Could the Fed successfully monetize government debt and keep inflation low by using deflationary and inflationary policy tools simultaneously?
This thought occured to me earlier today, but I realized it should be obvious. Couldn’t the Fed begin monetize the federal debt and avoid inflation by simultaneously raising reserve requirements? Couldn’t it also sell some of its other assets (e.g. gold, private securities) in order to offset inflation caused by monetizing the federal debt?
Has anyone here looked at the numbers enough to comment? Given that the Fed balance sheet is so small compared to the federal debt, selling Fed-owned assets wouldn’t be enough to repudiate anything but a very small portion of the federal debt. But could increasing reserve requirements and raising the discount rate be enough to avoid double digit inflation in the case of debt monetization?
I’m just asking this because it doesn’t seem like drastically cut spending or a debt default are politically viable. So I’m wondering if hyperinflation is really what we’ll be facing in coming years.
There will be as much inflation as there is money being printed by the Fed, provided dollar demand stays the same. This mean that as long as the Fed is only monetizing government debt, and no other kind of debt, inflation will not be hyper but will be proportional to the deficit.
Hyperinflation takes place when, to maintain low interest rates across the economy, the Fed starts monetizing every kind of debt, and then speculators begin borrowing money to acquire any conceivable asset that preserves value. Take for example consumers buying cars speculatively in Argentina.
The FED would have to monetize (print) 1.5 to 2 T dollars each and EVERY year forever and forever - especially since there is zero chance whatsover that politicians would ever show any restraint if it became the norm to monetize deficits. The deficits would likely increase.
And eventually - that printing would overwhelm the deflationary counter measures you spoke of - and still eventually unleash double digit price increases.
Altho your idea sounds like it would help out in the short term in some aspects - I just think though it would lead to an even greater expansion of gov’t and entitlements - since only the gov’t would be in a position to borrow.
Right, but what is proportional? We have a $14 trillion national debt, which is about the size of our entire economy. Then you factor in the velocity of money and the money multiplier, and you’ll have hell to pay for monetizing the national debt. Remember, stagflation occured in the 70’s when the Fed was monetizing just 1% of the federal budget.
My question was whether increasing reserve requirements (and thereby decreasing reserve requirements), raising the discount rate, and selling off assets owned by the Fed could do enough to offset the inflation caused by debt monetization. You have not even attempted to answer that question.
Soooooo… thanks for the bump?
You’re 100% right. Monetization of the debt would be an incentive for Congressmen to spend more of our money. But the political winds seem to be changing, and at least some Republicans are getting serious about the budget (e.g. Senators Rand Paul and Mike Lee). The radical thing is that the proposals (of cutting the budget by $500bn and not raising the debt ceiling) by these freshmen Congressmen and Senators are actually beginning to be taken seriously.
If the Fed could monetize at least some of the debt without adverse consequences while the Congress worked on reforming entitlement programs and cutting discretionary spending, then perhaps a major crisis could be averted.