Will the federal government monetize the debt?

Federal government may print money to "pay" debt

"While accelerating the printing presses could do irreversible damage to the dollar's international reputation and the U.S. economy, history suggests that this is the way Washington will go to avoid the political pain of having to raise taxes and cut spending on popular programs such as Social Security, defense and Medicare."

The Fed's most strident inflation fighter, Thomas Hoenig, president of the Fed's Kansas City reserve bank, warned on Tuesday that "short-term political pressures" are prompting Congress to take a risky gamble by continuing to borrow at unsustainable rates rather than address the deficit problem and he expects political leaders to be "knocking at the Fed's door" to demand that it print money to pay for the debt. 

 With regard to the World War II Debt . . .

The country never really paid off the war debt. Rather, it was able to reduce the debt burden within a couple of decades to a minimal 30 percent of economic output through a combination of robust growth after the war and moderate inflation rates of between 4 percent and 6 percent. By printing more dollars and slowly diminishing their value over several years, the U.S. was able to pay back its debts more easily. 

In the case of WWII, the inflation was more important than the economic growth, and spending restraint played almost no role . . .

The country never really paid off the war debt. Rather, it was able to reduce the debt burden within a couple of decades to a minimal 30 percent of economic output through a combination of robust growth after the war and moderate inflation rates of between 4 percent and 6 percent. By printing more dollars and slowly diminishing their value over several years, the U.S. was able to pay back its debts more easily.

 It's already been done a little bit . . .

The Fed printed money to purchase $200 billion of Treasury bonds last year in an effort to keep interest rates low and nurture an economic recovery. The rationale was that interest rates paid by consumers and businesses are linked to Treasury rates. But Fed officials ended the program in the fall, partly out of concern that it gave the appearance that the central bank was printing money to help underwrite the national debt.

Some are already advocating this course . . .

Some respected economists have openly advocated an inflation strategy for reducing the debt. Kenneth Rogoff, a former chief economist at the International Monetary Fund, has suggested a 4 percent to 6 percent inflation target for the Fed to help deal with the debt.

A Bank of England board member and a number of academic and liberal economists have urged the same approach, arguing it is better than driving the country into a debt crisis by turning down the Fed's money spigot and raising interest rates.

 What the Fed is already doing . . .

For now, the Fed remains on course to slowly end programs that have helped the Treasury finance its huge $1.5 trillion deficit in the past year, though it is maintaining short-term interest rates at very low levels that minimize the burden on the Treasury.

One program the Fed said it will end next month continues to help the Treasury through the purchase of $1.25 trillion of Fannie Mae and Freddie Mac mortgage bonds - ostensibly with the goal of aiding a recovery in the housing market. In that program, the Fed has displaced private and foreign investors who in the past purchased the mortgage bonds, pushing those investors into the Treasury market.

Interests rates on government bonds will ultimately control how much monetization can be done. The Chinese have already shifted to buying short term notes in order to protect themselves.