The Recovery Bonus Plan for Fast Recovery and Monetary Management Reform

The proposed Recovery Bonus is a series of adjustable-amount, same-for-all, additions to the paycheck of every worker who makes FICA Social Security contributions -- to quickly get newly-created money into the hands of those most likely to quickly spend it.

To be most effective, the Recovery Bonus should be part of a comprehensive, integrated Policy Tool Kit for federal fiscal, monetary and economic responsibility. This article focuses on the Recovery Bonus and monetary management reform. The other tools are described in more detail in the Key Macroeconomic Policy Tools section of this site.

1. A credible policy commitment to achieve a "fast soft landing" recovery growth rate, based on an explicit published formula. (A possible simple formula that needs to be tested for appropriateness could be: basic trend (potential) GDP growth rate (3 1/2%?) plus the excess of the current unemployment rate above 4%). Moreover, this commitment must subsequently keep the unemployment rate at or below 4%. This is the responsible policy goal mandated by the historic Humphrey/Hawkins "Full Employment and Balanced Growth Act of 1978," and was actually achieved again in 2000 without inflation. As someone even in the Bush Administration is said to have remarked recently: "It's still a depression until everybody who wants a job can find one."
2. Expanded unemployment benefits -- for those whose benefits have run out, and the many "discouraged workers" who are not now included in the official labor force and unemployment data because they are no longer currently job searching, with many seniors unwillingly forced to draw on Social Security. This would reduce the need for many other types of "depression relief" spending by private organizations and all levels of government, as well as reducing crime, drug use, family breakups, homelessness, and many other depression-exacerbated social ills, including disorganization of the skilled labor market by laid-off skilled workers taking unskilled jobs and pushing the unskilled into homelessness.

3. Assistance with recession-decimated state and local budgets -- to avoid the further desperate tax increases and cutbacks of essential education and health programs that tend to offset federal fiscal stimulus. This aid should take account of the fact that some areas have been harder hit than others due to factors over which they have no control. However, like the Recovery Bonus, it should have some "sunset" formula for its gradual reduction as the overall economy recovers.

4. A standardized Dual-Deficit federal budget format that finally excludes Social Security and divides the operating budget transparently into its two functional parts -- the Policy Deficit (PD), determined by congressional tax and spending decisions, and the High Unemployment Deficit (HUD), caused by above 4% unemployment. (Every 1% unemployment costs the budget over $70 billion -- the 2002 PD was about $160 b., HUD about $150 b.) This budget format differs from the Congressional Budget Office (CBO) version by being standardized at 4% unemployment rather than the CBO's 5.2%

5. Social Security projections also standardized at 4% unemployment (rather than the SS Trustees' 5 1/2%), with current financial shortfalls from this projection being reflected in the HUD rather than the SS Trust Fund. This projection finances full Baby Boom benefits with no financial problems. The US simply cannot afford the 75 years of average 5 1/2% unemployment. This reform is a key part of the recovery tool kit because it will help mobilize voters to also support the rest of the recovery program.

6. More effective tools for Federal Reserve (Fed) control of the money supply and economic growth, including much higher bank reserve requirements -- as described below.

7. More systematic coordination of monetary and fiscal policy -- as described below.

8. "No permanent tax cuts before the Policy Budget is balanced and unemployment is again below 4%." This must be the key principle of responsible fiscal policy.

9. More effective visual aids and cogent political "slogans" to gain public understanding and support for these policy tools.

The initial amount should be a politically and personally "attention-getting" amount, such as $50 a week. But unlike most other "economic stimulus" proposals, the RB amount is inherently highly flexible and would be rapidly reduced as unemployment declines. Subsequent amounts should probably be decided jointly by the Treasury Secretary and Fed Chairman, using a published formula based on a policy-determined "fast soft landing" recovery track of employment and GDP growth, such as that cited in Reform 1, above that also takes account of any inflationary tendencies or financial excesses. (There is still plenty of "excess" productive capacity to supply a fast recovery.)

Employers insert the bonus payments as an additional item in their regular payroll computer programs (no complicated and expensive individual checks), and treat the total RB payroll amount as an accounting offset to their current FICA payment to the Treasury. The Treasury informs employers of the current bonus amount by public announcements and e-mail. (To avoid criticism as an "unfunded mandate," employers could be compensated for the cost of compliance if this turns out to be significant.) After recovery, these payroll computer programs should remain in place for potential future preemptive use to actually prevent future recessions.

The resulting "economic stimulus"

In the present US credit-money economy, the new money that finances economic growth can only be created in the process of bank lending. Thus money growth normally depends on the growth of credit-worthy business and consumer demand for credit. But when that demand is too low ("like pushing on a string"), short-term interest rates fall so low ("real" rates are now actually 2% below zero) that the Fed "runs out of ammunition" for its traditional rate-cutting approach to monetary stimulus, and recovery stalls.

The systematically coordinated Recovery Bonus policy tool kit attacks both sides of this problem: (a) by its immediate direct addition to federal (and total GDP) spending, and (b) by the way the resulting temporary increase in federal borrowing facilitates traditional Fed monetary policy by reviving short-term interest rates.

Thus, if accompanied by an appropriate ("accommodating") Fed increase in money supply , the initial $50 a week Recovery Bonus payment would provide an immediate "fiscal stimulus" of over $5 billion a week ($20 billion a month). The extended unemployment benefits and state/local government aid would add more. This should be enough total stimulus to quickly "jump start" the U.S. economy. (If it is demonstrably too little, the RB could easily be increased by a Treasury/Fed policy decision.)

U.S. recovery would tend to "jump start" other economies around the world that rely on the US as an engine of world recovery -- especially if they also adopt our comprehensive recovery strategy. World recovery would then feed back into U.S. economic growth. As a result, the weekly amount of the Recovery Bonus could probably be quickly reduced -- in a matter of months, not years. The budget cost of the unemployment benefits would also be reduced as the economy approaches 4% unemployment, and the budget cost of the State/local aid would be gradually reduced according to its "sunset" formula.

Bush's hypothetical "supply side" claim that tax rate cuts will indirectly pay for themselves by the higher tax receipts from faster economic growth has been largely discredited by empirical research, and is unsupported by Greenspan, the CBO and even Bush's own "Economic Report of the President." By contrast, the potential economic growth effects of direct federal spending such as the Recovery Bonus payments, unemployment benefits and state/local fiscal aid, "accommodated" by appropriate money growth, are well understood (even if not acted on politically), and the likely effect of specific amounts can be empirically estimated. So, adoption of this approach would render the mostly fictional stimulus from the fiscally damaging Bush tax cuts irrelevant.

Fiscal treatment of Recovery Bonus financing

In relation to the overall federal deficit, the deficit financing of the Recovery Bonus should be thought of as a special proactive part of the reactive High Unemployment Deficit (HUD), rather than part of the Policy Deficit. But for maximum analytical transparency and effective public education, the RB deficit financing should also be explicitly and visibly distinguished from the rest if the HUD by the use of special, explicitly labeled, securities. And its amount should be reported monthly to the media, along with the HUD values, so that taxpayers can watch them decline together during recovery. After full recovery, the total cost of the deficit-financed RB payments can then be compared to the much larger budget cost of the HUD. Then, if another recession threatens, and the Fed again needs fiscal policy help, taxpayers will be glad to support Congress in re-invoking the Recovery Bonus program -- before the recession again falls into a typical downward spiral.

There are three main options for carrying out this financing:

• Option A: RB Bills and Notes -- These short-term (less than 2-year) marketable securities should have laddered maturities corresponding with the Fed/Treasury planned recovery track, but with provision that they can be redeemed (called) earlier, if, as likely, the special need for them ends well before the unemployment rate reaches the 4% recovery target.

  Under Option A, the Treasury's increased borrowing to finance the RB and related payments can reasonably be expected to increase present recession-reduced short-term interest rates enough to replenish the Fed's interest-cut ammunition -- so it can use this traditional charade to give the banking system the reserves it needs to create the recovery-needed new money, by buying the RB bills and notes. This increase in interest rates would also help induce other countries to adopt our RB recovery strategy in order to avoid losing "hot money" transfers to the higher-interest US.

  Option A is closest to traditional financing and most likely to get the quickest legislative action.

• Option B: RB Bonds -- These would be sold only to finance the RB payments, sold only to the Federal Reserve (like those it now sells to the Social Security Trust Fund), and would be permanently held by the Fed. This option offers the most benefits for the economy and the budget. It has a dual purpose: (a) to finance the RB payments most efficiently, and (b) to increase the presently miniscule and ineffective bank reserve ratio, so the Fed can again manage money growth and economic growth directly, and abandon the analytically misleading charade of interest rate adjustments.

• Option C -- similar to option B except that the RB bonds would be marketable and sold to the general public, with the Fed buying them up later, preferentially, in its open market purchases -- as in WW II.

How the Fed now controls -- and doesn't control -- the economy.

Greenspan still pretends to be managing the economy by means of the now-traditional adjustments in the fed-funds interest rate, even though this already multi-flawed "transmission mechanism" is now effectively unusable for a recovery monetary policy because of the close-to-zero interest rate.

So now, behind the rate-management charade, Greenspan is actually still trying to manage the economy on a largely ad hoc, judgmental "seat of the pants" (airplane pilot lingo) basis, using a multitude of difficult-to-interpret and often conflicting economic data and "forecasts." It shouldn't be surprising, therefore, that he now seems to be taking a "wait and hope" stance on economic recovery. But his recent worries about a potentially dangerous deflationary spiral are making this stance increasingly untenable.

The bottom line is that control of monetary policy and the resulting unemployment rate should not depend on the analytical, intuitive and political abilities of one person, however extraordinary those may seem at a particular time. Who knows what talents (or lack thereof) his successor will bring?

A reliable and responsible monetary policy requires these attributes:

1. A clear understanding of the role of money and money growth in the economy -- something that Greenspan, like most other economists does not have.

2. A framework of technically valid and publicly understandable rules or formulas for managing money growth and economic growth.

3. The political ability to clearly convey these understandings to the public (and Congress).

4. A full and transparent willingness to coordinate Fed monetary policy with other government agencies that are functionally related to monetary policy.

5. An intellectual and "gut" understanding of the key importance of a full-employment economic environment in a healthy democratic society, and the principle that relatively stable prices are a means to that end, rather than an end in themselves.

The basic relationship between GDP growth and money growth

It's actually quite simple:

The key role of the MDR -- The MDR -- the ratio of Money stock to GDP -- is a "structural" stock/flow ratio similar to the familiar inventory/sales ratio. A change in the MDR growth rate has the opposite effect of a change in the money growth rate. The more money is "withdrawn from circulation" in depositors' checkable-deposit "inventories," the more new money is needed to finance any particular rate of economic growth. Conversely, computer efficiencies that reduce the needed money-inventory also reduce the needed amount of new money.

Before the interest rate charade, when the Fed actually targeted money growth, it used to take explicit account of the MDR growth rate in its semi-annual reports to Congress (under the traditional name, "velocity" -- the reciprocal of the MDR). But now, behind the interest rate charade, the key role of the MDR growth rate seems to be generally ignored -- one reason why interest rate changes often don't achieve the expected result.

Checkable-deposit money is is created by banks "out of thin air" in the process of lending it. This finances economic growth because it constitutes an "exogenous" injection of purchasing power into the flow of total spending and income. Moreover, as it continues to circulate each dollar of new checkable-deposit money finances about a nine dollar increase in total GDP spending -- the "monetary multiplier" effect. To prevent the banks from creating too much money, they are required to hold reserve balances in the Fed (and their own vaults) equal to a certain percent of their checkable deposits, and the Fed supplies the banks with what it considers the appropriate amount of new reserves by buying Treasury securities in its "open market operations."

Accordingly, the basic "administrative" formula for monetary control of economic growth is a slightly rearranged version of the above formula that relates money growth to GDP growth:

Thus, to manage economic growth effectively, the Fed needs to monitor the MDR growth rate precisely and manage the money supply according to this formula. But to do this the Fed must: (a) use the checkable-deposit money-concept that banks actually create -- and that actually finances GDP growth, and (b) precisely manage the bank reserves that are supposed to control the money-creation process. As of now, the Fed can do neither of these effectively -- for both historical and bureaucratic reasons.

How the Fed got trapped into the interest rate charade. After the huge OPEC price increases of 1973 and 1979 caused disastrous worldwide inflation -- and a corresponding increase in interest rates -- the Fed started to allow interest payments on personal checking ("NOW") accounts, and limited checking on interest-paying savings-type accounts. This has confused the previous sharp distinction between checkable-deposit money, supposedly controlled by reserve deposits, and interest-paying saving and investment accounts, which aren't. Greenspan recently admitted openly that he doesn't now have a usable definition of "money," and checkable deposits are only a small part of the "M2" concept that is now most widely used as "the" definition of money.

The other key factor preventing direct Fed control of the money supply is the steep reduction in the required reserve ratio. It is now so low that most banks can meet the requirement with just the normal "vault cash" that they need to service depositors' requests for currency, leaving them completely "unbound" by Fed reserve control. Bank reserve balances at the Fed -- which is all the Fed does control -- are now only a miniscule 1.6% of checkable deposits, giving the Fed a "leverage" ratio that's like trying to put peas in a bottle with a 10 foot spoon -- a truly absurd situation. For effective direct control of reserves, money supply and economic growth, the Fed needs a much higher reserve ratio -- optimally, 100%.

Using Option B to increase the required reserve ratio

Because the Federal Reserve Act now prohibits direct sale of Treasury securities to the Fed, Option B would require Congress to amend the Federal Reserve Act to permit a special exemption for this purpose. But the present economic crisis and the underlying need for more effective management of money and economic growth is serious enough to warrant serious consideration of this reform by the post-2004 Congress. In the meantime, public discussion of this proposal will be very useful in helping people understand macroeconomic relationships and policy.

Financing the RB payments by direct bond sales to the Fed would combine the money creation and reserve creation processes, bypassing independent action by the banks. The needed new money would be created as the Treasury borrows it from the Fed, and the banks would get new reserves when they send the employers' RB checks to the Fed for collection

Because the banks could meet the present tiny reserve requirement with only a small fraction of the new reserves that would flow to them from the new-money-financed Reserve Bonus and other direct recovery payments, the Fed would need to keep increasing the required reserve ratio to prevent excessive money growth. However, these recovery-stimulus amounts would probably be only enough to increase the reserve requirement to perhaps the 20% of pre-1958. This might be enough for the Fed to dispense with the interest-rate charade, but nowhere near enough to give it the precise control over money and economic growth provided by 100% reserves.

However, Congress could increase the required reserve ratio closer to the optimum 100% by financing all of the proactive recovery payments, including unemployment benefits and state/local aid, by the special RB Bonds. Moreovers, because the present recession-reduced business and consumer borrowing has forced the banks to buy a much larger than normal amount of Treasury securities, the Fed could easily go all the way to 100% reserves without significant disruption of the financial system, by simultaneously raising the required reserve ratio and buying up the banks' "surplus" Treasuries.

Requiring 100% reserves for all checkable accounts would also solve the money definition problem for the money-management formula by making a clear distinction between these transaction accounts and non-checkable, interest-paying, saving/investment-type accounts, which require no reserves.

Why hasn't such an obviously useful reform happened before?

As usual, the answer is a combination of economics and political power.

With a 100% reserve requirement, checkable deposit creation would no longer be a source of loanable funds for banks. For most banks that wouldn't make much difference, because the creation of checkable deposits is a much smaller source than others, such as savings accounts, CDs, money market funds, and even bond and stock issues. In fact, in recent years, total checkable deposits have even declined for years at a time.

From the banks' perspective, increasing reserve requirements from the present pittance to 100% would require them to sell off several hundred billion dollars of their present earning assets, and presents a larger political problem.

Banks have traditionally opposed higher reserve requirements (and lobbied for lower requirements), arguing that the loss of interest income from non-interest-paying reserve deposits is an indirect form of taxation. This argument may seem true from the perspective of an individual bank. But it is quite false in terms of macroeconomic relationships -- because the Fed, by its purchase of Treasury securities in open market operations, has actually supplied them with most of their reserves, free of charge, and thus has no economic or moral obligation to pay interest on them. Reserve requirements are not an "unfunded mandate." That would still be true of reserves created under Option B. But in practical political terms, that's not a relevant consideration.

The needed political deal

The relevant question is how to neutralize bank opposition and get the 100% reserve reform through Congress. And here, the key has long been suggested by the Fed itself: pay the banks interest on their reserve deposits at the Fed.

Congress has always opposed this solution because it doesn't want to lose its revenue from Fed holdings of Treasury Securities. Under present rules, the net interest cost to the federal budget of Treasury securities owned by the Fed is relatively small because the Fed is required to return to the Treasury all its interest income that is not needed for the Fed's current operation.

(This is, of course, a key reason why the Federal Reserve Act prohibits the sale of Treasury securities directly to the Fed. Without that prohibition, it would be too easy for a fiscally irresponsible Congress or Administration to cause inflation by financing expenditures with Fed-created new money rather than taxes. That is why the direct sale of the Recovery Bonus bonds to the Fed would need to be an explicit special exception, under special rules.)

Fed interest payments to the banks' on their 100% reserves would also cost the federal budget practically nothing because the Fed would finance those payments out of the interest it receives on the Treasury securities it buys from the banks -- interest the Treasury would have to pay out anyway, whoever owns the securities. Now the Treasury pays that interest directly to the banks on the Treasury Securities they own. With 100% reserves, it would still be paying the interest to the banks, but indirectly, detoured through the Fed.

In politically justifying the payment of interest on Fed-created bank reserves, it would be useful to consider such payments as an economically beneficial subsidy for the many key economic services provided by banks -- including free checking accounts and the related payment clearance system, which, in effect, provide the financial "highway" for the economy's flow of payments, much as subsidized concrete highways provide for the flow of goods. It should be considered as merely one of the many economic subsidies -- for farmers, energy companies and even home ownership.

Other aspects of this deal would include the following:

1. The banks, the Fed and the economy would all benefit from the resulting 100% reserve against depositor "runs" on checkable deposits in some future financial crisis -- and thus no need for FDIC insurance (and its premiums) on such deposits.

2. With 100% reserves, the Fed could probably dispense with requiring the banks to have separate "clearing balances."

3. In the long run, the most appropriate interest rate for the Fed to pay on bank reserve balances would probably be slightly higher than the fed funds rate -- about what the Fed earns on the short-term Treasuries it buys in open market operations. But during a transition period, until the maturity of the Treasuries it buys from banks to reach the 100% requirement, it should probably, in effect, merely pay the banks what it gets from the purchased securities.

4. Because checkable accounts would no longer provide a source of loanable funds, some banks might be tempted to increase service charges on them. If competitive pressure did not avoid this, the The Fed might set limits on such charges, as part of the subsidy deal.

5. With 100% reserves, he Fed would still use open market operations to for precise control of total reserves, and individual banks would still use the fed-funds market to maintain their individual required reserve balances.

In the present political environment, it can be expected that the tax-cut ideologues will oppose the Recovery Bonus Plan -- because it would render irrelevant the mainly phony "economic stimulus" and "job creation" arguments for the budget-busting tax cuts. And it is likely that the Republicans' basic "anti-government" ideology will prevent them from developing a credible alternative recovery plan before the 2004 election. Therefore the proposal of this plan by Democrats and fiscally responsible Republicans could provide a bipartisan basis for a more economically and fiscally responsible election campaign.

This policy tool kit is not "class warfare" -- like Bush's tax cuts for the very rich and social spending cuts for the poor. Nor is it traditional Democratic "tax and spend" or Reagan/Bush "borrow and spend" in the Policy Budget. Its spending is rather a short-run credit-financed businesslike investment by the government for the specific purpose of regaining its pre-Bush profitability (from higher tax receipts and less "recession relief" costs) by reducing the recession-induced $140 billion High Unemployment Deficit and the tax-cut-induced Policy Deficit fiscal bleeding. It is merely a more pragmatic and economically and fiscally responsible approach to managing the budget and economy. Therefore, it should be difficult for the tax-cut and other right-wing ideologues to attack it successfully on a politically viable basis. In the meantime, the public arguments regarding this proposal will tend to give voters a much sounder understanding of budgetary and monetary relationships and policy alternatives.

Particular voter groups that would find aspects of this proposal particularly attractive:

1. Low and middle income voters, union members and other actual and potential Democratic "base" voters will welcome the credible full-employment commitment and Recovery Bonus payments.

2. Workers of all income classes and skill levels who have actually experienced the drastic job cuts and unemployment of the past three years, or fear the insecurity of their present jobs, will be attracted by the expanded unemployment benefits.

3. State and local government employees whose fiscal resources have been decimated by the recession and Bush tax cuts will welcome the proposed fiscal aid for their employers. (Democratic strategists would do well to focus more attention on this problem.)

4. "Old fashioned" fiscally responsible Republicans and Democrats will welcome the more transparent budget format and procedures, and the emphasis on effective devices for actually reducing the deficit, including the basic principle: "No permanent tax cuts until the Policy Budget is balanced and unemployment is below 4%."

5. Business-class suburbanites who respect responsible government will also welcome the more systematic approach to financing and managing the recovery and reducing the deficit.

6. Baby Boomers nearing retirement -- and the cynical young people who have been convinced by the false arguments of the Social Security privatizers that there will be no Social Security for them when they retire -- will welcome this simple and responsible solution to the phony Social Security "crisis."

7. Retired people and pensioners whose Social Security- and pension-gap funds are invested in savings accounts and money market funds will welcome the higher interest rates on these investments.

8. Wall Streeters and those whose retirement funds are invested in 401(k) investment plans will welcome the resulting recovery of stock market prospects.

9. Business people who are concerned about the economic "collateral damage" of the Bush-induced breakdown of normal diplomatic relationships with our trading partners will be attracted by the possibility this recovery proposal offers for renewed international economic cooperation and better monetary and fiscal coordination.

10. Business executives, editors, pundits, think tanks and economists will welcome the more transparent and businesslike monetary reforms.

11. Business executives disconcerted by continuing Bush-induced economic and political uncertainties will welcome the credible commitment to stable full employment growth that will enable them to again plan ahead.

12. The many potential voters who have been too turned off by Washington incompetence and partisanship will welcome the more transparent budget format and procedures that will help them tell who is lying and who is for real, and thus better enable them to relate debates on these crucial issues to their own personal self interest.

Stable full-employment growth is not a dream. It merely requires better economic and fiscal management.

For more detailed descriptions of these and related macroeconomic policy reforms, see

• Special Notice
• Current Policy Issues
• Key Macroeconomic Policy Tools