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Home Publications Blogs CEPR Blog It's the Fed, not the TARP

It's the Fed, not the TARP

Written by John Schmitt   
Sunday, 12 December 2010 15:23


Mary Bottari has a good post on the Federal Reserve Bank’s role in the ongoing financial bailout. The media and voters have focused on the Troubled Asset Relief Program (TARP) legislation passed in a hurry late in 2008. But, as Bottari emphasizes, the TARP is only a minor part of the federal bailout of the banks.
As she writes: “TARP funds were a mere seven percent of total funds disbursed by federal government to aid the financial sector since 2007 … the more we focus on the much-despised TARP, the less we see the invisible hand of the Fed doing the heavy lifting.”

The most important elements of the government intervention on behalf of the financial sector have been Fed actions: low interest rates and Fed asset purchases. Rock-bottom interest rates have allowed banks to borrow money from the Fed at close to no cost and then to lend those funds to the Treasury at a several-percent, zero-risk, profit. (Maybe we should allow unemployed workers to form “banks” like these. It would take a lot of pressure off state unemployment insurance systems.)

The Fed has also purchased a lot of troubled assets from financial institutions, helping to clear those bad loans from the private sector’s balance sheets in quantities that dwarf the Bush administration’s TARP.

Where I differ from Bottari is on the implications for taxpayers. She argues that the Fed’s actions put taxpayers at risk. But, even if every asset the Fed bought suddenly lost all its value, US taxpayers need not be on the hook for any of the losses. The Fed has limitless ability to print money. The only risk here is that the Fed’s actions increase the money supply and that this results in inflation. But, as with other discussions of Fed policy (quantitative easing, for example), the challenge we face now is deflation, not inflation, so the risks are slight.

This article originally appeared on John Schmitt's blog, No Apparent Motive.

Comments (3)Add Comment
No potential loss for taxpayers ?????????
written by Ralph Musgrave, December 15, 2010 12:07
The suggestion in the last para above that there is no risk for taxpayers is nonsense.

If the Fed prints $4.5 trillion (the figure in the above graph), that results in a HUGE addition to aggregate demand. Assuming constant AD, $4.5 (or the interest on it) will have to be withdrawn from the rest of the economy, which most certainly DOES cost the taxpayer. Alternatively, if the $4.5 trillion is NOT balanced by a withdrawal (i.e. if it constitutes an ADDITION to AD), then the money is additional money to which ordinary citizens and taxpayers have a far better moral claim than the relatively few wealthy individuals who own shares in incompetently run banks.

If $X trillion extra taxes were collected from taxpayers and given to Bill Gates, you could say that this costs taxpayers nothing, because Bill Gates is a U.S. taxpayer. I.e. there is no gain or loss in the aggregate for U.S. taxpayers. I doubt there is one single person in the U.S. who would regard the statement in the first sentence of this paragraph “this costs U.S. taxpayers nothing” as anything other than nonsense.

Also the figure could be far more than $4.5 trillion. The figure $9 trillion is mentioned here: http://www.youtube.com/watch?v...ture=email

No need for taxpayers to be liable
written by John Schmitt, December 16, 2010 8:05
On the issue of aggregate demand: we have about 15 million people who are unemployed and another 10 million, at least, who are working part-time even though they want full-time work or who have just given up looking for work. The capacity utilization rate is only about 75 percent, which means that about 25 percent of our plants, machinery, and production facilities are idle. These circumstances are a direct result of the massive collapse in aggregate demand that began at the end of 2007. A big increase in aggregate demand is exactly what we need right now. If we were running close to full employment, this kind of action would likely lead to inflation, but where we are now, increasing aggregate demand will only reduce unemployment and get the economy back on its feet.

On the issue of "taxpayers": to be clear, we need not be liable for any of the increase in spending by the Federal Reserve. If the Treasury spends money, we as taxpayers are liable. But, the Fed regulates the money supply by increasing and decreasing it in response to the state of the economy. If the Fed increases the money supply, that money is created by fiat by the Fed, it isn't extracted from taxpayers or anywhere else.

The Fed's actions have given an enormous gift to the financial sector. We could have used the same Fed resources for other purposes --to rebuild our infrastructure, to improve home insulation, to promote green energy, to pay for universal child chare.

Because the economy is operating so far below its capacity, we really have a "free lunch." High unemployment and low capacity utilization mean we are currently wasting enormous resources. Mobilizing those resources --by printing money and using that money to finance a federal deficit in the short run-- gives us an opportunity to improve the economy and solve some long-standing problems. Unfortunately, we've decided to give the free lunch to Wall Street.
Taxpayers versus bank shareholders.
written by Ralph Musgrave, December 20, 2010 7:39
Hello John, I fully appreciate that the US needs extra demand, and that having the Fed / government print and somehow spend an extra trillion or so would be beneficial. I also realise this money is not a cost on any normal meaning of the word, assuming the money is allocated in the best possible way (which in my opinion involves channelling stimulus to Main Street, not Wall Street).

However I think Mary Bottari’s “taxpayer on the hook” point is valid. She is saying that if the money is allocated to bailing out junk mortgages and by extension the bank shareholders who own the junk, then taxpayer / citizens have been cheated.

To illustrate, suppose banks suddenly realise on day that their mortgages are worthless (as per your last paragraph). Aggregate demand would slump in consequence. The proper solution is to let the banks hang out to dry (which is what Walter Bagehot would have recommended), and channel stimulus to households / taxpayers. If instead of that, stimulus is channelled to banks then, dollar for dollar, bank shareholders gain at the expense of ordinary households / taxpayers.

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