What would be the likely economic consequences of the "trillion dollar coin" idea to eliminate all government debt? Taken from this question over at politics.se, consider this article by Business Insider which describes a scenario in which the treasury mints a trillion dollar coin to pay off all the debts of the U.S. government.


  The premise of the idea is this: Although the Treasury can't just create money out of thin air to pay its bills, there is a technicality in the law that says the Treasury has special discretion to create platinum coins of any denomination, and the thinking is that Tim Geithner could make the coin and walk it over to the Federal Reserve and deposit it in the Treasury's bank account.


What would be the likely consequences of this type of action by the treasury? Specifically:


What would be the impact to inflation?
What would be the impact to the value of treasury bills? Particularly: a) those currently in issue and b) those issued in the future?
Could the answer to the question of how to pay for all future spending proposals simply be to mint another coin?
If you were an economist advising the administration on economic policy, would you advise in favor or against such a policy action. What would be your reasoning for your policy advice?
Quite obviously, the act of creating and depositing the coin can't possibly impact anything of economic interest (except for creating an imperceptibly small increase in demand for platinum and hence an imperceptibly small increase in its price).

The impact comes when the government starts to make withdrawals and spend money.  And the nature of the impact depends on a thousand things you haven't specified, most notably:  What does the government do with the money it withdraws?  Does it pay down existing debt that it had not previously planned to pay down?  Does it buy more missiles that it had not previously planned to buy?  Does it expand a welfare program  that it had not previously planned to expand?  Does it cut taxes that it had not previously planned to cut?  Does it trade the coin for a bathtub full of $10,000 bills for the president to bathe in?  

It's no use assuming that it does none of these things with the money, because it has to do something with the money.  So let's take the simplest example and suppose that they buy bonds (or cut taxes, which will have more or less the same effects).

In this case, you're swapping money for bonds, which is going to increase the price level.  The impact on inflation depends, once again, on things you haven't specified.  Does the government buy a trillion dollars worth of bonds at once?  If so, there is a jump in the price level but essentially no new inflation.  Do they spread the purchases out over a couple of years?  If so, that's going to be a very inflationary couple of years.

Could all future government spending be paid for this way?  Sure.  Here are some other things you could use to finance all future government spending:  A tax on food.  A tax on labor.  A tax on savings.  A head tax.  A tax assessed on random people in random amounts at random times.  What you're proposing is, in effect, a tax on holding money  (because it's the people who hold money who will lose when the price level adjusts).  Each tax has some advantages and some disadvantages.  In each case, the disadvantages grow nonlinearly as the tax increases, so it's very unlikely you'd want to just choose one tax to finance all government expenditures.  You probably want a mix, which is what we have now.  Whether we have exactly the right mix is open, of course, to a great deal of debate.