The vast majority of economists believe that the decision by the Federal Reserve to pay interest on bank held reserves was a good one, and that lowering the rate to zero now would have no material impact on bank lending. (Ironically, some of the very same economists believe that raising the rate on reserves will prove to be an effective new tool when the Fed needs to reverse course.) And there is also a small, but philosophically diverse, group of economists who believe that paying interest on bank reserves is counter-productive to the objectives entailed in three rounds of quantitative easing.
It’s a complex and nuanced issue. So, to simplify, let consider that old analogy that says the Federal Reserve’s role is to “remove the punchbowl before the party gets out of hand.” Of course, following the financial collapse of 2008, that analogy was turned on its head and the task of the Federal Reserve became “make more punch”. And make more punch they did! In fact, after buying $2 trillion worth of Treasuries and mortgage-backed securities, the Federal Reserve, as of last week, had $2.946 trillion in punch available.
But, they haven’t had many sippers – and certainly no drinkers. Hence, my suggestion: “Spike the Punch”. Translated: buy beyond the scope of mortgage-backed securities.
And then, to top it off, charge banks to hold reserves (i.e., a negative interest rate). Think of it as a cover charge that includes two free drinks. Know many people who pay the cover and then fail to consume the free drinks?
Furthermore, while we’re at it, let’s lower the drinking age and stop checking ID’s. In other words, loosen up some of those mortgage lending standards and streamline the process.
All of the above is heresy to a monetarist, such as me. But these are still unusual times. The solutions, both tried and offered, to date have been inadequate. Consider the deficit debates. The high-minded speak of the need for a “balanced” approach – spending cuts and tax increases. The fact is – that’s not enough. We can only get out of our current deficit dilemma, and the impending demographic time bomb of entitlement spending, with faster economic growth. Another year with fewer than two million jobs created and less than 3% growth will just put us deeper in the hole. It’s time to cast caution aside, drink up, and get the party going.