How and Why to Avoid Mixing Monetary Policy and Fiscal Policy

When Raymond Reddington (played by James Spader) burns a pile of US paper currency in the second season opening of “The Blacklist,” he is giving a gift to the Federal Reserve (the “Fed”), and through the Fed, to the US government. To see this, notice that right after the US paper money is burned, the Fed can ask the US Mint to print an equal amount of paper currency for its vaults, and other than the cost of the paper and ink themselves, get the same result as if Raymond Reddington had given the paper currency directly to the Fed. This would be income to the Fed, and unless the Fed increased its expenses, would ultimately be added to the check that the Fed sends to the US Treasury every year.  

Similarly, if the Fed mails money to every US citizen, instead of using the money it creates to buy US Treasury bills, as it usually does, then the US Treasury ends up selling those bonds to someone else and the US government ends up owing that amount to someone else who won't ultimately send the interest it earns back to the US Treasury as the Fed does. 

Indeed, if the Fed mails every citizen money–a so-called “helicopter drop”–it is equivalent to the Fed doing its usual thing of buying US Treasury bills, plus the US Treasury issuing treasury bills to finance sending money to every citizen. The reason treating a helicopter drop as the combination of these two operations is useful is that the first (the Fed buying US Treasury bills) is the normal way that the Fed changes interest rates (when the zero lower bound doesn’t get in the way), while the second (the US Treasury selling bonds to finance sending money to every citizen) brings in all the complexity of fiscal policy. In the present, it takes money from those who buy the new bonds (who presumably like to save) and gives it to all the citizens (among whom there are some who like to spend). From a long-run perspective, having the US Treasury sell bonds to finance sending money to every citizen takes money from future taxpayers, in proportion to who would be asked to pay extra future taxes, to spread it out relatively evenly to citizens now. So there is redistribution. And the overall amount of redistribution that takes place through fiscal policy is an object of fierce debate between the major political parties.

I think the debate about how much redistribution should take place should be carried out in as open and transparent a way as possible. But if there are to be any obfuscations in this area, leave the Fed out of those obfuscations! If you think it is a good idea to mail money to every citizen, let the US Treasury do it; then no one will mistake what is going on, and the argument can be in the open.   

Now, when the economy needs stimulus, and monetary policy is seriously constrained in a way that can’t be helped, mailing a credit card to every citizen with a $2000 line of credit as I have advocated is somewhere between regular fiscal policy and regular monetary policy, and might be appropriate to put under the Fed’s jurisdiction. Such a policy strives not to redistribute, though it unavoidably does to some degree when some fraction of people fail to repay the loan from the government. 

In addition to thinking that arguments about redistribution should be out in the open (as they are on my blog), I think it is important that the Fed be shielded from politics as much as possible in order to allow it to do its job of economic stabilization (keeping output at the natural level as that natural level shifts around in response to technological progress, and keeping the price level steady). That is why I argued in my column “Why the US Needs Its Own Sovereign Wealth Fund” that instead of having the Fed engaged in “quantitative easing,” buying anything other than 3-month Treasury bills should be left to another, new government agency:

… isn’t it a bit much to expect the Fed to both choose the right amount of stimulus for the economy and decide which financial investments are the most likely to turn a profit for a government that faces remarkably low borrowing costs?

Why not create a separate government agency to run a US sovereign wealth fund? Then the Fed can stick to what it does best—keeping the economy on track—while the sovereign wealth fund takes the political heat, gives the Fed running room, and concentrates on making a profit that can reduce our national debt.

I collected links to other posts I have written about sovereign wealth funds as an instrument of economic policy here

Through Roger Farmer, who also endorses sovereign wealth funds as an instrument of economic policy, I heard about Mark Blythe and Eric Lonergan’s plan, heartily endorsed by Matt Miller, to either (a) mail money to consumers, or (b) earn returns through the central bank acting as a sovereign wealth fund and then send the funds earned out to people: 

Central banks could issue debt and use the proceeds to invest in a global equity index, a bundle of diverse investments with a value that rises and falls with the market, which they could hold in sovereign wealth funds. The Bank of England, the European Central Bank, and the Federal Reserve already own assets in excess of 20 percent of their countries’ GDPs, so there is no reason why they could not invest those assets in global equities on behalf of their citizens. After around 15 years, the funds could distribute their equity holdings to the lowest-earning 80 percent of taxpayers. The payments could be made to tax-exempt individual savings accounts, and governments could place simple constraints on how the capital could be used.

Of these two ideas, I think the second, (b) is better. The money for redistribution is coming not from raising taxes but from having the government do risk bearing it is actually rewarded for, instead of through implicit risk guarantees that benefit private, often wealthy individuals.


  1. I think it is much better institutionally to separate the sovereign wealth fund from the central bank. A sovereign wealth fund, though immensely valuable, is inherently controversial. The Fed and other central banks face enough controversy even when they don’t act as sovereign wealth funds. They don’t need the added political burden.
  2. Although I like the idea of new revenue that doesn’t come from taxes being used for some form of redistribution, it is not clear to me that sending people money is the best form of redistribution. There should be a vigorous debate about the most effective ways to lift up the poor for a given amount of money used. This is the issue I have with basic income proposals as well. Are they really the most effective ways to help the poor per dollar spent? (For example, see 1 and 2.

Still, I am glad to see the idea of a sovereign wealth fund gain traction–not only

  • as a way to stabilize the financial cycle–which would continue to exist even if the Fed completely tamed the business cycle, other than those fluctuations that are an appropriate response to technology and other real shocks–but also
  • as an alternative way to add to government revenue on average without resort to taxes.

Notice that in the background I have a particular view on the rational level of risk aversion, which I plan to defend in a future post–though it is always hard to find time to write major, relatively technical posts.

I also want to be clear in saying that, after eliminating the zero lower bound (as it should), a central bank should only raise the amount of revenue that is consistent with maintaining zero inflation in the unit of account (except for a bare minimum of hard-to-avoid short-run fluctuations in inflation). In particular, inflation is a very costly way to renege on the promises a government makes when it issues bonds. That seems like a bad idea to me.

Ross Douthat Lays Out the Best-Case Scenario for a Romney Presidency

Ross argues (my title is a link) that Mitt is positioning himself to follow Franklin D. Roosevelt’s example of “bold, persistent experimentation” if he is elected. In my post “The Magic of Etch-a-Sketch: A Supply-Side Liberal Fantasy,” I effectively argue that–if one is willing to ignore other things Mitt has said–Mitt’s acceptance speech by and large leaves enough wiggle room for him to follow the policies I would recommend. My best guess of what Mitt will actually do can be found in my post Kevin Hassett, Glenn Hubbard, Greg Mankiw and John Taylor Need to Answer This Post of Brad DeLong’s Point by Point.

I explain why I intend to be coy about my own leanings as a voter in “What is a Partisan Nonpartisan Blog?” But I don’t mind telling you that I am genuinely undecided at this point. As you will deduce if you read “The Magic of Etch-a-Sketch: A Supply-Side Liberal Fantasy,” in the vector space of important issues, I don’t think one real-world candidate for president dominates the other. At some point in the future I will write a post expanding on the ethical case for gay rights to fill in one missing piece of the puzzle. I have already written on the ethical case for open immigration in my posts “You Didn’t Build That: America Edition” and “Adam Ozimek: What ‘You Didn’t Build That’ Tells Us About Immigration.” I take both of those issues very seriously, and they clearly favor Obama. 

The most important issue favoring Mitt is the issue of restraining nuclear proliferation. Mitt’s acceptance speech convinced me he really would deal with Iran more firmly than Barack. I talk about the importance of that in the beginning of my post “Avoiding Fiscal Armageddon.” Restraining nuclear proliferation is also an ethical issue: one of the few issues that can compare in importance to the ethical weight of gay rights and open immigration–and to the ethical weight of war itself. Restraining nuclear proliferation is something we owe our descendants. We can’t afford to let our war-weariness prevent us from doing what needs to be done to stop Iran from getting nuclear weapons. Here, I want you to remember that convincing one’s adversary that one is willing to go to war can sometimes be the best way to avoid both war and outcomes that are worse than war.

On economic policy, my fantasy “The Magic of Etch-a-Sketch: A Supply-Side Liberal Fantasy” aside, things are much murkier, because–as Ross Douthat emphasizes with his FDR analogy–no coherent account of Mitt’s intended economic policies has emerged. If Mitt is elected, I will certainly hope for the best, and will be reassured if he keeps Greg Mankiw close by his side during his presidency (and appears to be listening to Greg carefully), but at this point I trust Barack’s economic policies more. If Barack is reelected, I think he needs to do much more than he has done on the economic front, starting with Federal Lines of Credit, which you can read about in “Getting the Biggest Bang for the Buck in Fiscal Policy” and the other posts I list in “Short-Run Fiscal Policy Posts through August 23, 2012.” (I promise to post many other suggestions for whoever is our president come January.) At the upper end of what is reasonably possible, I think Mitt’s economic policies look better than Barack’s. But on the downside there are great dangers in the rejection by many Republicans of the conceptual framework of aggregate supply and aggregate demand in favor of a view of macroeconomics in which only aggregate supply matters. This view by many Republicans could easily have negative effects on macroeconomic policy in a Romney presidency even if Mitt himself believes that aggregate demand matters. 

Let me end by repeating here one of my tweets about my cousin Mitt:

News flash from Clive Crook: Romney NOT a heartless self-serving capitalist monster. …

In the event, Mitt might be a bad president, but some of the things that have been said about him are just wrong. If you follow Clive’s link above, and this link to the testimonial of my nephew Peter Kimball’s father-in-law Grant Bennett, you will see. (Peter is my brother Chris Kimball’s son. You can see Chris’s relatively negative opinion of Mitt in my post “Big Brother Speaks: Christian Kimball on Mitt Romney.”)

Note: I list my other political posts in the index post “Posts on Politics and Political Economy through September 1, 2012.”

Miles's First Radio Interview on Federal Lines of Credit

Bill Greider’s piece in The Nation’s blog on Federal Lines of Credit (see “Bill Greider on Federal Lines of Credit: ‘A New Way to Recharge the Economy”) was syndicated to the Detroit Metro Times (the link under the credit card), which in turn sparked a radio interview with Detroit Public Radio.

I listened back to the podcast myself and thought it turned out well. So I recommend it. It is short and sweet.

By way of clarification on Bill Greider’s piece, The Detroit Metro Times posted this note from me. The reply to Mike Konczal that note describes as forthcoming is already out as my post “Preventing Recession-Fighting from Becoming a Political Football.”