Indeed - an excellent point. We could also go a step farther and say that there is no obvious reason why deficits run during a downturn need be accompanied by new debt issuance in the first place.

Both observations make the fundamental point that the federal government does not in fact "finance" its spending via taxation and borrowing in the money market. It simply spends, and then borrows, or not, ex post, to achieve other goals (e.g., interest rate maintenance).

It would be nice if more economists could bring themselves to concede that rather obvious truth instead of cloaking it in a lot of obfuscatory nonsense about what government can and cannot "afford" to do, as though such a hard financial constraint, as opposed to prudential concerns about possible inflation, actually existed in reality.

there is no obvious reason why deficits run during a downturn need be accompanied by new debt issuance in the first place.

You mean, the US Treasury issuing money instead of debt? But that's unprecedented... since the last time it was done, I mean.
http://en.wikipedia.org/wiki/United_States_Note

US Notes don't count against the statutory debt limit (there's still some in circulation from when Kennedy issued them) and since there's no debt service on the backend, they'd rob deficit hawk scare charts of much of their scariness.
http://www.pgpf.org/images/blog/7646586/Federal Spending as Percentage of GDP graph.jpg

The bond markets keep beating Bernanke and other deficit alarmists over the head with their confidence in US debt: last month yields of US securities went down several tenths of a percent as the world "panicked" over Greece. But in fact there is little more that the Fed can do now with its supply-side solutions; money needs to be put in the hands of people who will use it. Money unspent does not cause inflation.

The Fed has $1.1 trillion in Mortgage backed Securities guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae.

Yes, the Fed can continue to these assets. Whether they can keep housing prices at their 2003 bubble prices is yet to be seen.

(The Case-Shiller housing price index from 2003 was 130.48, and as the end of 2009 was 136.)

Apparently Leonhardt has got religion from reading Baker, who could have written the article. Reduce real interest rates even further from negative 2% to negative 5% to escape from the Keynesian liquidity trap? Take that Zero Summers.

So inflation is not the problem says Bernanke. Market confidence is the problem, in lack of expected demand.

But deficit spending which offsets lack of demand must be reduced to restore market confidence, which in turn is threatened by the Fed's heavy inventory of monetized debt which will be dumped on future markets. It's like the cartoon of Obama the Fireman on one side with a fire hose shooting stimulus water onto the fire, and on the other side with an ax trying to chop the fire hose in two.

Bernanke knows he has to play the game of the One Percent Cheney Inflation Terrorism Doctrine to keep Obama alive politically, while addressing the 99% expected deflation and the $1T+ full employment output gap with even higher deficits in the short run designed to cure market confidence, not inflation.

Once the economy recovers if ever, demand-pull inflation returns with it as a potential prospect which indeed could push up nominal interst rates and begin to compete with the Fec's ability to price its debt and sell it. Now the market confidence problem would be solved, but at the expense of real inflation risk heretofore grossly exagerrated.

What's the worst case? No one buys the Fed debt at any rate for better choices from the private sector which has now recovered, and the Fed is stuck holding it even longer, unless it chooses to crowd out the private sector with sufficiently higher rates of return. Investors won't buy it now for lack of confidence and they won't buy it then because confidence was restored, even at full employment.

And if the Fed debt causes inflation by virtue of not being exchangeable for the flood of money that exists in the economy, the Fed can suspend attempts to sell its debt and cut off what would then be demand-pull inflation with increased reserved requirements as Baker says, which is effectively a Keynesian tool to reduce excess aggregate demand, a problem the US would really like to have about now.