Yipee: Krugman almost accepts functional finance.

Interesting exchange of views between James Galbraith and Paul Krugman. Crucial bits (as I see it) are thus.

Galbraith says “So long as U.S. banks are required to accept U.S. government checks — which is to say so long as the Republic exists — then the government can and does spend without borrowing, if it chooses to do so … Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system.”

Krugman answers: “OK, I don’t think that’s right. To spend, the government must persuade the private sector to release real resources.”

Galbraith responds: “In the actual world we live in, government does not have to “persuade the private sector to release real resources.” In the actual world, the private sector has already released those resources by the tens of millions of people.

All the government has to do, in the actual world, is mobilize those resources, which it does by issuing checks, preferably to pay people to do useful things.

Krugman’s only answer is to worry about the possible inflationary effects of the increased monetary base when the economy returns to normal (see final three paras).

The answers are thus. First, at the time of writing, the base increase is no more than the collapse in commercial bank created money, thus there has arguably been no money supply increase.

Second, an increased monetary base does not increase banks capital. Banks are capital constrained, not reserve constrained, thus the base increase does not increase banks’ ability to lend. Thus there won’t be an EXPLOSIVE increase in demand or inflation.

Third, it is obvious that the more monetary base is effectively in the hands of consumers, the higher demand will be (possibly leading to excess inflation). But governments and central banks are constantly having to deal with excess or deficient demand ANYWAY. For example if inflation looms, the extra money can be reined in as quickly as it was created, and by the usual anti-inflationary devices available to governments: increased interest rates, increased tax and so on.

Game, set and match to Galbraith.

The only remaining weakness in Galbraith’s argument is the point made by Milton Freidman, namely that governments are so hopeless at regulating demand that it would be better if they didn’t try. That is a good point, on the other hand the fact that the first twenty attempts to cure a disease don’t work is not a reason to give up, is it?