reading the paradigm shift genealogy

I'm currently slowly going through my paradigm shift genealogy timeline, and will add some quotes here to help me digest what they all are discussing. 

1. From Krugman on Jan. 2:

It’s true that printing money isn’t at all inflationary under current conditions— that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought. So even though right now that debt is just a claim by one more or less governmental agency on another governmental agency, it will eventually turn into debt held by the public.

2. From Coppola on Jan. 7. Them is referring to Keynes and Krugman.

So for them, the liquidity trap is a phenomenon associated with very low nominal interest rates - an abnormal situation by any standard. And we have had very low nominal rates for five years now, so it would be reasonable to assume that the liquidity trap we now find ourselves in is due to interest rates being near-zero, and that once we have restored the economy to sufficient health to allow interest rates to rise to historic norms, normal service will be resumed. 

But that's not actually the current situation. We have interest-bearing money. Yes, interest rates on money are very low at the moment. And therefore - as I explained above - so are yields on the investments which are near-substitutes for money. But if interest rates were to rise, would this change?

I can't see any reason why it should. Because interest-bearing money is freely exchangeable with government debt - and indeed the shadow banking system constantly performs that intermediation - the equivalence between government debt and interest-bearing money would hold at any level of interest rates. We are indeed in a liquidity trap, but it's not because of economic distress and near-zero interest rates. It is because the nature of money has fundamentally changed. Money is no longer just "cash". Money is any financial asset that flows freely and is readily exchangeable for currency.

3. From Duy on Jan. 12

Ultimately, I don't believe deficit spending should be directly monetized as I believe that Paul Krugman is correct - at some point in the future, the US economy will hopefully exit the zero bound, and at that point cash and government debt will not longer be perfect substitutes. Note that Greg Ip disagreed with this point:

I disagree. The Fed does not have to sell its bonds, or the $1 trillion coin, to control inflation (though it may do so anyway). It only needs to retain control of interest rates, and that does not depend on the size of its balance sheet. 

Ip argues that interest on reserves gives the Fed the power to control interest rates, and consequently the power to control inflation, regardless of the size of the balance sheet. If you follow Ip's analysis through to its logical conclusion, then why should the Treasury issue debt at all? Why not just issue platinum coins? Could cash and government debt combine to serve the same functions together that they serve separately? Consider the disruptiveness of that outcome to the status quo.

 4. Waldman on Jan. 13

What I am fairly sure won’t happen, even if interest rates are positive, is that “cash and government debt will no[] longer be perfect substitutes.” Cash and (short-term) government debt will continue to be near-perfect substitutes because, I expect, the Fed will continue to pay interest on reserves very close to the Federal Funds rate. (I’d be willing to make a Bryan-Caplan-style bet on that.) This represents a huge change from past practice — prior to 2008, the rate of interest paid on reserves was precisely zero, and the spread between the Federal Funds rate and zero was usually several hundred basis points. I believe that the Fed has moved permanently to a “floor” system (ht Aaron Krowne), under which there will always be substantial excess reserves in the banking system, on which interest will always be paid (while the Federal Funds target rate is positive).

5. Duy on Jan. 13

I think what I had in mind is this (and I admit that I am not wed to this, a little open-microphone now): The Fed has a portfolio of bonds which is a indirect transfer from Treasury which in turns allows it to pay interest on reserves. Lacking such a portfolio, the Fed would need to receive a direct transfer from the Treasury to pay interest on reserves. Operationally, these are the same. As long as both have the same objective function, it makes no difference if the Treasury's transfer goes through the middleman of a bond or just directly to the Fed. But what if the Treasury does not have the same objective function, does not want higher interest rates, and thus does not want to transfer the resources to the Fed? What claim does the Fed have on the Treasury to force it to act?  

Somewhere in this space is why we have come to accept the importance of an independent central bank. Indeed, this is a concern should the Fed need to pay interest on reserves that exceed the interest earned on its bond portfolio. Then the Fed would need to turn to the Treasury and say "Remember when we paid you $89 billion? Well, we need some of that back now."    

Ultimately, though, I have to agree with Waldman when I allow for the two authorities to have the same objective function. This is another way of saying that one side effect of the zero bound is the blurring of what many thought were sharp lines between fiscal and monetary authorities.

6. Waldman on Jan. 15

If “the crisis ends” (whatever that means) and the Fed reverts to its traditional approach to targeting interest rates, Krugman will be right and I will be wrong, the monetary base will revert to something very different than short-term debt. However, I’m willing to bet that the floor system will be with us indefinitely. If so, base money and short-term government debt will continue to be near-perfect substitutes, even after interest rates rise. 

Again, there’s no substantive dispute over the economics here. Krugman writes:

"It’s true that the Fed could sterilize the impact of a rise in the monetary base by raising the interest rate it pays on reserves, thereby keeping that base from turning into currency. But that’s just another form of borrowing; it doesn’t change the result that under non-liquidity trap conditions, printing money and issuing debt are not, in fact, the same thing."

If the Fed adopts the floor system permanently, then the Fed will always “sterilize” the impact of a perpetual excess of base money by paying its target interest rate on reserves. As Krugman says, this prevents reserves from being equivalent to currency and amounts to a form of government borrowing. So, we agree: under the floor system, there is little difference between base money and short-term debt, at any targeted interest rate! Printing money and issuing debt are distinct only when there is an opportunity cost to holding base money rather than debt. If Krugman wants to define the existence of such a cost as “non-liquidity trap conditions”, fine. But, if that’s the definition, I expect we’ll be in liquidity trap conditions for a very long time! By Krugman’s definition, a floor system is an eternal liquidity trap.

Am I absolutely certain that the Fed will choose a floor system indefinitely? No. That is a conjecture about future Fed behavior. But, as I’ve said, I’d be willing to bet on it.

Historical case studies

Concerning the new paradigm discussed at my paradigm shift genealogy, what are the historical case studies of the coin option or monetizing the debt.

Krugman mentions Japan's successful policies in the first half of the 1930s:

And beyond that, the credibility of a higher inflation target in the face of the deflationary bias of central bankers may well be best established by (a) reducing the central bank’s autonomy and (b) getting the central bank in the business of supporting — indeed, monetizing — government deficits, at least for a while. Gauti Eggertsson made this point long ago (pdf), pointing to Japan’s successful polices in the first half of the 30s as a clear example. Indeed, Gauti argued that having a large government debt can be a real advantage in such circumstances: efforts to raise expected inflation gain extra credibility if the government would clearly benefit in fiscal terms, and the central bank is sufficiently subordinated to elected officials that investors believe that it will take these fiscal benefits into account.

Tim Duy discusses Bernanke on Japan and helicopter drops.

However, besides possibly inconsistent application of fiscal stimulus, another reason for weak fiscal effects in Japan may be the well-publicized size of the government debt...In addition to making policymakers more reluctant to use expansionary fiscal policies in the first place, Japan's large national debt may dilute the effect of fiscal policies in those instances when they are used....My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt--so that the tax cut is in effect financed by money creation.

Grep Ip brings up the example of the pre-1951 Accord-era of 1942-51.

Yes, the Fed has sacrificed its independence for the sake of the national interest before, such as maintaining a ceiling on Treasury yields between 1942 and 1951; but that was (initially) in wartime, and it eventually led to inflation. Would avoiding the debt ceiling be important enough to compromise the Fed's independence? Perhaps not in this one case; but it would set a precedent future presidents will happily exploit and feed the perception that America’s economic institutions are in terminal decline. America has had debt ceiling crises before (in 1957, 1985, 1996 and 2011) and survived; are the unknown risks of the platinum coin option obviously preferable to the known risks of hitting the debt ceiling?

And mentions New Zealand:

Fed staff have laboured for years on the mechanics of this exit process; they can't be sure how it will transpire, since the Fed has never had to raise interest rates with so much excess reserves in the system. But the experience of other central banks, in particular the Reserve Bank of New Zealand, “suggests that tightening by increasing the interest rate paid on central bank balances can help reduce or eliminate the need to drain balances,” according to a 2010 study by three Fed economists. 

What this means is that while the platinum coin option expands the Fed’s balance sheet and, ultimately, the monetary base, it has no implications for inflation, even if the Treasury never buys back the coin.

Escape velocity and exit strategy

The Japanese Economy: Both Barrels? by Ryan Avent

I think I lean toward Mr Posen's view. Fiscal stimulus is neither necessary or sufficient for Japanese recovery, and though it could enhance a new monetary expansion it also carries some potentially serious risks. But I'm not that confident in the conclusion. Japan is a strange case. I suppose that makes the big upside of the situation (for economists, not the Japanese) the possibility that we'll learn something.

I disagree and agree with Krugman.

Floor System Paradigm Shift Genealogy*

I have an updated list here.

Jan. 2

Debt in a Time of Zero by Krugman

Jan. 7

On The Folly of Inflation Targeting In A World Of Interest Bearing Money by Ashwin Parameswaran

The end of RoRo, or is it? by Izabella Kaminska

Jan. 8

The liquidity trap heralds fundamental change by Frances Coppola

Jan. 9

Platinomics by Greg Ip

Jan. 12

On The Disruptiveness of the Platinum Coin by Tim Duy

Jan. 13

There’s no such thing as base money anymore by Steve Randy Waldman

A Trap of My Own Making by Tim Duy

Jan. 14

All Our Base Are Belong To Us (Wonkish) by Krugman

Floor Systems by Stephen Williamson

Jan. 15

Do we ever rise from the floor? by Steve Randy Waldman

All Your Base Are Belong To Us, Continued (Still Wonkish) by Krugman

Yet more on the floor with Paul Krugman by Steve Randy Waldman

Money and Debt, Continued by Tim Duy

Do sofas refute monetarism? by Nick Rowe

Currency matters, even with IOR by Scott Sumner

The Waldman-Krugman-Sumner Debate: It's the IOER Path by David Beckworth

Base money basics by Merijn Knibbe

Unifying The Fiscal And Monetary Functions: A Policy Proposal by Ashwin Parameswaran

All Your Bases and Dead Presidents Are Belong to the Government? by Cullen Roche

More on Floor Systems by Stephen Williamson

Jan. 16

Once you turn base money into short-term debt, can you go back? by Izabella Kaminska

Understanding the Permanent Floor—An Important Inconsistency in Neoclassical Monetary Economics by Scott Fullwiler


Jan. 17

All Your Base Are Belong To Us: What Is the Question? by Krugman

All Your Dorks Are Belong to This by Cullen Roche

Krugman, Kaminska, and Waldman by Scott Sumner

Monetary Policy: From Managing the Monetary Base to Setting an Interest Rate Floor by Peter Dorman

Let’s Talk About Interest on Reserves by Josh Hendrickson

Jan. 18

A confederacy of dorks by Steve Randy Waldman

THE PERMANENT FLOOR 2004 by Scott Fullwiler

Two extreme fiscal/monetary worlds by Nick Rowe

AND NICK ROWE IS THE LATEST ECONOMIST TO JOIN THE INARTICULATE DORKS... by Brad DeLong

The Coin is Dead! Long Live the Coin! by Michael Sankowski

Furthering Understanding of the Permanent Floor by Joshua Wojnilower

Shinzo and the Helicopters (Somewhat Wonkish) by Krugman

Jan. 19

Waldman Thinks Bernanke Will Go for (Flawed) Exit #1 by Robert Murphy

Murphy of the bad inflation bet, I think.

Jan. 28

Safe Assets and Financial Crises by Carola Binder

19JAN

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*provisional. Times are not sorted.

Well Ezra Klein doesn't admit that he was wrong - unlike Krugman. This damages his brand in my eyes. We'll see what Yglesias does on Monday. He was already hedging his bets, echoing what Dean Baker said about the Republicans falling into line over TARP.

Financial Collapse: A 10-Step Recovery Plan by Alan Blinder

(via Thoma)

Andy Harless comments at Waldman's latest:

OK, the Fed has two instruments, IOR and OMO’s, and two targets, the condition of the macroeconomy (which we can proxy with NGDP, though it is actually some mysterious combination of inflation and employment known only to the nonexistent collective consciousness of the Fed) and the health of the banking system. It sets its two instruments so as optimize the expected outcomes for its two targets. But since the instruments interact heavily, it’s somewhat arbitrary to say which instrument is affecting which target. 

The view in this post seems to be that, under a “floor” system, we should regard IOR as the lever that controls the macroeconomy and OMO’s as the lever that controls the banking system. Thus OMO’s are not inflationary: they are a microeconomic tactic that has little to do with macroeconomic outcomes. I have some sympathy for that view, inasmuch as it comports with what is likely to be the Fed’s own perception: when it wants to change macroeconomic conditions, it will change IOR, and when it wants to affect the health of the banking system, it will change its OMO policy. 

But I also find Scott Sumner fairly persuasive on this point. To hold the condition of the banking system constant, the Fed will have to adjust its OMO’s in response to its own changes in IOR. If it reduces IOR, liquidity will flow out of the banking system, and, to avoid making the condition of the system more precarious, the Fed will have to increase the base money stock. If it raises IOR, liquidity will flow into the banking system, and, to avoid paying for more liquidity than it wants, the Fed will have to reduce the base money stock. Holding the intended condition of the banking system constant, a change in IOR is an implicit promise of a change in OMO’s. Holding the intended condition of the banking system constant, the two changes are inseparable, so why should we associate the macroeconomic outcome with the former change rather than the latter? 

In the long run, unless there is a dramatic shift in the Fed’s preference regarding the condition of the banking system, it’s very clear that NGDP will be strongly correlated with the base money stock and very little correlated, if at all, with IOR. In the short run, it’s not clear which correlation will be stronger. (Even in the short run, as Scott points out, base money, at the very least, puts an upper constraint on expected NGDP, because IOR cannot go below zero.) I think there’s a strong case that, given the long run correlation, the presumption in associating an instrument with a target should be that we associate the base money stock with macroeconomic conditions. Hence OMO’s are inflationary, even if the commitment to do those OMO’s is inherent not in the OMO’s themselves but in a prior change in IOR.

If forced to guess, I would go with Jan Hatzius's predictions. 2.5 percent growth second half of 2013 and 3 percent in 2014. The Fed doesn't expect full employment until 2015. Nate Silver talks to him in "The Signal and the Noise."

Bill McBride interviews him here.

9.Will the Federal Reserve stop buying assets? 

No. Admittedly, the minutes of the December 11-12 FOMC meeting suggest that most Fed officials currently expect QE3 to end by late 2013. But we would not make too much of this. For one thing, it is important to remember that the outlook for monetary policy depends on the outlook for the economy.
...
10.Will interest rates rise? 

Not much. ... At the longer end of the curve, we do expect a small increase in 10-year Treasury yields to 2.2% by the end of 2013.

Abbreviations:

OMO is Open Market Operations

IOR is Interest on Reserves

I guess what I don't full understand is this bit where Greg Ip comments on what Krugman wrote:

...I’ve concluded the economics are more complicated and more benign than appreciated, but the political consequences are graver. 

(This is going to get rather abstruse, so bear with me.) Let’s start with the role of coins in the money supply. Long before there was a Federal Reserve, the United States government minted coins, often of silver and gold (specie). Private banks used these coins to back their own, private bank notes. The Fed took over issuance of bank notes in 1913, but coins remain the purview of the Treasury. Since bank notes are a liability of the Fed, they are, like reserves, part of the monetary base, the building block of the broader money supply. Coins, however, are a liability of the Treasury. In fact, in economic terms, coins are analogous to perpetual, zero coupon Treasury bonds. The Treasury can issue coins to the public and use the proceeds to finance the budget, just as if it issued bonds. 

Ordinarily, the Fed buys coins from the Treasury in response to demand from banks and pays for them by printing money which goes into Treasury’s account at the Fed. Sound familiar? It is, in economic terms, exactly the same as quantitative easing, when the Fed buys government bonds and pays for them with newly created money, deposited in banks’ reserve accounts. 

There are some differences, however. While the Fed’s balance sheet expands when it buys a coin, the monetary base- the building block of the money supply – does not. That’s because, coins, unlike bank notes, are an asset to the Fed, not a liability. You can see this by examining the Fed’s balance sheet here. The Fed would pay for the $1 trillion platinum coin by creating an equivalent deposit in the Treasury’s account. Treasury deposits aren’t part of the monetary base, either. As the Treasury spent that money, however, it would shift from the Treasury’s accounts to the reserve accounts of commercial banks. For example, suppose Treasury sends a $1000 refund check to a taxpayer, who deposits it in his account at Citibank. The Fed moves $1,000 from the Treasury’s account to Citibank’s reserve account. The Fed's liabilities remain the same, but the monetary base expands, by as much as $1 trillion, eventually. 

Is that inflationary? Paul Krugman says not now, but maybe later: 

      "Printing money isn’t at all inflationary under current conditions — that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought. "

I disagree. The Fed does not have to sell its bonds, or the $1 trillion coin, to control inflation (though it may do so anyway). It only needs to retain control of interest rates, and that does not depend on the size of its balance sheet. 

This, by the way, is at odds with the textbook IS-LM model in which the Fed sets a fixed money supply (represented by the upward sloping LM curve)...

Emphasis added. And:

The Fed influences the level of output by changing its interest rate, i.e. shifting the MP curve up or down. At any given interest rate the money supply is infinitely elastic, which simply means it is determined by demand, rather than the other way around, as monetarists think. I wish undergraduate courses used Mr Romer’s IS-MP model instead of the IS-LM model; students would have a much easier time applying their class work to the real world. 

This essentially explains why no major central bank targets the money supply. The money supply does matter, but for narrow, technical reasons. The Fed controls the short-term interest rates by adjusting the supply of reserve balances between banks. Ordinarily, creating trillions of dollars of reserves through QE (or buying a $1 trillion coin) would overwhelm any conceivable demand by banks for interbank funds, forcing the Fed funds rate down to zero. This would rob the Fed of control of interest rates and thus inflation. In this circumstance, Mr Krugman would be right: the Fed would have to sell vast amounts of bonds and other assets, and the $1 trillion platinum coin, to drain those reserves and regain control of interest rates. 

But in 2008, Congress gave the Fed authority to pay interest on reserves. Because banks should not lend reserves to each other for less than they can get from the Fed, this restores the Fed’s control over interest rates regardless of the size of its balance sheet, and thus over inflation.

Emphasis added. Ip doesn't agree with the Monetarists, like Nick Rowe? Is Ip agreeing with Waldman and Kaminska? Tim Duy's original reply:

Ip argues that interest on reserves gives the Fed the power to control interest rates, and consequently the power to control inflation, regardless of the size of the balance sheet. If you follow Ip's analysis through to its logical conclusion, then why should the Treasury issue debt at all? Why not just issue platinum coins? Could cash and government debt combine to serve the same functions together that they serve separately? Consider the disruptiveness of that outcome to the status quo.

Bottom Line: The platinum coin idea was ultimately doomed to failure because neither the Federal Reserve nor the Treasury could allow for even the remote possibility it might be successful. Its success would not just alter the political dynamic by removing the the debt ceiling as a threat. The success of a platinum coin would fundamentally alter the conventional wisdom about the proper separation of fiscal and monetary policy and the need to control the debt immediately.

At the Turn of the Tide

http://www.imdb.com/title/tt0167261/quotes

Gandalf: Gandalf? Yes... that was what they used to call me. Gandalf the Gray. That was my name. 

Gimli: Gandalf... 

Gandalf: *I* am Gandalf the White. And I come back to you now - at the turn of the tide.

The Sound of Republicans on the Debt Ceiling Fight: Run Away! Run Away! by Jonathan Cohn

The Fed Didn't Realize the Housing Bubble Was Driving the Economy by Dean Baker

Fed releases 2007 transcript

via Scott Sumner

The Future's so Bright ... by Bill McBride

Obama is off the chain

From Dec. 19th.

http://jaredbernsteinblog.com/debt-ceiling-strategies/

Transcript from presser earlier today: 

QUESTION: If you don’t get it done, Republicans say they would try to use the debt limit as the next pressure point. Will you negotiate with them in that context? 

OBAMA: No. And, I’ve been very clear about this. 

…the idea that we lurch from crisis to crisis, and every six months, or every nine months that we threaten not to pay our bills on stuff we’ve already bought, and default and ruin the full faith and credit of the United States of America, that’s not how you run a great country. 

So I’ve put forward a very clear principle. I will not negotiate around the debt ceiling. You know, we’re not going to play the same game that we saw happen — saw happen in 2011, which was hugely destructive. It hurt our economy. It provided more uncertainty to the business community than anything else that happened. And, you know, I’m not alone in this. You know, if you go to Wall Street, including talking to a whole bunch of folks who spent a lot of money trying to beat me, they would say it would be disastrous for us to use the debt ceiling as a cudgel to try to win political points on Capitol Hill. 

So we’re not going to do that. And — and — which is why I think that, you know, part of what I hope over the next couple of days we see is a recognition that there is a way to go ahead and get what it is you’ve been fighting for, these guys have been fighting for spending cuts. They can get some very meaningful spending cuts. This would amount to $2 trillion, $2 trillion spending cuts over the last couple of years. 

And in exchange, they’re getting a little over a trillion dollars in revenue. And that meets the pledge that I made during the campaign, which was two to — two dollars and fifty cents of spending cuts for every revenue increase. And that’s an approach that I think most Americans think is appropriate. But I will not negotiate around the debt ceiling. We’re not going to do that again.

--------------------------------------

Greg Sargent:

This also seems to deliberately keep it vague on whether the White House could ultimately support a clean three month extension. And it keeps the drumbeat going that Republicans are continuing to retreat.

Ultimately the game plan here is all about forcing Boehner to show that he can come up with 218 Republican votes for his three month extension, or whether he risks another conservative revolt and a “Plan B” fiasco, in which he ultimately can’t get the votes himself and again reveals his lack of control over the Tea Party caucus.

As I keep saying: The correct position for Democrats is that if Republicans won’t drop the threat of default, it’s their problem. Lather, rinse, repeat. Dems seem to be sticking to this hard line posture.

How long does Boehner last?

Not With A Bang But With A Whimper by Krugman

Alan Blinder’s ‘After the Music Stopped’ by Brad Plumer

Two extreme fiscal/monetary worlds by Nick Rowe

A confederacy of dorks by Steve Randy Waldman

Ben Bernanke Explains Journalism to the FOMC Board by Yglesias

This has nothing to do with monetary policy, but Ben Bernanke's explaination to the FOMC board of why Greg Ip is a great reporter is pretty solid: 

CHAIRMAN BERNANKE. I have the less pleasant duty of reminding everybody about the Wall Street Journal article on our communications policy that appeared some time ago. I don’t think anybody actually leaked the story, because the way Greg Ip works is that he goes around and talks to each person and gets a little of the story and then builds it up in that way. Nevertheless, I think it is obviously bad for our institution when our internal deliberations become public, and so let me just ask everyone, please, to be especially careful about maintaining confidentiality. Thank you.

That is, in fact, how it's done.

demand management and liquidity preferences*

A confederacy of dorks by Steve Randy Waldman

Krugman and I can enjoy an ecstatic “kumbaya” on both of his questions (no visuals please!), if he is willing to define as a liquidity trap any circumstance in which the central bank pays interest on reserves at a level greater than or equal to its target interest rate.

I don't have a firm grasp on the terms of the debate but do sort of get the gist of what they're discussing. As the quote shows, important concepts are IOR (interest rates on reserves held by the Fed), OMO (open market operations) and liquidity trap.

What also caught my eye was Izabella Kaminska's notion of multiple liquidity preferences and how it relates to how Alan Blinder said he changed his textbook to reflect the importance of multiple interest rates. During the crisis, private interest rates shot up as credit markets froze, while government set rates dropped. Kaminska:

In short, the problem wasn’t insufficient liquidity, per se. It was too much liquidity in some quarters and not enough in others. 

The challenge for the Fed was how to equalise the distribution of liquidity in the system, without putting further pressure on an already stressed-out repo market, on the verge of taking the “risk-free” funding rate negative. 

Offering interest on excess reserves was seen as an effective solution. Not only would IOER ensure that all banks holding excess liquidity could now benefit from a stable and positive rate — thus suspending the panicky capital destruction process — it would allow the Fed to continue adding liquidity until all shortfalls were covered, and more importantly all fear of potential shortfalls was removed from the market. 

In short, IOER was the key factor that compressed the spread between the risk-free and risky rate. But not because the risky rate was being suppressed. Rather, because the risk-free rate was being propped up with the IOER floor. 

Going back to Waldman’s argument, it’s at this point that “base money” became fully substitutable with short-term US debt. But, we would add, interest-bearing reserves even became preferable in some cases. 

Nevertheless, the entire debate really relates to liquidity preferences. 

The way we would put it is that IOER skewed the usual preferences in play. It’s the key reason why the proportion of reserves to currency in “base money” suddenly skyrocketed. The situation would undoubtedly reverse quickly if IOER was ever to drop to zero (or negative territory), since an opportunity cost would immediately be associated with holding reserves over zero-yielding currency. 

In fact, we would go one step further and argue that IOER was the key factor that stopped private rates turning negative, and in so doing suspended a process that could otherwise have led to a money market fund breaking the buck or even stacks of physical banknotes being hoarded and vaulted all over the United States. 

In this way, we agree with Waldman that the moment IOER created a preference for excess reserves over short-term debt assets or cash, was the moment excess reserves became a new type of safe asset security in their own right. 

Excess reserves became the equivalent of state debt. But, very importantly, a state debt taken with the intention of never being spent, but rather for the purpose of creating safe assets instead.

Also what struck me was the notion that the Fed might want to keep the reserves as a tool, even though the Fed seems to be saying they will exit when they can. In fact they keep prematurely talking about an exit.


I'm a bit at sea in this fascinating discussion since I don't have a firm grasp of the terms of debate and the mechanics under discussion. What stuck out for me was the notion that the Fed might keep hold of reserves. As I recall, they forced the banks to give them reserves in the midst of the panic to calm things down (even though, counterintuitively it was a tightening move, taking money from banks which could have been used to add credit to the economy.) And via the IOR, they recapitalized the banks, helped them deleverage, and restored confidence. A TARP supplement. This was Geithner's point about stablizing the financial system being a stimulus. Now the financial system is relatively stable, the economy is slowly growing and the banks are just sitting on the reserves, not lending them out when they can just earn the interest without risk. Meanwhile the Fed is doing QE, buying $85 billion in MBS assets until the unemployment rate drops some.

So the question is the exit when the economy starts growing, inflation is rising and the Fed wants to hit the brakes. It lowers the interest rates on reserves? What if the banks pull all their reserves?

The thing is the inflationistas keep predicting runaway inflation and it doesn't happen. The more mainstreamers keep prediciting a pick up in growth and it doesn't materialize. Goldman Sachs chief economist Jan Hatzius is predicting 2.5 percent growth in 2013H2 and 3 percent in 2014, so we'll see what happens.

Another point by Waldman:

When the Fed sets interest rates, it alters demand for money and government debt as a unified aggregate. What keeps the Fed special under a floor system is an institutional difference. The Fed issues the debt it calls “reserves” at rates fixed by fiat, while Treasury rates float at auction. The Fed leads, then Treasury rates follow by arbitrage. The Fed is powerful by virtue of how it prices its debt, not because it is uniquely the supplier of base money.

which is preceded by:

I agree full stop that “the Federal Reserve has great power over aggregate demand except when market interest rates are near zero”, even in a floor system. But, as Nick Rowe correctly points out, the source of this power is the Fed’s ability to affect demand for, rather than the supply of, money. And not just for money! 

which I don't undestand. Nick Rowe:

Even if the central bank kept the supply of base money constant, by printing more to offset what gets lost down the back of the sofa, waving the wand to increase the percentage from 1% to 2% would reduce the demand for base money and cause people to try to spend it before the sofa got it. Waving the wand would make base money a hot potato.

This seems to be the fundamental point, as Kaminska says:

But there are other problems associated with unwinding such a huge position on the market, too. Especially if you view this as tantamount to either “spending” the money borrowed, or paying it off. 

Consequently Waldman’s argument is essentially: why bother if you don’t have to? Let the excess reserves, just like state debt, roll on:

-----------------------------
*Update: Wow Waldman links to this post. Better clean up my thinking and grammar! Here's the link to my complete genealogy on the discussion of a possible paradigm shift.

Central Banks Can't Create Inflation?

Deflation: Making Sure "It" Doesn't Happen Here by Ben Bernanke (November 21, 2002)

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.17The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.

Fiscal Policy
Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.18

Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

Shinzo and the Helicopters (Somewhat Wonkish) by Krugman

As far as I can tell, Posen is going with the notion that unconventional monetary policy, by working both on asset demand and on expectations, can do the job. Maybe, but most of us have taken the limited payoff to quantitative easing as a cautionary tale. There’s a lot to say for the notion of using temporary fiscal stimulus to push the output gap down, ideally even causing some economic overheating, to jump-start the transition to an inflationary regime. 

And beyond that, the credibility of a higher inflation target in the face of the deflationary bias of central bankers may well be best established by (a) reducing the central bank’s autonomy and (b) getting the central bank in the business of supporting — indeed, monetizing — government deficits, at least for a while. Gauti Eggertsson made this point long ago (pdf), pointing to Japan’s successful polices in the first half of the 30s as a clear example. Indeed, Gauti argued that having a large government debt can be a real advantage in such circumstances: efforts to raise expected inflation gain extra credibility if the government would clearly benefit in fiscal terms, and the central bank is sufficiently subordinated to elected officials that investors believe that it will take these fiscal benefits into account. 

Recently Paul McCulley and Zoltan Pozsar (pdf) have broadened this point, arguing that Minsky-like cycles of leveraging and deleveraging mean that there are times when a central bank that is obliged to support fiscal expansion through “helicopter money” is exactly what the economy doctor ordered. And this is one of those times.

Perhaps why we didn't lapse back into Depression after World War II and demobilization as many economists include Paul Samuelson believed.

http://en.wikipedia.org/wiki/1951_Accord

The 1951 Accord, also known simply as the Accord, was an agreement between the U.S. Department of the Treasury and the Federal Reserve that restored independence to the Fed. 

During World War II, the Fed pledged to keep the interest rate on Treasury bills fixed at 0.375 percent. It continued to supportgovernment borrowing after the war ended, despite the fact that the Consumer Price Index rose 14% in 1947 and 8% in 1948, and the economy was in recession. President Harry S. Truman in 1948 replaced then Chairman of the Federal Reserve Marriner Eccles with Thomas B. McCabe for opposing this policy, although Eccles's term on the board would continue for three more years. The reluctance of the Fed to continue monetizing the deficit became so great that in 1951, President Truman invited the entire Federal Open Market Committee to the White House to resolve their differences. William McChesney Martin, then Assistant Secretary of the Treasury, was the principal mediator. Three weeks later, he was named Chairman of the Fed, replacing McCabe.

the complete Floor System timeline link list

Updated: This is outdated. Go here for the complete list.


Debt in a Time of Zero by Krugman

Platinomics by Greg Ip

On The Disruptiveness of the Platinum Coin by Tim Duy

There’s no such thing as base money anymore by Steve Randy Waldman

Floor Systems by Stephen Williamson (links to Waldman)

Currency matters, even with IOR by Scott Sumner (H/T Tim Duy)

The Waldman-Krugman-Sumner Debate: It's the IOER Path by David Beckworth

[I bracketed these links off because neither Krugman nor Waldman engage with or link to them. Update: Waldman did respond. see below.]

All Our Base Are Belong To Us (Wonkish) by Krugman

Do we ever rise from the floor? by Steve Randy Waldman

All Your Base Are Belong To Us, Continued (Still Wonkish) by Krugman

Yet more on the floor with Paul Krugman by Steve Randy Waldman

Money and Debt, Continued by Tim Duy

Once you turn base money into short-term debt, can you go back? by Izabella Kaminska

All Your Base Are Belong To Us: What Is the Question? by Krugman

Update:

A confederacy of dorks by Steve Randy Waldman (lots of links therein)

House GOP Considering New Strategy on Fiscal Issues: Surrender! by Yglesias

More Ideological Excuse Making for Bad Banks by Barry Ritholtz

Falling Real Interest Rates, Winner-Take-All Markets, and Lance Armstrong by David Glaesner

At "interfluidity" comment by JW Mason:

I understood Krugman to be saying that in a world of IOR significantly above zero, we need to change the definition of base money. Reserves held for their yield are not base money, in that scenario; when we talk about “the money multiplier” we should start talking about “the currency multiplier” instead. I’m not sure (and don’t actually care) if that argument is coherent, but I think it’s what he was saying. 

The interesting question to me is whether SRW is right that zero interest rates are here for good. The beginning of wisdom in this is to forget about the “natural rate” and ask whether there’s been a secular fall in desired expenditure relative to income at any given interest rate. I think there’s reason to think there has been. The shareholder revolution (and neoliberalism in general) has permanently shifted investment demand downward, by depriving firms of the low-cost pool of internal funds that formally financed investment. Another way of looking at this is that the effective (as opposed to legal) owners of nonfinancial corporations’ earnings have shifted from long-tenure professional managers, who were happy to convert those earnings to fixed capital since they were tied to the firm anyway; to rentiers with a strong preference for holding their wealth in financial form. This means that new investment needs to pass a much higher hurdle rate than before. (One nice way of seeing this empirically is the rise in Tobin’s Q after 1980 from less than 0.5 to around 1.) There may also have been a decrease in physical capital as a source of profits, toward IP-type rents; this would also tend to depress investment demand. 

These are secular shifts, not cyclical. The cyclical phenomenon is the intermittent masking of this long-term fall in investment demand by asset bubbles, first tech then real estate. In the absence of a bubble inflating expected returns, desired investment even at zero interest rates may not be enough to sustain full employment.

All Your Base Are Belong To Us: What Is the Question? by Krugman

My questions involve whether interest on excess reserves changes any of the fundamentals of monetary policy and its relationship to the budget. That is, does IOER change the fact that the Federal Reserve has great power over aggregate demand except when market interest rates are near zero, and the related fact that when we’re not in a liquidity trap there is an important distinction between debt-financed and money-financed deficits?

Reading Izabella Kaminska with Krugman's focus in mind:

For the record, FT Alphaville has long argued that IOER’s role as a sterilisation tool is under appreciated. (This, by the way, is why we believe it’s naive to argue that ECB liquidity operations are somehow less inflationary than Fed operations. Both are in reality sterilized.) 

It’s the icing that entices banks to hold excess liquidity rather than chasing secured loans or safe assets. This is needed to compress rates during a crisis — that is, to bolster secured (collateralised) rates so that they don’t plunge below zero and therefore distance themselves from positive, near-zero unsecured rates. 

This is important because banks that are frozen out of the unsecured market depend almost entirely on private collateralised markets for funding. 

If a bank can’t borrow unsecured for less than 5 per cent even when official rates are at zero, it has three options: 1) seek emergency funds (with the associated stigma) at a punitive rate from the Fed, 2) pawn its liquid collateral at the going repo rate, or 3) in the event it doesn’t have good enough collateral, either borrow the correct collateral from the Fed or (as happened in 2008) exchange poor quality collateral for better collateral via an emergency programme.
But the problem that really struck markets in 2008 wasn’t one of insufficient liquidity. Rather, it was the problem of collateral market bifurcation. 

Banks which previously had adequate amounts of collateral for use in repo markets suddenly found their collateral unusable. This led to genuine liquidity shortfalls in some quarters, which propagated fear in the unsecured funding markets, which subsequently froze the entire market.
Banks with plenty of liquidity, on the other hand — scared of lending to potentially insolvent banks — turned entirely to secured markets instead. But here they were presented with a different problem. There were suddenly not enough safe assets to lend against, at least not at rates comparable to or better than the Fed Funds rate. 

As healthy banks began to crowd each other out for any chance to lend against a diminished pool of safe assets, and/or just opted to keep excess reserves at the Fed for zero, repo rates understandably began to tank well below target. 

The following chart from the New York Fed illustrates the story well:

[graph] 

In short, the problem wasn’t insufficient liquidity, per se. It was too much liquidity in some quarters and not enough in others. 

The challenge for the Fed was how to equalise the distribution of liquidity in the system, without putting further pressure on an already stressed-out repo market, on the verge of taking the “risk-free” funding rate negative. 

Offering interest on excess reserves was seen as an effective solution. Not only would IOER ensure that all banks holding excess liquidity could now benefit from a stable and positive rate — thus suspending the panicky capital destruction process — it would allow the Fed to continue adding liquidity until all shortfalls were covered, and more importantly all fear of potential shortfalls was removed from the market. 

In short, IOER was the key factor that compressed the spread between the risk-free and risky rate. But not because the risky rate was being suppressed. Rather, because the risk-free rate was being propped up with the IOER floor. 

Going back to Waldman’s argument, it’s at this point that “base money” became fully substitutable with short-term US debt. But, we would add, interest-bearing reserves even became preferable in some cases. 

Nevertheless, the entire debate really relates to liquidity preferences. 

The way we would put it is that IOER skewed the usual preferences in play. It’s the key reason why the proportion of reserves to currency in “base money” suddenly skyrocketed. The situation would undoubtedly reverse quickly if IOER was ever to drop to zero (or negative territory), since an opportunity cost would immediately be associated with holding reserves over zero-yielding currency. 

In fact, we would go one step further and argue that IOER was the key factor that stopped private rates turning negative, and in so doing suspended a process that could otherwise have led to a money market fund breaking the buck or even stacks of physical banknotes being hoarded and vaulted all over the United States. 

In this way, we agree with Waldman that the moment IOER created a preference for excess reserves over short-term debt assets or cash, was the moment excess reserves became a new type of safe asset security in their own right. 

Excess reserves became the equivalent of state debt. But, very importantly, a state debt taken with the intention of never being spent, but rather for the purpose of creating safe assets instead.

 On the exit strategy:

But there are other problems associated with unwinding such a huge position on the market, too. Especially if you view this as tantamount to either “spending” the money borrowed, or paying it off. 

Consequently Waldman’s argument is essentially: why bother if you don’t have to? Let the excess reserves, just like state debt, roll on:

Why go to the trouble of unwinding the existing surfeit of base money, which might be disruptive, when doing so solves no pressing problem? 

And since not moving quickly enough poses too great a risk, the alternative would be committing to IOER as a long-term rate-steering alternative instead. 

As Waldman sums up:

If the Fed adopts the floor system permanently, then the Fed will always “sterilize” the impact of a perpetual excess of base money by paying its target interest rate on reserves. As Krugman says, this prevents reserves from being equivalent to currency and amounts to a form of government borrowing. So, we agree: under the floor system, there is little difference between base money and short-term debt, at any targeted interest rate! Printing money and issuing debt are distinct only when there is an opportunity cost to holding base money rather than debt. If Krugman wants to define the existence of such a cost as “non-liquidity trap conditions”, fine. 

But, if that’s the definition, I expect we’ll be in liquidity trap conditions for a very long time! By Krugman’s definition, a floor system is an eternal liquidity trap. 

Krugman, for now, remains unconvinced. 

Waldman has opted for the cunning use of apple analogies in one final attempt to explain. But we think we’ll leave it here.

Krugman's point is that the Fed's sterilization amounts to a form of government borrowing. And in non-liqudity trap conditions there's is a limit on borrowing. He seems to be arguing against the MMT position while Kamiska and Waldman are predicting we'll be in a liquidity trap for a long time.

Once you turn base money into short-term debt, can you go back? by Izabella Kaminska 

Forget about the $1 trillion coin debate. 

The most exciting wonky discussion being had right now is between Steve Randy Waldman and Paul Krugman over whether “base money” and short-term debt are perfectly substitutable or not, and what that may or may not mean for central bank policy. 

We confess that we have a bit of a vested interest here because for a long time we’ve been arguing much the same point as Waldman. 

That’s not to say that Krugman is necessarily wrong; he may just be taking Waldman slightly too literally....

Comments at Waldman's latest post:

 Carter writes:

Having paid a lot of attention to speeches by Dudley, Brian Sacks, etc, I suspect that there is a “middle path” that the Fed may take once growth warrants higher rates. Consistent with a “risk management” philosophy, the Fed will not want to surprise markets by raising rates much more quickly thatn the forwards. They played that game in the 1990s, and the result was Orange County and LTCM and BT’s clients. 

One might consider that the Fed will raise the short rates “in an orderly fashion” and perhaps use interest on reserves (a tool they are now enamored of) to “tail-the-hedge”. This means they may raise IOER faster than nominal fed funds

Fedwatch writes: 

Not sure if it’s been noted yet in these comments, but the April 2011 minutes are telling 

http://www.federalreserve.gov/newsevents/press/monetary/fomcminutes20110427.pdf#page=4 

Normalization steps were discussed, and “Most participants saw changes in the target for the federal funds rate as the preferred active tool for tightening monetary policy when appropriate.” And work how? “Most of these participants indicated that they preferred that monetary policy eventually operate through a corridor-type system in which the federal funds rate trades in the middle of a range, with the IOER rate as the floor and the discount rate as the ceiling of the range, as opposed to a floor-type system in which a relatively high level of reserve balances keeps the federal funds rate near the IOER rate.”

Dean Baker says in effect that Yglesias, Klein and I shouldn't be worried that the Republicans will bring on a default. They voted for TARP.

The Medieval Plague and Full Employment by Jared Bernstein

Bernstein links to Annie Lowrey's piece: "The Politics of Low Growth"

Tom Friedman discusses it as well.

Maybe my baby-boomer generation really does intend to eat it all and leave our kids a ticking debt bomb. If only we had a second-term president, unencumbered by ever having to run again, who was ready to test what really bold leadership might produce.

He's wrong as usual.

Nate Silver on the composition of government spending.

Serfs Up! by Krugman, cited by a commenter that Bernstein - who usually right -  is wrong.

Japan should rethink its stimulus by Adam Posen

huh? He favored fiscal stimulus early on for Japan and favors it for the U.K.

Fed’s Rosengren Says Economy Responding to Stimulus

Boston Fed President Eric Rosengren Had A Great Answer About The 'Cost' Of All That Fed Easing

Wow Jon Stewart sort of admitted he was ignorant about economics and his show wasn't meant to be informative, in regards to Krugman's pushback on the trillion dollar coin, but he did he repeat that the coin was a stupid idea. And he said he was a fan of Krugman.

Part of the point of the coin was that it was ridiculous,* as Krugman has written. So maybe Krugman's criticism wasn't well put but I still see Stewart as in the wrong. He can't have it both ways and yet you don't him to be dogmatic and always pushing the party line. Weird episode.

Krugman will have the last laugh if neither Obama or the Republicans back down and the government defaults, then the coin won't look so fucking stupid. Maybe this is what Klein and Yglesias are worried about.**

---------------------------------
*intended to counter/comment on the debt ceiling clown show.
**Yeah the more I think about the more I've come to the conclusion that they're worried Obama will box himself into a corner over not negotiating, the Republicans won't. We'll get default and disaster which is what Klein and Yglesias are worried about, they're not concerned Obama won't negotiate a good deal. Maybe I've been blaise like Stewart.

Obama is off the chain

As Nate Silver points out, he longer has to worry about re-election.

Is Yglesias doing a walkback-climbdown over his insistence that Obama has no credibility?

Americans For Prosperity Advises Members to "Calibrate Your Message" on Debt Ceiling by Yglesias

David Leonhardt tweets:

Obama sees politics as based on interests much more than relationships. And in fairness, he passed health reform and Clinton didn't.

The Floor System

The new thing for me is the realization - reading Waldman - that we will be in a liquidity trap for a long time. Atlanta's Lockhart says QE is not "QE infinity."

Yesterday Steve Williamson blogged:

The quantity of reserves held by US financial institutions is now approaching $1.6 trillion, and the Fed has promised to increase that stock by $85 billion per month for the indefinite future. Thus, it seems safe to say that the Fed will be working within a monetary regime with a large quantity of excess reserves for a very long time.

All Your Base Are Belong To Us, Continued (Still Wonkish) by Krugman

Yet more on the floor with Paul Krugman by Steve Randy Waldman

Krugman "And I think he’s implying that there’s really no difference between 2(b) and 3." 3 is what MMTers argue something Krugman has discussed before.

Waldman "But Waldman definitely does not at all believe that 2(b) and (3) are equivalent when the interest rate is positive." So he's not a subscriber to MMT?

At Economic View, Sadowski links to "the Money Illusion":

Currency matters even with IOR by Scott Sumner

Which I can't make sense of. As I understand it, there are three schools of demand management: the Modern Monetary Theoryist (MMTers, far left), the Market Monetarists (rightwing) and the mainstream DeLong-Krugman-Thoma axis to which I subscribe.

A link history of this discussion:

Debt in a Time of Zero by Krugman 

It’s true that printing money isn’t at all inflationary under current conditions— that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought. So even though right now that debt is just a claim by one more or less governmental agency on another governmental agency, it will eventually turn into debt held by the public. 

We are living in weird economic times, where many of the usual rules don’t apply and there are big free lunches to be had. But not everything is a free lunch, even now. Sorry.

Which led to Ip's blogpost which linked to the above:

Platinomics by Greg Ip

But the politics are utterly different. We have a central bank to separate fiscal from monetary policy. The Fed implements QE when it has decided that’s the best way to carry out its monetary policy objectives. Buying a coin solely to finance the deficit is monetizing the debt, precisely the sort of thing central bank independence was meant to prevent. How could any Federal Reserve chairman justify cooperating in such a scheme, in particular since the Fed would be taking the White House’s side in a fight with Congress over a matter of dubious legality? 

Yes, the Fed has sacrificed its independence for the sake of the national interest before, such as maintaining a ceiling on Treasury yields between 1942 and 1951; but that was (initially) in wartime, and it eventually led to inflation. Would avoiding the debt ceiling be important enough to compromise the Fed's independence? Perhaps not in this one case; but it would set a precedent future presidents will happily exploit and feed the perception that America’s economic institutions are in terminal decline. America has had debt ceiling crises before (in 1957, 1985, 1996 and 2011) and survived; are the unknown risks of the platinum coin option obviously preferable to the known risks of hitting the debt ceiling?

Duy linked to both Krugman and Ip:

On The Disruptiveness of the Platinum Coin by Tim Duy

Carrying the argument further, the illusion of a difference between cash and debt at the zero bound is counterproductive because it prevents the full application of fiscal policy.  Fears about the magnitude of the government debt prevent sufficient fiscal policy, but such fears are not rational if debt and cash are perfect substitutes. If cash and debt are the same, the fiscal authority should prefer to issue cash if debt concerns create a false barrier to fiscal policy.  Still, I would argue that this is best done in cooperation with the monetary authority.  Note that this is not really a new idea, as then Governor Ben Bernanke drew a similar conclusion with regards to Japan:

However, besides possibly inconsistent application of fiscal stimulus, another reason for weak fiscal effects in Japan may be the well-publicized size of the government debt...In addition to making policymakers more reluctant to use expansionary fiscal policies in the first place, Japan's large national debt may dilute the effect of fiscal policies in those instances when they are used....My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt--so that the tax cut is in effect financed by money creation.

And then we come to the platinum coin, which threatened to expose the illusion that cash and debt are different at the zero bound.... 

...
Ultimately, I don't believe deficit spending should be directly monetized as I believe that Paul Krugman is correct - at some point in the future, the US economy will hopefully exit the zero bound, and at that point cash and government debt will not longer be perfect substitutes. Note that Greg Ip disagreed with this point:

I disagree. The Fed does not have to sell its bonds, or the $1 trillion coin, to control inflation (though it may do so anyway). It only needs to retain control of interest rates, and that does not depend on the size of its balance sheet.

Waldman links to Duy and Ip:

There’s no such thing as base money anymore by Steve Randy Waldman

Krugman responds

All Our Base Are Belong To Us (Wonkish) by Krugman

Waldman responds

Do we ever rise from the floor? by Steve Randy Waldman

and then Krugman responds again (see above) and Waldman responds again (see above)

Update:

Tim Duy has another post:

My takeaway from Waldman is that under some institutional structures, there is little difference between platinum coins and government debt (or because we have debt we have a particular institutional structure?) In effect, the the zero-bound issue and platinum coin debate have forced us to think down paths that blur the lines between fiscal and monetary policy. The longer we are in at the zero-bound, the more we will challenge the existing status-quo. 

Alternatively, this can also be simply a misunderstanding on Krugman's part if he believes that Waldman is saying that we can use platinum coins to literally monetize deficit spending with neither budgetary nor inflationary implications. I don't think Waldman is thinking this, and if he is, then I think he would be wrong.

And  commenter RebelEconomist (from the UK) at Waldman's latest:

What a lot of fuss about nothing! Americans might save themselves much confusion if they paid more attention to practices in other countries. Well before the financial crisis and QE, the Bank of England switched to paying interest on reserves to make the demand for reserves more elastic and hence make moneymarket interest rates, through which the BoE regulated its monetary stance, less volatile. Provided that the interest rate paid on reserves is a bit less than low credit risk private sector debt, the banks will still hold reserves primarily as a settlement asset, but simply hold more reserves. On May 18 2006, the day the new regime was introduced, reserves held by British banks rose about twenty fold, a demand met by the BoE, without any disturbance to inflation, sterling exchange rates or government debt markets. I explain the reasoning in more detail in this old post of mine:  

http://reservedplace.blogspot.co.uk/2009/04/easing-understanding.html 

(especially paragraphs 20-24). I suspect that the Fed always wanted to introduce such a system themselves, but found it difficult to get past populist congressmen whining about giving money away to banks, and now they have it, they are going to hang onto it for operational reasons long after they cease paying interest on reserves for QE purposes!

Commenter Tom Hinkey at interfluidity:

I think that it is unlikely that the Fed will continue the setting floor rate by paying IOR for political reasons similar to the reason that the platinum coin was smothered in the crib. It gives the game away and threatens the illusion that government finance is like firm or household finance under the current monetary regime. This is not an operational requirement since there is no operational reason for government not to fund itself directly. The illusion that government needs to be funded from revenue or borrowing from the private sector is created by political means, that is legislation, regulation, and interpretation. There is serious speculation that the central bankers’ club nixed the platinum coin gambit for this reason, and I would not be surprised to see TPTB nix payment of IOR when it no longer suits their purposes. 

Another Updated(!) 

Once you turn base money into short-term debt, can you go back? by Izabella Kaminska

All Your Base Are Belong To Us: What Is the Question? by Krugman