In my last letter I explained why we have a Federal Budget deficit, and why we MUST have one, if the economy is to be in equilibrium.

Equilibrium is when all production is just barely consumed. If there is any stuff left over, producers will reduce production to clear the market. That means laying off workers. If the stuff is all gone, and people are still looking to buy it, then producers will hire more workers and produce more stuff.

Equilibrium is not a very good goal for us right now. Unemployment is very high, and growth is too low. We need to advance, not to stay the same. The way to advance is for somebody to buy more stuff, and then producers will hire more people. Economists call that “increasing aggregate demand”.

Government can influence the economy by spending more (or taxing less, and then consumers will have more to spend) to make it grow, or by spending less (or taxing more) to reduce its growth rate, or even make it shrink (i.e., recession). The policy question is always whether the deficit is too big, too small, or just about right.

(It matters what kind of spending government does. Some things are more effective than others, and some can be harmful to certain individuals, but any spending helps the economy, even if it is not the spending we would prefer.)

So, today, is the deficit too big, too small, or just right? If you like the current unemployment rate and growth rate, then it’s just right. But, if you want higher growth and lower unemployment, the way to do that is with a bigger deficit, not a smaller one.

But, don’t deficits cause inflation? Next time.

For more information see http://www.moslereconomics.com

Occasionally, the Fed engineers an inverted yield curve, driving short term rates above longer rates. They did it in 2006, and before that in the late 1990′s. Every time they do it, a recesion follows.

This is widely believed to be a causal relationship. How does MMT view the effects of the inverted yield curve?

“the real disconnect is caused by the (mistaken)mainstream belief that the issuance of Treasury bonds saps aggregate demand by forcing deferral of consumption.”

Mainstream among economists, maybe, but I don’t think the general public (my target) thinks in those terms. I think people generally believe that deficits cause inflation whether bonds are issued or not, and whether the Fed buys them or not. It’s just “deficit=bad”.

Perhaps you’re missing my point.

My point is ZIRP and Mr. Twisty combine to form a natural experiment.

Imagine the Fed did both, until the entire term structure was at 5bps, flat as a board. And of course, Treasuries would retain their infinite liquidity because the Fed was willing to purchase or finance without limit at a given price/yield.

What would be the practical difference between a Benjamin and a bond? Nothing. It would be as if the treasury had never issued a bond, and just printed greenbacks. Economists would tell you that if they just printed greenbacks we would have massive inflation.

Well guess what? Two year treasuries are trading at $99.40 or there abouts. They are infinitely liquid. And the fed has said that rates will be near zero for two years. The Fed *HAS* turned bonds into Benjamins. And yet no inflation.

It makes you want to shake an economist by the lapels. The truth is staring them in the face. The Fed turned every treasury from two years and in into cash, and …. wait for it …. inflation went nowhere.

We are so going to be Japan.

“the govt buys things when it deficit spends, and that they are offered for sale is the evidence that the economy wants the net financial assets.”

I agree in principle, but a big part of government deficit “spending” actually consists of transfer payments, right?

the reason the govt can deficit spend in the first place without causing ‘inflation’ via excess demand is because the economy has a net savings desire for whatever reason.

so govt doesn’t deficit spend first, and then, quick, offer some rate to keep those funds from causing inflation.

the govt buys things when it deficit spends, and that they are offered for sale is the evidence that the economy wants the net financial assets.

yes, the term structure of rates figures into that savings decision, but looking at the interest income channels and econometric evidence I suspect that higher rates reduce savings desires, and vice versa.

It would seem to be the easiest idea on earth to explain to an economist.

It’s enough to make me ashamed of my bachelors degree in economics.