- The Washington Times - Saturday, December 27, 2008


The current financial crisis has generated distrust of many financial assets. Those who once felt wealthy now feel poor. So they try harder to save money and pay off their debts. To counteract this effect and the resulting deflation, there is a need for much more money in the private sector. What is the correct way to inject this money?

The usual method is lending by the Federal Reserve System (FRS). However, this would also increase the indebtedness of the borrowers, which would tend to counteract the wealth effect. In addition, it may not be possible to do it in sufficient quantity because people are not obliged to borrow.

Another popular alternative is giving the money away or spending it on make-work projects. This undermines the incentive to be productive, and it makes it difficult to withdraw the money when the next inflationary boom begins.

Instead, I propose that FRS buy enormous amounts of common stock on the auction market. Also, it could buy commodity futures and options to exchange dollars for foreign currency. When the economy recovers, these should be sold (hopefully at a profit).

Going forward, an objective standard for monetary policy is necessary to minimize future booms and busts. Since the value of the dollar is supposed to be backed by the FRS’ reserve assets, the Monetary Base (M0, the dollar-denominated liabilities of FRS) should be equal to the sum of the prices of the reserve assets.

If the reserves fall below M0, this indicates that there is not enough money in circulation (credit is too tight). In this case, more assets should be purchased to put more money into circulation.

On the other hand, if the reserve rises above M0, this indicates that there is too much money in circulation (credit is too loose). In this case, assets should be sold to take some money out of circulation.


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