(Cross-posted at Monetary Realism)
Few things are more important than understanding precisely how the US government is able to eliminate solvency crisis through its institutional arrangements. One of the key Monetary Realism contributions is understanding these relationships and how they create the autonomous currency issuer. Banks are essentially harnessed as agents of the government in the funding process as they are required to bid at Treasury auctions. So the notion of not being able to procure funding is nonsensical. But even in a worst case scenario (let’s say a hyperinflation where the banks resort to self preservation mode and boycott auctions) the Fed can always step in as the lender of last resort. For more on this please see the Monetary Realism primer.
Although few people have gone into the intricate detail that JKH has on this topic, this understanding is not unique to Monetary Realists as noted in a recent Paul Krugman piece here (viaManifesto for Economic Sense):
“The confidence argument. Their first argument is that government deficits will raise interest rates and thus prevent recovery. By contrast, they argue, austerity will increase confidence and thus encourage recovery.
But there is no evidence at all in favour of this argument. First, despite exceptionally high deficits, interest rates today are unprecedentedly low in all major countries where there is a normally functioning central bank. This is true even in Japan where the government debt now exceeds 200% of annual GDP; and past downgrades by the rating agencies here have had no effect on Japanese interest rates. Interest rates are only high in some Euro countries, because the ECB is not allowed to act as lender of last resort to the government. Elsewhere the central bank can always, if needed, fund the deficit, leaving the bond market unaffected.”
That’s the contingent institutional approach whether he knows it or not. The next step is realizing that, because there is no solvency constraint for an autonomous currency issuer, that the true constraint is inflation rather than solvency. The policy responses are obviously very different (particularly in the current balance sheet recession) when you recognize this fact.
If you have yet to read JKH’s Contingent Institutional Approach please see here. It’s a must read.