Thread by @GeorgeSelgin

Thread: It's very important to distinguish the implications of Fed monetization of _outstanding_ Treasury debt from those of Fed monetization of net Treasury security issues.

https://twitter.com/TheStalwart/status/1324446235776921600

Monetization of outstanding debt doesn't make much difference, just as @TheStalwart suggests. In the simplest case, financial institutions swap their securities for reserves. The interest burden then becomes a function of the interest paid on reserves.

Generally speaking, there's no fiscal gain from such monetization. The interest rate on reserves may be lower than some longer term Treasury borrowing rates. But because it's an adjustable rate, which the Fed may have to raise to check inflation, it may not be a bargain.

On the other hand, the stimulus effect of monetization of outstanding debt may be rather paltry, even when undertaken on a large-scale (QE). Absent any stimulus effect, the policy adds nothing to the government's capacity to finance any of its programs.

So a Fed decision to monetize 100% of existing debt might be perfectly sustainable. But it also might accomplish little. It might, however, expose the Fed and Treasury to considerable interest-rate risk that could prove troublesome. msci.com/documents/1019…

Monetization of new Treasury debt is a very different matter. Such monetization generally can't go on without limit without posing serious problems, and without unduly burdening the public, even if it is "sustainable" in the narrow sense that default can somehow be avoided.

(I can't overstate how serious a mistake it is for anyone to suggest that a sovereign-money issuing government's ability to avoid default means that its citizens need never suffer as a result of its having taken-on too much debt.)

Unlike Fed monetization of existing debt, monetization of new debt obviously does put more financial resources at the government's disposal--though not more than it might secure by merely floating more debt without Fed support. Fiscal stimulus is therefore in play.

Let's grant--as many, including most if not all MMTs, presumably will--that fiscal stimulus is much more effective in raising nominal spending than mere Fed monetization of existing debt.

In that case, it follows that it must eventually reach at point at which unemployment becomes trivial and prices start to rise. That is, the "real resource constraint" all MMTs recognize begins to bind. Eventually may be a ways off. But this is after all a discussion of limits.

So, fiscal stimulus clearly "does" something. It actually matters little whether or not the Fed monetizes the debt issued to finance the stimulus: only the interest terms change. The point is that whether it does or doesn't, the increased indebtedness has real consequences.

So lets suppose that, thanks to Fed-financed deficit spending, inflation creeps up beyond 2% (or whatever). The government and Fed, if intent on testing the limits of its debt sustainability, faces several choices, none of which involve either default or reduced gov't spending.

(1) The Fed can raise the IOR rate, thereby curtailing private borrowing and spending, including investment spending, financed by means of such. Besides "crowding out" private borrowing this choice raises the government's real interest burden.

(1) The Fed and government can simply allow inflation to worsen. (3) The government can address inflation using means other than monetary restraint, such as wage and price controls or incomes policies, which have their own, potentially serious adverse effects.

All of these options allow the government to "sustain" its indebtedness. But they don't allow it to do so without imposing costs on their citizens. There is, in short, no such thing as an "unlimited debt free lunch."

This is no argument against fiscal stimulus and deficit spending to combat recessions. It is merely to say that in so far as these policies are able to combat recessions by boosting spending, they can also generate unwanted inflation once unemployment has fallen sufficiently.

And this is equally true whether the Fed finances the deficit spending (monetizes the new debt) or not.

These are perfectly mundane points. I make them only to counter suggestions that MMT proves otherwise. It may sometimes appear to do so. But that appearance is deceiving.

@threadreaderapp unroll please.

(Concerning the pointlessness of further QE--as distinct from fiscal stimulus--at present see this excellent, recent @jonsindreu report: wsj.com/articles/marke….)