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Robert Pollin: Nothing in Fed’s new plan will make banks lend more money

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay, coming to you today from the PERI institute in Amherst, Massachusetts. In the days following Tuesday’s election nothing much has changed, with the unemployment numbers officially somewhere around 9.6, 9.7 percent, in most people’s real world probably something just under 20 percent. With the Republicans now about to control the House, we’re not likely to see any more stimulus spending. Quite the contrary: talking about cuts in government spending. So what’s going to happen? Well, here’s the headline in today’s paper: “Fed tries to energize recovery”. Ben Bernanke at the Fed says he’s going to buy $600 billion of US bonds to increase the money supply and stimulate the economy. Will it do that? And what will be the effect of all of this? Now joining us to help us understand this is Bob Pollin, the codirector of the PERI institute. Thanks for joining us.


JAY: So, first of all, what’s the Fed’s objective here? And what exactly does it mean to go out and buy $600 billion of US bonds?

POLLIN: Well, the Fed always is buying bonds at more or less that level. What’s different now is that they’re buying long-term bonds. Usually what we call normal monetary policy, which is called open market operations, the Fed—basically all it is is the Fed goes and buys short-term bonds. And so the idea is that they’re trying to influence short-term interest rates.

JAY: Back up one step. What’s a bond? Who issues the bond? And if the Fed’s buying the bond, is it the government is—one arm is buying it from the other arm? What is this transaction? And then what happens to the money that goes—that bought the bond?

POLLIN: Okay. So normal monetary policy is the following. The Fed buys short-term government bonds, like, 3-month Treasury bills, 6-month Treasury bills, and they buy them from private banks, and when they do that, the banks get the cash from the Fed, so they’re holding more cash reserves, and the Fed has bought up the government Treasury bond. Right. Now, the net impact is supposed to be—.

JAY: Okay. I’m going to break this down. The private banks own some US government-issued bonds. The Fed’s buying the bonds from the private banks, not directly from—.

POLLIN: From the Treasury.

JAY: Not directly from the Treasury.

POLLIN: No. They’re buying outstanding bonds.

JAY: That the banks have bought as ways to invest, park their money, or—.


JAY: And in theory, these bonds are interest-bearing.

POLLIN: Yeah, they are.

JAY: Okay. So the Fed now buys these interest-bearing bonds from private banks, and now the Treasury’s paying some interest to the Fed. And, of course, our libertarian friends are saying, okay, but just what did the Fed use to buy these bonds with?

POLLIN: They just—they can just do it.

JAY: They just make up some money and they do it.

POLLIN: Yeah. That’s how you create—that’s the real way that you create money. Under normal procedures, the Fed only targets the purchase of short-term bonds held by banks, short-term Treasury bonds held by banks. And when they do that, by buying the bonds, that is increasing the demand for bonds overall, because they’re buying them. So there’s a fixed supply, let’s say. They’re demanding; the Fed is buying them. That drives up the price of the bond, which also means it drives down the interest rate.

JAY: And it’d be as if—just—it’d be the same as if you were selling shoes. If somebody came and bought up half your shoe supply, the other half [would] be worth more, because there’s just fewer shoes on the market. And now there’s fewer bonds on the market.

POLLIN: Right. Now, the interesting thing with bonds is that when you buy a bond and you drive up the price, that’s the same thing as saying you’re driving down the interest rate.

JAY: Right.


JAY: Okay. So, now—but in 3-month, 6-month, 90-day bonds, the Treasury has to pay the Fed what the bond’s worth.

POLLIN: Yes. Now—but the key is that the Fed already has been doing a lot of that, a huge amount of that, and that’s what has set the federal funds rate, which is essentially the policy rate, at zero or close to zero. That’s how they’ve been holding the federal funds rate at zero. Now, the problem is you can’t go below zero with buying up short-term bonds. So they’re stuck.

JAY: So that in terms of having kind of a stimulus effect, where do you go? ‘Cause there’s all—the interest rates are so low, it’s not helping to lower interest rates anymore.

POLLIN: That’s right. You can’t go any lower. So that’s where the idea of this—I don’t know how the term came about—the short-term thing is quantitative easing.

JAY: They have to hire PR firms to come up with this language.

POLLIN: Yes, yeah, yeah. So the quantitative easing idea is—.

JAY: But just to define it, quantitative easing means increase the money supply?

POLLIN: No, because both ways increase the money. If you buy a short-term bond or you buy a long-term bond, that will mean that the banks have more cash in their reserves, and so either way you’d increase the money supply. The difference between normal monetary policy and quantitative easing is that with quantitative easing the Fed is targeting longer-term bonds. So their aim here is to directly drive down the price of longer-term Treasury bonds.

JAY: Which also means the Treasury doesn’t have to repay the Fed within 30, 60, 90 days. In theory, it’s years away before the money ever has to come back out of the Treasury.

POLLIN: Yes, yes, that’s right.

JAY: Okay. So I don’t understand how this has—let me hold up the paper again—”Fed tries to energize recovery”. The banks are already sitting on $1 trillion and not loaning it to anybody. So what’s it going to do, putting more money into them?

POLLIN: Okay. So the idea is, again, we can’t do any more—we can’t drive the short-term rate below zero. So the idea is to drive down long-term rates, and not just long-term rates on Treasury bonds but all long-term rates. The big problem in the credit market is, yeah, money is not moving out, and so there is a very big gap between the short-term rate, at effectively zero, especially as applied to this inter-bank lending rate, and long-term rates that apply to businesses. For example, the long-term rate on, say, BAA corporate bonds, like, an average bond, is about 6 percent. So, essentially, you have a gap between a federal funds rate, which is the target monetary policy rate, and the corporate bond rate. An average for an average decent business is 6 percentage points. That’s actually gigantic.

JAY: In a zero—.

POLLIN: Yes. So—yeah. So the Fed is trying to drive that gap down, but the way they’re doing it is a half measure, because they’re still only targeting Treasury bonds. They’re not trying to drive down directly the rates on business bonds. They’re just doing it on Treasury bonds. And the problem with that is the real problem in the whole credit market is the level of risk perception. Now, there is no risk of default with a Treasury bond, so you can keep driving them down fine, but you’re still going to be having this big gap with the business rates, because people are afraid of businesses going bust. They’re not afraid of the US Treasury going bust, at least not yet. So the quantitative easing is not going to—in principle it is not targeting the thing that needs to be targeted and that Bernanke himself acknowledges needs to be targeted, which is things to give business lower rates.

JAY: If it does bring down long-term interest rates for businesses.

POLLIN: Long-term Treasury rates.

JAY: But it won’t, because the risk factor doesn’t change. You’re—still could be up at 5 percent, 6 percent, or whatever, or even worse in the real economy.

POLLIN: That’s right.

JAY: Okay. So the other argument, if I understand it correctly, is, okay, let’s say what you’re saying is right. The real objective here is to deflate the US dollar, to increase American exports, make imports more expensive, and that becomes a stimulus to the economy. So what we’re really trying to do is deliberately cause the US dollar to drop, and that’s the objective.

POLLIN: Well, that’s certainly part of it. That’s part of it. I mean, it’s both things. It’s to drive down interest rates, business rates. If it fails, well, at least—yeah, at least if you drive down the Treasury rates, that will affect the value of the dollar, and that’ll start bringing the dollar down. And so, yes, that should help—everything else equal, it should help weaken the value of the dollar in currency markets, which in turn, in principle, is supposed to enable us to sell more exports and make imports cheaper.

JAY: So will it?

POLLIN: Maybe a little bit.

JAY: Because what stops the Chinese or whoever—they’re just going to—

POLLIN: That’s it. That’s the point. Retaliation.

JAY: —they’ll just deflate their own currency—

POLLIN: They’re already doing it.

JAY: —so you wind up with deflation currency war.

POLLIN: That’s right. That’s exactly the problem with that strategy and will always be the problem with that strategy. I mean, the dollar has fallen 10 percent already. Whether it can go any—. I mean, the Chinese of course know when the dollar falls 10 percent. They’re not going to just sit there and take it. Nor for that matter will the Europeans or the Japanese. So, yes, we’re in a situation in which now, if we really want to, you know, invoke the 1930s, where you had the so-called beggar-thy-neighbor, where every country is trying to export its way out of the crisis—. Not all countries can be net exporters, by definition. Somebody has to be a net importer. So, if we are trying to aggressively increase our exports, that means somebody has to be equally willing to take in more imports.

JAY: And currency wars can lead to trade wars, and often trade wars lead to real wars.

POLLIN: Right.

JAY: So the piece of the scenario I don’t understand here is, why do they have to put the money back into the banks? If they want to actually use this creation of money and they think they can do it within a limit that won’t be inflationary, ’cause we’re in such deflationary times, why don’t you just put the money right into the Treasury, and the government then has money to spend directly?

POLLIN: Well, of course, I mean, some of that does go on. When the Fed buys the Treasury bonds, it makes it easier for the Treasury in turn to borrow. I mean, in fact, if there wasn’t this gigantic market for Treasury bonds supplemented by the Fed, then it would be harder for the Treasury to go out and run big deficits. So there’s some of that going on, of course, and I support that. I support that. I mean, that is—the key tool is to combine the Fed’s power to create money, lower interest rates, with the Treasury’s power to use that money to get it into government spending and to promote economic growth, job creation. So the quantitative easing is a step in the right direction that way. But as I said, it is a very mild half measure that does not get at the basic problem of how you get businesses low enough rates where they’re going to say, okay, yes, we’re in a risky situation; okay, I don’t necessarily see a market out there, but the rates are so juicy, I’m ready to move. And that’s where I think the Fed—the Fed should be targeting that mindset, and the quantitative easing only gets us a little ways.

JAY: Which would require, if I understand correctly, some direct government stimulus spending, which, given the way the elections went, we’re not very likely to see. Okay. So come back in a few days, and we’re going to talk more about, okay, what’s next, given the reality of today’s politics. Thanks for joining us on The Real News Network.

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Robert Pollin is Professor of Economics at the University of Massachusetts in Amherst. He is the founding co-Director of the Political Economy Research Institute (PERI). His research centers on macroeconomics, conditions for low-wage workers in the US and globally, the analysis of financial markets, and the economics of building a clean-energy economy in the US. His latest book is Back to Full Employment. Other books include: A Measure of Fairness: the Economics of Living Wages and Minimum Wages in the United States, and Contours of Descent: US Economic Fractures and the Landscape of Global Austerity.