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.