Tuesday, February 18, 2014

The Payments System and Monetary Transmission: One Little Thing

Following up on Rajiv Sethi's wonderful post that I looked at on Sunday. If everybody had bank accounts at the Federal Reserve, Sethi writes,

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. But these credits should not be immediately available for withdrawal: they should be released in increments if and when monetary easing is called for.

Sethi shows a bit of caution there. Probably wise. But I don't like his method of determining if and when monetary easing is called for.

Well, he doesn't specify it in the post. I assume Sethi, like everybody else, bases his determination on economic conditions. You know, the Phillips tradeoff: inflation and unemployment. The great, sad irony is that we continue to rely on the Phillips tradeoff, even though the Phillips curve has had the obligatory funeral.

Sethi is right to say we need better methods of monetary transmission. What he neglects to say is that we also need a better indication of "if and when" easing is called for. We need a better indicator of monetary conditions.

We need to look at the ratio of dollars that must be paid back, relative to dollars available to use for those payments. In other words, dollars of debt relative to dollars that can be used to pay down debt without creating new debt in the process. For it is only from the stock of existing dollars that money can be taken to finally reduce debt.

What is needed most is not to release the Personal Reserve Account funds "in increments if and when monetary easing is called for" but to look at the ratio of debt per dollar to determine what monetary conditions really are, and to drive that ratio toward its optimal range by "releasing" funds and at the same time deconstructing incentives to borrow.

Fail to do this, and we fail to take full advantage of Sethi's money transmission mechanism. Fail, and we fail to correct the imbalance between the level of accumulated debt and the quantity of money available for settlement of debt.

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