Thread by @Noahpinion

1/This Paul Krugman post reminded me of something I'd been wanting to talk about, regarding the debates around MMT.

Basically, monetary policy doesn't make much of an appearance in MMT or the public discussion around it.

nytimes.com/2019/02/25/opi…

2/A lot of people, both pro-MMT and anti-, have discussed the situation in which budget deficits get extremely large, and the Fed keeps interest rates at 0 forever, and the constraint on deficits becomes inflation.

3/This seems to have convinced a bunch of people that inflation is always the limiting factor on budget deficits.

But in fact, it's not.

It's only the limiting factor in the case where the Fed keeps rates at 0 forever.

4/If the Fed doesn't keep rates at 0, and in general doesn't agree to finance infinite borrowing by the Treasury, then private investors can force a government default by halting their purchases of government debt.

5/Without a compliant Fed, government interest payments can go to infinity, forcing infinite borrowing to roll over the debt, which will then cause a default.

6/Of course in real life, the Fed would absolutely step in to be the government's lender of last resort.

It would peg interest rates at zero and, if absolutely necessary, it would buy new Treasuries as they were issued.

7/Can the Treasury force the Fed to hold rates at 0 forever?

Probably.

Even if the Fed is nominally independent, if the government debt gets too large the Fed will hold rates at 0 to prevent a sovereign default.

8/This is a situation known as "fiscal dominance".

In fact, Japan is probably in this situation already. The Bank of Japan is afraid to raise interest rates because of the enormous interest payments that would impose on the central government.

9/So, fine, fine. A technicality, right? Just borrow so much that the Fed has to do what we want it to do, and we're good. We're back to the world where inflation is the only possible constraint on government borrowing.

Right?

10/But this ignores two things.

First, the Fed might wake up in a crazy mood and decide to force a sovereign default. At which point it would probably lose its independence, but possibly not quickly enough to avoid some severe economic disruption.

11/Second, and more insidious, is the possibility that keeping interest rates at 0 forever damages productivity - and thus the long-term health of the economy - in ways not captured by standard macro models or macro intuition.

12/Japan has grown OK in recent decades, when rates have been zero. And there's been no inflation.

But productivity growth has been slower than in the U.S. and elsewhere, requiring Japanese people to work and invest more to maintain growth.

google.com/url?sa=t&sourc…

13/Have Japan's perpetually zero interest rates - which allow unproductive companies to roll over their debts easily - been a factor in this slow productivity growth?

I don't know. Maybe, maybe not.

14/But in any case, I think the people debating MMT, on both sides, need to realize that a captive Fed, and permanently zero interest rates, and any outside-the-model negative effects those things might generate, are absolutely part of the very-large-deficit scenario.

(end)