When it comes to the "debt crisis," the sky is not falling.
An economy runs on credit, which can be increased infinitely. Increasing credit bolsters aggregate demand and has a positive effect up to the point of full employment and peak production. Beyond this point, an increase in credit causes inflation and results in economic dislocations. Needless to say, our economy is not presently overheating. There is still massive unemployment and a high rate of foreclosures.
If there is a shortfall between revenue and expenditures, the government can issue bonds to finance the deficit. The bonds are purchased by banks, which can simply create the necessary credit by making a credit entry on their books or today in their computer programs. Here the fractional reserve requirement comes into play. A bank must keep a fraction of its deposits currently 10 percent on hand to meet withdrawals. It can use the remaining 90 percent to make loans or purchase bonds (another type of loan). The money spent by the government circulates throughout the economy.
The Federal Reserve cannot purchase bonds directly from the Treasury, but it can purchase bonds on the open market from the banks that purchased the bonds in the first place, freeing these banks to purchase still more bonds. …