Gwynn Guilford: The Epic Battle Between Clinton and Trump is a Modern Day Morality Play

Link to Gwynn Guilford’s Quartz column “The epic battle between Clinton and Trump is a modern day morality play”

I am an admirer of Jonathan Haidt’s theory of moral intutions, laid out in his book The Righteous Mind. I applied it a while back to the measurement of national well-being in “Judging the Nations: Wealth and Happiness Are Not Enough.” Gwynn Guilford applied it in a trenchant July 31, 2016 Quartz column “The epic battle between Clinton and Trump is a modern day morality play” that is worth revisiting now that Labor Day is past and the general election campaign has begun in earnest. 

Here are some key passages in Gwynn’s column:

1. Hunkered down in their ideological corners, Clinton and Trump could have been talking about two wholly different countries.

And in a way, they were. Their convention themes described visions of the American moral order that light up the brains of different types of voters, appealing to discrete layers of the US electorate. Both candidates went for intensity over breadth. However, of the two, Trump exhibited a much deeper and more strategic understanding of human nature, as he had throughout the primaries.

2. In his book, Righteous Mind, Haidt shows how our responses to political debate are almost pure intuition; quick-firing moral reflexes that our brains overlay with rationales after the fact.

The other vital insight involves what Haidt describes as six types of intuitions—or, as he calls them, moral foundations: care/harm, fairness/cheating, liberty/tyranny, loyalty/betrayal, authority/subversion, and sanctity/degradation. These combine to form the unconscious attitudes that animate each of us, to form our sense of morality.

This doesn’t tend to happen in a vacuum; different swaths of American society construct morality with radically different proportions of these. Urban liberal communities that thrive on commerce tend to respond strongly to only the first two of these, care/harm and fairness/cheating (and, to some extent, liberty/tyranny). Democratic voters, therefore, generally prioritize openness and tolerance and tend to be suspicious of authority. Conservative morality, which stems more from agrarian roots, typically engages all of the moral foundations, but with a heavy emphasis on the latter three of loyalty/betrayal, authority/subversion, and sanctity/degradation.

3. [Clinton] championed equality—protecting people’s “rights” got 12 specific mentions—pushing down hard on the “fairness” moral foundation.

4. Clinton also played to the other biggie of liberal morality, caring for the suffering, oppressed, and downtrodden.

5. [Clinton] showed a deference to authority in praising the military, the president and vice president, and police officers. (Convention speakers like Khizr Khan, the father of a slain Muslim US solider, bolstered this theme even more.)

6. Though pundits largely expected Trump to use the convention to broaden his appeal to voters, the event was instead a sweeping tableau of America’s descent into immorality. Each night was themed around Trump’s campaign slogan, “Make America great again” (subbing in “safe,” “work,” “first,” and “one” for “great”). Throughout the convention, Trump proxies railed against Clinton’s supposed betrayal of America in her handling of the Benghazi embassy attack, while the tragic deaths of people killed by unauthorized immigrants was cited to illustrate the mortal threats citizens now face. Another pet theme was how the undermining of police by subversive groups (the implication, usually, being Black Lives Matter activists) is letting crime and chaos flourish. Meanwhile, political correctness forbids reasonable people from criticizing the ethnic and religious groups who are killing Americans. Tolerance has made America unsafe, unpatriotic, and (obviously) un-great.

7. As many have observed, the facts backing up Trump’s narratives are pretty thin on the ground. However, to people whose sense of morality is grounded heavily in respect for authority and loyalty to a certain in-group, Trump’s diagnosis makes intuitive sense. Anyone baffled that Trump’s supporters ignore the spuriousness of his arguments are very likely people whose moral configurations don’t incline them to favor authority and loyalty much in the first place.

Gwynn goes on to speculate about strategies that might help Hillary Clinton by tapping into a wider range of moral intuitions.

As a Utilitarian, my own moral intuitions center around the care/harm axis. But whatever one’s own primary intuitions, anyone who wants to use persuasion to help make the world a better place needs to understand and appeal to the full range of moral intuitions. As I wrote in “Nationalists vs. Cosmopolitans: Social Scientists Need to Learn from Their Brexit Blunder,” it is clear that many people do not have this understanding. Reading The Righteous Mindis a good start. Then follow that up by reading George Lakoff’s Moral Politics, where George Lakoff argues that the leftwing has a “nurturant parent” morality while conservatives have a “strict father” morality. (If the phrase “strict father” sounds bad to you, you probably don’t lean toward a strict father morality.)

On the care/harm axis that is primary for me, with loyalty to all of humanity rather than only a subset of humanity, the welfare of immigrants seems to me a central concern. As I tweeted yesterday, 

Preventing people from escaping poverty by preventing them from immigrating to the US is one of the cruelest things we do.

But in the interests of more open immigration, I have on various occasions also appealed to 

In any worthy cause–and if ever there were a worthy cause, this is one–it is important to make arguments that speak to all parts of the brain. We sell short the things we believe in if we do not try to make that kind of well-rounded argument for them.

Henry George on How the Civil War Led to High, Persistent Tariffs

“Nor could protection have reached its present height in the United States but for the civil war. While attention was concentrated on the struggle and mothers were sending their sons to the battle-field, the interests that sought protection took advantage of the patriotism that was ready for any sacrifice to secure protective taxes such as had never before been dreamed of—taxes which they have ever since managed to keep in force, and even in many cases to increase.”
— Henry George, Protection or Free Trade

Ben Bernanke: Negative Interest Rates are Better than a Higher Inflation Target

Link to “Modifying the Fed’s policy framework: Does a higher inflation target beat negative interest rates?” on Ben Bernanke’s blog

It is clear from Ben Bernanke’s September 13, 2016 blog post, that his answer to his title, “Does a higher inflation target beat negative interest rates?” is “No.” This is not a ringing endorsement of negative rates by Ben, but it is a recognition of the importance of negative rates as part of the monetary policy toolkit. And Ben is quite forthright in naming names of other central bankers he thinks have too negative a view of negative rates. 

Ben links to my paper with Ruchir Agarwal, “Breaking Through the Zero Lower Bound” in this passage:

… it is not clear that an inflation target as high as 4 percent would be politically tenable and hence credible in the U.S. or other advanced economies, whereas arguably feasible institutional changes, some as simple as eliminating or restricting the issuance of large-denomination currency, could expand the scope for negative rates.

Ben also says this in a footnote:

[3] The Fed could also encourage banks (or provide incentives for them) to pass on the negative rates to market-sensitive investors rather than retail depositors, as described here by Miles Kimball, a negative-rates proponent. For more on Miles’ overall argument, see here.

Let me expand on that footnote. I have advocated arranging part of the multi-tier interest on reserves formula to kill two birds with one stone: not only support bank profits but also subsidize zero interest rates in small household accounts at the same time–the provision of which is an important part of the drag on bank profits as it is now. I think being able to tell the public that no one with a modest household account would face negative rates in their checking or saving account would help nip in the bud some of the political cost to central banks.

To avoid misunderstanding, it is worth spelling out a little more this idea of using a tiered interest on reserves formula to subsidize provision of zero interest in small household checking and savings accounts. To make it manageable, I would make the reporting by banks entirely voluntary. The banks need to get their customers to sign a form (maybe online) designating that bank as their primary bank and giving an ID number (like a social security number) to avoid double-dipping. In addition to shielding most people from negative rates in their checking and savings accounts, this policy also has the advantage of setting down a marker so that it is easier for banks to explain, say, that amounts above $1500 average monthly balance in an individual checking+saving accounts or a $3000 average monthly balance in joint couple checking+saving accounts would be subject to negative interest rates. That is, the policy is designed to avoid pass-through of negative rates to small household accounts but encourage pass-through to large household accounts, in a way that reduces the strain on bank profits.

Comparison to Ben’s March 2016 Post and a December 2015 Interview of Ben by Ezra Klein

Ben also had an earlier March 18, 2016 post about negative interest rates: “What tools does the Fed have left? Part 1: Negative interest rates.”  Reading the two posts back to back, it is clear that Ben has warmed up to negative interest rates in the six months from March 2016 to September 2016. Nevertheless, even back in March, Ben leavened his skepticism about negative rates with these two passages:

1. The idea of negative interest rates strikes many people as odd. Economists are less put off by it, perhaps because they are used to dealing with “real” (or inflation-adjusted) interest rates, which are often negative. Since the real interest rate is the sticker-price (nominal) interest rate minus inflation, it’s negative whenever inflation exceeds the nominal rate. Figure 1 shows the real fed funds rate from 1954 to the present, with gray bars marking recessions.[3] As you can see, the real fed funds rate has been negative fairly often, including most of the period since 2009. (It reached a low of -3.8 percent in September 2011.) Many of these negative spells occurred during periods of recession; this is no accident, since during recessions the Fed typically lowers interest rates, both real and nominal, in an effort to spur recovery.

2. The anxiety about negative interest rates seen recently in the media and in markets seems to me to be overdone. Logically, when short-term rates have been cut to zero, modestly negative rates seem a natural continuation; there is no clear discontinuity in the economic and financial effects of, say, a 0.1 percent interest rate and a -0.1 percent rate. Moreover, a negative interest rate on bank reserves does not imply that the most economically relevant rates, like mortgage rates or corporate borrowing rates, would be negative; in the US, they almost certainly would not be.

It is also clear that Ben Bernanke has warmed up to my proposals specifically, if you compare what he wrote in his most recent September 13, 2016 blog post to what he said in part of a December 15, 2015 interview I transcribed in my post “Ezra Klein Interviews Ben Bernanke about Miles Kimball’s Proposal to Eliminate the Zero Lower Bound.”

Though Ben Bernanke is quite cautious about negative rates, I count him now as an ally in the effort to bring them fully into the monetary policy toolkit, with the actual use of negative interest rate tools remaining a very weighty decision. 

David Beckworth—The Balance Sheet Recession That Never Happened: Australia

I am grateful for permission from David Beckworth to mirror his post as a guest post here. Here is what David wrote:

Probably the most common explanation for the Great Recession is the “balance-sheet” recession view. It says households took on took on too much debt during the boom years and were forced to deleverage once home prices began to tank. The resulting drop in aggregate spending from this deleveraging ushered in the Great Recession. The sharp contraction was therefore inevitable. But is this right? Readers of this blog know that I am skeptical of this view. I think it is incomplete and misses a deeper, more important story. Before getting into it, let’s visit a place that according to the balance sheet view of recessions should have had a recession in 2008 but did not.

That place is Australia. It too had a housing boom and debt “bubble”. It too had a housing correction in 2008 that affected household balance sheets. This can be seen in the figures at the top of this post. 

Despite the balance sheet pains of 2008, Australia never had a Great Recession. In fact, it sailed through this period as one the few countries to experience solid growth. And, as Scott Sumner notes, it was also buffeted by a collapse in commodity exports during this time. If any country should have experienced a sharp recession in 2008 it should have been Australia.

So why did Australia’s balance sheet recession never happen? The answer is that the Reserve  Bank of Australia (RBA), unlike the Fed, got out in front of the 2008 crisis. It cut rates early and signaled an expansionary future path for monetary policy. It also helped that the policy rate in Australia was at 7.25 percent when it began to cut interest rates. This meant the central bank could do a lot of interest rate cutting before hitting the zero lower bound (ZLB). So between being more aggressive than the Fed and having more room to work,  the RBA staved off the Great Recession.

This experience in Australia speaks to why the balance sheet recession view miss the deeper, more important problem behind depressions: the ZLB. Unlike the RBA, the Fed was slow to act in 2008 and that allowed the market-clearing or “natural” interest rate to fall below the ZLB. Had the Fed acted sooner or had it been able to keep up with the decline in the natural interest rate once it passed the ZLB, the Great Recession may not have been so great (See Peter Ireland’s paper for more on this point).

Here is how I made this point in my review of Atif Mian and Amir Sufi’s book, House of Debt, in the National Review:

Why should the decline in debtors’ spending necessarily cause a recession?
Recall that for every debtor there is a creditor. That is, for every debtor who is cutting back on spending to pay down his debt, there is a creditor receiving more funds. The creditors could in principle provide an increase in spending to offset the decrease in debtors’ spending. But in the recent crisis, they did not. Instead, households and non-financial firms that were creditors increased their holdings of safe, liquid assets. This increased the demand for money. This problem was exacerbated by the actions of banks and other financial firms. When a debtor paid down a loan owed to a bank, both loans and deposits fell. Since there were fewer new loans being made during this time, there was a net decline in deposits [and thus] in the money supply. This decline can be seen in broad money measures such as the Divisia M4 measure. These developments—increase in money demand and a decrease in money supply—imply that an excess money-demand problem was at work during the crisis.
The problem, then, is as much about the excess demand for money by creditors as it is about the deleveraging of debtors. Why did creditors increase their money holdings rather than provide more spending to offset the debtors? …Mian and Sufi do briefly bring up a potential answer: the zero percent lower bound (ZLB) on nominal interest rates.
The ZLB is a floor beneath which interest rates cannot go. This is because creditors would rather hold money at zero percent than lend it out at a negative interest rate. This creates a big problem, because market clearing depends on interest rates’ adjusting to reflect changes in the economy. In a depressed economy, firms sitting on cash would start investing their funds in tools, machines, and factories if interest rates fell low enough to make the expected return on such investments exceed the expected return to holding money. Even if the weak economy means the expected return to holding capital is low, falling interest rates at some point would still make it more profitable to invest in capital than to hold money. Similarly, households holding large amounts of money assets would start spending more if the return on holding money fell low enough to make household spending worthwhile. This is a natural market-healing process that occurs all the time. It breaks down when there is an increase in precautionary saving and a decrease in credit demand large enough to push interest rates to zero percent. If interest rates need to adjust below zero percent to spur creditors into providing the offsetting spending, this process will be thwarted by the ZLB.
It is the ZLB problem, then, rather than the debt deleveraging, that is the deeper reason for the Great Recession.

Australia never hit the ZLB. That is why it avoided the Great Recession. If we want to avoid future Great Recessions we need to find better ways to avoid or work around the ZLB.

John Stuart Mill’s Defense of Freedom

I have finished blogging my way through John Stuart Mill’s On Liberty. I circled around to blog my way through the “Introductory” chapter last:

Chapter I: John Stuart Mill’s Introduction to a Defense of Freedom

These posts collect links for blog posts based on paragraphs in the other chapters:

Chapter II: John Stuart Mill’s Brief for Freedom of Speech

Chapter III: John Stuart Mill’s Brief for Individuality

Chapter IV: John Stuart Mill’s Brief for the Limits of the Authority of Society over the Individual

Chapter V: John Stuart Mill Applies the Principles of Liberty

I also have a few miscellaneous posts from when I first started writing posts inspired by On Liberty:

The Presumption in Favor of Any Belief Generally Entertained is Especially Weak in the Case of a Theory which Enlists the Support of Powerful Special Interests

“It should be remembered, however, that the presumption in favour of any belief generally entertained has existed in favour of many beliefs now known to be entirely erroneous, and is especially weak in the case of a theory which, like that of protection, enlists the support of powerful special interests. The history of mankind everywhere shows the power that special interests, capable of organization and action, may exert in securing the acceptance of the most monstrous doctrines. We have, indeed, only to look around us to see how easily a small special interest may exert greater influence in forming opinion and making laws than a large general interest. As what is everybody’s business is nobody’s business, so what is everybody’s interest is nobody’s interest. Two or three citizens of a seaside town see that the building of a custom-house or the dredging of a creek will put money in their pockets; a few silver miners conclude that it will be a good thing for them to have the government stow away some millions of silver every month; a navy contractor wants the profit of repairing useless iron-clads or building needless cruisers, and again and again such petty interests have their way against the larger interests of the whole people.”
— Henry George, Protection or Free Trade

How the Free Market Works Its Magic

Link to the Wikipedia article on “Harry Potter (character)”

Some people misunderstand free market principles. The free market depends on the establishment of property rights. That is the free market, not a departure from it. In particular, the free market yields good results only because after the obvious ways of getting ahead–lying, stealing and threatening violence–are outlawed, people have to exchange things that are valuable to other people in order to get ahead. 

Monetary policy is another interesting area to talk about. The logic saying that the free market yields good results comes from a model in which monetary policy doesn’t matter for anything important–have a central bank or not, it is all the same in that model. As soon as monetary policy matters, there is a genuine asterisk on the idea that the free market alone can do the job. As Milton Friedman recognized, some sensible monetary policy has to be appended to the establishment of property rights. 

Note: The timing of this post was inspired by yesterday’s post “Narayana Kocherlakota: Want a Free Market? Abolish Cash.”

Narayana Kocherlakota: Want a Free Market? Abolish Cash

Link to Narayana Kocherlakota’s column “Want a Free Market? Abolish Cash” on Bloomberg View

Narayana Kocherlakota has now joined me in advocating the complete elimination of the zero lower bound, and done it with a nice free-market argument. You can see the whole article at the link above. Let me quote my favorite passage and the bit about me:

… governments – by issuing cash and managing inflation – put a floor on how low interest rates can go and how high asset prices can rise. That’s hardly a free market.

Like any government interference, this causes inefficiencies. By preventing the future prices of goods and services from rising too far above the current prices, it constrains demand for current goods and services. The weak demand, in turn, leads companies to hire less and invest less in the development of new technologies, leaving the work force underutilized and productivity low. Sound familiar? …

The right answer is to abolish currency and move completely to electronic cash, an idea suggested at various times by Marvin Goodfriend of Carnegie-Mellon University, Miles Kimball of the University of Colorado and Andrew Haldane of the Bank of England. Because electronic cash can have any yield, interest rates would be able go as far into negative territory as the market required.

To clarify my own position, I have no objection to a cashless economy, but I think some nations may need to eliminate the zero lower bound in the near future, and a nonpar exchange rate between paper currency and electronic money (with electronic money as the unit of account) can be implemented on much shorter notice than arranging things so that the economy can easily do without paper currency entirely. So my own emphasis–as you can see from my bibliographic post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide”–has been on what might be seen as the transitional system of a taking paper off par to eliminate the zero lower bound rather than the total elimination of paper currency itself. 

Deirdre McCloskey: What Kenneth Boulding Said Went Wrong with Economics, A Quarter Century On →

Excerpts from this essay: 

1. It is appropriate to call economics since 1948 “Samuelsonian”

2. Science is about Mow Much. Existence theorems and tests of statistical significance have no connection to actual findings about How Much in actual economies”

3. There’s nothing, in short, unscientific about the humanities. Boulding spoke of the “inside track” we have as social scientists because we are the very thing we study, unlike the position of the physicist studying the atom or the biologist the cell or the geologist the mountain. “The outside track is frequently associated with scientific knowledge and the inside with folk or humanistic knowledge. The social scientist is frequently inclined to deprecate the inside track and to pretend that he operates only on the outside track. If we examine the social scientists carefully, however, we shall find that … their theoretical models owe a great deal to the power of man to known himself from the inside” (1964, p. 59). And how do we know ourselves from the inside? Through the arts and the humanities.

4. Many scientists mistakenly think that ethical categorization is not relevant to science: this is an echo of an attitude dating to Max Weber and adopted enthusiastically in economics during the middle of the twentieth century that fact and value are from different realms. Boulding did not agree. He realized, as many economists still do not, that “a process by which we detect errors in propositions of fact is not very different from that by which we detect error in propositions of value”

Tim Sablik: Subzero Interest

Link to the article on the Federal Reserve Bank of Richmond Econ Focus website

Tim Sablik interviewed me for a well-researched and well-written article “Subzero Interest” that he wrote for the Richmond Fed’s Econ Focus website. The entire article is a great piece for getting background on negative interest rates. As teasers, let me quote just the passages quoting me and a couple of very interesting passages quoting Marvin Goodfriend: 

Miles 1: “Cutting interest rates into negative territory stimulates the economy in exactly the ways that cutting interest rates stimulates the economy in positive territory, with very few difference,” says Miles Kimball, an economics professor at the University of Michigan who has advocated in favor of negative rate policy.

Miles 2: It may not be necessary to eliminate cash completely to achieve negative rates, however. Kimball has argued central banks could establish an exchange rate between physical currency and electronic currency at the cash window. For example, if the Fed wanted to adopt interest rates of negative 4 percent, the exchange rate for physical currency in terms of electronic currency would depreciate at 4 percent per year. Banks and financial markets would then pass along the nega­tive rates on physical currency as well as electronic accounts to the rest of the economy. To alleviate banks’ concerns about losing retail depositors, Kimball has said the Fed could reduce banks’ payments to the Fed of negative interest on reserves in order to subsidize their provision of zero interest rates to small-value bank accounts. This would shield most retail depositors from the effects of negative rates.

Additionally, he argues that the depreciation of paper currency would likely be invisible in most everyday trans­actions, at least to a point. “If you go to the grocery store now where they accept both credit cards and cash, they’re likely to accept both payments at par,” says Kimball. That’s despite the fact that both payment methods are not equal for merchants. They pay a fee to card networks for card transactions but don’t typically pass that charge on to cus­tomers. As a result, Kimball suspects many merchants would be willing to accept the “fee” of a small depreciation of cash without passing it on to customers.

“If merchants are still accepting cash at par at the store and you’re still getting a zero interest rate at your local bank, what do negative interest rates in the financial markets look like to you?” he says. “On things like car loans, they just look like lower positive rates. Most people wouldn’t personally see any negative interest rates.”

Marvin 1: In the long run, the likelihood that most countries move to all-electronic currency is quite high, Goodfriend argues. “If you give me a long time horizon of 150 or 200 years, I’d be absolutely shocked if societies did not move to eliminate the zero lower bound by making currency electronic,” says Goodfriend. “As society gets increasingly digitized, the inconvenience and costs of using paper currency will become glaringly high.”

Goodfriend also notes that while holders of digital cur­rency may lose money in times of negative rates, they could actually earn a positive return when rates are above zero, something paper money currently lacks. “If we expect that interest rates are going to be positive most of the time, then for most of the imaginable future, people are going to bene­fit from earning interest on currency.”

Marvin 2: This is why communication from central banks is criti­cal with these policies, says Goodfriend. “Any unorthodox move is complicated if the public has not been prepared for it. In that case, the central bank cannot be sure that these things will work as intended,” he says. But Goodfriend says most of the costs cited by critics of negative rates do not kick in only once rates fall below zero — they apply to all rate cuts. Cutting rates within positive territory also hurts savers and lessens the burden of public debt.

Still, negative rates represent largely uncharted territory for economists and policymakers, and many unanswered questions remain. The good news for monetary policymak­ers at the Fed and elsewhere is that they can wait and see how the experiments in Europe and Japan play out before making any decisions on negative rates. If it works, Goodfriend says he wouldn’t be surprised to see negative rate policy spread.

“If you’re standing around a pool and you don’t know what the temperature of the water is,” he says, “it’s a whole lot easier to jump in if somebody else goes first and tells you the water’s fine.”

How the Fed Could Use Capped Reserves and a Negative Reverse Repo Rate Instead of Negative Interest on Reserves

Link to the New York Fed’s webpage “FAQs: Reverse Repurchase Agreement Operations”

Charging banks for their reserve balances when the Fed decides someday to go to negative interest rates is probably within the Fed’s legal authority, since the Fed can charge fees related to expenses, and it can be argued that handing funds to the Fed requires the Fed to put those funds into other relative safe assets such as T-bills, which would have negative rates in that situation. But it is worth considering other options that might be even easier legally. 

In that vein, I want to refine what I wrote in “How to Keep a Zero Interest Rate on Reserves from Creating a Zero Lower Bound” by suggesting that after capping the amount of reserves (+ vault cash) banks are allowed to hold to a little above required reserves (plus an extra allowance for small accounts they hold, in line with “How to Handle Worries about the Effect of Negative Interest Rates on Bank Profits with Two-Tiered Interest-on-Reserves Policies”), allowing banks (along with other counterparties) to put funds into the Fed’s Reverse Repo Program, with a negative rate, is the natural way to have the same kind of economic effect as a negative interest rate on reserves while leaving the interest rate on reserves themselves at zero.

I suggested this possibility at Jackson Hole last Saturday as one of several reasons that the Fed should keep its Reverse Repo Program in operation. This was my comment after Jeremy Stein’s brilliantly clear presentation of how the Reverse Repo Program can enhance financial stability in  “The Federal Reserve’s Balance Sheet as a Financial-Stability Tool,” along with his coauthors Robin Greenwood and Sam Hanson.   

As you can see in the screenshot at the top of this post from the New York Fed’s website,  

A reverse repurchase agreement conducted by the Desk, also called a “reverse repo” or “RRP,” is a transaction in which the Desk sells a security to an eligible counterparty with an agreement to repurchase that same security at a specified price at a specific time in the future. The difference between the sale price and the repurchase price, together with the length of time between the sale and purchase, implies a rate of interest paid by the Federal Reserve on the transaction.

While only regulated banks are allowed to put funds into a reserve account, many other financial firms as well as banks are allowed to put funds into the Fed’s Reverse Repo Program. That clearly makes it different from reserves. But I want to argue that other than the more diverse set of participants allowed, the Reverse Repo Program can, in effect, act as if it were the second tier in a two-tier interest on reserves structure, while reserves themselves act as the first tier. As in any two-tiered interest on reserves policy, once the first tier fills up to its cap, it is the lower interest rate on the second tier that serves as the marginal interest rate that matters most for markets.  

There may be institutional and economic subtleties I don’t understand, which I would be glad to be corrected on. But let me write based on my current understanding of the Reverse Repo Program (RRP) until one of you corrects me. The reason funds in the Reverse Repo Program (RRP) can act, economically, as such close substitutes for reserves, is that during the day they become reserves, while at night, for the bank or other financial firm, they become something else that can earn a different interest rate from reserves. That is, with RRP, the Fed is borrowing money overnight using T-bills as collateral, and then repays the money in the morning by crediting the lender with funds that are reserves in some bank’s reserve account at the Fed. 

Above, I said that in the policy I envisioned, reserves would be capped, but that is only partly true: the reserves banks can hold are capped at night, but banks are allowed to have what is potentially a much larger amount of reserves during the day. At night, to meet their cap, banks both on their own account and on behalf of depositors have to sweep reserves above the reserve cap into RRP. An individual bank might find another alternative, but that just shuffles reserves around to another bank. So in the aggregate, the funds above the cap have to go into something with the Fed on the other side of the transaction, and RRP is what is available.

“During the day, reserves; during the night another alter ego that earns a different interest rate” sounds structurally a bit like the blurb for a superhero. The Reserve Repo Program may not be a superhero, but it could come in handy. I hope the Fed keeps it in operation, just in case it is more useful in some future situation than is now appreciated. 

Postscript: One reason the Fed is considering discontinuing the Reverse Repo Program in the future is the fear that too many funds might flee to it in a future crisis, allowing some other markets to collapse. The solution to this is already built into the structure of the Reverse Repo Program: over short horizons, there is a level at which the rate in the Reverse Repo Program adjusts by auction rather than the quantity adjusting with the same rate. Then over longer horizons–that is, as soon as the Fed can meet, which might be within a week during a crisis–the regular rate for the Reverse Repo Program should be adjusted downward sharply to avoid that rate becoming an obstructionist lower bound.