MMT Knows

Interest Rates are Set By the US Federal Reserve

All rates on US Treasury Securities, regardless of maturity, are indirectly set by the Federal Reserve
While not its explicit policy, by setting the overnight rate and various direct lending rates, the Fed determines the nominal yields on all US Treasury Securities

 Quick Lesson: We use what are called Primary Dealer Banks as middlemen between two branches of government: the Federal Reserve, and the US Treasury.  These PD banks can borrow from the Fed at one rate, and lend to the Treasury at a higher rate.  This is silly and totally unnecessary, and represents yet another form of Wall Street Welfare (Marriner Eccles called it “hocus pocus” back in the 1940’s!)  Nevertheless, as long as you understand this arrangement, you can understand that the Treasury’s account can never be short of funds

 Lets start by looking at two base rates from the Fed:
 The Effective Federal Funds Rate, which the Fed sets indirectly through Open Market Operations, and  The Discount Rate, the rate at which the Fed will lend directly to its member banks, which the Fed entirely controls (hence the even lines)

 As we can see, the two track each other pretty closely.

 The Fed generally likes to make direct borrowing a little more expensive than borrowing in the funds market, especially recently  Starting in 2008, Interest on Excess Reserves (IOER) changed the game in the fed funds market, while the discount process remained similar  Some spread remains due to counterparty friction and because FHLB’s can’t get IOER  Since 2003, financially strong and well-capitalized banks can borrow under the Discount Window primary credit program at a penalty rate above the target fed funds rate (rather than a subsidized rate, as in the past). For banks eligible for primary credit, the new DW is a “noquestions-asked” facility. Namely, the Fed no longer establishes a bank’s possible sources and needs for funding to lend under the primary credit program. Instead, primary credit for overnight maturity is allocated with minimal administrative burden on the borrower.

Comparing Rates
 So lets compare rates that we know the Federal Reserve controls directly, with interest rates on US government debt, known as Treasury Securities  Both the Treasury and the Federal Reserve create liabilities:
 Fed liabilities are called reserves, and can be withdrawn from the banking system as Federal Reserve Notes (cash). They do not bear interest
 Treasury liabilities are Treasury securities, and do bear interest

 All that monetary policy involves is swapping one liability for another

 The US Treasury issues several types of these securities, with varying maturities and coupons.

Comparing Rates
 As we will see, both types of government liabilities are closely related  Think of it this way: Treasury Securities are to reserves, what ice is to water
 A security, like ice is a “less liquid” form of the same thing  Just as water expands when it freezes, dollars in treasuries expand through coupon and interest payments

 For this exercise, we’ll take a look at the 1-month, 3-month, 6-month, 5-year, 10-year, and 30-year securities  Keep a close eye on how rates on these Treasury securities compares to the Federal Funds rate

Example #1
 Lets start with a short term security, such as the 1-month note:

 What do you notice?

 The FF acts as ceiling to the 1 month rate, since Fed Funds are uncollateralized

 Ok, how about a 3-month note?

 Oh look, it’s the same damn line (basically)

 6 Month Note with shorter time period:

If I had not used different colors, you probably could not have seen the difference

 Ok fine, how about a 5 year bill?

 Here, we can see some pricing of 5 year’s worth of inflation risk against an overnight rate, but the price still follows the funds rate neatly

 The “benchmark” 10-year bill, same story

A little more risk, a little more expensive. But still, follows the Fed!  However, there is enough daily noise to lead people to miss this crucial fact. This is why the long picture is so important!

 And finally the 30 year Bond:

 Weakest correlation thus far, but still obvious

Put it all together…..

• All of these nominal yields follow the Federal Funds Rate • Markets do a little pricing, but the Fed is always in the driver’s seat

An everyday comparison
 Think of it this way: Treasury Securities are just time deposits at the Fed, like a Certificate of Deposit is a time deposit at your bank.  Just as longer CD’s have higher rates; longer Treasuries have higher rates

 Federal Funds are like a checking account (demand deposit) at your bank. Since it is the most liquid, it has the lowest yield.
 All Treasury Securities are just priced out of that overnight rate.  The longer the term, the higher the yield (FF rate+time)

A Treasury Security is just a CD at the Fed
 When you buy a CD, do you think of yourself as “lending to the bank?” Not really. But this is what you are doing without realizing it. You probably think of it as just a safe, interest bearing place to put your money
 Treasury Securities are similar. While we think of buying them as “lending to the US Treasury”, we are really just putting money into a safe, interest bearing account, which functions as a CD/savings account at the Fed

How does this work into normal Fed operations?

 The Fed always buys bonds to hit its target rate, whatever that may be  The rate is voted on by the FOMC, the members of which are appointed by the US President and confirmed by the US Senatenot markets, bond vigilantes, the Chinese, or whatever

How does this work into normal Fed operations?
 That the target rate now happens to be near zero doesn’t matter. The Fed always has to set some rate! This rate has changed over time, as we have seen  Money market conditions are based on whatever the Fed wants them to be  Therefore, bond buys are not and cannot be discretionary! If the Fed buys too many bonds, the funds rate would sink below its target rate, forcing it to sell back the same amount of bonds just to raise the rate back up its target again

This means there are no such things as

helicopter drops”

“printing money” “debt monetization”

“interest rate suppression”
“loanable funds”

Quick note on Quantitative Easing (QE)
 There has been an enormous amount of confusion and hyperbole surrounding the recent unconventional monetary operations used since the crisis  Many (now-discredited) economists, operating with outdated ideas, were predicting hyperinflation and disaster  But QE is just one big FF operation. There is little procedural difference between QE and everyday Fed operations.  The only thing that differs is the targeted metric. In QE, the Fed directly seeks to affect Treasury and MBS rates, instead of indirectly through an overnight rate, as described in previous slides  The Fed does this by executing a certain “quantity” of bond purchases- $X per month.

No correlation between debt and rates


 See how the rising debt affects interest rates?  Me neither

And its not just the United States….
 Look at Japan:

Implications for the US Congress
 So now it should be obvious- The Fed sets all rates! Why?

 Because WE issue our own fiat currency, WE get to decide how much interest, if any, to pay on it
 Not Wall St., not foreigners, not markets, not “bond vigilantes”  That’s what it means to be a monetarily sovereign government

 Say it with me: “Uncle Sam’s a money sovereign, markets don’t tell him what he can spend! Congress does!”

That’s how you get this:

 A government that adds, not subtracts to the wealth of its citizens when it deficit spends.

You still think the Federal Government can run out of money?


You’ve made Marriner Eccles mad!

Who was Marriner Eccles?
 The original MMTer, Marriner S. Eccles was the architect of the Banking Act of 1935, which restructured the Federal Reserve System into its current form. He was heavily involved in the Bretton Woods negotiations that created the World Bank and International Monetary Fund, and he served as a key economic policy advisor to President Franklin D. Roosevelt.  Chairman of the Federal Reserve System, during the 1930s and 1940s  Played a huge role in monetary and fiscal systems of the United States during those years.

This building

is named after him (the Fed Board of Governors building on Constitution Ave)

70-year-old wisdom from Mr. Eccles
 “Interest rates on government securities have been and will continue to be determined by the Open Market Committee …it is unrealistic to presume, that if Congress votes for expenditures but does not vote for sufficient taxes to cover the expenditures, the money market should erect barriers to discourage the practice” • The fact that they [Congress] cannot go directly to the Federal Reserve Bank to borrow does not mean that they cannot go indirectly to the Fed, for the very reason that there is no limit to the amount that the Federal Reserve System can buy in the market. This is the way the war was financed. “

 “So it is illusion to think that to eliminate or to restrict the direct borrowing privileges reduces the amount of deficit financing. Or that the market controls the interest rate. Neither is true.”  “The facts of the matter are that the Federal Reserve System gets practically all of those bills every week, through an arrangement with the Government bond dealers, to put bids in at 3/8ths, with complete protection by the Reserve banks to take them off their hands before they even pay for them. This is what we call hocus-pocus, and we are of the opinion that we could exchange directly with the Treasury…”

More evidence
 Further argument form Beardsly Ruml, Chairman of the New York Fed in 1946:

 Eccles laid all this out during his tenure at the Fed. Unfortunately, most of his words have long since been forgotten.
 For more Eccles documents, go to

• The Federal Reserve is independent in the government, not of the government • There is no reason to pay banks a commission to serve as middlemen between inter-agency, intra-governmental transactions. • While statutory changes would be ideal (i.e. HVPCS, direct unlimited overdraft authority), we feel that in the short term, mere rhetorical changes could suffice.

• The word “deficit” is itself very prejudicial. American’s have been trained, like Pavlov’s salivating dogs, to elicit fear at the mere mention of the word. It implies some sort of lacking or running out of things, which as we know has no relevance to federal finance, so
• We strongly suggest using these terminology updates: •

Instead of “deficits” or “borrowing”, say “net financial injection” or “net financial assets”

• Instead of “spending” say “federal deposits” • Instead of “debt” say “risk free savings accounts” or simply “Treasury Securities”

Terminology Updates
• So lets stop using self-defeating, fearful rhetoric like
• “out of control debt” • “skyrocketing debt”

• “crushing debt”
• “Pay China First” • Only fires, wars, climate change can get “out of control”. Digital balance sheets cannot get out of control! • We need to use MMT to deploy a fierce practicality on fiscal issues to counter all the right-wing deception • Right-wingers feed on fear and confusion, so we have to stop using confusing terms ourselves

• Bond markets do not get to discipline our US government; the Chinese to not get to discipline our US government; Wall Street banksters do not get to discipline our government. Only we the voters get to do that. Thanks to the genius of the founding fathers, our participatory democratic form of government has been Constitutionally vested with the monopoly power of currency issuance.
• No Chinese Shylock is going to sail across the Pacific demanding a trillion pounds of American flesh. It just doesn't’ work that way. We are Americans, and only we can control our economic destinies. • The Chinese don’t command the US Treasury anymore than Chinese generals command the US Pentagon. Do US soldiers take orders from Chinese military leaders? Of course not, and the Treasury/Congress does not take orders from Chinese bankers.

• Therefore, for the purposes of clarity, we believe that there is no reason why any supreme, sovereign government should be issuing debt at all. Instead, such governments should be issuing debt free currency, that could be identified, or at least thought of, as equity. • The US government did this previously during the Civil War, when Abraham Lincoln ordered the Treasury to issue its own, debt free currency known as United States Notes. The Treasury continues to do this in limited form every time it mints coins and assigns them value. • Thomas Edison in 1921: “ If our nation can issue a dollar bond, it can issue a dollar bill. Both are promises to pay, but one promises to fatten the usurers and the other helps the people.”

• Nearly every publicly traded corporation funds itself through a mix of debt and equity issuance; why should the federal government not do the same? US dollars could be referred to as American Equity, and would represent a nominal claim to the massive production power of the United States economy.
• Further, direct creation of reserve balances would actually be less inflationary than the current system of security issuance. Reserve balances, unlike securities, are inert forms of government liabilities, because they do not continuously pump coupon or interest payments into the economy.

• So how could we go about doing this? Well the answer is, we already have, during World War II. Along with other New Dealers, Federal Reserve Chairman Mariner Eccles ushered in the era of modern public finance
• Due to emancipation from the gold standard and Mr. Eccles’ leadership, this was one of the first times in human history where a nation at war ran out of real resources before it ran out of money. Finally freed from self-imposed financial constraints, this new approach to public finance allowed the allies to produce a war machine of unprecedented size and strength:


• We strongly feel that the enormous 21st century challenges of income inequality, middle class collapse, and global climate change cannot be sufficiently tackled until the “how do we pay for it” question has been fully answered, and only MMT has that answer.

• We can both succinctly describe the operational realities of the current system, and suggest updates; we can provide both short term patches, and long term paradigm changes, and we have the academic backing and persuasive materials to make a bulletproof argument.

• Federal Reserve Economic Data (FRED), Federal Reserve Banks of St. Louis • Recent Developments in Monetary Policy Implementation by Simon Potter, Executive Vice President, Remarks before the Money Marketeers of New York • Marriner Eccles Testimony- Direct Purchases of Government Securities By Federal Reserve Banks. Hearing before the Committee on Banging and Currency, House of Representatives (1947) • Can Taxes and Bonds Finance Government Spending? By Stephanie Bell, July 1998

• The Greatest Myth Propagated About The Fed: Central Bank Independence (Part 2), L. Randall Wray, January 2014
• Soft Currency Economics II, Warren Mosler, October 2012 • Liberty Street Economics, Blog from the FRBNY

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