How Federal Reserve Savings Accounts Could Help Curb Inflation

All economists know that lowering prices by creating recessions hurts the most vulnerable and makes inequality worse. We would welcome a tool that helps boost savings and wealth for the non-rich in times of inflation. Larry Marsh is getting attention for his proposal to slow inflation humanely with digital currency accounts held at the Federal Reserve. Professor Marsh is a friend and former colleague from our time teaching at the University of Notre Dame, and I caught up with him recently to learn more about his idea.

Here is the bottom line: by adjusting the return on savings by U.S. citizens with accounts under $10,000, the Fed can use targeted interest rate increases to control consumer demand while helping boost savings.

Larry, why is the Fed raising interest rates by 75 basis points a brutal and excessively crude way to slow inflation?

The Fed raises interest rates to slow consumption and business borrowing, which in turn causes firms to cut inventories and hours, lay off workers, and close stores. In hiking rates, the Fed aims to reduce demand faster than supply. The brutality stems from making it harder for people to work and borrow — punishing workers for inflation they did not cause.

What humane way can we stop inflation?

We can stop inflation without raising interest rates across the board. The Fed could slow consumption by encouraging personal savings while not dampening business investment. If people save more and cut their spending voluntarily, mission accomplished! Demand is lower, price pressure is lower, and wealth is up.

I get it, savings slows inflation by slowing demand AND building wealth. Can you say more?

Right Teresa. When too much money chases too few goods, sellers raise prices. Conversely, when people save more, demand is reduced, which in turn suppresses price hikes and may even trigger price cuts. In short, savings help stop inflation. So I propose personal savings accounts at the Federal Reserve that the Fed controls.

Congress would have to authorize the Fed to create the accounts. And some in Congress are already thinking about alternatives to banks. In 2018, Senator Kirsten Gillibrand proposed ways to allow U.S. Post Offices to cash checks, open savings accounts, and provide small loans to displace loan sharks, pawn shops, payday loan dealers, or “cash now” providers. In 2021, Representative Rashida Tlaib proposed “The Public Banking Act” with basically the same provisions. But neither of these proposals explicitly addressed the need for a policy with macroeconomic stabilizing effects — one like targeted interest rate hikes.

Larry, if the Fed had authorization to create savings and checking accounts, how could they be used to stabilize prices and full employment?

The Federal Reserve is considering creating a central bank digital currency — as are 86 other countries, while 7 more have already completed the process. With Congressional action the Federal Reserve could use post offices as physical locations for people to access individual digital savings accounts and fund the initiative with income the bank earns ($107 billion in 2021). With a digital currency, people could register their smartphones at post offices for direct access to their Fed (central bank) digital accounts. When necessary, the Fed could raise the interest rates on the savings accounts to lure money from spending to savings.

If the government offers high interest rate savings accounts, won’t this undermine the private commercial banking system?

To make profits a bank charges higher interest rates on loans than it pays on savings. But the Federal Reserve doesn’t have to do that. As a tool to control the money supply the Fed would raise rates on their savings accounts. To avoid disrupting commercial banking, the Fed could limit the size of the savings accounts — say an upper limit of $10,000 for each account linked to one Social Security number. A U.S. Federal Reserve account would be the most secure place for Americans to hold cash.

Wouldn’t I-Bonds work just as well as your proposed Central Bank Digital Currency?

As of May 1, thirty-year U.S. Treasury I-Bonds offer a 9.62% inflation-adjusted rate. Which is great, but their base rate is 0%, and the inflation premium could be dropped after the first six months. I-Bonds also aren’t totally liquid. An I-Bond cannot be withdrawn for the first year and there is a three-month penalty for withdrawing money from an I-Bond before the end of five years. I-Bonds are ideal for emergency savings accounts and do their part as an automatic stabilizer, but they are not as attractive as the accounts I’m proposing, which would more closely resemble a regular savings account.

Thank you Larry.

Reader, watch my blogs space for other ideas about how to encourage savings, decrease consumption, and lower prices while avoiding a recession. Creating digital currency accounts within the Federal Reserve’s purview but owned by the ordinary public is just one of them.

Here’s another: Economist Kevin Hassett and I have a proposal for a retirement account for everyone funded with worker, employer, and government contributions. Expanding retirement accounts for all could also help us stabilize the economy.

My bottom line? We need new tools for the Fed to slow inflation humanely.