Despite my dismay at the Feds unwillingness to take dramatic action I really do think we have a variety of quasi-conventional means at our disposable to create monetary stimulus. As always an explicit price level target would be a good start.
However, it doesn’t end there. The Fed can buy up all sorts of government debt, including the debts of Fannie Mae and Freddie Mac. And, and in the end there is always the helicopter option – that is just tossing money from a helicopter.
Paul Krugman worries that the helicopter option wouldn’t be strictly “legal” as they say. The Fed has no authority to just hand out cash. Matt Yglesias says the Fed can just issue $1000 loans with a pair of socks as collateral. If people are “happen” to default on the loan the Fed will just refuse to return their socks.
However, its really even easier than that.
The Fed can purchase bonds backed by consumer credit. In the same way that Wall Street takes your mortgage and bundles it into a set of bonds, firms also take your credit card payments and bundle them into bonds.
The Fed can buy those bonds and to my knowledge there is no limit on the price they can pay. Bond prices are inversely related to interest rates. So, if the Fed pays a high enough price for the bonds, the effective interest rate would be negative.
This in turn would mean that the consumers would make money simply by borrowing money.
I don’t envision lots of credit card offers that say “–3% APR” However, I can imagine offers that say “0% APR for life on new purchases and 10% cash back”
For super nerds, notice that such a temporary credit facility would create de facto inflation. That is, if you get 10% back for buying something today. Then in effect it will be 10% more expensive tomorrow. This will balance against the actual deflation that is building.
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Thursday ~ July 15th, 2010 at 1:22 pm
Arpit Gupta
Correct me if I’m wrong–but I thought the Fed can only buy bonds with government guarantee–ie, Treasuries, Agency-issued MBS, and potentially state/local issues.
I argued here that credit card rates are actually increasing due to recent legislation:
http://www.economics21.org/blog/elizabeth-warren-starts-credit-crunch
Thursday ~ July 15th, 2010 at 1:52 pm
Karl Smith
Arpit:
I am not aware of any such restriction. I would also point out that Agency issued MBS does not have a de jure government guarantee, which would seem to be the key feature from this perspective.
Also, my intuition would also be that the new credit card legislation would lead to a decline in credit and a worsening of the recession. Though I have not looked at it in detail.
Thursday ~ July 15th, 2010 at 2:39 pm
Arpit Gupta
Regardless of the rules (I swear I’ve read this somewhere…) certainly the Fed is not exposed to credit risk on its current portfolio. All its current holdings are backed by someone else–the agencies or the federal government. This proposal would introduce credit risk into the Fed balance sheet, which might be cause for concern even if perfectly reasonable.
A possible fix would be for the Fed to buy other private bonds with private CDS protection.
Thursday ~ July 15th, 2010 at 2:42 pm
Dominic Pazzula
Why not fix 2+ birds with 1 stone?
Have the Fed buy a preferred equity interest in individual houses. The Fed would buy up to 50% of the assessed value of a property using a preferred equity arrangement. Owners would be charge the Fed Funds rate monthly on the amount. The Fed’s claim would be subordinate to the mortgages on the property (1st, 2nd, and/or HELOC). The owner would have the option of paying the Fed back the amount at any time for the face value.
This solves:
1 – Underwater mortgages. Owners would be required to refinance with the Fed buy in. 1st mortgages would now have a 50% cushion to sit on.
2 – More free cash for consumption. Loan payments would go down for individuals. They would now have extra cash to boost spending.
3 – Crap Loans on bank balance sheets (freeing up excess reserves). Loans are currently marked to face value, not market value. One of the reasons for all the excess reserves is that banks know the assets that they have marked at 100% are actually worth way less. These reserves sit as loan loss provisions. Further, why would you lend to additional $$$ to someone that is underwater on their current loans? As the bad mortgages are refinanced away, and loan ratios improve, these excess reserves can be freed up to be lent into the broader market.
Thursday ~ July 15th, 2010 at 3:40 pm
Chiming In « Modeled Behavior
[...] ~ July 15th, 2010 in Economics | by Niklas Blanchard Amidst all of the talk about crazy aerial acrobatics that the Fed could do to boost aggregate demand through highly unconventional policymaking, I [...]
Saturday ~ July 17th, 2010 at 7:51 am
OGT
Why does the solution always come down to preventing delevering? It seems far fetched to imagine the relentless growth of the financial sector and US private debt burdens over the post war era is unrelated to the conduct of monetary policy over that era.