How The Federal Reserve Plans To Make $3 Trillion Disappear
STEVE INSKEEP, HOST:
This week, the Federal Reserve will likely do something it hasn't done in years - raise its benchmark interest rate. The Fed has kept rates low by pumping money into the economy, some $3 trillion. Now, the Fed would like to suck that money back out of the economy, but that's risky. So in this encore presentation, David Kestenbaum of NPR's Planet Money podcast explains that the Fed is trying something different.
DAVID KESTENBAUM, BYLINE: Three trillion dollars is a lot of money. You do not want to suck it out of the economy too quickly.
JOE GAGNON: It would be disruptive.
KESTENBAUM: This is Joe Gagnon, an economist at the Peterson Institute. He used to work at the Fed, and he says the Fed used a lot of that new money to buy mortgage bonds to help out homeowners. So to suck the money out of the economy the Fed would have to reverse that.
GAGNON: And trying to unload a lot of that quickly would shoot mortgage rates sky-high then they'd come crashing down, and it would just be a mess.
KESTENBAUM: Instead, the Fed is going to try something it has not done before. It's going to leave those trillions of dollars out in the economy but try to make the money in a sense invisible. A lot of the cash is sitting at banks and the Fed is going to pay the banks to sit on it. It's going to pay them interest on their extra cash. That will make the banks less likely to lend it out. It will be as if the Fed had taken the money out of the economy.
It does feel like a magic trick.
GAGNON: It is a bit of a magic trick, yes.
KESTENBAUM: Gagnon says the Fed could end up paying the banks $30 billion a year for basically doing nothing. Now, the banks won't just get to pocket all the money. When the Fed starts paying the banks interest on the cash they have sitting around, the banks will probably also end up paying more interest to people with savings accounts. But Gagnon says the banks could end up profiting, which is a little awkward. Some of those banks of course help get us into this mess in the first place. Now we're going to pay them to do nothing?
Is that fair?
DAVID BLANCHFLOWER: I'm not going there.
KESTENBAUM: This is David Blanchflower, economist at Dartmouth.
BLANCHFLOWER: I'm not going there (laughter).
KESTENBAUM: (Laughter) Why not?
BLANCHFLOWER: Economics are - I mean (laughter) fairness is not anything I know about. I mean, economists are not good at what's fair, right? What's the famous phrase? The optimal allocation of resources may still be perfectly disgusting. Now try that on you. It's a famous quote. Good try though (laughter).
KESTENBAUM: The truth is, whenever the Fed does anything, it helps some people and hurts others. When the Fed lowered interest rates, some people got great deals on mortgages. But people with money in savings accounts, they earned almost no interest. The Fed is supposed to be thinking about bigger things, keeping the entire economy on track. And this trick of paying banks to sit on cash, it's been tried in other countries, but it has never been done on this scale. Remember, the Fed created over $3 trillion out of nowhere. We talked to a bunch of experts, though, and they were all confident it will work.
GLENN HUBBARD: Well, it doesn't worry me from technical perspective.
KESTENBAUM: This is Glenn Hubbard, dean of Columbia Business School, chair of the Council of Economic Advisers under President George W. Bush.
HUBBARD: The Federal Reserve has abundant tools to normalize monetary policy both in interest rates and in the size of its balance sheet.
KESTENBAUM: I thought you might be the guy we would talk to who would have some worries about the giant pile of money was out - that was out there and how they were going to eventually, you know, suck it back out.
HUBBARD: No, no.
KESTENBAUM: Hubbard's worry has been that the Fed is waiting too long to raise interest rates. Wait too long and you can get inflation or a housing bubble, which, after all, is what started the whole financial crisis in the first place. David Kestenbaum, NPR News. Transcript provided by NPR, Copyright NPR.