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		Front Matter
		Do Consumers in Developing Countries Gain or Lose from Globalization? [pp. 537-551]
		The Social Significance of Consumption: James Duesenberry's Contribution to Consumer Theory [pp. 553-572]
		Economic Power and the Firm in New Institutional Economics: Two Conflicting Problems [pp. 573-601]
		Do Taxes and Bonds Finance Government Spending? [pp. 603-620]
		The Menace of Competition and Gambling Deregulation [pp. 621-634]
		The Rise and Fall of Investment Companies in Slovakia [pp. 635-654]
		Game, Set, and Match for Mr. Ricardo? The Surprising Comeback of Protectionism in the Era of Globalizing Free Trade [pp. 655-677]
		Reassessing the Labor Supply Curve [pp. 679-692]
		National Inequality and the Catch-Up Period: Some "Growth Alone" Scenarios [pp. 693-705]
		Schumpeter's Entrepreneurs and Commons's Sovereign Authority [pp. 707-721]
			The Effects of the Minimum Wage: A Business Response [pp. 723-730]
			Garnett and Cullenberg on Postmodernism, Value, and Overdetermination [pp. 731-734]
		Editor's Notes [pp. 735-738]
			Review: untitled [pp. 739-746]
			Review: untitled [pp. 746-748]
			Review: untitled [pp. 748-751]
			Review: untitled [pp. 751-755]
			Review: untitled [pp. 755-757]
			Review: untitled [pp. 758-761]
			Review: untitled [pp. 762-764]
			Review: untitled [pp. 764-767]
		Books Received [pp. 769-770]
		Back Matter
Document Text Contents
Page 1

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Journal of Economic Issues.

Page 2

Vol. XXIV No. 3 September 2000

Do Taxes and Bonds Finance Government Spending?

Stephanie Bell

Debates over the impacts of various ways of financing government deficits and
about the relative impact of monetary and fiscal policy have, unfortunately, been
carried out without recognition of the institutional process by which modem govern-
ment spending, borrowing, and taxation are accomplished.1 In the United States,
close cooperation between the Treasury, the Federal Reserve System, and deposi-
tory institutions makes the traditional distinctions between monetary and fiscal pol-
icy hard to use in describing actual processes and renders irrelevant many of the
theories about the most appropriate mix of borrowing and taxation. Indeed, the en-
tire treatment of taxation and of government borrowing assumes a monetary system
quite unlike that of the modern U.S. system. My purpose in this paper is to de-
scribe, in some detail, the way in which the Treasury and the Federal Reserve coor-
dinate policies that are neither purely fiscal nor purely monetary and to argue that
theories of monetary/fiscal policy should incorporate more discussion of the issues
of reserve management.

The "Reserve Effects" of Taxing and Spending

Before examining the reserve effects of various Treasury operations, it is, per-
haps, prudent to begin by looking closely at aggregate member bank reserves.2 Be-

The author is a Ph.D. candidate at The New School for Social Research and a Lecturer at the
University of Missouri-Kansas City. This paper was wntten while the author was Cambridge University
Visiting Scholar at The Jerome Levy Economics Institute at Bard College and has been presented at the
Post Keynesian Summer Conference in Knoxville, Tennessee, July 1998; the Post Keynesian Graduate
Workshop in Leeds, United Kingdom, 1998; and at the Conference on the Economics of Public Spending
in Sudbury, Ontario, 1999. Financial support from the Center for Full Employment and Price Stability is
grateftly acknowledged. Helpful comments from Victoria Chick, John F. Henry, Peter Ho, Anne
Mayhew, Edward Nell, Alain Parguez, James Tobin, Randy Wray, and twao anonymous referees greatly
improved the arguments made in this paper.


Page 9

610 Stephanie Bell

Treasury's ability to hit its target closing balance. Daily contact between the Treas-
ury and the Fed provide the Treasury with "numerous occasions . . . to assist the
Reserve authorities to achieve a desired objective" [Auerbach 1963, 328].

Unfortunately, the Treasury is unable, even with the cooperation of the Federal
Reserve, to completely offset the effects of its daily spending using tax and loan
calls and direct investment. Indeed, as Table 1 shows, the Treasury's average
monthly closing balance can differ substantially from its $5 billion target.

This, again, is the result of the inherent uncertainty regarding the size/timing of
receipts and expenditures. While it is easy to see how this uncertainty would prevent
daily inflows and outflows from offsetting one another, Table 1 shows that even on
an average monthly basis, the Treasury's balance can close as much as 31 percent
above its target level. Thus, as Figure 5 confirms, one expects a non-zero change in
the Treasury's daily closing balance. Despite this, changes in the daily closing bal-
ance do tend to fluctuate fairly closely around zero, deviating most drastically with

Table 1. (Give this a short, descriptive title)

Month Average Closing Balance ($ Millions)
November 1997 5,015
December 1997 5,371
January 1998 6,563
February 1998 5,118
March 1998 5,763
Five-Month Average 5,618

Source: Daily Treasury Statement,

Figure 5. Change in Daily Closing Balance (November 1997-March 1998)

= 8,000
> 6,000


O__ A- 0A


Z -6,000
. -8,000 05 ' O C LO 0 t ( DC CY

Source: Daily Treasury Statement, http://fedbb.acsgop.n co

Source: Daily Treasury Statement,

Page 10

Do Taxes and Bonds Finance Government Spending? 611

quarterly tax payments (January, April, June, and September) and with the collec-
tion of withheld business taxes.

In sum, three important points have been made regarding the Treasury's opera-
tions. First, the Treasury recognized the disruptive nature of its cash operations and
responded by maintaining accounts at private depositories. Second, the Treasury
uses these accounts to diminish the reserve effect of its operations by using tax and
loan calls and direct investments to minimize the net changes in Reserve account
balances (to coordinate the flow of its receipts with its expenditures). Finally, the
Treasury and the Fed cooperate to bring about a fairly high degree of harmony in
managing the Treasury's balances at Reserve banks.

SeUling Bonds to Coordinate the Treasury's Operations

So far we have addressed only the Treasury's attempts to balance its taxing and
spending flows in order to minimize the reserve effect of its operations. Implicit in
our discussion, therefore, was the notion that the government attempts to balance its
budget. What if it doesn't? That is, what if the government runs a budget deficit?
How does the sale of bonds affect the Treasury's cash flow operations and, sub-
sequently, the reserve effect? There are three scenarios that must be analyzed in or-
der to determine the reserve effect of selling bonds, the key being by whom and
how are they purchased.

First, it must be recognized that tax and loan accounts actually receive not only
proceeds from tax payments, but also funds from the sale of government debt.
When commercial banks with tax and loan accounts (or customers of these banks)
purchase government bonds, there may be no immediate loss of reserves to the pur-
chasing bank or the banking system. If, when the Treasury auctions new debt, it
specifies that at least some portion of the bonds are eligible for purchase by credit to
tax and loan accounts, Special Depositories may acquire the bonds by crediting de-
posits (in the name of the U.S. Treasury). These depositories, therefore, will not
lose reserves as they purchase newly issued bonds.F4 Similarly, the purchase of
newly issued government debt by a customer of a Special Depository, as long as the
Treasury specifies that some (or all) of the offering is eligible for purchase by tax
and loan credit, will leave reserves unaffected. For example, when a customer of a
Special Depository purchases government securities, the Treasury redeposits the
check into the bank on which the check was drawn. The bank then credits the Treas-
ury's tax and loan account, offsetting the debit to the buyer's account. Thus, like the
purchase of government debt by a Special Depository, the sale of government debt
to a customer of one of these institutions can be effected without any loss of re-

The second method concerns the private purchase of newly issued government
debt that does not involve crediting a tax and loan account. When the securities are

Page 18

Do Taxes and Bonds Finance Government Spending? 619

ineligible recipients of additional tax and loan funds. Additionally, tax and loan accounts,
like the Treasury's account at the Fed, may swell during unusually heavy quarterly tax
payments. Because banks must pay interest on tax and loan accounts, they limit the size of
the tax and loan balances they are willing to accept. When direct investment is not an op-
tion, the Treasury can attempt to cancel previously scheduled calls in an attempt to draw
down its balance in Reserve banks.

14. The reader might wonder whether additional reserves are required as a result of the larger
tax and loan balance. The answer is no. Since the establishment of interest-bearing note
accounts in November 1978, Special Depositories have been free of reserve requirements
against tax and loan deposits.

15. The Federal Reserve was, for a time, prohibited from purchasing bonds directly from the
Treasury. This changed during World War II, when the Fed was authorized to purchase
up to $5 billion of securities directly from the Treasury. Since then, the limit has been
raised several times.

16. Boulding [1966] notes that deficit spending most commonly involves this practice.
17. Note that the government can deficit spend without taxing or selling bonds first, but if

government spending is greater than taxation, the banking system will be left with excess
reserves. The Treasury, therefore, prefers to use bonds to coordinate its deficit spending,
selling them to Special Depositories (and allowing tax and loan credit) before spending
from its accounts at Reserve banks. The bonds, then, allow the government to defend (ex
ante) the fed funds rate.

18. Note that bonds would have to be sold even if the government ran an annually balanced
budget. This is because it is impossible to eliminate the "reserve effects" of the Treasury's
daily operations. Thus, swings in the Treasury's daily closing balance, which threaten to
move the funds rate away from its target, would induce the sale of bonds despite an annu-
ally balanced budget.


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