April 18, 2009
New County Heard From: Subzero as a Target

Greg Mankiw is an interesting case: a sometimes rational, apparently intelligent, and to some extent even open-minded professor of economics at Harvard who advised the Bush administration. Whah?

In the Sunday Times he’s written a short and interesting piece proposing that the Fed use one of a number of possible schemes to lower interest rates below zero. Does it bring you up a bit short to have such an idea proposed by a former Bush advisor? Wait, there’s more.

He acknowledges the unlikelihood of anyone with spare cash wanting to loan it at sub-zero interest rates. But there are ways to get around that, and one of his grad students came up with a clever one recently. The Fed announces the policy that once a year it will draw out of a hat a number between 0 and 9. All currency with serial numbers ending in that digit would be immediately invalid.

When the expected return on holding cash is minus ten percent, people would be glad to lend at minus three percent, lending a hundred bucks and getting back 97. Or alternatively they could find it more appealing to spend the money; but since economic stimulation is what we’re after, that’s a feature, not a bug.

Attentive observers, meaning all BA readers, will observe that large chunks of cash are not widely kept in bills with serial numbers, they’re simply bits on a computer disk somewhere. But the principle is a fascinating idea. We’re giving billions, eventually trillions, to the banks and Wall Street, who are passing it out in bonuses and dividends. In other words, taxpayers are giving their money to the rich, to assuage the latter’s angst over having destroyed the economy. Unfortunately they’re not yet flush enough with our money to begin loaning it back to us. Maybe we need to force their hands.

If all of this seems too outlandish, there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.

Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations.

Do we still have an injustice barometer, or do we depend on mediated rage for an outlet? And how bad is it when a former Bush advisor is way ahead and to the left of the President who was gonna change everything?


Posted by Chuck Dupree at April 18, 2009 02:28 PM
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Deflation is generally considered something to be avoided, worse than inflation. Certainly for the Fed to promise high inflation in the future might encourage people to borrow -- but it won't encourage anyone to lend.

Posted by: Mahakal on April 18, 2009 8:54 PM

Actually, announced inflation would provide an incentive to lend. If you know the Fed intends to peg inflation at, say, five percent over the next year, then loaning your money at zero percent interest is a win compared to letting it sit and losing that five percent.

Posted by: Chuck Dupree on April 18, 2009 9:18 PM

Oh, and I meant to add: as readers of Bill Greider's magnificent Secrets of the Temple: How the Federal Reserve Runs the Country will be aware, deflation is considered something to be avoided by the lower rungs on the economic ladder, but there are times when the top rungs desperately desire it. If everyone's flush, after all, how can you tell you're rich? A New Yorker cartoon recently showed two execs talking, and one says, "It's even more of a kick making money when no one else is."

Or, as Adam Smith put it, “All for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.”

Posted by: Chuck Dupree on April 18, 2009 9:23 PM

How is loaning your money at zero percent any different from letting it sit and devalue, except for the risk of non-repayment.

Posted by: Mahakal on April 19, 2009 11:04 AM

I think Helicopter Ben had this srategy mapped out a long time ago. How else to deal with the national debt? Inflate. But it creates inevitable imbalances and the law of unintended consequences always kicks in. Retirees holding cash also get hurt, as well as retirees on a fixed retirement amount. And Social Security can get out of balance if the measurements come from a stacked deck.

Posted by: Buck on April 19, 2009 12:28 PM

Yeah, but the law of unintended consequences applies to doing nothing much more strongly.

Our current system is set up to concentrate the maximum proportion of the country's wealth in the minimum number of hands. We're really, really good at this, the best there's ever been in any non-dictatorial form of government (monarchs and dictators are of course more efficient at concentrating wealth). Largely this happens through what Chomsky calls the Pentagon system, whose main goal is redistribution of wealth.

And what have we got for that? Economic collapse, imperial overstretch, no health care, and all those consequences that are not, in reality, unintended.

There are no actions without consequences, including no action.

I don't think there's any chance the Fed will try to deal with the national debt by inflating. The Fed hates inflation and doesn't give a damn about the national debt. In fact, the Fed represents foreign and domestic lenders, AKA bondholders, above all, as Greider demonstrates in Secrets of the Temple, and lenders do not want inflation or a reduced debt.

Posted by: Chuck Dupree on April 19, 2009 4:40 PM
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