Wednesday, April 17, 2013

The Three Places Reserves Can Go

This post is very similar to my previous list of ways in which reserves can leave the banking system, but here I'm not worrying about what's inside or outside the banking system, which greatly simplifies matters. Also keep in mind that the titles to both this post and the prior one are technically incorrect and misleading: by definition reserves are base money INSIDE the banking system, so they can't go anywhere outside of it. Basically there's only three places reserves (really the base money that makes up the reserves) can go (not making a distinction between required and excess reserves here):

  1. To an entity with a Fed deposit account: Treasury, GSEs, banks (foreign and domestic), foreign central banks, IMF, etc. Note that private individuals and non-bank businesses and organizations don't have Fed deposit accounts, and thus reserves cannot go to them*. Also note that not all banks (for instance) have reserve accounts either.
  2. Withdrawn from commercial bank customer deposits as paper bills or coins, in which case they cease to be reserves (vault cash). They return to vault cash reserve status once they're redeposited at a bank.
  3. Back to the Fed (central bank), where they are annihilated**. This is because reserves are liabilities of the Fed***. Electronic reserves are literally annihilated. Paper bills and coins, of course, might not physically be "annihilated" but instead might be sold again (i.e. exchanged for electronic reserves) to another bank. Of course they might also be literally annihilated (i.e. taken out of circulation permanently due to wear and tear).
Please see my other post for more details and an explanation of terms used here!

*Reserves can be credited to the bank where a private individual or non-bank business or organization holds its account with the bank instructed to in turn credit the private non-bank entity's deposit. This happens, for instance, when the Treasury pays a non-bank individual or business for services to the government from its Treasury General Account (TGA) Fed deposit (Note that funds held in the TGA and other non-bank Fed deposits are not technically "reserves" unless they are transferred to banks). It also happens when banks pay for goods or services or when they pay salaries or dividends to private non-banks when the non-bank recipients of the funds hold their deposit accounts at other banks. Note that in both cases, however, Fed deposits don't disappear: they simply move from one Fed deposit to another. Also note that this doesn't mean that banks can "loan out reserves" to non-banks. That's not how commercial bank lending works. I suppose you could claim that reserves could be loaned out indirectly in this manner, but that's always the case, even when there are no excess reserves in the system: when there are no excess reserves in the banking system, commercial banks will simply borrow the needed reserves from the Fed... and the bulk of this borrowing is on a very temporary basis (the exception being required reserves needed, by regulation, to support expanding commercial bank demand deposits). This is because the Fed (central bank) ALWAYS provides the reserves (if needed) to transfer deposits, clear payments, or expand the deposit base. That's one of the main things it's chartered to do! Also, if it didn't, it couldn't control the overnight rate (one of the other main things it does). Thus having excess reserves in the banking system really doesn't make commercial bank loans more likely. Non-bank private entities literally have no use for Fed deposits, which is why they don't need Fed deposit accounts. Non-bank private entities are really only concerned with their bank deposits and physical cash, and that physical cash (most of it anyway) originates from bank deposits (e.g. ATMs).

**Note that both coins and paper bills (notes) are minted by Treasury, but the Fed only pays Treasury the cost of production for the paper bills whereas they pay face value for the coins.

***Coins (as opposed to paper notes) are actually assets of the Fed after being purchased from Treasury at face value (but before being sold to banks): kind of a historical oddity, and I think the basis of the Trillion Dollar Coin idea for skirting the debt limit. The vast bulk of bank reserves (paper notes and electronic reserves) don't show up on the Fed's balance sheet until they are sold to banks, and then they appear as a liability to the Fed (in the case of electronic reserves they of course don't even exist until they are credited to banks!). Of course when coins are sold to banks, they are removed  from the Fed's balance sheet (i.e. they are erased as Fed assets).

Friday, April 12, 2013

Help Requested!

If you're like me, concepts stay fuzzy until you make a concrete example out of of them. There are still a couple of important MR concepts that I'm having a hard time understanding fully. One has to do with the "Corporate Profits Breakdown" chart on this post and the related Kalacki equations:

Cullen has an explanation in his "Understanding the Modern Monetary System" paper/posts, but there's also this more detailed explanation here by JKH:

Right there at the top of JKH's post he also covers the other concept I'm still having a hard time with (because I still can't fully think of simple concrete examples for it), and that's the S = I + (S - I) and related formulas/identities.

I'm wondering if it's possible to create a tiny-Macro world to illustrate these concepts on balance sheets, similar to the way I've done it elsewhere in this blog. In particular, I'd love to be able to populate a world with a minimal set of entities with which to illustrate each concept. Perhaps that's a fools errand and I should quit now!! I don't know.

What I'm imagining I'd need is (at least one of each):

1. central bank (CB)
2. Treasury (gov)
3. domestic commercial bank
4. person
5. foreign CB with an account at the CB
6. foreign commercial bank with an account at the CB
7. foreign person
8. Some kind of physical asset(s)? (not sure if I need this)

Ideally I'd like to start off with everyone's balance sheets absolutely clear, except perhaps for ownership of some physical asset (perhaps a bull and a cow that can reproduce and create more), by a person say. Perhaps a bank loan could kick start the economy into gear. The goal would be to demonstrate in a concrete way on each entity's balance sheet, all the concepts/flows that JKH and Cullen cover in their posts on this subject. In particular I mean:

GDP = C + I + G + (X – M)

GDP = C + S + T

S = HS + FS

Business gross profit = undistributed gross profit + distributed profit

Business gross profit
= I – (HS + (T – G) + (M – X)) + DIV       
= investment – household saving – government saving – foreign saving + dividends

I'd also like to demonstrate, in a concrete way, exactly how JKH explains where MMT goes wrong (read JKH's entire post to see what I'm talking about). My level of understanding at this point isn't great enough that I could confidently dig in and start to populate balance sheets to demonstrate these concepts! To see how I struggle sometimes, take a look at this post which I put together after multiple comments exchanged with commentator "Joe in Accounting" here at pragcap:

Here's the thread:

Anyway, the point of this post is to let people know about this project and ask for your help! I guess I could start with exactly which kind and quantity of entities I'd need to populate my world with. Or perhaps somebody has already done exactly what I'm looking for and I can save myself a whole lot of trouble by just looking at what they've already done!

Any ideas?? Please contact me or leave a comment. Thanks!