This one was triggered by a New York Times article regarding China raising the banking reserve requirement to curb inflation, and he begins by saying,
U.S. economists seem to not understand that central banks can raise reserve requirements as way to control inflation. This is apparently the reason they find it inconceivable that the Fed could buy and hold large amounts of debt without leading to inflation.
Increasing the reserve requirement means that banks hold on to more money, that they do not lend it, that they keep it out of circulation. That reduces the amount of money that is circulating and it therefor reduces inflation, which is the specific and only reason for doing it.
Buying government debt may be done for any number of reasons, but it is frequently bad news. A government buys its own debt, for instance, when nobody else will do so and that causes interest on that debt to increase because it becomes seen as risky debt. That would not apply to US debt.
The other reason for buying our own debt is when we are issuing new debt to increase the money supply, and that is seriously inflationary. We have been doing some of that, and we have been buying some of that new debt.
I don’t know how much we have been issuing nor how much we have been buying, and it's not really pertinent here.
What Baker wants us to do is buy existing debt held by others and hold it so that we are paying interest on that debt to ourselves, and I have no doubt that is a fine idea. There are just a couple of problems with his suggestion.
How did his plug for buying debt to reduce interest cost and control the deficit arise from an article about China reducing the money supply to control inflation? And where do we get the money to buy the debt? Holding our own debt would not be inflationary in itself, but issuing new money to buy it certainly would be.
Holding our own debt would not be inflationary in itself, but issuing new money to buy it certainly would be. No, it would almost certainly not be. What is now called orthodox, mainstream economics holds it would be. A good rule of thumb is that mainstream economics reverses everything, and it holds here too.
ReplyDeleteThere are many opposing effects, but right now lower rates are probably disinflationary, deflationary. People aren't going to start spending like wild because they are getting less interest on their savings. Banks aren't going to grant more loans to shaky business just because rates are decreasing, and businesses aren't going to raise their prices - maybe they'll even lower them - just because their borrowing costs have dropped.
That low interest rates may be disinflationary is called Gibson's paradox (name due to Keynes). Partly due to his influence, the US & UK kept interest rates low during WWII, and this was notably successful against inflation. Another example is Japan for the last 20 years. Low interest, and deflation. Mainstream "economics" treats these examples by covering its ears and saying lalala I'm not listening.
I did not say that low interest rates was going to cause inflation. I am not an idiot. Where in my piece did I say that low interest rates is going to cause infaltion?
ReplyDeleteI said that issuing more money not backed by any goods or services would be inflation. If there is $x in circulation, and you increase that to $z, with $z being larger than $x, and you have the same amount of goods and services, then those goods and services are now being traded for $z instead of $x and that is, by definition, inflation.
That has nothing whatever to do with interest rates.
The Fed issuing more currency, buying bonds with it, drives bond prices up. This is the same thing as saying interest rates come down.
ReplyDeleteThe Fed creating money out of thin air, and buying Treasury bonds with it is not inflation according to the modern definition of inflation - price inflation. The only way it can be considered to be inflation is if (a) you used the Austrian/obsolete definition of inflation as increasing the "quantity of money" and (b) wrongly consider bonds as "not money" and currency as "money".
Issuing bond-debt, then the Fed buying it with new currency is of course just the same as if the government just spent by turning on a printing press and spent the new money. In current conditions, this is probably less inflationary than
spending "backed by government bonds". The only real-world difference is the effect on interest rates, which is why I talked about them above.
And I know that there is more than one definition of inflation, to boot. One place I read the increasing prices for goods was actually "deflation" because it meant that the money was worth less, as in "deflation of currency." Whatever.
ReplyDelete