NRO is 90 Degrees Off
By Bryan Caplan
When Tom Nugent of National Review Online tells us:
Will private borrowers be crowded out [by increased government deficits]? Impossible. The causation is “loans create deposits,” as taught on day one of every traditional money and banking class. The act of borrowing itself creates exactly that same amount of new liabilities (deposits). The process is “self funding” and circular, as a matter of accounting. The concept of a “pool of savings” that somehow gets “used up” by borrowers is a throwback to the time of fixed exchange rates and gold standards, and has no application in today’s floating-exchange-rate world.
Arnold correctly scoffs:
When I was in grad school, I somehow missed the lecture where they said that government deficits are self-funding in a flexible exchange-rate regime.
But my co-blogger is actually being too charitable. Most of the empirical evidence says that savings is highly INelastic, and the NRO story essentially assumes that savings is perfectly elastic. If you rotated NRO’s horizontal supply curve 90 degrees to the left to get a vertical supply curve, you’d be close to the truth.