What can the Fed do instead of causing a recession?

All economists know that lowering prices by creating recessions harms the most vulnerable and worsens inequalities. We would love to have a tool that helps boost the savings and wealth of the non-rich in times of inflation. Larry Marsh draws attention for his proposal to humanely slow inflation with digital currency accounts held at the Federal Reserve. Professor Marsh is a friend and former colleague in our time who teaches at the University of Notre Dame, and I recently caught up with him to find out more about his idea.

Here’s the gist: By adjusting the yield on savings of U.S. citizens with accounts below $10,000, the Fed can use targeted interest rate hikes to control consumer demand while helping to spur economic growth. saving.

Larry, why the The Fed raises interest rates 75 basis points a brutal and excessively crude way to slow inflation?

The Fed raises interest rates to slow consumption and business loan, which, in turn, drives companies to reduce inventory and working hours, dismiss workers, and close the stores. By raising rates, the Fed aims to reduce demand faster than supply. The brutality stems from making it harder for people to work and borrow – punishing workers for inflation they didn’t cause.

In what human way can we stop inflation?

We can stop inflation without raising interest rates at all levels. The Fed could slow consumption by encouraging personal savings without dampening business investment. If people save more and voluntarily reduce their expenses, mission accomplished! Demand is lower, price pressure is lower, and wealth is on the rise.

I get it, saving slows inflation by slowing demand AND creating wealth. Can you say more?

Exactly Therese. When too much money chases too few goods, sellers raise prices. Conversely, when people save more, demand is reduced, which in turn suppresses price increases and may even trigger price decreases. In short, savings help stop inflation. So I to propose personal savings accounts at the Federal Reserve that the Fed controls.

Congress should authorize the Fed to create the accounts. And some in Congress are already considering alternatives to banks. In 2018, Senator Kirsten Gillibrand proposed means to enable U.S. Post Offices to cash checks, open savings accounts, and make small loans to displace loan sharks, pawnbrokers, payday loan dealers, or “cash” providers now”. In 2021, Representative Rashida Tlaib offers “The law on public banks with essentially the same provisions. But none of these proposals explicitly addressed the need for policy with macroeconomic stabilizing effects, such as targeted interest rate hikes.

Larry, if the Fed were allowed to create savings and checking accounts, how could they be used to stabilize prices and full employment?

The Federal Reserve plans to create a central bank digital currency — as well as 86 other countries, while 7 others have already completed the process. With action from Congress, the Federal Reserve could use post offices as physical locations for people to access individual digital savings accounts and fund the initiative with revenue the bank earns ($107 billion in 2021). With a digital currency, people could check in their smartphones at post offices for direct access to their Fed (central bank) digital accounts. If necessary, the Fed could raise interest rates on savings accounts to attract money from spending to savings.

If the government offers high-interest savings accounts, won’t that weaken the private commercial banking system?

To make a profit, a bank charges higher interest rates on loans than it pays on savings. But the Federal Reserve doesn’t have to. As a tool for controlling the money supply, the Fed would raise rates on its savings accounts. To avoid disrupting commercial banking, the Fed could limit the size of savings accounts — say an upper limit of $10,000 for each account linked to a Social Security number. A US Federal Reserve account would be the safest place for Americans to hold money.

Wouldn’t I-Bonds work as well as your Central Bank digital currency proposal?

As of May 1, 30 I-U.S. Treasury Bonds offer an inflation-adjusted rate of 9.62%. Which is great, but their base rate is 0% and the inflation bonus might be removed after the first six months. I-Bonds are also not fully liquid. An I-Bond cannot be withdrawn in the first year and there is a three month penalty for withdrawing money from an I-Bond before the end of five years. I-Bonds are great for emergency savings accounts and do their job as an automatic stabilizer, but they’re not as attractive as the accounts I offer, which would look more like a regular savings account.

Thanks Larry.

Reader, watch my blog for more ideas on how to encourage savings, decrease consumption, and lower prices while avoiding a recession. The creation of digital currency accounts under the jurisdiction of the Federal Reserve but owned by the general public is just one of them.

Here’s another idea: Economist Kevin Hassett and I have a proposal for a retirement account for all financed by contributions from workers, employers and the government. Expanding retirement accounts for all could also help us stabilize the economy.

My bottom line? We need new tools for the Fed to humanely slow inflation.

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