Bryan Caplan  

Consols Contra the Liquidity Trap

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Pace Scott Sumner, suppose a country is stuck in a liquidity trap.  Conventional monetary policy is futile, and unconventional monetary policy isn't working either.  What would happen if the government did the following?

Step 1: The Treasury refinances the entire national debt with perpetual bonds, better known as consols.  As you know, such bonds pay a fixed coupon every year, and never mature.  The coupon divided by the asset price equals the interest rate.

Step 2: The central bank uses standard open market operations to bid up the price of consols until nominal GDP starts rising at the desired rate.

Notice: With regular bonds, the difference between 1% interest and .1% interest seems trivial.  With consols, it's massive.  A fall from 1% to .1% multiplies the sale price of a consol by a factor of ten!  There is an even bigger difference between a 1% interest rate and a .01% interest rate.  That multiplies the sale price a hundred-fold.  Can we really imagine that this massive increase in the public's net worth won't translate into higher consumption and investment?  And if not .01%, how about .00001%?

The only limit, as far as I can tell, is that the central bank might inadvertently retire its national debt.  When the bond price gets high enough, everyone sells.  But this seems like a remote possibility.  

If raising nominal GDP despite a liquidity trap is your goal, what's wrong with this approach?


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COMMENTS (10 to date)
Grant Gould writes:

I'm pretty sure that writing obligations on the entire future population in perpetuity is even more grossly undemocratic than existing long-term bonds.

Heck, why not issue special consols that only start paying out after, say, thirty years. They'd still have massive NPV, but nobody involved in voting on them would every have to bear any of the cost!

Your plan is a free lunch for everyone who actually votes on it, but that is not really a positive feature.

Kevin Dick writes:

Consols are typically redeemable at the _option_ of the government. So they are isomorphic to an instrument with a maturity date that can be extended at the option of the government.

If the future population wants to begin treating consols as ordinary bonds at some point, they are free to do so. So it's hard to see how they are more "grossly undemocractic".

Scott Sumner writes:

Many people who believe in liquidity traps (and I would say all well informed people in that group) actually believe that central banks could always inflate if they bought enough risky assets. This if a central bank went beyond T-bonds, and started buying up large quantities of riskier stocks and bonds, almost everyone would agree that this would "work". They also worry that it could lead to the bankruptcy of the central bank.

This plan could create similar worry. If rates later rose from 0.01% to 1%, then the value of the Fed's portfolio might fall by 99%. In that case they'd lack sufficient assets to sell off if hyperinflation threatened.

Hans writes:

Liquidity Trap is a claptrap for those whom
wish to engage in economic babble with like
minded people.

It gives economics a bad name.


https://www.richmondfed.org/~/media/richmondfedorg/publications/research/region_focus/2012/q1/pdf/jargon_alert.pdf

Market Fiscalist writes:

I think the flaw may be this:

Assume an extreme case where all wealth is held in the form of govt bonds, which are converted to consoles as in the post.

As the CB bids up the price of consoles people's paper wealth increases but their stream of income from those console's does not.

As their income has not gone up this will not drive extra spending. But people might still spend from their increased paper wealth. However a rational person will know that this wealth has come purely from CB activity and expect it to be reversed out in the future - so likely will just sit on the console's.

Radford Neal writes:

"Assume an extreme case where all wealth is held in the form of govt bonds"

I think we can't assume that, because it eliminates all real aspects of the economy. In particular, I take the argument to be that when many people are currently living in a modest appartment, but own consoles that could be sold and the proceeds used to buy a luxurious mansion, it's implausible to think that none of them would actually do that.

Pyrmonter writes:

Governments do redeem console though: the UK government redeemed the perpetual gilts of literary fame, first issued before the American rebellion, last year:

http://www.dmo.gov.uk/index.aspx?page=gilts/about_gilts

Benjamin Cole writes:

A smartie at Jefferies has suggested consols for Japan that pay no interest.

I prefer money financed fiscal programs, which were used in Japan in the Great Depression, and which were the primary reason why the Great Depression largely sidestepped Japan.

They did not get hyperinflation.

Airman Spry Shark writes:

There are a few additional benefits that Bryan omits:

  1. As the principal is never due, there is no 'debt' per se, so no more debt-limit shenanigans.

  2. Most of the current debt is continuously rolled over anyway; this would obviate interest rate risk at rollover.

  3. Since the principal is never due, this would refocus fiscal attention on the servicing costs; the fiscal position of the government is stable sos long as those grow slower, on average, than NGDP.

Airman Spry Shark writes:

Addendum: if having closed-end government securities is valuable for macroeconomic and/or monetary policy reasons and somehow aren't synthesized by the financial industry as consol-derivatives, the Fed could do so themselves.

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