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Notes -
Over the course of this Qeek, I've been learning about the concept of fiscal dominance.
Do you think that we are starting to see that phenomenon in the United States? It seems like the symptoms of said event line up with what we're seeing: stubborn inflation, ripping equities, increasingly schizophrenic Treasury behavior. On the other hand, I'm always suspicious of something that fits a little too well.
If it is happening, what should private American citizens expect, other than high inflation? How would an Argentinian prepare for their fiscal dominance scenario if a time traveler warned them ahead of time?
Same as it ever was, really. People in the last 50 years really wanted to think of central bankers as our modern wizards, fine-tweaking the economy with their monetary policy dials, while we breathlessly hang on every word of their forward guidance. But they've been more accurately caricatured as the kid in the passenger seat with a fisher-price steering wheel & pedals who thinks they're the one driving. The only awkward part is that the adult who is actually driving (fiscal policy of spending & taxing, which have enormous clear 1st-order effects) is often actually looking at the kid and also thinks they're the one controlling the car.
As for "monetization" inflation theories: Anyone who still thinks of interest-bearing government debt in the form of central bank reserves as "money" but interest-bearing government debt in the form of treasury securities as "not-money" has been exposed as having an incoherent understanding of the accounting fundamentals. QE not being stimulative or inflationary broke a lot of those brains awhile back, but people come up with cope or just conveniently forget about it and go back to their old textbook understanding years later ('gasp, you shouldn't monetize the debt, that would be inflationary!'). Some mainstream economists like Summers & Krugman finally came around in the mid/late 2010s to notice that in a zero-rate environment, there is no 'money' difference, and the deficit is effectively printing money regardless of what form it ends up in, be it reserve balances, securities balances, physical coins/notes, etc. They still didn't seem to note that in the post-2008 world, the monetary policy regime switched to hitting their interest rate target by paying interest on reserves directly (a much better & simpler system than using reserve requirements and OMOs to drain all excess reserves all the time from the banking system), so there's no 'money' difference between reserves and securities even if the policy rate isn't zero.
Fiscal dominance for American citizens has been happening for 250 years, so I would anticipate more of that general trajectory. Especially similar is the last 90 years with a central bank that got modernized based on the experience of the great depression, and the introduction of income taxes which are a massive fiscal automatic stabilizer where taxes paid go up & down with the state of the economy without any active intervention needed by congress. Just because it's the water we swim in, doesn't mean it's less important; that's the steering wheel that's actually attached to something.
To the extent that you actually have to check empirically to find that raising the policy interest rate to 50% (meaning the government effectively increases the size of all bank accounts constantly with a bunch of free money), turns out to shocked pikachu drive inflation up to 50% rather than 'taming' it down to 0...well I would say you're learning which 'channels' are more powerful in the real world, free money vs cost-of-borrowing, rather than needing to get too creative speculating about whether we've transitioned between monetary vs fiscal dominant worlds at any given moment. And it starts to click why the Fed couldn't get inflation up to 2% no matter how low they set rates, and now can't get it down to 2% no matter how high they set them. I haven't read the econ blogs in awhile, but I know of at least John Cochrane as still trying to get the 'fisherian' word out that interest rates are positively causally correlated with inflation, as well as MMT's Warren Mosler.
I don't think it's accurate to say central bank policies have no effect. I've heard a lot of talk about zero-interest-rate phenomena and its influence on the tech market scene, for example, and I think that has a lot of basis under it. If you give people access to infinite money with the condition on "give it back some time later, maybe" it will have an influence on the economy, how could it not? I do not deny government spending and taxation has its effects too - I mean, we're talking trillions here, how could it not, and I think nobody would ever deny taxation directly influences economic behavior, and so does subsidizing.
That said, I think the idea that the Fed is only interested in pegging inflation to 2% and nothing else matters is naive at best. The Fed is seen as the steward of the economy as a whole, whatever is meant by that - I am sure they have enough charts for everybody - and the government would reach out to them (either quietly or flamboyantly, in Trump's case) if they want some economic policy to happen. I think that has been the case for a long time, one can call it by whatever term they want, but the government and the Fed have some ideas how the economy should look like, and they use all their tools to achieve it, and the inflation is only one measure among many.
All I would say from my perspective is that I've seen quite a lot of people who don't seem to know or write much about banking/accounting/money, still very much took to the zirp 'free money' story as part of any fun narrative-building they wanted to do. It reminds me of narratives about the falling rate of profit in capitalism or peak oil doomerism, where people work in some kind of questionable economic fudge factor for why some dam hasn't quite broken yet in their story.
In the same way that every random redditor "knows" that the Fed was allowing inflation to stay up in '22 and was screaming at them to raise rates to kill that inflation, similarly tons of people "know" about the distortionary impact of zirp as some story for anything happening in the 2010s. I just don't think the story really works like that. The default neutral state is for the risk-free monetary base to be non-interest-paying. It takes active government intervention to artificially set the base risk-free rate at something above 0%, upon which all other interest rates get set at a spread above. And banks don't just give infinite free money out when the base rate is zero, they take their marginal cut for the service they're providing, do their best to price in the credit risk appropriately, and get closed by the government for failing to be run properly. The economy clearly wasn't exactly turbocharged by 0% or negative interest rates, the way the wizard-believers were hoping.
As for other jobs the Fed does, yeah they have a ton of different roles. In addition to being charged with trying to use monetary policy to achieve stable prices and low unemployment, they also run the payment settlement system, do much of the financial regulatory policing, run the Treasury's books (so technically even treasury securities are a type of account at the Fed), and the branches each do plenty of interesting academic research & paper-writing to different audience levels, etc. If this was stemming from the 'toddler thinks they're driving the car' analogy, that was saying that monetary policy really doesn't drive the economy, compared to the overwhelming dominance of spending & taxing. Not that it has no effects, or that they do nothing useful.
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