FacebookTwitterGoogle+RedditEmail

Central Bankers and Budget Deficits

Ron Paul is a long-serving representative in the U.S. Congress. He is a committed libertarian who is now embarking on his third presidential campaign. He has built up a devoted political following over the years.

While many of his ideas are outside of the mainstream, that doesn’t mean that they do not deserve to be taken seriously. As a solution to the impasse over the debt ceiling in the United States, Mr. Paul suggested that the Federal Reserve Board destroy the $1.6 trillion in government bonds that it currently holds. This act would put the government far below its $14.3 trillion debt ceiling providing perhaps two more years before any action needs to be taken to raise the ceiling again.

Destroying $1.6 trillion in government debt might seem far-fetched, but it actually makes a great deal of sense. The Fed acquired this huge stock of debt through its policy of quantitative easing. This was an effort to try to provide further stimulus to the economy once the short-term lending rate had already been pushed to zero. Since the short-term rate could not go any lower, the Fed bought up several trillion dollars of mortgage-backed securities and government bonds in order to directly lower long-term interest rates.

While the mortgage-backed securities are debt from private parties to the Fed, since the Fed is an agency of the U.S government, the bonds held by the Fed are literally money that the government owes to itself. In fact, each year the Fed refunds back to the Treasury the interest earned on its assets in excess of its operating costs. This means that the interest that this is paid on the bonds held by the Fed is effectively interest that the government is paying itself.

In this context, it is very difficult to see any downside in eliminating a bookkeeping entry. The Fed would lose $1.6 trillion in assets and the government would lose $1.6 trillion in liabilities and suddenly be far below the debt limit.

In addition to the short-term benefit of getting around the standoff on the debt ceiling, this move also has the great long-term benefit of reducing the government’s future interest burden. While the bonds do not create any net interest burden as long as they are held by the Fed, the plan is for the Fed to sell them off as the economy recovers. The Fed would do this to pull reserves out of the banking system, limiting its lending ability and thereby preventing inflation.

Once the bonds are in the hands of the private sector, they do create an interest burden for the government. While the Fed is currently expected to refund $80 billion to the Treasury in 2011, in 2017 it is projected to refund just $33 billion. The difference of $47 billion is lost revenue to the government.

However if the Fed destroys the bonds that it currently holds then the interest on this debt can never be a burden to the government. The bonds would cease this exist.

This would mean that the Fed would not be able to sell bonds to pull reserves out of the banking system. However it can accomplish the same result with a different tool. It can simply raise the reserve requirement, forcing banks to hold a larger fraction of their deposits on reserve.

Raising the reserve requirement can be just as effective as reducing the quantity of reserves in limiting lending. If the amount of reserves in the banking system is doubled, and the reserve requirement is also, then the banking system will just be able to make the same amount of loans. The big difference between these two paths is that the government would not have to pay as much interest on its debt, in the case where the volume of lending is limited by higher reserve requirements.

This is in effect exactly what we should want to see in this situation. The reason that the U.S. government and other governments are running large deficits is because of the collapse in private sector spending. The deficits are supporting output and employment by filling the gap in demand. In normal times, deficits may be pulling away resources from the private sector and crowding out investment; this is not the case in the downturn. The deficit is sustaining demand and therefore most likely increasing private sector investment.

The one downside to this story is that the deficit is creating a tax burden for the future. However if the government destroys the debt issued to finance its spending in the downturn, then the debt need not ever pose a tax burden.

The idea of effectively getting money for free may seem peculiar, but that is exactly the story of an economy that is below its full employment level of output. In such circumstances, the economy is not supply constrained. If there is more demand, there will be more output. The real waste in this context is the failure of the government to spend. In that case workers who have the skills and desire to work go unemployed and factories and other facilities go idle.

Representative Paul’s proposal provides exactly the sort of mechanism that we should want to see in this situation. It allows the government to generate the demand needed to push the economy back toward full employment, without creating a major debt burden for future generations of taxpayers.

Now, this may not be exactly how Mr. Paul viewed his proposal. After all, he has a long history of hostility to the Fed as an institution. Two years ago he wrote a book titled End the Fed. But Mr. Paul’s motives don’t matter. This is a proposal that deserves to be taken seriously not just for the Fed, but by other central banks as well. The debt incurred to boost economies out of recessions should not place a burden on future taxpayers and we know how to prevent this from happening.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy and False Profits: Recoverying From the Bubble Economy.

This article originally appeared in the International Relations and Security Network.

 

 

 

 

 

More articles by:

Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC. 

January 16, 2019
Patrick Bond
Jim Yong Kim’s Mixed Messages to the World Bank and the World
John Grant
Joe Biden, Crime Fighter from Hell
Alvaro Huerta
Brief History Notes on Mexican Immigration to the U.S.
Kenneth Surin
A Great Speaker of the UK’s House of Commons
Elizabeth Henderson
Why Sustainable Agriculture Should Support a Green New Deal
Binoy Kampmark
Trump, Bolton and the Syrian Confusion
Jeff Mackler
Trump’s Syria Exit Tweet Provokes Washington Panic
Barbara Nimri Aziz
How Long Can Nepal Blame Others for Its Woes?
Glenn Sacks
LA Teachers’ Strike: When Just One Man Says, “No”
Cesar Chelala
Violence Against Women: A Pandemic No Longer Hidden
Kim C. Domenico
To Make a Vineyard of the Curse: Fate, Fatalism and Freedom
Dave Lindorff
Criminalizing BDS Trashes Free Speech & Association
Thomas Knapp
Now More Than Ever, It’s Clear the FBI Must Go
Binoy Kampmark
Dances of Disinformation: The Partisan Politics of the Integrity Initiative
Andrew Stewart
The Green New Deal Must be Centered on African American and Indigenous Workers to Differentiate Itself From the Democratic Party: Part Two
Edward Curtin
A Gentrified Little Town Goes to Pot
January 15, 2019
Patrick Cockburn
Refugees Are in the English Channel Because of Western Interventions in the Middle East
Howard Lisnoff
The Faux Political System by the Numbers
Lawrence Davidson
Amos Oz and the Real Israel
John W. Whitehead
Beware the Emergency State
John Laforge
Loudmouths against Nuclear Lawlessness
Myles Hoenig
Labor in the Age of Trump
Jeff Cohen
Mainstream Media Bias on 2020 Democratic Race Already in High Gear
Dean Baker
Will Paying for Kidneys Reduce the Transplant Wait List?
George Ochenski
Trump’s Wall and the Montana Senate’s Theater of the Absurd
Binoy Kampmark
Dances of Disinformation: the Partisan Politics of the Integrity Initiative
Glenn Sacks
On the Picket Lines: Los Angeles Teachers Go On Strike for First Time in 30 Years
Jonah Raskin
Love in a Cold War Climate
Andrew Stewart
The Green New Deal Must be Centered on African American and Indigenous Workers to Differentiate Itself From the Democratic Party
January 14, 2019
Kenn Orphan
The Tears of Justin Trudeau
Julia Stein
California Needs a 10-Year Green New Deal
Dean Baker
Declining Birth Rates: Is the US in Danger of Running Out of People?
Robert Fisk
The US Media has Lost One of Its Sanest Voices on Military Matters
Vijay Prashad
5.5 Million Women Build Their Wall
Nicky Reid
Lessons From Rojava
Ted Rall
Here is the Progressive Agenda
Robert Koehler
A Green Future is One Without War
Gary Leupp
The Chickens Come Home to Roost….in Northern Syria
Glenn Sacks
LA Teachers’ Strike: “The Country Is Watching”
Sam Gordon
Who Are Northern Ireland’s Democratic Unionists?
Weekend Edition
January 11, 2019
Friday - Sunday
Richard Moser
Neoliberalism: Free Market Fundamentalism or Corporate Power?
Paul Street
Bordering on Fascism: Scholars Reflect on Dangerous Times
Joseph Majerle III – Matthew Stevenson
Who or What Brought Down Dag Hammarskjöld?
Jeffrey St. Clair - Joshua Frank
How Tre Arrow Became America’s Most Wanted Environmental “Terrorist”
Andrew Levine
Dealbreakers: The Democrats, Trump and His Wall
FacebookTwitterGoogle+RedditEmail