Paul Krugman, in “The Simple Analytics of Invisible Bond Vigilantes (Wonkish)”, has lent his support to the view, emphasized by Modern Monetary Theorists, that bond vigilantes cannot impede a sovereign currency issuer. Krugman has made this important observation in the past, but this time he spells out his reasoning, step by step, and the key points align closely with that of Modern Monetary Theory (MMT).
These are the points Krugman identifies as critical in the case of “the United States (or for that matter the UK)”:
Greece didn’t have its own currency, and therefore didn’t have its own monetary policy or its own exchange rate. We do. …
… an attack by bond vigilantes has very different effects on a country with a fixed exchange rate (or a shared currency) versus a country with a floating exchange rate.
In short, “we have our own currency and a floating exchange rate.”
By way of explanation, Krugman writes:
Think about it this way: with the Fed setting interest rates, any loss of confidence in US bonds would cause not a rise in rates but a fall in the dollar – and a fall in the dollar would be a good thing, helping make US industry more competitive.
He then adds an important caveat that is very familiar to Modern Monetary Theorists:
Things will be different if you have large debt denominated in foreign currency – but we don’t.
So what are the fiscal fear types thinking? Basically, they aren’t. But to the extent that they do have a model … they’re imagining that American macroeconomics are just like those of a country on a fixed exchange rate with no independent monetary policy.
All this is both interesting and heartening. Clearly, Krugman has based his argument on the following observable facts:
1. The US government is a currency issuer, not currency user.
2. The US government allows the exchange rate to float.
3. The rate of interest under a flexible exchange-rate sovereign currency regime is set as a matter of policy rather than being market determined.
4. The US government does not have large debt denominated in foreign currency.
These four points are all points emphasized by Modern Monetary Theorists, 1 being necessary for currency sovereignty, 1 and 2 taken together maximizing the policy space of the currency sovereign.
Krugman’s view strikingly resembles the MMT position on what is a fundamental point: markets cannot dictate the terms on which a currency sovereign issues its own liabilities.
Despite remaining differences in theoretical perspective, hopefully Krugman’s post on the “invisible bond vigilantes” will help to move the policy discourse forward.