George Selgin on Fed Master Accounts, Central Bank Independence, and the Fed’s Balance Sheet

George Selgin is a senior fellow and director emeritus of the Center for Monetary and Financial Alternatives at the Cato Institute. George is also a frequent guest of the podcast, and he rejoins Macro Musings to talk about some of the recent developments in the monetary and fiscal policy space. Specifically, David and George discuss recent updates regarding Fed master accounts, the problematic aspects of the Fed’s balance sheet, why a second Trump term would threaten central bank independence, and much more.

Check out our new AI chatbot: the Macro Musebot!

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: George, welcome back to the show.

George Selgin: Thank you, David. It's always great to be on it.

Beckworth: It's great to have you on, and I was checking, it’s been a year since you've been on the podcast. That's been way too long for a George Selgin appearance on this program.

Selgin: Yes, it's hard to believe. It doesn't seem like that long ago.

Beckworth: It has. In fact, it's a little over a year. To be precise, it was February 2023. Since then, a lot of things have happened, George. As you know, we had the banking turmoil in March of 2023, so right after your last [appearance] on the show. We've had that steep decline in inflation since then. It came down a lot. Of course, now, it's moving sideways. And tied to that, we had the big expectations of rate cuts as inflation was coming down. Everyone was pricing in rate cuts. That's also been put on hold.

Beckworth: We were also, at that time, in the midst of this big de-dollarization talk, and we're still in the midst of large ongoing budget deficits, despite being outside of the pandemic. This has raised concerns about fiscal dominance [and] high interest payments going forward, and that's just the US economy. You're in the eurozone. You're in Spain, and there's a lot going on over there as well. So, maybe catch us up to speed. What's been happening in your life? What's the latest on your book? What's happening, George?

Selgin: Well, David, life is fine. Life here in Spain is just lovely. Right now, you've caught us in the middle of spring, of course. The spring in Granada is just splendid, absolutely splendid, so I'm having a good time. My book, False Dawn, is at the publishers, which now means that it's just about going into the manuscript editing phase. That is, I'm done editing it, but they're going to take a look, and, probably, I'll have to do some more editing in response to whatever they say, and that'll happen next month. But the book probably won't come out until spring [or] summer of next year, because there's a publishing cycle, and they don't think that it'll be ready on time to market it earlier than that, so there we are. I've got plenty of time. I'm anxious to get it out, but at least I don't have to rush, so there's that.

Beckworth: For listeners, they can go back and check a previous show where we discussed the book. We'll come back and revisit the book once it comes out again in about a year, it sounds like, so, looking forward to that.  One other interesting development, George, since we chatted last, is the introduction of an AI chatbot that we have brought to the show. It's called the Macro Musebot, and, George, all of your shows are a part of that. So, if you ask it questions, it will tell you about George Selgin's shows, his views. It can also tell jokes. I've asked jokes about, “Assume George Selgin, Peter Conti-Brown, [and] Bill Nelson walk into a bar, tell a funny story,” and it'll tell some very funny discussions. For the sake of time, I won't share all of those, but I encourage listeners to check it out. Have serious conversations with the chatbot or more fun, just experiential conversations as if you're there talking to the guest. 

Selgin: This isn't going to put me out of business, is it, David?

Beckworth: It won't put you out of business. It may put me out of business, so, that's the concern, right? In fact, I had Mary Daly on the podcast just a few episodes back and we talked about this. In theory, the AI knows me. It knows my mannerisms, knows the questions, my interests. You could also take my voice, and you could create a David Beckworth AI bot that could ask questions. And maybe at some point in the future, George, I'll have you back on, and I'll have the AI version of me ask you questions, and I'll ask you questions, and you’ll have to guess which one is real [and] which one is an AI. That would be a fun experiment.

Selgin: Yes.

Beckworth: Well, let's move on to our discussion today, and like previous shows, what we're going to do is we're going to work through some recent developments that have struck our fancy, something that we want to comment on. We've done three articles each in the past, so we'll follow that format today. And George, I'm going to let you lead off. I know you have some thoughts on the recent developments with the Custodia case and Fed master accounts. So, why don't you share with us what's happening there and your concerns and interest in it?

Updates on Fed Master Accounts and the Custodia Case

Selgin: Yes, sure. I've been involved in this in some fashion for quite some time, and I want to step back a bit and just remind you and others that-- Oh, I don't know how long ago— I wrote a paper for Cato, where I suggested that if we really want to allow stablecoins to be on a level playing field with other US dollar exchange media, but are worried that they might not be safe, a good compromise is what I call "narrow stablecoins." Let's have stablecoin issuers be able to get master accounts at the Fed, which they absolutely need to be able to be used in payments and play with the other payment systems providers, right? That's what being on a level playing field means. You get to be on the same turf, so to speak, with the same rights. But let's say that they must back their stablecoins with 100% reserve assets.

Selgin: Of course, if they do have master accounts, we know that they have the reserve assets. We know how many they have even if we don't require them to. Though, obviously, if they're required to have 100% reserves, that can be monitored. Anyway, this would mean that there's very little risk from these stablecoins, fully reserved. Of course, you have to arrange for the assets to the reserves to be specifically assigned to the stablecoins, but it can be done. Anyway, what Custodia proposed to do was— not specifically with regard to stablecoins, but possibly with regard to them— is to have a 100% reserve institution. Some of your listeners know, I'm a fan of fractional reserve banking, and I criticize people who say that it's fraud and, for other reasons, want to ban it. But that doesn't mean that I don't think that 100% reserve banking has no place, and this is where it might have a place.

Selgin: Anyway, Custodia was proposing to have-- it has a bank charter. It's eligible, by law, to apply for a master account because it has a charter. The Federal Reserve routinely approves of such applications, except in a few recent cases. And Custodia was-- its business plan was one where it wouldn't have deposit insurance. Instead, it would have 100% Federal Reserve deposits backing its dollar liabilities. And far from being a controversial idea, it's been long understood by people, and often recommended, that 100% reserves is an alternative and, in many ways, a superior alternative to deposit insurance, because it really eliminates risk entirely. You're not just going to bail people out, or have banks bail each other out, if the risk proves to be fatal. Anyway, they went and applied to the Fed. The Fed did what it's done with several such proposals by unorthodox or special-purpose depository institutions.

Selgin: It sat on its application for a very, very long period of time, which I think was very cowardly. It was a way for them to, essentially, deny them a master account without having to say why and without having to justify it. Finally, Custodia took them to court, and I participated a little bit in that in preparing an amicus brief, one of several that was involved in the prosecution side of this case. But unfortunately— this was in a circuit court, I think— the judgment came down in favor of the Fed, saying that it had the right to deny the application, which is keeping Custodia off the payments playing field that everyone else, all of the legacy players [and] banks, get to play on. Now, there is an appeal, and Custodia has hired some big-time lawyers to handle the appeal. Of course, I have no idea what's going to happen, but I know what I want to see happen. I want to see the Federal Reserve told that [it] needs to be open to this kind of financial innovation, and that [its] charter does not allow [it] to play favorites or second-guess what kinds of innovations are okay and which ones aren't, unless that [it] can make a case that they pose serious systemic risks. Okay, that's my spiel.

Beckworth: No, it's very interesting, and it's been fun to follow this case. And you highlighted that Custodia has hired these big guns, and these big guns are people who served as an acting solicitor general under President Barack Obama and, also, a former solicitor general of Virginia. And they both have represented Democrats in highly publicized cases, so they're coming out swinging. So, it'll be interesting to see what this means for this case. Also, it was interesting, George, that in the judge's decision, he cited the fact that the Fed now has to report this database of Fed master accounts, ones that it had both accepted and rejected, as evidence that it has this discretionary authority. And Senator Pat Toomey, who helped write this law, said, "No, that has nothing at all to do with the motivation for this law."

Selgin: Yes, I think the decision was very, very poor. It was so poor that it was almost as bad as the defendant, that is the Fed's, arguments in the case, which were atrocious. And if I may just point out an example of what I mean. Since they could hardly argue against all sorts of evidence and theory that the proposal of Custodia to resort to 100% reserve banking as an alternative to deposits was dangerous, particularly dangerous in a systemic sense— they couldn't possibly argue that— what they argued instead was, “well, this plan isn't going to work.” In other words, “you're not going to get enough business.” That's really what they were arguing. “Therefore, we're not going to let you try.” That's absurd. Since when is it the Fed's duty or responsibility to second-guess the probable success of a new bank or depository institution and make its judgment about whether this is likely to be a successful entrepreneurial venture, a judgment having nothing to do with dangers posed to third parties, a reason for denying a master account?

Selgin: Well, I don't know if we can imagine a lot of things, but imagine that we had another government regulatory agency in charge of, let's say, housing construction, and it could decide that you couldn't start a new business because you probably wouldn't succeed. The American way is that you let people try, and they find out that way. We don't want bureaucrats deciding. It was awful, and there was a lot more to the Federal Reserve's pathetic arguments for not granting Custodia a master account. But most people by now have no appetite for more absurdity, but anyone who wants can just read the Federal Reserve's defense document. You'll see all kinds of stuff like that.

Beckworth: We'll provide a link to these documents [in] the show notes for this program. So, we are talking about Fed master accounts, and they're tied into the Fed's balance sheet. So, I want to use that as a segue into the first article or topic that I want to bring up, and that is the New York Fed's annual report on open market operations. So, it's a fun read for people like you and me. For many people, it'll probably put them to sleep, but it goes over the developments in the Fed's balance sheet.

Beckworth: And of course, as we know, the Fed has been running down its balance sheet. It had a peak of $8.9 trillion. Now, it's down to $7.4 [trillion]. Most of that runoff has occurred through the overnight reverse repo facility in terms of the liability side, and on the asset side, Treasury securities. Not many mortgage-backed securities have been sold off or have been unwound. Of course, the other big, maybe interesting, part of the story is the net income loss that the Fed has been experiencing— $117 billion in 2023.

Beckworth: Then, maybe less interesting but still fascinating for folks like you and me, are the unrealized losses, and they have forecasts for the net income losses, unrealized losses. And they project [that] the net income losses will come to an end in 2025, depending on what happens to interest rates. Now, if rates stay higher, which they look like they are, this may go on longer. So, it's a lot of interesting facts, charts, forecasts, but I want to, maybe, bring up what it doesn't discuss.

Beckworth: So, it's a great report, a lot of hard work. Kudos to the authors. But some of the issues that we've talked about before, George— and let me just list a few here. Number one, given the size of the Fed's balance sheet, it's effectively becoming part of the public debt management of the US government, which is a role that Congress has delegated to Treasury. And we would like to maybe see more, at least, discussion. “Hey, we are doing more. Yes, we're affecting the duration of the public debt. Yes, that affects financing costs, [and] maybe even hits the taxpayer.”

Beckworth: So, I think that's something that isn't discussed enough, or it definitely wasn't brought up in this report. That’s not the objective of this report, to be fair, but it's something, I think, that's important. Another observation that I have is, when you look at the future of the Fed's balance sheet, you can think that you're roughly two-thirds— now, depending on what happens to the size of the TGA balance— roughly two-thirds of it is going to be, on the liabilities side, interest-earning liabilities. That didn't used to be the case. It used to be a majority of zero interest-earning liabilities, mostly currency. So, if two-thirds— roughly, or so— of the Fed's liabilities going forward will be earning interest, it's more likely [that], in the future, we're going to have reoccurring periods like this where the Fed loses money because of liabilities. 

Beckworth: So, every time the Treasury yield curve inverts, what's going to happen in the Fed's balance sheet? Depending on what it has bought and purchased, it could be problematic, right? So, we talk about the Treasury yield curve, when it inverts, predicting recessions, and that's kind of lost its steam. The new thing may be, whenever that Treasury yield curve inverts, the Fed may be losing money or at least earning less money, depending on what they have on their balance sheet. Any thoughts on those observations?

Problematic Aspects of the Fed’s Balance Sheet

Selgin: Yes, I think you're right. It's a subtle thing, though, because, of course, by paying interest on its liabilities, the Fed also increases the demand for those liabilities. In other words, it's getting more support for having a big balance sheet. It's not giving interest away. It's getting the finances it needs to sustain a large balance sheet, and it's really just indirectly acting as a part of the Treasury in this case, albeit one that changes the term structure, or the maturity structure, of the outstanding debt.

Selgin: The problem I see is that, as you've suggested, when we have crises and go to zero interest rates, or very low interest rates, that's also when the Fed tends to resort to quantitative easing. So, the tendency is to, as it were, buy high and sell low. Buy high in the sense that they're buying securities or loading up on securities and often long-term securities, of course, which is the typical recipe for quantitative easing, right? Buying long-term securities when their interest rates are low and their prices are high.

Selgin: And then, they're not necessarily selling these off. They're not realizing losses on them, but they are incurring losses when they get out of the crisis. That’s when they have paper losses, and that's when they have to have deferred assets and stop remitting funds to the Treasury. My concern is that, given the cyclical nature of the Fed's quantitative easing, that if the Fed does it enough times, this strategy of deferred assets becomes problematical because of the whole idea of deferred assets.

Selgin: The only thing that keeps it from being, basically, an accounting swindle is the presumption that, eventually, you start making profits again or getting capital gains instead of losses that offset prior losses. That's the presumption. And so, what a deferred asset strategy is, is just saying, "Let's just count on those offsetting gains and just give ourselves a little IOU for them." But that only makes sense if you don't have these [losses] piling up over time. I think there is a long-run problem here with old strategy. It's a long-run potential problem. It's not an immediate problem. That's my concern about all of this.

Beckworth: Yes, I think that's mine as well. It doesn't matter, necessarily, right now, but if this repeats over time-- and to be clear, when I talk about the Fed and inverted Treasury yield curves being a problem, I'm assuming what you just said, that they'll revert to QE where they'll buy these longer-term securities as opposed to if they just had Treasury bills on the asset side. If they just had Treasury bills on the asset side, then this would be less of an issue, but they're not going to do that. QE means that you're trying to take risk out of the market, buy longer-term securities. So, this is going to be a repeat problem if balance sheet policy is now a conventional tool. It used to be unconventional. It's a conventional tool going forward. And what's interesting is, Governor Chris Waller had a paper he wrote before he was in his current position where he talks about this fiscal cost to the floor, a large balance sheet, that will be with us.

Beckworth: And, again, maybe it won't be that big. Maybe it'll turn out to be something trivial. But at a minimum, it definitely creates, I think, political challenges for the Fed, which could undermine its independence, which leads me, George, to this next point about this report, and this more general conversation about the Fed's balance sheet, and that is [that] we've seen a number of other central banks have a review of their operating systems; so, the Reserve Bank of Australia, the Bank of England, the European Central Bank, the Riksbank. 

Beckworth: In fact, from the ECB, I had Isabel Schnabel on the show, and she kind of led this effort at the ECB. And they're moving to what she calls a “demand-driven operating system.” Basically, and, I think, [in] very simple language, they're moving a little bit away from a floor towards a corridor system. They're trying to get more market activity. In fact, one of the ultimate goals is to resurrect the overnight unsecured interbank market, because they value that price discovery there. And I think [that with] most of these other central banks, it's the same motivation. They want to move back, maybe not all the way, but part of the way there. This raises the question of whether the Fed will review its operating framework as well.

The Importance of the Overnight Unsecured Interbank Lending Market

Selgin: Well, David, there's been a lot of talk about the Fed being behind the curve on payments and other aspects of its responsibilities, but I think a case where it's particularly behind the curve, or one of them, is on reviewing, really taking a hard look at, its floor operating system, which is something it fell into, so to speak— fell onto, I should say— by a circumstance back in 2008. It wasn't planned. Its merits weren't seriously debated.

Selgin: And, indeed, the talk at the time was, "Well, we might end up in a floor, and if we do, well, we'll have to figure out what we want to do." Of course, they decided to keep this accidental reform even though, if you go and look at the publications that were defending it at the time, saying what its virtues were, and you go down the list of virtues, you find [that] hardly any of them have turned out to be what was made of them. It isn't easier to operate. It isn't cheap. Some of this requires a much bigger balance sheet. It hasn't led to the Fed firing its open-market staff.

Selgin: I think it probably has a lot more people working on the open market than it ever did. It's got a million new facilities [that] it didn't need before and interest rates. The whole thing's a Rube Goldberg mess. One of the problems with it, though— and I think one of the most important— is, indeed, that it killed the overnight lending market. When I wrote my 2014 book about this— I can't remember when the darn thing came out, but it was one of the earliest and one of the only books about the floor system, arguing that the Fed should get out of it very early.

Selgin: The collapse of the interbank market, and the fact that it wouldn't revive as long as you kept the system, was one of the points I made against it. As you said, the ECB and all of the other central banks— and there have been quite a few— have seriously looked at this system to decide whether it's worth keeping. But many of them have reconsidered. They're moving away from it. Often, they're moving away [in] the easiest way possible, which is a so-called tiered system, which makes it unnecessary to completely unwind the big balance sheet, so, that's why that's appealing.

Selgin: But they're all saying, "Look, we need an active interbank market. That market does a lot of things." But most importantly, it's a way to give banks an incentive, both to deal with each other on a regular basis, and to monitor and learn about each other's situation on a regular basis. What that does is to put limits on contagion effects when trouble breaks out, because the banks know more about each other's situation. That's extremely important, and they have killed this institution. It's typical of, I'm afraid, central bankers' blindness to arrangements that help contain trouble that aren't of their own creation. They only recognize it as a desirable thing if they came up with it. But if it developed spontaneously as the fed funds market did— and I suppose as similar markets in other countries have— then they just don't get it, that this is also useful for handling systemic risk.

Beckworth: So, just to be clear, George, the importance of this overnight unsecured market between banks— there's information there that you're not going to find, say, in stock prices or bonds that banks issue. There's truly a missing market where we're missing information that we could otherwise have.

Selgin: Yes, and there are some very good articles. There was literature about this, while those markets were active, talking about their role in encouraging interbank monitoring and information and limiting contagion spillovers that way. So, it's always been out there. As far as I know, nobody said, "Oh, this stuff is all wrong. You don't need an interbank market." They didn't think about what they were doing when they killed it. That was an unintended consequence.

Selgin: Of course, they said, "Well, that's great. Now, banks have all of the reserves they need, and they don't have to worry about having to borrow at the last minute." But they're ignoring the fact that having to borrow at the last minute, besides allowing you to get by with fewer reserves— which has its advantages— also generated important information and incentives to collect it. That's very serious, I think. The destruction of that is a very serious thing. It's, by the way, not easy to recreate it. It's going to take time.

Selgin: That's why you probably need to rely heavily on things like the standing repo facility and what have you. And in the meantime, something like that stands in for the interbank market if banks run short of reserves, once you introduce a threshold where they're not getting interest on reserves. So, you need something like that, but [you] do ultimately want to wean the banking system off of any central bank facilities and get it back on to a private fed funds market or something like it, like getting off of any kind of temporary drug onto a more healthy diet.

Beckworth: So, the one argument that I find convincing or reasonable for why the Fed's balance sheet, at times, does need to be larger, is the role that it plays in global dollar markets, because there's a global dollar system that's large. It can have swings. It can have panics. It does occasionally need to blow its balance sheet up— currency swap lines, foreign repo accounts, I think that those things are important— but, I think, points that you have made in the past is that you can do all of that. You can have a corridor, scarce reserve system and collapse into a floor, ample reserve system when it's needed, but then you go back, right?

Selgin: Not only can, [but] it's inevitable. If interest rates go to zero— which is the other situation where making the balance sheet large may be appealing, right? Well, once they're at zero, guess what? You don't have to pay interest on reserves to get banks to-- banks are hoarding reserves and QT is the only game in town, right? So, corridor systems become floor systems when interest rates hit their zero lower bound, and that's when you need quantitative easing. You don't need quantitative easing when interest rates aren't at their zero lower bound.

Selgin: So, the only time you need to have a floor system is whether you're going to get it one way or the other, even if you don't try to keep it all of the time. We have a permanent floor system. That is, we have a floor system that's operating even when interest rates are above, and perhaps well above, their zero lower bound, when you shouldn't have to do any quantitative easing. And one of the other things that I think is bad about this— and another reason for not wanting to have a floor system— is that it invites the abuse of quantitative easing when it isn't necessary for legitimate countercyclical purposes.

Selgin: This is the subject of one of my other books, The Menace of Fiscal QE, that nobody has read, and everybody should. If they watch your program, they should, because they're really intelligent people who will appreciate it. But that book argues that you have a real political danger of abuse of a balance sheet, that can be expanded arbitrarily without undermining monetary targets, even when interest rates are positive. And I think, from a political economy point of view, a setup where you can only do QE when it's necessary is a wise setup, and that's what a corridor system allows.

Beckworth: So, George, I have read the book and we have talked about it on the podcast, so we'll provide a link in the show notes again for that, and, yes, it's a great book, the threats and danger of fiscal QE. And I do think that it would be great to be in a world that you envision, one where the Fed is flexible enough and talented enough to quickly go from a corridor to a floor and then back to a corridor. And we saw something like that with the Bank of Canada after the 2008 crisis. They went corridor, floor, back to corridor. 

Selgin: They don't even have to try. All they have to do is get a corridor system, or a tiered system, and when interest rates come to zero, that's when they say, "Oh gosh, we need to do QE." Well, okay, so do it. You're in a floor. Nobody has to think about anything. They get the floor when they need the QE. They don't get the floor when they don't need the QE. It's that simple and that automatic.

Beckworth: Now, to be fair, I know that Fed officials listening will say, "Well, but, part of the problem is these new regulations. Banks demand reserves." But Bill Nelson has pointed this out as well as others, there's a ratchet effect. You kind of create a dependency and stuff. In fact, let me segue to Bill Nelson. So, Bill Nelson has had some comments recently that suggest that the Fed will actually be revisiting this at some point. Maybe they'll be behind the curve, George, as you said, behind the other central banks.

Beckworth: But he noted that, in the March minutes, it says, "Participants also shared their initial perspectives on longer-term aspects of balance sheet policy beyond the more immediate issues concerning slowing the pace of runoff." And Bill, being a former Fed insider, says, "That really says to me that they're looking at this issue, and are going to start talking about it like other central banks have." So, I will put that out there, George. You can hang your hopes on [it]. 

Selgin: With a tiered system, you get that same automatic thing. Your marginal reserves are not earning interest. It's only when interest rates hit their zero lower bound that, at the margin, QE becomes feasible. Even in a tiered system, it's exactly the same thing. The difference, and this gets to Bill Nelson's concern, is that if you switch to a tiered system, well, you don't have to worry about that pesky problem of undoing all of the past QE. You kind of grandfather it in, and that's why a lot of central banks that are moving or have moved away from floor systems have taken this tiered system alternative or something like it, because it spares them having to unwind the balance sheet much, or at all, depending on how they do it.

Beckworth: Okay, let's move to our second set of articles, and, George, I was on Twitter. I know it's called X, but I prefer to call it Twitter still. I was on Twitter, and I saw that you engaged in a conversation that surrounded Jared Bernstein. He got involved in a hack job by some MMTers, and they created this video with selected clips that made him look questionable on his understanding of public finance, which is unfair to him, because he's clearly a smart guy. In fact, he's been on this show before, great person. But you had some comments that you wanted to share about that, because you responded to this whole episode.

Responding to the Jared Bernstein Incident

Selgin: Yes. Well, first of all, my heart goes out to Jared. Anybody who's been on movies or TVs or in the news, something like that, you screw up now and then. You're not ready. You're discombobulated. Well, as I said in one of my tweets, he blew it. But we all blow it. At some point, we all blow it. In every Macro Musings [episode] I've been on, and I've been on a lot of them now, at some point, I say the opposite of what I meant to say. I say up if I meant down and down if I meant up. It happens to everybody. So, all you have to do is wait long enough, talk to somebody long enough about enough things, throw enough questions at them, and you might get some pretty embarrassing soundbites. So, that can happen to anybody. On the other hand— and I think I said this in the same thread— it's not that hard, when you're not discombobulated, to respond to the kinds of questions that they ask.

Selgin: Turns out, I'm in that movie too. That sounds like a line from something, I don’t know. I've seen that movie too. I was in that movie. I forgot all about it, and I think it's because— like Jared and the rest of us, David Andolfatto and a few people are in it— they did it so long ago. And at the time, they may not have said, "Hey, we're MMT people. We're trying to get some gotchas. Would you mind getting on camera for a while until we do?" They just said, "We're doing a movie about monetary theory and some of the questions will be about modern monetary theory." I haven't seen the movie. Here in Spain, we can get it. You have to pay for it and all of that. I'm told that I did okay. I didn't say anything— Well, obviously, you can bet that if I said anything really stupid, everybody would know, and I'd be right there with Jared licking my wounds.

Selgin: But I think, instead, I just pointed out that I think a lot of it is a big nothing-burger. And I don't mean that MMT should be ignored. I've learned a lot from MMT people. I've criticized them, but I know that they're smart, and they know stuff, certainly, about the workings— the legal aspects of our monetary arrangements, but, also, a lot of other stuff. I've interacted with them way back. I knew Randy Wray, and we've talked before this whole thing became like the British invasion. A lot of what they say, you can agree with.

Selgin: I think that they try— and so do their critics try— to exaggerate the differences. For example, they like to say, "Oh, taxes aren't a way of funding the government. They're a way of controlling inflation." Other people, of course, say, "Oh, that's crazy. Taxes are a way of funding the government, not a way of controlling inflation." Well, guess what? They're both. They can do both things. It's like saying that if you go on a diet— you have a diet, right? What's some famous diet? You do it, so I can't remember the name. Can you think of any of these famous diets?

Beckworth: The Atkins diet?

Selgin: Okay, yes. It's just like saying, the Atkins— So, what's the Atkins diet? Well, it's a thing that tells you what to eat. So, you eat and you don't starve, or it's a thing that helps you lose weight. Well, which is it? Well, it's both, because, obviously, if you're following this diet, you're feeding yourself. That's one thing you're doing. What's the other thing you're doing? Well, you're controlling your weight. It's the same thing. So, we can look at things from different perspectives, and a lot of these debates between MMTers and other people just has to do with one party insisting that one perspective is the only possible way to look at it, and the other saying that the other one is. It's kind of boring when you get right down to it. I should say, also, a big thing in MMT, a big inspiration, is Lerner's functional finance article. Have you read that, David?

Beckworth: I've only read excerpts from it. I've not read the entire thing.

Selgin: You should go read that. You know why? He's one of us. The whole thing's basically about how he's emphasizing fiscal policy. But, of course, he takes the same kind of, "Let's look at the government, the central bank, and Treasury as one big thing, one big unit, as if it's a common agency." So, he's coming at it from the fiscal policy lingo, but it's equivalent to monetary policy, because the government is, ultimately, through its taxing and borrowing and spending, determining the money supply. Okay, fine.

Selgin: The point is [that] it's all about keeping nominal spending stable. It's all about what we call NGDP targeting. He starts, essentially with the premise that that's what the government should be doing, and that its control of taxes, spending, et cetera, should be about that. Well, neither of us is going to disagree with it, but I think that there are a lot of other people who shouldn't disagree with it. And that is at the heart of modern monetary theory. When it really comes down to brass tacks, where the disagreements really are substantial, it's not in the rhetoric or the perspective— though those are very different in many cases— It has to do, fundamentally, with how far away we are from the sloping or vertical part of the aggregate supply schedule. That's it. And what do we do when we get there and prices start to rise? Those are the real bones of contention.

Selgin: Everybody should agree that the resource scarcity, or the resource constraints, are, ultimately, the most important, not the constraints on creating paper money. Although, those constraints exist to a greater extent than the modern monetary theorists tend to emphasize. They set them aside altogether when they talk about consolidated government. They assume that you don't have to worry about the fact that, if you try to substitute money creation for taxation too much, you not only get a lot more inflation eventually, but you can only get so much.

Selgin: If we try to finance everything with money creation today, no taxes, we'd end up going to the wrong side of the Bailey curve, or what people probably would recognize more as the inflation Laffer curve. Anyway, there's a lot of issues like that, but the things that are [of] most important concern— again, how close are we to the upward-sloping supply schedule? Not exactly something economists didn't argue about before there was much talk of MMT. And what do we do when we get there? Do we actually raise taxes? Do we rely on monetary mechanisms other than raising taxes? Do we have incomes policies, otherwise known as wage-price controls?

Selgin: Certainly, the MMTers are more inclined to say when inflation breaks out that, "Oh, this isn't just aggregate demand," or "It's not aggregate demand at all. It's not too much spending. It's greedy corporations," which I don't find very compelling, but those are the issues, and they're not new issues. They're old issues. So, everybody needs to calm down about this whole thing, because all we're doing is juicing up people who were making something that's already, in some ways, too big of a deal, an even bigger deal by contributing to the impression that the substantive differences are greater than they really are.

Beckworth: That is really interesting that you bring up Abba Lerner as a nominal GDP targeter of sorts back then. I guess he'd be considered kind of a post-Keynesian figure, is that right? Is he considered post-Keynesian?

Selgin: Well, yes. I think they’ve adopted or embraced him, certainly, and all MMTers. Most MMTers are post-Keynesian. They're a branch of post-Keynesianism, I think you could say.

Beckworth: So, we've got Abba Lerner, who's post-Keynesian, who, implicitly, would endorse nominal GDP targeting, but some other, more traditional Keynesians— James Meade, James Tobin— they both were early nominal GDP targeters, and they were Keynesian.

Selgin: Keynes himself came within an inch of embracing NGDP targeting. If you read the General Theory— I think that I wrote about this. Yes, I wrote about it in an article called, “Hayek versus Keynes on How the Price Level Ought to Behave”— Keynes got really close with his talk about a stable wage unit and all of that, and then he just, at the last minute, kind of chickened out and said, "Oh, let's have price level stability or inflation stability as our ideal." Of course, he wasn't an inflationist despite what many conservatives said. And so, no, lots of people are NGDP targeters. Some of them just don't want to admit it.

Beckworth: They don't know it.

Selgin: Anybody who thinks that stable aggregate demand is a good way to counter cycles should be one of us, if you ask me.

Beckworth: Very interesting. Okay, since we're talking about personalities here— Jared Bernstein, MMT folks— I'm going to jump into my second article, which also deals with a personality, in this case, Donald Trump, who may be our next president, depending on how this election goes. And there were a number of articles recently surrounding some of his intentions, should he become president, for the Federal Reserve, [and] also, relatedly, some of his intentions for the U.S. dollar policy. So, I'm going to group this together all as an interventionist in monetary policy and dollar policy. So, The Wall Street Journal, in late April, had an article titled, *Trump Allies Draw Up Plans to Blunt Fed's Independence.* And this article—  I'll just summarize it for the sake of time, but it goes through and talks about how they want Trump to almost become an ex officio member of the FOMC, or he gets to weigh in, or veto FOMC decisions.

Beckworth: Also, they raised the question of, can he fire Jay Powell as soon as he becomes president? So, this raised a lot of concerns, as you can imagine, among people in our circles. They're really worried about that. I saw one person say, “the greatest threat to price stability,” and they showed a link to this article. They were also just worried about independence in general. I wanted to respond to all of this commentary, and it is alarming. Yes, we wouldn't want that to happen, but I think there's a broader context to understand Trump and how he's on this scene.

Beckworth: So, first off, I would say that Trump is, in part— not entirely, but in part— a response to populism and this push coming out of the great financial crisis. There's a lot of research showing that after a deep financial crisis, you tend to have these populist movements. Some would also argue globalization. He's a response to that. Even though we both believe globalization has been wonderful for humanity overall, some sectors have lost out, and he could be seen as a response to that. So, on one hand, maybe we shouldn't be so surprised.

Beckworth: But the other point I wanted to bring up about him is that many people are pointing out that he's just going to further politicize the Fed, lose independence, inflation. The challenge, though, is that the Fed already has been politicized to some degree, and one side of America sees the Fed as politicized. When the Fed ventures into climate policy, to income inequality issues, one side sees the Fed as becoming very politicized. And so, to me, it seems a little naive to say, “Oh, Trump is the beginning of this politicization of the Fed,” when, for many people, they already see it as becoming politicized. And I think we are both concerned about preserving the Fed's independence, no matter who's in office. So, I think there are bigger forces at work than just Trump and some of the chaos he might bring to the table.

Donald Trump, Central Bank Independence, and Dollar Dominance

Selgin: Some thoughts about that. First of all, yes, we know a lot of people who say, "Look at Arthur Burns. We got him dead to rights, just caving in to Nixon. Look at Johnson, practically assaulting—” No, not practically, he assaulted, physically--

Beckworth: Right. At his ranch.

Selgin: That's right, his Fed chair. So, the conclusion comes that Federal Reserve independence is a myth, and there have been books about it. Well, hold on. Yes, it's not all it’s cracked up to be, to put it mildly, but it's not nothing. It is something. It is not entirely the case that Fed chairmen are simply catering to whatever the president has to say. If that were the case, Trump wouldn't have anything to complain about, and he wouldn't have anything to change. So, let's get the first thing right here. There is something to Federal Reserve independence, and part of that something— there are many aspects to it. The Fed not having a budget from Congress is one of the aspects. The length of the appointment of the chair and the other members of the Board of Governors, that's another. And the inability of the president to just fire any long-term appointee is a third, and I could go on with this list.

Selgin: But these are things that raise the costs— or lower the probability, as you like— of the Fed being nothing more than an agency, a branch of the White House. Now, the other thing that I think is important is that we need somebody, somewhere, whose job it is to control inflation. You and I would rather say control nominal spending, but let that pass. The difference for our purposes now isn't that great. The way things are set up now, that's the Fed. We have an agency that, at least, is supposed to do that. MMTers, to get back to them just for a moment, they'd like to see the Treasury just handle the whole thing.

Selgin: In principle, in theory, let's say, that could work, but you have to assign the duty. It has to be explicit. You have to say, like Lerner did, “Look, your job, you're in charge of the Treasury and deciding how much to tax and how much to spend and whether to borrow, but you're doing these things with an eye towards your responsibility for controlling inflation.” That's what Lerner said, and that would be fine. Let's just allow it. That would be fine, too.

Selgin: Right now, though, we don't have that. We don't have a Treasury that works that way. We don't have a White House— Nobody in those other parts of government is bearing, or has, the responsibility that the Fed has, however badly it meets it or however well. So, when you put these two facts together, facts about the current situation, and then you consider Trump's proposal— or some interpretations of what it might be, I should say, because we don't really know all of the details— then some of these possible reforms are pretty scary, because they aren't reforms that are placing clear responsibility for inflation in some other hands and allowing, and preventing, that responsibility from being undermined by executive authority. They're not doing any of that.

Selgin: They're just allowing executive authority to interfere, if you will, or put pressure on, and then undermine the independence of the agency that, right now, as things stand, is the only one that's in charge of the problem of controlling inflation. So, I don't like it. That's not to say that there aren't some aspects of this proposed plan that aren't okay. I think, of course, the Fed needs to answer to Congress. It already does. Should it also answer to the executive? Well, I'm not so sure. I'm pretty sure he shouldn't be able to fire the Fed chair. Everything depends on just what it means to report to the president. Reporting, in itself, okay, but the minute you start having the executive be able to tell the Fed what to do, then that's a problem. 

Selgin: And who has ever heard— Well, with rare exceptions— But who has ever heard of an executive who didn't want interest rates to be lower, even if inflation was a potential consequence, particularly if he was up for re-election? The political business cycle is also a thing. It's not a very, very solid thing, but it's there. You would never have gotten a tape where Nixon is giving hell to his Fed chair because he's not raising interest rates enough. We would never have seen that. So, there's a bias, that we want to have an arrangement that avoids that bias, and we don't want to chip away at the things that keep it able to do so. So, anyway, those are some of my thoughts about this, but I do want to emphasize [that] the Fed isn't that independent, but it is independent, a wee bit, and we need all of that ability, on the Fed's part, to resist political pressure, that we can have.

Beckworth: Yes, so, the independence that the Fed does have— even if some of it's been eroded over time and depending on where we are in history— the independence that it does have, we want to preserve, and this proposal would vastly undermine that.

Selgin: Possibly, yes. And in a way, the less you have, the more you want to fight to keep it.

Beckworth: Right, right. The marginal unit of independence is very valuable. So, one other article related to this— and I'm kind of grouping these all into one— is what Trump could bring to the table. There is another, I think, related discussion, and this is a Bloomberg article. This is titled, *Trump Advisors Discuss Penalties for Nations That Move Away from the Dollar.* I'm going to read just the first two paragraphs here. "Former President Donald Trump's economic advisors are considering ways to actively stop nations from shifting away from using the dollar, in an effort to counter budding moves among key emerging markets to reduce exposure to the U.S. currency, according to people familiar with the matter. Discussions include penalties for allies or adversaries who seek active ways to engage in bilateral trade in currencies other than the dollar— with options including export controls, currency manipulation charges, and tariffs, the people said, speaking on the condition of anonymity.”

Beckworth: Let me jump down a paragraph here. They're quoting Trump now. "’I hate when countries go off the dollar,’ Trump said in a March 11 interview on CNBC. ‘I would not allow countries to go off the dollar, because when we lose that standard, that would be like losing a revolutionary war,’ he said.” So, a couple of things. One, I find this incredibly ironic, because he was pushing hard against a strong dollar in his first administration. In fact, he's the first president where his Treasury declared China a currency manipulator. So, he is very much on, “let's weaken the dollar.” Now, he's back on the other swing in the other direction, proposing things that could also be very chaotic for the global dollar standard and have a bearing on monetary policy as well.

Selgin: I'm not sure if inconsistency is the right word. He wants to have his cake and eat it too. It's not quite the same. He has two policies that, in principle, you can push. He wants a weak dollar, and he doesn't want anyone to stop using it. He wants both of those things. So, what he wants to do is, instead of relying on a strong dollar to keep the dollar's predominance in international markets, he wants to be able to have a weak dollar and punish people who try to use something else.

Selgin: That's not unlike a lot of tax policy. You want to raise taxes like hell, which is what inflation is an example [of], and then you want to make it really hard for people to not pay them, to evade them. If he's inconsistent, his inconsistency is consistent with the way governments think, with what they would like to do. Now, having said that, I think this is horrible. I think it's absolutely god-awful. The right way to preserve the dollar's status, if that's what we want to do— to preserve the exorbitant privilege— is to have a good, strong dollar and good, strong payments arrangements to go with it, dollar payments arrangements, [and] not to try to smack people on the head if they— other countries, I mean, if they, or their citizens, tried to switch.

Selgin: I think that the dollar still has plenty of oomph. But if it's going to lose that oomph in the long run, it's going to lose it by being a currency that depreciates too rapidly and that sort of thing. Letting the Fed do its job, to get back to the original proposal we’re discussing, is the best way to avoid having the dollar’s standing in the world decline. I should say, letting the Fed do its job, as opposed to doing what Trump would like to do with it, because, of course, we could complain that the Fed could do a better job than it's been doing preserving the dollar's integrity. I just think that Trump is not the one to get them to do that.

Beckworth: Well, with that, our time is up. Our guest today has been George Selgin. George, thank you again for coming back on the program.

Selgin: Thanks a lot, David.