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     Is Monetary Financing Inflationary?

      A Case Study of the Canadian Economy, 1935–75





James Galbraith
Paul's argument is that *infinite* inflation is a theoretical possibility. Well, yes. It happened in Germany in 1923.
There is no reason to cut Social Security benefits or Medicare now, with effect in the future, in order to avoid the theoretical possibility that some combination of policies might at some time in the future give us the economic conditions of post World War I Germany.
Those conditions were desperately resource-constrained.
In the actual world we live in, government does not have to "persuade the private sector to release real resources." In the actual world, the private sector has already released those resources by the tens of millions of people.
All the government has to do, in the actual world, is mobilize those resources, which it does by issuing checks, preferably to pay people to do useful things.
There is no reason why this should be considered "costly." Done correctly, in economic terms it amounts simply to the reduction of the waste that is associated with unemployment.
Nor is it necessary, when the government issues a check, that it issue a bond to "borrow" the money behind that check. The check creates money in the first place. (Yes, it does this from thin air, by changing numbers in bank accounts.)
Operationally, this is a free reserve in the banking system. The reason the government issues a bond later, is that the banks like to have a higher rate of interest than they can earn on reserves, and the government likes to oblige them.This is why Treasury auctions don't fail: the government has already created the demand for the bonds, by issuing checks to the banking system.
If the government spent but declined to "borrow," what would happen? Nothing much. Banks would hold their reserves as cash rather than bonds, and their earnings would be a bit lower. It is *not* true, as a rule, that people (or banks) move readily to substitute lumps of coal for dollars, unless the price level is already moving up and out of control.
It is very difficult to get other people to accept coal in place of dollars!Paul's logical error here is that of assuming-the-consequent. He assumes the inflation which causes dumping of money. But if there is no dumping of money, the inflation will not generally occur.Yes, again, it's technically possible that the banks and others would start dumping dollars and buying up oil, wheat, rubber, and so forth (and leasing storage facilities for the stuff) thereby driving up the price level.
I wrote -- correctly and deliberately -- that bankruptcy, insolvency and high real interest rates were not risks. Inflation *is* a risk.
By this, to be clear, I mean an ordinary garden-variety increase in the inflation rate is a risk -- not the *infinite-inflation* scenario.
Inflation, though unattractive, is not remotely comparable to bankruptcy or insolvency, unless you get to Paul's *infinite* inflation scenario. So what about that?
In his model, it is driven by his monetarist (quantity-theory) simplification, that the increase in money flows directly into prices. But this is just a modeling error. In the real world, especially in broadly deflationary conditions, people -- and banks -- simply hang on to cash. There is a Paul Krugman who understands this, from close study over many years of the Japanese stagnation.
However, and again, in the present state of the world economy, and for the foreseeable future -- and except for the energy sector -- surely a small rise in the inflation rate is a trivial risk.My position is that the government should focus on real problems: unemployment, care for the aging, energy, climate change, and the disaster in the Gulf of Mexico.The so-called long-term deficit is not a real problem. And the capital markets demonstrate every day that they agree with this judgment, by buying long-term Treasury bonds for historically-low interest rates.


Deficit spending 101

– Part 3


  • budget deficits place downward pressure on interest rates;
  • bond sales maintain interest rates at the RBA target rate;

Accordingly, the concept of debt monetisation is a non sequitur. Once the overnight rate target is set the central bank should only trade government securities if liquidity changes are required to support this target. Given the central bank cannot control the reserves then debt monetisation is strictly impossible. Imagine that the central bank traded government securities with the treasury, which then increased government spending. The excess reserves would force the central bank to sell the same amount of government securities to the private market or allow the overnight rate to fall to the support level. This is not monetisation but rather the central bank simply acting as broker in the context of the logic of the interest rate setting monetary policy.


Ultimately, private agents may refuse to hold any further stocks of cash or bonds. With no debt issuance, the interest rates will fall to the central bank support limit (which may be zero). It is then also clear that the private sector at the micro level can only dispense with unwanted cash balances in the absence of government paper by increasing their consumption levels. Given the current tax structure, this reduced desire to net save would generate a private expansion and reduce the deficit, eventually restoring the portfolio balance at higher private employment levels and lower the required budget deficit as long as savings desires remain low. Clearly, there would be no desire for the government to expand the economy beyond its real limit. Whether this generates inflation depends on the ability of the economy to expand real output to meet rising nominal demand. That is not compromised by the size of the budget deficit.