The 1943 Proposal to Fund Government Debt at Zero Interest Rates

One thing Jan Kregel’s new policy note makes clear is that congressional debates about raising the debt ceiling were a great deal more enlightening in the 1940s and ’50s. Here is Rep. Wright Patman (D-TX) in 1943 defending his proposal to fund what were expected to be huge wartime expenditures by bypassing the private financial system and placing government debt directly with the Federal Reserve Banks at zero interest rates:

the Government of the United States, under the Constitution, has the power, and it is the duty of the Government, to create all money. The Treasury Department issues both money and bonds. Under the present system it sells the bonds to a bank that creates the money, and then if the bank needs the actual money, the actual printed greenbacks to pay the depositors, the Treasury will furnish that money to the banks to pay the depositors. In that way, the Government farms out the use of its own credit absolutely free.

To Patman, “farming” out the government’s credit in this way was just a direct — and unnecessary — subsidy to private banks: “I am opposed to the United States Government, which possesses the sovereign and exclusive privilege of creating money, paying private bankers for the use of its own money. These private bankers do not hire their own money to the Government; they hire only the Government’s money to the Government, and collect an interest charge annually.” “If money is to be created outright,” he argued, “it should be created by the Government and no interest paid on it.”

As Kregel points out, one of the challenges for Patman’s proposal is that a zero rate on government debt seems to require giving up control over interest rates as a tool of monetary policy. However, Kregel notes that a proposal appearing in a 1946 Federal Reserve annual report (and repeated a number of times until the 1951 Fed-Treasury Accord) offers a solution: with the aid of supplementary required reserves, it would be possible to maintain a zero rate on government bonds while allowing the policy rate to rise. (As Marriner Eccles realized, the use of such policies would also require that fiscal policy play a role in controlling inflation — very much in the vein of Abba Lerner’s functional finance, Kregel observes.)

One of the takeaways from this discussion — beyond the remarkable deterioration of the quality of congressional debate — is that the supposed problem of financing the debt should be getting a lot less attention than it does in today’s deficit and debt ceiling debates. The real question, Kregel stresses, is “whether the size of the deficit to be financed is compatible with the stable expansion of the economy.”

Read Kregel’s policy note: “Wright Patman’s Proposal to Fund Government Debt at Zero Interest Rates: Lessons for the Current Debate on the US Debt Limit“