Europe and the Future of Italy — Plan A and Plan B

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Warren Mosler argues that Italy (and other countries of the EU) should stay in the EU but lobby for larger fiscal leeway, effectively restoring the ability of government to enact counter-cyclical economic policies and reversing the main intent of the Maastricht treaty. At the same time, Italy should be prepared to introduce a dual currency regime, such that its citizens are free to keep the Euro as they have and use a new Lira issued by the Italian government in its renewed capacity as the country's sovereign currency issuer. If Brussels tuns a cold shoulder to Italy's demands for larger fiscal space, it  can wield the stick of a regime of parallel currencies,

I do not fully grasp how the duplex currency system can work successfully - but watch with me Warren Mosler explaining it to us:

Transforming the World on the Strength of Lousy Climate Data

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... the world's governments have spent tens, perhaps hundreds of billions of dollars on global warming research and mitigation and have done almost zero to build out and improve a reliable temperature measurement system and historical temperature database.

The source.

Why should they? The science is settled.

(3) Neutrality of Money — The Barter Illusion of Economics

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Continued from here.

I have found an interesting and very brief history of the concept of money neutrality in economic thinking. After a hard working day, I was too tired to read more than about half of the piece tonight. Here it is for future reference: The Barter Illusion in Classical and Neoclassical Economics by Dudley Dillard.

Continued here.

(2) The MMT Perspective — Introducing Money Into Economics

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What makes MMT a fruitful alternative to traditional economics is the fact that the latter misrepresents the role of money in an economy. 

See my (2) Neutrality of Money ...

By showing the disastrous effect of this omission and introducing money (properly accounted for) into economic science, MMT exposes a dangerously misleading orthodoxy and offers an alternative and realistic account of economics. 

MMT is a great tool to come to grips with prevalent economic theory and its distorting view of the economy, while it opens for the student entirely new vistas of the economy.

There is no need to adhere to MMT with dogmatic fervour. Even if it should turn out to be flawed, in need of improvement and containing elements to be discarded, it is an excellent approach to learning the economic way of thinking, see through pretence and pick the better parts of it. 

(2) Neutrality of Money — Say's Law and The Need to Believe in a False Theory

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Continued from here.

Modern economics is incapable of integrating money into its model of the economy. One of the intellectual disasters one would expect to be caught out by the public, leading to the rejection and demise of incumbent economics. But nothing of the kind occurs. Our society is surprisingly tolerant of egregious misconceptions that one would think the mark of less sophisticated times.

Money (properly accounted for) must be excluded from the purview of economics because its inclusion would tear apart the veil of apparent coherence cast over the fragments by which economic theory (ET) purports to describe the nature of the economy.

The crux of the ideological compulsion to hang on to a wrong theory of money's role in the economy is this: traditional ET likes to portray the economy as a network of sub-markets all of which quite naturally clear / attain a state of equilibrium if left alone, thereby achieving equilibrium in the economy as a whole.

I leave aside the fact that markets do not operate as described by ET, and the mechanisms that supposedly make these markets interact to bring about equilibrium in the economy at large do not exist. I have dealt with this in a series of posts beginning with (1) Neoliberal Economics and Its Rival.

More recent mathematically sophisticated theories of a general equilibrium (Walras, Arrow-Debreu) depend for a solution — tantamount to instant simultaneous clearing of all markets — on a level of abstraction requiring where everything characteristic of real markets and a real economy is assumed away.

But the original paradigm which these sophisticated models take up in an effort to prove them mathematically, suffer from a kindred deficiency: they require that all markets clear in a coordinated fashion to achieve general equilibrium in the economy.

While the modern variants simply assume instant coordinated clearance, excluding space and time from the first, classical economics still bothered to demonstrate that economic agents actually behave in a way that conforms to the postulate of instant simultaneous clearing in all markets and in the economy at large.

Their crucial argument is known as Say's Law (or Say's Law of Markets). According to Say's Law money is neutral, i. e. it does not affect real variables like output, employment and real GNP. While this is clearly wrong, admitting money in its actual role into economic theory would introduce a factor disrupting the prestabilised harmony of General Equilibrium economics.

The construction by which Say tries to save the possibility of general equilibrium posits that people produce products / offer services with the products / services in mind into which they intend to exchange their own products / services. In other words: people barter. If these plans (of mutually coinciding supplies and demands) work, there will be no overproduction and equilibrium prevails.

Writes Say (see source below for references):

Every producer asks for money in exchange for his products, only for the purpose of employing that money again immediately in the purchase of another product; for we do not consume money, and it is not sought after in ordinary cases to conceal it: thus, when a producer desires to exchange his product for money, he may be considered as already asking for the merchandise which he proposes to buy with this money. It is thus that the producers, though they have all of them the air of demanding money for their goods, do in reality demand merchandise for their merchandise (Say 1816: 103–105).

Below is a quote in which a certain self-styled "Lord Keynes" ably explains that money as used in the real economy is quite capable of driving a wedge between aggregate demand and aggregate supply, frustrating the move towards general equilibrium.

Classical advocates of Say’s law argued that saving would result in reasonably quick consumption or investment, but that simply does not follow. Money savings can become idle balances (“hoards,” in the terminology of Keynes). But even idle balances of money are not the only cause of a shortfall in demand. We can list the various “leakages” from aggregate income as described above, as well as some other ones, as follows:

(1) People desire to hold money as a hedge against future uncertainty (the “precautionary motive,” in Keynes’ theory), and since expectations are subjective such holdings can vary. In depressions or recessions, people may choose to hold more of their money as cash. In underdeveloped and pre-modern economies, hoarding can take the form of holding money physically outside of banks as cash or coin (Gootzeit 2003: 182). In the Great Depression, the rise in the hoarding of money was a significant factor, as it probably was in pre-1914 downturns in the business cycle (Wicker 1996: 144). 

(2) As we have seen, even when people hold money either as individuals or as savings in financial institutions, not all the money will be invested in production of producible commodities (= goods and services). Money can be used to speculate on asset prices. New savings or a rise in savings can be diverted to purchasing of financial assets (or real assets) with the money used to buy such assets then flowing to other speculators, who buy new financial assets or hold money idle in the process of using it in further speculation on assets. Thus there is a “speculative demand” for money that can rise or fall. 

(3) In modern economies where savings are held in demand deposits and saving accounts in banks, money is invested by banks themselves. But even here investment by banks will be subject to subjective expectations under uncertainty. In recessions or depressions when expectations are low, banks may simply choose to keep their depositors’ money as excess reserves or use it to buy financial assets on secondary markets. Thus even modern banks can “hoard” by reducing investment and leaving money in idle balances (at central banks or held in reserve for speculation on financial assets). 

(4) Money income can be spent on imports causing a trade deficit, which in pre-fiat money days could result in a contraction of the money supply and deflationary pressures.
(5) A government might levy taxes and a run budget surplus without re-injecting that money back into the economy (and effectively destroying it). 

Once propositions (2) and (3) of Say’s law above are shown to be false, propositions (4) and (5) collapse completely, and the idea that supply equals demand ex post cannot be possible. 

For all these reasons, aggregate demand failures can cause recessions, whenever aggregate demand falls short of supply. Equilibrium will not result and is not necessarily a condition of free markets. Say’s law is a myth.

The source. 


Continued here.

(1) The MMT Perspective — Macroeconomic Balance Sheet Visualizer

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This is a useful tool that helps to understand how the macroeconomic balance sheet and the balance sheets of government, the central bank, private banks, households and companies are affected by certain operations like government spending or government taxation.

Do play around with its wonderful functionality. Here is the link to it.

(1) Neutrality of Money — Definition and Refutation

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Mainstream economics posits that money is neutral. What is that supposed to mean?

First, a simple definition: 

neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages and exchange rates but no effect on real (inflation-adjusted) variables, like employment, real GDP, and real consumption.

http://en.wikipedia.org/wiki/Neutrality_of_money 

The macroeconomic theory called monetarism held that money is neutral “in the long run.” This essentially means that money is thought to have insignificant effects on real variables such as output, the level of employment and real GDP in the long term. The New Classical macroeconomics of Robert Lucas used rational expectations to argue that money is also neutral, both in the short and long run. According to this view, if the money supply is increased, then only nominal variables will be affected, rather than real variables like relative prices, output and employment, and prices and wages will simply adjust to their general equilibrium values (Horwitz 2000: 11). 

The source. 

However, as I have shown here, money does affect real variables such as output, the level of employment and real GNP. And as Kalecki has argued, there is no categorical distinction between the long-run and the short-run in so far as the former is build up from the latter. That is to say, the short run cannot impact real variables only to result in the long run no longer showing that impact.

Increasing the money supply is a necessary condition for a growing economy, i. e, for more and better output, optimal capacity utilisation and a growing real GNP.

An economy in which the money supply is constant and where money circulates out of consumption (is withdrawn from the consumption budget and put) into savings and from savings into investments is a stagnant economy, and possibly prone to crisis as the money that is diverted to finance investments is subtracted from effective demand. But it is the latter that sustains higher levels of sales whose prospect induces corporations to expand production, thereby adding to effective demand in that their investments mean additional income for other economic agents (workers, suppliers etc.)

In this way, investment creates more income which increases the ability of economic agents to put savings aside. Thus investment creates saving and not the other way around.

Newly created money makes it possible to increase investments which increase income which increases (the ability to accumulate) savings. 

Novel money drives the Promethean economy.

Ultimately, what makes modern economic growth possible, is not a system of interlocking markets bringing about an overall equilibrium, but the intervention of the state into the economy as sovereign currency issuer.

Continued here.

Geldschöpfung, Wachstum und Spekulation — Mathias Binswanger

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An excellent lecture (in German) about money creation, growth and speculation. Essentially Binswanger argues that economic growth depends on ongoing money creation from nothing. The conventional loanable funds theory is illogical: an economy cannot grow if investments are to be financed via savings. Savings reduce consumption, thus: what companies receive in the form of savings they will lack in terms of demand for their products. Rather investment creates savings. From new money new purchasing power is fed into the economy which fuels economic growth, and from this growing "pie" people may divert additional savings.

Creation of new money can have two effects. If the money is used for productive purposes providing us with more and better useful goods and services, the result is growth that makes us wealthier and better off in other ways.

Increasing the money supply through fiat money additionally created ex nihilo can also have negative repercussions.  If productive investment is insufficient, more money will compete for the same or even less products and services, kindling inflation. Another negative effect occurs when new money goes into speculative markets that do not add to the productive infrastructure and resource base of an economy, creating bubbles in the financial markets and related sectors (real estate). 

The Sky Is the Limit

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An interesting article about the history of New York's skyline.

(6) — Bank Reserves — The Basic Picture

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Quoting from L. Randall Wray's "Modern Money Theory", page 90 ff:

[When] a government spends, there is a simultaneous credit to someone's bank deposit and to the bank's reserve deposit at the central bank; taxes are simply the reverse of that operation: a debit to a bank account and to bank reserves.

That is the whole story in a nutshell.

By spending, government pumps money into the economy and bank reserves into the accounts of banks at the central bank. Crediting the banks with reserves means that the banks are able to credit the accounts of the recipients of government spending and make the credit entries in favour of the bank's clients fungible among banks, so that all banks can settle payments for all bank clients in the banking system. [No matter with which bank one banks, payments can be made risk-free to every bank client of every bank in the banking system and payments can be received from every bank client of every bank in the banking system.]

By taxing, government withdraws money from the economy and bank reserves from the accounts of banks at the central bank. The money that had been pumped into the economy being backed up by bank reserves had been circulating in the economy, flowing from bank to bank (and ultimately to their clients) by virtue of a journey from central bank account (of a payor bank) to central bank account (of a payee bank). The journey stops when banks are asked to settle their clients' tax liabilities by debiting their clients accounts and "giving back"/debiting their bank reserve accounts at the central bank. The money is gone.

For new money to enter the system, government needs to spend it into existence.

Why Is So Little Attention Being Paid to the Physics of CO2?

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I feel that the empirical evidence and many more arguments suggest that catastrophic anthropogenic global warming (CAGW) is an erroneous hypothesis that is certainly not fit to support large scale projects purportedly stopping or reducing apocalyptic weather and climate effect. While being mostly more sympathetic to skeptics of the hyped scare, I keep wondering why the skeptics shun criticism of CAGW based on the physics of CO2. 

Loosely speaking, my impression is that the physical foundations are little understood both by alarmists and skeptics.

Apparently climate "science" is at best a very immature fledgling subject of which it is misleading to speak of as a science similar to highly developed Newtonian physics. A budding torso-"science" attracts many hypothesis sooner or later to be filtered out. A torso-"science" is a magnet for wrong-headed ideas, charlatanry and opportunistic political abuse.

Below find another example of an argument challenging CAGW on the basis of fundamental physics. I am not in a position to judge whether it is pertinent or wrong and confused.

Still further below is a comment in German from a friend of mine. I agree with her that the author's claim that leading skeptics — by virtue of entertaining their own theory of a greenhouse effect — prove to be really alarmists in disguise is abstruse. Discussions with my friend yielded the result that we are not even able to establish whether other aspects of atmospheric physics might render his refutation invalid.

All in all, we feel there is a dire need to explain the physical foundations of the atmospheric sciences (or the mix of subjects most effective in explaining the climate). Scientifically sincere elucidations will not come from the alarmists, as they possess absolute knowledge of the "problem" and know the "only and ideal solutions" thanks to being zealous members of a climate church. I hope the skeptics will make the physics of CO2 more transparent. This might add maturity to climate "science", so that unscientific and anti-scientific components will find it harder to become part of received wisdom.

Below, I quote from here.

Here is the IPCC definition of the greenhouse effect, upon which climate alarm and its socially, politically, economically and scientifically destructive movement is based: 

Note that radiant emission from a cooler atmosphere is adding as heat to a warmer surface below it, in an attempt to explain why the surface is warmer than the cooler atmosphere. 

Now consider the definition of heat, from “Thermodynamics”, G. J. V. Wylen, John Wiley & Sons, 1960: 

“Heat is defined as the form of energy that is transferred across a boundary by virtue of a temperature difference or temperature gradient. Implied in this definition is the very important fact that a body never contains heat, but that heat is identified as heat only as it crosses the boundary. Thus, heat is a transient phenomenon. If we consider the hot block of copper as a system and the cold water in the beaker as another system, we recognize that originally neither system contains any heat (they do contain energy, of course.) When the copper is placed in the water and the two are in thermal communication, heat is transferred from the copper to the water, until equilibrium of temperature is established. At that point we no longer have heat transfer, since there is no temperature difference. Neither of the systems contains any heat at the conclusion of the process. It also follows that heat is identified at the boundaries of the system, for heat is defined as energy being transferred across the system boundary.” 

Thus, there is no heat transfer from the atmosphere to the surface.  Thus, the climate science greenhouse effect is incommensurate to the modern definition of heat.  Thus, the climate science definition of the greenhouse effect, upon which alarmism and its associated socially, politically, and economically regressive and scientifically destructive political movement is based, is false.  Thus, climate alarm and much of the entire field of climate science itself, is in fundamental error. 

At this point a secondary argument for a radiative greenhouse effect arises, where emission from a cooler object “slows the emission” from a warmer object thus making the warmer object warmer still.  This is called the “blanket analogy”.
However, given the Stefan-Boltzmann Law, where an object’s emission is proportional to its temperature and given its emissivity: 

F = σεT4 

and given the definition of radiant heat transfer: 

Q = Fhot – Fcool = σThot4 – σTcool4 

then one can see that one cannot prevent something from emitting at the temperature that it is at.  That is, emission from a cool object does not slow the emission from the hot object. 

In other words, you cannot prevent something from emitting at the temperature that it is at.  And of course, again, radiant emission from a cooler object does not transfer heat to a warmer object. 

A blanket is about preventing convection, and has nothing to do with radiation.  And there is no stopping radiation – everything emits at the temperature it has acquired and you can’t stop it from emitting at the temperature that it is.  Whereas, one can prevent what would be open convection.  And so this alternative version of the radiative greenhouse effect is as logically baseless as the original IPCC one.  Radiant emission can’t be prevented, whereas convection can be prevented; therefore it is a false analogy.

And here my friends comment:

... ich glaube, der Schreiber will sagen:

die Klimakonzepte sowohl der Skeptiker als auch der Klimaretter basieren auf falschen physikalischen Annahmen.

Vermutlich will er sagen, dass es gar keine Möglichkeit gibt, an der Erdtemperatur zu "schrauben", weil sich die Erdtemperatur an die Weltraumtemperatur anpassen wird. Es lässt sich nicht verhindern, dass sich Wärme (oder Energie) vom wärmeren Objekt zum kälteren bewegt. Die Art und Weise, in welchem Maß dieser Austausch stattfindet lässt sich nicht beeinflussen, auch nicht, wenn man eine Art Wintermantel oder eine Decke um die Erde legt. Der Mantel oder die Decke verhindert nicht die Strahlung von warmen Körpern und die Angleichung/Übergänge an die kältere Umgebung. Ich denke, der Autor will damit sagen: es kann doch gar keinen Treibhauseffekt geben.

Dann fragt er sich: warum übernehmen die Kritiker die physikalisch falschen Annahmen der Retter? Warum zeigen sie nicht die Absurdität der Annahmen der Retter und greifen stattdessen deren falsches Konzept auf? Wollen sie letzten Endes doch eine[n] Klima-Alarm?

Der letzten Textabschnitt von CB und die Folgerungen, die der Schreiber daraus zieht, scheinen mir etwas fragwürdig, bin mir aber auch nicht ganz sicher, was er damit will. Anscheinend will er sagen: die Wahrheit in der Wissenschaft ist letzten Endes immer einfach (was nicht stimmt - ich ... habe früher auch so gedacht, aber bei Dir gelernt, dass das ein Trugschluss ist), auch wenn der Schreiber vermutlich mit seinem Fazit recht hat:
die Physik und in seinem Fall die Wärmelehre verändert sich nicht, also können wir davon ausgehen, dass die Theorie dahinter stimmt, während sich die Klima-Treibhaus-Theorien ständig ändern, anpassen, verschieben.

Zusammenfassend:

Mir scheint, der Schreiber reduziert das Treibhausthema auf die Wärmelehre, weiss nicht, ob man das so machen kann.


Liebe Grüße ...

Social Symmetries

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As the modern state evolved it was discovered that it is the form of government  which subjects itself to restrictions of its power that turns out to be most effective in terms of advancing the interests of its constituent population.

There is a social symmetry between the interests of the state and the interests of the population. To be most effective, the state must allow its clients to put restrictions on it. For the state to be powerful (in a way that is socially effective) it must accept the power of the people to restrict it.

A self-reinforcing social symmetry.

There seems to be a similar social symmetry involved in the way in which alpha animals are selected and supported by the population they belong to. They are required to make substantial contributions to the community, which goods they can only deliver if they conform to exacting social demands from those who they lead. While demonstrating superior (physical and charismatic, and even more importantly social) power they must balance their drive for dominance by restricting their behaviour so as to be able to provide their peer group with significant social benefits. They must be disciplined and strongly restrained (rather than self-aggrandising) to be able to make the requisite contributions. 

The truly powerful state is not the totalitarian state (which is always headed for burnout) but a state where power is plural, competitively controlled, and hence balanced. 

The successful alpha animal is not a bully but a social worker. 

Virtue Signalling — The New Religion

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Here are two articles, one in German, the other in English, describing a syndrome of our times: elites and the powers that be return magical thinking to a position of cultural preponderance in sophisticated modern societies; they have  enough resources at hand to invest in irrational beliefs that destroy the economic and moral basis of society.

California's Middle Class Is Disappearing As "Virtue Signaling" Elites Drive Wealth Gap Ever Wider

and

Stickoxid Grenzwerte – Ein Geschenk des Himmels?

The the new religious entrench themselves behind walls of rancour and malice that keep their magical thinking insulated against rational criticism.

There is no doubt that their magical aberrations will eventually end the way unsustainable fads always do. In the meantime, the suspension of rationality, civility, and pluralistic-democratic restraint in favour of a zealous conceit of absolute knowledge and a self-appointed sacral right to dominance over other attitudes does enormous damage to civilisation.

The EU, Italy, and the Left's Turncoat Syndrome

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Addressing this post, I commented:

You write: "In order to reverse these damaging trends, a shift in bargaining power back towards labour is surely necessary." 

I agree with you on this and practically every point you make in this post featuring a very important issue. 

We may disagree on your suggestion of an earlier and more pronounced ascent of neoliberalism in the UK compared to Europe; but the matter is many faceted and you may be right in a number of aspects of the issue while your point may appear less convincing in others. But this question is naturally controversial and not that important for my present purposes. 

However, I'd like to point out that continental Europe witnessed a dramatic neoliberal turn in the early 1980s, with Mitterrand making an astounding about-face, transforming a man campaigning on the promise of pursuing staunch socialist policies into a neoliberal champion of austerity. 

More generally, what I find particularly pertinent to the issue that you are writing about in the present post is that the left as the champion of the working population has disappeared. 

Those considering themselves to be on the left are more into protecting the environment than human beings. While the problems with the environment are fictitious, the hardships suffered by millions of people in the EU are real. 

The Italian government has to beg the EU for charity in order to pursue a socially responsible economic policy. 

But the EU figureheads and their bureaucrats do not relent, insisting that their totem be worshiped — the procyclical and antisocial Maastricht criteria whose observance boils down to fetishising meaningless numbers at the expense of the welfare of millions of Europeans. 

It is the high priests against the masses, while the better off Europeans sneer at their disadvantaged brethren. 

Where are the calls for socially acceptable policies? 

Where is the left? Well, the left left long ago.  

The EU is a monument to the death of social democracy, the victory of neoliberalism and the defection of the left to its former opponents and its acceptance of the world view of capital. 

There is an urgent need of Vergangenheitsbewältigung (coming to grips with the past after a period of utter political failure) on the part of the left, who ought to look carefully into the matter of their turncoat-syndrome. 

Fetishising Meaningless Figures at the Expense of the Welfare of Millions of Europeans

Check the image credit. 

What a farce. 

The Italian government has to beg the EU for charity in order to pursue a socially responsible economic policy. 

But the EU figureheads and their bureaucrats do not relent, insisting that their totem be worshiped — the procyclical and antisocial Maastricht criteria whose observance boils down to fetishising meaningless numbers at the expense of the welfare of millions of Europeans.

It is the high priests against the masses, while the better off Europeans sneer at their disadvantaged brethren.

Where are the calls for socially acceptable policies?

Where is the left? Well, the left left long a go. They are more into protecting the environment than human beings. While the problems with the environment are fictitious, the hardship suffered by millions of people in the EU are real.

The decision to increase spending was “difficult though necessary,” Tria [Italy's Finance Minister] said in his letter. He cited slow economic growth and the “difficult economic situation the poorest segments of the Italian society are facing.” 

Seeking to placate Brussels, Prime Minister Giuseppe Conte, speaking in Rome, said the deficit target should be seen as an upper limit and it could still be narrower.

The source.

See also my Balance The Economy, Not the Budget and here.

(5) Bank Reserves — Accounting

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Note, the below, rather than being snapshots of a balance sheet, are T-accounts recording only changes to the balance sheet.

Once again the balance sheet of the Federal Reserve provides a simple starting point. The Treasury holds an account (called Treasury’ General Account, TGA) at the Fed, which is part of L3.

When Treasury spends, the Fed debits the TGA and credits the reserve balances of banks. Simultaneously, private bank credits the account of private economic units. Say the Treasury buys $100 worth of paper from a paper company.

If Treasury receives $25 of income tax payments, the following happens:

Therefore, in case of a deficit (taxes less than expenses), there is a net injection of reserves. The consolidation of the two previous fiscal operations is:

 The source.

(4) Bank Reserves — Taxation

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Here is a link to Stephanie Kelton's (née Bell) classic piece of research: Can Taxes and Bonds Finance Government Spending? Note especially the passage starting at the bottom of page 20 (of the paper, page 22 of the pdf)  down to "Summary and Conclusion" on Page 22 of the paper (page 24 in the pdf).

I chanced on it in my search for a precise account of the role of bank reserves in discharging tax liabilities. Intuitively I become surer and surer of the process, but for the penny to ultimately drop, I'd like to go through a concrete example of the accounting. 

(3) Bank Reserves — Total Amount Driven by Fiscal Policy

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Government (central bank) fiscal stance drives the amount of bank reserves in the system. Government spending adds bank reserves, fiscal drag lowers overall bank reserves. When government spends reserves increase, banks may even come to hold excess reserves that they are keen on getting rid of, if they do not receive any/sufficient interest on them. Hence, they try to lend reserves to other banks in need of them. This can end up in a race to the bottom (zero percent interest), as any positive interest income is better than holding non-interesting paying reserves.

If the government is targeting a 3% interest rate, competitive interbank lending may pass below this level compromising government`s monetary target. 

At this, point the central bank begins to sell bonds to the banks, seemingly in an act of borrowing funds from them. In truth, this has nothing to do with borrowing funds; selling government debt is designed to stop banks from lowering the interest rate below the level desired by the central bank. With the central bank setting the debt's yield at an appropriate level banks will no longer have an incentive to drive down the interest rate below the target rate.

Thus, government "borrowing" is really a monetary operation (in defense of a desired level of interest rates) rather than a fiscal activity (to garner funds to be able to spend).

Exogenous factors (like deficit spending) impact on the amount of reserves in the banking system. If nothing is done about the reserve excess that emerges defined as supply being greater than demand, the overnight interest rate drops and the BOJ loses control of its interest rate target (unless it is zero) as the interbank rate heads south to zero. 

Note that we are in the domain of monetary policy. The fiscal policy decisions have been made and executed – sovereign governments spend by crediting bank accounts or issuing cheques which end up in bank accounts. These actions add to reserves. If net spending is positive then bank reserves will rise and vice versa (if tax receipts are greater than government spending). 

In the case of a budget surplus, bank reserves are destroyed and vanish from the system. The private sector feel the impact of the surplus because there is less income to spend and less employment and less public infrastructure provision and more. But the banking system just notes a decline in reserves. The surpluses do not “go anywhere” – into storage for later use. The transactions are recorded electronically, the bank reserves adjusted and everyone goes home for the night. 

Thus borrowing is about monetary policy. This is a major flaw in mainstream macroeconomics textbooks which always have the borrowing in the fiscal policy chapter based on the flawed – backwards logic that the debt funds spending. 

Public borrowing is a monetary policy act because it is one of the means that central bank can use to drain excess bank reserves which stops interbank competition undermining its interest rate target each day. It has nothing at all to do with funding the government spending. That is done and dusted! But the net spending (positive or negative) impacts on the bank reserves and requires a monetary policy response. 

It couldn’t be clearer than that. Budget deficits put downward pressure on interest rates. Financial crowding out does not occur via budget deficits.

The source.

(2) Bank Reserves — Facilitator of Settlement Between Banks

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In discussing widely held misconceptions about bank reserves, Garreth Rule sketches in the below excerpt the process by which banks effect settlement among themselves by transferring bank reserve balances from one bank's (bank reserve) account at the central bank to that of another bank. 

Bank reserves are like a special kind of money held and exchanged only between banks and the central bank. Any net liability held by one bank vis-à-vis another bank, the central bank or other agencies of the state can only be discharged by offering bank reserves in payment. 

Garreth Rule shows that banks are unable to dictate the overall level of reserves in the system; instead they are restricted to distributing the given level among themselves.

Banks must at all times have enough funds to acquire the bank reserves they need to conduct their operations. Under this condition, they are able to alter the proportion of bank reserves and other assets they hold within their overall portfolio of assets. Thy can do this by 

• selling bonds to obtain bank reserves, 

• buying assets from the central bank to reduce bank reserves,

• borrowing bank reserves from the central bank or other banks

•  lending them out to other banks. 

However, while these operations alter the composition of the portfolio of assets held by the individual banks, in aggregate they cannot bring about a reduction or an increase of the total amount of reserves available to all banks.

I have singled out the below passage as it gives a broad outline of how rearranging bank reserve balances among banks ensures settlement in the payment system.

Misconceptions regarding reserves Misconception 1 — reserves and other assets One of the biggest misconceptions is the idea that commercial banks in aggregate can choose between reserves and other assets. This supposes that the total amount of reserves being held at the central bank at any point is directly controlled by commercial bank decisions. While it is true that an individual commercial bank is free to choose between reserves and other assets, at the system-wide level the quantity of reserves is determined by accounting identities on the central bank’s balance sheet. 

(1) To understand this idea, consider what happens when an individual commercial bank attempts to reduce its reserve balance (Table C). 

(2) If the commercial bank buys an asset, then while the purchasing bank’s reserve balance has been reduced, the selling bank’s account has been credited by the same amount. If the institution selling the asset does not hold a reserve account at the central bank then its correspondent account at its clearing bank is credited with the balance and that clearing bank’s reserve account is credited with the reserves. Even if the commercial bank attempts to reduce its reserve balance by purchasing an asset in a foreign currency then the reserves will remain in the system. To purchase the foreign asset the commercial bank must obtain the foreign currency: to do this it must exchange its domestic currency (the reserves) for this foreign currency with another bank. The bank providing the foreign currency then receives the reserves. 

Even when commercial banks increase their lending they cannot reduce the total amount of reserves in the system (Table D). 

The initial process of lending involves only the extension of an individual commercial bank’s balance sheet, an increase in assets from the freshly created loan and a matching increase in liabilities from the accompanying deposit created for the recipient of the loan.  

At this point there is no impact on the quantity or distribution of reserves across commercial banks; it is only when the recipient of the loans spends their new deposit then reserves may move between commercial banks in the manner discussed above for settling transactions. If there is a distinction between required and free reserves, the process of lending can lead to a reclassification of reserves, but not a change in the total quantity. From the initial starting point, Bank A makes a new loan, the impact of which is to lengthen its balance sheet by increasing loans as assets and deposits as liabilities. There is no impact on reserves. 

If the borrower subsequently spends the loan at a business that holds its account at Bank B, the deposit transfers from Bank A to Bank B and in return reserves move from Bank A to Bank B. There is no impact on the total quantity of reserves. The only feasible means by which commercial banks can independently reduce the total quantity of reserves in the system is by exchanging reserves for banknotes. However, similar opportunity costs exist for commercial banks in holding banknotes as for individuals. In particular bank vaults are expensive to maintain. Moreover this does not reduce the monetary base, merely alters its composition.

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