Republicans and Democrats have many disagreements about fiscal policy. But almost all lawmakers on Capitol Hill agree that there are exactly three ways that the U.S. government can finance new public spending: By raising taxes, cutting existing outlays, or increasing the national debt.
But this is a fiction.
In truth, the federal government can fund large-scale public investments without burdening taxpayers, trimming other budget items, or adding to deficits. And not only can Uncle Sam work such sorcery in theory, he has already done so in practice.
During World War II and its immediate aftermath, the Federal Reserve committed to buying as many Treasury bonds as necessary to keep yields on U.S. debt flat. Much of that debt never made its way back into private hands. In keeping those bonds permanently on its balance sheet, the central bank effectively financed much of the U.S. war effort through printing money. When a central bank takes permanent ownership of its own government’s debt, that debt ceases to exist for all practical purposes. The Fed may own the U.S. government bonds, but the U.S. government owns the Fed. No entity can be meaningfully indebted to itself. Thus, by buying up its own bonds, the U.S. financed about 15 percent of its involvement in WWII through printed dollars rather than present or future taxes.
The United States is (almost certainly) bankrolling its response to the coronavirus crisis by the same means. The Fed is poised to buy up trillions of dollars worth of U.S. Treasuries this year, covering the bulk of the anticipated $3.7 trillion deficit. Officially, these bonds will sit on the central bank’s balance sheet only temporarily. But given the difficulties the Fed had in unwinding its balance sheet after the 2008 crisis, the safe money says much of this debt will remain on the central bank’s books in perpetuity; which is to say, much it signifies direct central bank financing of public expenditure.
Or so much of Wall Street believes. As Bloomberg reports:
With entire industries shuttered and unemployment soaring, only public spending is keeping millions of households and businesses afloat. The governments on the hook for this relief effort are running up some of history’s biggest budget deficits. And they’re paying at least some of the bills with what are effectively loans from their own central banks – debt that can be rolled over indefinitely, and is really more like money.
“We’ve had a merger of monetary and fiscal policy,” says Paul McCulley, the former chief economist at Pacific Investment Management Co. “We’ve broken down the church-and-state separation between the two.”
“We haven’t had a declaration to that effect,” says McCulley, who now teaches at Georgetown University. “But it would be surprising if you had a declaration – you just do it.”
As already indicated, America’s (tacit) embrace of debt monetization doesn’t actually put us in uncharted waters. Beyond our own nation’s experience in World War II, the Japanese government has spent the past quarter-century effectively financing large fiscal deficits by purchasing its own bonds. Japan has not officially declared that those bonds will never need to be paid back. But no one is under the illusion that the Bank of Japan will ever be fully unwinding its balance sheet.
Which raises the question: Why is the simple fact that the U.S. has the power to finance new spending without raising taxes or taking on (genuine) debt so thoroughly obfuscated in our political debates?
One answer is that conventional wisdom has long held that once you add “print money” to the fiscal tool kit of democratically accountable politicians, they will inevitably turn to it with abandon and trigger hyperinflation. Thus, the notion that all public spending must be “paid for” — either through taxes or the assumption of debts — serves as a noble lie to constrain the myopic profligacy of voters and those who represent them.
In other words, the widespread taboo against monetary finance rests on its presumptive political flaws, not its technical shortcomings. In fact, if implemented perfectly, financing stimulus through direct money creation has clear advantages over the issuance of debt. As then-Fed Chairman Ben Bernanke argued in 2003, when a government tries to fend off deflation with debt-financed public spending, some of the stimulative effect is lost to fears about future debt burdens. Funding stimulus by simply “making the money printer go brrr” eliminates such thrift-inducing fears.
Meanwhile, there is no technical reason why monetary finance should inevitably lead to hyperinflation. As Adair Turner, former chairman of Britain’s Financial Services Authority, recently explained:
That possibility terrifies those who believe that monetary finance must eventually lead to hyperinflation. But such fears are absurd. [Milton] Friedman famously said that in a deflationary depression, we should scatter dollar bills from a helicopter for people to pick up and spend. Suppose US President Donald Trump ordered just $10 million of such helicopter money: the impact on either real activity or inflation would be miniscule. But suppose he ordered $1,000 trillion: obviously, there would be hyperinflation. The impact of monetary finance depends on the scale.
The presumed problem with explicit monetary finance is, thus, that governments will inevitably want too much of a good thing. And this premise informs the broader ideal of central bank independence that’s reigned throughout the developed world since the 1970s: All questions of monetary policy should be walled off from the realm of democratic contestation so as to prevent short-termist politicians from sowing the seeds of runaway inflation.
This view isn’t baseless. Our government’s electoral institutions — which compel lawmakers to seek voters’ reaffirmation every few years — do incentivize a degree of short-termism. Presidents have frequently tried (often successfully) to tailor monetary policy to the political exigencies of an election year rather than the best long-term interests of the economy. And many states throughout human history have sown economic crises through profligate money printing.
But the fiction that the government cannot spend without raising taxes or taking on debt creates its own political hazards, especially in the deflationary environment where the developed world now lives. Democratically accountable politicians may be eager to overspend in theory; in practice, though, they’ve been erring in the opposite direction. Mainstream technocrats now widely agree that the United States and (to an even greater extent) Europe provided too little fiscal stimulus in the wake of the 2008 crisis, not too much. Today, the chairman of the Federal Reserve is imploring Congress to stop worrying about deficits and start more comprehensively replacing the income that households, firms, and state governments have lost to the pandemic — while the president, who must face voters this November, is vigorously resisting Jerome Powell’s invitation to prime the pump. Meanwhile, in the Democrat-controlled House, Nancy Pelosi declined to include automatic stabilizers in her latest stimulus proposal — even though there is near-unanimous support for such measures in her caucus — because she feared that the way the policy would be scored by the Congressional Budget Office would make it look toxically expensive to the voting public.
The myth that all new spending must be paid for is supposed to check politicians’ (allegedly) insatiable appetite for stimulus. At present, however, it is compelling democratically accountable officials to sanction less stimulus than unelected technocrats deem prudent.
This seems to suggest that the logic behind both central bank independence in general — and the taboo against monetary finance in particular — is wrong, or at least correct only in certain circumstances. Perhaps, in an economy where a large, militant labor movement exists, politicians will have a tendency to implement inflationary policies in the name of full employment and high wage growth. But in the present context — in which labor’s bargaining power is so weak, and the gains of growth so unevenly distributed, central banks were struggling to generate inflation before COVID-19 shuttered vast swaths of the economy — there’s little basis for presuming that Congress will err on the side of overspending. This is true both because it simply takes a lot of fiscal policy to overspend in a deflationary context and because, in the absence of pressure from organized labor, politicians are liable to privilege the interests of well-heeled constituencies who have more to fear from inflation than unemployment.
All of which is to say: If obfuscating how money actually works does not make politicians more inclined to authorize the level of deficit spending that technocrats deem prudent, then perhaps the public should be allowed the opportunity to make informed decisions about how their money is spent — and created.
