Cross-posted from Credit Writedowns
Paul Krugman has another piece up on MMT. I like this piece a lot more than the last one he wrote. I suggest you read it.
Here’s the one passage I do find troubling, however:
Let’s have a more or less concrete example. Suppose that at some future date — a date at which private demand for funds has revived, so that there are lending opportunities — the US government has committed itself to spending equal to 27 percent of GDP, while the tax laws only lead to 17 percent of GDP in revenues. And consider what happens in that case under two scenarios. In the first, investors believe that the government will eventually raise revenue and/or cut spending, and are willing to lend enough to cover the deficit. In the second, for whatever reason, investors refuse to buy US bonds.
It’s actually just three words that bother me: “for whatever reason”. i think the whole discussion hangs on those three words actually. Interest rates largely reflect the expected path of future policy rates. It does not follow logically for me that investors would refuse to buy US bonds ‘for whatever reason’. Sure, currency revulsion can cause the exchange rate to collapse and inflation to go through the roof. As Dr. Krugman points out, you could even get hyperinflation under certain circumstances.
But as I pointed out earlier today:
In the end, this is about interest rates. Why is Paul Krugman worrying about the US losing access to the bond market when the term structure of the yield curve largely reflects expected future policy rates? We just saw this is true after the Fed moved to permanent zero at the last FOMC meeting. “The 0.375% US Treasury note maturing on 31 July 2013 is now yielding only 19 basis points.” The Fed can do as much ‘financial repression’ as they want by keeping rates below the headline inflation rate since it has monopoly power in the market for base money. Inflation and currency depreciation are the issues – not a steeper yield curve.
Remember, we have just witnessed investors willing to flee to the liquidity of Treasuries even as the government threatened to default on those securities. That doesn’t speak to investors refusing to buy US bonds in the least. I suppose they could do at some undetermined point in the future. However, saying ‘for whatever reason’ presupposes the outcome. I need to see the steps that get us from 2.25% 10-year rates to 4 or 5% without the Fed set to actively raise rates because the only way rates are going higher is because the Fed is forced by inflation to raise them.
Source: MMT, Again, Paul Krugman