The Federal Reserve, appearing satisfied that the economy is close enough to 2% inflation and full employment, is reviewing strategies and tools. Perhaps it should consider some radical options — such as letting ordinary individuals establish accounts at the central bank and injecting “helicopter money” into each of those consumer accounts when the central bank determines the economy needs a boost.
Historically, when the economy slowed, the Fed pushed down the federal-funds rate that banks pay one another to borrow excess reserves. That rippled through to rates for short-term lines of business credit, 10-year and 30-year Treasury securities, corporate bonds and home mortgages.
Along with buying and selling Treasury bills to manipulate the federal-funds rate, the Fed can adjust what it pays banks for their deposits at the central bank. Currently, banks receive 2.35% on those accounts, even as they only pay their own depositors less than 0.2% on similar accounts.
The federal-funds rate that Fed policy makers consider neutral — one that will neither boost inflation nor slow economic activity — has fallen. Before the financial crisis, the Fed raised that rate to 5.25% but it would never set it that high even with unemployment so low these days.
Currently, the target is about 2.25% to 2.5%, and the Fed doesn’t have much room to cut rates if the economy slows. That’s the most compelling reason for its strategic review.
Moreover, longer-term rates on Treasury securities, corporate bonds to finance big investment projects and home mortgages don’t move up and down with federal-funds rate as they once did. When Ben Bernanke raised the federal-funds rate in 2004-2006, longer-term Treasury rates hardly budged. And as the Fed pushed up rates four times in 2018, the Fannie Mae 30-year mortgage rate rose but then fell back, even before the final rate increase in December.
Globally, ordinary business is increasingly conducted in dollars, even when Americans aren’t involved. The dollar’s share of cross-border debt financing has jumped to 62% and about 40% of all cross-border trade is denominated in dollars, even though the U.S. is less than one-fifth of the global economy.
To accommodate all this, foreign banks, businesses and individual investors hold large amounts of dollars and dollar-denominated securities. If U.S. long-term rates creep up in response to adjustments in the federal-funds rate, foreign money seeking yield can flow into U.S. Treasurys and mortgage-backed securities and drive those rates back down.
In the wake of the financial crisis, the Fed lowered the federal-funds rate to near zero in 2008 without much effect. Ordinary folks on the precipice of bankruptcy — thanks to job losses, crashing stock and home prices worth less than their mortgages — weren’t about to borrow to buy cars or remodel kitchens. And banks were not about to lend to technically insolvent customers.
The Fed turned to quantitative easing — it purchased $3.7 trillion longer term Treasurys and 30-year mortgage-backed securities — and helped the Treasury bail out the biggest banks.
Near-zero borrowing rates for bank funds is like free steel for auto makers, but in the early days of the financial crisis, those rates did little to revive the economy because banks had no appetite for new lending. And consumers required several years to work off excessive credit card balances, unload houses they couldn’t afford or get debt forgiven altogether.
The next time a recession harkens, the Fed might consider being more democratic — not just lend money cheaply to banks but rather give it away to ordinary working folks. As the Fed would have to account for that money on its balance sheet, that would require the Treasury to place on deposit securities of equal value.
Essentially the Fed would be financing (monetarizing) an increase in the national debt to stimulate the economy but cutting out the middleman — new federal spending on roads, bridges and the like, which take so much time to effect.
Then when dark clouds gather, instead of giving money to banks to squander on big salaries, deposit a tidy sum in the account of every American to spend or pay down debt.
That would get the economy rolling again — quickly.