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.
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.