Sunday, April 19, 2009

And Yet He Still Has A Job?

Bush advisor, Harvard professor and "economist" N. Gregory Mankiw shares a harebrained idea for inspiring people to spend. It amounts to a 10% tax on savings,1 although its implementation is murky. Mankiw suggests that the Fed should set negative interest rates, and then coerce banks into lending money at a loss for fear of the tax. Mankiw is apparently aware that this idea is silly, and thus blames it on a student:
At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that. (I will let the student remain anonymous. In case he ever wants to pursue a career as a central banker, having his name associated with this idea probably won’t help.)
Wow. It's such a brilliant idea that Mankiw writes a New York Times editorial about it, but it would cost this poor student the potential for a job as a central banker if Mankiw gave proper attribution? And if the student did decide to develop the idea, he can't now because Mankiw has grabbed it and published it? Oh, it's a small loss - assuming the student exists, and is not a construct meant to enable Mankiw to raise his own ideas without accountability, it's a lousy idea. But Mankiw should be more honest here - he's raising the idea and he still has a job.
Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.
And if we did this every year for ten years, no currency would remain legal tender and we'll all be rich! Seriously, the day before such a 10% tax were imposed, what do you think the U.S. dollar will look like on foreign currency exchanges.

But I'm getting ahead of myself. How will this work? If my bank is solvent it will be taxed 10% on its assets? My bank account does not contain any actual money - it's just a balance, not a stack of physical bills - does Mankiw propose that the bank will pass this tax along to its customers - 10% off the top? What percentage of the nation's wealth does Mankiw believe can be tied to physical, paper money? What accounting games would this invite, so that financial institutions and other companies could claim to have no cash assets on tax day? Will banks and business shut down on tax day so that they can avoid taking cash that might suddenly become worthless? After the tax day announcement, how many man hours will be spent scrutinizing the serial numbers of bills, one at a time, to ferret out which are valid and which are not? (Or does Mankiw figure we'll replace all paper money with new bills, at enormous expense and inconvenience?)
People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10.
And people will be delighted to switch their currency holdings to Euros and other stable currencies well in advance of tax day, to avoid the massive tax Mankiw proposes. This "stroke of genius" may be just what it takes to inspire the world that the greenback can no longer be trusted, and that it's time to make some other currency the standard for international commerce.
Of course, some people might decide that at those rates, they would rather spend the money - for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw - it’s a benefit.
Thus Mankiw illustrates that he very much intends this tax to hammer consumers. Why not? Every institution where we might save our money will be hammered. You can apparently get exempted from the tax by, for example, holding stocks and bonds or foreign currencies. And if you're not in the investment class, what does it matter if that money is your retirement savings, your kid's college tuition, the money you're using to start a business, your employee payroll account, money for anticipated medical expenses.... Buy a car with it or pay the tax - and everybody benefits! At least, everybody Mankiw cares about.

Mankiw proposes something less "outlandish", effectively producing negative interest rates through inflation:
In this case, while nominal interest rates could remain at zero, real interest rates - interest rates measured in purchasing power - could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.
Didn't we have something like that a while back? A serious recession with a downturn in consumer confidence, coupled with inflation? Is Mankiw proposing stagflation as a cure for economic malaise?2

In any event, it's nice to know we have people like Mankiw out there, searching for clever ways to make the recession and recovery even harder on working Americans.

1. Is it inaccurate to call this a tax? It amounts to "unprinting" 10% of U.S. currency, not pulling 10% of savings into government to be spent on deficit reduction or government projects. But it is, in essence, the government's taking of 10% of your cash savings and using it to reduce the money supply.

2. This is Something of a caricature, but I'll blame Mankiw for that. If he believes inflation is the "real solution" he should have used his column to explain how that would work and why it would not create risk of stagflation or impeding an economic recovery, the common reaction to any suggestion of inflation, and apparently a fundamental belief of the Fed, rather than spending so much time discussing an absurd tax on savings. Also, it seems that a proposal for sustained inflation is no more likely to endear you to central bankers than is the proposed 10% tax on savings.

Assuming Mankiew believes that inflation would be kept low and could help the recovery - that is, if Mankiw wants to join with economists like Paul Krugman and endorse a modest, sustained rate of inflation to help reduce the consumer "debt overhang" dating back to the housing industry collapse without having a material negative impact on growth and employment - why not just say so?

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