Trump and Sanders: Fiscal Policy Bros
What do Donald Trump and Bernie Sanders have in common? Both are believers in Modern Monetary Theory. There is little doubt that politicians be they democrat or republican ascribe to Modern Monetary Theory in which governments can print all the money it wants and not worry about such silly things as deficits, default or inflation. To wit: MMT says sovereign governments cannot default. They can always print the money to redeem whatever government bonds are maturing – see Greece and Japan. So debt doesn’t matter and governments can function nicely by increasing it through ever growing expenditures. If inflation occurs, as surely it must, then all the government has to do is to increase taxes to take the money out of circulation. Of course, governments rarely do this and use the additional tax receipts to increase expenditures even more.
In the MMT world, the government need not sell bonds to finance its spending since it can create money to do that. Bonds exist to allow the Fed to manipulate excess reserves in the banking system to set the Fed funds rate. If the Fed wants to decrease the rate, then it will buy bonds from the banks which increases their excess reserves and lowers the Fed funds rate. The result will be an increase in the money supply via the banks. MMT says that large deficits don’t matter and that deficit spending is actually beneficial in that it builds people’s savings.
In our political world it is probably not surprising that Bernie Sanders is a fan of MMT. But so apparently is Donald Trump. MMT provides cover for fiscal irresponsibility. Trump’s budget bill shows that he is a fan of ever increasing deficits. That he is a devotee of MMT is apparent when he keeps pressuring the Fed to accommodate his fiscal policy by lowering interest rates. Never mind that traditional economics says that lowering interest rates in this particular economic climate will create inflation. Trump’s notion is “What me worry?” He also wants the Fed to lower borrowing costs of the deficit. Here, the Fed’s lowering short term rates will actually increase long term yields as inflationary expectations rise. To counter the Fed would have to buy back Treasury bonds. That action would increase Treasury prices and lower their yields. Mission accomplished? Not so fast my friends. The end result of that action would also lead to inflation and more pressure on the bond market. Do we really want to see a repeat of the Fed’s increasing their balance sheet by buying governments? During Covid, the Fed’s balance sheet exploded going from around $3 trillion to over $8 trillion.
Of course, when the Fed buys all these bonds, it creates new money which in turn is inflationary. Although the MMT crowd would say that this is no big deal, I guess one approach would be for the Fed to be the main purchaser of new Treasury bond issues to drive down bond yields and have the Treasury not spend the money. Sure. Then the Fed’s balance sheet can grow without limits. Any interest payments from the Treasury would be made to the Fed which could then remit them back to the Treasury. Who needs foreign investors? Of course, the question is what happens if US inflation causes a de-dollarization in world markets, imperiling the dollar as a reserve currency? In Trump’s world this does not matter since his ideal is a return to mercantilism and a minimizing of imports which in turn minimize dollars flowing into world markets and central banks.
Thus the key to MMT is a compliant central bank. The Fed must always subordinate monetary policy to fiscal policy. This is not a given with our “independent” Fed but would be if the Fed were merely a branch of the Treasury Department. That way the Fed would be to do the bidding of the president. Then Trump would not have to rant and rave about Powell “lowering” interest rates. MAGA folk may want this but imagine what the economy would then look like the next time a Joe Biden is elected president.
Trump’s budget like all those before it depends on spending more and more. To spend the government must either tax, borrow or print. With Trump, increased taxes are out so it is borrow or print. Yet borrowing is expensive as evidenced by the latest Treasury auction – unless we have the Fed purchase all the new issues of Treasury bonds. So print baby print. But in either case, what me worry? As long as the Fed is accommodating. Let MMT reign!
haroldblackphd.com 