http://rajivsethi.blogspot.com/2013/11/the-payments-system-and-monetary.html
QuoteAbout forty minutes into the final session of a recent research conference at the IMF, Ken Rogoff made the following remarks:
QuoteWe have regulation about the government having monopoly over currency, but we allow these very close substitutes, we think it's good, but maybe... it's not so good, maybe we want to have a future where we all have an ATM at the Fed instead of intermediated through a bank... and if you want a better deal, you want more interest on your money, then you can buy what is basically a bond fund that may be very liquid, but you are not guaranteed that you're going to get paid back in full.
Prof. Sethi goes on to elaborate further.
Basically the proposal is to get private banks out of the business of managing the payments system and give that responsibility to the Fed.
What that does is eliminate the need for a vast system of deposit guarantees and related regulation. Consumers are given clear options between 100% safe deposits and non-guarateed investments.
The other advantage in theory is that Too Big to Fail is solved, moral hazard vanishes, and there is no need for capital regulation. The lower regulatory load compensates the banks for their loss of the ability to fund themselves with govt insured deposits.
Problems I see are:
1) political infeasbility. The Ron/Rand Paul audit the Fed nutters go ape. And the anti-keynsians (read the entire GOP and decent swaths of the Dems) oppose for the very reason Sethi likes the idea: it facilitates the ability to monetize debt-financed stimulus on the debtor side.
2) it doesn't end up solving TBTF for the same reasons that Lehman's collapse was problematic even though Lehman wasn't a deposit taking bank. The government still has a interest in preventing total disruption of asset markets, even if there is no direct impact to the payment system. And it is very likely that during a boom period, ordinary consumers will move balances from the safe Fed accounts to private bank investment accounts - putting huge pressures on the government to bail out those institutions. One way to deal with these problems is to only bail out indirectly by infusing cash into debtors as per Sethi's proposal, but that brings us back to #1.
I like it, a nice barbell strategy. You can either have near-total safety or here-be-dragons high risk investment, with corresponding interest rates and payoff.
Middle-of-the-road seems to be all respectable and able, but once every century or so, it goes spectacularly bust.
I may just be a stupid general practice lawyer, but why is this proposal superior to reinstating Glass-Steagall?
Quote from: Scipio on November 20, 2013, 07:17:29 PM
I may just be a stupid general practice lawyer,
Well, I wasn't going to say, but I'm glad someone did.
...and all types of credit except bond issuance, including consumer credit and small business loans, disappear.
Quote from: Admiral Yi on November 20, 2013, 07:20:45 PM
...and all types of credit except bond issuance, including consumer credit and small business loans, disappear.
And that would be an overall plus, right ?
edit:silly me, I forgot you need unsustainable consumer booms to bribe the electorate and fuel politics (18-24 mth election cycles)
Quote from: mongers on November 20, 2013, 08:01:29 PM
And that would be an overall plus, right ?
Oh yeah, anything that keeps the little man down is OK in my book.
Quote from: Admiral Yi on November 20, 2013, 08:03:08 PM
Quote from: mongers on November 20, 2013, 08:01:29 PM
And that would be an overall plus, right ?
Oh yeah, anything that keeps the little man down is OK in my book.
I wasn't suggesting you thought it was, but that I thought it was.
Quote from: mongers on November 20, 2013, 08:05:26 PM
I wasn't suggesting you thought it was, but that I thought it was.
You can see how I might be a little confused, seeing as how you directed the question at me and put a "right" at the end. :hmm:
Quote from: Admiral Yi on November 20, 2013, 07:20:45 PM
...and all types of credit except bond issuance, including consumer credit and small business loans, disappear.
Why? I read the article and didn't see anything that would indicate non-Fed banks ceasing to exist.
Yeah, would consumer credit disappear if banks lost the "safe deposits" business? Presumably they'd charge whatever interest the market could bear for their services as long as there was a market for consumer credit...?
Quote from: Jacob on November 20, 2013, 08:25:16 PM
Yeah, would consumer credit disappear if banks lost the "safe deposits" business? Presumably they'd charge whatever interest the market could bear for their services as long as there was a market for consumer credit...?
That's how I read it. Maybe Yi has different thoughts on the matter.
Quote from: fhdz on November 20, 2013, 08:15:01 PM
Why? I read the article and didn't see anything that would indicate non-Fed banks ceasing to exist.
No, you're right. They would presumably turn into non-bank lenders like those mortgage lenders that are always advertising.
The problem, rather, is whom the Fed would lend to and on what terms.
Quote from: Admiral Yi on November 20, 2013, 08:30:51 PM
Quote from: fhdz on November 20, 2013, 08:15:01 PM
Why? I read the article and didn't see anything that would indicate non-Fed banks ceasing to exist.
No, you're right. They would presumably turn into non-bank lenders like those mortgage lenders that are always advertising.
:yes: Specialized lenders, like mortgage "banks" and etc.
QuoteThe problem, rather, is whom the Fed would lend to and on what terms.
What are your thoughts on how they could do it and avoid economy damage?
I remember Sberbank. :)
Quote from: fhdz on November 20, 2013, 08:33:50 PM
What are your thoughts on how they could do it and avoid economy damage?
Theoretically it should be simple enough: adjust lending rates up or down to adjust credit and money supply. The problem to me is how do you create rigorous credit analysis, and insulate it from political pressure, in a governmental organization.
Quote from: Admiral Yi on November 20, 2013, 08:43:40 PM
Quote from: fhdz on November 20, 2013, 08:33:50 PM
What are your thoughts on how they could do it and avoid economy damage?
Theoretically it should be simple enough: adjust lending rates up or down to adjust credit and money supply. The problem to me is how do you create rigorous credit analysis, and insulate it from political pressure, in a governmental organization.
My guess is that instead of trying to insulate it, you would instead want to make it exceptionally transparent, such that political corruption is quickly visible and hopefully rooted out.
EDIT: By "it" I mean both the criteria and mechanisms of credit analysis.
Quote from: Scipio on November 20, 2013, 07:17:29 PM
I may just be a stupid general practice lawyer, but why is this proposal superior to reinstating Glass-Steagall?
They are both variants on the narrow banking concept, but Glass-Steagall is a very kludgey and ineffective way of eliminating depositor risk. It limits the types of risks banks can take on but not the magnitude. So historically G-S coexisted with deposit insurance and neither eliminated moral hazard nor the occasional crisis. G-S did not prevent the S&L crisis for example. And even a hypothetical G-S plus that is even more strict wouldn't guarantee stability, because even if all banks do is simple maturity transformation, there is always interest rate and credit risk.
Quote from: Jacob on November 20, 2013, 08:25:16 PM
Yeah, would consumer credit disappear if banks lost the "safe deposits" business? Presumably they'd charge whatever interest the market could bear for their services as long as there was a market for consumer credit...?
To respond to you and Yin, consumer credit and small business loans would continue to be provided on commercial terms. Simple profit motive at work. The government could still subsidize if it wishes.
Quote from: Scipio on November 20, 2013, 07:17:29 PM
I may just be a stupid general practice lawyer, but why is this proposal superior to reinstating Glass-Steagall?
For one thing, it would eliminate the temptation for the banks to push to repeal Glass-Steagall (again) or to otherwise find ways to steal people's money so that the bankers can get bonuses.
Quote from: Admiral Yi on November 20, 2013, 08:30:51 PM
The problem, rather, is whom the Fed would lend to and on what terms.
Presumably that wouldn't change. The Fed wouldn't be providing credit to consumers. Maybe very limited short-term overdraft facilities but nothing else. The Fed could still provide credit to institutions as policy dictates.
Quote from: The Minsky Moment on November 20, 2013, 07:01:15 PM
2) it doesn't end up solving TBTF for the same reasons that Lehman's collapse was problematic even though Lehman wasn't a deposit taking bank.
I thought the problem with LB is that threatened banks that did have deposits. That would not happen in this scenario.
Quote from: fhdz on November 20, 2013, 08:50:24 PM
My guess is that instead of trying to insulate it, you would instead want to make it exceptionally transparent, such that political corruption is quickly visible and hopefully rooted out.
EDIT: By "it" I mean both the criteria and mechanisms of credit analysis.
I'm not talking about political corruption per se. I'm talking about whiny people whining that they're getting too high a rate compared to that guy, that women and minorities aren't getting their fair share, etc. And think of the can of worms that would be opened when a borrower defaults to the Fed.
Quote from: Iormlund on November 20, 2013, 08:59:38 PM
Quote from: The Minsky Moment on November 20, 2013, 07:01:15 PM
2) it doesn't end up solving TBTF for the same reasons that Lehman's collapse was problematic even though Lehman wasn't a deposit taking bank.
I thought the problem with LB is that threatened banks that did have deposits. That would not happen in this scenario.
The problem with LB was that it stood as counterparty on a vast amount of asset transactions, and thus threatened the solvency of many institutions. Some of those were deposit-takers but that wasn't the key factor - rather the concern was to the integrity of the financial system as a whole. The proof of that is the AIG bail-out, which was undertaken in significant part by US authorities to prevent contagion spreading to AIG's European counterparties, which obviously didn't have US depositors at risk.
It would have a bit of a positive impact on TBTF from the standpoint that the ones capable of taking the Fed rate would not be limited like it is now. That would spread some risk around, I would think.
Well, it is not like having the free choice over where to receive and keep your income is a big part of personal liberty, nor there is any risk to having a single state institution handle the finances of the entire population. Not to mention the complete lack of temptation of corruption and/or short-sighted populist political actions with that insane power over the citizens` savings. So I say go ahead.
Quote from: Tamas on November 21, 2013, 04:56:01 AM
Well, it is not like having the free choice over where to receive and keep your income is a big part of personal liberty, nor there is any risk to having a single state institution handle the finances of the entire population. Not to mention the complete lack of temptation of corruption and/or short-sighted populist political actions with that insane power over the citizens` savings. So I say go ahead.
So you are arguing "go ahead" because you don't think it changes anything significant regarding of those concerns right now? I can buy that. The proposal vastly reduces the number of potential points of failure, without significantly increasing the changes of any one potential point of failure actually failing.
Quote from: grumbler on November 21, 2013, 07:27:06 AM
Quote from: Tamas on November 21, 2013, 04:56:01 AM
Well, it is not like having the free choice over where to receive and keep your income is a big part of personal liberty, nor there is any risk to having a single state institution handle the finances of the entire population. Not to mention the complete lack of temptation of corruption and/or short-sighted populist political actions with that insane power over the citizens` savings. So I say go ahead.
So you are arguing "go ahead" because you don't think it changes anything significant regarding of those concerns right now? I can buy that. The proposal vastly reduces the number of potential points of failure, without significantly increasing the changes of any one potential point of failure actually failing.
I was being sarcastic :P Now I admit there seems to be logic to having basic deposits with the Feds since they insure it anyways. But besides my above concerns I have a hard time believing "too big to fail" would stop to operate. Saving the asses of their own influence group (bankers and all) have been the top priority of the Fed, why would this change, if no decision makers or the way they make decisions change radically?
Quote from: Tamas on November 21, 2013, 08:12:01 AM
I was being sarcastic :P
There's nothing quite so fun as showing someone that their imagined hyperbole is actually just a description of the real situation. :D
QuoteNow I admit there seems to be logic to having basic deposits with the Feds since they insure it anyways. But besides my above concerns I have a hard time believing "too big to fail" would stop to operate. Saving the asses of their own influence group (bankers and all) have been the top priority of the Fed, why would this change, if no decision makers or the way they make decisions change radically?
I have no idea what an "influence group" is, nor why a member of the Fed Board would want to "save the ass" of a random banker, but the Fed doesn't save the "too big to fail" banks, anyway. That takes Congressional appropriations. If you are arguing that the proposed changes don't effect the relationship between the major bank officers and the US Congress, then you are arguing way off the topic, and if you aren't arguing that, what, exactly,
are you arguing?
I think I will just cut this short and concede that you, again, won a match of the sport called Grumblerwinsinwhathecallsdebate. Knock yourself out.
Quote from: Tamas on November 21, 2013, 04:56:01 AM
Well, it is not like having the free choice over where to receive and keep your income is a big part of personal liberty, nor there is any risk to having a single state institution handle the finances of the entire population. Not to mention the complete lack of temptation of corruption and/or short-sighted populist political actions with that insane power over the citizens` savings. So I say go ahead.
Individuals would have free choice in the proposal - they could put whatever amount of savings they want in a private bank, they just wouldn't get a government guarantee to back it. That is arguably a more free market solution than the present system.
It does whittle away at the distinction between fiscal and monetary policy - a distinction that is rather artificial to begin with in any fiat currency regime like the US. And that does raise the other concern you mention because either the political branches would tend to give up control over fiscal instruments (unlikely) or the political independence of the monetary authority would be curtailed.
Quote from: Tamas on November 21, 2013, 09:06:12 AM
I think I will just cut this short and concede that you, again, won a match of the sport called Grumblerwinsinwhathecallsdebate. Knock yourself out.
Okay, emo-boy. Dunno what your knickers are all twisted about, but they seem to have cut off blood circulation to your brain. Glad you were able to finish the ad hom before you burst into tears and shorted out your keyboard.
Quote from: grumbler on November 21, 2013, 10:24:13 AM
Quote from: Tamas on November 21, 2013, 09:06:12 AM
I think I will just cut this short and concede that you, again, won a match of the sport called Grumblerwinsinwhathecallsdebate. Knock yourself out.
Okay, emo-boy. Dunno what your knickers are all twisted about, but they seem to have cut off blood circulation to your brain. Glad you were able to finish the ad hom before you burst into tears and shorted out your keyboard.
:lol:
Quote from: Tamas on November 21, 2013, 09:06:12 AM
I think I will just cut this short and concede that you, again, won a match of the sport called Grumblerwinsinwhathecallsdebate. Knock yourself out.
I'm going to interpret your concession of defeat as a sign that you lost this argument.
Quote from: The Minsky Moment on November 21, 2013, 10:19:13 AM
Individuals would have free choice in the proposal - they could put whatever amount of savings they want in a private bank, they just wouldn't get a government guarantee to back it. That is arguably a more free market solution than the present system.
It does whittle away at the distinction between fiscal and monetary policy - a distinction that is rather artificial to begin with in any fiat currency regime like the US. And that does raise the other concern you mention because either the political branches would tend to give up control over fiscal instruments (unlikely) or the political independence of the monetary authority would be curtailed.
both good points
Quote from: The Minsky Moment on November 21, 2013, 10:19:13 AM
It does whittle away at the distinction between fiscal and monetary policy
Please elaborate.
Quote from: Admiral Yi on November 21, 2013, 12:21:21 PM
Quote from: The Minsky Moment on November 21, 2013, 10:19:13 AM
It does whittle away at the distinction between fiscal and monetary policy
Please elaborate.
I think it would break down a bunch of the layers we have between the policymaking steps officialdom can take and the average Joe's bank balance. Right now, if the Fed alters the funds rate, it does affect Joe, but only after trickling through several other layers of errata in the economy. This would create a direct immediate link between Joe and Bernanke, and we've never seen anything quite like that before. That would, in turn, democratize the Fed much more and inject it with a hell of a lot more politics. At least I'm guessing it would.
The next things to come would be using the Fed accounts to assist tax collection, enforce child support, etc.
Quote from: Admiral Yi on November 21, 2013, 12:21:21 PM
Quote from: The Minsky Moment on November 21, 2013, 10:19:13 AM
It does whittle away at the distinction between fiscal and monetary policy
Please elaborate.
Imagine two institutions.
One is called LH. LH spends money-units (Mu) on various projects. In order to fund that spending it levies Mu from people who benefit from those projects, and it also can raise additional Mu by issuing IOUs (bonds). Looked at in isolation it appear that LH is credit constrained - that is, all spending of Mu must ultimately paid out of levies and LH's ability to obtain credit advances is just a matter of shifting the burden of those levies into the future.
Second is RH. RH is a depository for Mu holdings that has a special power - it can create stocks of Mu at will.
Now imagine that LH stands for left hand and RH stands for right hand. They are two parts of the same body. If that is so then the apparent credit constraint on LH is an illusion. If the left hand needs Mu to fund projects it can just get it from the right hand. It doesn't need recourse to levies. In this world, what purpose do the levies serve? Essentially two: (1) as a way to control the quantity of Mu (inflation) - because raising levies brings Mu back out of the economy and into the LH-RH depository, and (2) to create a need (demand) in the general population for Mu - i.e. because they are needed to satisfy levies. Bond issuance serves the purpose of providing benchmarking and convenient collateral for the private financial system.
You could simply the whole LH-RH system by amalgamating the institutions into one: LRH. LRH would make a decision on how much to spend on projects (G). It then would set levies/taxes (T). This appears to be fiscal decision but now in fact is monetary. T is set in order to achieve a desired level of Mu. If LRH wants to expand Mu, it cuts T in relation to G; if it wants to contract the supply it raises T in relation to G.
This is a nutshell is Abba Lerner's old theory of Functional Finance which he argued is a feature of any fiat currency regime. For LH read Treasury, and for RH read the Fed. Only it doesn't really work that way in the US because of convention as reflected in the legal and institutional structure of the Treasury and the Fed. The two are kept formally separate by law and convention and hemmed in by various rules in an attempt to separate a fiscal budgeting function from the monetary function. But when push comes to shove, it is all one government, and there can be a blurring, as happened in the financial crisis where the Fed and Treasury coordinated jointly to fund and support the banking system.
The logical ending point of the Rogoff concept (as elaborated by Sethi) is an LRH institutional structure that breaks down the separation of functions.
Doesn't that describe the way it used to work in the UK?
I like the sound of the idea because it's quite simple and elegant.
Quote from: The Minsky Moment on November 20, 2013, 07:01:15 PM
Problems I see are:
1) political infeasbility. The Ron/Rand Paul audit the Fed nutters go ape. And the anti-keynsians (read the entire GOP and decent swaths of the Dems) oppose for the very reason Sethi likes the idea: it facilitates the ability to monetize debt-financed stimulus on the debtor side.
2) it doesn't end up solving TBTF for the same reasons that Lehman's collapse was problematic even though Lehman wasn't a deposit taking bank. The government still has a interest in preventing total disruption of asset markets, even if there is no direct impact to the payment system. And it is very likely that during a boom period, ordinary consumers will move balances from the safe Fed accounts to private bank investment accounts - putting huge pressures on the government to bail out those institutions. One way to deal with these problems is to only bail out indirectly by infusing cash into debtors as per Sethi's proposal, but that brings us back to #1.
3) The fed would have to either recreate or incorporate customer banking, or let existing banks act as a front end for these federal accounts (and provide some way for the banks to access these accounts). That sounds like a project that could make the ACA website look like a walk in the park, and with many worse potential consequences for security holes.
I can see a number of problems with the proposal.
1. The 800 pound gorilla is ceding control of the money supply to the political-legislative process. Economic history is littered with examples of the damage this can cause.
2. The dissapearance of Treasury securities from the market would cause serious problems in terms of bank capitalization and collateralization of deals.
3. There will be times when you don't want fiscal and monetary policy to coincide: for example, a war fought during full employment/risk of inflation.
4. Surely there is *some* value in having the government compete for available funds on the open market with other users of credit. This proposal eliminates that competition.
Quote from: frunk on November 21, 2013, 03:02:56 PM
3) The fed would have to either recreate or incorporate customer banking, or let existing banks act as a front end for these federal accounts (and provide some way for the banks to access these accounts). That sounds like a project that could make the ACA website look like a walk in the park, and with many worse potential consequences for security holes.
That shouldn't be a problem. The Fed already has tried and true linkages to private banks. For things like ATM service (e.g.) the Fed could contract out to competing service providers, or even better - set basic standards and then link their system to whoever wants to enter the market and satisfies the standards.
Thread worthless, entertainment wise, without contribution from anti-FIAT currency nut.
I'll try and deputise, but I'm way outta my depth with regular economics, let along the tinfoil stuff. :(
Quote from: Admiral Yi on November 21, 2013, 03:13:46 PM
I can see a number of problems with the proposal.
1. The 800 pound gorilla is ceding control of the money supply to the political-legislative process. Economic history is littered with examples of the damage this can cause.
Hence the rage for independent central bank structures following the 70s. But that has issues of its own. One could see the present structure as a way to maximize technocratic control over the economy without causing the peasants to revolt. There is something to be said for that. Also something to be said against that
2. The dissapearance of Treasury securities from the market would cause serious problems in terms of bank capitalization and collateralization of deals.
The government could still issue bond if it wished, even absent a budgetary function - see below
3. There will be times when you don't want fiscal and monetary policy to coincide: for example, a war fought during full employment/risk of inflation.
War finance presents the same problem as now: whether the government can create a credible commitment to undo the monetary expansion once the crisis ends. If the government;s commitment is credible then there won't be an expectation of permanent monetary enlargement and inflation can be kept under control. Under this schema that could be done the traditional way - selling warbonds to mop up the excess liquidity with a commitment to retire the bonds in the future
4. Surely there is *some* value in having the government compete for available funds on the open market with other users of credit. This proposal eliminates that competition.
see above
Responses in italics.
Quote from: The Minsky Moment on November 21, 2013, 04:15:13 PM
That shouldn't be a problem. The Fed already has tried and true linkages to private banks. For things like ATM service (e.g.) the Fed could contract out to competing service providers, or even better - set basic standards and then link their system to whoever wants to enter the market and satisfies the standards.
These linkages, I assume, are on an institutional level and not at the individual account. If the communication is now hundreds of millions of accounts involving billions or more transactions per day I think it becomes significantly more complicated. Could I potentially access my federal account from different banks, or would it be "assigned" to one and there would have to be a process to switch between them?
Quote from: The Minsky Moment on November 21, 2013, 04:25:58 PM
Hence the rage for independent central bank structures following the 70s. But that has issues of its own. One could see the present structure as a way to maximize technocratic control over the economy without causing the peasants to revolt. There is something to be said for that. Also something to be said against that
One could and should see it as a way to take control of monetary policy away from elected leaders who, time and again, and have demonstrated their propensity to buy votes in the present with the illusion of cost free affluence. The only thing to be said for that is the illusion of cost free affluence.
Quote The government could still issue bond if it wished, even absent a budgetary function - see below
Or it could not.
Quote War finance presents the same problem as now: whether the government can create a credible commitment to undo the monetary expansion once the crisis ends. If the government;s commitment is credible then there won't be an expectation of permanent monetary enlargement and inflation can be kept under control. Under this schema that could be done the traditional way - selling warbonds to mop up the excess liquidity with a commitment to retire the bonds in the future
You misread my hypothetical. Think Vietnam. Easy money was used to finance the war, which led to 70's stagflation. Now one could argue that revenues should have been raised to finance the war, but the case can also be made that wars are exceptional events [insert mongers-type joke here] which can and should be financed through deficit spending. In this one handed system you can't run a deficit and maintain steady, non-inflationary money supply.
Quote from: Admiral Yi on November 21, 2013, 04:54:49 PM
You misread my hypothetical. Think Vietnam. Easy money was used to finance the war, which led to 70's stagflation. Now one could argue that revenues should have been raised to finance the war, but the case can also be made that wars are exceptional events [insert mongers-type joke here] which can and should be financed through deficit spending. In this one handed system you can't run a deficit and maintain steady, non-inflationary money supply.
I think Vietnam shows that having a two-handed system doesn't fix that problem.
In either system the problem is the same: in order to finance war without generating inflation, the government must make a credible commitment to run G-T<0* for a period of time after the war concludes.
In a two-hand system, if the government chooses to finance by selling bonds, it must convince investors that it will be able to repay those bonds without unduly inflating away their real value. That means the future commitment to keep G-T down. Otherwise either people won't buy the bonds or the debt burden will be inflated away ex post.
In a one-hand system, the problem is the same. A temporary increase in the money supply will not raise inflationary expectations if the population truly believes it will be reversed in the future. In the one hand system that means the government committing to keep G-T down after the war's end.
To the extent it helps convince the population of the credibility of the commitment, and to temporarily mop up excess liquidity that finds its way into private hands during the war, the one-handed government can issue warbonds just as the two handed one does. But that will only work if the population believes the government will redeem them after the war by increasing the rate of T instead of just rolling the printer. Again, same as in the two-handed case.
* really not strictly zero, but below RGDP growth after accounting for interest burdens.
Quote from: The Minsky Moment on November 21, 2013, 06:09:23 PM
In either system the problem is the same: in order to finance war without generating inflation, the government must make a credible commitment to run G-T<0* for a period of time after the war concludes.
* really not strictly zero, but below RGDP growth after accounting for interest burdens.
This is not true. Countries can pack on additional debt, up the elusive tipping point when investors start to flee, without causing inflation. National debt skyrocketed in the last 6 years, and inflation is running around 2%. Surely you're not going to claim that this is because investors know that this additional debt will be paid off with surpluses for a period of time after Teh Greatest Recession is over.
Quote from: Admiral Yi on November 21, 2013, 07:13:52 PM
This is not true. Countries can pack on additional debt, up the elusive tipping point when investors start to flee, without causing inflation.
In a dual system like ours, the question is whether people believe the debt will ultimately be repaid through taxation. If the "tipping point" is reached and people don't believe the government can or will repay the real value of the debt, either there will be a default or the expectation that the debt will be inflated away (the only difference being distributional consequences). If the latter, then inflationary expectations will build.
In the unitary system it is really no different. The government makes the expenditures directly, but there is no permanent increase in the money supply if the government commits to retire the issuance in the future by taxing it away, or cutting future spending. A purely emphemeral increase in the monetary supply shouldn't affect inflationary expectations. And if the government is concerned about temporary excess liquidity it can always issue bonds, in which case the result is exactly the same as in the dual system.
In both cases, the government's task is the convince the public that the expansion of spending will be reversed in the future, and in both cases the consequences of failure are either a buildup in inflationary expectations or a default.
QuoteNational debt skyrocketed in the last 6 years, and inflation is running around 2%. Surely you're not going to claim that this is because investors know that this additional debt will be paid off with surpluses for a period of time after Teh Greatest Recession is over.
Inflation is actually running well under 2% by some measures . . .
In our dual system, the issuance of debt should have zero inflationary impact unless the public believes either: (1) that the government will elect to resolve the debt in the future in part by inflating it away, or (2) that the underlying spending will jump start the economy onto a more expansionary (nominal) path. The lack of inflationary expectations indicates that neither belief predominates in the markets, and IMO for good reason.
Inflation is low because notwithstanding the Fed's pumping reserves into the banking system, the reserves are for the most part just sitting dormant in Fed accounts and the private financial system is not creating new money by lending. Whether this is demand side (firms cutting investment plans) or supply side (banks being cautious and restricting credit) or both is hard to say but the result is plain enough. The markets looks ahead and see stagnant nominal growth.