Sunday, February 16, 2014

Rajiv Sethi: The Payments System and Monetary Transmission

"This is an idea that's long overdue," says Rajiv Sethi. "Allowing individuals to hold accounts at the Fed would result in a payments system that is insulated from banking crises."

Sethi lists several features of such a system, features I'm quite sure you like. "But the greatest benefit of such a policy would lie elsewhere," he says, "in providing the Fed with a vastly superior monetary transmission mechanism." He writes:

Any profits accruing to the Fed as a result of its open market operations could then be used to credit these accounts instead of being transferred to the Treasury.

"It's helicopter money," says Nick Rowe in comments.

"That's exactly what it is Nick," Rajiv Sethi says.

It is a way to put money into the economy without adding debt to the economy. It is exactly what we need. It is a far, far better idea than, say, letting the Fed fund a lottery (which is the best I could come up with). It is a way to reduce the debt-per-dollar ratio and restore vigor to our economy.

"The main advantage of such an approach is that it directly eases debtor balance sheets," Sethi says. "In contrast, monetary policy as currently practiced targets creditor balance sheets." Yes! This is precisely what I was trying to convey here:

The Federal Reserve created "money from nothing"... and used it to buy up "toxic assets" in order to reduce "risk" in the financial sector... It had to be done. But look what it did: It took risky assets out of the economy, and left the risky liabilities to fester.

and again here:

The Fed buys the IOU from my lender. The lender gets cash. And I get to make the same payments I made before, except now I pay somebody else. That really doesn't do much for me. It doesn't do much for the economy, either.

Purchasing assets removes those assets from the economy, replacing them with money. But the liabilities remain as they were: draining income, depressing demand, hindering economic growth.

We have to deal with problem liabilities, not just problem assets. We have to ease things for debtors, not just for creditors. Otherwise, the economy never heals.

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