A lump-sum payment in digital dollars for all Americans during a recession or to raise inflation, as an alternative to QE and negative interest rates, which have failed.
By Wolf Richter. This is the transcript of my podcast last Sunday, THE WOLF STREET REPORT. You can listen to it on YouTube or download it wherever you get your podcasts.
There is a lot of discussion suddenly about a Federal Reserve project to make direct payments to households during an economic crisis. In March, legislation was proposed in the House and in the Senate to authorize the Fed to do this.
At the beginning of August, two former Fed officials floated a trial balloon of this type of operation with some specifics as to how it would work and how it would be accounted for on the Fed’s balance sheet.
And now, the president of the Federal Reserve Bank of Cleveland, Loretta Mester, gave a speech on the modernization of the decades-old, slow, and cumbersome payment systems we have in the United States. The Fed has been working on this modernization since long before the Pandemic. And near the end of that speech, she said that the Fed was looking into ways in which it could make direct and instant payments to every American, even those that don’t have bank accounts.
So free money for all Americans. This is very different from the stimulus checks because the government had to borrow the money that it sent to consumers. The Fed would just create the money and send it to consumers. And this is getting pretty serious now.
What is particularly interesting is that by making this proposal, the Fed essentially agrees that the trillions of dollars of asset purchases by the Fed have not been successful in shifting funds to the majority of households, where they’re needed the most in a recession, since consumer spending is 70% of the economy.
Nor have asset purchases been successful in creating consumer price inflation, though they have created asset price inflation, and a situation where even during the Good Times, the Fed cannot raise interest rates enough and cannot steepen the yield curve enough because there isn’t enough inflation to do so. And when the recession comes, there isn’t a whole lot left that monetary policy can accomplish, in terms of the real economy, consumer demand, and inflation.
These proposals show that the Fed is trying to avoid negative interest rates and is working on alternatives, such as sending money directly to consumers, which would boost actual consumer demand, and consumer price inflation.
A higher rate of inflation would allow for the Fed’s policy rates to remain above zero, but far below the rate of inflation. Hence, big negative real interest rates, while maintaining positive policy rates.
So sending money directly to consumers may be lining up as a replacement for QE and negative interest rates.
What the Fed has been doing in this crisis, and during the Financial Crisis, and for years afterwards, is buying large amounts of assets, such as Treasury securities, mortgage-backed-securities, and now other assets, such as corporate bonds, including junk bonds, bond ETFs, and junk bond ETFs, to drive up the prices of these assets.
These price increases then transfer to related assets. For example, the purchases of mortgage-backed securities drove up prices of mortgage-backed securities, thereby driving down their yields, which pushed down mortgage rates to record lows, and this in part triggered the gigantic land rush we’re now seeing, along with home price increases, despite the worst unemployment crisis in a lifetime.
The stated purpose of driving up asset prices used to be called the “Wealth Effect.” Even Yellen, when she was still at the San Francisco Fed, used the term. It’s designed to bail out asset holders, and the biggest asset holders – meaning the richest people – get bailed out the most, and become even wealthier. A billionaire might gain a billion dollars in net worth during this asset purchase frenzy, while the lower 60% of households gain relatively little or nothing, because they have relatively few or no assets, thereby massively widening by totally artificial means the already horrendous wealth inequality.
Fed chair Jerome Powell has come under fire for being at least in part responsible for increasing by a huge amount the already horrid wealth inequality.
The thing that is most destructive to the economy, and to society, and to the spirit of the American economy is the Fed’s policy of asset purchases. It’s the most terrible thing the Fed can do.
So now the Fed is struggling with alternatives to these policies – namely sending money directly to all Americans during a crisis so that they can spend it and crank up demand, and crank up the economy and inflation, even if they lost their jobs.
And however terrible of an idea that may be, it’s a lot less terrible than asset purchases and a lot less terrible than negative interest rates.
So on September 23rd, Cleveland Fed president Loretta Mester, in a speech, discussed the effects of the Pandemic on the U.S. payments system – which includes a variety of payment methods, such as checks and the ACH payment system with which payroll is direct-deposited into employees’ bank accounts, and which is used for direct payments between companies and between the government, companies, and consumers.
For example, many people have direct credit and debit set up with the IRS via this ACH system, to where the IRS can directly deposit tax refunds into their bank account, or withdraw taxes-owed from their bank account. The connection between people’s brokerage account and bank account works the same way.
The millions of people who had this ACH setup with the IRS received their stimulus payments via direct deposit right away in April. People who didn’t have that set up received their payments via check weeks or months later. And some people are still waiting for their payments because the IRS doesn’t know where to send them to.
But the ACH system is decades old, slow, and cumbersome. It doesn’t allow for instant payments. The Fed, which is at the core of these payment systems, has been working to come up with a modern replacement where payments are instantly available at a low cost or at no cost for all transfers – companies, individuals, and governments alike.
So Mester said, “The pandemic has underscored the need to ensure that during a crisis, payments can flow quickly and to everyone: those with and those without a bank account.” She said that the target release date for the new system is in 2023 or 2024.
I’m not sure why this modernization hasn’t happened years ago. Payment systems that produce instant transfers have been available for years, but they’re not universal and so are of only limited utility.
But at the end of her speech was this bit about how the Fed could send payments directly and instantly to all Americans during a crisis – and the technology needed to do this.
This technology would be a digital dollar – or more broadly, a “central bank digital currency,” as it’s called. These direct payments would require authorization from Congress. And Mester says, there is already some proposed legislation, perhaps making reference to the legislation proposed in March.
Under this system, each American would have an account at the Fed in which these digital dollars could be deposited.
When the recession hits, the Fed could just create a certain amount of digital dollars and deposit them into these accounts, and a minute later, you could transfer this money to your bank or spend it via an app or whatever.
And she outlined who at the Fed is already working on it, including the Fed Board of Governors’ technology lab with staff from several of the Federal Reserve Banks, along with software developers; the Boston Fed in a partnership with MIT; and the New York Fed in a partnership with the Bank for International Settlements.
But nothing has been decided yet, and lots of work remains to be done. And she said that all kinds of risks need to be studied and understood, etc., etc., the usual disclaimers, and she said that these efforts do not signal any decision by the Fed to adopt a digital currency.
In early August, two former Fed officials – one from the New York Fed, the other from the Fed’s Board of Governors – outlined their proposal to Bloomberg News for a mechanism by which the Fed would send a lump-sum payment directly to all American citizens and green-card holders. They talked in greater detail than Mester’s brief mention.
The amount could be set at a certain percentage of GDP, divided by the number of recipients. Each would get the same amount. And the thing would also be available on an app. In other words, this would even reach people who don’t have bank accounts.
And it would happen instantaneously, they said, without the clunky mechanisms that Congress has to go through to send stimulus payments to consumers, some of whom still haven’t received them.
On the Fed’s balance sheet, the amount in freshly created digital cash sent to consumers would be carried as a liability, same as currency in circulation which is the paper money wadded up in your pocket.
The counter-entry on the Fed’s balance sheet would be on the asset side in form of freshly created securities they call “recession insurance bonds.” In other words, the Fed would create equal entries on both sides of the balance sheet, and so the balance sheet would remain in balance.
They said that it would be “most efficient from a macroeconomic standpoint in supporting spending and confidence.”
They said that by “getting money to consumers you can limit the depth and duration of a recession.”
They said, “you could actually generate real inflation.”
They said, “it could be beneficial for not only avoiding negative rates but creating a more healthy interest-rate market, a more healthy yield curve.” Meaning higher long-term interest rates.
Higher inflation would make possible a steeper yield curve, and higher long-term rates, and even higher short-term rates during the Good Times, that would allow the Fed to drop rates more drastically during a recession without having to go negative.
There are about 210 million adults in the US. If the Fed decided to throw $3 trillion not at the markets as it has done since March, but at Americans directly, it would translate into a lump-sum payment of about $14,000 for each adult. So a household of two adults would get $28,000, whether this household is made up of a couple living in a tent or a couple shuttling between their mansions with billions of dollars in assets.
The relatively small percentage of wealthy people wouldn’t spend a dime of this money, but the lower 60% or 70% or 80% on the income scale would likely spend most or all of it over time, thereby creating demand for goods and services and pressure on consumer prices.
Asset purchases are the most horrible thing the Fed can do because all they accomplish is further widening the wealth inequality while screwing up the economy and investment decisions. And imposing negative interest rates is the second most horrible thing the Fed can do.
So, in my humble opinion, replacing those two horrible policies with a policy of sending money directly to consumers, with each American, rich or poor, getting the same amount would be an improvement,
There would be costs and there would be risks, but at least all Americans would benefit the same – not just the wealthy.
This will take time to implement. But the folks at the Fed are thinking about it, and they’re working on it, and they’re seriously trying to figure it out.
With these efforts, the Fed is admitting that asset purchases and negative interest rates aren’t working in stimulating the economy, and that they create asset price inflation, instead of consumer price inflation, when the Fed really-really wants to create consumer price inflation more than anything. And sending freshly created money instantly to all consumers would do that trick. You can listen and subscribe to THE WOLF STREET REPORT on YouTube or download it wherever you get your podcasts.
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