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The so-called zero-lower-bound (ZLB) plays a prominent role in modern (and even older) macroeconomic theories. It is often introduced in a paper or at conference as a fact of life -- an unavoidable property of the physical environment, like gravity. But is it correct to view it in this way? Or is the ZLB better thought of as legal constraint--something that can potentially be circumvented by policy?

The Financial Services Regulatory Relief Act of 2006 allows the U.S. Federal Reserve (the Fed) to pay interest on reserve accounts that private banks hold at the Fed. Specifically, the Act states that:

Balances maintained at a Federal Reserve bank by or on behalf of a depository institution may receive earnings to be paid by the Federal Reserve bank at least once each calendar quarter, at a rate or rates not to exceed the general level of short-term interest rates.
The effective date of this authority was advanced to October 1, 2008, by the Emergency Economic Stabilization Act of 2008.

It is not clear (to me, at least) whether the Act grants the Fed the authority to pay a negative interest rate on reserves. Note that if the interest-on-reserves (IOR) rate is set to a negative number, then banks would in effect be paying the Fed a "service fee" for the privilege of holding reserve balances with the Fed. But if the Fed is not legally permitted to use negative interest rate policy (NIRP), then the ZLB is obviously a legal constraint.

This legal constraint, however, may not be binding if the ZLB is also an economic constraint. In fact, the traditional explanation for the ZLB is the existence of physical currency bearing zero interest. The idea that arbitrage will effectively keep interest rates from falling below zero is deeply ingrained in the minds of economists. For example, Corriea, et. al. (2012) write:

Arbitrage between money and bonds requires nominal interest to be positive. This "zero bound" constraint gives rise to a macroeconomic situation known as a liquidity trap. It presents a difficult challenge for stabilization policy.
However, we know from recent experience that the ZLB appears not to be an economic constraint.  Several central banks today have set their deposit rates into negative territory:




There is currently over $10 trillion of government debt in the world yielding a negative nominal interest rate; see here. As of this writing, even long bonds like the German 10-year Bund are in negative territory.

Well, alright, so the ZLB is evidently not an economic constraint. But surely there is some limit to how low nominal interest rates can fall? This lower limit is called the effective lower bound (ELB). And economic theory is clear: if we're at the ELB in a recession, then monetary policy has done about as much as it can be expected to do.

But what exactly is the ELB? Is it -1%, -2%, -5%, or perhaps even lower? Economists like Miles Kimball believe it to sufficiently negative to warrant NIRP as an effective policy tool; see here (see also the discussion by Ken Rogoff in chapter 10 of his book). These arguments, however, did not seem to gain much traction. For example, in the present discussions concerning the Fed's new long-run monetary policy framework, the possibility of NIRP is not even mentioned. But perhaps it should be if the ELB is in fact significantly below zero. In what follows, I want to make my own (related) argument for why the ELB is probably a lot lower than most people think.

Suppose the Fed was to set the IOR to -10% (in a deep demand-driven recession, this would presumably be accompanied with a promise to raise the IOR at some point in the future). The traditional economic argument suggests that any security dominated in rate of return by cash would in this case be driven out of circulation.

The first thing we could imagine happening is banks attempting to convert their digital reserves into vault cash. Banks are presently holding over $1.6 trillion in reserves with the Fed. The largest denomination Federal Reserve note is $100. This is what $1 trillion in $100 bills apparently looks like:




That's about the size of a football field. Banks would not convert all of their reserves into cash--even if it was costless to do so--because they'd need about $20-30 billion or so to make interbank payments. Of course, managing all that cash would be far from costless. But there is a simpler reason for why banks would not make the conversion. The Fed could simply charge banks a 10% service fee on their vault cash.

Alright, well what effect is the -10% IOR rate going to have on the deposit rate (or fees) that banks offer (or charge) their depositors? Banks are not likely to pass the full cost on to their depositors, especially if they view the NIRP to be temporary, because they'll want to maintain their customer relationships.

But let us take the extreme case and suppose that NIRP is perceived to be permanent. Then surely deposit rates will decline (or bank fees will rise) significantly. Deposit rates may even decline to the point where depositors start withdrawing their money from the banking system. Banks may well let this source of funding go if they could borrow more cheaply from the Fed (banks would need to borrow reserves to honor the withdrawal requests of their customers). Of course, the Fed lending rate is also a policy variable and could, in principle, be lowered to negative territory as well.

But how realistic is it to imagine all or most bank deposits converted to cash? While this might be the case for small value accounts, it seems unlikely that the business sector would be able to manage its payments needs without the aid of the banking system. Even money market funds need to work through the banking system. I suppose one could imagine a new product created by (say) Vanguard in which they create a cash fund with equity shares redeemable for cash that is collected and stored in rented Las Vegas vault. But the moment the activity is intermediated, it becomes taxable. If the Fed is not permitted to tax (oops, charge a service fee) such entities, the fiscal authority could, in principle, implement a surcharge that is set automatically off the IOR rate in some manner.

I think in this way one can see how the ELB might easily be well below -5% (or more). This is probably low enough to allow us to disregard the ELB as a binding economic constraint. The relevant constraint is always a legal one. And laws can be changed if it is deemed to serve the public interest.

Keep in mind that in a large class of economic models, ranging from Keynes (1936) to New Keynesian, there is potentially much to be gained by eliminating the ZLB. If these models are wrong, then let's get rid of them. But if they're roughly correct, why don't we take their policy prescriptions seriously? Let's stop talking about the ZLB as if it's a force of nature. It is a policy choice. And if it's a bad policy choice, it should be changed.

Background The Greek economy went through a steep recession for ten years in the aftermath of the global financial crisis of 2007-2008. What started as a unique episode of a sovereign debt crisis in a monetary union, triggered a banking sector crisis and a sequence of adjustment programmes aiming at macroeconomic stabilization and economic recovery. … Continued

The gift for incoming governor Republican Atty.
Gen. Jeff Landry is both not
enough to help much with the trap set by spendthrifts leaving office in two months
and a way to kickstart Louisiana towards better economic development possibilities,
if Landry and new GOP legislative leaders plan well.

Last
month, the required report seeking to close the books on the previous fiscal
year showed a surplus for fiscal year 2023 of $330 million. That amount will be
fine-tuned before the end of the year, and available for action by the new
Legislature next year.

Sort of. Constitutionally, any surplus not in the
current year can go only a half-dozen uses, and a portion gets taken right off
the top mandatorily. A quarter goes to the Budget Stabilization Fund while a
tenth goes towards paying off unfunded accrued liabilities in pension funds
(this will increase to a quarter courtesy of a constitutional amendment passed
last month, but starting with FY 2025).

There's not a lot the sum can do to stave off damage
done in past years that rocketed
state spending up 72 percent since FY
2016. This past year alone, hundreds of millions of dollars in new
commitments were plugged in, which makes a challenge managing that in FY 2026
and FY 2027 budgeting as migration of vehicle fees into capital outlay and
rolling off the 2016/18 sales tax hike of 0.45 will reduce incoming revenues by
hundreds of millions of dollars.

But, and apparently
by accident rather than by design, citizens caught a break when an
anticipated $200 million pay raise for educators turned out to be in the form
of a one-year bonus instead. Unfortunately, Democrat outgoing Gov. John Bel Edwards did
the general public no favors by reversing
a $100 million cut (hardly worth a mention when the entirety in state
dollars is $4.5 billion) in the Department of Health allocation and in part to
balance that removed $125 million from paying down the UAL.

Here's where Landry and GOP leaders can use the
surplus to be declared to offset and put the state on more solid footing. With
a potential $247.5 million available for this purpose, they could assign it all
to reduce the Teachers Retirement System of Louisiana UAL. In turn, this would generate
enough money saved by local government by reducing their allotments that
they otherwise would have to forward to pay off the TRSL UAL by an average of
$1,150 per teacher, enabling them to use that amount for a permanent raise.

And that $82.5 million should have an additional
salutary impact complementing the impending sales tax increase reduction. Sent
to the Budget Stabilization Fund, that should trigger a mechanism
in state law that lowers income taxes. This additional tax relief should
multiply the freeing of the state's economy that continues
to score lowly on several indicators of economic health.

Yet looming deficits over a half a billion dollars
in both FY 2026 and FY 2027 mean the spending side as well must be tackled. One
area that could provide relief is in Medicaid
disenrollment to compensate for policy that allowed ordinarily ineligible recipients
to continue receiving those services, that will wrap up the middle of next
year. One of the slowest starters, Louisiana still hasn't reviewed over
three-quarters of cases and is removing a below-average proportion of
individuals. Upon taking office, Landry could ramp up the speed and increase
the scrutiny of cases to ensure only individuals truly needy and qualifying remain
on the health care dole, saving the state more money.

Most revolutionary, Landry (with legislative
approval if necessary) could move the state in part or wholly out of Medicaid
expansion, where many of its recipients today with characteristics similar to
those previous to expansion paid for their own insurance. This costs Louisiana taxpayers
– not counting the portion they pay in their federal taxes – about $450 million
annually.

Big spenders of both parties enthralled with
traditional populism infused into Louisiana's political culture have rigged a
budget trying to lock in as much spending as possible before limited government
advocates like Landry took office. It will be a challenge for them to combat
these poison pills that attempt to thwart their mission, but they have some means
by which to succeed despite that.

Republican Gov. Jeff Landry produced
a solid budget request for Louisiana, in a refreshing change of pace one
designed to live within the state's means rather than as an instrument to grow
government.

Overall,
the budget envisions slightly lower spending, although about two-thirds of that
fall is driven by reductions in federal dollars as the debt binge used to hose
down states with money dries up. Much of the rest comes from a decline in
statutory dedication receipts, with very nominal decreases in the general fund
and self-generated funds. In these cases, the revenue sources that fell largely
are tied into economic activity at first overstimulated by the enormous
increase in federal spending then sapped by the resulting sagging
economy slowly slipping into recession.

Thus, Landry and budget architect Commissioner of
Administration Taylor
Barras concentrated on slicing spending tied to temporary initiatives or
bonuses. For example, higher
education received about a $100 million cut, but that mostly came from non-recurring
spending outside of the funding formula disappearing. In almost all instances spending
will continue at around standstill levels.

The budget also carves out new money for certain
initiatives. Perhaps principally, even as most parts of state government will
see pullbacks in spending, more dollars will go to corrections, likely in anticipation
of swinging back the pendulum in punishment from policy changes starting with a
special session on justice matters commencing next week for the next two that look
to increase costs through sentencing that requires more jail time and reduced reliance
on alternatives like parole. Of course, health care received the biggest absolute
increase, largely because state spending in that category is held hostage to
federal programmatic rules, with this reliance increasing substantially under Landry's
predecessor Democrat Gov. John Bel Edwards.

That's the problem Landry faces. Edwards, perhaps
understanding the flukish nature of his governorship that pitted his
considerably leftist ideology against the center-right preferences of the
population and Legislature, tried to bake in as much government spending as
possible when in office, designing things to make it difficult to rein in
spending and where any economic downturn or amelioration of federal dollars flowing
into the state would produce revenue crunches that discouraged any kind of tax
relief.

This has left a poison pill for Landry, particularly
beginning in fiscal year 2026 staring next year when around $477 million in sales
tax receipts roll off the books. Even as other revenues as of now seem likely
to creep higher, that tax relief by cutting sales taxes by about a tenth
creates a budgetary headache for at least a couple of years.

It's not like insufficient revenues have been the
problem in the past two decades leading to this budget year. Rather, spending has
continued higher with general fund outlays averaging almost three percent a
year growth in that interval, outstripping inflation
over that time span by about 15 percentage points – while the state's
population increased exactly 0.5 percent. Less discretionary expenditures
through self-generated and statutory dedication funding grew even higher, while
federal funds leapt upwards at a rate over double that of general fund dollars.

Landry's task has been to corral higher spending
in order to induce the right-sizing of government dependent upon less revenues.
And the FY 2025 budget along with his handling of surpluses from previous years
give clues as to how he will approach that.

For starters, the state has a $91 million surplus
this current year that could be appropriated for any purpose. Landry wants to
have it go to justice measures, to backstop future emergency or disaster
spending, and to resolve the contentious issue of updating two-decade-old
voting machines.

With the $325 million from the previous fiscal
year, except for constitutional requirements steering money to the Budget
Stabilization Fund and to pay down unfunded accrued liabilities in pension
funds, he wants all of it to go to capital projects involving transportation,
coastal restoration, and deferred maintenance of state buildings. This explains
why the general fund contribution to capital outlay will drop 60 percent in the
upcoming budget, freeing up $100 million.

One
alternative would have put as much as possible into paying down the Teachers
Retirement System of Louisiana UAL, which would have freed considerable dollars
for local education agencies to provide educator pay raises on their own. Last
year, the Minimum Foundation Program had included these at a cost of $198
million, but the Legislature didn't accept that because at the last minute it
wanted to change allocations within it. The rules such as they are, legislators
had to budget with the FY 2023 formula that didn't include the raise.

This facilitated
a happy accident where instead of a permanent raise a stipend was given by
the state. Landry again chose this route rather than the paydown, as it
provided more flexibility to fulfill state priorities, even if outside the current
MFP formula, which the Board of Elementary and Secondary Education could alter
to reflect, that would promote performance pay and target high-need subjects.
It gives him the option to scale back next year and/or for BESE to adjust the
formula next year to account for fewer, but more efficiently spent, dollars.

In short, the effort wisely recognizes that the
state must live within its means that concomitantly acknowledges it has tried
to take too much from its people at the expense of economic development, and
sets up a good structure initially to achieve goals of right-sized government
at an appropriate taxing level. As well, it leaves open the opportunity of
future fiscal reform by not locking in new permanent programmatic commitments. The day/night contrast to the previous eight years is stunning and welcome.

A threatened de facto tax increase mainly on
denizens in the Lake Charles area now seems set to wither away by the time
incoming governor Republican Atty. Gen. Jeff Landry takes command.

That
was the proposal by the outgoing Democrat Gov. John Bel Edwards to
have tolls finance
$1.3 billion of a projected $2.1 billion to construct a new Interstate 10
bridge across the Calcasieu River in Lake Charles, as well as perform some
widening around its bases. The remainder of the money the state planned to
leverage with a mix of state and federal dollars, primarily complemented by a
$40 million a year revenue stream from the switchover of vehicle taxes from the
general fund to transportation.

The plan announced this summer raised hackles
immediately. The economics
behind it weren't all that bad, in that users rather than general taxpayers
statewide would foot the bill, and likely it could have been completed at lower
cost through a public-private partnership relying on tolls to keep the state's maintenance
costs close to zero for a half-century.

But the problem was local drivers just trying to
get around would end up paying per trip tolls of at least two dollars, perhaps summing
to substantial annual amounts depending upon how peripatetic their journeying,
or otherwise facing substantial lengthy and time-consuming detours as they
maneuvered around Lake Charles and in particular to and from Westlake. The idea
would have had negative economic consequences either by siphoning money out of
the users or in lowering productivity with all the wasted gas and travel time.

Accordingly, not long after statewide elections confirmed
Landry's path to the governor's mansion, the Legislature's transportation
committees met jointly to vet a deal that the state had struck with a
consortium of builders to engage in a public-private partnership to build the
new bridge over seven years. After debate, the House
Transportation Committee's Republican majority quashed the idea minus GOP
state Rep. Barbara
Freiberg who joined with its Democrats present unanimously in support after
a move to delay consideration by Freiberg failed.

Afterwards, the Edwards Administration announced it
would pursue rehabilitation the existing structure, deemed structurally deficient
by federal authorities, that would extend the bridge's lifespan perhaps three
decades or around a third of the expected life of a new bridge. In fact, the
cost for doing so would not match the $800 million in scratch money, but it
argued eventually a replacement would have to be built, even if in stages over
the years, that would require additional monies.

Not that the state doesn't have plenty. Just
this past legislative session alone nearly $2 billion was pumped into a
variety of capital projects, some worthy, others less so, or put away into
funds constitutionally or statutorily required. One such recipient, the Revenue
Stabilization Trust Fund, which could be used to pay for a new bridge immediately
by legislative supermajorities, has
$3 billion in it.

But that would leave fewer bucks to spread around
than by indirectly taxing people around Lake Charles and long-haul
out-of-staters and make government smaller, so the Edwards Administration made
a never-say-die announcement that it would continue to
solicit bids for a P3 toll bridge until Feb. 1, over three weeks after
Landry assume office. Given the rebuffing of the former awardee, it's highly
unlikely anybody would make an offer, and once Landry takes over, expect the
opportunity to go away.

The dual track rehabilitation and new bridge
strategy produces the best return on investment without unduly burdening a
subset of Louisianans. The RSTF when above $5 billion can have up to a tenth of
it included in annual capital outlay, which could provide a steady stream of financing
in a few years for the new structure, and don't forget that now with
Louisianans occupying the top two positions in the U.S. House of
Representatives and a reasonable expectation that will continue for the next
few years that special attention will go to ensuring federal funds are there to
help.

That strategy adheres best to the sea change
approaching in Louisiana government that shies away from growing government and
places greater emphasis on letting people keep more of what they earn.

President Joe Biden and Chinese leader Xi Jinping are expected to meet next month for a summit in San Francisco. The anticipated sit-down comes amid a renewed White House push to stabilize relations with Beijing as the U.S. juggles crises in the Middle East, Europe, and the Asia Pacific region. Though the face-to-face meeting has not yet been formalized, U.S. officials are projecting confidence that a Biden-Xi summit has been agreed to in principle. It's "pretty firm" that there will be a meeting, an official told the Washington Post, adding that details pertaining to the summit have yet to be ironed out by the two sides. The planned Biden-Xi summit comes on the heels of a bipartisan Senate delegation to China that kicked off in Shanghai last week. The delegation's leader, Senator Chuck Schumer, presented a list of grievances in a press conference on Monday, including longstanding U.S. concerns over "unfair" Chinese trade practices, deadly fentanyl inflows into the U.S., and China's close relationship with Russia. The delegation does not appear to have yielded any substantive points of agreement, possibly presaging the course of the upcoming Biden-Xi talks. Schumer expressed disappointment to Xi that China did not condemn the Hamas attacks against Israel on stronger terms. The Chinese Foreign Affairs Ministry released a statement denouncing "all violence and attacks on civilians" later that day, earning Schumer's praise. "I'm gratified the Foreign Ministry issued a new statement that did condemn the loss of civilian life," he said. Yet the new Foreign Ministry statement neither explicitly named Hamas nor blamed it for the attacks. The only statement to that effect came from the Chinese embassy in Israel, reflecting a tactical decision to allay specific audiences rather than an overall shift in messaging. Criticisms over the tone struck by Chinese officials belie a wider and more serious divergence on the Israel conflict: China, like many major non-Western players including Turkey, Russia, and Saudi Arabia along with much of the Middle East, has not echoed the shared western position of "steadfast and united support" for Israel accompanied by "unequivocal condemnation of Hamas and its appalling acts of terrorism."Indeed, Beijing is unlikely to take any actions that could diminish its posture as a potential broker between the Israel and Palestine. "China is trying to take a position of greater neutrality than the United States and to be seen in the world as a more neutral, or honest broker, and not necessarily aligned with Israel as the United States. And I think that's consistent with a desire to gain influence in a lot of the developing world," Benjamin Friedman, policy director at Defense Priorities, told VOA Mandarin. The upcoming summit appears aimed less at finding venues for cooperation and more at setting the tone for the mounting global competition between the world's two largest economies. The Biden administration is expected to roll out updated export controls intended to further tighten the screws on China's access to semiconductor equipment as early as next week, Axios reported on Saturday. The White House, in keeping with its efforts to establish a model of consistent and predictable competition with Beijing, has warned Chinese officials to expect the new control measures in October. Implementing the updated controls on the one-year anniversary of the original export restrictions, introduced in October 2022, establishes a "clear cadence," an official told Reuters. Beijing has denounced the export controls as a cynical ploy to hobble China's economic growth. "China firmly opposes the U.S.'s overstretching of the national security concept and abuse of export control measures to wantonly hobble Chinese enterprises," said the Chinese embassy in Washington. China has responded by signaling its intention to grow its semiconductor business in the face of mounting U.S. restrictions, with Chinese tech giant Huawei unveiling a smartphone powered by an advanced, domestically produced 7-nanometer chip during Commerce Secretary Gina Raimondo's visit to the country. Yet the Chip War is only one instance in a slew of bilateral disputes that are unlikely to be ameliorated by the Biden-Xi summit. China has staked out a persistently neutral position on the 2022 invasion of Ukraine, bolstering its trade ties and other venues for cooperation with Moscow much to the continued frustration of U.S. policymakers. "Deepening Russian-Chinese cooperation against the United States is not the product of ideological affinity; it is their shared perception that Washington has been attempting to subvert their security, perhaps fatally," said George Beebe, Quincy Institute's Director of Grand Strategy. "The United States is in no position to drive a wedge between the two states, but it can and should refrain from gratuitously driving them together to our detriment."There are even fewer prospects for a meeting of minds regarding Taiwan, with the diplomatic framework in place since the 1970's for managing differences over the self-governing island — particularly the key concepts of strategic ambiguity and agreeing to disagree on how best to resolve Taiwan's status — all but dashed against the rocks. To be sure, there is a substantive policy basis for the kind of stabilization sought by the White House. China, faced with serious demographic challenges and anemic growth, is interested in at least partial economic rapprochement with Washington. The Biden administration, for its part, wants to restore the channels for military communication that were severed by Beijing following former House Speaker Nancy Pelosi's visit to Taiwan, dial down military tensions in the Asia-Pacific, and to work with China on implementing its climate change agenda. There is room for targeted cooperation on these areas that, though well short of the reset or thaw in relations previously envisioned by Biden, could advance the administration's goal of upgrading China-U.S. ties from their present state of spiraling hostilities to a sustainable model of managed competition. But that requires a degree of goodwill and flexibility that, so far, has been lacking in the bilateral relationship.As with the uneventful senate delegation to China, the Biden-Xi summit will surely provide a stage for both leaders to relitigate established concerns and restate the same positions; achieving anything else will be an uphill climb.

House of Representatives debate over a bill to call
a limited constitutional convention in Louisiana exposed the shoddy, illogical,
and evidence-free arguments against it, hopefully propelling it to Senate
passage and enactment.

HB 800 by
Republican state Rep. Beau Beaullieu,
in its current form, would convene legislators plus 27 gubernatorial appointees
to meet in committees or as one starting as early as May 30 to review what eligible
portions of the constitution should be converted into statute. No later than
Aug. 1 the entire convention would begin review of the committees'
recommendations with any of these sent forth as a proposition for voter
approval accepted by the convention no later than Aug. 15. Separate majorities
of representatives, senators, and gubernatorial appointees would have to coalesce
for this forwarding. Articles dealing with citizen rights, power distribution, the
legislative branch, the executive branch, judges, district attorneys, sheriffs,
tax collection, bond funding, the Budget Stabilization Fund, the homestead
exemption, state employee rights, retirement matters, and existence of the
Southern University System would be off limits to transfer out.

It passed
the House 75-27,
surpassing the two-thirds supermajority required, with the only GOP member present
state Rep. Joe
Stagni in opposition but with Democrat state Reps. Roy Daryl Adams,
Chad Brown,
Robby Carter,
and Dustin
Miller in favor, with Miller being the only black male among them while all
other black Democrats plus the two white Democrat females were against, among
those present. Even if badly outnumbered, the opposition went down spewing a
lot of hot air.

Basically, they threw out three objections to the
bill. First, they claimed legally the convention couldn't be limited. Second,
they said the matter was too rushed, leaving insufficient time for deliberation
among delegates and within the public. Third, they argued few in the public
wanted this.

All such objections, when exposed to scrutiny, are
nonsense. There is a question about whether a convention can be limited, as the
constitution itself
on the matter is silent. But that's irrelevant particularly when each chamber has
a veto power over anything that would come out of a convention. If the enabling
legislation contains guardrails enacted by two-thirds and more majorities, its
reasonable that they would adhere to those at the convention itself.

Nor is the matter rushed at all. Keep in mind that
whatever a convention would come up with, it doesn't change anything about how
the state is run. Whatever product if approved by voters merely becomes a
bookkeeping exercise of transferring constitutional provisions into statute at
the end of 2024, and nothing more. That makes it all a very simple question:
does the voter support transforming a specified list of constitutional
provisions into statute. Nothing is being changed and nothing is going away. And
two months of public input during the committee phase, two weeks of public
deliberation at the convention, and nearly three months of public discussion prior
to the national election date on any end product would be more than adequate
for gauging the wisdom of engaging in such a simplified procedural move.

Finally, anybody who thinks elected officials must
act solely as mouthpieces for the public, articulating whatever they think the
public wants and if they don't think the public cares then ignoring the issue,
has no clue as to how to perform their job. Politicians by design are invited
to inject their judgment into their governance, as presumably by their positions
and successful elections they have demonstrated such aptitude. If they spot something
about which the public may seem to be apathetic but that they realize is
important to lead the polity to better living, they must pursue it. And even if
the public cares and solidly expresses a preference contrary to the better judgment
of a politician, that official should act to follow his own conscience even if
unpopular. That's what it means to lead, and any elected official that can't do
that shouldn't be in office, much less argue for inaction (for the record, a recent
news organization poll noted that out of a menu of items only one percent
of the public argued having a convention was the most important issue and only
just over half even had an opinion about a new constitution, slightly
negative).

And even if any of these excuses not to have a
convention were valid, opponents ignore the most crucial point of all: any
changes must meet with popular approval at the polls. If a majority of the
people don't like the product, if they think it was rushed, if they don't see a
need for a change, or all of the above, they'll vote it down. There's no reason
not to see what a convention comes up with, since the people will have the
final say and if approving will signal they agreed with the subject matter,
they felt they had enough information about it, and they thought a change was
needed.

Senators can't let specious argumentation derail their
understanding that, in the short run, to address looming fiscal concerns and, over
the long term, to improve the state's economic development fortunes and the
life prospects of its citizens they need to start down the road of reform of a
state government that wastes too much as a part of spending too much that the
straitjacket of a constitution written under a very different political ethos
of a half-century ago prevents fixing. Laying out such bad argumentation
against this betrays the real goal of those in opposition: maintenance of big
government to slake their own thirst for power and privilege and that of the
special interests backing them. Don't be fooled by their whining.

As the war between Israel and Hamas rages on, with horrifying humanitarian toll for the civilians in Gaza, the United States is continuing its unwavering support for Israel: it is not only sending Israel arms and shielding it from criticisms at the United Nations, but also boosting the deterrence against the so-called "axis of resistance," which includes Iran and its allies in Lebanon, Syria, Iraq, and Yemen.The U.S. moves to show solidarity with Israel are understandable. However, unless they are complemented by a credible diplomatic strategy in pursuit of a comprehensive stabilization in the Middle East, not only will they fail to bring the U.S. any benefits, but, to the contrary, they would risk entangling it in a wider regional war. To prevent such a dire scenario, Washington should, in addition to its existing contacts in the region, launch a direct channel to Tehran and seek serious talks about the future not only of Gaza and Palestine, but the broader Middle East.Since the war started on October 7, following Hamas's terrorist attack on Israel, Washington reportedly warned Tehran, through third parties, against expanding, either directly or through allies, the front against Israel. To deter Iran, Biden sent an attack submarine to the Persian Gulf, in addition to two aircraft carriers with warplanes and other military assets already dispatched to the region in the immediate aftermath of Hamas's attack.The usual suspects in Washington were quick to jump on the war's bandwagon to push for their favorite obsession: make it all about Iran. Sen. Lindsay Graham (R-S.C.), true to form, threatened military action to target Iran's oil infrastructure. United Against Nuclear Iran, hawkish advocacy group, painted doomsday scenarios of impending multi-front "Iranian escalation" against Israel. And others like the Atlantic Council's Matthew Kroenig fell back on a tired cliché of Iran and its allies being the principal source of all instability in the Middle East.Making the Israel-Hamas war being all about Iran not only completely denies Palestinians' own agency and conditions under the occupation. It also misreads actual Iranian policies, as opposed to the rhetoric.As usual, Tehran presents a mix of ideology and pragmatic pursuit of national interest. Top officials, starting with the Supreme Leader Ayatollah Ali Khamenei, while expressing full support for Hamas, clearly emphasized that Iran had no operational role in the attack of October 7. Iran is not willing to confront Israel or the U.S. directly as such a conflict would be too destructive for it and its most prized assets in the region, like the Lebanese Hezbollah. Hence, Tehran insists that the "resistance front" has autonomy in its actions against Israel and the U.S.Another factor that the rulers in Tehran need to take into account is that the Iranian population on the whole cares far more about the difficult economic conditions in their own country rather than Gaza. With the regime hard-liners doubling down on divisive policies, such as insistence on mandatory hijabs for women, the gap between the establishment and significant portion of the Iranian population is growing. Since the commitment to Palestine is one of the Islamic Republic's enduring identity badges, it is not surprising that a growing disaffection with the system translates into a weaker support for Iran's involvement in what many Iranians consider a foreign conflict.The fact that Iran is compelled to act, so far, in a restrained fashion, opens a window of opportunity for some bold, creative diplomacy on the U.S. side. A true diplomatic effort should go far beyond sending warnings to Tehran through third parties like Qatar, Oman, or Iraq. It should include direct talks not only about how to end the war in Gaza, but also the outlines of a broader order in the Middle East.Given the entrenched enmity between the U.S. and Iran, it may seem like a tall order. Yet, as international relations scholar Stephen Walt reminds us, some of the roots of the current situation could be traced to the Madrid peace conference on the Middle East in 1991 and subsequent Oslo agreements on Palestine. While crediting then-President George H.W. Bush and his secretary of state James Baker with a serious effort to bring peace to the Middle East, Walt points to a fatal flaw of the Madrid/Oslo process: the exclusion of Iran and the whole "rejectionist" front from the discussions, which only incentivized Iran to act as a spoiler against a regional order that was being shaped explicitly against its interests.Importantly, that happened at a time when Iran, exhausted by the long, brutal war with Iraq and under the pragmatic presidency of Ali Akbar Hashemi-Rafsanjani was showing signs of moderation and willingness to re-engage with the U.S. Rebuffed, Iran turned to Islamic Jihad and other extremist Palestinian groups that contributed to a collapse of the peace process.As the U.S. and its allies ponder their next steps, they should avoid repeating the same fatal mistake. The costs of non-relationship between Washington and Tehran are already highlighted by the almost daily attacks by the Shiite militias in Syria and Iraq on U.S. military assets in those countries. The U.S. retaliates in what it claims to be "self-defense strikes" against Iran's Islamic Revolutionary Guard Corps (IRGC). In the absence of a meaningful diplomatic track and de-escalation mechanisms, these exchanges could easily spiral out of control and lead to a direct military confrontation between the U.S. and Iran.In such a scenario the U.S. would have little regional support as the Arab and Islamic world is focused on ending Israel's war in Palestine, not joining a new one against Iran. It is highly meaningful that it was the war in Gaza that provided the context for the first visit of Iran's president Ebrahim Raisi to Saudi Arabia after years of hostility — for a joint meeting of the League of Arab States and Organization Islamic Conference. A handshake between Raisi and Saudi Crown Prince Mohammad Bin Salman in Riyadh would have been unthinkable only a few years ago.The U.S. should encourage these regional reconnections and establish its own direct dialogue with Iran. The alternative — dividing the region neatly into the moderates (such as Saudi Arabia, UAE, Egypt and Jordan) and pariahs (Iran and its allies and proxies) — has been tried and failed abysmally. The consequences of this failure are being tragically played out in Gaza. Establishing direct talks with Iran will not solve all of the region's problems. It may also carry domestic political risks for Biden in the pre-election year. But doubling down on the strategy of exclusion of Iran from any solution in Gaza and future security configuration in the Middle East is guaranteed to perpetuate the cycles of violence in the region.

There are a lot of moving parts to the MMT program. I want to focus on one of these parts today: the relation between monetary and fiscal policy.
One thing I find appealing about MMT scholars is their attention to monetary history and
institutional details. I've learned a lot from them in this regard.
But as is often the case with details, one has to worry about whether they help
shed light on a specific question of interest, or whether they sometimes let us not see
the forest for the trees. And in terms of the broader picture, since I grew up
in that branch of macroeconomics that tries to take money, banking, and debt
seriously (i.e., not standard NK theory), I sometimes have a hard time understanding what all the fuss is
about. Much of standard monetary theory (SMT) seems perfectly consistent with
some of the ideas I seen discussed in MMT proponents; see, for example, The Failure to Inflate Japan. 

  

This post is devoted to better
understanding a contribution by Eric Tymoigne. Eric is one of the people I go
to whenever I want to learn more about MMT (if you're interested in MMT, you
should follow him on Twitter @tymoignee). In this post, I discuss his
article "Modern Monetary Theory, and Interrelations Between the Treasury
and Central Bank: The Case of the United States." (JEI 2014). Passages quoted from his paper are highlighted in blue. The working
paper version of the paper can be found here. Eric has kindly agreed to respond to my comments and let me post our conversation. We had to some editing, hopefully this did not disrupt the flow too much. In any case, I hope you find it interesting. And, as always, feel free to join in on the conversation in the comments section below. -- DA



============================================================================



DA: Eric, let's start with the opening paragraph:



One of the main contributions of modern money theory (MMT) has been
to explain why monetarily sovereign governments have a very flexible policy
space. Not only can they issue their own currency to spend and to service their
public debt denominated in their own unit of account, but also any self-imposed
constraint on budgetary operations can be easily bypassed. 



I'm
curious to know what the contribution is here relative to standard monetary
theory (SMT). In SMT, the government can also issue its own currency to spend
and to service the public debt denominated in its own unit of account. So this
degree of "flexibility" is already accounted for. As for
"self-imposed constraints on budgetary operations," SMT takes several
approaches to this issue, depending on the purpose of the analysis. One
approach is to take these constraints as given and then to study their
implications. But it is also common to consolidate the central bank, treasury
and government into a single authority, which implies no self-imposed
constraints on budgetary operations. 


Perhaps what is meant is that MMT shows how existing self-imposed constraints
on budgetary operations can be (or are) bypassed in reality.  This leads
us to question, however, concerning what those self-imposed constraints are doing there in
the first place. Are they there by design and, if so, why? Or are they there by
accident (and, if so, how in the world did this happen)?



ET: Yes
consolidation is not unique to MMT as we have said repeatedly. Not only is it
used quite commonly in the economic literature, but also it is a common
rhetorical tool in economic talks, discourse, etc.

























 

DA: Right, so everyone understands this (at least, they should)--it's perfectly consistent with standard monetary theory. So far, so good.



ET: Most
economists, politicians and the public don't understand this or its
implications. They will interpret the above as saying that it is obvious that
the government can create money but it is not a normal way to proceed and it is
inflationary. MMT just pushes consolidation to its logical conclusions and
shows that institutional details do back those conclusions. In a consolidated
framework, the federal government can only implement spending by creating
money, this is not abnormal and it is not inflationary by itself. There is no
other way to find the necessary dollars to spend. Here is what consolidation means in terms of balance sheets:



For the federal government, taxes destroy currency
(L1 falls) and claims on non-fed sectors falls (A1 falls) (an alternative
offsetting operation is net worth of government rises). When US spends, it
credits accounts (L1 rises). Similarly, bond issuance does not lead to a gain
of any asset for the government; all it does is replace a non-interest earning government
liability (monetary base) with an interest-earning government liability (Treasury
securities).



DA: I am not going to argue against your accounting. As for bond-issuance, in
SMT, an open-market operation is modeled as a swap of zero-interest reserves
for interest-bearing treasuries. The interest on treasuries is explained by
their relative illiquidity (another self-imposed constraint). The economic
consequences of such a swap depends on a host of factors, which I'm sure you're
familiar with. 



ET: Sure, in
addition, self-imposed financial constraints (e.g. debt ceiling, no direct
financing by the Fed, no monetary power for treasury) have been put in place at
various times with the argument that they impose discipline in public finances.
MMT argues, these financial constraints are not necessary and are bypassed
routinely through Treasury-Central Bank coordination.



DA: Sure, the standard view is that these
self-imposed constraints are designed to impose discipline in public finance.
The proposition that these financial constraints are or are not necessary, however, must be
based on a set of assumptions that may or may not be satisfied in reality. (The
fact that these constraints may be bypassed through Treasury-Central Bank
coordination does not seem relevant to me -- the conflict emphasized by SMT is
between an "independent" central bank and the legislative authority
(e.g., the Fed and Congress, not the Fed and Treasury). I'm not sure why a new
theory is needed here. We know, for example, that if the legislative branch of
government fully trusts itself (and future elected representatives) to behave
in a fiscally responsible manner, the notion of an "independent"
central bank (and other self-imposed constraints) makes little sense. 



ET: Remember
that MMT emphasizes the irrelevance of financial/nominal constraints for
monetarily sovereign governments (bond vigilantes, risk of insolvency of social
security, etc.). One can do that by using the consolidated government (taxes
don't finance, bonds don't finance, government spends by crediting accounts,
etc.) or by using the unconsolidated government (the central bank helps the Treasury,
the Treasury helps the central bank). The second method conforms to actual
federal government operations but it is much less easy to use rhetorically and it
waters down the core point: government finances are never a financial issue as
long as monetary sovereignty applies.

Given that point, as you note, financial constraints are not only
irrelevant, but also disruptive and used for political games. MMT wants to make
government financial operations as smooth and flexible as possible. Once
society has decided how, and to what degree, government should be involved in
solving socioeconomic problems, finding the money should not be an issue when
monetary sovereignty prevails. That means demystifying
and eliminating financial barriers to government operations so the political
debate can focus on solving real issues (environment issues, socio-economic
issues, etc.). Fearmongering about the public debt and fiscal deficits makes for
poor political debates and policy prescriptions.



There is a view, expressed by Paul Samuelson, that if
we tell policymakers and the public that there are no financial limits to
government spending, policymakers will spend like mad; therefore, economists
need to lie to policymakers and the public (and themselves). This is nonsense.
We ought to discuss policy choices not on the basis of Noble Lies but rather on
the basis of sound and informed premises. Economists needs to make sure that
policymakers focus on resource constraints.



In addition, political constraints on government should be geared
toward improving the transparency and participatory aspects of government (e.g.
limit role of big money in elections, limit wastes, etc.). We already have a
government that passes a budget (it needs to do so for transparency and
accountability purposes), we already have an auditing process, and we already
have some (limited) democratic process, so aim at improving these aspects. MMT
proponents are not naive, we know that some politicians are self-interested, we
know that policy implementation may lead to mistakes, we know people may try to
game the system ("free riders"); however we trust that a transparent and
democratic government can (and does) get through these issues. MMT does not see
financial constraints as helping in any ways, rather they inhibit the
democratic process.



Of course, MMT proponents also have a policy agenda (Job guarantee,
financial regulation based on Minsky, etc.) because we do not see market
mechanisms as self-promoting full employment, price stability and financial
stability. As such, as you said, MMT proponents favor alternative means to
achieve these goals through direct government intervention. We don't see the
central bank as an effective means to promote price stability. The central bank
should focus on financial stability through interest-rate stabilization and
financial regulation (an area where the Fed has not performed well).



Finally, yes independence
of the central bank is seen as a big deal but MMT disagrees for two reasons.
First, MMT emphasizes the lack of effectiveness of monetary policy in managing
the business cycle and, second, and probably more importantly, MMT notes that
central-bank independence in terms of interest-rate setting and goal settings
does not mean independence from the financial needs of the Treasury.



DA: I think it's fair to say most people want to see government
operations run smoothly, and would welcome a sober debate over the issues at
hand without the fear-mongering that some like to promote. The broad objective seems the same--the debate is more over implementation--how monetary and fiscal policy is to be coordinated--given human frailties. 



Having said this, I think you go too far by asserting that
"government finances are never an issue as long as monetary sovereignty
applies." Of course, technical default on nominal debt is not an issue (we
all understand this). But SMT also recognizes the importance of economic default
on nominal debt. True, a government can always print money to satisfy its
nominal debt obligation, but if money printing dilutes the purchasing power of
money, this is a de facto default. 



On a related issue, SMT asks "what are the limits to
seigniorage?" The fact that a government can print money does not give it
the power to command resources without constraint. People can (and do) find
substitutes for government money (they may also substitute out of taxed activities
into non-taxed activities). SMT treats the limits to seigniorage as a financial constraint.
Maybe MMT has a different label for this constraint? Perhaps it is related to
what I hear MMT proponents call an "inflation constraint." Maybe
one way to reconcile MMT with SMT on this score is by recognizing that SMT
usually assumes (sometimes incorrectly) that the inflation constraint is always
binding. If this is the case, a monetarily-sovereign government does have
a financial constraint, even according to MMT. 



ET: Yes, ability to create a
currency does not mean ability to command resources because there may not be a
demand for the currency. That is where tax liabilities and other dues owed to
the government become important (cf. the chartalist theory of money, a
component of MMT). That's also why taxes, monetary creation and bond issuance
are not conceptualized by MMT as alternative financing means but rather as
complementary. The government imposes a tax liability, spends by issuing the
currency necessary to pay the tax liability, then taxes and issues bonds. Spending may be inflationary
indeed and so there is an inflation constraint; but it is not a financial constraint,
it is a resource constraint.



About the "printing" of money
by government, inflation and economic default. Regarding the first two, there
is no evidence of an automatic relation between money and inflation. In a
consolidated view, government always spends by monetary creation but controls
the impact on inflation via taxes and the impact on interest rates via bond
issuance. In an unconsolidated view, the central bank routinely finances and
refinances the Treasury by helping some of the auction bidders and by
participating in the auction.

Finally, regarding economic
default, governments routinely "default" in that sense with no problems. I
don't see that as a relevant concept unless someone can show that economic
default raises interest rates or generates rising inflation (it does not); here
again, there is no automatic link between inflation and interest rates. That
link depends on how the central bank reacts; if it does not then market
participants don't either.



DA: Let me return to the manner in which the Fed/Treasury/Congress
are consolidated (or not) in SMT and why this matters, in your view. In some
SMT treatments, Congress decides spending and taxes, which implies a primary
deficit. It's up to the Treasury to finance that deficit, with the Fed playing
a supporting role (by determining interest rate and issuing reserves for
treasury debt). What's wrong with this approach?

   

ET: That goes in the
right direction with an understanding that the government really has no control
over its fiscal position. All this, which relates to the implementation of
monetary sovereignty, helps understand why the financial crowding out is not
operative, why monetary financing is not by definition inflationary, why i >
g is normal. It helps explain why the hysterical rhetoric surrounding the
public debt and deficits in nonsense. I recently wrote a piece for Challenge Magazine on that topic. Surpluses are celebrated, governments implement
austerity during a recession to "live within our means", Social Security needs
to be fixed to avoid bankrupting it, governments need to save more, etc. All of this is incorrect.



DA: I'm not sure why you claim SMT leads to the idea of i > g.
The case i < g is perfectly consistent with SMT (see Blanchard's 2019 AEA
Presidential address, and also my posts here and here). The
correct criticism (I think) is that mainstream economists have assumed i > g
as being the empirically relevant case (it is not).



ET: That is what I meant. MMT links that to monetary sovereignty.



DA: I think that's correct. I should like to add that mainstream economists (apart from a small set of
monetary theorists) have not appreciated the role of high-grade sovereign debt
as an exchange medium in wholesale financial markets and as a global store of value, which in my view likely explains a lot of the "missing inflation." But as for
"surpluses being celebrated," you are now talking about individual
viewpoints and not SMT per se. There were plenty of calls out there
for countercyclical fiscal policy based on standard macroeconomic principles.
But I do agree virtually all mainstream economists are (perhaps overly)
concerned about "long-run fiscal sustainability." The view is that at
the end of the day, stuff has to be paid for -- and that having the ability to
print money, while granting an extra degree of flexibility, does not get around
this basic fact. 



DA: I'd like to ask you about this statement you make:



In (the unconsolidated) case, the Treasury collects taxes and
issues securities before it can spend. However, federal taxes and bond
offerings also serve another highly important function that is overlooked in
standard monetary economics. Specifically, federal taxes and bond offerings
result in a drainage of funds from the banking system, and MMT carefully
analyzes the implication of this fact. From that analysis, MMT argues that
federal taxes and bond offerings are best conceptualized as devices that
maintain price and interest-rate stability, respectively (of course, the tax
structure also has some important role to play in terms of influencing
incentives and income distribution; something not disputed by MMT). 



DA: Well, yes, taxes serve both as a revenue device
(permitting the government to gain control over resources that would otherwise
be in control of the private sector) and as a way to control inflation. I'm not
sure about the idea of the Treasury offering bonds for the purpose of achieving
interest-rate stability (though this may happen to some extent when the
treasury determines which maturity to offer). I don't think this is the way
things work in the U.S. today.



ET: Taxes and issuance of
treasuries drain reserves and so raise the overnight rate. Hence, on a daily
basis, a fiscal surplus raises the overnight rate and a fiscal deficit lowers
it. There has been significant Treasury-Fed coordination to smooth the impact
of taxes (and treasury spending) on the money market.



DA: Fine, but so what? We all understand
"coordination" between Fed and Treasury exists at the operational
level. 



ET: I think you are too kind to other
economists and policymakers. On taxes as price-stabilizing factors, there is
indeed some similarities here. On the role of treasuries for interest-rate
stability, it does work like this today. It may not be obvious because of the
current emphasis on treasuries as Treasury's budgetary tools, but Treasury has issued securities for
other purposes than its budgetary needs. In the US, this occurred most recently during the 2008
crisis (SFP bills). In Australia, in the early 2000s, the Treasury issued
securities while running surpluses in order to promote financial stability.



DA: But even if this is not the way things actually work
(in my view, it's the Fed that stabilizes interest rates, possibly through OMOs
involving U.S. Treasuries), I'm not sure what point is being made. I think we
can all agree that monetary and fiscal policy can be thought of as being
consolidated in some manner. What would be good to know is how a specific MMT
consolidation matters (relative to other specifications) for a specific set of
questions being addressed. There is nothing in the abstract or introduction of
this paper that suggests an answer to this question.  

ET: The point being made is that in a consolidated
government, tax and bond issuance lose the financial purpose
they have for the Treasury but keep their price and interest-stability purposes.





DA: In standard monetary theory, tax and bond issuance keeps
its funding purposes for the government and at the same time can be used to
influence the price-level (inflation) and interest rates. Is this wrong? I
don't think so. At some level, taxes (a vacuum cleaner sucking up money from
the private sector) must have some implications for the ability of government
to exert command over real resources in the economy. What we label this ability
(whether "funding" or ''finance" or whatever, seems
inconsequential). 



ET: Ok here comes the crucial difference between financial
and real sides of the economy. In financial terms, taxes do not increase the
capacity of the government to spend, i.e. the government does not earn any
money from taxing; taxes destroy the currency. In financial terms, there is no
reason to fear a fiscal deficit; deficits are the norm, are sustainable and
help other sectors grow their financial net wealth. As such, it is not because a
government wants to spend more that it must tax more or lower spending
somewhere else. That is the PAYGO mentality. This mentality makes policymakers
think of spending and taxing in terms of how they impact the fiscal balance
instead of their impact on employment, inflation, incentives, etc. While
deficits may have negative consequences, they are not automatic. If
one takes a look at the evidence, deficits have no automatic negative impacts
on interest rates, tax rates, public-debt sustainability, or inflation.



In real terms, the necessity to increase tax rates to prevent
inflation, and so move more resources to the government, depends on the state
of the economy and the permanency of the increase in government spending relative to
the size of the economy. In an underemployed economy, the government
can spend more without raising tax rates. In a fully employed economy, shifting
resources to the government without generating inflation does require raising
tax rate and/or putting in place other measures such as rationing, price
controls, and delayed private-income payment. Here Keynes's "How to Pay for the
War" provides the roadmap. Standard economics is full-employment economics so
opportunity costs are always present. MMT follows Kalecki, Keynes and the work
of their followers (have a look at Lavoie's "Foundations of Post
Keynesian Economic Analysis") and note that capitalist
economies are usually underemployment and economic growth is demand driven. Put
in a picture, the economy is usually at point a.









Put succinctly, the real constraint is conditionally relevant, the
financial constraint is irrelevant if monetary sovereignty prevails. That is
the proper way to frame the policy debates and to advise policymakers; don't
worry about the money, worry about how spending impacts the economy.



ET: Moving to another topic, consolidation of the government brings to the forefront
forces that are operating in the current system but that are buried under
institutional complications. Namely that a fiscal deficit lowers interest rates
and treasuries issuance brings them back up, that spending must come before
taxing and treasuries issuance, that monetary financing of the government is
not intrinsically unsound and does not mean that tax and treasuries issuance
don't have to be implemented. 



DA: The statement that "deficit lower
interest rates" needs considerable qualification. Among other things, it
depends on the monetary policy reaction function. As for the claim that
spending *must* come before taxes, this is not a universally valid statement
(even if it may be true in some circumstances. But even more importantly, who
cares? Mainstream theory does not suggest that monetary financing is
intrinsically unsound (seigniorage is fine, if it respects inflation ceiling).
As for money, taxes and bonds not being alternative "funding"
sources, I worry that this semantics. You can call X a "funding"
source or not -- it's just a label. The real question is: what are the
macroeconomic implications of X? 



ET: Let me emphasize where I agree. Yes, evidence
shows the central role of monetary policy for the direction of interest rates,
fiscal policy is at best a very small driver. And yes, one ought to focus on
the real implications of government spending and we ought to forget about the financial implications. A fiscal
deficit is not unsustainable nor abnormal; deficits are the stylized fact of
government finances and are financially sustainable if monetary sovereignty is
present. So don't try to frame the policy debate and set policy in terms of
household finances, bankruptcy, fixing the deficit, etc.

To conclude I see three reasons why the "taxes/bonds don't
finance the government" rhetoric is helpful:



1- It is strictly true for the federal government (i.e.
consolidation).



2- it brings to the forefront some lesser-known aspects of taxes
and treasuries issuance: impacts on money market, role of central bank in
fiscal policy, role of treasury in monetary policy.



3- It changes the narrative in terms of policy and political
economy: government does not rely on the rich to finance itself, taxes should
be set to remove the "bads" not to finance the government (e.g. one
should not set tax rates on pollution with the goal of balancing the budget but
with the goal of curbing pollution to whatever is considered appropriate, that
may lead to much higher tax rates than what is needed to balance the budget),
PAYGO is insane, one should focus on the real outcomes of government policies
not the budgetary outcomes.



DA:

1. I think this is semantics.

2. Not sure how it helps in this regard.

3. I think all of these positions are defensible without the
statement "taxes/bonds don't finance the government", so
if this is the ultimate goal (and I think it should be), perhaps we should set
aside semantic debates and focus on the real issues at hand. 



ET: 1 is not semantic. I know you have in mind taxes as a
means to leave resources to the government. MMT makes a clear difference
between financial (ability to find the money) and resources constraint (ability
to get the goods and services) as explained above. The financial
constraint is highly relevant for non-monetarily sovereign governments so it
should be noted and clearly separated from the real constraint. Too many
policy discussions and decisions by policymakers operating under monetary
sovereignty are based on an inexistent inability to find money and the imagined dear financial
consequences of budgeting fiscal deficits. 2 helps to understand how monetary
sovereignty is implemented in practice. On 3, yes focus on the real issues.



DA: We agree on 3! Thank you for an interesting discussion,
Eric. There's so much more to talk about, but let's leave that for another day. 



ET: You are welcome and thank you too!

With President Milei's election in Argentina, dollarization is suddenly on the table. I'm for it. Here's why. Why not? A standard of valueStart with "why not?'' Dollarization, not a national currency, is actually a sensible default. The dollar is the US standard of value. We measure length in feet, weight in pounds, and the value of goods in dollars. Why should different countries use different measures of value? Wouldn't it make sense to use a common standard of value? Once upon a time every country, and often every city, had its own weights and measures. That made trade difficult, so we eventually converged on international weights and measures. (Feet and pounds are actually a US anachronism since everyone else uses meters and kilograms.  Clearly if we had to start over we'd use SI units, as science and engineering already do.) Moreover, nobody thinks it's a good idea to periodically shorten the meter in order to stimulate the economy, say by making the sale of cloth more profitable. As soon as people figure out they need to buy more cloth to make the same jeans, the profit goes away. PrecommitmentPrecommitment is, I think,  the most powerful argument for dollarization (as for euorization of, say, Greece): A country that dollarizes cannot print money to spend more than it receives in taxes. A country that dollarizes must also borrow entirely in dollars, and must endure costly default rather than relatively less costly inflation if it doesn't want to repay debts. Ex post inflation and devaluation is always tempting, to pay deficits, to avoid paying debt, to transfer money from savers to borrowers, to advantage exporters, or to goose the economy ahead of elections. If a government can precommit itself to eschew inflation and devaluation, then it can borrow a lot more money on better terms, and its economy will be far better off in the long run. An independent central bank is often advocated for precommitment value. Well, locating the central bank 5,000 miles away in a country that doesn't care about your economy is as independent as you can get!The Siren Vase. Greek 480-470 BC. Source: The Culture CriticPrecommitment is an old idea. See picture. It's hard. A country must set things up so that it cannot give in to temptation ex post, and it will regret and try to wriggle out of that commitment when the time comes. A lot of the structure of our laws and government amount to a set of precommitments. An independent central bank with a price-level mandate is a precommitment not to inflate. A constitution and property rights are precommitments not to expropriate electoral minorities. Especially in Argentina's case, precommitment is why full dollarization is better than an exchange rate peg or a currency board. A true exchange rate peg -- one dollar for one peso, as much as you like -- would seem to solve the temptation-to-inflate problem. But the country can always abrogate the peg, reinstitute currency controls, and inflate. An exchange rate peg is ultimately a fiscal promise; the country will raise enough taxes so that it can get the dollars necessary to back its currency. When that seems too hard, countries devalue the peg or abandon it altogether. A currency board is tougher. Under a currency board,  every peso issued by the government is backed by a dollar. That seems to ensure adequate reserves to handle any conceivable run. But a strapped government eyes the great Uncle-Scrooge swimming pool full of dollars at the currency board, and is tempted to abrogate the board, grab the assets and spend them. That's exactly how Argentina's currency board ended. Dollarization is a burn the ships strategy. There is no return. Reserves are neither necessary nor sufficient for an exchange rate peg. The peg is a fiscal promise and stands and falls with fiscal policy. A currency board, to the governmentFull dollarization -- the country uses actual dollars, and abandons its currency -- cannot be so swiftly undone. The country would have to pass laws to reinstitute the peso, declare all dollar contracts to be Peso contracts, ban the use of dollars and try to confiscate them. Dollars pervading the country would make that hard. People who understand their wealth is being confiscated and replaced by monopoly money would make it harder -- harder than some technical change in the amount of backing at the central bank for the same peso notes and bank accounts underlying a devalued peg or even an abrogated currency board. The design of dollarization should make it harder to undo. The point is precommitment, to make it as costly as possible for a following government to de-dollarize, after all. It's hard to confiscate physical cash, but if domestic Argentine banks have dollar accounts and dollar assets, it is relatively easy to pronounce the accounts in pesos and grab the assets. It would be better if dollarization were accompanied by full financial, capital, and trade liberalization, including allowing foreign banks to operate freely and Argentinian banks to become subsidiaries of foreign banks. Absence of a central bank and domestic deposit insurance will make that even more desirable. Then Argentinian bank "accounts" could be claims to dollar assets held offshore, that remain intact no matter what a future Peronist government does. Governments in fiscal stress that print up money, like Argentina, also impose an array of economy-killing policies to try to prop up the value of their currency, so the money printing generates more revenue. They restrict imports with tariffs, quotas, and red tape; they can restrict exports to try to steer supply to home markets at lower prices; they restrict currency conversion and do so at manipulated rates; they restrict capital markets, stopping people from investing abroad or borrowing abroad; they force people to hold money in oligopolized bank accounts at artificially low interest rates. Dollarization is also a precommitment to avoid or at least reduce all these harmful policies, as generating a demand for a country's currency doesn't do any good to the government budget when there isn't a currency. Zimbabwe dollarized in 2009, giving up on its currency after the greatest hyperinflation ever seen. The argument for Argentina is similar. Ecuador dollarized successfully in much less trying circumstances. It's not a new idea, and unilateral dollarization is possible. In both cases there was a period in which both currencies circulated. (Sadly, Zimbabwe ended dollarization in 2019, with a re-introduction of the domestic currency and redenomination of dollar deposits at a very unfavorable exchange rate. It is possible to undo, and the security of dollar bank accounts in face of such appropriation is an important part of the dollarization precommitment.) The limits of precommitmentDollarization is no panacea. It will work if it is accompanied by fiscal and microeconomic reform. It will be of limited value otherwise. I'll declare a motto: All successful inflation stabilizations have come from a combination of fiscal, monetary and microeconomic reform. Dollarization does not magically solve intractable budget deficits. Under dollarization, if the government cannot repay debt or borrow, it must default.  And Argentina has plenty of experience with sovereign default. Argentina already borrows abroad in dollars, because nobody abroad wants peso debt, and has repeatedly defaulted on dollar debt.  The idea of dollar debt is that explicit default is more costly than inflation, so the country will work harder to repay debt. Bond purchasers, aware of the temptation to default, will put clauses in debt contracts that make default more costly still. For you to borrow, you have to give the bank the title to the house. Sovereign debt issued under foreign law, with rights to grab assets abroad works similarly. But sovereign default is not infinitely costly and countries like Argentina sometimes choose default anyway. Where inflation may represent simply hugging the mast and promising not to let go, default is a set of loose handcuffs that you can wriggle out of painfully. Countries are like corporations. Debt denominated in the country's own currency is like corporate equity (stock): If the government can't or won't pay it back the price can fall, via inflation and currency devaluation. Debt denominated in foreign currency is like debt: If the government can't or won't pay it back, it must default. (Most often, default is partial. You get back some of what is promised, or you are forced to convert maturing debt into new debt at a lower interest rate.) The standard ideas of corporate finance tell us who issues debt and who issues equity.  Small businesses, new businesses, businesses that don't have easily valuable assets,  businesses where it is too easy for the managers to hide cash, are forced to borrow, to issue debt. You have to borrow to start a restaurant. Businesses issue equity when they have good corporate governance, good accounting, and stockholders can be sure they're getting their share. These ideas apply to countries, and the choice between borrowing in their own currency and borrowing in foreign currency. Countries with poor governance, poor accounting, out of control fiscal policies, poor institutions for repayment, have to borrow in foreign currency if they are going to borrow at all, with intrusive conditions making default even more expensive. Issuing and borrowing in your own currency, with the option to inflate, is the privilege of countries with good institutions, and democracies where voters get really mad about inflation in particular. Of course, when things get really bad, the country can't borrow in either domestic or foreign currency. Then it prints money, forcing its citizens to take it. That's where Argentina is. In personal finance, you start with no credit at all; then you can borrow; finally you can issue equity. On the scale of healthier economies, dollarizing is the next step up for Argentina. Dollarization and foreign currency debt have another advantage. If a country inflates its way out of a fiscal mess, that benefits the government but also benefits all private borrowers at the expense of private savers. Private borrowing inherits the inflation premium of government borrowing, as the effective government default induces a widespread private default. Dollarization and sovereign default can allow the sovereign to default without messing up private contracts, and all prices and wages in the economy. It is possible for sovereigns to pay higher interest rates than good companies, and the sovereign to be more likely to default than those companies. It doesn't always happen, because sovereigns about to default usually grab all the wealth they can find on the way down, but the separation of sovereign default from inflationary chaos is also an advantage. Greece is a good example, and a bit Italy as well, both in the advantages and the cautionary tale about the limitations of dollarization. Greece and Italy used to have their own currencies. They also had borders, trade controls, and capital controls. They had regular inflation and devaluation. Every day seemed to be another "crisis" demanding another "just this once" splurge. As a result, they paid quite high interest rates to borrow, since savvy bondholders wanted insurance against another "just this once."They joined the EU and the eurozone. This step precommitted them to free trade, relatively free capital markets, and no national currency.  Sovereign default was possible, but regarded as very costly. Having banks stuffed with sovereign debt made it more costly.  Leaving the euro was possible, but even more costly. Deliberately having no plan to do so made it more costly still. The ropes tying hands to the mast were pretty strong. The result: borrowing costs plummeted. Governments, people and businesses were able to borrow at unheard of low rates. And they did so, with aplomb. The borrowing could have financed public and private investment to take advantage of the new business opportunities the EU allowed. Sadly it did not. Greece soon experienced the higher ex-post costs of default that the precommitment imposed. Dollarizaton -- euroization -- is a precommitment, not a panacea. Recommitments impose costs on yourself ex post. Those costs are real.  A successful dollarization for Argentina has to be part of a joint monetary, fiscal, and microeconomic reform. (Did I say that already? :) ) If public finances aren't sorted out, a default will come eventually. And public finances don't need a sharp bout of "austerity" to please the IMF. They need decades of small primary surpluses, tax revenues slightly higher than spending, to credibly pay down any debt. To get decades of revenue, the best answer is growth. Tax revenue equals tax rate times income. More income is a lot easier than higher tax rate, which at least partially lowers income. Greece and Italy did not accomplish the microeconomic reform part. Fortunately, for Argentina, microeconomic reform is low-hanging fruit, especially for a Libertarian president. TransitionWell, so much for the Promised Land, they may have asked of Moses, how do we get there? And let's not spend 40 years wandering the Sinai on the way. Transition isn't necessarily hard. On 1 January 1999, Italy switched from Lira to Euro. Every price changed overnight, every bank account redenominated, every contract reinterpreted, all instantly and seamlessly. People turned in Lira banknotes for Euro banknotes. The biggest complaint is that stores might have rounded up converted prices. If only Argentina could have such problems. Why is Argentina not the same? Well, for a lot of reasons. Before getting to the euro, Italy had adopted the EU open market. Exchange rates had been successfully pegged at the conversion rate, and no funny business about multiple rates. The ECB (really the Italian central bank) could simply print up euros to hand out in exchange for lira. The assets of the Italian central bank and other national central banks were also redenominated in euro, so printing up euros to soak up national currencies was not inflationary -- assets still equal liabilities. Banks with lira deposits that convert to Euro also have lira assets that convert to euro. And there was no sovereign debt crisis, bank crisis,  or big inflation going on. Italian government debt was trading freely on an open market. Italy would spend and receive taxes in euros, so if the debt was worth its current price in lira as the present value of surpluses,  it was worth exactly the same price, at the conversion rate, in euro. None of this is true in Argentina. The central problem, of course, is that the government is broke. The government does not have dollars to exchange for Pesos. Normally, this would not be a problem. Reserves don't matter, the fiscal capacity to get reserves matters. The government could simply borrow dollars internationally, give the dollars out in exchange for pesos, and slowly pay off the resulting debt. If Argentina redenominated interest-bearing peso debt to dollars at a market exchange rate, that would have no effect on the value of the debt. Obviously, borrowing additional dollars would likely be difficult for Argentina right now. To the extent that its remaining debt is a claim to future inflationary seigniorage revenues, its debt is also worth less once converted to dollars, even at a free market rate, because without seigniorage or fiscal reforms, budget deficits will increase. And that leads to the primary argument against dollarization I hear these days. Yes it might be the promised land, but it's too hard to get there. I don't hear loudly enough, though, what is the alternative? One more muddle of currency boards, central bank rules, promises to the IMF and so forth? How do you suddenly create the kind of stable institutions that Argentina has lacked for a century to justify a respectable currency? One might say this is a problem of price, not of quantity. Pick the right exchange rate, and conversion is possible. But that is not even clearly true. If the state is truly broke, if pesos are only worth anything because of the legal restrictions forcing people to hold them, then pesos and peso debt are genuinely worthless. The only route to dollarization would be essentially a complete collapse of the currency and debt. They are worth nothing. We start over. You can use dollars, but you'll have to export something to the US -- either goods or capital, i.e. stock and bonds in private companies -- to get them. (Well, to get any more of them. Lots of dollars line Argentine mattresses already.) That is enough economic chaos to really put people off. In reality, I think the fear is not a completely worthless currency, but that a move to quick dollarization would make peso and peso claims worth very little, and people would rebel against seeing their money holdings and bank accounts even more suddenly worthless than they are now. Maybe, maybe not. Just who is left in Argentina counting on a robust value of pesos? But the state is not worth nothing. It may be worth little in mark to market, or current dollar borrowing capacity. But a reformed, growing Argentina, with tax, spending, and microeconomic reform, could be a great place for investment, and for tax revenue above costs. Once international lenders are convinced those reform efforts are locked in, and Argentina will grow to anything like its amazing potential, they'll be stumbling over themselves to lend. So a better dollarization plan redeems pesos at the new greater value of the post-reform Argentine state. The question is a bit of chicken and egg: Dollarization has to be part of the reform, but only reform allows  dollarization with a decent value of peso exchange.  So there is a genuine question of sequencing of reforms. This question reminds me of the totally fruitless discussion when the Soviet Union broke up. American economists amused themselves with clever optimal sequencing of liberalization schemes. But if competent benevolent dictators (sorry, "policy-makers") were running the show, the Soviet Union wouldn't have failed in the first place. The end of hyperinflation in Germany. Price level 1919-1924. Note left-axis scale. Source: Sargent (1982) "The ends of four big inflations." A better historical analogy is, I think, the ends of hyperinflation after WWI, so beautifully described by Tom Sargent in 1982. The inflations were stopped by a sudden, simultaneous, fiscal, monetary, and (to some extent) microeconomic reform. The fiscal problem was solved by renegotiating reparations under the Versailles treaty, along with  severe cuts in domestic spending, for example firing a lot of government and (nationalized) railroad workers. There were monetary reforms, including an independent central bank forbidden to buy government debt. There were some microeconomic reforms as well. Stopping inflation took no monetary stringency or high interest rates: Interest rates fell, and the governments printed more money, as real money demand increased. There was no Phillips curve of high unemployment. Employment and the economies boomed. So I'm for almost-simultaneous and fast reforms. 1) Allow the use of dollars everywhere. Dollars and pesos can coexist. Yes, this will put downward pressure on the value of the peso, but that might be crucial to maintain interest in the other reforms, which will raise the value of the peso. 2) Instant unilateral free trade and capital opening. Argentina will have to export goods and capital to get dollars. Get out of the way. Freeing imports will lower their prices and make the economy more efficient. Capital will only come in, which it should do quickly, if it knows it can get out again. Float the peso. 3) Long list of growth - oriented microeconomic reforms. That's why you elected a Libertarian president.  4) Slash spending. Reform taxes. Low marginal rates, broad base. Subsidies in particular distort prices to transfer income. Eliminate. 5)  Once reforms are in place, and Argentina has some borrowing capacity, redenominate debt to dollars, and borrow additional dollars to exchange pesos for dollars. All existing peso contracts including bank accounts change on the date. Basically, you want people to hold peso bills and peso debt in the interim as claims on the post-reform government. Peso holders have an incentive to push for reforms that will raise the eventual exchange value of the peso.   6) Find an interim lender. The central problem is who will lend to Argentina in mid stream in order to retire pesos. This is like debtor in possession financing but for a bankrupt country. This could be a job for the IMF. The IMF could lend Argentina dollars for the purpose of retiring pesos. One couldn't ask for much better "conditionality" than a robust Libertarian pro-growth program. Having the IMF along for the ride might also help to commit Argentina to the program. (The IMF can force conditionality better than private lenders.) When things have settled down, Argentina should be able to borrow dollars privately to pay back the IMF. The IMF might charge a decent interest rate to encourage that. How much borrowing is needed? Less than you think. Interest-paying debt can simply be redenominated in dollars once you pick a rate. That might be hard to pay off, but that's a problem for later. So Argentina really only needs to borrow enough dollars to retire cash pesos. I can't find numbers, but hyper inflationary countries typically don't have much real value of cash outstanding. The US has 8% of GDP in currency outstanding. If Argentina has half that, then it needs to borrow only 4% of GDP in dollars to buy back all its currency. That's not a lot. If the peso really collapses, borrowing a little bit more (against great future growth of the reform program) to give everyone $100, the sort of fresh start that Germany did after WWII and after unification, is worth considering. Most of the worry about Argentina's borrowing ability envisions continued primary deficits with slow fiscal adjustment. Make the fiscal adjustment tomorrow."You never want a serious crisis to go to waste," said Rahm Emanuel wisely. "Sequencing" reforms means that everything promised tomorrow is up for constant renegotiation. Especially when parts of the reform depend on other parts, I'm for doing it all as fast as possible, and then adding refinements later if need be. Roosevelt had his famous 100 days, not a 8 year sequenced program. The Argentine reform program is going to hurt a lot of people, or at least recognize losses that had long been papered over in the hope they would go away. Politically, one wants  to make the case "We're all in this, we're all hurting. You give up your special deal, preferential exchange rate, special subsidy or whatever, but so will everyone else. Hang with me to make sure they don't get theirs, and in a year we'll all be better off." If reforms are in a long sequence, which means long renegotiation, it's much harder to get buy in from people who are hurt earlier on that the ones who come later will also do their part.  The standard answersOne standard critique of dollarization is  monetary policy and "optimal currency areas." By having a national currency, the country's wise central bankers can artfully inflate and devalue the currency on occasion to adapt to negative shocks, without the inconvenience and potential dislocation of everyone in the country lowering prices and wages. Suppose, say, the country produces beef, and exports it in order to import cars. If world demand for beef declines, the dollar price of beef declines. The country is going to have to import fewer cars. In a dollarized country, or with a pegged exchange rate,  the internal price of beef and wages go down. With its own country and a floating rate, the value of the currency could go down, leaving beef and wages the same inside the country, but the price of imported cars goes up.  If lowering prices and wages causes more recession and dislocation than raising import prices, then the artful devaluation is the better idea.  (To think about this question more carefully you need traded and non-traded goods; beef, cars, and haircuts. The relative price of beef, cars, and haircuts along with demand for haircuts is also different under the two regimes). Similarly, suppose there is a "lack of demand'' recession and deflation. (90 years later, economists are still struggling to say exactly where that comes from.) With its own central bank and currency, the country can artfully inflate just enough to offset the recession. A country that dollarizes also has to import not-always-optimal US inflation. Switzerland did a lot better than the US and EU once again in the covid era. This line of thinking answers the question, "OK, if Argentina ($847 bn GDP, beef exports) should have its own currency in order to artfully offset shocks, why shouldn't Colorado ($484 bn GDP, beef exports)?''  Colorado is  more dependent on trade with the rest of the US than is Argentina. But, the story goes, people can more easily move across states. A common federal government shoves "fiscal stimulus" to states in trouble. Most of all, "lack of demand" recessions seem to be national, in part because of the high integration of states, so recessions are fought by national policy and don't need state-specific monetary stimulus. This is the standard "optimal currency area" line of thinking, which recommends a common currency in an integrated free trade zone such as US, small Latin American countries that trade a lot with the US, and Europe. Standard thinking especially likes a common currency in a fiscal union.  Some commenters felt Greece should keep or revert to the Drachma because the EU didn't have enough common countercyclical fiscal policy. It likes independent currencies elsewhere.I hope you're laughing out loud by now. A wise central bank, coupled with a thrifty national government, that artfully inflates and devalues just enough to technocratically exploit price stickiness and financial frictions, offsetting national "shocks" with minimum disruption, is a laughable description of Argentina's fiscal and monetary policies. Periodic inflation, hyperinflation and default, together with a wildly overregulated economy with far too much capital and trade controls is more like it. The lure of technocratic stabilization policy in the face of Argentina's fiscal and monetary chaos is like fantasizing whether you want the tan or black leather on your new Porsche while you're on the bus to Carmax to see if you can afford a 10-year old Toyota. Another reason people argue that even small countries should have their own currencies is to keep the seigniorage. Actual cash pays no interest. Thus, a government that issues cash earns the interest spread between government bonds and interest. Equivalently, if demand for cash is proportional to GDP, then as GDP grows, say 2% per year, then the government can let cash grow 2% per year as well, i.e. it can print up that much cash and spend it. But this sort of seigniorage is small for modern economies that don't have inflation. Without inflation, a well run economy might pay 2% for its debt, so save 2% by issuing currency. 2% interest times cash which is 10% of GDP is 0.2% of GDP. On the scale of Argentinian (or US) debt and deficits, that's couch change.  When inflation is higher, interest rates are higher, and seigniorage or the "inflation tax" is higher. Argentina is living off that now. But the point is not to inflate forever and to forswear bigger inflation taxes. Keeping this small seigniorage is one reason for countries to keep their currency and peg to the dollar or run a currency board. The currency board holds interest-bearing dollar assets, and the government gets the interest. Nice. But as I judge above, the extra precommitment value of total dollarization is worth the small lost seigniorage.  Facing Argentina's crisis, plus its catastrophic century of lost growth, lost seigniorage is a cost that I judge far below the benefit. Other countries dollarize, but agree with the US Fed to rebate them some money for the seigniorage. Indeed, if Argentina dollarizes and holds 10% of its GDP in non-interest-bearing US dollars, that's a nice little present to the US. A dollarization agreement with Argentina to give them back the seignorage would be the least we can do. But I don't think Argentina should hold off waiting for Jay Powell to answer the phone. The Fed has other fires to put out. If Argentina unilaterally dollarizes, they can work this sort of thing out later. Dollarization would obviously be a lot easier if it is worked out together with the US government and US banks. Getting cash sent to Argentina, getting banks to have easy payment systems in dollars and links to US banks would make it all easier. If Argentina gets rid of its central bank it still needs a payment system to settle claims in dollars. Accounts at, say, Chase could function as a central bank. But it would all be easier if the US cooperates. Updates:Some commenters point out that Argentina may be importing US monetary policy just as the US imports Argentine fiscal policy. That would lead to importing a big inflation. They suggest a Latin American Monetary Union, like the euro, or using a third country's currency. The Swiss franc is pretty good. Maybe the Swiss can set the world standard of value. Both are good theoretical ideas but a lot harder to achieve in the short run. Dollarization will be hard enough. Argentines have a lot of dollars already, most trade is invoiced in dollars so getting dollars via trade is relatively easy, the Swiss have not built out a banking infrastructure capable of being a global currency. The EMU lives on top of the EU, and has its own fiscal/monetary problems. Building a new currency before solving Argentina's problems sounds like a long road. The question asked was dollarization, so I stuck to that for now. I imagined here unilateral dollarization. But I didn't emphasize enough: The US should encourage dollarization! China has figured this out and desperately wants anyone to use its currency. Why should we not want more people to use our currency? Not just for the seigniorage revenue, but for the ease of trade and international linkages it promotes. The Treasury and Fed should have a "how to dollarize your economy" package ready to go for anyone who wants it. Full integration is not trivial, including access to currency, getting bank access to the Fed's clearing systems, instituting cyber and money laundering protocols, and so forth. Important update: Daniel Raisbeck and Gabriela Calderon de Burgos at CATO have a lovely essay on Argentinian dollarization, also debunking an earlier Economist article that proclaimed it impossible. They include facts and comparison with other dollarization experiences, not just theory as I did. (Thanks to the correspondent who pointed me to the essay.) Some quotes:At the end of 2022, Argentines held over $246 billion in foreign bank accounts, safe deposit boxes, and mostly undeclared cash, according to Argentina's National Institute of Statistics and Census. This amounts to over 50 percent of Argentina's GDP in current dollars for 2021 ($487 billion). Hence, the dollar scarcity pertains only to the Argentine state....The last two dollarization processes in Latin American countries prove that "purchasing" the entire monetary base with U.S. dollars from one moment to the next is not only impractical, but it is also unnecessary. In both Ecuador and El Salvador, which dollarized in 2000 and 2001 respectively, dollarization involved parallel processes. In both countries, the most straightforward process was the dollarization of all existing deposits, which can be converted into dollars at the determined exchange rate instantly.in both Ecuador and El Salvador, dollarization not only did not lead to bank runs; it led to a rapid and sharp increase in deposits, even amid economic and political turmoil in Ecuador's case....There is a general feature of ending hyperinflation: People hold more money. In this case, people hold more bank accounts once they know those accounts are safe. Short summary of the rest, all those dollar deposits (out of mattresses into the banking system) allowed the central bank to retire its local currency liabilities. Emilio Ocampo, the Argentine economist whom Milei has put in charge of plans for Argentina's dollarization should he win the presidency, summarizes Ecuador's experience thus:People exchanged their dollars through the banks and a large part of those dollars were deposited in the same banks. The central bank had virtually no need to disburse reserves. This was not by design but was a spontaneous result.In El Salvador also, Dollar deposits also increased spontaneously in El Salvador, a country that dollarized in 2001. By the end of 2022, the country's deposits amounted to 49.6 percent of GDP—in Panama, another dollarized peer, deposits stood at 117 percent of GDP.El Salvador's banking system was dollarized immediately, but the conversion of the circulating currency was voluntary, with citizens allowed to decide if and when to exchange their colones for dollars. Ocampo notes that, in both Ecuador and El Salvador, only 30 percent of the circulating currency had been exchanged for dollars four months after dollarization was announced so that both currencies circulated simultaneously. In the latter country, it took over two years for 90 percent of the monetary base to be dollar‐​based.Cachanosky explains that, in an El Salvador‐​type, voluntary dollarization scenario, the circulating national currency can be dollarized as it is deposited or used to pay taxes, in which case the sums are converted to dollars once they enter a state‐​owned bank account. Hence, "there is no need for the central bank to buy the circulating currency" at a moment's notice.Dollarization starts with both currencies and a peg. As long as people trust that dollarization will happen at the peg, the conversion can take a while. You do not need dollars to soak up every peso on day 1. Dollarization is, above, a commitment that the peg will last for years, not a necessary commitment that the peg will last a day. I speculated about private borrowing at lower rates than the sovereign, once default rather than inflation is the only way out for the sovereign. This happened: ... as Manuel Hinds, a former finance minister in El Salvador, has explained, solvent Salvadorans in the private sector can borrow at rates of around 7 percent on their mortgages while international sovereign bond markets will only lend to the Salvadoran government at far higher rates. As Hinds writes, under dollarization, "the government cannot transfer its financial costs to the private sector by printing domestic money and devaluing it."A nice bottom line: Ask people in Ecuador, El Salvador, and Panama what they think:This is yet another lesson of dollarization's actual experience in Latin American countries. It is also a reason why the vast majority of the population in the dollarized nations has no desire for a return to a national currency. The monetary experiences of daily life have taught them that dollarization's palpable benefits far outweigh its theoretical drawbacks. Even more important update:From Nicolás Cachonosky How to Dollarize Argentina  The central problem is non-money liabilities of the central bank. A detailed plan. Many other blog posts at the link. See his comment below.  Tyler Cowen on dollarization in Bloomberg. Great quote: The question is not how to adopt a new currency, it is how to adopt a new currency and retain a reasonable value for the old one. Dollarization is easy. Hyperinflate the Peso to zero a la Zimbabwe.  Repeat quote. Emilio Ocampo on dollarization as a commitment device. One of the main reasons to dollarize is to eliminate high, persistent, and volatile inflation. However, to be effective, dollarization must generate sufficient credibility, which in turn depends critically on whether its expected probability of reversal is low.... The evidence suggests that, in the long-run, the strongest insurance against reversal is the support of the electorate, but in the short-run, institutional design [dollarization] can play a critical role.Fifty years ago, in testimony to U.S. Congress, Milton Friedman argued that "the whole reason why it is an advantage for a developing country to tie to a major country is that, historically speaking, the internal policies of developing countries have been very bad. U.S. policy has been bad, but their policies have been far worse. ... (1973, p.127)."In this respect, not much has changed in Argentina since. Craig Richardson explains how dollarization failed in Zimbabwe, a wonderful cautionary tale. Deficits did not stop, the government issued "bonds" and forced banks to buy them, bank accounts became de linked from currency. Gresham's law prevailed, the government "bonds" circulating at half face value drove out cash dollars. With persistent government and trade deficits there was a "dollar shortage."