In the year of the apocalypse 2020, a year fraught with pandemic, war, and economic recession, governments of the world have stepped up their game with respect to ‘printing money.’ In the month of March, the M2 money stock grew by $1.1 trillion, more than it grew throughout the entirety of 2019. This phenomenon can be explained by Federal Reserve banks purchasing Treasuries in order to finance the stimulus provisions enacted by Congress this year, as well as the general revenue slump. Since private investors are not interested in holding extremely low-rate securities, and have actually on the net dumped these assets, the only way for the government to borrow in this extraordinary situation has been for the Federal Reserve to essentially manufacture credit to purchase Treasuries with.
There are many a libertarian or economic conservative fearing an onslaught of inflation, perhaps even hyperinflation, but thus far there has been effectively no inflation. How can this be? Well the simple answer is increasing the money supply does not necessarily result in inflation. In normal times, increases to the money supply result in some level of increase in spending, and if spending increases faster than the real resources of the economy, a auctioning effect kicks in, driving prices up.
Milton Friedman famously said “inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” This is not precisely accurate. You could print $10 quadrillion dollars and shoot it into space, never to be spent, and you’d have zero inflation at home. This is due to the fact that it is not simply an increased quantity of money that results in inflation, but an increased quantity of money spent.
A great share of government credit in 2008 went to businesses in order to shore up their balance sheets and avoid bankruptcy. This money was not spent on food, housing, etc. Meanwhile, consumer spending fell and millions lost their jobs. This is why in 2008, trillions in lending and deficits did not result in inflation, but in fact deflation. So far this crisis, personal consumption expenditures have fallen like a brick (something like a third in the first quarter), and personal savings have skyrocketed to a couple or few times the previous record. For all of the money printing going on over at the Federal Reserve to finance stimulus checks and programs such as the Paycheck Protection Program, we’ve only managed to muster a meager 0.6% inflation over the 12 month period preceding July.
While it’s true that monetizing federal spending and lending has caused prices to be higher than they would have been without intervention, if anything, it’s a good thing, because deflation can suffocate the economy and cause a depression, as we’ve seen in the past. A controlled recession took place from 1979 to 1981 when Paul Volcker over at the Federal Reserve decided to raise the primary rate to over 19%, which strangled the economy and caused the highest unemployment since the Great Depression (not to be surpassed until 2020).
So we have the ability to essentially pull money out of thin air to finance government operations, lending, and whatever else is necessary to keep the economy afloat in an extraordinary circumstance such as our own. The question I’d like to ask, however, is can we do this outside of a recession? The national debt has exploded and now exceeds our gross domestic product, and as interest rates rise again, the the cost of servicing the debt will increase the deficit, crowding out spending on national defense, infrastructure, and public services. There are a few things we have to look at to find the answer.
First off, we’ve already done this in a way, though not for the purpose I’ve described. The Federal Reserve attempts to limit or expand availability of credit through the use of interest rates, with the aim of maximizing employment and maintaining modest inflation. There’s the concept of NAIRU, or Non-Accelerating Inflation Rate of Unemployment, which is the hypothetical level of unemployment at which increasing spending would simply cause inflation, due to the real resources of the economy being fully utilized (as I mentioned earlier, if spending increases faster than the real resources of the economy, inflation results). In order to essentially print money for government use (or monetize the debt), the Federal Reserve would need to stop preempting inflation by raising interest rates when unemployment dips under four percent, and raise inflation targets until Congress is satisfied with public debt levels. Next, the Federal Reserve would need to directly purchase Treasuries, which would also probably need to be restricted from private investors.
Because inflation has been fairly low for roughly a decade now (1.8% on average since 2010), we do have room to expand a little. At what rate monetized spending or debt ‘nullification’ raises inflation, we can’t be precisely sure. We do know that as much as forty percent of US government securities are held by the top 1%, who have very high savings rates. I would imagine that almost all the rest of these securities are held by the top 2% or 5%, who also, as it happens, have very high savings rates. Further, I would guess if their Treasury holdings were to one day become cash, they’d probably put it in the stock market. This would cause inflation… but only in the stock market, where price growth is a beloved phenomenon.
It’s not clear how big of an impact it makes, but an increased stock market capitalization allows firms to raise more capital when selling or issues shares, and a larger market would presumably confer larger capital gains to shareholders, which are taxed (so we’d see some increase in revenue, though perhaps small). We can see that monetizing the debt is to some large degree a monetization of the stock market, which if done modestly, is probably does us more good than bad.
The main issue then, I believe, is inflation. If inflation is the result of demand outstripping supply, how much of this Federal Reserve money printing is going to find itself paying for groceries and new automobiles, and how much of the national debt could we nullify while keeping inflation under 3%? The Federal Reserve banks project a long-term inflation rate of about 2%, so we’re giving ourselves an additional 1%. If we make a ballpark estimate that half of paid debt will move to the stock market, then we can ‘print’ about twice as much money as would result in 1% inflation. If we figure the level of consumer price inflation is directly proportional to increases in personal consumption expenditures (assuming we’re fully utilizing the economy’s resources), then using 2019 figures as an example, we should’ve been able to monetize $300 billion of public debt that year.
This is obviously a sketchy way to estimate the amount of debt monetization we can get away with, but I believe it’s more or less coherent and logical. If it’s wrong by even a factor of three, we can still essentially print a hundred billion dollars, which is pretty awesome. I mostly fear that openly using this method, even if it’s not on paper particularly inflationary, could have a very negative psychological impact on markets, causing speculative inflation. Definitely something to consider. Personally I don’t think debt monetization is a wise policy, and I have a pretty conservative attitude towards Modern Monetary Theory-type ideas like this one, but I think it has its merits.
What do you think? Do you think it’s worth trying to in one way or other print away our national debt? While there are clear benefits, there are less clear, and potentially very dangerous drawbacks that we should be wary off. Perhaps inflating the currency is not inherently problematic, but governments given the power overuse and abuse it, at some point leading to hyperinflation. The Federal Reserve may print the dollars, but the Treasury gives them securities to purchase in order to finance the whims of Congress.
If there’s one thing we can probably all agree on, it’s that we would do better not to get in a load of debt in the first place.