Paul Krugman lays out a hypothetical scenario, mainly to refute the MMT position that money-financed deficits are not much different from bond-financed deficits. He tries to point out that money-financed deficits will eventually lead to inflation.
Let’s have a more or less concrete example. Suppose that at some future date — a date at which private demand for funds has revived, so that there are lending opportunities — the US government has committed itself to spending equal to 27 percent of GDP, while the tax laws only lead to 17 percent of GDP in revenues. And consider what happens in that case under two scenarios. In the first, investors believe that the government will eventually raise revenue and/or cut spending, and are willing to lend enough to cover the deficit. In the second, for whatever reason, investors refuse to buy US bonds.
Let's question the assumptions here one by one. In this hypothetical scenario where private demand has already revived, why does the government still feel the need to commit to spend equal to 27 percent of GDP? What kind of government spending is so necessary that the government will risk possible hyperinflation or mass aversion to its bonds by insisting on spending 27% of GDP?
Since we're on the realm of FICTION anyway, let's assume that in this full employment scenario (let's dream and pretend this is next year), US GDP goes from 15 trillion to 30 trillion. This means the government commits to spend 8.1 trillion. What's with the 27%?
The point of insisting on government expansion right now is because the private sector is in retreat. But when the private sector gets back in full bloom, we should all be insisting on government scaling back. I don't think anybody's goal, MMT or not, is for government to become permanently big. Large government by itself is not a virtue, but a necessary countervailing mechanism, for when both private demand for funds, and its supply, are anemic. When this has reversed, people should insist that private sector lead the way. If enough new funds are being created and demanded by the private sector, we can have a string of balanced government budgets, and believe it or not, even budget surpluses.
Whether money-financed or bond-financed, adding excess government demand to an already strong private demand will lead to inflation. Why advocate big government spending in such a scenario?