Knowing and Making

...and why the Bank of England and Fed are right to have done so already. I'm not talking about whether the European Central Bank should directly buy eurozone government bonds. This causes a moral hazard problem - it might encourage governments to be profligate and reduce incentives for structural reform. It's, at the very least, debatable. I'm talking about a more general question: why should central banks print money in a recession? This post won't have much new to say to macroeconomists, but it attempts to address a concern of many non-economists - won't printing money just cause more inflation? First, let's run a thought experiment. Imagine that your national government has decided that profligate use of fossil fuels is a problem. Probably because of the risk of climate change. Instead of using a carbon tax, the government decides to restrict the supply of oil coming into the country. It could allow more oil in if necessary - in fact it has a large res...

Models and Agents hints at the Fed increasing the interest rate it pays on banks' excess reserves. Is that a good idea? Given that banks seem to be building up those reserves instead of lending them out, paying more (or any) interest would just encourage them. Instead, I suggest a small tweak in the other direction. Charge banks a negative interest rate to hold their reserves - even as small as 0.1%. While rational calculation implies that the difference between 0 and -0.1 is virtually no difference at all, the real world doesn't necessarily work that way. Behavioural experiments clearly show a phenomenon called loss aversion  where people are asymmetric in their valuation of profits and losses. They will typically give up twice as much to prevent a £1 loss as they would to make a £1 profit. In this case, I would bet that loss aversion will kick in and encourage the banks to lend into the private sector instead of having their money drain away to the central bank. Even if ban...