If the Federal Reserve created central-bank-digital-currency (CBDC) bank savings accounts for everyone, the Federal Reserve could have a return-on-savings tool to directly impact consumer demand on Main Street to reduce demand pressure to stop inflation without throwing the economy into recession. Currently, the Federal Reserve relies primarily on changing the interest in the financial markets on Wall Street, which affects the availability of funds for businesses to use to increase supply. Raising interest rates in the financial markets just makes it harder for businesses to add another line of production to increase supply to meet the excess demand where too much money is chasing too few goods and services on Main Street.
Demand could be tamped down, and supply encouraged, by creating Federal Reserve CBDC savings accounts that offer high interest rates during inflationary periods on balances up to some specified limit, such as $10,000 (with no interest earned on amounts above that limit). Interest rates would only apply to accounts with a Social Security number and only one account per Social Security number. Businesses and individuals without a Social Security number could have CBDC accounts but would not earn any interest on their account balances. Meanwhile, rates in the New York financial markets could remain relatively low to stimulate, not suppress, supply. See YouTube video at: https://www.youtube.com/watch?v=nnMT7DVyK0g
Higher interest rates will encourage savings. Saving more and spending less is obviously what is needed when too much money is chasing too few goods. If the Federal Reserve were to offer high enough interest rates, excess demand could be reduced enough to stop inflation without forcing the economy into an unnecessary recession. This approach would withdraw money from the economy by offering a return on investment, not by taxation. Everyone with a Social Security number would automatically get a CBDC account and IRS tax refunds could be deposited into these accounts. This would especially benefit the elderly who need a good return on their savings to help finance their retirement. CBDC accounts offering high interest rates also could attract savings from people with high marginal propensities to consume (poor and middle-class people) who tend to spend most of their income. Encouraging more people to save more money would also serve as an automatic stabilizer by providing people with the savings they need to ride out economic downturns, which, in turn, would make such downturns shorter and less extreme -- protecting profits and tax revenues.
Currently, when the Fed raises interest rates on Wall Street, it suppresses supply for seasonal, cyclical and other businesses that depend on short-term liquidity to maintain and establish inventory and cash flow. It suppresses business. Production is cut back when borrowing costs increase. This traditional approach suppresses both supply and demand as workers find less work and their incomes fall. The economy slides into recession.
The mechanism for creating these accounts could take a page from our past. Under the Postal Savings Act of 1910, our post offices served as banks for more than 50 years from 1911 to 1966. You could go to any of our post offices (currently numbering 31,000) to cash a check or set up a savings account.
Such a loan program already has been proposed in bills formulated in both the U.S. Senate and the House of Representatives in the last few years such as Senator Kirsten Gillibrand's Postal Banking Act as Senate bill S.2755 or Representative Rashida Tlaib's Public Banking Act as House bill H.R.8721. The Public Banking Act, which was recently introduced in the Congress to create postal savings accounts, could be modified to provide the Federal Reserve with a return-on-savings tool to curb excessive inflation without throwing our economy into a recession.
The Federal Reserve, not the taxpayers, can pay for setting up and operating the postal banks. The Federal Reserve also could help pay for postal employee pensions. This would reduce, not increase, the overall tax burden. Currently, the Federal Reserve uses a cost-of-borrowing tool to stop excessive inflation by raising interest rates. That approach works by constraining business enough to cause closing of outlets, cutbacks in working hours and layoffs that suppresses consumer demand. This is an indirect and rather brutal way to reduce demand for goods and services that also reduces supply. The effect is to make it harder for firms to increase supply and harder for people working paycheck to paycheck to handle medical emergencies, automobile accidents and other situations where they need a small loan just to get by.
Current supply shortages call for encouraging supply. But the traditional Federal Reserve policy approach will do the opposite of what is needed. Sure, suppressing business to lay off workers to reduce demand will work if you slam on the brakes hard enough. But trashing our economy to stop inflation is not necessary. Why punish the poor to stop inflation and make it harder for firms to increase supply? Targeting demand through CBDC accounts to stop excessive inflation or, alternatively, to stimulate demand in a weak economy will be much more cost effective in offering more bang for the buck, will be more direct and have a more immediate impact, use less money, would not require an increase in taxes, and would be less disruptive of our economy than current Federal Reserve money-supply stabilization strategies. As a professional economist, how do you think about this problem? What is your perspective on how we can effectively stop inflation without causing a recession? Are there other policies that could help deal with this problem of stopping inflation without causing a recession? Thank you for your consideration of this question?