What if the U.S. Treasury and the Federal Reserve stopped trying to stimulate the economy by encouraging more borrowing with quantitative easing -- and instead dropped money into household bank accounts?
In an era of rising concern about massive Federal deficits, such a policy may seem like the wrong idea at the wrong time, but proponents have an interesting argument, which the country should understand without dismissing out of hand.
While the economics jargon can get very heavy in discussions of monetary and fiscal policy, the basic ideas aren't that difficult to understand.
The Current Policy: Shovel Money at Banks
The current policy is called quantitative easing, and the idea is this: By expanding bank credit and lowering interest rates, a central bank (in the U.S., the Federal Reserve) stimulates more borrowing and thus more spending by businesses and households.
The problem with this policy is that none of the funds goes directly into consumers' accounts. If consumers are tapped out or wary of taking on more debt, then bank credit can be expanded to the moon and households won't borrow more money.
So while the Fed, Treasury and the FDIC have shoveled several trillion dollars into the nation's banking sector in various bailouts and guarantees, these actions haven't actually distributed any cash to consumers or businesses. The Fed's rescue operations in the recent crisis have been loans to banks and other financial institutions and purchases of financial assets, not helicopter drops of cash into household accounts.
The Problem With Quantitative Easing
The problem with quantitative easing is fairly obvious to all: It hasn't really stimulated the economy -- which, despite the trillions of dollars spent on bank bailouts, remains in the doldrums.
Put another way, the popular conception of Fed policy as a "helicopter drop" of money is misleading. A real helicopter drop would put money directly into household bank accounts, rather than expanding bank credit that might never get used.
Some policies do put money in consumers' pockets. A trillion-dollar tax cut, for example, leaves more cash in the accounts of taxpayers -- the basic idea behind the Bush tax cuts currently being debated in Congress.
The limits of tax cuts as a way of stimulating the economy are also obvious. As I reported in Why Growth May Still Leave 95% of Americans Behind, rising income disparity means that tax cuts benefit the top 5% and make relatively little difference to the bottom 95%.
Maybe a Real "Helicopter Drop" Is What We Need
Proponents of a "helicopter drop" of money directly into household checking accounts argue that a broad-based distribution of freshly issued cash would directly stimulate spending and thus employment. This is why they recommend replacing the macroeconomic role of bank credit with broad-based direct distributions of cash to households.
What if the Fed and Treasury distributed $4 trillion directly to households rather than using it to prop up bank lending? At least some households would use some of the funds to pay down debt, meaning the money would flow to the banking sector anyway, but with one critical difference: Household debt would actually decline, leaving household balance sheets in better shape and consumers owing less interest every month. That would mean households would have more cash, not just this month, but in future months as well.
With quantitative easing, the idea is to increase the debt load on households. With a helicopter drop of fresh cash, the idea would be to reduce the debt load that's crushing many households. Banks would benefit, too, as more consumer debt would be paid off in full, compared to the current policy of promoting heavier debt loads. The negative consequence of pushing more debt on households is also obvious: More loans become uncollectible and go into default, creating more loan losses for banks.
Directing the Economy Away from Debt
If the cash transfers were broadly distributed, the subsequent spending would be more representative of sustainable demand than other means of stimulus, such as costly, questionably effective "job creation" programs.
Most importantly, the status quo monetary policy distorts economic activity towards debt-based financial assets and debt-financed durable goods such as the "cash for clunkers" program to boost auto sales. According to the proponents of quantitative easing, adding more debt to households is the cure to our economic malaise. But for most households, high debt is the disease, not the cure, and adding more debt to "stimulate spending" is like trying to put out a fire with gasoline.
Some might argue that a direct deposit of freshly issued cash into households would be inflationary. But other economists argue that if inflation is a monetary policy issue, and a helicopter drop of cash is fundamentally fiscal in nature, then the worry over sparking inflation is misplaced.
What seems clear is that expanding bank credit through quantitative easing policies of funneling trillions of dollars into banks isn't working. Putting the same money thrown into banks ($4 trillion) into households would certainly put the money where it could either be spent or used to pay down debt -- both of which are direct cures for over-indebtedness and a no-growth economy.
Understanding Stock Market Indexes
What does it mean when people say "the market is up 2%"?View Course »