Paul Krugman and James K. Galbraith agree that this is a time for fiscal stimulus, not austerity. But they differ on a larger question: do government deficits ever matter? Or is the government so special–by virtue of its ability to create money out of thin air–that its spending can exceed income forever, by any amount?

In an interesting blog post (warning: not safe for the equation-challenged), the New York Times columnist and Nobel laureate Krugman argues that, carried to extremes, deficit spending by government can lead to runaway inflation. But, he adds, “we’re nowhere near those conditions now. All I’m saying here is that I’m not prepared to go as far as Jamie Galbraith. Deficits can cause a crisis; but that’s no reason to skimp on spending right now.”

Krugman wrote this in response to testimony by Galbraith, a Levy senior scholar, to the federal Commission on Deficit Reduction. Galbraith responds in the comments by asserting that Krugman’s conclusion is the result of a modeling error. But his key graf comes earlier:

If the government spent but declined to “borrow,” what would happen? Nothing much. Banks would hold their reserves as cash rather than bonds, and their earnings would be a bit lower. It is *not* true, as a rule, that people (or banks) move readily to substitute lumps of coal for dollars, unless the price level is already moving up and out of control.

Randall Wray, also a Levy senior scholar, weighs in with this:

f you look at the data on tax revenue growth over the previous two cycles you will observe that in the upswing federal revenue grows at an annual rate above 15%–typically two to three times faster than GDP and government spending. This is why the deficit is reduced. Your scenario in which govt just keeps “pumping” money into the economy even as we reach full employment of resources is not plausible. In any case, your original case against the Modern Money Theory approach adopted by Galbraith had to do with insolvency, not inflation. Insolvency is a matter of inability to meet NOMINAL commitments as they come due. When govt spends by crediting bank accounts, there is no situation in which it cannot make its promised payments. You have tried to shift this to a case of full employment of all resources, when govt cannot move more resources to the public sector. But again that is not plausible–so long as there are any resources for sale for dollars, the federal govt can compete with the private sector for them, and can win by bidding up the price. Note I am not advocating such policy.