At the Heart of Fed Monetary Policy: A Fallacy!

Heterodox economist L. Randall Wray takes Ben Bernanke to task for a failure of comprehension.  The whole article, while a bit wonkish, is certainly worth a read.  Wray does an excellent job explaining, in a few paragraphs, how modern monetary systems (fiat currency based) actually function (as opposed to how the Wingnuts and goldbugs think it functions).

So many of our policy makers simply do not understand that a sovereign issuer of the currency is not like a household user of the currency. For a sovereign issuer, there is never a solvency constraint. And a sovereign issuer spends by issuing its currency—not by borrowing it.

A sovereign government does not really borrow its own currency, nor does it really even spend its tax revenue (receipts of its own currency). The best way to think about sovereign spending is “keystrokes”: the sovereign government “keystrokes” its own IOUs into existence as it spends.

But what really get’s Wray going is Bernanke’s faulty assertion that the deficit will drive interest rates up.  Uhhh, no. It won’t.  Unless the Fed Open Market Committee says it should.

The base interest rate is set by a vote of the FOMC. Period. It is not set by markets. It is not determined by the government’s “borrowing requirement”. Sovereign currency-issuing government budget deficits place no upward pressure on interest rates. Ever.

Indeed, he should understand that as government spends by crediting bank reserves, the pressure is DOWNWARD on the overnight rate—as banks offer excess reserves in the overnight market. That is relieved by the Fed—if it wants to—to hit its target.

The deficit CANNOT raise interest rates unless Bernanke & Co. decide to vote to raise rates. They can always “just say no”: no rate hikes in response to budget deficits.

He also does a good job of explaining away the gold buggery fears of “ZOMG HYPERINFLATION!!!!!”  Read the whole thing, it’s quite worthwhile.

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2 thoughts on “At the Heart of Fed Monetary Policy: A Fallacy!

  1. Nice, very nice! I doubt that it will cause the dogmatists to budge, but it’s a great handbook for those who really care.

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