The last filmy slips of fabric have been stripped away, and macroeconomists must now view the once-romanced US Congress in flagrante delicto with a real paramour: Mr. Big Bucks Deficits.
The Congressional Budget Office, the Budget Committees, the Tax Committees, the endless pompous pettifogging about national debts—all tossed overboard on the Washington IOU Love Boat.
Worse, Congress is not having a mere wild love affair—they have brought Mr. Big Bucks Deficits to the altar.
So Now What?
From here, a premise of Federal Reserve monetary policy must be that it takes place alongside $1 trillion annual deficits.
For many, the new reality suggests an even tighter monetary policy to offset the fiscal stimulus (of course, for many, monetary policy should everywhere and always be tighter).
Oddly enough, tighter money may be exactly the wrong course. Tighter money could, perhaps probably, trigger a recession that would only dramatically deepen federal deficits, as we have repeatedly seen in the US and many other nations.
When life hands you a lemon, then make lemonade. There may be some workable options.
The Bank of Japan has bought back about 45% on Japan’s national debt, and has held interest rates to 0.10% on 10-year JGBs. Despite record-low unemployment in Japan, the BoJ cannot seem to break a 1% inflation ceiling.
The successful deployment of the QE option raises a hope that the US national debt can be transferred to the Fed’s balance sheet, from which interest payments flow back into the US Treasury, thus mitigating the tax burden of the debt. This is working now, in fact (if not theory), in Japan. What works, works.
Perma-Bonds at Zero
Curiously, if the Fed does go to tighter money and triggers a recession, likely we will see interest rates for government debt fall to zero (government debt already pays zero interest in Japan and Germany).
From this untoward position, the US Treasury might be able to issue perma-bonds at zero or very low nominal rates, such as 0.10% (as in present-day Japan). So the Treasury might aggressively re-fi debt at 0.10% through perma- or very long-term bonds. Again, this alleviates the debt burden.
Another option is dispense with bonds and Fed balance sheets and the banking system altogether, and use the Fed to simply print money and pay for federal operations, called money-financed fiscal programs, aka helicopter drops.
I prefer that helicopter drops not finance federal operations, but rather finance tax cuts, such as a tax holiday on Social Security taxes paid by employees and employers. This tax loss would be offset by Fed printed (digitized) money injected into the Social Security fund.
The best Fed policy is still to target NGDPLT.
But there is a near-certainty of soaring national debt in the future, which could become unserviceable and suffocate real growth.
Innovative use of monetary policy options, such as long-term QE, or helicopter drops, must now be prominently placed in the Fed tool box.
The use of a central bank to deleverage a nation, without causing inflation, until lately might have been considered unlikely. But we have seen in Japan the BoJ accomplish exactly that. The recent use of QE in the United States also was not associated with inflation. These policy options may be unpalatable to some.
But the option of not mitigating soaring national debts through monetary policy may prove even less palatable, and less pragmatic.