Friday, July 23, 2010

Bruce Bartlett on What the Fed Can Do

Bruce Bartlett has been discussing what the Fed can do to help stabilize aggregate demand.  In this piece he  joins the growing chorus of observers calling for the Fed to abolish paying interest on banks' excess reserves: 
[M]any economists believe that the Fed has unwittingly encouraged banks to sit on their cash and not lend it by paying interest on reserves. Eliminating interest on reserves would therefore encourage lending. A rumor that the Fed might do so caused the stock market to rise earlier this week, according to press reports. But the policy remains in place.

[...]

To use a hackneyed phrase, the Fed needs to think outside the box and be more innovative and aggressive about getting money to circulate, getting banks to lend, and raising inflationary expectations. Ending payments to banks on money they aren’t lending would be a step in the right direction.
I agree and have been making this same point since October 2008 when the Fed first started this policy. At this juncture, though, the Fed should also add some explicit nominal target--my favorite would be a nominal GDP target--to stabilize nominal expectations and shore up velocity.  As I have said before--and contrary to what Bruce Bartlett claims in his other Fed piece--there is a lot monetary policy can do now to stabilize aggregate demand if it wanted to do so.

5 comments:

  1. The Congress needs to think outside the box and consider issuing a currency that isn't based on the creation of debt by private banks. The Fed is the problem, not the solution.

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  2. Anonymous,

    The monetary monopoly which the Fed enjoys may be the fundamental problem. However, short of a transition to free banking, the Fed can help equilibrate the supply and demand for money.

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  3. The WSJ had an article on Bernanke's reasons for not lowering the IRR:

    Lowering the interest rate it pays on excess reserves — now at 0.25% — could create trouble in money markets, he said.

    “The rationale for not going all the way to zero has been that we want the short-term money markets, like the federal funds market, to continue to function in a reasonable way,” he said.

    “Because if rates go to zero, there will be no incentive for buying and selling federal funds — overnight money in the banking system — and if that market shuts down … it’ll be more difficult to manage short-term interest rates when the Federal Reserve begins to tighten policy at some point in the future.”

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  4. Stephen Williamson also chimes in
    http://newmonetarism.blogspot.com/2010/07/what-happens-if-interest-rate-on.html
    Bottom line: lowering the IRR would have minimal effects.

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  5. ECB:

    In my playbook, lowering interest on reserves would only be one part of a broader monetary strategy. I would note, however, that contrary to Williamson's claim the stock market viewed just the potential of such a move very favorably (before being dissapointed). In other words, the market saw the move as stimulative. And if the market believes it to be so and acts upon it then no matter what Williamson or others say it would have a meaningful affect.

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