Noted for January 10, 2013
Mourning the Death of James Buchanan

Between Greece and Zimbabwe

Within limits—until it starts printing money fast enough to become Zimbabwe—a country that controls its own currency and can print its own money does not face a tight and binding government budget constraint: the government spends what it wishes, taxes what it wishes, borrows what it wishes, prints money to make up the difference, and the exchange rate and the price level and interest rates then do their things as investors try to figure out on what terms they want to hold domestic as opposed to foreign assets and on what terms they want to hold bonds rather than cash.

By contrast, a country with a fixed exchange rate has its money stock nailed by the requirement that it maintain its exchange rate peg. That then forces spending, taxes, and borrowing into a configuration in which bond vigilantes believe that the debt will be paid off—and if they don’t believe that, then spending must be equal to taxes minus the debt repayment the bond vigilantes demand.

But suppose that you are in an intermediate case, where the Treasury and the central bank do not want to peg the currency (and the internal price level) but do not want to let it (them) do their own thing without limit either? Suppose the Treasury Secretary believes that a strong dollar is in America’s interest. What you then have is a mix of the polar gold-standard and MMT cases. But what are the proportions of the mix?