In a recent post, "Franc Thoughts On Long-Run Fiscal Issues", Paul Krugman has once again engaged with MMT. His main argument this time concerns the difference, if any, between issuing debt when deficit spending rather than simply allowing balances to mount in reserve accounts. He agrees that under current circumstances zero interest short-term debt and zero-interest reserves are close substitutes, but argues that issuing debt and allowing reserves to mount will have different inflationary implications when interest rates are positive.
The composition of public liabilities as between debt and monetary base does matter in normal times — hey, if it didn’t, the Fed would have no influence, ever. So if we try at that point to finance the deficit by money issue rather than bond sales, it will be inflationary.
The MMT position is that if the interest rate target is positive, short-term debt would remain a close substitute to reserves provided the Fed paid the equivalent interest rate on reserves. This would be the most straightforward approach to monetary policy: simply to pay interest on reserves at the target rate rather than issuing short-term debt.
Nevertheless, MMT is in agreement with Krugman that if the Fed did not pay the target rate on reserves, then allowing reserves to mount rather than issuing debt would have a different inflationary impact. Doing so would cause the interest rate to fall to the rate paid on reserves (possibly zero). In that case, reserves would not be close substitutes for short-term debt, and the inflationary implications would be somewhat different.
Even so, the MMT position is that any difference in inflationary impact would be due to the difference in interest rates paid on reserves and short-term debt, and not influenced by the quantity of reserves. This is because MMT rejects the money-multiplier reasoning. It is argued that there is no predictable relationship between the so-called monetary base (currency plus reserves) and the broader money supply (currency plus private demand deposits), and further that since loans create deposits, expansion of the broader money supply is neither constrained nor driven by the base.
This relates also to Krugman’s suggestion that if MMT were correct, “the Fed would have no influence, ever.” Although MMT does in fact suggest that monetary policy effects are less certain and weaker than fiscal policy, there is no suggestion that there can be no impact. Rather, the impact can only be through price (interest rates), not quantity (e.g. of reserves). In short, if reserves pay the same interest rate as short-term debt, the inflationary implications will be virtually identical. So, again, MMT suggests the best approach would be to pay the target rate on reserves, obviating the need for debt.
It is encouraging to see Krugman continue to engage with MMT. Right now, the public debate often seems to be bordering on the insane. Krugman is one of the few prominent voices advancing sensible policy responses to the crisis. As he mentions:
… for the time being the MMT people and yours truly are on the same side of the policy debate.
And with everything that is currently going on in the world, the time being is a pretty important time to be, and to try to be heard.