Far too many times have I seen the "debt monetization" or "money printing" canards put forward about the supposed dangers of deficit spending without issuing TSY securities. After a long and frustrating twitter exchange with the excellent Frances Coppola, I feel compelled to expand on the logic for why this is much ado about nothing. Her position repeats the conventional opinion that deficit spending without issuing TSY securities is inherently inflationary because TSY securities "sterilize" the dollars the deficit spending adds to the economy. Lets break this down into two parts:
1) The accounting impact of the deficit spending
2) The accounting impact of the TSY security issuance
First of all, we need to recognize that all Govt spending and taxing transactions are settled exclusively with US currency aka reserves at the Fed. The Govt does not spend in cash so we can ignore that part of the US Currency supply in this analysis. So what happens when the Federal Govt makes an unemployment insurance payment of $1000 to unemployed Joe and this is all done via deficits? Well, Joe presumably has a bank account at a private bank, and in turn, that private bank (lets assume he uses Chase) has a bank account at the Fed.
So step 1:
The TSY General Account's (TGA) checking=reserve account at the Fed = -$1000
Chase's checking=reserve account at the Fed = +$1000
But Chase doesnt get those funds for free, they must in turn credit unemployed Joe's checking account = +$1000
So far, so simple. The TGA account is reduced by $1000, Chase's net financial position does not change as their assets (reserves) increase by the same amount as their liabilities (Unemployed Joe's deposit account), and unemployed Joe gets a nice net credit to his checking account of $1000.
Is this spending inflationary? Well that depends on what unemployed Joe does with this money and what the state of the economy is. Money that is sitting in bank accounts and not spent on goods and services cannot drive up inflation. Its not the money supply per se that effects inflation, its the spending. If the economy is at full employment and Joe spends this $1000, he may contribute to driving up the price of goods and services. But the economy is never at full employment any more. Since 1980 we've had unemployment below even 5% for less than 7 years out of 34:
And if spending causes more people to be employed, which in turn increases the number of goods and services available for sale, then that spending need not be inflationary at all.
So what does issuing TSY securities have to do with this? According to conventional economic mythology, this deficit spending is inherently inflationary unless we "sterilize" an amount equal to the deficit spending by issuing TSY Securities. So lets see what that looks like:
Step 2) Pension Fund A wishes to save $1000 and earn a guaranteed interest return. Pension Fund A also banks at Chase.
So Pension Fund A's checking account gets debited = -$1000
Pension Fund A's securities account at the Fed gets credited = +$1000
Chase's liabilities (customer deposit) gets debited = -$1000
Chase's assets (Reserve account) also gets debited = -$1000
The TSY General Account at the Fed gets credited = +$1000
So Pension Fund A has no change to its net financial position
Chase has no change to its net financial position
And the TGA gets a $1000 credit
I dont understand what this is supposed to accomplish with respect to inflation. Pension Fund A didnt lose anything by buying a TSY security, and they can sell it anytime they like to get back their private checking deposits at Chase. And some other entity takes Pension Fund A's place in the accounting
But what if the Fed implements QE and buys this TSY security from Pension Fund A directly? We simply reverse all the accounting in step 2) and its like the Govt never issued that TSY security in the first place. But if Pension Fund A doesnt go out and spend this $1000 on real goods and services, this money can have no impact on inflation as Pension Fund A is saving by definition, not spending.
Granted, Pension Fund A will most likely not just keep this money idle in a checking account at Chase as thats not a practical way to save money for a Pension Fund. Maybe they would buy stocks or municipal bonds instead, increasing the prices of those financial assets. But financial asset appreciation is not consumer inflation. Maybe the sellers of the financial assets to Pension Fund A are going to use that $1000 to buy real goods and services, but maybe not. Maybe the sellers buy a $1000 financial asset from other sellers and the new sellers now spend that $1000 on real goods and service. Or maybe they dont. Either way the inflationary impact of the original deficit spending comes down to the state of the economy and the spending vs savings desires of the private sector in the aggregate. Issuing TSY securities does not prevent anybody from spending money, so how can they be anti-inflationary? The people and entities that save in TSY securities are far more likely to simply save some other way than they are to go out and spend that money on real goods and services.
If QE results in the exact same financial effects as if those TSY securities were never issued in the first place, and "debt monetization" or "printing money" (aka deficit spending US Currency without an equivalent amount of TSY securities issuance) is inherently inflationary, shouldnt we have seen some of this inflation by now? Hell, Japan has been doing QE for 20 years, and all we keep hearing about is how deflation is hurting the Japanese economy. I cant imagine a better real world example for a social science then QE for demonstrating why these mythological dangers of "printing money" are simply unfounded.