Tuesday, July 15, 2008

Fannie & Fredie

The Secretary of the Treasury is advocating Federal loans at low interest rates to the mortgage firms known as Fannie and Freddie. This proposal while laudable in purpose further increases the Federal debt. Why do we do it that way? Is money in short supply such that there is a real opportunity costs if diverted? I do not think so. There is plenty of unused capacity in the real economy. There is no reason for taxpayers to consume less so that these mortgages can be extended. Why does not the Federal Reserve and the Treasury simply write a check to Fannie and Freddie? We do it the old way only because we are locked in to old customs and obsolete institutions. It is time for modernization of fiscal policy. I call it zero interest public debt.


Inflation is in the news and blamed on the rise in oil and food prices. But, inflation is defined as a rise in the general price level, not the rise in the price of particular items. The only way that the rise in oil prices can cause inflation is if the banking system accommodates it by an increase in the money supply. If the money supply is constant, then a price rise for oil means a price drop for other things depending on their relative demand elasticities. The popular misconception of inflation causes us to look at the wrong policy options.