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Home Publications Blogs Beat the Press The Painless Way to Reduce the Deficit

The Painless Way to Reduce the Deficit

Wednesday, 23 March 2011 04:49

The NYT reported on the Federal Reserve Board's payment of $82 billion to the Treasury last year, more than 2.3 percent of the total budget. This is striking because this figure vastly exceeds most of the budget items that have dominated the attention of Congress and the media.

In principle, the Fed can offset much of the burden of the debt run up to boost the economy during the downturn by simply buying and holding it. In that case, the interest would be paid to the Fed and then refunded to the Treasury, leaving no net burden for taxpayers. The Fed could prevent this from leading to inflation when the economy recovers by raising reserve requirements. Of course most economists agree that a somewhat higher inflation rate would be desirable at the moment since it would alleviate the debt burden of consumers.

It is remarkable that this path towards dealing with the deficit has garnered so little attention. This could perhaps be explained by the fact that the Wall Street actors who are the main financiers of the anti-deficit crusade are not interested in a deficit reduction path that does not cut social spending and risks somewhat higher inflation. Higher inflation is generally anathema to the financial industry, since it devalues the debt it owns.

It is also worth noting that most people involved in the debate on economic and budget policy are not very astute observers of the economy. They were unable to see the $8 trillion housing bubble that both gave us the current downturn and the large deficits that have fixated Washington.

Comments (11)Add Comment
Glenn Beck Plans to Strike Back
written by izzatzo, March 23, 2011 5:33
This could perhaps be explained by the fact that the Wall Street actors who are the main financiers of the anti-deficit crusade are not interested in a deficit reduction path that does not cut social spending and risks somewhat higher inflation.

That's the last straw. Now Baker is attributing motive and intent to imply conservatives want unemployment to remain high to boot out Obama and take the Senate.

Just for that I'm going to start my own economics channel after the Fox contract expires with my new show, Beat the Dean.

The first show will explain how contracting the money supply by raising reserve requirements to stop inflation instead caused the Great Depression of 1929 just like Milton Friedman said it would.
Of course ...
written by Benedict@Large, March 23, 2011 5:34
Of course, we could always have the Fed simply buy it and "disappear" it, which would be the effective result if the Fed adopted a "hold to maturity" policy for the purchased debt. Then if any inflation did arise from this, we could simply tax that out of the economy, which of course is what taxes do in a fiat currency anyways.
Professor of Economics, retiredI
written by Richard Hattwick, March 23, 2011 7:01
Kudos to Dean Baker for regularly calling this public policy option to our attention. What a shame that more economists don't educate the public on this point .... both in the media and in the classroom. What a shame that neither our legislators nor the White House seems to be aware of this option.
written by kharris, March 23, 2011 8:01
"Monetizing debt" is bad, but (except to the Paul family) standard Fed monetary operations are good. The only Fed official I ever heard admit that standard monetary operations are precisely monetization of debt was Evans at the Chicago Fed.

What DB is arguing is that monetization of debt, if handled properly, can boost output without causing prolonged acceleration in inflation. The problem is that, to make this national policy, we'd have to bet past the demonization of "monetizing the debt". Right now, that would probably be a hard trick to pull off.
Is that so?
written by Fempus Tugit, March 23, 2011 8:16
"just like Milton Friedman said it would." ... Huh. The way this is stated one would think that izzatzo thinks Friedman made an a priori prediction rather than a post facto explanation. Moreover, attributing the Great Depression solely to monetary policy is simply being in denial or reality and the empirical evidence: greed unchecked kills. Keep hoping for that show, dude, but first you need to actually beat Dr. Dean.
written by Max, March 23, 2011 12:11
The article correctly points out that the government debt is voluntarily providing an income stream to the private sector. Which calls into question the popular idea that the debt is a "burden", doesn't it?

However, the article buys into the popular myth that "debt financing" is less inflationary than "money financing" (it's a meaningless distinction in a fiat currency system). Also, inflation can't be controlled with reserve requirements - it's another myth that banks are constrained by reserves.
Japan has done this for 20 years
written by MicronEcon, March 23, 2011 5:50
DB is right as usual, and there is a real-world current example.

Japan has not succeeded in breaking out of the liquidity trap, but they have managed debt-to-gdp ratios that are far larger than anything in the U.S. forecast.
Re: Fempus Tugit's take on izzatzo
written by diesel, March 24, 2011 8:20
Let's see, Milton Friedman was born in 1912. That would have put him in late adolescence during the Depression. The predictions Izzatzo claims he made would certainly have to have been the product of a precocious youth. But if Mozart could compose a symphony at age three, then anything is possible, I suppose.

What I can't get my mind around is that if izzatzo did indeed hear these words of wisdom from the Font himself, then as his contemporary, izzatzo would today be nearly a century old. Pretty feisty for an old gaffer.

Hobble on izzatzo!
Izzatzo must be simple.
written by Ralph Musgrave, March 24, 2011 3:18
Izzatzo must be a simpleton if he thinks Republicans aren’t happy to keep unemployment high if this helps boot out Obama. Senate Minority Leader Mitch McConnell actually said that if getting rid of Obama “means doing nothing to help 15 million Americans searching for work who can't find it, too bad.” See: http://www.thefiscaltimes.com/...-Want.aspx
written by pwoody82, March 24, 2011 7:17
Having the Fed buy the debt and then refund the interest to the treasury only works if the Fed is the only holder of US debt. Unfortunately, many foreign nations and investors as well as many individuals hold our debt, and I doubt if they will be willing to give up the interest or the principal either. Also, there has to be a limit on just how much debt the Fed can purchase since it is a private corporation owned by some of the larger US banks. I do not think those large banks will be able to buy/create that much more debt than they already have. If the Fed just holds ever increasing debt my first question is, where is the interest that is being given to the treasury coming from? Answer, the treasury, hence a wash transaction. Also, the more money the Fed prints and loans the treasury, the more inflation we will have as the amount of currency in circulation skyrockets. Eventually, it won't make any difference how much money the Fed creates, it will be even more worthless and have even less purchasing power than the present circulating currency does. How does everyone having an annual income of a trillion dollars sound? Great, except that the trillion won't buy what fifty thousand does today. It's just another something for nothing scheme.
Let's monetize!
written by Ralph Musgrave, March 24, 2011 11:11
Pywoody83 claims existing debt holders may not be willing to give up their government bonds. My answer to that is that under QE, there has not been any difficulty in persuading bond owners to relinquish their bonds. But if there IS any such difficulty, this proves there is ample appetite for more govt debt. I’m not in favour of large govt debts, but if this appetite exists, there will be no problem letting the national debt expand for the next few years.

Pywoody83 also makes the common mistake of thinking that “the more money the Fed prints and loans the treasury, the more inflation we will have as the amount of currency in circulation skyrockets.” The answer to that point, as David Hume pointed out 250 years ago, is that expanding the money supply has no effect unless the extra money is SPENT. And the fact of spending it raises demand and gets us out of the recession. So, print the right amount and we escape the recession with without rampant inflation!

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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.