"How will you pay for that?" has become one of the defining questions of the 2020 Democratic primary. Sen. Elizabeth Warren (D-Mass.), for example, is now preparing a comprehensive revenue plan to go with her Medicare-for-all proposal, after being relentlessly dogged on the issue.
But imagine if, upon being asked, Warren simply shrugged and said, "I’m not going to pay for it. Let the Federal Reserve figure it out." The howls of outrage and sneering contempt would be ubiquitous. Journalists, pundits, and experts would come out of the woodwork to declare Warren unserious and fiscally irresponsible.
They would all be wrong.
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The problem of federal spending is fundamentally one of tradeoffs. When people ask "How will you pay for that?," they're basically asking how you'll handle those tradeoffs. For local and state governments, the tradeoff is pretty simple: To spend U.S. dollars, they first have to go out and get them, which means taxes. But the federal government is another beast entirely.
The federal government has the legal authority to create U.S. dollars. When it spends, it doesn't have to go out and "get" the money from anywhere. It creates the money out of thin air. That doesn't eliminate the tradeoffs, but it does change them profoundly. What the federal government has to worry over is how much demand is in the economy: Crudely speaking, spending new dollars adds demand, while taxes remove demand. Too little demand, and we get unemployment and wage stagnation. Too much demand, and we get inflation.
But taxes and government spending aren't the only tools available to manage that balance. In fact, just about everyone in the mainstream thinks taxes are an unusually bad tool for managing inflation, for both practical and political reasons.
This brings us to the Federal Reserve and its control over interest rates: By raising interest rates, the Fed chokes off demand by making credit more expensive, while lowering interest rates encourages more demand by making credit cheaper. For the "serious" mainstream, that's the preferred tool.
This is also why, other than the importance of congressional fiscal responsibility, few canards are more sacred to mainstream elites than the political independence of the Federal Reserve. Ask any mainstream economist or economics reporter why it's bad for the Fed to obey President Trump's whims, and the answer you'll get is: if politicians controlled the Fed's monetary policy, we'd get runaway inflation. The theory here is that elected officials cannot be trusted to manage the competing priorities of jobs versus price stability. The task must be given to well-trained technocrats — i.e. the officials at the Fed.
What no one notices is that the logic justifying the Fed's design and role also just happens to completely negate the logic behind demanding balanced budgets from Congress. If Congress ever threw caution to the wind and just massively deficit spent, driving us past full employment and into a serious bout of inflation, the Fed could always step in and hike interest rates — shaving just enough demand off the top to keep the economy trucking without pitching into overheating.
In short, if giving the central bank political independence and control over interest rates is a good idea that works, it cannot simultaneously be the case that Congress needs to adhere to "fiscal discipline." The whole point of setting up the Fed this way is to inoculate the economy against willy-nilly fiscal excess — to remove the need for congressional discipline.
Let's return to our hypothetical Warren scenario: She wants to pass Medicare-for-all. When reporters ask how she'll pay for it, she could simply respond, "I won't. I'm going to finance the whole thing with deficits, and the Fed can do whatever it needs to do to keep inflation in check." That would be a 100-percent serious and legitimate response. Granted, there would be moral and distributional concerns: the costs of using interest rates to control inflation fall heaviest on the poor and the marginalized. But it's not as if inequality has ever been a top concern for the mainstream. As far as the raw economics go — dealing with the tradeoffs created by a big deficit-financed program — it's an answer that gets the job done, by the mainstream's own logic.
Why, then, wouldn't the mainstream accept it?
A few reasons, none of them good. A big part is just habit and the weight of groupthink. Fiscal "responsibility" sounds, well, responsible.
Another wonkier concern deals with something called "crowd out." Basically, if Congress just deficit spent to get us Medicare-for-all and a Green New Deal, and the Fed hiked interest rates, that would make credit more expensive, and cut down on lending and investment in the private sector. We'd get full employment, alright. But the government would wind up directing a much bigger portion of all economic activity.
Is this a problem? It is if you buy the stale old caricature that government investment is intrinsically less efficient than private investment: You'd have to believe, for example, that Apple enjoying cheap credit to finance its next high-tech toy for adults is more important for the economy's long-run productive potential than government upgrading the national infrastructure and switching us over to clean and renewable energy. It's absurd on its face.
Finally, a lot of mainstream economic models assume the economy naturally and quickly returns to full employment after recessions. In which case, it would make sense for the government to aim for fiscal balance over the long term. But we've learned the hard way that assumption is wildly off.
With every recession over the last four decades, interest rates have dropped lower and lower, and the Fed hasn't been able to get them back to their previous high without crushing the economy. Meanwhile, wage growth and productivity growth haven't boomed in this era of cheap credit — they've stagnated. Now the Fed is basically out of room to cut rates should another collapse occur. The only remaining tool to juice the economy is fiscal stimulus.
Which brings us to the final irony. If Warren or Sen. Bernie Sanders (I-Vt.) or anyone else were to simply cast off the mainstream's conceptual shackles and refuse to bother with "paying for" their agendas, they wouldn't simply be justified on the economics. They'd be doing the Fed a massive favor.
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