A Path to Improved Economic Growth
27 June 2017 | Pago Pago, American Samoa
The Fed has put the economy in a box. Its expansionary policies have pushed interest rates to zero but that creates problems. It generates excessive cash and near cash hoarding. It pushes leverage ratios up in pursuit of reasonable yields. It destroys saving. It exacerbates capital flow variability. Finally, and worst of all it renders customary monetary policy largely useless.
Fine, you say. Just raise interest rate to usual or historical levels and go from there. But that creates a problem. The interest burden on the national debt skyrockets and eats an impossible chunk out of the federal budget. MMTers don't much consider that, but we do, staying within the politically imposed federal budget restraint. So the question becomes how can matters be repaired.
Nobel Laureate Michael Spence has the right idea. For central banks to exit the low interest rate boxes they are in, the federal debt must be restructured, banks capitalizations must be improved and every fiscal effort must be made to restore aggregate demand and real investment. A coordinated fiscal policy push is being called for, along with debt restructuring, to restart the economy and raise interest rates to normal levels.
But how can the federal debt be restructured so higher interest rates are not a budgetary burden? First, much such debt is held by the federal government itself. It can just stop paying interest on that debt and reallocate budgets internally to the government so receipts are the same. They net out to zero anyway on this part of the national debt. Of course, that portion of the debt cannot be sold, but it isn't normally anyway.
Second, still staying within budgetary restraints, the Fed has the capacity to buy any quantity of federal bonds it choses on the open market and it does not need to be paid interest on those it buys. The Fed could, for example buy 1/3 of the rest of all bonds outstanding and not held by the government.and do it along any timeline profile it thought prudent.The inflationary consequences are likely to be zip because of huge income inequality and the propensity to hoard of the rich. Monetary policy does much work now anyway, right? There's the proof. Doubters would have tax hikes to pull liquidity out of the system if inflation came to be a problem.
These two steps alone could reduce the interest burden to the government massively, all staying with the federal budget restraint. Now, if additionally we abandoned that restraint and listened to the MMTers, we could simply use federal credit to buy back or call federal bonds and debt, to any extent we wanted. and to pay any interest load on any amount of debt we wanted, all subject to the limitation of inflation, of course. The real question becomes, what is the optimal amount of debt, all things considered, including the demand for it.
Now, out from under the burden of interest payments on the federal debt, the Fed could allow interest rates to rise to their natural levels, largely by getting out of the business of trying to fix rates and focusing on other means to regulate reserves and target the money supply. Friedman wasn't wrong here.
Now with debt restructured, we can focus on the rest of Spence's recommendation which is to make every fiscal effort to stabilize the economy and restore aggregate demand and real investment at the same time.
The point is we are not even trying.