From time to time I’ve been asked about the idea that the government bonds the Reserve Bank is now buying, and will most likely be holding for years to come, might be written off. I thought I’d written an earlier post on the idea but I can’t find it – perhaps it was just a few lines buried somewhere else – and the question keeps coming up.
The Reserve Bank’s own answer to the question – I’ve seen it recently from both the Governor and the Chief Economist (the latter towards the end of this) – is to smile and suggest that, since they are the lender, it really isn’t up to them. That, of course, is nonsense. It is quite within the power of a lender to write-off their claim on a borrower, and that doesn’t require the borrower first to default or to petition for relief. To revert back to some old posts, that is how ancient debt jubilees worked.
I guess that, in answering the way the do, the Bank is simply trying to avoid getting entangled in controversies that they don’t need. I have some sympathy for them on that, and so just possibly it might be a tactically astute approach. A better approach would be for them – as the specialists in such things, unlike the Minister of Finance – to call out the idea of that particular debt being written off for what it is: macroeconomically irrelevant.
In reality, of course, if the debt held by the Reserve Bank were to be written off, it would only be done with the concurrence of the government of the day. Apart from anything else, if the Governor (or the Board, when the new Reserve Bank legislation is enacted) were to write off the Bank’s claims on the government, it would render the Bank deeply insolvent (very substantial negative equity). You can’t have management of a government agency just deciding – wholly voluntarily – to render the agency deeply insolvent.
And that is even though the Reserve Bank is quite a bit different than most public sector entities, in that life would go – operations would continue largely unaffected – if the Reserve Bank had a balance sheet with a $20 billion (or $60 billion) hole in it. The Bank isn’t a company, its directors don’t face standard penalties and threats, and – critically – nothing about substantial negative equity would adversely affect the Bank’s ability to meet its obligations as they fall due. The Reserve Bank meets its obligations by issuing more of its own liabilities (notes or, more usually, settlement cash balances). People won’t stop using New Zealand dollars, and banks won’t stop banking at the Reserve Bank, just because there is a huge negative equity position.
(This isn’t just some hypothetical. Several central banks have operated for long periods with negative equity; indeed I worked for one of them that had so many problems it couldn’t even generate a balance sheet for years at a time. It also isn’t materially affected by arguments that seignorage revenue – from the issuance of zero interest banknotes – means that “true” central bank equity is often higher than it looks (much less so when all interest rates are near zero, and not at all if other interest rates are negative).)
The big reason why writing off the claims the Reserve Bank has on the government through the bonds it holds wouldn’t matter much, if at all, for macroeconomic purposes is that the Reserve Bank is – in substance – simply a branch of the government. Any financial value in the organisation accrues ultimately to the taxpayer, and the taxpayer in turn is ultimately responsible for the net liabilities of the Bank. Governments can – and sometimes do – default, but having the obligation on the balance sheet of a (wholly government-owned and parliamentarily-created) central bank doesn’t materially change the nature of the exposure. If anything, governments have tended to be MORE committed to honouring the liabilities of their central bank – their core monetary agency, where trust really matters – than in their direct liabilities (thus, in New Zealand – as in the US or UK – central and local governments have – long ago – defaulted, but the Reserve Bank has never done so).
It is worth remembering what has actually gone on in the last few months. There are several relevant strands:
- the government has run a huge fiscal deficit, (meeting the gap between spending and revenue by drawing from its account at the Reserve Bank, in turn resulting in a big increase in banks’ settlement account balances at the Reserve Bank, as bank customers receive the net fiscal outlays),
- the government has issued copious quantities of new bonds on market (the proceeds from the settlement of those purchases are credited to the Crown account at the Reserve Bank, paid for by debiting – reducing – banks’ settlement account balances at the Reserve Bank,
- the Reserve Bank has purchased copious quantities of bonds on market (paying for them by crediting banks’ settlement accounts at the Reserve Bank).
In practice, the Reserve Bank does not buy bonds in quite the same proportions that the government is issuing them. But to a first approximation – and as I’ve written about previously – it does not make much macroeconomic difference whether the Reserve Bank is buying the bonds on market or buying them from the government directly. In fact, it would not make much difference from a macroeconomic perspective if the Reserve Bank had simply given the government an overdraft equal to the value of the bonds it was otherwise going to purchase. There are two caveats to that:
- first, under either model the Reserve Bank has the genuine power to choose, and
- second, that the fiscal deficit itself is not altered by the particular mechanism whereby the funds get to the Crown account.
But that seems a safe conclusion for now under our current institutional arrangements and culture.
From a private sector perspective, the net effect of the various transactions I listed earlier has been that:
- private firms and households have been net recipients of government fiscal outlays, (which, in turn, boosts the non-bank private sector’s claims on banks)
- banks have much larger holdings of (variable rate) settlement cash balances at the Reserve Bank.
Those settlement cash balances are the (relevant) net new whole-of-government debt.
By contrast, quite how the core government and the Reserve Bank rearrange claims between themselves just doesn’t matter very much (macroeconomically) at all.
Suppose the Minister of Finance and the Governor did get together and agree no payment needs to be made in respect of the bonds that Bank holds at maturity. What does it change? It doesn’t change is the appropriate stance of monetary policy – determined by the outlook for the economy and inflation. It doesn’t change the nature and extent of the Reserve Bank’s other liabilities – which still have to be met when they mature. And it doesn’t change anything about the underlying whole-of-government fiscal position.
I guess what people are worried about is that the government might feel it had to raise taxes – or cut spending – more than otherwise “just” to pay off those bonds held by the Reserve Bank. But remember that the Reserve Bank is just another part of government. What would actually happen in that scenario is that settlement account balances held by banks at the Reserve Bank would fall (as, say, net taxes flowed into the government account at the Reserve Bank) – and those are the new claims the private sector currently has on the government. In other words, the higher taxes or lower spending still extinguish net debt to the private sector. And if the government didn’t want to raise taxes/cut spending, it could simply issue more bonds on market. In the process they would (a) repay the bonds held by the Reserve Bank, and (b) reduce settlement cash balances at the Reserve Bank, but (c) increase the net bonds held by the private sector. Total private claims on whole of government aren’t changed.
(Now it is possible that at the point where the bonds mature, the Reserve Bank still thought that for monetary policy reasons settlement cash balances needed to be as large as ever. If so, then of course they could purchase some more bonds on-market, or do some conventional open market operations. Neither set of transactions will change the overall claims of the private sector on the government sector – net fiscal deficits are what do that.)
And what if the bonds were just written off? As I noted earlier, write off the bonds and the Reserve Bank has a deeply negative equity position. I don’t really think that is a sustainable long-term position. It is a bad look in an advanced economy. It is a bad look if we still want to have an operationally independent central bank. And we can’t rule out the possibility that, for example, risk departments in major international financial institutions might be hesitant about continuing to have the Reserve Bank of New Zealand as a counterparty, including for derivatives transactions, if it had a balance sheet with a large negative position – even though, as outlined above, the Bank could unquestionably continue to pay its bills. So at some point of other, the Bank would have to be recapitalised. But again that has little or no implications for the rest of the economy – or the future tax burden. The government subscribes for shares…and settles them by issuing to the Bank…more bonds. The government, of course, pays interest to the Bank – whether on bonds or overdrafts – but, to a first approximation, Bank profits all flow back to the Crown.
This post has ended up being quite a lot longer than I really intended, as I’ve tried to cover off lots of bases and possible follow up questions. Perhaps the key thing to remember is that what creates the likelihood of higher taxes and lower spending (than otherwise) in future is unexpected/unscheduled fiscal deficits now.
Those deficits might be inevitable, even desirable (as many, perhaps most, might think of those this year as being), but it is they that matter, not what are in effect the internal transactions between the core government and its wholly-owned Reserve Bank. That is true even in some MMT world, provided one takes seriously their avowed commitment to keeping inflation in check over time. You could fund the entire government on interest-free Reserve Bank overdrafts and the consequence would be explosive growth in banks’ settlement cash balances at the Reserve Bank. But real resources are still limited (see yesterday’s post). Over time, if you are serious about keeping inflation in check, you still have to either pay a market interest rate on those balances, or engage in heavy financial repression of other sorts, imposing additional imposts on the private sector just by less visible means.
Perhaps the other point worth remembering is the relevance of focusing on appropriately broad measures of true whole-of-government indebtedness, not ones dreamed up from time to time for political marketing purposes.
croaking cassandra 
There seems to be a gaping whole in your analysis Mike. The settlement balances of the banks are assets of the private sector and claims on the government, just as are government bonds issued directly to the public. Book entries between the government and its central bank, whether debt or equity, cannot wish away those claims of the private sector that must be honoured. A government that defaults on those balances or inflates them away undermines its currency and credibility which is the road to ruin. Like any renege on promises. No amount of banking language can hide the fact that governments printing money are doing so to avoid confronting the public with the cost of their promises. It may take years, even a generation or two, but there is a reckoning eventually.
LikeLike
Paul
I can’t have been clear enough, because I agree almost entirely. I was trying to stress that settlement cash balances are the relevant liabillity and can’t be wished away. As it is I haven’t heard anyone suggesting defaulting on those or any other privately-held govt debt. As I noted in the post, the key issue is the underlying fiscal deficit and the real resource implications of that. As I noted, I think those who argue for writing off RB-held govt bonds suspect there would be real (real resource) gains from doing so, and my point – with which I think you agree – is that they are quite wrong to do so.
LikeLike
All this propaganda of $100 billion NZ treasury bond buying by the RBNZ is just a lie. As at July, the RBNZ Balance Sheet shows only $27.7 billion, QE bond buying. The other side is the Settlement cash which is $43.8 billion. If we remove the bond buying, that actual settlement cash is $16.1 billion. Compared to July 2019 the settlement cash balance was $11.3 billion. Banks must surely be lending less than last year because the increased settlement cash equates to $4.8 billion less lending than last year.
LikeLike
Thanks, agreed. And with Cochrane cited in your MMT blog..
LikeLike
The Minister of Finance has just ruled this out in question time today: https://ondemand.parliament.nz/parliament-tv-on-demand/?itemId=215409
LikeLike
Yes, good to see. Not because it makes much macro difference either way, but because he seems to recognise that. I hope it prompts the champions of a write off to dig a little deep and get to the same conclusion.
LikeLike
I think a lot of the confusion over the amount of settlement balances held at the Reserve Bank is because you often see comments to the effect banks are “parking” QE-generated funds at the RBNZ rather than lending them out. However, as I understand it, these “funds” are not available to the banks for lending purposes. Only actions of he RBNZ (or the govt thru their account at the bank) can influence the level of settlement balances. The private-sector banks go about their normal banking activities; their settlement balance being largely irrelevant……….
LikeLike
That isn’t quite right. From a banking system perspective, the volume of settlement cash is determined by the RB, but from an individual bank perspective new deposits (from whichever source) attract settlement cash and new lending uses/loses it. But also relevant is that until the crisis any balances in excess of about $7bn in total earned 0%, then well below market. The RB is now paying OCR on all settlement account balances, and OCR is essentially the market rate for wholesale funding. So banks aren’t currently unhappy to have lots of settlement account balances and aren’t desperately trying to get rid of them (either more lending or lowering deposit rates) as they would have been if the pre-March rules were still in place.
LikeLike
Reserve Bank assets (and liabilities) are consolidated into the Government accounts, so RB held bonds appear on both sides of the Crown balance sheet. Cancellation merely shrinks both sides but the Bank is decapitalised as you point out.
LikeLike
Michael, you say “So banks aren’t currently unhappy to have lots of settlement account balances and aren’t desperately trying to get rid of them (either more lending or lowering deposit rates) as they would have been if the pre-March rules were still in place”
To me this implies that individual bank settlement account holdings are indeed available for lending out. Is that what you are saying ?
LikeLike
Yes, individual banks have plenty of deposits and plenty of settlement cash, which could support lending growth.
But it isn’t really to be expected that there would be much lending growth because (a) we are in a recession, (b) lending rates haven’t fallen much, (c) and there is huge uncertainty about the way ahead. All those factors will affect both demand and supply for credit, and in respect of the latter we know – from the RB credit conditions survey – that lending standards etc have tightened, which seems an entirely rational response to recession/heightened uncertainty.
LikeLike
All very confusing, especially if one reads this article: Repeat after me: Banks cannot and do not “lend out” reserves
Click to access S_and_P__Repeat_After_Me_8_14_13.pdf
Yet you say “individual banks have plenty of deposits and plenty of settlement cash, which could support lending growth.”
Perhaps you mean reserves support lending growth but are not the actual source of the lending itself. We all know banks can lend without having deposits on hand. Loans create deposits; not the other way around.
Furthermore, why would the RBNZ be considering a term lending facility for banks (in addition to negative rates) ? If banks have all those billion in settlement balances available for lending surely they wouldn’t need it ?
LikeLike
On your third paragraph, yes. One can think of the last decade: there has been a lot of growth in loans/deposits (simultaneously) with no change in aggregate settlement balances. But it is worth remembering that the indiv bank position is different from that of the system as a whole. For an indiv bank, the ability to attract/retain deposits/sett cash really matters, because a single bank can’t just assume that increasing its lending will routinely and commensurately increase its deposits.
What makes this episode a bit different is that there has been a big discretionary policy-led increase in settlement cash balances. If, say, the OCR were 10% and excess sett cash deposits earned zero, banks would be aggressively trying to lose settlement cash, lowering deposit rates and/or increasing lending (if they could find creditworthy borrowers).
On your final para, yes aggregate or indiv bank liquidity has not been the binding constraint on banks this year. I think what they are trying to do with the funding for lending facility (if they actually launch it) is to try to drive deposit rates further down. I’d be surprised if it works v well – the negative OCR will make more difference – but time will tell.
LikeLike
Forgive my potential misunderstanding but are you saying that either way government wins and either way bond buyers and citizens lose? That’s in terms of their likely solutions for not writing bonds off and the result if they do write off.
LikeLike
No, I’m saying it really makes no difference – good or ill – to anyone. The bonds owned by the RB are really just an inter-branch transaction. What matters to the public is (a) the big fiscal deficit and (b) the resulting net borrowing from the private sector (in this case mostly taking the form of settlement account balances at the RB.
(And to be clear I’m not suggesting they are a bad thing either, just that they are the economically relevant bit of the picture.)
LikeLike
I’m pretty new to all this so appreciate your explainations. I guess that’s the crux of what I’m trying to wrap my head around. Does this not leave the risk that the govt. can just buy itself out at the expense of those who buy the bonds – in terms of value lost? Do we not also run the risk – as we are at the moment – of totally shafting anyone who wants to save (for retirement, a car, a house or anything else for that matter)?
LikeLike
Two different points there I think.
The downside of fiat money is that there is no limit on how much inflation a govt could generate if it wanted to. We rely on transparency and societal consensus to limit that risk – hyperinflation tends to happen when the internal political tensions re fiscal pressures become utterly irreconcilable. Of course, the issue for the last decade has been surprisingly low inflation, below target.
On the savers point, are you referring to reduced (or even negative) interest rates? If so, I don’t think the issue is one of “shafting”, but that in a climate in which people are v cautious, and both keen to save and reluctant to undertake investment projects savings just aren’t worth very much at the margin. In a market-based monetary system, real returns to depositors would likely be deeply negative this year (improving as confidence recovers and with it a willingness to spend and invest). There is nothing natural or inevitable about positive returns to savings in any particular year.
LikeLike
Agreed that officially inflation is low but you don’t have to go very far to see the signals that inflation isn’t low at all. I’m sure this is an on-going arguement around the globe. I can’t reconcile what I can easily see happening around me (plus what other respected economists are saying) vs what official numbers are saying.
Correct, on the interest rates. I see your point. I guess I’m not happy with a system that can so easily manipulate spending/debt habits and one which actively encourages the average person to spend/invest rather saving for something before buying it. Or just saving in general. I’m probably influenced by a more Austrian take though.
Appreciate your replies.
LikeLike
Paulus, consumer inflation is definitely low because Chinese factories have excess inventory and excess production capacity. We import most of our consumer products and with a strong NZD, those products are getting cheaper. Investing is saving. Kiwis are shifting their savings from cash deposits to the NZX and into property. What we currently have is asset inflation in the NZX and in property due to cheap and low interest credit.
LikeLike
Getgreatstuff, I disagree. 1. most of some types of products come from China but a great many don’t…like food. 2. you’ve changed my statement to ‘consumer products’ which is something I never even alluded to.
I’d argue the NZ dollar isn’t that great or strong, certainly not at the moment. It certainly doesn’t have much to back it up either.
Investing is investing. It’s taking a risk to make profit/increase production. It can be hard to access and during times or hardship has often lost significant value. That’s different from saving. Saving allows you have have a fall back or to put cash aside for a large (or small) purchase.
Of course Kiwi’s are shifting their savings. At the moment they are likely to be making a loss if they have it in a savings account. The system is making winners of those with assets and losers of those with cash. Our property market is stuffed/makes no sense.
LikeLike
On the question of the large settlement balances being accumulated by the banks as they sell bonds to the RBNZ, as the first comment on this post points out, the settlement balances are an unsecured claim on the RBNZ, more specifically the RBNZ’s assets. These assets are mainly govt bonds. So the only way banks can reduce their settlement balances is by reversing the original trade i.e. buying bonds back form the RBNZ (they could also convert their settlement balances into cash, paper money, but that would be a nuisance all round). Settlement balances are ring-fenced; the banks, as a group, can’t “lent them out” to bank customers.
LikeLike
Funnily enough this came up in a convesation with a friend the other day – I thought I knew the answer but now not sure.
Let us say the by the end of Covid the Govt needs $100Bn which the bank then lends to them.
In the banks books is this
DR owed by the Government
Cr Bank (ie they how have a huge overdraft for want of a better expression)
Or does that liability somehow sit with the banking system?
If not, what would happen of the Government cosed the Reservce bank and created RB2 with exactly the same assets and liabilities apart from the 100Bn.
I know there is no such thing as free money so there has to be a reason why this cannot work.
And if I could ask one more question, in my half-qualfiication in economics I was taught PY = MV
Isn’t this 100BN a huge increase in M and a time when Y is potentially decreasing?
LikeLike
The key thing is that if the RB lent the govt $100bn and the govt then spent it, there would be $100bn more sitting in the settlement accounts commercial banks hold at the RB. It is those deposits – which reprice with the OCR – which represent the govt borrowing from the private sector.
MV=PT (or PY) is an identity, In your example, an additional $100bn of govt spending funded only by deposit balances banks held at the RB would represent an increase in that measure of M, but how it splits between P, T(y), and V will depend on what else is going on, including how generous (or not) the interest paid on those settlement cash balances is.
In NZ this year, settlement cash balances are about $20bn higher than previously, while the volume of econ activity has fallen, so V (this measure) will have fallen. Banks are pretty happy to sit on higher settlement cash balances as they are earning the full OCR interest rate (whereas prior to this crisis, when the OCR was higher, increments to settlement cash earned 0%.
LikeLike
Free money is discussed in July 25 Economist Magazine leader.
Headline “ Governments can now spend as they please.That presents opportunities— and grave dangers.”
Well worth a read.
LikeLike
There is no free money in NZ. There is only settlement cash created and held by the RBNZ that is owed to third party banks in exchange for the NZ treasury bonds bought from those banks. The settlement cash is not freely available to banks. I believe these settlement cash held by the RBNZ in favour of third party banks can only be depleted by onlending to the NZ business and public only.
LikeLike
And also can be depleted to buy NZ treasury bonds. With $43.8 billion in Settlement cash building up on the RBNZ Balance Sheet, clearly the government is not issuing sufficient new bonds to clear those Settlement cash accounts. What’s the point of QE when the government is not using it and spending if?
So far all we get from Jacinda Ardern is corruption riddled $10 million spend up on 1 bungy jumping company and $11 million on 1 private school because it has the name Green on it.
LikeLike
I think that some diagrams or charts showing these flows of money might help. Yes, I know it smacks of Economics 101 textbooks, but this is supposed to be a blog accessible to the layman.
And on that front I know you’ve written at least one article on MMT but I’m still amused to see that it won’t go away, as seen in these comments on my blog post at NoMinister, $5,630,859,000,000:
Or this…
LikeLike
Fortunately, Grant Robertson and Jacinda Ardern are starting to realise that the NZ government does not print money and has no ability to print money freely. That is why their generosity with the wage subsidy ended and the lockdown even though extended was not funded through wage subsidies by the government. There was also a rush to get Auckland out of lockdown because without Aucklanders travelling the entire NZ tourism industry fails. After funding Bungy jumping to the tune of $10 million and Green schools for another $11 million. Borrowered shovel ready projects wasted if Aucklanders are in lockdown and unable to attend.
All money printing his is handled by an independent RBNZ. They have nominated a very disciplined approach. The government must borrow from third parties and not directly from the RBNZ through its public issue of NZ treasury bonds.
The RBNZ goes into the market and buys up from the third party banks holdings of NZ Treasury bonds and creates settlement cash accounts in favour of those banks. That settlement cash pays an interest of OCR rate of 0.25% which banks can use those settlement cash funds for lending to borrowers only.
LikeLike