Consols Contra the Liquidity Trap
Pace Scott Sumner, suppose a country is stuck in a liquidity trap. Conventional monetary policy is futile, and unconventional monetary policy isn’t working either. What would happen if the government did the following?
Step 1: The Treasury refinances the entire national debt with perpetual bonds, better known as consols. As you know, such bonds pay a fixed coupon every year, and never mature. The coupon divided by the asset price equals the interest rate.
Step 2: The central bank uses standard open market operations to bid up the price of consols until nominal GDP starts rising at the desired rate.
Notice: With regular bonds, the difference between 1% interest and .1% interest seems trivial. With consols, it’s massive. A fall from 1% to .1% multiplies the sale price of a consol by a factor of ten! There is an even bigger difference between a 1% interest rate and a .01% interest rate. That multiplies the sale price a hundred-fold. Can we really imagine that this massive increase in the public’s net worth won’t translate into higher consumption and investment? And if not .01%, how about .00001%?
The only limit, as far as I can tell, is that the central bank might inadvertently retire its national debt. When the bond price gets high enough, everyone sells. But this seems like a remote possibility.
If raising nominal GDP despite a liquidity trap is your goal, what’s wrong with this approach?