Thoughts On A More Effective And Egalitarian Monetary Policy

Here’s Tim Carney, tracking the genuinely interesting meeting-of-the-minds Wall Street and the Left arrived at in supporting Janet Yellen for Fed Chair.

The reason for the former’s enthusiasm is pretty straight forward: Yellen is a big fan of quantitative easing. That’s the relatively new form of unconventional monetary stimulus the current Fed Chair, Ben Bernanke, and his supporters have used to try to boost the economy. They’ve already cut short-term interest rates to zero through conventional monetary policy, so that can’t go any further — the infamous “zero lower bound.” So with quantitative easing, the Fed creates new money, then injects it into the economy by buying up both U.S. Treasuries and other instruments on the financial markets, like mortgage-backed securities, in an effort to move long-term interest rates and inflation expectations.

“Wall Street loves quantitative easing much more than it dislikes regulation,” wrote Yellen critic John Berlau of the free-market Competitive Enterprise Institute.

Republican investor Stanley Druckenmiller sounded a similar note: “This is fantastic for every rich person,” he said of quantitative easing. The Fed’s buying binge drives up demand for stocks and bonds, thus boosting the price of these financial assets. “Who owns assets?” Druckenmiller continued. “The rich, the billionaires.”

This critique of quantitative easing — that it inordinately benefits the rich — is hardly new. What interests me here is you really only ever see it deployed as an argument for not doing quantitative easing period. But that doesn’t follow! This critique has nothing to do with the basic macroeconomics of the matter, which say we’ve suffered an aggregate demand collapse and are teetering on the edge of a deflationary spiral, and thus the economy needs a big injection of new money. All the “it helps rich” critique implies is that, hey, maybe we should find some way to get the money into the economy other than buying up stocks and bonds.

Which is something I’m genuinely curious about. What are our alternatives? Well, the wonky ideal would be through direct cash giveaways. The Fed should literally just start cutting Americans checks. This would be the proverbial “helicopter drop,” properly understood. Steve Randy Waldman put forward a pretty slick version of how this could work a while back: whenever the Fed wants to inject money into the economy, it could just deposit it into every American’s bank account. When it wants to take money out, it could just coordinate temporary tax hikes with Congress.

Whither the injection of new money?

Whither the injection of new money?

I can see some possible problems with this. For one thing, roughly one quarter of Americans carry out some, or even all of their financial business without a bank account. These are the people who would need those stimulative Fed deposits the most, yet they’re also the hardest to get those deposits to in practical terms. I’d also worry about the political efficacy of tightening monetary policy by hiking taxes. That seems like a quick way to make everyone hate the Fed, and to make tight monetary policy even harder to carry out politically than it already is. (That said, I’m in agreement with Waldman and much of the blogosphere that insufficient monetary tightening has been the least of the Fed’s problems for the last few decades.)

At any rate, it’s certainly the cleanest and simplest proposal I’ve seen. The thing to remember is that the central bank isn’t really a “bank” in the popular sense. It’s more of a ballast chamber for the money supply. Right now it sucks money in and pumps it out in the form of bought and sold financial instruments. But there’s no reason it couldn’t do the same with direct cash transfers.

A less radical proposal, built more on existing policy, could leave conventional monetary policy’s buying and selling of government bonds unchanged, but turn to direct cash transfers whenever the zero lower bound looms. Essentially, replace quantitative easing with temporary boosts in social safety net spending. Congress could write language establishing a menu of programs that rely on giving people cash directly — TANF, unemployment insurance, Social Security, the earned income tax credit, the child tax credit, and so on — and then the Fed just decides how much extra cash it wants to inject and when, and spending levels on those programs would rise accordingly. If we ever established a universal basic income (and I definitely think we should) it could be added onto the menu.

It wouldn’t be perfect — you’d still be choosing Wall Street as the entry point for money creation under conventional operations — but I think it would be a big improvement over the status quo.

Now, contra the “it inordinately benefits the rich” argument, Scott Sumner has argued that where the money gets injected doesn’t have distortionary effects on distribution. But it does seem to me (and I admit we’re at the far outer limits of my policy acumen here) that his argument only works as long as the money actually circulates fully through the economy. Which gets us to Carney’s other point: the Fed has increased the money supply by about $2.7 trillion since the 2008 recession, but there’s been no corresponding increase in inflation, and the economy remains middling. So where’d all that money go?

Here’s one clue: Banks are holding $2.3 trillion in reserves — compared to less than a trillion in 2008. Also, corporations, feeling cautious these days, are sitting on record piles of cash, according to the Bureau of Economic Analysis.

This makes sense, considering the mechanism of QE: The Fed buys Treasuries from banks. But gun-shy banks don’t lend it so it sits on their books instead of entering the real economy, where it could cause job growth, inflation or both.

This is a slightly different problem that what Sumner was responding to. Not that quantitative easing amounts to Wall Street cronyism, but that economically privileged recipients of the new money are the least likely to push it out into the broader economy, precisely because they’re the least likely to feel the pinch in a downturn. Recipients of social safety net spending, on the other hand, are the most likely to feel that pinch. So why not make them the entry point for the new money?

Lastly, Joseph Weisenthal raised another suggestion, that corporate and bank cash hoarding simply shows the Fed hasn’t raised inflation expectations enough. Monetary policy simply remains too tight. Strictly speaking, I think this is correct. As Milton Friedman pointed out, nominal GDP growth and inflation are the two things by which monetary policy should be measured. Both remain quite low, which suggests policy is too tight as opposed to too loose.

There’s a solid case that the Fed’s policies so far, while failing to boost the economy out of its torpor, have effectively put a floor under it and prevented things from getting any worse. I’m also persuaded that a four percent inflation target would be vastly preferable to the Fed’s current target of two percent.

So I do think we could get more economic stimulus if the Fed went even bigger with its money creation. And given the current menu of options and political realities, that’s almost certainly the best course of action.

But I also wonder if we could be getting “looser” monetary policy by changing its structure as well as its size or ostensible targets. If every last dollar the Fed created was immediately getting pushed into circulation by its recipient, as opposed to piling up in corporate books and bank reserves, could we be getting more bang for the buck?


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