Inside the Bitcoin advocates’ closed-door meeting with federal regulators

If the nominal interest rate exceeds nominal growth in GDP, then wealth effects (aka people have more money thanks to interest and therefore spend more) will eventually encourage faster growth of nominal GDP - either by stimulating more production (real GDP growth) or by driving up prices (inflation), or, more likely, by a mix of both.

If nominal interest rates are below nominal growth in GDP, then it becomes more profitable to borrow money to invest in production. People will do this, and this will adjust interest rates up (you can understand this from two directions: on the one hand, profit is being spread around via interest, on the other hand, demand for loan drives up interest rates).

These adjustments do not take over night - they probably operate on the timescale of years (unfortunately, economics tends to pay very little attention to how fast such market mechanisms operate, so we basically have no scientific basis for such statements, just common sense and gut feelings). Still, you cannot escape those adjustments of the interest rate in the long term.

What does this have to do with governments, inflation, and financing the deficit? If the government consciously acted to increase inflation to finance its deficit [1] this would indeed temporarily benefit borrowers. However, this is a temporary measure and certainly not the case today. Furthermore, governments have also consciously acted to decrease inflation, which obviously has the opposite effect. So in the end, it's at best a wash.

One last point:

the Fed does in fact purchase US Treasury Bonds without requiring the Treasury to pay back the debt

The same happens in the real economy as well. Firms operate using debt that is effectively never paid back. The debt is regularly rolled over, sure, but it is de facto permanent and contributes to a permanent increase of the money supply, which is what matters (if any of those quantities matter).

The Fed does buy mostly Treasuries to create the monetary base (which is necessary for purely technical reasons), but what else would you have them buy? I personally wouldn't want "my" central bank to gamble on risky assets.

[1] Also, I find it fascinating that the goldbugs never point to actual examples where this happened. I suspect they don't because it's a myth, at least in the countries those people come from outside of wartime.

If real GDP growth stops or even becomes negative, then the real interest rate will have to end up being zero or less as well, regardless of what the government supposedly does to create inflation or not. Ultimately, even if government acts like every gold bug wants it to act, the private sector will create inflation through its action if the real interest rate remains too high. [1]

So I don't know what we should make of all this? Perhaps you want the government to stop borrowing when the Limits of Growth have been reached? But (a) we are not at this point yet, so it is irrelevant for current decisions, and (b) how would you recognize when we've reached this point?

Perhaps you recognize it when there is zero unemployment and real GDP is still shrinking?

In any case, this is very unclear territory.

[1] Since I don't want to repeat myself too much, this is the comment where I've tried to explain my understanding of the mechanisms behind this: https://news.ycombinator.com/item?id=6291096

As I said QE is about creating money in the short term. However, there are vary good reasons why the FED buys bonds vs say Gold. A major goal is to reduce the interest rate on long term loans. But, this means that the asset they acquire is generally worth more nominal dollars in the future. So when sold or simply paid back the money supply shrinks.

That's not to say the FED can't purchase more assets to make up for the lost money. But, the temperary nature of QE is seen as a benifit that helps avoid inflation.

The thing is, though, that banks hand out loans independently of how much reserves they have. Only afterwards do they check whether they need more reserves, and obtain them if necessary. This is even reflected in the internal organization of banks: Loans and reserves are in different departments.

The central bank creates new reserves as a reaction to increased demand by banks as part of its normal operation. It is not a political decision to do so. The political decision is to set the target interest rate (Fed funds rate). The money supply fluctuates to accommodate the demand of borrowers given that interest rate. Because of that, private banks can and do account for the monetary expansion that goes hand in hand with rising prices.

However, it is probably more accurate to say that banks accommodate rising prices, i.e. the causality goes from rising prices to an increase of money (that is, causality goes from right to left in MV = PQ).

Most importantly, firms use more credit to cover their operating expenses as prices rise, and home owners take out larger mortgages as house prices rise, etc. This increase in the loan volume as a reaction to price increases is what drives the growth in the money supply.

All this about reserves is of course very far away from the fairy-tale stories of banks taking in deposits and loaning them out. Unfortunately, banking tends to be pretty opaque, and you really need to dig into this stuff to understand it. People like the MMT bloggers have popularized a proper understanding though, so it's not as difficult as it used to be (the MMT bloggers like Bill Mitchell and Randall Wray tend to have blind spots in other areas, but they have studied the monetary system pretty thoroughly and know what they're writing about in that regard).

Inflation is a matter of supply and demand. As long as there is excess supply, one can buy the supply with newly created money without raising prices. That's supply and demand 101.

The only tricky part is figuring out how much money can be safely printed. Central planning tends to be bad at this (which is why so-called military Keynesianism is a bad idea from an economics point of view, even if you don't care about pacifism).

The trick is to figure out a decentralized and automatic approach. That is, an approach that automatically increases the amount of money creation when there's slack in the economy, and automatically scales back when the economy is operating at full capacity.

"The actual process of money creation takes place primarily in banks. As noted earlier, checkable liabilities of banks are money. These liabilities are customers' accounts. They increase when customers deposit currency and checks and when the proceeds of loans made by the banks are credited to borrowers' accounts.

In the absence of legal reserve requirements, banks can build up deposits by increasing loans and investments so long as they keep enough currency on hand to redeem whatever amounts the holders of deposits want to convert into currency. This unique attribute of the banking business was discovered many centuries ago.

It started with goldsmiths. As early bankers, they initially provided safekeeping services, making a profit from vault storage fees for gold and coins deposited with them. People would redeem their "deposit receipts" whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would deposit them for safekeeping, often with the same banker. Everyone soon found that it was a lot easier simply to use the deposit receipts directly as a means of payment. These receipts, which became known as notes, were acceptable as money since whoever held them could go to the banker and exchange them for metallic money.

Then, bankers discovered that they could make loans merely by giving their promises to pay, or bank notes, to borrowers. In this way, banks began to create money. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time. Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment.

Transaction deposits are the modern counterpart of bank notes. It was a small step from printing notes to making book entries crediting deposits of borrowers, which the borrowers in turn could "spend" by writing checks, thereby "printing" their own money."

Modern Money Mechanics - Federal Reserve Bank of Chicago

[1] http://en.wikisource.org/wiki/Modern_Money_Mechanics/Introdu...