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A breakthrough plan to make central banking populist
The Washington Post, October 22, 2014

If, like me, you're a seeker of broadly shared prosperity, chances are you've been haunted by two nagging policy conundrums.

Conundrum No. 1: Why is fractional reserve banking the only way the central bank can create money in our system? In other words, instead of injecting money into the economy by indirectly goosing bank lending, why can't the Fed just create money and give it to people directly?

Conundrum No. 2 starts with something we all know: Enormous wealth is being created in this era of globalization and rapid technological change (a good thing), but virtually all of it is ending up in the hands of a few affluent "winners" (a bad thing).

But here's the puzzle: Shouldn't there be some way to give everyone a modest equity stake in all this new wealth so that sagging wages for workers would be more than offset by capital accumulation? If we could figure this out, then today's surging inequality—which undermines social cohesion as well as the broad purchasing power a healthy economy needs to function—would vanish.

These may be the two most pressing questions in macroeconomic policy, yet they have received virtually no attention. Until now.

Mark Blyth, a professor at Brown University, and Eric Lonergan, a London-based hedge fund manager and author, have tackled both conundrums (in the latest issue of Foreign Affairs) with the most innovative macroeconomic proposals I can recall.

Think of it as a breakthrough plan to make central banking populist.

Start with money creation. Since the 2008 crisis, the Fed has tried to boost growth by creating $3.5 trillion in new banking reserves in the hope that this would lift lending and spending. But buying government bonds and mortgage-backed securities on an unprecedented scale hasn't had the desired effect. Banks haven't lent the new reserves out as expected, either because they're spooked about uncreditworthy borrowers or because nervous businesses haven't sought new loans. Demand hasn't budged much. Growth and wages remain stuck in a ditch.

Meanwhile, the toxic side effects are mounting. The Fed's policy of holding interest rates near zero may have fueled a new bubble in stocks, as investors desperate for more than 1 or 2 percent returns search for higher yields. (In recent days we've seen what happens when investors wake up to the idea that it may have been a bubble all along.)

Blyth and Lonergan say there's a better way for central banks to fight recessions. Just have the Fed give money to millions of people directly, by crediting their bank accounts with, say, $1,000 or $2,000 when recession hits and demand needs a quick boost.

Conservative icon Milton Friedman floated this notion of "dropping money from helicopters" decades ago. Ben Bernanke spoke favorably of the idea in 2002 by way of explaining how, in a fiat money system, a central bank could always stave off deflation. George W. Bush adviser Gregory Mankiw of Harvard made a similar prescription for Japan in 1999. But it hasn't been tried.

The main objection to boosting demand in this way is that it amounts to giving people something for nothing. It's "redistribution," critics cry.

But money creation already involves "printing cash" from thin air; it's just done via the complex and opaque process of banking reserves. Blyth and Lonergan suggest we think about direct central bank handouts in a recession as akin to "an unanticipated inheritance." There's no risk of moral hazard. As Blyth told me, "No one's going to sit around not working in hopes that a recession will come and they'll get 500 bucks" from the Fed.

And as for redistribution—well, sorry, but the Fed already does that on a massive scale. How else can we describe an artificially low interest rate policy that for six years has taken money from millions of savers to deliver relief to millions of borrowers? Or a policy to artificially lift the stock market in hopes that some of the paper wealth created would trickle down in the form of higher spending?

No, the Blyth-Lonergan plan is discomfiting because it forces us to confront explicitly the "mystery" of money creation, as well as the Fed's hidden yet hugely redistributive role in our society. But we're all adults here. If we need to boost demand in downturns, why not choose a method that is quicker, simpler and more effective at lower cost? If this feels like fiscal policy, it's because it basically is, in different form—it would have the same impact as if Congress enacted a one-time refundable tax credit of $1,000 or $2,000 a head.

One former Fed governor, who's open to the idea, told me that for this reason it likely requires a few lines of legislation to make clear the Fed has these powers. But why shouldn't we put a smart new tool in the Fed's policy arsenal instead of relying on century-old methods that aren't working and that create unintended harms?

Blyth and Lonergan reckon that direct central bank handouts in a recession would need to be only 2 to 5 percent of gross domestic product to be effective, compared with the roughly 20 percent of GDP in new bank reserves the Fed has already "printed." And unlike "quantitative easing," these handouts are uncomplicated to turn off. What's not to like? Europe, where Spain, Italy and Greece are coping with Depression-era levels of unemployment, needs this policy innovation even more urgently than we do.

Blyth and Lonergan's second big idea—dealing with wealth inequality—is just as interesting. Today the conversation on the left mostly stresses new taxes on the wealthy. But why not get serious about lifting the bottom instead? Most economists agree that government should borrow at today's ultra-low interest rates to fund infrastructure investment. Blyth and Lonergan make this concept more ambitious: Have the central bank issue debt to invest in a passive global equity index held by a new sovereign wealth fund. Fifteen years from now, the Fed could repay the loan and distribute the equity to the bottom-earning 80 percent of Americans. At a stroke, this would give every worker and family an owner's stake in the gains from technology and globalization.

There are details to work out, but you get the point. These are big ideas—and, like all breaks with orthodoxy, they're sure to be deemed impractical or worse. But history is full of economic ideas that go from unthinkable to indispensable with surprising speed, from the minimum wage and the weekend to social insurance and more. And by promoting asset ownership in creative ways that tamp down the political energy now devoted to "punishing" the rich, these ideas should appeal to far-sighted conservatives, too.

The best next step? If Ron Wyden, Elizabeth Warren, Sherrod Brown or Bernie Sanders took an interest and called hearings, the discussion could move from the margin to the mainstream overnight. So hurry, Senate Democrats, act now while you still hold the gavel. With a little imagination, such hearings could seed the ground with some needed fresh ideas just as the 2016 presidential campaign starts to pick up steam.