There has been an ongoing debate over whether bond issuance lowers inflation risk. MMT says no. Bill Mitchell addressed this in a recent post, Painstaking, dot-point summary – bond issuance doesn’t lower inflation risk.
A commenter at Bill's named Tom posted this objection,
But guys I think that you are avoiding a main problem of this topic. i.e. Billy’s claim that “bond issuance doesn’t lower inflation risk”. If you agree with this statement do you think that it wouldn't matter if all of US government debt was in the form of monetary base (100% of GDP)? Because it is a straightforward conclusion from Billy’s claim.And guys I would like to know if you agree with Billy that it wouldnt matter if monetary base in the USA was equal to its GDP. ($15 trillion)
This is a pretty common objection that comes up wrt the MMT claim that tsys issuance is operationally unnecessary and could be eliminated. If the Fed wished to continue to set a positive overnight rate, then it could simply pay a support rate greater than or equal to the target rate. Otherwise, it could set the overnight federal funds rate to zero. Being operationally unnecessary under the present monetary system, interest on tsys constitutes a subsidy to holders. Does it serve a public purpose? If not, it seems that tys issuance should be eliminated as inefficient.
My response (edited slightly here):
What is the difference between tsys, which are essentially savings accounts at the Fed that pay interest, and reserves that pay interest if there are no tsys and the Fed pays a support rate?
In the first case, the owner of the tsys gets the interest and in the second case the bank holding the reserves gets the interest. If entity that would have owned the tsys were not a bank, then the funds would remain in a customer deposit account at no interest unless the bank paid interest on deposit accounts. Therefore, it is ublikely that the hold of the deposit account would just leave the funds in the deposit account but rather either save at interest, invest, or spend, or some combo thereof. Since this is a counterfactual, we don’t know empirically and have to speculate. (QE doesn’t add much since it is a special case.)
The most logical answer seems to be to be that an entity who would have held tsys if they were available — look at who the typical tsys holders are and extrapolate — would seek the nearest substitute or at least the most appropriate risk-weighted return wrt portfolio management in a given context. This is essentially a portfolio management issue. It is actually an issue at present since there are not enough government securities to meet global demand, which is creating demand for more securitization and expanding shadow banking.
This would mean that more funds would flow into other savings vehicles (financial investment), some funds would also likely flow into primary investment, and some into commodities and real assets, increasing price levels. There is little reason to expect increased spending on consumption. If some increases in consumption did occur, whether this would be inflationary depends on the employment rate.
If all tsys were redeemed immediately, a one-off rise in financial and real asset price level could be expected in adjustment. More likely is that the Treasury would cease issue and redeem existing tsys as they matured, which would largely cover a span of ten years. This would imply a more gradual asset price level adjustment.
The optimal solution would be that funds would shift substantially from saving to investment. The problem the world is facing at present is over-saving and under-investment. This is creating a demand for financial innovation, creating new assets classes such as commodities and farmland, and increasing the role of shadow banking and other issues that led to the GFC.
The MMT claim is that elimination of tsys would not be inflationary since there is no causal transmission mechanism from increased reserves to increased consumption. But that doesn’t mean that eliminating tsys would not make a difference in portfolio management or the financial markets. Those differences would have to be addressed.