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?