Now unlike Joe, the Fed can inflate away the debt of the federal government any time it pleases, which is why we don't have to worry about ending up like Greece, even if spending and tax rates remain about where they are today.
I often hear this notion of "inflating away the debt" but I don't really get what that would look like in practice. I get that the general idea is that the government pays down the debt in devalued dollars but the consequences of such a weakened dollar are surely dire, no?
A devalu
ing dollar causes lots of problems in the short to medium term, and the risk is always that you kick off a self reinforcing pattern of hyper inflation you cannot pull out of. A devalu
ed dollar, if you've gotten there and if you are able to return to more regular levels of interest/inflation doesn't actually cause many problems at all, although one side effect would be a significant redistribution of wealth, since the poor tend to owe debts (credit cards, mortgages, unpaid medical bills) and the wealthy tend to own debt (bonds/CDs/etc), and a lot of inflation would drastically reduce the value of both the money the poor owe and the money owed to the wealthy.
So what would inflating the debt away look like? Well there are essentially two tools the Fed has to increase inflation. One is cut interest rates (but these are already almost at zero). The other is to increase the supply of money in the economy by purchasing assets with brand new money (this is the "quantitative easing" that was talked about a lot right after the 2007/2008 crash). It turns out one of the big assets the fed purchases to put new money into the economy is government bonds, right now close to 15% of the total federal government debt of $20T is owned by the federal reserve. Purchasing treasury bonds also decreases the supply, so if demand for treasury bonds from everyone else in the economy stays the same, the interest rate the federal government pays decreases.
Anyway, one way that inflating away the debt could look like is the federal reserve purchasing more and more government bonds on the open market.
1. This increases the money supply since the federal reserve is creating new money to pay for the bonds, which should eventually lead to inflation,* making the whole of government debt worth less and easier to pay off.
2. It puts downward pressure on the interest rates the US treasury has to pay on its debt which makes the debt easier to service and/or even pay off.
3. And, because the federal reserve pays the interest income on the debt it purchases back to the US treasury, the purchased bonds themselves effectively no longer contribute to the national debt, since the treasury is just paying interest to itself.
There are more extreme models where the US Treasury creates new money to pay off the debt themselves, which again increases the money supply, producing higher inflation, but these tend to require either changes to existing laws, or weird end-runs around the intent of existing laws which would certainly produce court challenges and just be a big mess (see "platinum coin seigniorage" and the idea of the trillion dollar coin, which periodically comes up during government shutdowns and debt ceiling crises**).
*It should be mentioned that since the housing crisis the federal reserve has drastically increased the money supply through this very process, yet have inflation has not occurred. One argument is that there is something wrong with the standard economic models in which case point #1 wouldn't have the effect I describe. Another is that we were really in for a lot of deflation (like the great depression), so that and the inflationary pressure of the new money just canceled each other out.
**https://en.wikipedia.org/wiki/Trillion_dollar_coin
