Since we released our blog post on the U.S. version of the Swiss sovereign-money referendum, I’ve heard more than a few times that it can’t happen here. It certainly won’t happen anytime soon. However, coverage a day later in the New Republic shows that this “FedAccounts” proposal from former Obama Administration and Elizabeth Warren staff is part of a well-designed campaign to advance a plan that simultaneously slams big banks, harnesses the Fed to national priorities, and gives households a lot more for their money that would be put into a far safer depository: the Fed. What’s not to like? For one thing, this proposal would make American economic inequality even worse. However, its appeal means one has to take FedAccounts seriously. Taking them seriously means reckoning with a formidable attack on interest on excess reserves (IOER) and what that means for monetary policy and macroeconomic prosperity.
Even with the small relative drop in IOER announced on Wednesday, the billions now flowing into banks will only increase as rates rise unless or until the Fed’s portfolio is truly tapered into a mini. As IOER increases, IOER will be the easiest aspect of the FedAccount proposal to bring quickly into the public debate. For all Democratic progressives and Republican populists disagree, they are united that IOER is a big-bank “subsidy.” Each wants it for its own purposes – progressives want the money to go to the people directly and populists want it to go to the people by way of the Treasury. But still they agree that IOER is a subsidy and its billions should go to the public.
In a 2016 paper, we laid out the reasons IOER is in fact no subsidy to large banks. We also show what would happen were IOER recaptured by Republicans to reduce the deficit – sharp and immediate destabilization of a still-fragile financial system. The FedFin paper doesn’t address what might happen if IOER were instead captured by payments to household and business depositors at the Fed because we didn’t in 2016 think anyone would follow the Swiss example in support of “sovereign money.” Given that IOER is indeed in play as part of a wholesale rewrite of the Federal Reserve’s function, it’s worth also considering what would happen if IOER were redirected as the FedAccount paper would have it.
As the paper readily acknowledges, accepting deposits would mean that the Fed’s portfolio would have to grow from big to huge. This would have a very dangerous unintended consequence: for all the benefits of a safe place to store household funds at higher rates of return, FedAccounts would make the U.S. a lot less equal in terms of both wealth and income.
The wealth-inequality impact comes from the reallocation of return resulting from a huge Fed portfolio. As a lot of research has persuasively shown, the Fed’s holdings already make the wealthiest households a lot richer because the value of “financial assets” – stocks, bonds, and the like – has skyrocketed in response to quantitative easing (QE). In sharp contrast, most low-and-moderate income (LMI) households derive what wealth they have from their homes. Higher-price housing has shot up sharply since 2012 along with financial assets, but lower-price house values are still below where most were before the financial crisis, leaving millions of LMI households with under-water mortgages in devastated communities.
The FedAccounts plan assumes that it would not have the inequality impact of QE because the Fed would funnel its funding back into the “real” economy through banks via discount-window liquidity. The idea is that the Fed would essentially recycle what had been bank deposits back to banks at high enough discount-window rates to ensure positive Fed earnings along with lots of credit availability through the private sector.
Nifty, but this would only work if banks could in fact profitably lend out these high-cost discount-window advances given not only prevailing rates and demand, but also the cost of collateralizing these advances from the Fed with the Treasury obligations and other high-quality collateral required by the Fed. As long as the Fed demands discount-window collateral, loans funded by it are essentially 100 percent reserved and there thus would be a lot fewer of them. The less lending, the greater the income inequality because the engine of growth – financial intermediation – is turned off.
Hypothetically, the Fed could solve this equality problem by accepting at least some of these loans as collateral – the ECB and other central banks are willing to accept some corporate debt. However, banks would likely make only those loans that count as collateral. Unless the Fed accepts LMI loans (e.g., first-time mortgages, small business start-up loans) as collateral, private credit would flow only to the largest, most affluent borrowers. Maybe it would trickle down into more economic growth, but this hasn’t happened in the ten years since the crisis and is unlikely to do so given the still greater impediments to bank lending under the FedAccount plan.
As a result, to accept sovereign money on the deposit side, the U.S. would have also to accept sovereign lending. Swiss proponents of “Vollgeld” had no problem with this because Switzerland is far less suspicious of its central banks and, even more importantly, a far more economically equal nation than the U.S. It’s at least possible that the Swiss National Bank could have taken deposits and lent them out in ways that advance both wealth and income equality throughout the Alps. I doubt it, but it’s at least possible. Here, it’s simply impossible to have a sovereign-money central bank and promote equality unless we also nationalize the banking system, throttle non-banks, and allow political appointees to decide who gets how much of a loan for what purpose. I’m not sure even the most progressive Democrats are willing to go that far. I know I’m not.