In Lenders and Spenders, I recently wrote,
this sets the political system up for conflict and strife in year two, when the burden of paying the debt has to be apportioned. As we have seen, it could be divided any number of ways. However, consider this: Lois is expecting three bushels of corn, based on what she produces and her expectation of having her loan repaid. Meanwhile, Sammy is expecting two bushels of corn, based on what he produces. There are only four bushels of corn available, and there will be a political battle over who gets disappointed the most.
This is one of my favorite essays.
Government spending is the issue, the financing less so. The political squabbles are about equal if the government taxes and then redistributes from Lois to Sammy every year versus borrowing and redistributing.
You start with “a simple economy, where the only product is corn. There is no foreign sector, and there are no financial claims more complicated than IOUs”. You then work your way to talking about the Fed and “long-term bonds and mortgages” but if we have those things, the corn example doesn’t really work.
1. So great to have you back blogging!
2. You write: “Many of the securities that the Fed has acquired are long-term bonds and mortgages. As inflation and interest rates increase, the value of these securities plummets. (A bond that pays 2.5 percent interest loses roughly half its value when market rates rise to 5 percent.) In this scenario, the Fed will be incurring losses, which will require a subsidy from the government budget.”
Is the government legally required to keep the Fed solvent from an accounting standpoint? Anyone know a link that explains this? (I feel like this has been asked and answered before, so I apologize for still not knowing the answer!) Theoretically, it is not clear to me why the Fed needs to be solvent from an accounting standpoint, although, obviously, a negative net worth might dramatically damage fed credibility.
The Fed has to pay for its operations somehow. Historically, it has earned profits and returned them to the Treasury. Presumably, if it incurs losses, and it doesn’t want to just print money to cover them, then funds must come from the Treasury. I do not know whether that would require legislation or not.
I was wondering about that myself…
The first thought that came to mind is the USPO method of financing…
Thanks!
It won’t need cash to cover losses anyway. It only needs enough cash to cover operating expenses, not market losses. It will never run out of money.
It still seems a bit odd to me that we must have 6 posts on government debt for every one on private debt. I think you can make a pretty reasonable case that our privately held debt is at least as much of a problem in our economy as publicly held debt.
Steve
Society has a good mechanism for discharging private debt, bankruptcy. While I am personally in favor of explicit government default, if it ever comes to a major crisis, most others are not. The politics of restructuring the debt are much uglier than those of a firm or personal bankruptcy.
Simple models are good for illustrating simple points. Yes redistribution creates conflict.
The main complication comes from growth and investment. Let’s make the model where to produce two bushels every year you need to use half a bushel for seeds. How can the society reclaim the bushel from Sammy without making him cut the 0.5 bushel investment in next year’s harvest?
It’s a wonderful essay. The perfect example of something every economist will agree with instantly, but that the popular discussion is trying to ignore. It’s well worth beating on.
It really is a good essay. I think it is good to recognize that while government borrowing can mimic private borrowing or transfers, there are ways in which it is distinct. Assumptions matter a tremendous amount.