The Macro Implications of Monetized Debt
By Arnold Kling
most of the publically issued $9 trillion of Treasury notes and bonds are now in the hands of foreign sovereigns and the Fed (60%) while private market investors such as bond funds, insurance companies and banks are in the (40%) minority. More striking, however, is the evidence in Chart 2 which points out that nearly 70% of the annualized issuance since the beginning of QE II has been purchased by the Fed, with the balance absorbed by those old standbys – the Chinese, Japanese and other reserve surplus sovereigns.
Pointer from Tyler Cowen. The way I see it,
1. The government is issuing a huge amount of debt.
2. The central bank is monetizing it.
The implications from various macroeconomic perspectives.
Traditional monetarist: Yikes! Hyperinflation coming in 1, 2, …
1960’s Keynesian: No worries. Inflation is all about the Phillips Curve. This policy is just what the doctor ordered. He might even have ordered more of it.
Modern macro theorist: look at market expectations of inflation (Scott Sumner would say to look at expectations for nominal GDP). The Fed is managing those about right. Presumably, it can continue to do so.
Me: Think of inflation as a fiscal phenomenon. The issuance of a lot of debt is inflationary.
Everybody talks about a monetary “exit strategy” once a strong recovery takes hold. But what about a fiscal exit strategy? Other than Ron Paul, does anyone have several hundred billion in spending cuts ready to go?
Tyler Cowen’s NYT column is on what he calls “fiscal illusion.” Maybe it should be the “fiscal allusion,” because he alludes to so many things, or the “fiscal elusion,” because the implications of his writing may be elusive. But one interpretation is that we need fiscal rules, because discretionary fiscal policy is biased toward deficit. That is, the Keynesian prescription is for surpluses when times are good and deficits when times are bad, but the Keynesian prescription is only taken when times are bad.