Once again, I won’t spend much time recapping the major points of contention. My intent is to highlight a few questions that came to mind while reading but, in my opinion, were not adequately addressed. Hopefully the answers put forth will shed light on areas of the debate that remain dark.
Question(s): What are the inflationary effects, if any, of the “platinum coin” both at and away from the zero lower bound (ZLB)? Under a “permanent floor” vs. “corridor” system?
Answer(s): As stated previously:
When the Treasury deposits a $1 trillion platinum coin at the Fed, the Fed credits the Treasury’s account with $1 trillion in reserves. These reserves, however, are not counted in the monetary base since the Treasury's account does not count as reserve balances in circulation. The simple action of depositing a platinum coin at the Fed therefore has no direct impact on the economy that would require sterilization*. In fact, the primary (sole?) purpose of this exchange is to allow the Treasury (Congress) to spend without requiring debt sales that would exceed the debt limit.The platinum coin, in itself, is therefore not inflationary regardless of whether or not the economy is at the ZLB. The story, however, need not end there. Unburdened by the obligation to sell debt when deficit spending occurs, government deficit spending (up to the coin’s value) will directly increase the monetary base by adding reserves to the private banking system (reserves in circulation).
Operating within a “permanent floor” system, the Fed can maintain control of interest rates by paying a positive interest rate on reserves (IOR) AND elect whether or not to sterilize the monetary base expansion. If sterilized, the Fed could actually increase interest income in the private sector by selling assets with a higher yield. This would have an inflationary effect, though it may be offset by portfolio rebalancing. If left unsterilized, the monetary base expansion would likely generate asset price inflation and rising inflation expectations, at least in the short-run, given recent experiences with QE. In either case, the increase in deficit spending (otherwise not permitted by the debt limit) should ensure an overall inflationary bias.
Under the old monetary regime (pre-2008; “corridor” system), the Fed would probably sterilize the expansion by selling Treasuries (at least initially). Although the monetary base and interest rate are left unchanged, the deficit spending results in the private sector gaining net financial assets (NFAs; e.g. Treasuries). This is exactly the same result we see today! The only tweak is that the Fed, not Treasury, becomes the supplier of Treasuries.
Still under the old monetary regime, if left unsterilized, the expansion of the monetary base would push interest rates to the ZLB. The inflationary effects of the downward pressure on short-term rates depends on the time period in consideration (often short-term) and the degree of influence from several potential cross-currents (in no particular order):
1) Decreases interest income - deflationary
2) Weakens the currency - inflationary
3) Lowers debt service costs to borrowers - inflationary
4) Increases bank lending - inflationary
5) Raises inflation expectations - inflationary
The above list is in no way exhaustive, but does suggest an inflationary bias. Countering this view, Scott Sumner states:
higher interest rates are inflationary. They increase velocity. If you don’t believe me, check out interest rates and velocity during any extremely high inflation episode. When rates rise, inflation usually rises.Perhaps surprisingly, I do believe that interest rates and velocity show a relatively strong correlation over time. What I disagree with is the direction of causation that Sumner ascribes to this relationship. From my perspective, decreasing velocity implies decelerating bank lending and/or declining inflation expectations. Witnessing either of these factors would encourage the Fed to lower interest rates, hence any causation runs in the opposite direction of Sumner’s claim. Determining whether interest rates or velocity tends to move first would be enlightening, if feasible, but for now I’ll conclude that lower interest rates are inflationary.
Under any of these circumstances, the transaction entailing a platinum coin between the Treasury and Fed, in and of itself, is not directly inflationary*. However, presuming the platinum coin is accompanied by greater deficit spending, some inflation will stem from the growth of private NFAs regardless of the monetary regime and sterilization decision. Corresponding monetary base expansion will also likely display an inflationary bias, unless the Fed elects to sterilize the expansion under the old “corridor” system. The platinum coin is therefore always inflationary.
Special thanks for their contributions through comments are still owed to Scott Fullwiler, JKH, RebelEconomist, Dan Kervick, Ashwin Parameswaran, wh10, Detroit Dan, K, JW Mason, jck and last, but not least, Mike Sax. Stay tuned for at least one more post in this series.
*it may indirectly impact the economy by altering expectations