Quote from: BubbleBoy on September 30, 2011, 12:54:28 PM

I think hugolp put it nicely. Sure, the government could print tiny amounts of money as required, and derive it's main revenue from taxation. Strangely enough, it never happened in history. The government will always abuse the money creation privilege by treating it as a revenue source (which is not!), and unleash hyperinflation. Always. The only way for fiat to work is it's issued by an independent central bank, and the government behaves just like a normal borrower on the market: if it needs more money that it can tax, it needs to find lenders, and appear trustworthy to them.

The Government does create, indirectly via the issuance of Treasuries, money. If the supply of Treasuries compared to cash is too great, then the Central Bank will step in, and purchase Treasuries with new cash. Therefore for the Central Bank to create money, there must be Treasuries circulating, and shows that Treasuries are the initial form of money. If your American, the Debt Ceiling is the true limit on the amount of money that can be created. Treasuries function like money, and since the Central Bank generally purchases Treasuries for fresh money, then this may have little effect upon inflation. So the the Government does not function like a normal borrower, because it can continue to create Treasuries indefinitely, but bound by the debt ceiling. The only issue, is if there is an inflation, but unlike popular opinion, if the Central Bank is only exchanging one form of money(M2) for another(M0), then this has little if any effect upon inflation, and this is what happened during Q.E 2.

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The 'myth' is that Government Debt behaves like Household Debt. Unlike households the state can create as much currency as it wants. So when the Bond comes due, the State can simply issue more money to pay back the Bond. This is a result of the interaction between the Treasury and the FED, where the FED purchases Treasuries in exchange for cash. But the total number of Treasuries that the FED can purchase is bound by the number of Bonds. Therefore the amount of money that the FED can create is bound by the size of the National Debt.

The only reason the govt. has any ability to borrow at all is precisely because the market expects it to treat it as household debt, i.e to tax and pay it back as opposed to simply print it into existence. Without that guarantee nobody would borrow money to the government. Nobody lends money to Zimbabwe in zimdollars: Mugabe's only option is to print more zimdollars or borrow in foreign currency. The Fed could monetize all 15 trillions of debt, yet it does not because it would create massive inflation, and that's against the Fed's raison d'etre. The slightest hint of such a strategy (default in real terms) would sent bond values to zero and prof. Krugman will have the dubious pleasure to meet those "bond vigilantes" whose existence he so adamantly denies.

Sure if there is a disconnect between the issuer of the currency and the capacity of the economy then of course there will be an inflation. As I said before the FED doesn't create inflation if it is swapping one form of base money(M0-M2) for another.

http://research.stlouisfed.org/fred2/data/BASE_Max_630_378.png

As you can see, the amount of money that the FED has created since 2008 has increased dramatically. There is 3.8 times as much money now compared to 2008. So you would expect to see an inflation of atleast 200%, and that has not happened. In fact core inflation is around 3%. This is because when the FED created most of that money(inflationary), it also purchased a heap of assets that behave exactly like money(deflationary), therefore the inflation has not changed dramatically.