How Do You Make $3 Trillion Disappear? The Fed Will Soon Find Out
AUDIE CORNISH, HOST:
The Federal Reserve is the one institution with the power to create money out of thin air. And after the financial crisis, the Fed did a lot of that. It created more than $3 trillion to try to lower interest rates and help the economy. Now that things are looking better, this would normally be the time to suck that money back out of the economy so it doesn't cause inflation or bubbles. But, as David Kestenbaum with our Planet Money podcast explains, the Fed is not going to take the money out of the economy. Instead, it's going to use a new trick to make that money disappear.
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 the economy, the Fed would have to reverse that.
GAGNON: 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, helped 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 (laughter) not going there.
KESTENBAUM: (Laughter). Why not?
BLANCHFLOWER: Economists - 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? OK. The optimal allocation of resources may still be perfectly disgusting. Now try that on you. There'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 a technical perspective.
KESTENBAUM: This is Glenn Hubbard, Dean of Columbia Business School, chaired 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 that was out there and how they were going to eventually, you know, suck it back out.
HUBBARD: No. No.
KESTENBAUM: Hubbard's worry is just that the Fed will wait too long before raising interest rates. He thinks the time is now, David Blanchflower thinks the Fed should wait a bit longer. David Kestenbaum, NPR News.
NPR transcripts are created on a rush deadline by Verb8tm, Inc., an NPR contractor, and produced using a proprietary transcription process developed with NPR. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of NPR’s programming is the audio record.