So if you want to look at sort of the expansion and contraction of the supply of bank reserves during the day, remember I said it would open at about 15 and end at 15. During the day, the typical maximum amount would be something like $150 billion. So if you're trying to equate changes in the money supply and changes in inflation, I'll just tell you a fact. Every day, well, you were doing your job, the Fed would basically blow up bank reserves by a factor of 10 and then contract them by a factor of 10. 

Peter Stella: I'm kind of finished with my facts, the maybe shocking facts, so now we can talk about all kinds of things in a different context. But the bottom line in my view is, please don't tell me we need more bank reserves to make payments. We don't need any more cash. But if you want it, the Fed is happy to give them to you. They're not rationing reserves. 

David Beckworth: This raises some interesting questions. There was this interesting debate now whether we moved to a corridor system or stay with the floor system. One of the observations some Fed officials will make is, "Well, it was just a mess pre-2008. It was this system where banks would have to borrow from the Fed, or there were spikes in the interest rate." 

David Beckworth: And what you're describing is a system that actually worked fairly well. 

Peter Stella: Right. So let's come back to, why do we call them central banks? What's central about the central bank? Well, in the old days, the bank ... In fact, this is still the legal structure of the Fed. Banks joined together, kind of in a co-op, where they would pool their reserves at the central bank. They would go and they'd bring their checks and payments and they would settle payments among themselves. They would just move the reserves around, it's like a clearinghouse model. So in the physical times, we had to have the bank in the US, we would have to be in New York, so everybody could physically bring the thing, it's got to be in a central location. So now we're just doing it electronically. Right now it's like there's one balance sheet. Oddly, the US has 12 balance sheets, but that's, you know, electronically they were consolidated. 

Peter Stella: So that's kind of the basic function of the central bank, is to facilitate payments. Now, we come along to say, okay, so what is monetary policy? And I think one of the big mistakes that academics have made, and people have made in general is to think of the central bank as everything that goes on inside a building. Central banks do different functions. One is this payment system function I'm talking about. And then they do the monetary policy function, they might do some legal regulation function, and so forth and so on. So when we talk about central bank independence, I don't think anyone really argued that Janet Yellen shouldn't have to pay her parking tickets because she's independent. Or that Janet Yellen can do fiscal policy because they're independent. No, no, no. All the argument was about monetary policy independence. 

Peter Stella: We can argue that's a good idea or a bad idea, it's probably a good idea. But what I'm saying is, we have to make a distinction between what we want the central bank to be accountable and independent for, and the other things that, wait a minute, we didn't mean that you could do these other things. So when we come back to this notion that the payment system and say, "Oh, things weren't working well before," I would absolutely argue against that if I know anything. Just the statistics I'm giving you, right? 

David Beckworth: Right. 

Peter Stella: US payment, unbelievably efficient. You can handle this five trillion a day. Nobody even knows. Nobody even thinks about it. And I think, incidentally, that people who manage corporate, bank treasurers, a lot of this is done in Florida. They're in Florida, IT systems, right? It's just an IT system. So it's not part of what we think of as the normal banking business, but it's a big part of the economy and that's what the central bank is supposed to do, make sure that works well. 

Peter Stella: If you look at September 11th, the tragedy, physical destruction of primary dealers and so on and so forth, yes, there had to be some kind of injection of liquidity and all that. But really, it was remarkably resilient, remarkably efficient, robust. It's just unacceptable. I mean, it's absolutely state of the art technology. So this idea that we need sort of crypto coins or something because we don't have enough money is, to me, just ... I don't get it. 

David Beckworth: It's ludicrous. 

David Beckworth: Yeah. So that's the pre-money creation payment system, going into the crisis. So we go into the crisis, 2008, the Fed begins its large-scale asset purchase programs or QE. And you and Manmohan did a number of pieces, I referenced earlier, about the adverse side effects or consequences of that. Tell us, why did those purchases create strain on the financial system? 

Peter Stella: If we want to talk about why I never use the term QE to refer to the US, that's another long story. So the US, in my opinion, never did QE, so they did large-scale asset purchases. So what's the unintended consequence of that? 

Peter Stella: Basically, what you've done is, you've done a debt swap. Let's consider bank reserves as part of US debt. It's a liability of the Fed, and if you dig deep on the US Treasury website, you'll find that the US Treasury considers the federal reserve notes as a liability of the US Treasury. By the way, they're signed only by treasury officials, which could give you pause. Say, well, why aren't we like other countries where the head of the central bank signs the bank notes? Well, actually, if you look at them, they're signed by the treasurer. So they're a liability of the treasury. And I know some people have said, "Oh yeah, but that's not interest-bearing." 

Peter Stella: Well actually it's always been interest-bearing, just a nominal interest rate of zero. Real rate was positive, if you have deflation. It's negative if you have inflation, but it's no different than a treasury bill in that sense, like treasury bill is auctioned usually at a discount, so you make interest. But now in many countries, they're being auctioned at premium, so you're making a negative return. 

David Beckworth: I agree with that point. I think it's fair to say that, even implicitly, I think market expects the treasury to bail out the Fed should something go wrong, so these are liabilities of a consolidated kind of government balance sheet. 

Peter Stella: Okay, great. So basically then, let's put the MBS aside for now. So when a central bank buys treasury securities, it's paying with a different kind of treasury security. So it's a debt management operation. Now, treasuries do debt management operations all the time. They buy bank long-term debt, they issue short-term debt, they issue long-term debt, they buy back short-term debt. Treasuries all over the world do that every day. I mean, that's what a debt manager does. 

Peter Stella: So now we have this other sort of entrant, we call them the central bank or the FOMC, whatever we want to call them. And they say, you know ... Well, let me take a step back. A debt manager is basically trying to sell the debt at the minimum cost. That's their job. 

David Beckworth: Exactly. 

Peter Stella: They need to finance the deficit, they need to roll over the debt, so they're auctioning the debt, seeing what the market wants. Taking the market is given, and talking to the market, say, "Hey, do you want a ten year or you want the ... " 

Peter Stella: They'll sell you what you want, because you're going to get a better lower rate, is the assurance. So the central bank comes along and says, you know, you've given me one thing, and that is I can set the rate on this overnight treasury bond. That's my policy tool. You have the rest of the yield curve, Treasury. I'm going to set this one. 

Peter Stella: Now I'm saying, I want to lower this below zero and I can't. So why don't I try to lower the ten year rate. Well, how do you do that? Supply and demand. I'm going to go out and say I'm going to buy up all the ten year treasuries that are in the market. Okay? What happens? Goldman, hedge funds, pension funds, individual investors say, "Wow, there's a whale in the market, I'm going to eat up all this debt, I'm going to buy it," price goes up, yields go down. That's the simple idea. 

Peter Stella: Now, unlike the US Treasury, so the US Treasury could have done that too, could have said, "We're going to buy back all the ten year debt," well, how does the US Treasury finance that? It's got to issue some other debt. How does the central bank do that? Well, there's only one kind of debt the central bank can issue, and it's called bank reserves. So they, you can say, buy them with money creation, but it's really just a debt management operation. You've consolidated the balance sheets. All you have done is taken the ten years out and you've issued this overnight floating rates thing. 

Peter Stella: Now, I think that was actually a good idea, right? Good idea. But now, we come to the unintended consequence. You've issued, as the Fed, let's say $3 trillion in this instrument. And if you come back to my discussion of the way payment systems work, well, you know what? The market, the society, we only really wanted $10 billion of this and now we've got $3 trillion. So, what are we going to do with this? I mean, it's there. And one of the bad things about bank reserves is, oh by the way, the only people who can hold them are banks. And the treasuries that you bought, they could be held by banks, they could be held by David, they could be held by me. They can be held by anyone, they could be held by the Chinese. So, and use a million dollar word, they're more fungible. Or, ironically, believe it or not, they're more liquid. There's a bigger market for them. Banks that can only trade them among ourselves, and we all have more than we need. So it's not actually that great. 

Peter Stella: And because you've blown up the Fed's balance sheet, you've blown up the banking system's balance sheet. So they've got $3 trillion in assets, let's take JP Morgan, I had $2 billion in Fed reserves in 2007, 2008, middle of the year, that I was doing just fine. Now I've got $500 billion. And I've got to have something on the liability side to finance that, right? 

David Beckworth: Right. 

Peter Stella: And if you look at the data, it's actually financed by increase in deposits at the banks. So the banks are caught in this kind of weird squeeze, the banking system has to hold the reserves with the Fed, and they've got finance it, and they really don't want it. They're not making any money on this. And Dodd Frank has introduced some interesting regulations which basically say, by the way, no matter how you finance your balance sheet, you have to pay FDIC charges now, number one. And number two, by the way, we're going to introduce an enhanced supplemental leverage ratio. That says, you're going to have to hold capital against all of your assets, including Treasury bonds. So why do you have to do that? Okay. Regulators said we messed up and you know, risk weighted assets or whatever, we have this fall back to say, well, we also don't want your balance sheet to get too big. 

Peter Stella: Now, the banking industry in 2015 said, wait a minute, this doesn't make any sense. We're holding $2 trillion in deposits at the Fed. Why do we have to hold capital against them? And the regulators say, too bad. I mean, you could look at the federal digest and see this discussion. 

David Beckworth: That's interesting. That's a super safe deposit ... 

Peter Stella: Right, right. 

Peter Stella: So basically, what is the problem? The problem is, you've inadvertently, because this is the only way the Fed can do a debt swap, is with this instrument. And this instrument is inferior to basically every other treasury security. And to look at it a different way, if you went to the US Treasury or any treasury in the world, and you said to them, "I think you're missing out on this great instrument that you could use to finance the deficit." 

Peter Stella: "Oh yeah? What is it?" 

Peter Stella: "Well, it'd be a floating rate overnight security that only banks could hold." 

Peter Stella: I mean, any treasury in the world would say, "Are you out of your mind?" 

David Beckworth: It's a small market. 

Peter Stella: This is not a good idea. We don't want to issue that. 

Peter Stella: So, now we're ... If this had been a temporary thing, if we were going to kind of blow up the balance sheet and then contract it, before running into the problem with the leverage ratio of potentially squeezing out lending, raising the cost of capital for banks unnecessarily. I'm not against increased capital requirements for banks, I think it's a very important lesson out of the crisis. But you have to agree with me, it doesn't make any sense to require banks to hold capital against their deposits at the Fed which they don't really want to have. 

David Beckworth: Yeah, that's hard to understand. 

Peter Stella: So we're going to shrink it back. Okay, I don't care if it's ... We're back to $10 billion, I don't care whether you're including that in the leverage ratio or not. But if we're going to stay at $2 trillion or $3 trillion, something has to happen. And actually, in the UK, in 2016 they carved deposits at the central bank out of the leverage ratio. 

David Beckworth: Oh, they did? 

Peter Stella: Actually, the Basel Committee was not too happy, because they ... 

David Beckworth: So is there any discussion about doing that in the United States? 

Peter Stella: There is some talk about it now, I know that. 

David Beckworth: Banks are probably pushing hard. 

David Beckworth: So in short, what you're saying is the Fed, by doing these large-scale asset purchases, or QE, they effectively drained liquidity out of the system. They took out more liquid assets and put less liquid assets because they can only trade among banks, the reserves. 

Peter Stella: Right. 

David Beckworth: So you would think they would want to do it the other direction in a period of a weak recovery and slow times. In your view, then, what was the net effect of large-scale asset purchases? We had maybe some reduction, arguably ... There's been debate on this, but there's some reduction in long-term yields, long-term treasury rates. But it's offset by this concern you just raised. How do you view the net effect? 

Peter Stella: You have had, I would say, unintended consequences. So the objective was fine. The US Treasury could have done this in a more efficient way. Now, we could argue politically, whatever, is that possible or not possible and so forth and so on. But conceptually, the treasuries could have done this, and in fact, the US treasury did do this. People have forgotten about this, but in 2008, before the Fed started buying anything ... This was under the Bush administration, there was a law passed which enabled the treasury to buy mortgage-backed securities and debts to support the housing market. 

Peter Stella: Now, the difference between what the treasury did and what the Fed did was that the treasury needed permission of Congress to issue the debt, because this was a net increase in treasury debt outstanding. You are issuing treasury debt to buy mortgage-backed securities. The treasury secretary had to declare in the law that this was some kind of emergency. There was a cap on it, it was going to be reviewed by Congress. There were limits. It was a Congressional appropriation for this purpose. And by the way, those securities were bought and subsequently they were auctioned off by the treasury. So the treasury doesn't have any more of those securities any more. And part of it was because it ran into the debt ceiling and it had to reduce, so that's our problem with having a ... It's kind of a gross debt ceiling. 

Peter Stella: But when the Fed is doing it, it actually began doing it in exactly the same way. So before Lehman, the Fed was lending, increasing bank reserves. Well, it was selling from its portfolio treasuries to absorb that liquidity. So the amount of liquidity, and when we say liquidity here, I mean this quantity of bank reserves didn't change at all. People talked about the Fed's balance sheet was blown up. It didn't blow up by a dollar before Lehman. So everything that was put in with one hand was taken out by sales of treasury. But when you think about it, it's just what the treasury would have done. Sold treasuries to the market and taken the money and…David Beckworth: So you view it as a good thing, then, that for every dollar loaned they were selling a dollar of treasury to the marketplace. That was adding liquidity that the treasuries back into the public? 

Peter Stella: Right. So basically, what you were doing, and this period, euphemistically, of the Fed before Lehman, was known in the market as treasuries for trash. Later on it became cash for trash, but before it was treasuries for trash. And that's what the market wanted. They didn't want reserves at this central bank. They wanted treasuries. So they wanted to get rid of their trash collateral, all the MBS that suddenly were not usable for repo finance. So the banks were investing in these and using them to fund them cheaply, as collateral. And then taking the maturity mismatch. And then the market said, hey, wait a minute. I think all these mortgage-backed securities might default. I'm not rolling over my loan any more. 

Peter Stella: So what do you do? Well, you offload them to the Fed, you get treasuries, and then people are willing to lend you against treasuries. And there are countries, Norway, for example, where the government, the central bank did not get involved at all, in this exact same process. So what happened in Norway was the government had a special auction, arranged by the central bank. The government issued three year bonds and did a collateral swap. Basically took the mortgage-backed securities and the three years that the thing was unwound. So you didn't get all this confusion about creating money and all this stuff. It was done completely on the treasury's balance sheet. 

Peter Stella: In countries where they have a really clear distinction between monetary policy and fiscal policy, they had the treasury do it. But coming back to why it's better, yeah, basically because the market, everyone, was better off with a treasury bond or treasury bill. Shorter duration, because you're trying to influence the yield curve than bank reserves. They're just not as useful as people think. We don't need more bank reserves to make payments. We don't need them. They're absolutely unnecessary. And they have the inefficiency of not being fungible. 

Peter Stella: Now, if you look at the reverse side of this, suppose you want to unwind. If you were the US Treasury and you had done this, so you had issued short-term debt and bought long-term debt, when you want to unwind the impact on the yield curve, you could do it in a thousand ways. You could issue three year, two year, one year, eight year, ten year, 11 year, fixed rate, floating rate. As a government treasury you don't say, "Oh, I want to unwind this yield curve." 

Peter Stella: I think the Japanese have a nice term for this, it's called yield curve control. So this is really what it was all about. So we want to unwind this. You're the treasurer of the United States ... I made a presentation to the US Treasury, I had some props in front of me. You don't turn around and open the safe and look in and say, "Hey, what did we buy ten years ago? We have to sell that to unwind." 

Peter Stella: Of course not. You'd just dematerialize, you buy back securities that just disappear. But when the FOMC wants to unwind the portfolio, they're turning around, opening the vaults, which we call this SOMA portfolio, system open market account portfolio, saying, "Oh yeah, if we want to unwind, we have to sell what we bought three or four years ago." 

Peter Stella: That's kind of crazy. I mean, it's like no degrees of freedom there at all. 

David Beckworth: It's a very inefficient way of doing this. 

Peter Stella: Right. And you absolutely don't want to do it in the opposite way. You don't want to start selling, dump ten year bonds on the market. You want to do it very, very gently. So instead of doing that, I mean the Fed can't do it that way. The treasury could do it perfectly. So instead they're adopting, let's do this in a way that's like watching paint on the wall dry. We'll let them mature over time, and then we won't re-buy them ... 

David Beckworth: Very slow, yeah. 

Peter Stella: And you're just saying, why? You're saying that that's exactly the optimal sequence? I mean, it can't possibly, right? Can't optimally be the sequence to just do it the way they're doing. 

David Beckworth: Well, let me ask you a related question. There's this literature, and a lot of discussion during this time as well, on the safe asset shortage problem, which predates the crisis. In fact, some would argue contributed to the crisis, and the argument basically is that there's just a dearth of safe storage vehicles globally, and so the world goes looking for it and we're one of the best suppliers of it and we first supplied treasuries, when they ran out we provided private label, which really wasn't so safe. And so, do you view then these large-scale asset purchases as adding to an existing problem, or creating their own problem? 

Peter Stella: I have to smile now. When the crisis was happening, I was still at the IMF. And basically, in any other country in the world, if the genesis of the crisis is your financial markets, you have kind of a banking collapse, you have a fiscal collapse, whatever. But in this situation, people ran for the safest assets around, which is US treasuries. So the best performing asset class in 2008 was US treasuries. So it's kind of crazy. But yes, so we're very ... I say we, the United States is really good at producing lots of safe assets. So having a big debt actually is not so bad. People talk about seigniorage and all that. It's really, exorbitant privilege, if we can use Barry Eichengreen’s term. It's not so much that we can print money, because I'm telling you, we don't print any money. $15 billion, that's nothing. That's literally the case, right? Not making it up. But the exorbitant privilege is, yeah, everybody loves the US treasuries. Use them as collateral, they trade all over the world. This super liquid market, the legal system is perfect. Hopefully Congress won't have a technical default. 

Peter Stella: That's fantastic. We're in the business, let's say, the great things, America, Hollywood, we produce lots of films and all that stuff- 

David Beckworth: I'm with you on this, yeah. 

Peter Stella: And we produce this thing, it's called safe asset, and we might not appreciate it, but the rest of the world… It's what makes the financial system work. $10 billion of bank reserves is not what makes the financial system. It's the trillions of dollars of treasury that's floating around that makes it work. 

David Beckworth: I completely agree with your point about… we provide a valuable service to the world. We're the banker to the world, of sorts.  Everyone looks to us and until the international monetary order changes, they need us. We've joked before on this show that one of our comparative advantages is exporting debt. 

Peter Stella: Absolutely. 

David Beckworth: It's a hard sell to Congress, maybe politically, but the world needs us. And this is, I guess, the Triffin dilemma that has been brought up in the past, that the world needs us to run these deficits, even though we don't need to run the deficits, they need us to run deficits. 

Peter Stella: I mean, you remember the panic when it looked like Clinton was going to repay the debt, it's like, oh, what are we going to do? How are we going to do monetary operations? 

David Beckworth: Yeah, what would have happened? What if we do pay off our national debt? Would that create chaos financial markets? 

Peter Stella: This is a question that I've looked at in the framework of developing government debt markets in countries that don't have government debt markets. There's this debate about, does the government have to be first or could the private sector do it. Let's say you're taking a case like Singapore, huge government surpluses, we want to have a domestic debt market. I think in the US, railroad bonds were kind of that triple-A thing at some point. Of course, they went bankrupt, but anyway. 

Peter Stella: So what the government of Singapore did, this kind of gets back to this issue with the debt. They decided to issue a ton of government debt. So let me take a step back, if you look at the balance sheet of the central monetary authority of Singapore, gigantic foreign reserves on the asset side, like 200 percent of GDP, I don't know ... What's on the liability side? Well, it's like foreign exchange swaps. This is different kind of derivatives to finance that, they could issue some of their own bills. But then they said, well, we'd like to develop a corporate debt market in Singapore, in Singapore dollars. We want to base that off the government yield curve, which is the normal way all the things are priced. 

Peter Stella: So the government decided to issue, I don't know, 50 percent of GDP in government debt, and just keep the money at the central bank. You just say, "Well, why would they do that?" 

Peter Stella: Well, they're trying to develop the debt market. Like, the market wanted this debt, they were able to issue it, and it basically replaced these other interest-bearing liabilities of the central bank. So in Singapore, the central bank pays interest on that deposit equivalent to the interest the government is paying on its debt. There's zero fiscal cost. Some other countries do this, Mexico, Israel. Government debt is issued in a gross sense to make the market more liquid. We don't have that problem in the United States, but if you did, you're issuing debt simply as a public good to the financial system. 

David Beckworth: That's interesting. 

Peter Stella: You don't need it, and Singapore's the classic case, right? You say, "Oh, they've been running surpluses for 30 years, why are they doing it?" 

Peter Stella: No, they're doing it precisely to provide the market a liquid benchmark, so the corporates can price their debt off the sovereign risk…. 

David Beckworth: That's a tough argument to make though, again, I think…. 

Peter Stella: Well, in the US, I think we have enough debt, we don't probably have to do that. Although when you come back to the safe asset shortage, and I've talked to some people in the German treasury and the ECB about this, but if you're in a situation ... The German government right now can issue, I think it's five year bond at minus 40 basis points. So basically what the market is saying to you is, treasury, I will pay you for you to give me a five year bond, and as a treasury, you can go to the ECB, take the cash, you sell the bond, take the cash, buy Euro bank notes and lock them up in a vault. You make zero. 

Peter Stella: It's a money maker, right? For the tax payer. So how do you explain that unless there's some kind of artificial shortage of German debt or Swiss debt or other debt? One of the biggest contributors to the safe asset shortage is Swiss National Bank. The Swiss have bought, it's been foreign exchange intervention, so they've created Swiss francs and they've bought Euro bonds, German bonds, Japanese bonds, US bonds, they've taken them out of circulation. So they're a big contributor to this. But all of the large-scale asset purchases have taken really fungible, valuable collateral out and replaced it with this- 

David Beckworth: Reserves. 

Peter Stella: …Thing that we don't really want. In terms of exiting, for example, Swiss National Bank can issue its own debt, and I suspect that that's how they are going to exit is starting to issue their own debt. The US is not going to do that, the ECB has a political problem with doing that. Although they could do that, the ECB could do that. 

David Beckworth: Well, let's talk more about that. You've suggested as a path forward a way to improve operations in the United States and elsewhere, and you have several articles, they're very interesting, about this. You've suggested that the US Treasury issue bills to the Fed, to the central bank, that they can use in their operations. Tell us why and how that would help. 

Peter Stella: Okay. So, this is not an idea I came up with on my own. This is a proven, tried and tested strategy that's worked wonderfully in Mexico and Israel and some other countries. And basically, if I can just step back, where were they coming from? So the typical emerging market crisis country was afflicted by what a lot of people call original sin. So they couldn't issue domestic debt in their own currency, we all knew that. So Mexico couldn't issue peso debt, Israel couldn't issue- 

David Beckworth: Because no one would want to buy it. 

Peter Stella: No one wants to buy it, right. 

Peter Stella: So we've kind of gotten really far. The successful countries, Chile and Mexico, Brazil, they're now able to issue domestic debt. Now, what happened during the crisis when they couldn't issue domestic debt, they had a banking crisis. The central bank created all of these reserves, and instead of leaving them in the market, which of course we now understand, this didn't make sense. It would have put a run on the currency and all that. They just manufactured their own debt out of thin air. 

David Beckworth: The central bank. 

Peter Stella: The central banks. So the Bank of Israel issued debt ... I mean, basically you can go down two dozen central banks that issued their own debt. Because there was nothing else. 

David Beckworth: So just to be clear, the central bank was issuing its own treasury bill-like debt- 

Peter Stella: Absolutely. 

David Beckworth: In addition to the government issuing its own treasury bills. 

Peter Stella: The government wasn't issuing its own treasury bills because of the original sin. 

David Beckworth: Oh, okay. Oh, I see, I see. 

Peter Stella: So there was no market, so the central bank in a crisis created the market, so to speak. 

David Beckworth: Interesting. 

Peter Stella: And that's not a good time to be issuing debt, right? When the whole world is falling apart, your country is falling apart. So basically the banks, you know, it was basically, "Here. Here's all this local currency," and the banks would say, "Oh, okay, I'm going to buy dollars from you, central bank." 

Peter Stella: Central bank, "We don't have any dollars, so here, take these interest-bearing obligations. 

David Beckworth: Did they take it willingly? Was it kind of pushed on them? 

Peter Stella: Yeah, it was either like, "Take this or go bankrupt," basically. But typically they were very bad instruments. It would be like you or me just suddenly saying, "Okay, I've got to issue a bond and sell it," you know, you've given pretty good terms. 

Peter Stella: So basically, as you've got out of that problem, treasuries started issuing domestic debt, but there was an incumbent in the market, it was the central bank. So you have a bifurcated market. In fact, if you look at Chile today, if you consider central bank debt a sovereign debt, which I do, basically 50 percent of the domestic sovereign debt is obligation of the central bank and 50 precent is obligation of the treasury. 

David Beckworth: Very interesting. 

Peter Stella: So that's inefficient, right? You're kind of dividing the pool of liquidity into two, and there's all kinds of problems with that. So one of the things that I've been doing maybe the last ten years or so most, is trying to unify domestic debt markets. Basically what it involves is issuing treasury debt to buy back central bank debt. I mean, that's a big picture. 

Peter Stella: So again, we come back to this idea of what we should have, the one sovereign debt manager. It's the treasury, they're going to manage the debt, we're going to get the central bank out of the debt management business, like issuing their own debt. So Mexico did this very successfully, for example. 

Peter Stella: What I see in the big balance sheet countries, the new big balance sheet, so called advanced countries, is you've suddenly done the similar thing to what the other central banks did, in a crisis, you issued all this new kind of debt. I say new in the sense that, okay, yeah, there was like $15 billion, but it wasn't being used for the payment system, right? So you've issued this new kind of instrument, which isn't the best instrument. I'm not saying all of this was dumb. You had to do it, right? Lehman is Sunday, on Wednesday you've got to do something. 

Peter Stella: I'm not saying that they should have come up with some magical formula that no one else came up with 20 years ago when they had their crisis. And as I said, if it's going to shrink back, I don't care. It's not a big deal. But if you're going to keep it big for a long time, well, what these other central banks did was, they found a way to issue these tradable debt instruments that could be traded not only by banks, but by everyone. It makes sense. So this whole idea of having huge bank balances forever, just doesn't make any sense. 

Peter Stella: So when you talk about, I wrote a few things on helicopter money, and one of the, sort of ... People agree, okay, helicopter money is actually fiscal policy. The problem is, okay, that it has to be a permanent thing. So we have to have monetary injection, it's got to stay there forever. And then we're like, "Oh, that interferes with central bank independence," all that stuff. Well, it turns out, it's very implausible that you would ... I mean, nobody would want to hold massive amounts of bank reserves forever. But people would want to hold US treasury debt forever. I don't think the US Treasury is ever going to pay off its debt. So if you want to do helicopter money, you don't need to use money, you use bonds. You just give away bonds. 

David Beckworth: So how would this work with the Fed? Let's use the Fed. If Jay Powell is listening now, if Steve Mnuchin is listening now, how would this work? 

Peter Stella: Okay. So, basically what I want ... Let's sit together and say, this is our sovereign balance sheet. And we're going to look at the maturity distribution of our sovereign balance sheet. The US Treasury, for decades has had a nice yield curve, and they're issuing just whatever. Then all of a sudden, right, this big spike, like overnight liability appears. You're just saying, "Hey, this doesn't make sense. This can't be the optimal ... We were going along for 30 years, the optimal distribution kind of looked like a bell curve or whatever, now it's got this big spike there." 

Peter Stella: So, take that spike, let's color it red, because it's under the control of the Fed and everything else is blue. Just say to, Powell says to Mnuchin, "Look, that stuff, that's for you to manage. You should be managing that. We shouldn't be managing that. You distribute it along the yield curve the way you think is the best way." 

Peter Stella: Simple. 

David Beckworth: So would the treasury then just deposit ... How would that actually take place? Would the treasury create these bills, notes, bonds, based on their preference and then send them over to the Fed? 

Peter Stella: Right. So it's kind of like who has the paint brush in their hands. Is it the Fed or the Treasury? And we could argue independence and all that. So let's say we want the paint brush to be in the Fed's hands. So the Treasury says to the Fed, "Okay, you've got this," again, we're going and opening the safe. "You've got this collection of ten years and five years and eight years and whatever. I'm going to do a swap with you. I'm going to give you 30 day treasury bills for the whole amount." 

Peter Stella: So I'm giving you this molding clay, the artist analogy. Clay. You want them all to run off in 30 days? You can. But you're not. You can roll them over for 30 years. I mean, that's what the Fed was doing before. It was holding treasury bills and would just roll them over and roll them over. The portfolio's only getting bigger. So you're not constrained to ... There should be absolutely no connection between how and how fast you roll off the balance sheet and the bonds that you happen to have bought in 2009 and 2010. There should be absolutely no connection. 

Peter Stella: So you say to the Fed, "Here's the 30 year treasury bills." 

Peter Stella: Roll them over for 30 years, 20 years, 15 years, roll them over now. You have complete ... You can duplicate what you're doing, but you can do like a million other things. You can speed it up, slow it down, the markets aren't going to freak out. 

David Beckworth: So you would do this to reduce the balance sheet, but in a much more efficient manner. 

Peter Stella: Right. 

David Beckworth: Okay. 

Peter Stella: I mean, basically it gives you a million degrees of freedom to do it faster. What I'm certain of is that it would work. People would suddenly say, "Oh, yeah, this makes sense." 

Peter Stella: But it's just coming back to, no treasury would ever have done an operation like this. 

David Beckworth: This has been experimented with in a similar form with the supplemental financing program during the crisis, is that right? 

Peter Stella: Right. 

Peter Stella: So, by the way, this is the brilliant thing. If you want to be proud of the US policymakers. So literally, Lehman, I think was September 15th. Files for bankruptcy on Monday or whatever. AIG goes into conservatorship on Wednesday, September 18th, I think it is. US Treasury issues like a three-sentence press release on that day, but the world is falling apart, I mean literally, people are circulating memes of cats falling out of windows, whatever. So nobody's paying attention to this little press release of the US Treasury. 

Peter Stella: So the US Treasury announces the supplementary financing program. What's the purpose of this? It's to help the Fed manage the balance sheet consequences of its recent interventions. Okay, let me translate that. As I said, up to that Monday, the Fed had been injecting bank reserves to certain institutions with one hand, then selling treasuries with the other hand and withdrawing those bank reserves from the market. Why? Because the Fed funds rate target was whatever it was. 200 basis points. 

Peter Stella: So you had to keep demand and supply in balance with that $15 billion number. So, that's what you were doing. After Lehman, that didn't have enough treasuries to absorb it. They didn't want to broadcast that at the top of the Empire State Building, "Hey, we can't absorb all this money that we're creating." 

Peter Stella: Because everyone's, "Oh, there's going to be a hyperinflation." 

Peter Stella: It's totally wrong, but ... You don't want to be yelling fire when there's ... I mean, you've already yelled fire, right, you don't need to sort of throw gasoline on the fire. 

Peter Stella: So, what happens? What happens in that case? That's when you come back to my 25 years at the IMF, I say, okay, you can do it this way, this way, this way. So, what happened? There was discussion on ... The timing might not be quite right, discussions in New York that I, let me say, became aware of while I was at the IMF. They were discussing issuing their own debt. So the idea was, "Hey, we don't have enough treasuries to absorb all this money. If we don't absorb this money, Fed funds rate is going to plummet," which it did, actually. It went below the target. Bill Poole was one of the few people in kind of real time who noticed that and said, "What's going on here? Is the Fed secretly cutting rates, not telling anybody?" 

Peter Stella: No, it was simply an arithmetic fact, they couldn't absorb the reserves. So one option was, okay, we issue our own debt. New York Fed issues its own debt, absorb those reserves, and we get into the Chile… whatever. 

David Beckworth: Yeah, sounds like Mexico. 

Peter Stella: And now you talk to people in New York Fed, you get different stories on that. One is they said, "Well, it wasn't illegal for us to do it." 

Peter Stella: The other, Simon Potter said, "No, no, this was a dumb idea. We fragment the debt market." 

Peter Stella: I said, "Simon, absolutely. I've been dealing with this for ten years all over the world." 

Peter Stella: So anyway, they didn't do that. So what happened? They had to have had a conversation with the treasury. Treasury said, "Okay, we are going to issue cash management bills and keep that money in a special account at the New York Fed." 

Peter Stella: So the only reason we're doing this, we're going to pay interest on them. Of course, interest rates at that time were really, really low. But treasury says, "I'm going to do that for you, I'm going to keep the money at the New York Fed to keep the supply of bank reserves manageable by you." 

Peter Stella: And the Treasury, I mean, it was a fantastic agreement, in my opinion. My years of looking at fighting between treasuries and central banks, that they did this so quickly and in such a clever way. I think they should be extremely proud that they did this. It was purely to assist the Fed. So the US Treasury was issuing debt that it didn't need. Paying interest on it. But enabling the Fed to maintain this. 

Peter Stella: And so from zero, obviously this program didn't exist before, so we had a zero balance in these special cash management bills. We went up to about $565 billion. Cumulative stock. So it's really remarkable, but it comes back to your point, US Treasury, I mean, that's the strong point. People want to… that, so we can do that. Almost no other country could do that, right. Just go from, "Oh, we're going to issue another $565 billion in debt in six weeks' time," which is basically... It's really amazing. 

David Beckworth: And your proposal, though, is to kind of make this official, or make it more of a permanent feature of what we do in the US. 

Peter Stella: Right. So again, maybe this is my idea, but it's based on practice of other countries. But if you look carefully, somewhere around 2010, I think, Ben Bernanke gave a speech. This was very far in advance, talking about how this will be unwound, and he says, "Well, we could resume this program." 

David Beckworth: Oh, he actually mentioned that. 

Peter Stella: He actually says that. Right. 

David Beckworth: Fascinating. 

Peter Stella: And I think if he ... 

David Beckworth: Too bad. 

Peter Stella: He taught me at Stanford, I can't pretend to be grading him, but to me, that's an A plus answer right there. 

David Beckworth: Sure you can. 

Peter Stella: The other ways, oh, okay, it's like a B answer. Yeah, you can do it that way. But that's the A plus one, and you actually have done that. 

David Beckworth: Right. So you have experience, they know. 

Peter Stella: And other countries have done similar things like that. So, my kind of argument, by the way, because people are going to say, "But you're issuing a lot more debt," whatever. My claim is, and there's evidence for this claim, is you're either financing this part of the balance sheet by paying interest on reserves at a rate above money market rates, or you're issuing treasury bills, which everyone wants. Not just banks can hold, everybody wants. 

David Beckworth: Yep. 

Peter Stella: You're going to sell them at a lower interest rate than the interest rate on reserves. So you're going to save the taxpayer money. Everybody's going to be happy. Banks are going to be happy because they can shrink their balance sheets. In other words, get all the dead wood off, the reserves on one side and the liabilities financing the reserves, to get rid of that. The global financial markets are happy, because they get more treasury bills they couldn't hold before. Which the German tax payer, they should be doing this too, but anyway. But they're not doing it, so let's do it. And tax payers should be happy. The only loser in this is actually the FDIC, because right now, the FDIC is collecting insurance premium on deposits that are backed by reserves at the Fed, which is kind of nonsense. 

David Beckworth: But overall it's a very positive message. It's a very, a lot of winners, and a definitely more efficient outcome. 

Peter Stella: Yeah, and I think, you know, I can't put myself in President Obama's shoes, but would have been nice for him to have said, "By the way, the crisis is over. We shrunk the Fed's balance sheet back to where it was. It's over, it's done." 

Peter Stella: But we're still kind of keeping this thing going and I think there's a lot of people now who suddenly, now that the balance sheet is big, think, "Oh yeah, let's think of a reason why we should keep it big," because it's giving them more power and more influence that ... Then we get into this, in a democratic society, shouldn't it be the Treasury who's managing the country's debt, not kind of the Treasury and the Fed? 

David Beckworth: Your proposal, though, is very, I think, a promising idea. 

David Beckworth: Our time is out, unfortunately, but I think we ended on that great note there, that this is an idea that we should consider, and over the next six months as the Fed is considering its operating methods, its targets, maybe it's something they should put on the table. 

David Beckworth: Our guest today has been Peter Stella. Peter, thank you so much for coming on the show. 

Peter Stella: Thank you, David. 

David Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. If you haven't already, please subscribe via iTunes or your favorite podcast app, and while you're there, please consider rating us and leaving a review. This helps other thoughtful people like you find the podcast. Thanks for listening. 

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David Beckworth
Calendar Date: 
Feb 18, 2019
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A Macro Musings Transcript