Waste and inefficiency are not consistent with conservative values. In its limited role, government must always strive to get the most bang for the buck. Using a very inefficient system is not helpful in this regard. When excessive inflation has too much money chasing too few goods, Federal Reserve policy needs to efficiently and effectively decrease demand and increase supply. The Fed needs to encourage, not discourage, supply, and get the greatest reduction in demand for each dollar spent.
Many retail firms borrow money to operate throughout most of the year and, finally, in the holiday season at the end of the year, they cover their costs and make a profit. Without relatively inexpensive loans to see them through the less lucrative seasons, they would have to close down their operations. Farmers may have a number of marginal fields that are only worth cultivating if low-cost loans are available to see them through the cost of plowing, planting, fertilizing and watering until harvest time when they can sell their crops to cover costs and make a profit.
When the Federal Reserve faces excessive inflation and wants to slow the economy, it increases the cost of borrowing. Wealthy people do not have to borrow money to buy a car or buy a house. It is the poor and middle class people who have to adjust their spending from things that require a loan to less expensive things that don’t require a loan. Saving money is not a good option because money is rapidly losing value in real terms (i.e., purchasing power) in times of excessive inflation.
Unfortunately, when the Fed raises the cost of borrowing to stop excessive inflation, banks realize that the Fed is trying to slow the economy and start to worry about many possible loan defaults in the face of a slowing economy. At such times, banks cut back on loans and typically have excess reserves. Paying out additional interest on savings is just an unnecessary expense that banks don’t need and don’t want. They don’t want additional money because they are cutting back on loans. Consequently, most banks will not offer a savings rate sufficient to cover the excessive inflation, so any money you hold in savings will typically be losing value in real terms.
Without additional Congressional authorization, the Federal Reserve is stuck with a cost-of-borrowing tool that just transfers demand from things that require a loan to things that don’t require a loan. In other words, while it decreases demand for automobiles, houses, and students loans, it just transfers that demand to many other everyday items that people need. Overall demand is not reduced.
On the other hand, raising the cost of borrowing can discourage production and reduce supply, which is exactly the opposite of what is needed during excessive inflation when too much money is chasing too few goods. Retailers, farmers and other businesses that require loans to operate cut back on production, which means reducing worker hours and laying off some workers. Since workers cannot spend money they don’t have, the suppression of business activity ultimately results in an overall reduction in demand for goods and services. Excessive inflation is eventually eliminated, but only through a very slow and inefficient process.
The most important economic variable that is ignored in this process is the marginal propensity to consume. When people have more money than they need, their spending tends to flatten out since they can only wear one pair of shoes at a time, or drive one car at a time, and buying more that a couple of vacation homes or a lot more cars becomes a burden in maintenance and upkeep. Consequently, wealthy people tend to save and invest their money, especially if there are somewhat more risky investments that will cover inflation and offer a premium above the rate of inflation. Investors have to be able to ride out the ups and downs of the stock and bond markets to get sufficiently high returns on their savings.
The bottom line is that wealthy people have the lowest marginal propensity to consume because their needs are basically already met with their current spending patterns. If you are already going out to eat at expensive restaurants three times a day, it makes no sense to increase such eating to four or five times a day. What is left is to bid up the price of Picasso paintings or exclusive properties, but such increases in what economists call “rents” doesn’t directly increase the production of goods and services.
Whether one is trying to slow the economy to stop excessive inflation or stimulate the economy to get out of a recession, it makes much more sense to target the people with the highest marginal propensity to consume. The poor and the lower middle class people have by far the highest marginal propensity to consume. A high interest rate that provides a sufficiently high return on savings to not only cover inflation but offer a sufficiently high return above and beyond the rate of inflation is what is needed to get less well-to-do people to cut back on spending and save some money.
But the amount of savings that earns that high return must be limited to some relatively small amount (say, no more than $10,000) in order to avoid paying rich people for just moving their money around without cutting back on their demand for goods and services. Targeting the poor and lower middle class people, who are the ones with the highest marginal propensities to consume, provides the most bang for the buck in reducing the demand for goods and services to stop excessive inflation when too much money is chasing too few goods.
The Federal Reserve typically earns hundreds of billions of dollars each year from its operations and those of its twelve regional banks. It would not cost the tax payer a penny for the Federal Reserve to take responsibility for setting up and operating savings accounts at every post office. In times of excessive inflation the Fed’s postal savings accounts could offer a high savings rate to cover inflation and provide a premium above the inflation rate to attract as much money as possible from the people with the highest marginal propensity to consume (i.e., lower income people).
For example, a sign at the entrance of every post office offering 10 percent on savings could encourage people to save as much money as they could. Building up the savings of lower income people would not only help them when their hours were cut back or they lost their job, but would also provide an automatic stabilizer for the economy as a whole. The high savings rate would only apply to amounts up to a set amount, such as $10,000, so that more wealthy people would not bother moving large amounts of money around to take advantage of such a high interest rate on savings.
Conversely, in the event of a recession, the Federal Reserve could target the lower income people who are the ones with the highest marginal propensity to consume, instead of moving large amounts of money into the New York financial markets which primarily benefits the wealthy people, who are the ones with the lowest marginal propensity to consume. By sending money directly to each person with a Social Security number, the Federal Reserve would get a much greater bang for the buck than sending enormous amounts of money into the financial markets with the hope that some money would trickle down to bring about an increase in the demand for goods and services.
Congress needs to authorize the Federal Reserve to work directly with the people who have the highest marginal propensity to consume and stop wasting money in the financial markets to finally create a system that works efficiently, effectively and quickly to overcome excessive inflation or recessions. Post office savings accounts and direct Federal Reserve payments would greatly enhance our monetary policy system.
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