improve the balance sheet positions of potential borrowers. a money - financed tax cut is essentially equivalent to milton friedman ’ s famous “ helicopter drop ” of money. of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. if the treasury issued debt to purchase private assets and the fed then purchased an equal amount of treasury debt with newly created money, the whole operation would be the economic equivalent of direct open - market operations in private assets. japan the claim that deflation can be ended by sufficiently strong action has no doubt led you to wonder, if that is the case, why has japan not ended its deflation? the japanese situation is a complex one that i cannot fully discuss today. i will just make two brief, general points. first, as you know, japan ’ s economy faces some significant barriers to growth besides deflation, including massive financial problems in the banking and corporate sectors and a large overhang of u. s. bureau of the census, historical statistics of the united states, colonial times to 1970, washington, d. c. : 1976. a tax cut financed by money creation is the equivalent of a bond - financed tax cut plus an open - market operation in bonds by the fed, and so arguably no explicit coordination is needed. however, a pledge by the fed to keep the treasury ’ s borrowing costs low, as would be the case under my preferred alternative of fixing portions of the treasury yield curve, might increase the willingness of the fiscal authorities to cut taxes. some have argued ( on theoretical rather than empirical grounds ) that a money - financed tax cut might not stimulate people to spend more because the public might fear that future tax increases will just “ take back ” the money they have received. eggertson ( 2002 ) provides a theoretical analysis showing that, if government bonds are not indexed to inflation and certain other conditions apply, a money - financed tax cut will in fact raise spending and inflation. in brief, the reason is that people know that inflation erodes the real value of the government ’ s debt and, therefore, that it is in the interest of the government to create some inflation. hence they will believe the government ’ s promise not to “ take back ” in future taxes the money distributed by means of the tax cut. government debt. plausibly, private - sector financial problems have muted the effects of the monetary policies that have been tried in japan, even

further stimulate aggregate demand and the economy. at a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. indeed, under a fiat ( that is, paper ) money system, a government ( in practice, the central bank in cooperation with other agencies ) should always be able to generate increased nominal spending and inflation, even when the short - term nominal interest rate is at zero. the conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. a little parable may prove useful : today an ounce of gold sells for $ 300, more or less. now suppose that a modern alchemist solves his subject ’ s oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. what would happen to the price of gold? presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal. what has this got to do with monetary policy? like gold, u. s. dollars have value only to the extent that they are strictly limited in supply. but the u. s. government has a technology, called a printing press ( or, today, its electronic equivalent ), that allows it to produce as many u. s. dollars as it wishes at see clouse et al. ( 2000 ) for a more detailed discussion of monetary policy options when the nominal short - term interest rate is zero. essentially no cost. by increasing the number of u. s. dollars in circulation, or even by credibly threatening to do so, the u. s. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. we conclude that, under a paper - money system, a determined government can always generate higher spending and hence positive inflation. of course, the u. s. government is not going to print money and distribute it willy - nilly ( although as we will see later, there are practical policies that approximate this behavior ). normally, money is injected into the economy through asset purchases by the federal reserve.