OK, we are indeed, as Steve Randy Waldman says, all dorks, and so are you if you are reading this. What’s more, we’re inarticulate dorks, or so it seems.
Here’s what I think is going on: somehow, Waldman and I are asking different questions. (Another summary of the discussion here.) I agree with him, mostly, on the question I think he’s asking; it’s not clear to me whether he agrees with me on the question(s) I’m asking.
My questions involve whether interest on excess reserves changes any of the fundamentals of monetary policy and its relationship to the budget. That is, does IOER change the fact that the Federal Reserve has great power over aggregate demand except when market interest rates are near zero, and the related fact that when we’re not in a liquidity trap there is an important distinction between debt-financed and money-financed deficits?
My answer to both questions is no. Fed policy might in future take the form of changes in the interest rate on excess reserves rather than open-market operations – sort of a mirror-image version of the historic role of the discount rate – but while this might change the operational look of policy, it won’t change the reality of Fed power. And there will continue to be a big difference between debt-financed and money-financed deficits, as long as we’re careful about what we mean by those terms. A federal deficit financed by borrowing from the Fed, which in turn induces a rise in excess reserves and thereby sterilizes any inflationary impact by raising the interest rate it pays, might look like a money-financed deficit to the unwary; but it’s really debt financed. On the other hand, if the government borrows from the Fed and the Fed does not raise IOER, the government will be printing money – literally – to cover the gap, expanding the quantity of currency. And this will be inflationary unless you’re in a liquidity trap.
So as I see it, IOER leaves the basics unchanged.
It may, however, change the operational details; textbooks that describe monetary policy in terms of the money multiplier will have to be rewritten. But that was already true: serious applied monetary economists pretty much stopped talking about monetary aggregates as a measure of policy years ago, and these days it’s almost all in terms of target interest rates.
My concern is that when saying that money and debt are the same thing, it’s way too easy to lose sight of the real distinctions between monetary and fiscal policy that remain.
