A Couple of Quick Economic Fixes

With Donald Trump’s ascension to the throne taking of the oath of office imminent, I thought there were a few quick economic fixes that the upcoming Trump administration might be open to that the outgoing Obama administration never would have been.

Stop paying interest on bank reserves

The Fed should reduce or eliminate the interest rate it pays on the roughly $2.5 trillion of banks’ excess reserves. There may have been some good economic theories prior to the financial crisis as to why we should pay banks to not lend money, however the practical effect of that is that banks have far less incentive to loan out money than it did.  So no surprise, it’s now harder to secure business loans.  From the banks point of view, it’s a win/win.  They either don’t loan out money for a small interest rate, or loan the money out for a larger interest rate. If the practice of paying interest by the FED on excess interest vanished, banks would keep less cash on deposit at the Fed. The liberated funds would probably flow mainly into the money markets, but some would probably find their way into increased lending—which would give the economy a little boost.

Restore the Taylor Rule

In 2013 Carnegie Mellon Professor Allan Meltzer testified at a Congressional hearing that in its “100-year life the Fed has produced “only two multi-year periods [1923-1928 and 1985-2002] during which inflation was low, real income and employment fluctuations were modest and recessions were mild.” The common denominator in those two periods was a monetary rule, first the “gold-exchange standard” and later “the Taylor rule.””

Well there is little chance that we’re going back to the gold standard, but the Taylor Rule is much more likely. The Taylor rule states that, “for each one-percent increase in inflation, the central bank tends to raise the nominal interest rate by more than one percentage point.” Locking in a rule like that again, might provide a little bit more stability to both the markets and the banking system.

Corporations repatriate overseas funds via tax free loans to the government

One of the Trump economic plans to bring home overseas profits from US corporations involve allowing US companies to repatriate profits back to the US by paying just a flat 10% or tax instead of the usual 35% US corporate tax rate. That’s not a bad idea, but there is another way to skin that same cat that also works into financing another Trump idea, the 1 Trillion dollar infrastructure proposal.

Instead of charging the 10% fee on returning corporate profits, let the companies offer the government long-term, no-interest financing in lieu of cash. Although an interest free loan to the government benefits more than just financing infrastructure, if you are going to spend money for infrastructure, doing it with no interest loans is not a bad way to do it.

Switch emphasis of Small business administration to new businesses

Economic research has shown that small businesses, just by virtue of being small businesses, don’t add to job growth, new businesses do. New businesses account for 3% US employment but 20% of new jobs.  So it seems that should be encouraged. Switching the mandate and focus of the Small Business Administration to focus on new companies (the type that are more likely to generate innovation) seems a better bet if you want to generate jobs than just keeping small businesses small.

Granted, these are all small scale ideas, but a good economic environment is made up of a lot of factors, some big, some small. The more little tweaks that are made to the overall economic environment of the country, the better.

 

 

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If You Read One Story About the Economy This Year…

…make it this one.

Fed: US consumers have decided to ‘hoard money’

One of the great mysteries of the post-financial crisis world is why the U.S. has lacked inflation despite all the money being pumped into the economy.

Well it’s not that big a mystery.  Part of the answer is has been the interest rates the FED has been paying on excess reserves that Congress approved with the 2008 TARP bill.  That’s given the banks more incentive to sit on those reserves rather than loan them out.  With the current low interest rates, it’s a safer and better deal to draw interest from the FED than take a chance loaning out the money for not a substantially greater interest rate, but with much more risk.

The St. Louis Federal Reserve thinks it has the answer: A paper the central bank branch published this week blames the low level of money movement in large part on consumers and their “willingness to hoard money.” The paper also cites the Fed’s own policies as a reason for consumers’ unwillingness to spend.

That seems like a cheap shot to the American consumer, but what they are really describing is the Velocity of Money, “The rate at which money is exchanged from one transaction to another, and how much a unit of currency is used in a given period of time.”  In other words, how fast is money changing hands, going from one transaction to another.   Right now this low money velocity may actually be a good thing because otherwise:

Under normal circumstances, according to the Fed analysis, when the money supply increases at a faster rate than economic output, which has been the case since the Fed has instituted its aggressive easing practices, prices should keep pace. Factoring in the growth in the money supply against output, inflation should have grown at a whopping 33 percent annually, when in fact it has been rising less than 2 percent.

33 percent inflation rate!  That is what we should have been dealing with under conventional economic theory!

The reason that inflation hasn’t kept up with gains in the money supply simply has been that people are sitting on cash rather than spending it, which has kept money velocity at historically low levels.

So that makes me wonder, what happens when the economy eventually recovers, normal economic resumes, and the money velocity returns to its normal rate?  It’s unlikely to happen under the Obama administration, unless there is a major turnaround of economic policies, but one assumes that eventually there will be an administration that will right the economic ship.  Will we have to deal with a massive burst of inflation just to finally recover from our sluggish economic growth?