Debt monetization and a 0% target Fed Funds rate

Tim Walsh

Doomsday predictions of hyperinflation have been quite popular lately

among the crowd of economic experts. Virtually all the predictions I

have read demonstrate an incomplete or flawed understanding of our

monetary system and money creation process. Most of these experts

fear the large budget deficits because they think the government wont

I think all of us here agree that the government will never be unable

to sell Treasuries, and Ive tried to explain that to some people. But

I want to go one step further and tell people that debt monetization

is not only unnecessary but impossible. The best treatment of this

that Ive seen is the following passage from Warren Moslers Soft

Currency Economics:

The subject of debt monetization frequently enters discussions of

monetary policy. Debt monetization is usually referred to as a process

whereby the Fed buys government bonds directly from the Treasury. In

other words, the federal government borrows money from the Central

Bank rather than the public. Debt monetization is the process usually

implied when a government is said to be printing money. Debt

monetization, all else equal, is said to increase the money supply and

can lead to severe inflation. However, fear of debt monetization is

unfounded, since the Federal Reserve does not even have the option to

monetize any of the outstanding federal debt or newly issued federal

debt. As long as the Fed has a mandate to maintain a target fed funds

rate, the size of its purchases and sales of government debt are not

discretionary. Once the Federal Reserve Board of Governors sets a fed

funds rate, the Fed’s portfolio of government securities changes only

because of the transactions that are required to support the funds

rate. The Fed’s lack of control over the quantity of reserves

underscores the impossibility of debt monetization. The Fed is unable

to monetize the federal debt by purchasing government securities at

will because to do so would cause the funds rate to fall to zero. If

the Fed purchased securities directly from the Treasury and the

Treasury then spent the money, it’s expenditures would be excess

reserves in the banking system. The Fed would be forced to sell an

equal amount of securities to support the fed funds target rate. The

Fed would act only as an intermediary. The Fed would be buying