Federal Reserve Mandates Slow Growth. So Fed Must Finance American Infrastructure

 This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/economics--politics-education/federal-reserve-mandates-slow-growth-so-fed-must-finance-american-infrastructure?post=91756&uid=4798

My hope is that you follow this article closely, if you are interested in Federal Reserve matters, because we have uncovered more proof that the Fed will not allow a booming economy, period. So, knowing this we need to take Ellen Brown's article and Bernanke's quotes towards the end of this article seriously, because without sufficient taxation from a booming economy, we will need other means of financing the nation's crumbling infrastructure problem or it will not be financed.

Ellen Brown, a contributor to Talkmarkets, recently covered Congress' efforts to use the Federal Reserve to fund the highway bill. In this instance the Congress actually tapped dividends that the Fed pays to member banks.

But there is an even more ambitious way to use the Fed, interest free. Now that the Congress has tapped the Fed there is no reason why the Fed cannot help out America in this time of infrastructure need. The need is widespread, with bridges crumbling, with airports not measuring up to international quality, and with roads and city streets failing to be repaired in a timely fashion.

The Fed alone issues base money, and the banks issue loans based upon the amount of base money in the system. The banks create the money supply but cannot do so without base money. Currently, we are all aware of the massive amounts of base money sitting as excess bank reserves at the Fed. The banks could loan that money out some 2.4 trillion dollars times 10, to get roughly 24 trillion dollars additional money supply into the system.

The Fed fears that the banks could lend so much of the reserves out that the practice would cause inflation or that in an inflationary scenario, the Fed could not raise rates sufficiently enough to stop the outflow of lending by the banks! So, before I continue, this is what I have been writing about, that the Fed predisposes low rates.

 A researcher at the Minneapolis Fed said this:

Banks in the United States have the potential to increase liquidity suddenly and significantly—from $12 trillion to $36 trillion in currency and easily accessed deposits—and could thereby cause sudden inflation. This is possible because the nation’s fractional banking system allows banks to convert excess reserves held at the Federal Reserve into bank loans at about a 10-to-1 ratio. Banks might engage in such conversion if they believe other banks are about to do so, in a manner similar to a bank run that generates a self-fulfilling prophecy.
The author, Fed consultant Christopher Phelan, goes on to say that the Fed pays interest on reserves totalling about 2.4 Trillion dollars, in order to prevent lending that could increase the money supply by 24 trillion dollars.

The author goes on to say that the base money, or monetary base, or also called high powered money, is now at 4 trillion dollars, with excess reserves making up 60 percent of that total. Base money could be used start a bank run, to draw reserves out of the Fed, creating a bank run on the Fed itself!

The author then goes into game theory as to why the banks have not already raced to get their lending out into the real economy. He says:

On the question at hand, of excess reserves and liquidity, Bassetto and I consider a central bank that commits to pay a given nominal interest rate on excess reserves, but where banks are free to convert these excess reserves to loans at any time.1 Within this setting, we consider two scenarios: In the first, households, firms and banks all expect inflation to be low. In this scenario, the interest rate offered by the Fed is sufficiently high relative to the interest rate banks could get by loaning out their excess reserves to induce the banks to leave the excess reserves at the Fed.
In the second scenario, households, firms and banks all expect inflation to be high. Given this expectation, households and firms will be willing to pay higher interest rates to banks for loans since they expect to pay back in cheaper dollars. In this situation, the Fed’s interest rate on excess reserves is no longer high enough to induce banks to leave their reserves at the Fed, and when banks convert their excess reserves to loans, they create extra liquidity that generates higher inflation. Thus, the expectation of higher inflation induces the reality of higher inflation.
Phelan then states that the Federal Reserve must consider the scenario where inflation is expected, and will not necessarily be able to raise interest rates high enough to insure banks won't lend.

So, basically, the Fed doesn't want banks to lend too much and the multiplier is not fully realized because the Fed will not be able to raise interest rates when the time comes to fight inflation! 

Phelan says:

Couldn’t the Fed, in the face of an increase in inflation expectations, simply increase the interest rate it pays on reserves to a level sufficient to induce banks not to convert their excess reserves to loans? Not necessarily, either because the Fed can’t move quickly enough or because it faces political constraints on how high it can raise interest on reserves. Is the Fed really unlimited on the discretionary payments it can make to private banks? If banks think at some point the Fed won’t match the interest rate offered by firms and households, then this self-fulfilling prophesy of inflation expectations applies. 
So, since taxation will not be sufficient in a slow growth economy to fix infrastructure, I believe that the Fed must, must use base money to fund infrastructure. After all, this would be interest free, not a gift, but rather a right of government to use its created money interest free! Seems like a no brainer right?

Well, the Fed would say there is no control over spending by congress if interest is not charged. Yet, it is not like government is not obligated to pay back the base money. Of course the government is obligated to pay back the base money. It is just interest free. The Fed just likes interest bearing devices and has been shown to want to create gold out of debt.

But even Bernanke has said that base money could be used in infrastructure efforts. Scott  Sumner quotes Bernanke regarding the creation of base money to fund government projects:

Here is a possible solution. Suppose, continuing our example, that the Fed creates $100 billion in new money to finance the Congress’s fiscal programs. As the Treasury spends the money, it flows into the banking system, resulting in $100 billion in new bank reserves. On current arrangements, the Fed would have to pay interest on those new reserves; the increase in the Fed’s payments would be $100 billion times the interest rate on bank reserves paid by the Fed (IOR). As Kocherlakota pointed out, if IOR is close to the rate on Treasury bills, there would be little or no immediate cost saving associated with money creation, relative to debt issuance.
However, let’s imagine that, when the MFFP is announced, the Fed also levies a new, permanent charge on banks—not based on reserves held, but on something else, like total liabilities—sufficient to reclaim the extra interest payments associated with the extra $100 billion in reserves. In other words, the increase in interest paid by the Fed, $100 billion * IOR, is just offset by the new levy, leaving net payments to banks unchanged. (The aggregate levy would remain at $100 billion * IOR in subsequent periods, adjusting with changes in IOR.) Although the net income of banks would be unchanged, this device would make explicit and immediate the cheaper financing of the fiscal program associated with money creation.
Sumner says there are other ideas like upping the inflation target or NGDP targeting, but remember, the Fed says it can't raise rates in an inflationary environment so it is locked into slow growth. Maybe Bernanke's idea is one whose time has come, as base money must find its way into the banking system once it is created.

The base money would just take a detour through funding projects where the money is deposited by the project managers into the banking system. Let's face it, there just won't be a big enough boom to repair our nation without base money financing, and it should be interest free.




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