A Fix for the Debt Ceiling That No One Is Talking Abou

Dean Baker
August 1, 2011 | 12:00 am

Economists believe that people respond to incentives. The fact that economists never suffer career consequences for failing to consider new ideas explains why they so rarely consider any policy that has not long been in the standard bag of tricks. I mention this background since it is relevant to the reaction given a proposal on the debt ceiling that Ron Paul originally put forward and that I subsequently endorsed. Paul suggested that the Fed could destroy the $1.6 trillion in government bonds that it now holds as a way of getting room under the debt ceiling. Debt to the Fed counts as part of the government debt subject to the limit. If the Fed destroyed $1.6 trillion in debt, then it would create a space of $1.6 trillion under the ceiling.

This is an interesting way of getting around the ceiling, although it would almost certainly require an act of Congress to do it. As it turns out, the other side of this story is even more interesting. The Fed plans to sell off the $1.6 trillion in government bonds it currently holds. It also plans to sell off more than $1 trillion in mortgage backed securities it bought to help stabilize financial markets at the peak of the financial crisis. Following the logic of Paul’s idea, I suggest that the Fed could simply hold on to large amounts of debt for an indefinite period of time. The interest on this debt would continue to be paid to the Fed and then be refunded to the Treasury—an effective and easy way to reduce the deficit that almost no one is talking about.