Isn't the really obvious consumption tax we should raise the gas tax?
Hell, I wouldn't mind a system where when we need to slow things down we increase gas taxes and when we need to speed them up increase SNAP funding both as one way rachets.
I disagree with your conclusions ... but the problem is you have some fundamental misunderstandings about macroeconomics and monetary policy. No wonder you come to the conclusions you do, based on those initial errors!
The "primary way" that the Fed changes interest rates is NOT by changing the interest paid on reserves. (Prior to 2008, IOER was almost never used. Fed monetary policy got a little more complicated after 2008, that's true, but you should start with the usual case before you complicate it.) Instead, the actual "primary way" the Fed changes interest rates is by first changing the quantity of the money supply, via Open Market Operations (buying and selling financial assets).
The Federal Funds Rate is NOT the rate that the Fed pays on reserves. Please! Look it up! Use Wikipedia! The FFR is a FREE MARKET rate, that commercial banks charge EACH OTHER for loans. It is NOT a rate "set" by the Fed. It is instead "targeted" by the Fed. And the Fed achieves this target by changing the money supply.
You then assume that bank lending, via interest rates, is the primary monetary policy transmission mechanism. This is wrong. The primary mechanism is the Hot Potato Effect, due to changes in the money supply. Changes in the Fed's interest rate TARGET are a COMMUNICATIONS mechanism, to indicate the stance of monetary policy (stimulus or contraction). That does not at all mean that they are the cause of changes in an economy. (In fact, free market prices -- like the FFR interest rate -- only balance supply and demand; they can never be the "cause" of ANYTHING. That is a fundamental economic error of "reasoning from a price change".)
I could go on and on. Friedman was wrong about "long and variable lags"; in fact, since "expectations" are actually the most powerful part of monetary policy, it typically acts with "long and variable LEADS" instead: the economy changes BEFORE the Fed engages in any concrete actions (OMOs), in anticipation of those coming actions.
I completely disagree with your preference for fiscal policy, but let me also mention how odd your Constitutional concern about taxation is. You're of course right that the Constitution gives Congress the power to levy taxes. Let me ask you why the Fed is allowed to manage the money supply. Article I, Section 8, Clause 5 clearly also gives Congress the power "To coin Money, regulate the Value thereof". And yet Congress then passed the Federal Reserve Act, and delegated this power to the Fed. Surely delegating taxation to the Fed would be no better or worse than the current delegation of money creation. Either both would be Constitutional, or else neither should be. There's no principle by which "money" is ok for Congress to delegate but "taxes" aren't.
While you are certainly right about the nature of how the fed targets the FFR I'm not seeing why it really matters. In practice by increasing or decreasing the money available to banks via repo agreements and the like don't they set interest rates making that a reasonably good first approximation to explain it.
And yes, technically the FFR is a free market rate, but as you point out the targeted FFR is not and setting that target *does* have both effects directly via expectations and via the free market ops that are applied to bring the FFR into the targeted range.
So sure, in some sense the cause is the setting of the rate target and the subsequent free market operations that bring the FFR into agreement but is there any harm to speaking loosely about the FFR causing changes?
The difference between "setting" a rate and "targeting" a rate is enormous. It "really matters", because this mistake allows the authors of the post to argue -- incorrectly, but plausibly given the fundamental error -- that the mechanism is that "higher interest rates make it more expensive to borrow..." and that "it's odd to fight inflation with a tool that so directly hammers investment ... investment is how economic productivity increases. It's what grows the supply side of the economy and ultimately allows for higher living standards." That entire argument sounds persuasive -- and is entirely wrong. For exactly this reason.
Go back to Econ 101, supply and demand. If the government "set" any price floor (e.g. rent control), the economic consequence is deadweight loss and shortages. Even though the price of apartments is fixed, you'll find that there are no apartments available at the advertised price, and there's also a thriving black market of non-price mechanisms for allocating the scarce apartments that are available.
That is NOT what is happening with bank lending, credit, and interest rates. The FFR is a free market rate. It balances supply and demand. There are no shortages.
The central bank has one main tool: changes in the money supply. Using this tool, they could target ANY nominal price in the economy. The price of gold; the price of oil; the price of grapes or concrete. What they are doing is using money supply changes in order to change aggregate demand, and changing demand changes the price level. Of ALL prices. The fact that they communicate this monetary policy by saying "we will change the money supply until the FFR rate hits our target", is no different economically from saying "we will change the money supply until the price of grapes hits our target". In either case, they either increase or decrease the money supply, until the overall economy changes enough (everywhere!), that their one targeted price (FFR, or grapes) reaches their desired level. In NEITHER case is the mechanism of "bank lending" (via interest rates) a particularly important causal factor for the changes in the economy.
The "harm to speaking loosely" about interest rates causing changes, is that it leads to exactly the false conclusions in the post. It leads to the false idea that monetary contraction preferentially affects interest-rate sensitive industries; the false idea that it crushes the supply side right when you want to invest and grow supply; and the false idea in the conclusion that fiscal policy would be a better inflation-fighting tool than monetary policy. All of those are wrong, and the core of why they are wrong is the complete misunderstanding of how monetary policy actually works.
Arguably congress already delegates taxing power as I believe it lets the treasury set various limits and values via regulation and I suspect it could just do that with rates as well.
I'm not sure how politically palatable it would be to increase prices even more by raising consumption taxes when prices are already increasing too fast for people's comfort.
Under this policy, price increases due to inflation will be faster and larger, but presumably stop increasing sooner. Is this what the average person wants? People complaining about the prices of things will be even more impacted by faster and larger price increases.
I’m sure it won’t happen, but I’d love to see Congress and Biden eliminate the cap on the Social Security payroll tax, with no corresponding increase in benefits. Not only would it fight inflation, it would buy time to debate other changes to keep Social Security solvent.
Out of curiosity, did the super-high federal funds rate in the early 80s (peaking at 20%) blow up any medium-to-large banks?* If not, does anyone know why?
* (If I understand correctly, the high rates played a role in the S&L crisis, which blew up a lot of savings and loans associations, which are basically little banks that mostly make long-term loans.)
Leaving aside the unreality of this proposal, as our authors readily admit, would we *want* to put management of the business cycles entirely in the hands of technocrats? We've already gone halfway in that direction, with Fed control of interest rates, but would it make sense to give them the other, fiscal, tool to do so as well?
I'm a good government, solid Democrat type of person, and I quail at that prospect. I don't fully trust people who are entirely removed from the political (i.e., democratic) process.
Late to the party yet again due to being a person experiencing Westernness, so likely again just one brief top level comment before I move for the day.
I was prepared to fiercely disagree with the article based upon the two headlines, but this is why "did you even read the article" matters, my anticipated disagreement was lowered. I strongly agree that increasing aggregate supply should always be the first tactic to take, but barring that, monetary policy via interest rate adjustment should take on the lion's share of the policy, and I don't find that weird at all--with fiscal policy via tax increases being a last resort. I do agree that such an increase, like all tax policy should be, should be very neutral on source so we don't devolve into political arguments, though instead of a VAT I'd prefer something structured like FICA but with no cap on taxable income.
Also, the paragraph about delegating tax increases to the Fed being dead on arrival at this Supreme Court is dead on correct, and it gave me some chills that, if this SCOTUS is going to go off on the rails on the non-delegation doctrine, it could very well be receptive to an ultra-libertarian argument that the Fed changing rates without being subject to the political process is unconstitutional. And if that happened...RIP the economy while politicians bicker over it.
The primary way the Federal Reserve does this is raising or lowering the interest paid on banks' reserve balances at the Fed, which passes through to other interest rates in the financial system and the broader economy. The idea is that when the Federal Funds Rate changes, other interest rates throughout the economy change in the same direction.
Pretty sure this is wrong. The Fed Fund's rate isn't the rate on reserve accounts (the Fed didn't pay interest on reserve accounts until pretty recently). The Fed Funds rate is what banks charge each other for over night loans to meet reserve requirements. Also the Fed doesn't set it. They target it, and try to meet that target trading short term debt (mostly treasuries) on the open market.
One unspoken advantage of interest rates as policy is they ripple out automatically - they don't require anyone to do anything specific.
I do software development, and I can tell you that it would take a lot of extra effort to get everyone in compliance with a VAT that can change arbitrarily week-by-week. Obviously this isn't impossibly hard, especially for modern systems. But it would be a nightmare for people with older systems that wouldn't be designed to handle something that complicated.
You'd need to have rules around how rapidly you need to be in compliance with a VAT change. Make that window short, and lots of people will yell that you're being unfair and making unreasonable demands. Make the window long and savvy operators will exploit that to the hilt to minimize their VAT payments.
Interest rates have been artificially low for a long time. I'm not THAT old but I can remember when you could routinely get 5% interest from an ordinary savings account.
That the interest rate on savings dropped to essentially zero was the result of so-called "quantitative easing" - printing money to finance chronic budget deficits. You can argue whether spending was too high or taxes too low, but these deficits were, and still are, the root of many economic evils.
This whole mess has been caused by the greed behind these artificially low rates. I'm all for the variable consumption tax proposed in the article. It would control deficits by raising revenue and allowing the Fed to keep rates higher. You should have to pay interest to borrow money. It's a service. You should be able to balance your portfolio betweens cash, bonds, and equities in order to manage the risk of economic cycles. The last 10-15 years has been a stupid bubble created by this Wall Street/Washington revolviing door. Outsourcing R&D and the risk associated with it to venutre capitialists and private equity should never have passed any smell test.
The current tax code is written and maintained by lawyers and accountants whose livlihoods depend in its complexity. Imagine what we could do if we put back all of the money the investment bankers, lawyers, advisors, and accountants suck out of the economy. Algorithims could set interest and tax rates and do a much better job than Jerome Powell. Collecting a consumption tax would be easy, just another transaction fee. It would also free up everyone to quit obsessing on interest and taxes so they can focus on generating profits by running their business effectively, investing smart, and spending within their means, which will grow our economy just as well or better than propping up spending with easy money.
Sorry for the Utopian rant, but the stupidity of the past year has been tough to take.
Seems like getting a VAT, in the USA, would be harder than adding auto stabilizers onto the VAT. VAT is nice cuss at least you're letting ppl opt into being savers (the whole time portion of spending), using a payroll tax....would not go over well.
Congress tried a luxury tax in the 90s. It failed miserably. Rich people just bought their yachts and jewelry in Europe, and our domestric ship building industry crashed.
I think the reason why we outsource inflation fighting to the fed is raising taxes is unpopular while the fed raising interest rates is opaque and detached. Biden can pretend he wouldn’t have made the call to not acknowledge it when in reality HE nominated Powell.
“To really reduce inflation via tax policy requires either dramatically higher taxes on the rich...”
good article, but what is the reasoning for this claim?
Isn't the really obvious consumption tax we should raise the gas tax?
Hell, I wouldn't mind a system where when we need to slow things down we increase gas taxes and when we need to speed them up increase SNAP funding both as one way rachets.
I disagree with your conclusions ... but the problem is you have some fundamental misunderstandings about macroeconomics and monetary policy. No wonder you come to the conclusions you do, based on those initial errors!
The "primary way" that the Fed changes interest rates is NOT by changing the interest paid on reserves. (Prior to 2008, IOER was almost never used. Fed monetary policy got a little more complicated after 2008, that's true, but you should start with the usual case before you complicate it.) Instead, the actual "primary way" the Fed changes interest rates is by first changing the quantity of the money supply, via Open Market Operations (buying and selling financial assets).
The Federal Funds Rate is NOT the rate that the Fed pays on reserves. Please! Look it up! Use Wikipedia! The FFR is a FREE MARKET rate, that commercial banks charge EACH OTHER for loans. It is NOT a rate "set" by the Fed. It is instead "targeted" by the Fed. And the Fed achieves this target by changing the money supply.
You then assume that bank lending, via interest rates, is the primary monetary policy transmission mechanism. This is wrong. The primary mechanism is the Hot Potato Effect, due to changes in the money supply. Changes in the Fed's interest rate TARGET are a COMMUNICATIONS mechanism, to indicate the stance of monetary policy (stimulus or contraction). That does not at all mean that they are the cause of changes in an economy. (In fact, free market prices -- like the FFR interest rate -- only balance supply and demand; they can never be the "cause" of ANYTHING. That is a fundamental economic error of "reasoning from a price change".)
I could go on and on. Friedman was wrong about "long and variable lags"; in fact, since "expectations" are actually the most powerful part of monetary policy, it typically acts with "long and variable LEADS" instead: the economy changes BEFORE the Fed engages in any concrete actions (OMOs), in anticipation of those coming actions.
I completely disagree with your preference for fiscal policy, but let me also mention how odd your Constitutional concern about taxation is. You're of course right that the Constitution gives Congress the power to levy taxes. Let me ask you why the Fed is allowed to manage the money supply. Article I, Section 8, Clause 5 clearly also gives Congress the power "To coin Money, regulate the Value thereof". And yet Congress then passed the Federal Reserve Act, and delegated this power to the Fed. Surely delegating taxation to the Fed would be no better or worse than the current delegation of money creation. Either both would be Constitutional, or else neither should be. There's no principle by which "money" is ok for Congress to delegate but "taxes" aren't.
While you are certainly right about the nature of how the fed targets the FFR I'm not seeing why it really matters. In practice by increasing or decreasing the money available to banks via repo agreements and the like don't they set interest rates making that a reasonably good first approximation to explain it.
And yes, technically the FFR is a free market rate, but as you point out the targeted FFR is not and setting that target *does* have both effects directly via expectations and via the free market ops that are applied to bring the FFR into the targeted range.
So sure, in some sense the cause is the setting of the rate target and the subsequent free market operations that bring the FFR into agreement but is there any harm to speaking loosely about the FFR causing changes?
The difference between "setting" a rate and "targeting" a rate is enormous. It "really matters", because this mistake allows the authors of the post to argue -- incorrectly, but plausibly given the fundamental error -- that the mechanism is that "higher interest rates make it more expensive to borrow..." and that "it's odd to fight inflation with a tool that so directly hammers investment ... investment is how economic productivity increases. It's what grows the supply side of the economy and ultimately allows for higher living standards." That entire argument sounds persuasive -- and is entirely wrong. For exactly this reason.
Go back to Econ 101, supply and demand. If the government "set" any price floor (e.g. rent control), the economic consequence is deadweight loss and shortages. Even though the price of apartments is fixed, you'll find that there are no apartments available at the advertised price, and there's also a thriving black market of non-price mechanisms for allocating the scarce apartments that are available.
That is NOT what is happening with bank lending, credit, and interest rates. The FFR is a free market rate. It balances supply and demand. There are no shortages.
The central bank has one main tool: changes in the money supply. Using this tool, they could target ANY nominal price in the economy. The price of gold; the price of oil; the price of grapes or concrete. What they are doing is using money supply changes in order to change aggregate demand, and changing demand changes the price level. Of ALL prices. The fact that they communicate this monetary policy by saying "we will change the money supply until the FFR rate hits our target", is no different economically from saying "we will change the money supply until the price of grapes hits our target". In either case, they either increase or decrease the money supply, until the overall economy changes enough (everywhere!), that their one targeted price (FFR, or grapes) reaches their desired level. In NEITHER case is the mechanism of "bank lending" (via interest rates) a particularly important causal factor for the changes in the economy.
The "harm to speaking loosely" about interest rates causing changes, is that it leads to exactly the false conclusions in the post. It leads to the false idea that monetary contraction preferentially affects interest-rate sensitive industries; the false idea that it crushes the supply side right when you want to invest and grow supply; and the false idea in the conclusion that fiscal policy would be a better inflation-fighting tool than monetary policy. All of those are wrong, and the core of why they are wrong is the complete misunderstanding of how monetary policy actually works.
Arguably congress already delegates taxing power as I believe it lets the treasury set various limits and values via regulation and I suspect it could just do that with rates as well.
I'm not sure how politically palatable it would be to increase prices even more by raising consumption taxes when prices are already increasing too fast for people's comfort.
Under this policy, price increases due to inflation will be faster and larger, but presumably stop increasing sooner. Is this what the average person wants? People complaining about the prices of things will be even more impacted by faster and larger price increases.
Repeat after me: "Inflation is always and everywhere a monetary phenomenon."
I’m sure it won’t happen, but I’d love to see Congress and Biden eliminate the cap on the Social Security payroll tax, with no corresponding increase in benefits. Not only would it fight inflation, it would buy time to debate other changes to keep Social Security solvent.
Out of curiosity, did the super-high federal funds rate in the early 80s (peaking at 20%) blow up any medium-to-large banks?* If not, does anyone know why?
* (If I understand correctly, the high rates played a role in the S&L crisis, which blew up a lot of savings and loans associations, which are basically little banks that mostly make long-term loans.)
Leaving aside the unreality of this proposal, as our authors readily admit, would we *want* to put management of the business cycles entirely in the hands of technocrats? We've already gone halfway in that direction, with Fed control of interest rates, but would it make sense to give them the other, fiscal, tool to do so as well?
I'm a good government, solid Democrat type of person, and I quail at that prospect. I don't fully trust people who are entirely removed from the political (i.e., democratic) process.
Isn't the big problem that VATs are very regressive?
Late to the party yet again due to being a person experiencing Westernness, so likely again just one brief top level comment before I move for the day.
I was prepared to fiercely disagree with the article based upon the two headlines, but this is why "did you even read the article" matters, my anticipated disagreement was lowered. I strongly agree that increasing aggregate supply should always be the first tactic to take, but barring that, monetary policy via interest rate adjustment should take on the lion's share of the policy, and I don't find that weird at all--with fiscal policy via tax increases being a last resort. I do agree that such an increase, like all tax policy should be, should be very neutral on source so we don't devolve into political arguments, though instead of a VAT I'd prefer something structured like FICA but with no cap on taxable income.
Also, the paragraph about delegating tax increases to the Fed being dead on arrival at this Supreme Court is dead on correct, and it gave me some chills that, if this SCOTUS is going to go off on the rails on the non-delegation doctrine, it could very well be receptive to an ultra-libertarian argument that the Fed changing rates without being subject to the political process is unconstitutional. And if that happened...RIP the economy while politicians bicker over it.
The primary way the Federal Reserve does this is raising or lowering the interest paid on banks' reserve balances at the Fed, which passes through to other interest rates in the financial system and the broader economy. The idea is that when the Federal Funds Rate changes, other interest rates throughout the economy change in the same direction.
Pretty sure this is wrong. The Fed Fund's rate isn't the rate on reserve accounts (the Fed didn't pay interest on reserve accounts until pretty recently). The Fed Funds rate is what banks charge each other for over night loans to meet reserve requirements. Also the Fed doesn't set it. They target it, and try to meet that target trading short term debt (mostly treasuries) on the open market.
https://en.wikipedia.org/wiki/Federal_funds_rate
One unspoken advantage of interest rates as policy is they ripple out automatically - they don't require anyone to do anything specific.
I do software development, and I can tell you that it would take a lot of extra effort to get everyone in compliance with a VAT that can change arbitrarily week-by-week. Obviously this isn't impossibly hard, especially for modern systems. But it would be a nightmare for people with older systems that wouldn't be designed to handle something that complicated.
You'd need to have rules around how rapidly you need to be in compliance with a VAT change. Make that window short, and lots of people will yell that you're being unfair and making unreasonable demands. Make the window long and savvy operators will exploit that to the hilt to minimize their VAT payments.
Interest rates have been artificially low for a long time. I'm not THAT old but I can remember when you could routinely get 5% interest from an ordinary savings account.
That the interest rate on savings dropped to essentially zero was the result of so-called "quantitative easing" - printing money to finance chronic budget deficits. You can argue whether spending was too high or taxes too low, but these deficits were, and still are, the root of many economic evils.
I think low rates were more a function of population aging.
This whole mess has been caused by the greed behind these artificially low rates. I'm all for the variable consumption tax proposed in the article. It would control deficits by raising revenue and allowing the Fed to keep rates higher. You should have to pay interest to borrow money. It's a service. You should be able to balance your portfolio betweens cash, bonds, and equities in order to manage the risk of economic cycles. The last 10-15 years has been a stupid bubble created by this Wall Street/Washington revolviing door. Outsourcing R&D and the risk associated with it to venutre capitialists and private equity should never have passed any smell test.
The current tax code is written and maintained by lawyers and accountants whose livlihoods depend in its complexity. Imagine what we could do if we put back all of the money the investment bankers, lawyers, advisors, and accountants suck out of the economy. Algorithims could set interest and tax rates and do a much better job than Jerome Powell. Collecting a consumption tax would be easy, just another transaction fee. It would also free up everyone to quit obsessing on interest and taxes so they can focus on generating profits by running their business effectively, investing smart, and spending within their means, which will grow our economy just as well or better than propping up spending with easy money.
Sorry for the Utopian rant, but the stupidity of the past year has been tough to take.
Seems like getting a VAT, in the USA, would be harder than adding auto stabilizers onto the VAT. VAT is nice cuss at least you're letting ppl opt into being savers (the whole time portion of spending), using a payroll tax....would not go over well.
Congress tried a luxury tax in the 90s. It failed miserably. Rich people just bought their yachts and jewelry in Europe, and our domestric ship building industry crashed.
I think the reason why we outsource inflation fighting to the fed is raising taxes is unpopular while the fed raising interest rates is opaque and detached. Biden can pretend he wouldn’t have made the call to not acknowledge it when in reality HE nominated Powell.