Quote: Original post by Prefect
The next step in understanding is to understand what the interbank interest rate is. The government regulation requires banks to keep a certain minimum amount of reserves (in some countries this minimum amount is 0, just like for private accounts, in other countries it is a fraction of deposits at the bank). Even if the total sum of reserves stays exactly the same, it is natural that over the course of one day, imbalances are created, where one bank obtains a surplus (excess) of reserves while other banks do not have enough reserves.
The central bank always acts as a lender of last resort to banks that do not have enough reserves, but it asks a certain interest rate for this kind of credit - this is called the discount window. On the other hand, excess reserves do not earn interest. So of course it is beneficial for banks with lack of reserves to meet with banks with excess reserves for lending purposes, as both parties will get a more favourable interest rate.
However, if excess reserves accumulate in the system, that is, the total sum of deposits at the central bank increases, then most likely all banks will have excess reserves on which they do not earn interest. Of course it is likely that banks will try to get rid of reserves in some other way first, but ultimately they will fall back to buying interest earning bonds.
But if the US government continues to simply inflate the money supply to pay this interest, how is this useful? Wouldn't banks simply invest elsewhere, in assets that yield better returns? A not insignificant amount of US debt is financed by foreigners and private organizations and these would certainly have an incentive to find new places to put their money.
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David got very quiet, deep in thought, thinking it through. “You know, when I came here, I didn’t think I’d have to think through how the Reserve Bank’s check-clearing works,” he stated, in an attempt at humor. But no one in the room laughed or made a sound. They were totally focused on what his answer might be. It was a “showdown” on this issue. David finally said, “No, we’ll clear the check, but it will cause inflation and the currency will go down. That’s what people mean by unsustainable.”
Ah, so there is a consequence to printing money.
Now, what remains unanswered is how government spending can stimulate demand. If a stable income alone were enough to stimulate consumer spending, why not simply deliver the money directly into peoples' hands instead of going through layers of bureaucracy to set up work programs that might be misdirected?
There was dead silence in the room. The long debate was over. Solvency is not an issue, even for a small, open economy. Bill and I instantly commanded an elevated level of respect, which took the usual outward form of “well of course, we always said that” from the former doubters and skeptics.
I continued with David, “Well, I think most pensioners are concerned about whether the funds will be there when they retire, and whether the Australian government will be able to pay them.” To which David replied, “No, I think they are worried about inflation and the level of the Australian dollar.” Then Professor Martin Watts, head of the Economics Department at the University of Newcastle inserted, “The Hell they are, David!” At that, David very thoughtfully conceded, “Yes, I suppose you’re right.”
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Source: ibid, p. 15
Here is a quote from the good Federal Reserve Bank Chairman, Ben Bernanke, on 60 Minutes for support:
SCOTT PELLEY: Is that tax money that the Fed is spending?
CHAIRMAN BERNANKE: It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.
The Chairman of the Federal Reserve Bank is telling us in plain English that they give out money (spend and lend) simply by changing numbers in bank accounts. There is no such thing as having to “get” taxes (or borrow) to make a spreadsheet entry that we call “government spending.” Computer data doesn’t come from anywhere. Everyone knows that!
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When has spending, taxing, and printing money restored an economy? It certainly hasn't worked well for Japan.
Quote: Japan isn't really a good example, since their deficit is caused by automatic stabilisers (low taxes, high social spending due to slow economy) and not by an expansionary fiscal stance.
How is this different from our deficit? Our deficit results from a combination of mandatory spending programs (social spending) and an enormous defense budget and, now, a slow economy (although we also ran deficits in better times).
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The obvious example where spending, taxing, and "printing" money (which is really the same as spending money) has restored an economy is the Second World War.
Is this the only example? If so, then it isn't a very convincing one. New Deal programs weren't able to generate a rapid recovery and they are more akin to what was initially implied by Obama's stimulus proposals. The effect of Roosevelt's programs and policies is still debated to this day, as is the WWII recovery itself. During the war, there does not seem to have been a real recovery -- GDP growth did not reflect economic well being because most of it had to do with a bubble in munitions, a bubble that burst with the end of WWII. Rationing and price controls were common during the war years. Surely that did not spur a recovery.
Business-friendly policies in the aftermath of WWII and, I think, more difficult to quantify psychological factors associated with winning such a calamitous war and emerging the sole global superpower had a lot to do with it. After a decade of depression and years of global warfare on a scale never before seen in history, Americans emerged with new confidence and new priorities, leading to a baby boom.
I don't see how this can be replicated with government spending programs today, no matter how large. Nor do I think had the US would have emerged from the depression had it simply built all of that war equipment in the 1940's and then just dumped it into the ocean (as I once heard a commentator declare).
