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The debate between Krugman and the proponents of Modern Money Theory (MMTers) involves, among other things, an MMT proposal to fund deficits through issuance of new money (money issue) rather borrowing (bond sales), a policy that kept the number of dollars constant during the gold standard but has since resulted in a costly $14-trillion national debt.  In 2010 the U.S. Treasury spent over $400 billion on interest and is projected to spend twice that much per year on average for the next 15 years.  

If that spending is unnecessary, the potential savings would exceed the four-trillion-per-decade target set by both Obama and S&P.  And, that fact makes this debate into something of more than academic significance.

Economists of all stripes agree that the U.S. government can issue new money to pay its expenses, including the principal and interest on its debts:

  • Alan Greenspan (8/07/2011): “The United States can pay any debt it has because we can always print money to do that.”
  • Paul Krugman (4/21/2011):    "[A]  state must, one way or another, collect enough revenue to pay for its spending.    Does the same thing hold true for the federal government? Well, the feds have the Fed, which can print money."
  • James K Galbraith (4/18/2011): "[Since the US prints its own currency or simply issues electronic payments whenever it needs it:] As long as there is diesel fuel to power up the back-up generators that run the government’s computers, they will have the money to back their own bonds.”
  • Ben Bernanke (11/21/2002): "[T]he U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost."

In fact, legislation authorizing the Treasury to issue and spend new money is already in place.

But, per Krugman: "[T]oo much reliance on the printing press leads to unacceptable inflation,"   and:

At a future date, when we’re out of the liquidity trap, public finances will matter — and not just because of their role in raising or reducing aggregate demand. The composition of public liabilities as between debt and monetary base does matter in normal times — hey, if it didn’t, the Fed would have no influence, ever. So if we try at that point to finance the deficit by money issue rather than bond sales, it will be inflationary.

... [S]uch a hypothetical US deficit crisis wouldn’t be self-correcting: the biggest source of our long-run deficit isn’t the overhang of debt [interest was 25% of the 2010 deficit], it’s the prospective current cost of paying for retirement, health care, and defense. So such a crisis — again, it’s very much hypothetical — could spiral into something very nasty, with very high inflation and, yes, hyperinflation.

Krugman hypothesizes that in "normal times" prices are proportional to the money supply (the quantity theory of money) and that deposits count as money but bonds do not.

By contrast, the MMT view seems roughly to be that demand for goods and services is based on wealth, and that wealth is wealth regardless of whether it's in the form of deposits or bonds, since these two are readily interconvertible via the bond market.  So, exchanging deposits for bonds (bond sales) has relatively little effect on inflationary pressure.  More accurate and complete characterizations of the MMT perspective can be found here and here.

Note that this MMT proposal does not preclude governmental borrowing for other purposes, e.g., to control interest rates and/or inflation.  It simply decouples such borrowing from the funding of deficits.  The Treasury could, in fact, borrow as much or more than it borrows now if that were necessary to control inflation.  Or, the Fed could offer interest-bearing time deposits to take money out of circulation.

So the proper debate is whether or not Treasury bonds effectively take money out of circulation, and if so, whether the volume of bond sales should be tied to the annual deficit.

Likely conservative opposition to this MMT proposal.  So far as I can tell, there are no economic concerns about this proposal other than the possibility of inflation.  But, the conservative strategy has long been to destroy "the welfare state" by decreasing taxes and maxing out the nation's credit card while they are in power and crying for "fiscal responsibility" when they are not. The policy of funding deficits via borrowing together with the debt limit gives conservatives a death grip on the throat of the the U.S. government, which they hope to drown in Grover Norquist's bathtub.  It will not be easy to pry their fingers loose.

UPDATE 1235am pdt:
Summary points from the diary and the comments:

  • Economists of all stripes agree that the U.S. government can issue new money to pay its expenses
  • The Treasury is already authorized under existing legislation to issue new money to fund any and all appropriated expenses.
  • There's no reason to tie the funding of the deficit to bond sales (borrowing) as we have been doing by a tradition left over from the gold standard.
  • The only reasons to sell bonds are to lower interest rates and to fight inflation, neither of which apply now.  Current bond sales are running up the national debt but not incurring a lot of interest charges.
  • Treasury bills and bonds are cash equivalents in terms of liquidity.
  • But, the more real interest that money is earning the less propensity people will have to spend it, i.e., as Krugman claims, the mix of bonds and cash matters.
  • Interest payments do, however, expand the money supply, which counteracts some of the anti-inflationary effects of interest mentioned in the previous point.

UPDATE 2 (11:00 am PDT on 8/21/2011) :
Commenter clonal antibody left links to two very relevant and interesting postings:

  •  One is from Arun Dubois a Canadian - Mythologies: Money And Hyperinflation , which discusses some of the unique aspects of the hyperinflation that occurred 1in Germany in the 1920s under the Weimar Republic.
  •  The other, Bond issuance doesn’t lower inflation risk, is by Bill Mitchell and, as you can see from its title, addresses the key point of dispute discussed in this diary.  Reading that article and the accompanying comments refined my thinking a bit. This was my response:
    Selling bonds raises interest rates. Higher interest rates encourage saving, thereby diminishing the demand for goods and services, thereby lowering the risk of inflation.

    Of course, higher interest rates pump more interest revenue into the economy, some of which will be saved but the rest will be spent on goods and services, thereby increasing the risk of inflation.

    Which of these effects dominates depends on the marginal propensity to save with respect to interest rates ( i.e., the partial derivative of that propensity with respect to interest rates).

    If that marginal propensity is sufficiently high, it would seem that issuance of bonds would indeed lower the risk of inflation. Otherwise, not.

Originally posted to wigwam on Wed Aug 17, 2011 at 03:28 PM PDT.

Also republished by Money and Public Purpose.

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Comment Preferences

  •  Thanks for posting this diary (1+ / 0-)
    Recommended by:

    Republished to Money and Public Purpose.

    For the first time in human history, we possess both the means for destroying all life on Earth or realizing a paradise on the planet--Michio Kaku.

    by psyched on Wed Aug 17, 2011 at 03:54:02 PM PDT

  •  Why question it? (0+ / 0-)
    Treasury bonds effectively take money out of circulation
    There is no question about this.  Buying bonds out of the market is one way the Fed puts money into the money supply, and selling their holding of bonds into the market allows the Fed to take money out of the money supply.
    whether the volume of bond sales should be tied to the annual deficit.
    Huh?  If you're considering just increasing the money supply to pay bills, look at Germany in the 1920's (41% inflation per day), Hungary in post-war years (41 trillion percent annual inflation), and Zimbabwe in the early 21st century (merely 11 million percent).
    •  Responses (1+ / 0-)
      Recommended by:
      Treasury bonds effectively take money out of circulation

      There is no question about this.

      The MMTers have questioned that hypothesis.  If I understand correctly, they  contend that Treasuries are so readily interconvertable with deposits they they contribute to inflation just as surely as cash.  That sounds quite plausible to me, but it's a hypothesis that should be subjected to empirical verification or refutation.
         whether the volume of bond sales should be tied to the annual deficit.

      Huh?  If you're considering just increasing the money supply to pay bills, look at ...

      Paying the government's bills puts money into circulation.  Borrowing is supposed to replace money in circulation with something less inflationary, namely Treasury bonds.  The point of contention seems to be whether or not Treasury bonds are in fact less inflationary.

      •  Paying Visa with Mastercard (1+ / 0-)
        Recommended by:

        The Fed is buying Treasury debt because NOBODY ELSE WILL (at least not at the current rates - and higher rates will only hasten national bankruptcy).

        Like it or not, we've been living beyond our means for some time - and once Nixon walked away from Bretton Woods the value of the $US has been decreasing at faster and faster rates.

        That INFLATION has been VERY REAL.

        We got away with borrowing for years because other countries  needed the $US as a medium of global exchange.  But now the rest of the world has caught on to the scam.

        THe US is INTENTIONALLY  inflating the $US to make our debt more manageable.  

        They THINK they can do this slow enough and in a controlled enough manner but.... at the end of it all - whether inflation runs rampant or is gradual - eventually your savings are worth nothing.  

        History has shown that the value of EVERY fiat currency -eventually goes to ZERO.  Governments - and citizens - can't resist unchecked spending.  CItizens demand more and more - but don;t want to pay for it.  So governments get more and more in debt, borrow more, print more.

        Even Rome collapsed - debasing its money so that at the end there was no silver at all in its coinage.  

        The $US - a Federal Reserve Note - now is simply a PROMISE TO PAY.  So were Continental Dollars.

        Our Founding Fathers saw how THAT worked out and were opposed to ANY form pf paper money - stipulating that the $US was to be coinage in the form of silver or gold.  This created its own problems - neverending shortages of 'money'    - inadequate supplies needed for commerce as the economy grew.

        BUT when you expand the money supply faster than the  expanded value/wealth created by the economy, you get inflation.

        Wealth is created by ADDING VALUE - dig up ore, cut down trees, grow crops - smelt ore into metal, turn metal into THINGS......etc.

        The money EARNED by creating real wealth is DEVALUED by a government that creates new money without expanded wealth creation.  YOUR savings will not earn the interest it should if the money you EARNED has to compete worth no cost money provided by government.

        You can argue that government spending CAN help in times like these but it helps ONLY when done correctly - in ways that INCREASE VALUE in society.

        A quote from another:

        FDR borrowed money from Americans to put Americans to work so they could buy goods from other Americans putting more Americans to work.     (Of course you can also argue  that without WWII, this approach was still not working very well)

        NOW we are borrowing money from foreign powers to allow Americans NOT to work (while continuing to export jobs) so those Americans can afford to continue to buy goods made by other FOREIGNERS.  Which BTW only puts more foreigners to work while increasing the US trade deficit)

        Adding to that much of the funds lent out to banks and Wall Street at 0% are NOT being used to create jobs but used to MAKE MORE MONEY via SPECULATION.   Commodities prices are being driven up, stock prices are being supported by all this liquidity but the average person sees little benefit.

        The average person is being bled dry - and his children and grandchildren will be as well - to PAY FOR the debt incurred.

        Yes, I believe we need government 'help' but we cannot simply borrow endlessly without real returns.  Tax rates need to be higher on those that have profited from past policies (the uberwealthy and corporations) and the money being spent needs to go to create REAL JOBS and REAL VALUE in society.

        Sadly, I believe the insanity will continue - bread circuses and an untouchable military trying to preserve a status we can no longer afford.  You can't FORCE the world at the end of a gun to subsidize you consumption of goods and services.

        •  Per the Wikipedia (0+ / 0-)

          This is not to dispute you but to put your comments in context:

          Fiat money is money that has value only because of government regulation or law. The term derives from the Latin fiat, meaning "let it be done", as such money is established by government decree. Where fiat money is used as currency, the term fiat currency is used.

          Fiat money originated in 11th century China,[1] and its use became widespread during the Yuan and Ming dynasties.[2] The Nixon Shock of 1971 ended the direct convertibility of the United States dollar to gold. Since then all reserve currencies have been fiat currencies, including the dollar and the euro.


          Chartalism is a monetary theory that states the initial demand for a fiat currency is generated by its unique ability to extinguish tax liabilities. Goods and services are traded for fiat money due to the need to pay taxes in the money.
          [edit] Loss of backing

          A fiat-money currency generally loses value once the issuing government refuses to further guarantee its value through taxation, but this need not necessarily occur.

          MMTers are chartalists.
      •  Cash and Cash Equivalents (1+ / 0-)
        Recommended by:

        See Wiki - Cash and Cash Equivalents

        Cash and cash equivalents are the most liquid assets found within the asset portion of a company's balance sheet. Cash equivalents are assets that are readily convertible into cash, such as money market holdings, short-term government bonds or Treasury bills, marketable securities and commercial paper.

        Also Investopedia - Cash And Cash Equivalents - CCE

        What Does Cash And Cash Equivalents - CCE Mean?
        An item on the balance sheet that reports the value of a company's assets that are cash or can be converted into cash immediately.

        Investopedia explains Cash And Cash Equivalents - CCE
        Examples of cash and cash equivalents are bank accounts, marketable securities and Treasury bills.

        •  Thanks. So the question is whether T bonds are .. (1+ / 0-)
          Recommended by:

          ... "cash equivalents" that should be counted as a component of M in the MV = QP equation.  If they are, then Krugman is way off base in his prediction that

          [I]f we try [in normal times] to finance the deficit by money issue rather than bond sales, it will be inflationary.

          And, they certainly are "assets that are readily convertible into cash, such as money market holdings, short-term government bonds or Treasury bills, marketable securities and commercial paper."

          Given this equivalence, there's no reason Bernanke should have expected quantitative easing to have any effect.  Of course, Krugman would explain the fact that QE1 and QE2 had at most negligible effect by noting that these are not normal times.

          •  The more important (1+ / 0-)
            Recommended by:

            question is - What would an entity do if it did not hold those T-notes and T-Bonds?

            Most of the businesses I know (and they are the primary holders of "Government Debt") would continue to hold it in shorter term instruments. They would not go out and spend the money.

            And unless the money is spent, it is not inflationary. So it really is immaterial, if the money is held in 1 month T-Bills or in thirty year T-Bonds. Both are seen by the business as having a ready market, but with one earning more interest than the other. It may take a little bit longer to convert the T-Bond to cash -- but the reason the T-Bond was bought in the first place was that the money was not immediately needed.

            So IMO, since the money that is invested in a T-Bond was not going to be spent, but rather put into interest bearing securities, that money is no more likely to cause inflation than cash that is stored under the mattress.

            However, it is quite likely that the interest on the T-bond will be spent. So a case could be made that T-Bonds are more inflationary than cash held in the bank!

            •  Hmmmmmm. (0+ / 0-)
              So IMO, since the money that is invested in a T-Bond was not going to be spent, but rather put into interest bearing securities, that money is no more likely to cause inflation than cash that is stored under the mattress.

              Krugman's thesis seems to be that, if the public sector has more of its money in bonds, it will spend less.   Perhaps he observed that money invested in bonds gets spent last and made an invalid inference.
            •  Okay, so here's Krugman. (0+ / 0-)
              So suppose that we eventually go back to a situation in which interest rates are positive, so that monetary base and T-bills are once again imperfect substitutes; also, we’re close enough to full employment that rapid economic expansion will once again lead to inflation.

              Perhaps he is imagining a case where the interest rates are sufficiently high that they'd induce the holders of T-bills to forego spending.

              But, then again, anyone holding cash who wanted interest could buy some T bills.

              But, then again again, if the government weren't selling so many T bills, the price would be higher making that investment less attractive, etc.

              So, if the government sells more T bills, they'll be a more attractive option to those who might be induced to forego near-term spending.  Or something like that.

              I'm skeptical, but it is vaguely plausible.

              •  A New Article by Bill Mitchell Explains (2+ / 0-)
                Recommended by:
                Calgacus, wigwam

                bond issuance doesn’t lower inflation risk

                I will finish this week with a painstaking, dot-point summary of some key elements of Modern Monetary Theory (MMT) to show clearly why bond-issuance which might accompany a budget deficit doesn’t lower the inflation risk of the deficit spending – not now, not tomorrow, nor at some mythical “long-run” point in time. All the inflation risk is on the spending (aggregate demand) side. The monetary arrangements that might or might not accompany the spending decisions of government do not add or subtract from the inflation risk. Mainstream theory thinks they do. That theory is demonstrably false. I will also cover several related myths that seem to have cropped up over the last week – both in the international media and among the comments made on this blog. It seems that we need some baby steps. So with my fire-suit (always) on

                Also, since the example of Germany in the 1920's is often a knee jerk example given to counter MMT proposals, here is a very good article from Arun Dubois a Canadian - Mythologies: Money And Hyperinflation

                In an earlier post, Marc Lee mentioned in passing the German hyperinflation episode of the 1920s. It’s remarkable that this event still holds such sway over the popular imagination despite other more recent instances of hyperinflation. Certainly, the imagery is powerful: German citizens pushing wheelbarrows full of worthless paper money around for everyday purchases, banknotes used as wallpaper, or dramatic charts showing a hyperbolic spike in the price of gold measured in German marks.

                The policy conclusion is equally dramatic: under no circumstances must central banks countenance the idea of “printing money” to support government spending. Mankiw’s textbook is illustrative of the common interpretation of this event: “When the quantity of money started growing quickly, the price level followed, and the mark depreciated relative to the (US) dollar (and gold).” Translation: the quantity theory of money holds: MV = PY where V and Y are assumed constant such that any chance in M (money) drives P (prices).

                So how to reconcile what we know happened in Germany (money printing, hyperinflation) with MMT views? After all, MMT theorists tend to downplay worries about “money printing” (a misnomer in the modern world but we’ll let it pass for now). In fact, I wrote a blog post around the time of the first round of quantitative easing where I suggested that resulting concerns about inflation were misplaced and based on a faulty understanding of monetary policy and inflation.

                A little more history helps reconcile the MMT view to the standard historical account. Before exploring that alternative story, an acknowledgement: the information used in this post is from a very smart federal bureaucrat who for reasons related to his position, would prefer to remain anonymous. This bureaucrat drew much of his insight from a fascinating historical piece by the St. Louis Federal Reserve, a bastion of monetarist thought and no obvious friend of MMT.

                •  Thanks for those two excellent links. (0+ / 0-)

                  If incorporated them and my response to Bill Mitchell's article into a second update to this diary.  I'd be interested in your comments on my response to Mitchell's article.

          •  They are not counted in US. Other countries have (1+ / 0-)
            Recommended by:

            other definitions of money supply.

          •  Printing money is inflationary. That's not an (0+ / 0-)


            •  Money doesn't do anything except when it's spent. (1+ / 0-)
              Recommended by:

              Suppose I print money and then burn it.  That would cause no inflation.  So it's not the printing of money that causes inflation.  Rather it's the spending.

              And, Congressional appropriations determine how much gets spent by the Treasury, regardless of where the money comes from.  Money has no effect except when it is spent, and at that moment it's origin makes no difference.

              The borrowing of money (bond sales) has an effect, because at that moment money is being spent by the bond purchaser.

              Krugman claims that if we sell more bonds, that decreases inflation.  The MMTers disagree.

              •  MMTer's (1+ / 0-)
                Recommended by:

                claim that purchasing a Treasury Bond is much like buying 4 quarters using a dollar bill. Is that spending my dollar?

                The gold bugs would say that the 4 quarters are worth more than the dollar bill!

                Some may claim that 4 quarters are more inflationary than a dollar bill. Others may claim the reverse.

                I could make a case for each scenario!

      •  OMG.......... (0+ / 0-)

        This *&^%$%^& Modern Money Theory crap is based on taking loose, not serious comments and turning them into a fantasy version of monetary theory.

        It's a STRAW DOG. A weak argument, used to prepare the way for a more serious argument that would not fly through on its own without nasty argumentation.

        A distraction.

        (MMT is similar to the Michelle Bachmann candidacy. both are STRAW DOGS. Contrary to early Iowa bullshit, Bachmann is a distraction. She soaks up media attention. That's all she does. Effectively, Bachmann is a blocker -- she keeps media away from the second tier candidates. Works like a charm.)

        Yeah, studying economics is way to waste your early- and mid-twenties.

        Similar to chasing girls. Being a ski bum. Surfing.

        But really, MMT is not a serious proposal. No way.  Pumping out fresh money would be met by huge rises in the interest rates needed to attract T-Bill buyers.

        Other countries would beat us like rented mules.

        Angry White Males + Crooks + Personality Disorder psychos + KKKwannabes + "Unborn Child" church folk =EQ= The Republicans

        by vets74 on Wed Aug 17, 2011 at 05:47:09 PM PDT

        [ Parent ]

  •  MMT is a description, not a prescription (2+ / 0-)
    Recommended by:
    wigwam, Calgacus

    MMT describes actually monetary operations that are now in place. The kerfuffle with PK is not over what should be, but what is. PK doesn't understand how the current monetary system operates. He is totally confused on how the Treasury, Fed, and commercial banking system operate and interact.

    What MMT is saying is that real resources are the only constraint and never "affordability." The US can always afford to fund whatever programs the Congress legislates.

    The only question is inflation. If the money spend in the economy in total results in nominal aggregate demand that exceeds the capacity of the economy to expand in order to provide, then inflation will result. That is the only issue, other than the political issue of the desired proportion of public v. private use of the available real resources.

    The right is trying to make this a question of affordability. It is not. But many Democrats are getting sucked into this false argument. Even PK is claiming that the budget needs to be balanced over a cycle. MMT shows why this is not the case.

    Live unity, celebrate diversity.

    by tjfxh on Wed Aug 17, 2011 at 05:34:10 PM PDT

    •  Exactly! (0+ / 0-)
      The US can always afford to fund whatever programs the Congress legislates.

      ... so long as the funding is via "money issue," which PK insists would lead to unacceptable inflation in normal times, i.e., when the volume theory of money holds.  ;-)
  •  You can print money (0+ / 0-)

    And it probably is the way it ought to be done.

    However, you can't print gasoline and Chinese stuff.

    If Chinese or OPEC think the crank on the greenback printing press is being turned too fast, they probably will demand payment in Euros, yen, gold, or silver.

    The ladies will be able to gas up at Exxon-Mobil Gas4Gold for a year or two, but the guys will have to thumb rides.

  •  The process of national governments borrowing (0+ / 0-)

    stems from a time when gold and money were one and the same.

    Once a government beat the gold coins out of the hands of the peasants, then the government had to find another source of gold.

    Foreign financiers had some they'd lend for a lucrative rate of interest.

    The soldiers expected payment in gold and it wasn't a good idea to take gold off one's soldiers while there was a war on.

    After victories, the enemy cities got pillaged and much of the loan could be repaid.

  •  Putin called the US a "parasite" (0+ / 0-)

    and expressed strong disapproval of US money creation policy.

    Many key Germans and Chinese don't like excessive US money creation either.

  •  Bonds pay interest. Money doesn't. If you (0+ / 0-)

    issue bonds, it doesn't devalue your existing money b/c interest on bonds compensates that. If you simply print money, you are devaluing the existing money. I don't see how any theories get around it.

    •  We're selling a lot of bonds at near-zero interest (1+ / 0-)
      Recommended by:

      ..., which by your theory makes them the equivalent of newly issued money.  But, I don't see a lot of inflation.

    •  The interest payment can be inflationary (3+ / 0-)
      Recommended by:
      wigwam, FG, Letsgetitdone

      Bond issuance vs currency issuance is just choosing between issuing 2 different kinds of money ("NFA").  I've never seen an argument for bond issuance except for when the economy is at full employment (or for distributional reasons, like WWII war bonds.)  As Abba Lerner noted long ago in his 'Economics of Control' there are both inflationary & deflationary effects of "printing bonds" instead of "printing money". As they cancel each other, the difference between "printing money" & "printing bonds" is "not likely to be very large".  

      And what evidence there is tends to show that the inflationary effect of bond issuance/high interest rates is larger than the deflationary effect.  As shown by Japan  20 years of "printing money" can mean 20 years of fighting deflation.  The thing to always remember is that inflation is only caused by spending.  How bond issuance affects consumption, investment and saving is the only thing to look at.

      •  A very lucid explanation. Thanks. (n/t) (0+ / 0-)
      •  Japan was issuing tons of bonds as well. (0+ / 0-)

        Which is how they got to the debt of 180% of GDP. And any significant differences between MMT and standard neo-Keyneisanism are the most obvious at full employment or close to it anyway. At zero bound there is indeed little if any difference between issuing bonds and printing money.

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