Mistaken Fears That The Fed Is Running Out Of Ammunition Ignore The Possibility Of QE-Financed Tax Rebates

Many well-known economists have been expressing the fear that the Federal Reserve is running out of ammunition to head off the next recession, given that interest rates are already at rock bottom levels. The fear is heightened by the fact that ultra-low interest rates have not engendered a strong enough economic recovery to bring about historically normal interest rates, with the long-term Treasury bond yielding at least 5% instead of the current 1.8%, a 50-year low. The fear is that another round of QE by the Fed will only result in even lower interest rates with no stimulative effect, the phenomenon known as “pushing on a string”.

The reason such fears are mistaken is that QE financing by the Fed can be used both in effective and ineffective ways, and that so far it has never been used in the most effective way. The most effective way is to finance tax rebates. Tax rebates put money directly in consumers’ pockets, resulting in increased consumption and reduced consumer debt, which is exactly what we need and have needed since the financial crisis began in 2008. In fact, QE-financed tax rebates should be the standard economic stimulus tool. They are immediately effective, and they are fair, since all taxpayers receive the exact same rebate check from the U.S. Treasury.

Had the 2009 $800 billion Obama stimulus consisted entirely of a tax rebate, each taxpayer would have received a $5,000 check. A household of two taxpayers would have received two checks for a total of $10,000. Not only would consumption have immediately jumped, but the housing/banking crisis would have been nipped in the bud, as families having trouble keeping current with their mortgages would have suddenly had the means to do so. There would have been no need to bail out many banks, and the budget deficits would have been much smaller. Many consumers would also have paid down some of their debt.

Furthermore, when one considers that QE-financing consists essentially of printed money by the Fed with which it buys newly issued Treasury bonds, there is no increase in the “real” indebtedness of the government, only a temporary “virtual” increase, so long as the Fed cancels those bonds at maturity. So, there is no increase in federal indebtedness, and actually there is a decrease in real indebtedness of both the government and the private sector thanks to the cyclical upturn which results in higher tax revenues, reduced unemployment and welfare expenditures, and widespread debt pay-downs by consumers and businesses.

As we have seen, the enormous QE financing between 2010 and 2013 totaling over $3 trillion did not result in higher inflation, contrary to the fears of most economists. The reason is that the amount of QE was not excessive, i.e., it did not produce excess aggregate demand, the situation of “too much money chasing too few goods”. So long as the Fed properly calibrates the amount of QE financed tax rebates there will be no significant rise in inflation. Such calibration requires taking into consideration the real level of slack in the economy, i.e., the level of real unemployment and the level of real capacity utilization.

We need the Congress to approve a QE-financed tax rebate of $2,000 per taxpayer now, and to approve properly calibrated QE-financed tax rebates in the future to always nip recessions in the bud, thereby avoiding high unemployment. QE-financed tax rebates should become the standard stimulus tool.

© Edward Sonnino 2020

February 25, 2020