DAVID KESTENBAUM, HOST:
ROBERT SMITH: Yes.
KESTENBAUM: Do we need to put a warning on this next podcast?
SMITH: Why would we have a warning? Do you swear?
KESTENBAUM: No, it's about monetary policy and the Fed.
SMITH: Oh, do not listen while driving or operating heavy machinery.
KESTENBAUM: You've been warned.
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STEVE HENN, HOST:
OK, the Federal Reserve has this one magical thing it can do. It can create money out of nowhere.
KESTENBAUM: And in my mind, just because I have a small mind and I like to think about things in simple ways, I have always imagined that the Fed has this magical printer. And also, when it's time for the money to disappear, they have a shredder.
HENN: Yeah, and like the way things normally work, if the economy is struggling, the Fed will print some money and then when the economy recovers, the money goes into the shredder.
KESTENBAUM: And in normal times that is basically right, but after the financial crisis, the Fed created an enormous amount of money - over $3 trillion. You know, they were trying to keep the economy from collapsing. But today, the economy has basically recovered. So normally this would be the time to start throwing those $3 trillion into the shredder, otherwise eventually you'd risk getting inflation or you could get big bubbles in the economy that would pop.
HENN: And the folks at the Fed are right now talking about undoing all of that money creation. But they're not going to do it in the normal way. They're not going to use the shredder at all. In fact, they're going to leave all those trillions of dollars out there in plain sight.
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KESTENBAUM: Hello, and welcome to PLANET MONEY. I'm David Kestenbaum.
HENN: And I'm Steve Henn. Today on the show, how to make $3 trillion disappear without actually making it disappear.
KESTENBAUM: Can you actually do that, and what are the consequences?
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KESTENBAUM: Steve, I should say upfront that, like, this is one of those topics that is just fascinating, but it also just makes my head hurt because it is like talking about what happens to the laws of physics when you get close to a black hole.
HENN: Take me right up to the black hole. I'm with you.
KESTENBAUM: I can do that actually because we were allowed to go right up to the edge of the black hole. Back when the Fed was creating all this money, they invited me and Chana Joffe-Walt here at PLANET MONEY into the room where it was happening. They told us we were the first reporters allowed in there. And I don't really know what I pictured, but the room - it's basically just, like, a bunch of cubicles. You know, there was a stray, half-finished water bottle. There was a yoga ball. There was this pingpong trophy.
HENN: Was there a pingpong table?
KESTENBAUM: No, there was no table - just, like, a trophy. I don't know. There was - and there was no printer. What there were were economist types sitting around at computers.
UNIDENTIFIED MAN: Current price is $1.02, so you'd select the different counterparties.
KESTENBAUM: Here is how the Fed creates money out of nowhere.
HENN: The Fed is basically a bank for banks. Every bank in the country has an account at the Fed. So to make money, economists in this little room, they go into those accounts, they click a mouse and poof, they create billions of dollars.
KESTENBAUM: The Fed doesn't just give money for free to the banks. What it does is it buys bonds from the banks and it pays for those bonds with the money that it has created. So here - say, I'm the Fed and, Steve, say, you are a big bank.
KESTENBAUM: Steve, I would like to buy a billion dollars' worth of boring government bonds from you.
HENN: Well, all right. I will sell you a billion dollars' worth of bonds. Here you go.
KESTENBAUM: OK. All right, hang on a second. There you go. I just changed the numbers in your account. Now you've got an extra billion in cash.
HENN: Thank you very much.
KESTENBAUM: (Laughter) Richard Dzina at the New York Fed was one of the people walking us through this when we visited. He's executive vice president, and he says, that is it.
RICHARD DZINA: And voila, money is created.
KESTENBAUM: Basically you press a button and then in their account it says we have this much more money and they figure you're good for it.
KESTENBAUM: Does that seem weird to you at all after all these years?
DZINA: Yes, it is still a magical process.
KESTENBAUM: And that is how the Fed created all that money. The technical term for this was quantitative easing. So when you read that in the newspapers, you can now think of a bunch of economist types sitting in a room with a pingpong trophy staring at computer screens.
HENN: And in normal times, when the economy started getting better, the Fed would just reverse the whole process - basically do the entire thing backward.
KESTENBAUM: All right. Let's walk through it, right? I'm the Fed. I have those bonds I bought from you before. Now I'm going to sell the bonds back to you.
HENN: Will you give me a good price?
KESTENBAUM: I'm going to give you the market rate.
HENN: All right, fine.
KESTENBAUM: OK. Here you go. Here are the bonds, and there you go. I just subtracted a billion dollars from your account. Poof, it's gone into the black hole.
HENN: And that's how this works in normal times, but these are not normal times. Joe Gagnon is an economist at the Peterson Institute. He used to work at the Fed.
KESTENBAUM: Were you actually involved in putting that money out there?
JOE GAGNON: Yes, I was, in fact. I was managing the first round back in 2009
KESTENBAUM: Did you ever click the button to create money?
GAGNON: No, no, I didn't do that, but I was the person in Washington who reported on it to Bernanke and company.
HENN: We asked Gagnon why the Fed can't do what it normally does - click that mouse, sell the bonds, reverse the entire process - basically, roll out the shredder.
GAGNON: Well, they can and they haven't totally ruled it out, but it would be disruptive.
KESTENBAUM: Disruptive because a lot of what the Fed ended up buying with all that money was mortgage bonds. This was a really unusual thing for the Fed to do. Normally the Fed just buys boring government treasury bonds. But the idea was to try to help out the housing market. Mortgage bonds are collections of people's mortgages, so by buying them the Fed was basically lending people money to buy houses. It was lowering interest rates for people trying to get mortgages. It made it easier for people to buy homes.
So if you were to click a mouse and sell a trillion dollars' worth of these bonds, that would cause trouble.
GAGNON: Yes, especially in mortgage markets. 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.
HENN: And the U.S. doesn't need another housing mess. Gagnon says there's a way out of this. The Fed has a trick, a way basically to make that money vanish without really taking it out of the economy.
KESTENBAUM: Here it is. You ready? The Fed is going to pay banks to sit on that money. The Fed will say, hey, J.P. Morgan Chase, Citibank, Bank of America, you already keep your extra cash here at the Fed. Collectively, it's this giant pile of money - trillions of dollars. We're going to pay you to keep it here.
HENN: So there's a complicated technical term for this. It's called interest on excess reserves and basically it means that those $3 trillion out there in the economy, the banks will sit on it. It will be invisible.
KESTENBAUM: It does feel like a magic trick.
GAGNON: It is a bit of a magic trick, yes.
HENN: Gagnon says on paper this should work. It should do exactly what the Fed wants. The whole reason the Fed wants to take money out of the economy in the first place is to basically apply the brakes to the economy so all that money it created doesn't cause a bubble or inflation.
KESTENBAUM: If the banks are getting paid to sit on the money, they are less likely to loan out into the economy. It's just like if you had money in a savings account. If the savings account didn't pay any interest, you might be like, oh, what the heck, I'm going to take the money out and do something with it. But if you're going to earn interest on the money while it's sitting there, if the account pays 1 percent or 2 percent or 3 percent, you are more likely to just leave the money there.
HENN: But there is this one little awkward piece to this. The Fed will be paying the banks money to basically do nothing, the very banks that many argue helped get us into this entire mess to start with
KESTENBAUM: Gagnon figures that by next year, the Fed will probably be paying the banks 1 percent on the extra cash they have, as a disincentive to lend it out. But that 1 percent, it adds up.
GAGNON: So 1 percent of a trillion is about 10 billion, so 1 percent of 3 trillion would be about 30 billion.
KESTENBAUM: So ever year they'd be paying...
GAGNON: Every year they'd be paying the banks $30 billion.
HENN: When I heard about this, when we figured this out for the first time, it just sounded like a huge gift to the banks. And, David, you and I got in this long, drawn out argument about this.
KESTENBAUM: Yeah, I wasn't so sure because, you know, the whole idea is that if banks can suddenly get 1 percent interest on the cash they have sitting around, they will also end up having to pay out more 'cause, you know, people have savings accounts at banks and you could imagine the banks end up having to pay more on those savings accounts because if banks can suddenly get 1 percent on cash they have just sitting around, some bank is going to turn around to all the depositors and say, hey, everybody, move your savings accounts to my bank. You know, we're going to pay you more interest. In fact, this is the whole reason the Fed is going to pay banks interest. It is trying to raise interest rates throughout the economy. So you could imagine that for banks, this all kind of comes out in the wash. In fact, Janet Yellen, the current Fed chair, has said this will not be a subsidy to banks.
HENN: But we talked to Joe Gagnon about this and he kind of sided with me. You know, he thinks that some of this money will be passed on to people with savings accounts, but probably not all of it.
GAGNON: They can't do nothing. It's going to be hard for them to do nothing. But I suspect it will not all get passed through.
KESTENBAUM: Gagnon says there is a legitimate debate about this and we're just going to have to wait to see how it shakes out. But I wanted to know, like, how should we feel about it? So we called up another central bank expert.
DAVID BLANCHFLOWER: I'm David Blanchflower. I'm a professor of economics at Dartmouth College and an ex-member of the Monetary Policy Committee at the Bank of England.
KESTENBAUM: England's central bank.
BLANCHFLOWER: Yes, sir.
HENN: So we asked Blanchflower if paying interest to banks benefits banks, increases their profit and they're not doing anything, is that fair?
BLANCHFLOWER: I'm not going there.
KESTENBAUM: (Laughter) Why not?
BLANCHFLOWER: I'm not going there. I mean, in economics, there's (laughter) fairness is not anything I know about. I'm going to pass on it.
KESTENBAUM: Come on.
BLANCHFLOWER: No, I'm passing on it. I mean, economists are not good at what's fair, right? I mean, the perfect - what's the famous phrase? OK, the optimal allocation of resources may still be perfectly disgusting.
BLANCHFLOWER: Now try that (unintelligible). There's a famous quote. Good try though (laughter).
KESTENBAUM: I get this. I mean, the truth is that whenever the Fed does anything, it hurts some people and it helps other people. I happened to buy a house during all this. I got a very low interest rate on my mortgage. I didn't really do anything to deserve that. I just got it.
HENN: And everyone we talked to said, look, the Fed has much bigger things to think about. Its job is to keep the entire economy on track for the benefit of everyone. It's supposed to do these two things - maximize employment - make sure everyone has a job who can get a job - and keep prices stable, keep inflation from taking off.
KESTENBAUM: Fairness is just not in there.
HENN: OK, so I get that, but we also have another big question. Will this plan work? I mean, if you think about the economy as a car traveling down a highway, basically the Fed has reengineered the brakes on that car and it is has not used them yet. And it's about to tap the brakes for the first time.
KESTENBAUM: We asked everybody we talked to, like, is this plan going to work? David Blanchflower said he was basically not worried. He says paying banks to sit on money - that has been done in other countries. It's been done in Canada and Sweden and it has worked fine. But he says what the Fed is doing at this scale, this whole quantitative easing thing, this is uncharted territory.
BLANCHFLOWER: When we started to do QE, we had this - the economists come in and say to us - we'd say, well, how do we do it? What do we buy? How much do we buy? What's the unit? What's the lot of money? How quickly do we do it? How do we get out? And they'd say no idea. There's no economics really to tell you. So if that was true on the way in, it's also true on the way out.
KESTENBAUM: I've heard this kind of thing a lot. You know, I've read it in a lot of press reports about what the Fed has done. You know, we're in uncharted territory. This stuff is not in the textbooks. But when you ask the next question, you dig in to what the concerns are, they're always really small. It's like, well, we're not sure these brakes on the car are going to work quite as well or quite as smoothly as the normal brakes. Like, no one's worried that it's not going to work or that the car is somehow going to crash. We asked David Blanchflower, give us the name of one reasonable person who has a big, serious concern.
BLANCHFLOWER: There aren't any (laughter). Who's a reasonable person? It's pretty hard to find many.
KESTENBAUM: There must be one person. Give me one name.
BLANCHFLOWER: One name - oh, I don't know Glenn Hubbard, Glenn Hubbard.
GLENN HUBBARD: What doesn't worry me from a technical perspective...
HENN: This is Glenn Hubbard, dean of Columbia's Business School. He chaired the Council of Economic Advisers under President George W. Bush. He was happy to talk - also not worried about the Fed's plan.
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.
KESTENBAUM: Steve, I give up.
HENN: Hubbard basically agrees with Blanchflower. The only difference they have is on timing. Hubbard would like the Fed to tap the brakes now. Blanchflower says we should be careful and wait a bit.
KESTENBAUM: Eventually those trillions of dollars that the Fed created will come back out of the economy. That is the plan. They'll either use the shredder slowly over time or they'll just let the bonds expire, which eventually happens. But Joe Gagnon says this may not for another 10 years, which is amazing even to him.
GAGNON: If you had asked me when I was working in this six years ago if we'd still be in this position six years later, I would never have believed you. It is truly amazing in that sense. No one would have predicted this - no one.
KESTENBAUM: I suppose it's a testimony to how big a mess this was.
GAGNON: Yeah, it is, it is.
HENN: As dramatic as the creation of all that money was, the undoing of it may not be something you even notice, just someone gently keeping their foot on the brake so this car, our economy, doesn't get going too fast.
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KESTENBAUM: And just to head off the emails that I'm sure are on their way from the supernerds out there - yes, we left out one tool that the Fed seems like it will use called overnight reverse repo agreements - sorry about that. Actually, I'm not sorry. You can Google it if you're interested.
HENN: Email us at email@example.com or tweet us - @planetmoney.
KESTENBAUM: Our show today was produced by Alex Goldmark. Thank you, Alex. Also one final note, we are looking for a new intern. Interns are really important here at PLANET MONEY. They help out with everything, transcribing interviews, doing research for us, they sit in and help with edits, they taste cookies and decide which tastes better, Hydrox or Oreo. And it pays. If you want to apply, just Google PLANET MONEY intern.
HENN: A quick correction - in our Bubblelicious episode, the developers of the Salesforce Tower in San Francisco claimed it would soon be the tallest building west of the Mississippi. Our listeners in LA wrote in pointing out that the spire of the new Wilshire Grand Center going up in downtown would actually be a bit taller.
KESTENBAUM: I love that people are fighting over that.
HENN: I know.
KESTENBAUM: And if you're looking for another show to try, check out StoryCorps. It's unscripted stories about real life. You can find the StoryCorps podcast now at npr.org/podcasts and on the NPR One app. I'm David Kestenbaum.
HENN: And I'm Steve Henn. Thanks for listening.
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