Oh dear sweet Jehovah.
First Republicans, after spending years warning about the danger of a debt default, decide to not only recommend a U.S. sovereign default, but actively push for one in Congress.
Now, after Republicans spent years warning us about the (then nonexistent) possibility of hyperinflation, Ron Paul comes out and suggests a policy that would be a huge step toward hyperinflation.
Specifically, Ron Paul wants to have the Fed destroy its holdings of U.S. Treasury bonds. This would be retroactive seigniorage; it would mean that the money that the Fed printed in the past to buy those Treasury bonds was actually printed to pay off the U.S.'s sovereign debt.
As any Econ 101 student knows, large-scale sustained seigniorage is what causes hyperinflation. Now, the Fed doing a one-off round of retroactive seigniorage would not be enough by itself to push us into Weimar Republic territory - in particular, because the money has already been printed. But it would also send a signal that the Fed is no longer an independent central bank, and that Congress feels free to strong-arm the Fed into paying off U.S. sovereign debt with printed money at any time in the future. That would be a signal that much more seignorage is on the way, which would push us into hyperinflation. (Tyler Cowen sees this possibility, but rather euphemistically labels the future seigniorage "QEIII".)
So what the heck is Ron Paul thinking? Paul is a well-known supporter of the gold standard, which policy-wise is the exact opposite of hyperinflation. Is he simply betting that we'd decide to go back on the gold standard after we got tired of pushing around wheelbarrows full of billion-dollar bills? Or does he just know absolutely nothing about economics?
Update: Greg Mankiw agrees that Paul's idea is crazy, but is actually less worried than I am about the signal of future seigniorage that would be sent by revoking the Fed's independence in order to pay off our debt. Dean Baker actually likes the idea, and thinks we could deal with any inflationary effects by raising reserve requirements. So he's really cavalier about revoking central bank independence.
Update 2: A bunch of people (including Greg Mankiw and Andy Harless) are saying "But the Ron Paul plan just transfers money from one part of the government to another, and hence would be harmless." I tried to explain above why I don't think that's the case, but let me try again. Yes, having the Fed destroy a bunch of government bonds would be harmless if we only did it once, and if people believed we were only going to do it once. If we did it again and again as a regular policy, we would have to get the Fed to keep printing more and more money so that we could destroy U.S. Treasuries again and again. That would cause hyperinflation. But suppose we only do it just this once. Could we convince people that it was only a one-time thing? I doubt it. First of all, doing the Ron Paul plan even once requires revoking the independence of the Fed, which tells people that Congress is now willing to use the Fed to implement fiscal policy. That by itself is a huge policy change. Second of all, if the Ron Paul plan achieved results that pleased lawmakers (i.e. reducing headline federal debt), that would tend to make the lawmakers want to do it again. And again. So there is every reason to think that the Ron Paul plan would lead to popular expectations of large-scale seigniorage...and hence to hyperinflation. In any case, it's an absolutely enormous risk. To take that risk, for the sole purpose of reducing headline debt (while leaving net debt unchanged), is, as Greg Mankiw says, crazy.
Would it truly lead to hyperinflation:
ReplyDeletehttp://neweconomicperspectives.blogspot.com/2010/03/hyperinflation-hyperventalists.html
I remember reading this on Mankiw's blog this morning and thinking...
ReplyDelete(For #1) Huh? Destroy debt that it (the government) owes itself? What will that do?
(For #2) Make banks even more unwilling to loan out money? Aren't we in a credit crunch already? Who the $#@$ is Dean Baker? A journalist?
......
Well geez, I'd make a better macroeconomist than that guy.
I completely missed the seigniorage aspect of it though. Nice catch!
I don't think Ron Paul knows economics.
ReplyDeleteRon Paul knows nothing about economics, but…
ReplyDelete…after many of the claims in your post I have decided that you don't know anything about economics either
Example: "As any Econ 101 student knows, large-scale sustained seigniorage is what causes hyperinflation."
Nobody in the article is talking about large-scale sustained seigniorage, and
Our productivity has not been massively restricted.
Paul
Noah,
ReplyDelete"Ron Paul wants to have the Fed destroy its holdings of U.S. Treasury bonds. This would be retroactive seigniorage; it would mean that the money that the Fed printed in the past to buy those Treasury bonds was actually printed to pay off the U.S.'s sovereign debt."
Okay. If the Fed can do that, it can do this:
Suppose that instead of destroying Treasury bonds, the Fed destroys the mortgage-backed securities it bought since the crisis.
That way we get rid of the risky liabilities that created the risky assets that created the problem to begin with.
We stop the deflationary contraction of M1, which happens when people pay down debt.
We bring relief to many homeowners, leaving them with more money, perchance to stimulate the economy.
And we would reduce the debt that has created problems for our economy since the 1970s: private sector debt.
ArtS
By the definition that you linked to, the Federal Reserve is already engaged in seigniorage:
ReplyDelete"Some economists regarded seigniorage as a form of inflation tax, redistributing real resources to the currency issuer. Issuing new currency, rather than collecting taxes paid out of the existing money stock, is then considered in effect a tax that falls on those who hold the existing currency.[3] The expansion of the money supply may cause inflation in the long run."
They have been debasing the currency for nearly 100 years. Destroying 1.6 trillion in treasuries they hold will not cause hyperinflation or further debase the fiat paper money now created out of thin air. Beyond staving off the argument over raising the debt ceiling, it will have a minor effect to the contrary, if at all. And your claim would only have merit (if at all) under a commodity backed currency.
Give Dr. Paul a break and put down the Marxist central bank crack pipe!
Ron Paul does everything he can to signal that he is a crank. Therefore, I believe him to be a crank.
ReplyDeleteMankiw does everything he can to signal that he is a hack. So, I believe him to be a hack.
What was the question?
Oh yeah, what is the standard for responsible policy-making, when, with unemployment at 9+% and real wages declining, our politicians are debating whether it is better to default or disinvest, and who has the better plan to destroy Social Security?
It is a mark of our advanced decadence that Ron Paul, the crank, knows more useful economics that the corrupt hacks, who are the "serious" experts.
P.S. The Arthurian is right: serious, non-hacks would have proposed a doomsday in 2008 or 2009, to deal with the insolvency of the financial system, by acclerating the adjustment of bad debt. In effect, we would have just burned a lot of private financial claims, which originated in fraudulent or incompetent financial processes. Instead, we larded them onto the Federal government, transforming the claims manufactured by Wall Street grifters into full faith and credit obligations of the United States. And, not even a peep of an objection from the likes of Krugman or Thoma or DeLong than any of the Right-wing hacks.
Much of mainstream, "orthodox" economics is no better than astrology combined fetishism, in terms of its ability to demonstrate or teach management of our collective economic affairs.
Roll your eyes all you like; economists made this world the way it is.
Ron Paul would've never let us get into this situation in the first place. Look at his voting record. At least he's honest on where he stands.
ReplyDeleteSounds like another hit piece on Ron Paul...I'd say this guy knows what he's talking about and thinks it's a great idea:
ReplyDeletehttp://www.tnr.com/article/politics/91224/ron-paul-debt-ceiling-federal-reserve
Oh, and since when has the Fed been independent?
ReplyDeleteBarring an effect on expectations, Ron Paul's suggestion would be nothing more than an accounting gimmick, both (as Greg Mankiw notes) in the short run and (also) in the long run. Dean Baker brings up reserve requirements, but they are an unrelated issue: the Fed faces the same choice with respect to reserve requirements whether or not it destroys the bonds. When the time comes to tighten, the Fed will have to choose among three actions: raise reserve requirements, sell bonds, or raise the interest rate it pays on reserves. The last two of these actions are essentially equivalent in their effects: the Fed can raise long rates directly by selling bonds (and pay for it by taking losses on the bonds), or it can raise long rates indirectly by raising the path of short rates (and pay for it by paying more interest on reserves). Taking away one of these two equivalent options (by destroying the bonds) has no substantive effect.
ReplyDeleteThe only difference is that the Fed's balance sheet will show a deficit. Presumably the Fed will make up the deficit by applying its future profits to its own balance sheet rather than remitting them to the Treasury. In effect, missing out on the Fed's future profits will be the Treasury's way of servicing the debt.
By the way, I'm not sure Greg Mankiw is right about the productivity implications of raising reserve requirements. Reserve requirements are essentially a distortionary tax, and as such they are an alternative to some other form of taxation, borrowing, or budget cutting. Unless you know what the alternative would be and how it would affect productivity, you can't say that reserve requirements are more distortionary than the alternative. You could be taxing profits, crowding out investment with government borrowing, or allowing infrastructure and basic research to collapse, and I think I would prefer raising reserve requirements (from a productivity point of view). Also, since our current system taxes corporate profits twice but interest only once, taxing the production of loans by raising reserve requirements might partly serve to offset an existing distortion.
ReplyDelete@Andy:
ReplyDelete"Barring an effect on expectations"
But expectations are the name of the game when it comes to inflation. If we tell the Fed to cancel U.S. sovereign debt, it A) destroys any notion of central bank independence, and B) sends a message that we'll do so again, if our debt gets too high.
It seems hard to argue that that wouldn't have an effect on expectations.
"But expectations are the name of the game when it comes to inflation"
ReplyDeleteAre inflation expectations rational? Rules of the game are dictated by your theory. Drop your theory and rules will change.
"As any Econ 101 student knows, large-scale sustained seigniorage is what causes hyperinflation."
ReplyDeleteNo it isn't. The theory is completely wrong.
There are billions sat in the reserve accounts now and no sign of any inflation.
That's because money is endogenous. The banks don't need no stinkin' reserves to lend money. They lend money whenever anybody is prepared to pay the rate on offer.
Destroying the bonds would mean Fed liabilities are greater than assets, i.e. the Fed would be bankrupt.
ReplyDeleteTherefore in order for the Fed to continue operating, the Government would need to recapitalize it using new debt. i.e. the total debt would remain unchanged.
This is another way of saying that, in reality any currency issued is a liability of the Fed, and if the Fed fails, a liability of the Government. The whole concept of having a central bank that is required to maintain solvency is what enforces compliance with this fundamental principal.
It is a self-imposed constraint that underpins the credibility of the currency.
If they stop counting currency issued as debt, that's the beginning of the end for the currency.
Anon--
ReplyDelete"Destroying the bonds would mean Fed liabilities are greater than assets, i.e. the Fed would be bankrupt."
Excellent; great clarity. Thanks.
The Fed does not have, nor does it not have assets…
ReplyDeleteAssets have been created by keystrokes since 1971…
Thinking otherwise is a mirage.
Uh, no, that article is very inaccurate. Here is Robert Wenzel on that hit piece: http://www.economicpolicyjournal.com/2011/07/denninger-displays-total-confusion-on.html
ReplyDeleteRoll your eyes all you like; economists made this world the way it is.
ReplyDeleteHorseshit Bruce! If you want to scapegoat, then point fingers at financial industry lobbyist, investment bankers, credit rating agencies, insurance agencies that backed CDO's stuffed with toxic MBS, etc. If you want to blame an ideology, then look at the deregulatory orthodoxy that permeates Washington.
You might as well just run around in a circle screaming "The sky is falling!"
I don't think Ron Paul knows economics.
ReplyDeleteRon Paul knows "Austrian" economics. Austrians don't really understand economics either, it's a laughing stock economic school of thought amongst the academic community. Of course, Austrians will dismiss the academic community, people who spend their whole lives empirically testing/studying economic phenomena, as being Marxist-Statist-Socialistic-Nazis who have allowed Keynesian economics to dominate the Wall Street and Federal government community because it benefits their own self-interest.
Don't believe me, go to youtube and look for users who sympathize with Austrian economics. It's a damn religion! I've never seen such aggregated stupidity in my life. Ron Paul and Peter Schiff are their high priests apparently.
There is no effect here -- either the Fed earns interest on its debt and rebates it to the Treasury or it doesn't and it rebates nothing to the Treasury. Unless, as Noah surprisingly gets correct, it signals a change in the "type" of the government we have that says we're going to do things according to the Austrian (non)-model of the economy. Then we're all pretty much fucked.
ReplyDeleteCan we convince people that it's a one time thing?
ReplyDeleteAre you convinced that bailing out the banks, converting their grifters' paper into obligations of the United States, as Bernanke and Geithner did in 2008-9 on a huge scale, was a one-time thing?
There's an asymmetry in your thought, which I cannot quite fathom or credit
Noah:
ReplyDelete"expectations are the name of the game"
But if something substantive doesn't change, then there's no reason for expectations to change. You're essentially saying that the destruction of bonds is a sunspot, but we don't really know how the market will interpret any given sunspot, and there's no a priori reason to expect any particular interpretation, given that sunspots, after all, have no fundamental effect.
"If we did it again and again as a regular policy, we would have to get the Fed to keep printing more and more money so that we could destroy U.S. Treasuries again and again."
First of all, the proposal is only to destroy the bonds that the Fed currently holds, not to require the Fed to buy new bonds. It doesn't require the Fed to print any money at all, and neither would any future iteration. What it does is prevent the Fed from destroying existing base money. Given that the Fed can pay interest on reserves, however, that prohibition, along with any future iteration of it relative to future base money, is irrelevant. Next year, in 20 years, in 200 years, in 2000 years, if the Fed wants to tighten, it need only raise the interest rate it pays on reserves (or raise the reserve requirement, which is more or less equivalent to raising the IOR rate and then taxing back the increased interest payments). In effect, the Fed can issue its own bonds to replace the government bonds.
"doing the Ron Paul plan even once requires revoking the independence of the Fed"
Why can't the Fed do it unilaterally, on its own volition? (It could be justified as a way to avoid a debt crisis if Congress fails to pass a debt ceiling.) Frankly, I think that's more likely to happen than having both houses of Congress pass Ron Paul's proposal.
The real issue is what would happen when the Fed has a deficit on its balance sheet, and whether there is any limit to the size of the deficit the Fed can show before something happens. Since the Fed has the ability to create money on its own, it can presumably maintain its liquidity no matter how technically "insolvent" it is, so there is no practical limit on the Fed's ability to control the money supply. Severe Fed insolvency might be the sort of sunspot that would lead people to expect inflation. On the other hand, markets might anticipate that the Fed would not want to become too severely insolvent. If the Fed has to worry that it may need to destroy future bonds, it has reason to be cautious about purchasing those bonds in the first place, and this would tend to give future policy a deflationary bias rather than an inflationary one.
Also, I just have a hard time imagining going from where we are now to hyperinflation in the short-to-intermediate time frame. We're talking about a demand-side effect here, so the mechanism would presumably involve an economic boom. I don't think that would be a bad thing. If our recession turns into a boom, I'm sure we can figure out a way to deal with it before it gets out of hand.
@Andy:
ReplyDelete"But if something substantive doesn't change, then there's no reason for expectations to change."
Many kinds of policy changes are substantive, not sunspots. I believe that loss of central bank independence is one of them. I believe that the manipulation of the Fed's balance sheet with the publicly stated intention of reducing headline debt is another.
"First of all, the proposal is only to destroy the bonds that the Fed currently holds, not to require the Fed to buy new bonds."
See Tyler Cowen for a response to this assertion.
"Why can't the Fed do it unilaterally, on its own volition?"
It could, but A) that is not what Ron Paul is proposing, and B) if it did so in seeming response to verbal urging by legislators, that would send a signal of reduced Fed independence.
"Also, I just have a hard time imagining going from where we are now to hyperinflation in the short-to-intermediate time frame. We're talking about a demand-side effect here, so the mechanism would presumably involve an economic boom."
Look at historical episodes of hyperinflation, and see if they came during or shortly after economic booms. I think you will find that they did not.
Andy Harless: "Why can't the Fed do it unilaterally, on its own volition?"
ReplyDeleteNoah: "It could..."
It could? Are you sure? Because (as I said above) "If the Fed can do that..."
But expectations are the name of the game when it comes to inflation. If we tell the Fed to cancel U.S. sovereign debt, it A) destroys any notion of central bank independence, and B) sends a message that we'll do so again, if our debt gets too high.
ReplyDeleteWell, I'm getting old and Econ 101 was so long ago that I either forget or never learned the seigniorage stuff, but what exactly is the problem with B? As long as people believe, which they will, that our government will never fail to pay our debts to bond-holders outside our own government, what is the problem with sending this message?
It does erode some of the ritualized pretenses about the relationship between the Treasury and the Fed. Maybe we should just drop the pretenses, and the antiquated ritual designed to obscure reality and blow smoky incense over the reality of actual monetary operations? One part of the government pretends to loan money (that it has created) to another part of the government, working through intermediaries, and then the latter part of the government pretends to pay that money back with interest - interest which is returned to the Treasury.
Why would failing to pay the debt to the Fed be inflationary? The money has already been created to buy the bonds in the first place, and the inflation isn't happening. Why would inflation happen due to an ex post facto conceptual re-labeling of an operation that has already occurred?
Nothing here that makes any sense. I was educated in The Chicago School (MBA), but I've since disregarded most of what I was taught because it's contradicted by observation.
ReplyDeleteCrowding out? Explain Japan. It looks as if MMT predictions are a much better fit to reality.
Ricardian Equivalence - Consumers do not save all of their tax rebates or tax cuts, so this is clearly wrong.
Unregulated Markets - Disaster when it's in the financial sector.
Comparative Advantage - the primary comparative advantage in a modern economy is dirt cheap labor.
Free Trade - not Pareto Efficient because many workers suffer.
Cause of The Great recession - Collapse of aggregate demand caused by over-levered consumers.
Miller on Capital Structure - What is irrelevant for individual firms *is* relevant for the economy as a whole. Another fine example of the Fallacy of Composition.
RJ: "Horseshit Bruce! If you want to scapegoat, then point fingers at financial industry lobbyist, investment bankers, credit rating agencies, insurance agencies that backed CDO's stuffed with toxic MBS, etc. If you want to blame an ideology, then look at the deregulatory orthodoxy that permeates Washington. "
ReplyDeleteAnd who was promoting that deregulatory orthodoxy? Could it be - right-wing economists?
"Cause of The Great recession - Collapse of aggregate demand caused by over-levered consumers." -- Dismayed
ReplyDeleteNoah,
Your willingness to argue against Ron Paul's debt-reduction plan -- by discussing the consequences it may have -- indicates that you accept Ron Paul's premise that the federal debt is the problematic debt which must be reduced.
It is the premise that is flawed.
Art
I'm late to this ... for a long-time I have wonder why, when facing concerns over government debt, wishing to avoid fiscal contraction, facing v. low inflation, why a large one-off monetization of government debt isn't at least an option on the table.
ReplyDeleteHowever, the Fed doesn't need to rip up the debt (how would the central bank balance sheet balance if you did that?) it just needs to commit to never selling that debt again, and rolling it over in perpetuity (i.e. when a bond matures, immediately turn round and buy antoehr one). You are effectively saying: this portion of government debt will never have to be repaid out of taxes and can be regarded as written off.
I don't belive the MMT position that such action are not inflationary, but I figure in current context, impact on inflation could be small.