What would be the likely economic consequences of the "trillion dollar coin" idea to eliminate all government debt?

Question

Taken from this question over at politics.se, consider this article by Business Insider which describes a scenario in which the treasury mints a trillion dollar coin to pay off all the debts of the U.S. government.

The premise of the idea is this: Although the Treasury can't just create money out of thin air to pay its bills, there is a technicality in the law that says the Treasury has special discretion to create platinum coins of any denomination, and the thinking is that Tim Geithner could make the coin and walk it over to the Federal Reserve and deposit it in the Treasury's bank account.

What would be the likely consequences of this type of action by the treasury? Specifically:

1. What would be the impact to inflation?

2. What would be the impact to the value of treasury bills? Particularly: a) those currently in issue and b) those issued in the future?

3. Could the answer to the question of how to pay for all future spending proposals simply be to mint another coin?

4. If you were an economist advising the administration on economic policy, would you advise in favor or against such a policy action. What would be your reasoning for your policy advice?

Answer 1

Quite obviously, the act of creating and depositing the coin can't possibly impact anything of economic interest (except for creating an imperceptibly small increase in demand for platinum and hence an imperceptibly small increase in its price).

The impact comes when the government starts to make withdrawals and spend money. And the nature of the impact depends on a thousand things you haven't specified, most notably: What does the government do with the money it withdraws? Does it pay down existing debt that it had not previously planned to pay down? Does it buy more missiles that it had not previously planned to buy? Does it expand a welfare program that it had not previously planned to expand? Does it cut taxes that it had not previously planned to cut? Does it trade the coin for a bathtub full of $10,000 bills for the president to bathe in?

It's no use assuming that it does none of these things with the money, because it has to do something with the money. So let's take the simplest example and suppose that they buy bonds (or cut taxes, which will have more or less the same effects).

In this case, you're swapping money for bonds, which is going to increase the price level. The impact on inflation depends, once again, on things you haven't specified. Does the government buy a trillion dollars worth of bonds at once? If so, there is a jump in the price level but essentially no new inflation. Do they spread the purchases out over a couple of years? If so, that's going to be a very inflationary couple of years.

Could all future government spending be paid for this way? Sure. Here are some other things you could use to finance all future government spending: A tax on food. A tax on labor. A tax on savings. A head tax. A tax assessed on random people in random amounts at random times. What you're proposing is, in effect, a tax on holding money (because it's the people who hold money who will lose when the price level adjusts). Each tax has some advantages and some disadvantages. In each case, the disadvantages grow nonlinearly as the tax increases, so it's very unlikely you'd want to just choose one tax to finance all government expenditures. You probably want a mix, which is what we have now. Whether we have exactly the right mix is open, of course, to a great deal of debate.

Answer 2

I like @Steven Landsburg's point about inflation as another form of taxation, and thinking through how the government responds to having this new revenue source.

I'd like to make narrower monetary point. I'm not sure there is anything special about the trillion dollar coin that wouldn't be true for the federal government minting or printing an extra trillion in other coins and paper bills. FRED reports that there is about \$1.8 trillion worth of currency in circulation, so in some sense we would go from having an M0 of \$1.8 trillion to one of \$2.8 trillion. Which sounds like a pretty big change, but when you consider that most money is not in the form of currency but rather in bank deposits (almost \$16 trillion), perhaps the effects would be better measured by assuming a change in the broader money stock of \$1 trillion / \$M2, or about 6-7%. Yes, that's large for a given year, but not actually a huge rate of change relative to historical experience:

The general monetary rule of thumb is that prices are roughly proportional to the money supply (the neutrality of money). This means we would expect an additional and unexpected 6% increase in the money supply to increase prices by 6%. There may be important distributional consequences that depend on what the government spends the money on.

Does the coin money have to be spent to trigger this inflation effect? I'm not sure. From Wikipedia:

The concept of striking a trillion-dollar coin that would generate one trillion dollars in seigniorage, which would be off-budget, or numismatic profit, which would be on-budget, and be transferred to the Treasury, is based on the authority granted by Section 31 U.S.C. § 5112 of the United States Code for the Treasury Department to "mint and issue platinum bullion coins" in any denominations the Secretary of the Treasury may choose. Thus, if the Treasury were to mint one-trillion dollar coins, it could deposit such coins at the Federal Reserve's Treasury account instead of issuing new debt.

I believe the way the Treasury's bond issuance works is that when the account is in deficit (subject to statutory limitations) the Treasury issues bonds to keep the government spending in line with congressional appropriations. What follows is a discussion from the NY Times when the it looked like the government might run an extended budget surplus (U.S. Treasury: No Lending; With Big Budget Surpluses, Some See The End of New Bonds and Notes By Jonathan Fuerbringer)

Yet pressing relentlessly against the Treasury market's viability is the expected size of budget surpluses compared with the amount of debt maturing each year. When the surplus exceeds the amount of old Treasury notes and bonds maturing, the government has no need to raise more cash to operate. So it will have a hard time arguing that it needs to keep selling new securities, including the 10-year note, which has already replaced the 30-year Treasury bond as the benchmark.

I therefore suspect that there are standard processes that would translate the resulting surplus into reduced debt issuance (potentially including not rolling over some existing debt).

However, I suspect the more important change from a huge influx of cash would be a concern that the US government would repeatedly do this. This would change expectations about inflation, which could create a large shock to current prices. The rough idea is that if people expect there to be a lot more money printed in the future, then prices will be higher in the future (and rise faster than they would have), so buying things now, before prices rise, especially long lived assets and durable consumption goods becomes a good idea. The resulting shifting of demand through time and the big inflation shock can be particularly harmful and wasteful.

Historically, countries that have tried to use printing money to solve serious budget issues have experienced very high inflation and a massive decline in the external value of their currencies. For example, my understanding is that every historical episode of hyperinflation has debt monetization as the most important cause behind the episode.