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potentially more difficult risk-return tradeoffs in using fiscal policy to fight a financial crisis, respond to a large-scale natural disaster or pandemic, or mobilize for a physical conflict or cyberwar. As a great deal of empirical evidence has shown, nothing weighs on a country’s long-term trend growth like being financially hamstrung in a crisis. The right approach to balancing risk and reward is for the government to extend the maturity structure of its debt, borrowing long-term instead of short-term. This helps to stabilize debt-service costs if interest rates rise. And if things get really difficult, it is far easier to inflate down the value of captive long-term debt (provided it is not indexed to prices) than it is to inflate away short-term debt, which the government constantly has to refinance. True, policymakers could again resort to financial repression and force citizens to hold government debt at below-market interest rates as an alternative way of reducing the debt burden. But this is a better option for Japan, where most debt is held domestically, than for the U.S., which depends heavily on foreign buyers. Having the Fed issue short-term liabilities in order to buy long-term government debt turns policy 180 degrees in the wrong direction, because it shortens the maturity of U.S. government debt that is held privately or by foreign governments. Contrary to widespread opinion, the U.S. central bank is not an independent financial entity: the government owns it lock, stock, and barrel.
Unfortunately, the Fed itself is responsible for a good deal of the confusion surrounding the use of its balance sheet. In the years following the 2008 financial crisis, the Fed engaged in massive “quantitative easing” (QE), whereby it bought up very long-term government debt in exchange for bank reserves and tried to convince the American public that this magically stimulated the economy. QE, when it consists simply of buying government bonds, is smoke and mirrors. The Fed’s parent company, the U.S. Department of the Treasury, could have accomplished the same thing by issuing one-week debt, and the Fed would not have needed to intervene. Perhaps all the nonsense about MMT will fade. But that’s what people said about extreme versions of supply-side economics during Ronald Reagan’s 1980 U.S. presidential campaign. Misguided ideas may yet drag the issue of U.S. central- bank independence to center stage, with unpredictable and potentially serious consequences. For those bored with the steady employment growth and low inflation of the past decade, things could soon become more exciting. © Project Syndicate
Kenneth Rogoff , Professor of Economics and Public Policy at
Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003.
American Consequences
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