Should Central Banks Burn All Their Government Bonds?

In June of 2008, Ron Paul made a radical proposal: the Fed should simply burn all the U.S. Treasuries it’s currently holding, reducing the government (U.S. Treasury) debt by $1.6 trillion, or about 10%. (Yes: bonds held by the Fed are counted as part of “Debt Held by the Public,” even though the government basically “owns” the Fed.)

Paul called this “bankruptcy,” but it’s actually pure MMT thinking, acknowledging that 1. the Fed and the Treasury are most reasonably viewed as a single consolidated entity (“the government”), and 2. that government debt is something of a side issue in the big monetary picture (bonds are a vehicle for interest-rate management by the Fed), compared to the matter of central importance: how much newly created money the government puts into the economy by deficit spending, or takes out with a surplus (destroying more money by taxing than it creates by spending).

This is pretty radical talk, for sure. (I wonder if Paul and Kucinich ever eat lunch together.) But now Gavyn Davies tells us in the Financial Times that such notions are at least floating about in some decidedly traditional circles (emphasis mine):

Two separate journalists (Robert Peston of the BBC and Simon Jenkins of The Guardian) said that Lord Turner’s “private view” is that some part of the Bank’s gilts holdings might be cancelled in order to boost the economy. Lord Turner distanced himself in public from this suggestion on Saturday. However, the notion will now be widely discussed. It is easy to see how the idea could appeal to a finance minister facing the need to tighten fiscal policy during a recession in order to bring down the public debt ratio. [that’s “Adair Turner, the Chairman of the UK Financial Services Agency, and reportedly a candidate to become the next Governor of the Bank of England.”]

Davies doesn’t like the idea (inflation worries), and apparently Lord Turner has his qualms as well. But the fact that these ideas are getting any consideration at all in the world of central banking is pretty radical in itself. Heck, the fact that Davies is even writing about it (and explaining it rather well, IMHO, with some caveats) speaks volumes. He has been, after all, a partner, Managing Director, Chief Economist, and Chairman of the Global Investment Research Department at Goldman, Sachs. Not your typical internet econocrank.

For those who follow these discussions, Davies’ two footnotes might be the most significant:

[1] Similar proposals have however been widely debated by economists in the past. This goes back at least as far as the works of Abba Lerner in the 1940s on “functional finance” and the role of fiat money. More recently, the Modern Monetary Theorists have reawakened Lerner’s ideas. See this explanation of MMT, and Paul Krugman’s rejection of the approach as being likely to lead to hyperinflation in the long run.

[2] Samuel Brittan makes the case that part of the budget deficit should be money financed in this column. Martin Wolf makes a similar case in this column. Both argue that money financing of deficits is preferable to “everlasting austerity and slump”.

Cross-posted at Asymptosis.