Never a Lender or a Lender Be

Unless you’re the Fed. Brad DeLong takes us to Greg Ip on credit crunches in the rich world. Look, there’s an old saying “You can lead a horse to the water, but you can’t make it drink.” Unfortunately, the greenback is kinda like that. If the evil debaser-Jew Ben Bernanke puts fifty quadrillion dollars in a Supermax prison – and then hides the key – there would be no inflation.

America’s banking system is somewhat like this: the locks are just too damn tight. It’s not that easy monetary policy does not work, just that it’s throttled by an unhealthy banking system:

But credit policy may be more important than either. The credit crunch now suffocating peripheral Europe is not just the endogenous consequence of weak growth or the Greek crisis; it is also rooted in deliberate policy choices.

But Ip is too easy on monetary expansion (in its current incarnation) when he calls credit policy a “third lever”. Easy money is more like the petrol, and a banking system the fire. The weakness of our financial intermediaries are ipso facto a weakness of monetary policy. Fiscal policy just isn’t handcuffed in the same way.

For easy money to be immediately expansionary, we have to consume against future earnings. And it’s very important that any expansion happen immediately, so that more workers don’t fall into long-term unemployment. There’s nothing intricate about this principle, but Serious People are allergic to bold moves. This requires either more deficits or more inflation (and no, one does not imply the other).

Ip calmly notes that “both tight [monetary or fiscal policy] might be at work”. But the responsibility to offset fiscal austerity lies squarely on the Federal Reserve. If easy money can’t do the trick, market monetarists way oversold their mandate. All this said, there are ways to loosen credit with current policy framework.

Stop paying interest on excess reserves

An interest rate determined between a borrower and lender is the weighted average of all other options: the expected return a bank would earn if it kept its (excess) reserves at the Fed overnight versus the return a borrower must pay at the discount window – both weighted by market power. The weight on the former grows proportionally to:

w_lender = x/b,

where x is the total excess in the banking system and b is the capital reserve ratio. In America, today, this is very high implying that a reduction in interest paid on x will linearly decrease the funds rate.

I would even encourage a penalty on any excess, but this would be dampened by diminishing marginal returns, as w_lender falls linearly on x. This assumes the capital reserve requirement is immutable and, within the current political environment, this is fair.

Direct Policy

After the first paragraph, you should have asked yourself “why does the horse need to be drinking water anyway?” Consumer spending has shown a strong recovery in the first quarter despite front-loaded austerity measures, including payroll taxes. Standard arguments against cash handouts – that they would be used to deleverage and is hence ineffectual – are just false. This means if the Fed printed a fresh $100 note and gave it to me, I’ll spend it all.

Oliver Blanchard likes knocking on the banking system noting that contrary to common opinion, the IS and LM would be endowed with different interest rates, or the spread on r and rb, where LM is perfectly elastic. This means nominal spending on goods and services has to increase to achieve equilibrium. 

This also means that printing money is not inflationary. In fact, any easy money folks who support cheap lending through the discount window but not direct checks should explain how the expected outcome is different. Quantitative easing just isn’t as exotic as it used to be.

Fiscal Stimulus

See – Paul Krugman

Inflationary Local Currencies

See – Me:

The trick here is creating a unit of exchange that is in the public conscious not a store of value. This gives the government broad scope to inflate that currency to spur consumption, without hurting savers. The dollar would loose some value, as the Fed guarantees an exchange rate. Today some people are saying we need 4% inflation or more to stabilize AD. This would be a cheaper way to do the same thing.

At worst, people just immediately trade the currency for dollars. This reduces to a plain monetary stimulus of the helicopter sort. On the other hand, it can support a sustained increase in money velocity, commerce, and AD recovery. And if things ever “heat up” too much the Fed can just devalue the currency. Because it came out of nowhere.

Federal Lines of Credit

See – Miles Kimball: 

In my ten-minute presentation, I proposed an addition to the toolkit of fiscal policy: “Federal Lines of Credit” or FLOC’s.  Here is the idea.  Imagine that the economy is in a recession and the President and Congress are contemplating a tax rebate.  What if instead of giving each taxpayer a $200 tax rebate, each taxpayer is mailed a government-issued credit card […] Even though people would spend a smaller fraction of this line of credit than the 1/3 or so of the tax rebate that they might spend, the fact that the Federal Line of Credit is ten times as big as the tax rebate would have been means it will probably result in a bigger stimulus to the economy.  But because taxpayers have to pay back whatever they borrow in their monthly withholding taxes, the cost to the government in the end—and therefore the ultimate addition to the national debt—should be smaller.  Since the main thing holding back the size of fiscal stimulus in our current situation has been concerns about adding to the national debt, getting more stimulus per dollar added to the national debt is getting more bang for the buck.

Note, I think this is a regressive version of helicopter money. Debt would disproportionately chain the nation’s most vulnerable to a government. But I think Kimball is onto something serious here, and I’d support a modified version aimed at business investment complimented with other policies for consumers.

Ultimately, there’s a lot we can do to make the banking system healthier. Or we can just bypass it altogether. But Ip is wrong in calling credit policies a “third lever of macroeconomics”. Fiscal policy is direct, effective, and necessary. Low interest rates mean we’re borrowing too little. There is something profoundly wrong when the Dow looks like the ascent of Mt. Everest and unemployment a hilltop. That is because the conspiracy theorists got one thing right: monetary policy in its current incarnation is distributively biased towards the rich.

It’s not just the banking system. My parents, and many like them, have a fantastic credit history, secure employment, and sound prospects for retirement. They should be borrowing money to buy a second house. Or at least that’s what economics says. They’re not. Behaviorally they are risk averse (loosing more than a years salary in a few days because of financial collapse can do that to you). They, and many other relatively high-income folks, are immigrants. Even though now’s a great time to buy that fancy audio equipment they always wanted, I’m sure we’ll irrationally wait longer.

And they have a busy life. No one likes borrowing. It is a source of comfort (not to mention pride) not to be in debt. So when people don’t maximize their borrowing limits for irrational reasons, it is time for the federal government to act as borrower of last resort.

Monetary policy is intimately connected with fiscal action. The Fed guarantees cheap rates and the government translates that into better education, basic research, and infrastructure. We’re halfway there but, as Aristotle said, “well begun is half done”. I think Long-term Unemployed Larry wants more than that.


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