CEPR - Center for Economic and Policy Research


En Español

Em Português

Other Languages

Home Publications Blogs Beat the Press Greg Mankiw and Monty Python

Greg Mankiw and Monty Python

Monday, 04 July 2011 12:48

One of the great skits from the days of Monty Python's Flying Circus was the "Stake Your Claim Game Show." The first contestant on this show is introduced as claiming that he wrote the complete works of Shakespeare.

By asking the contestant's age, the host is able to quickly determine that works of Shakespeare were known for several hundred years before he was born. At that point the contestant acknowledges that this is where his claim breaks down and concedes that the host is more than the match for him.

I felt sort of like this contestant when I saw that Greg Mankiw had discovered that Ron Paul's plan to destroy the $1.6 trillion in government bonds held by the Fed (which I endorsed) to get around the debt ceiling was "just an accounting gimmick." Clearly Mr. Mankiw is more than the match for me.

Of course it is an accounting gimmick. We have an accounting problem (the debt ceiling). It cries out for an accounting solution.

However, there is a more serious issue in the second part of the story. If the Fed destroyed the bonds, rather than selling them back to the public as currently planned, it can save the government close to half a trillion in interest payments over the next decade. That sounds like a good deal to me, especially in a context where people are talking about cutting Social Security and Medicare as a way to reduce deficits.

Destroying the bonds would create some problems. The reason that the Fed plans to sell the bonds is to pull reserves out of the system thereby preventing inflation at a point where the economy has recovered. The alternative that I suggest is that the Fed could simply raise reserve requirements to accomplish the same goal. 

Mankiw points out that:

"assuming the Fed does not pay market interest rates on those newly required reserves, it is like a tax on bank financing."

This is true. Higher reserve requirements will increase the gap between the interest rate that banks charge on loans and the interest rate they pay on deposits. However, this may be seen as a relatively harmless tax. After all, what's the consequence of people getting 20 basis points (0.2 percentage points) less on average on their bank deposits or paying 20 basis points more for loans?

In any case, this implicit tax seems like the sort of proposal that should be in the policy mix right now. After all, I suspect that most people would consider it preferable to the bi-partisan plans to reduce Social Security payments 3 percent by changing the cost of living adjustment formula.

Comments (12)Add Comment
written by denim, July 04, 2011 1:47
So basically the nation's economists, pundits, and politicians have been spending thousands of man hours trying to solve the deficit and debt issue, but all it takes is a little advice from a backwoods doctor turned politician. Who would have thought!
Baker Hack Released From Monty Python Argument Clinic, Low-rated comment [Show]
Soak the Rich
written by bakho, July 04, 2011 4:22
Destroy the bonds and collect taxes from the wealthy instead of borrowing the money from them and paying them interest.
Bank Reserve Requirements
written by Ron Alley, July 04, 2011 5:54

Are you telling us that, throughout the expansion of the financial bubble, the Federal Reserve could have increased bank reserve requirements and, by doing so, could have increased federal government revenue during the Bush Borrowing Spree, raised the cost of loans (including mortgage loans) and perhaps deflated the financial bubble?

That would seem to be news to Mr. Greenspan and Mr. Bernanke.
written by skeptonomist, July 04, 2011 6:22
Actually most of the $1T in long-term bonds bought in QE1 were Fannie and Freddie MBS's, not exactly government bonds. The true value of this stuff is unknown, and the Fed may never sell it, partly to prevent the true market value from becoming known.
Making the debt vanish.
written by Ralph Musgrave, July 05, 2011 3:56

Denim above is surprised by the fact that the debt can reduced at the stroke of a pen. I’ve got more surprises for Denim. First, a significant proportion of the debt is debt owed by one US government department to another. That just ain’t debt owed by the US to anyone.

Second, the debt can easily be reduced simply by printing money and buying it back. As to the resulting inflationary effect, that can be countered by raising taxes. As long as the deflationary effect of the latter equals the above inflationary effect, GDP stays the same as does total numbers employed, and so on. For more details click on my name above.
written by stronage, July 05, 2011 5:43
The Fed reimburses the Treasury on this interest anyway. Why wasn't this mentioned?
Or we could just go with the constitutional solution
written by LSTB, July 05, 2011 6:48
The validity of the public debt of the United States, authorized by law ... shall not be questioned.

U.S. Constitution, 14th Amendment, section 4.

Obviously the state legislatures that ratified this in 1868 didn't intend it to apply to the debt ceiling since that's a 20th century phenomenon, but I think B.H. Obama will just declare the debt ceiling unconstitutional and the Supreme Court will side with him months later when the case gets to its docket.
Or we could just go with the constitutional solution
written by LSTB, July 05, 2011 6:52
The validity of the public debt of the United States, authorized by law ... shall not be questioned.
U.S. Constitution, Amendment 14, Section 4.

Obviously, the state legislatures that ratified the 14th Amendment didn't have the debt ceiling in mind as that's a 20th century phenomenon, but if B.H. Obama were to declare it unconstitutional and order the Treasury to keep issuing the bonds, I doubt the Supreme Court would overrule him when the case gets to its docket months later.
written by Warren, July 05, 2011 4:17
You're getting there, Dean. One day you might even realize that the Fed could buy up all outstanding debt and destroy it, putting an end just like that to all your worries about the debt.

Will this be inflationary? Was QE? Nope. It will greatly increase bank reserves, of course, but so what? Banks don't lend out of reserves. They lend to qualified customers.
It is more criminal to rob a man of his years of retirement
written by Scott ffolliott, July 06, 2011 7:25
It is more criminal to rob a man of his years of retirement than it is to default on government bonds; it is more criminal to rob a man of his healthcare than it is to default on government bonds.
written by Calgacus, July 06, 2011 1:43
Hmmm. Warren.
Earl? Elizabeth? Beatty? Buffett?

Scott: Hard to see your point. The destruction of these bonds is not a default. It is just somebody (who happens to own a bank) tearing up a post-dated check he wrote to himself.

Write comment

(Only one link allowed per comment)

This content has been locked. You can no longer post any comments.


Support this blog, donate
Combined Federal Campaign #79613

About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.