The Fed needs more flexibility to act more equitably

President Biden’s climate initiative boasts a new term “environmental justice,” which speaks to the disproportionate burden of pollution and climate catastrophes that are imposed on vulnerable populations. As the financial system comes to terms with climate risks, climate justice should also be considered. 

The Federal Reserve was founded in 1913 in response to perennial liquidity crises — financial emergencies that caused cash to be suddenly unavailable. In addition to being the lender of last resort, its role evolved into managing inflation, and over the last 10 years the focus has been on staving off deflation.  

Deflation is a situation whereby prices fall. It sounds like a shoppers dream, but remember that prices are only falling if demand is down, and demand usually falls in response to job losses or wage cuts. Think of the financial fallout in 2008 or the coronavirus crisis 2020. If the Fed had not stepped in with massive liquidity injections we would be in economic collapse. Deflation is caused by a shock to the economy such as a large percentage of homeowners defaulting on their mortgages or the coming environmental catastrophes caused by a hot planet.

Preparing for climate catastrophes means many things: infrastructure that can withstand floods and agriculture that is drought resistant; and smarter insurance. It also means that central banks like the Fed need to implement new scenarios into their forecasts, and make adjustments. And we also need to think about the social justice implications of these new policies, including an upgrade to those already existing. 

Today, the Fed’s deflation toolbox has only one widget: Quantitative Easing (QE). QE is when the Fed prints money to buy treasury’s or other bonds. This floods our economy with cash and prevents systemic collapse. QE is alive in our banking system and has worked well — our economy has continued to grow. But at the same time, it has also exacerbated income inequality.

Contrary to initial worries that QE would cause hyperinflation, it led to only asset price inflation. Stocks and bond prices rose in a fashion not commensurate with economic growth. Over the last 10 years, the S&P 500 almost tripled and home prices almost doubled. Yet our economy slowed to 1.7 percent growth per year, from 3 percent prior to QE.

 Meanwhile, wages have increased by a quarter. Taking into account the fact prices are up 20 percent over this same period, wage earners are only 5 percent better off while the rich more than doubled their wealth.

Tomorrow’s Fed toolkit needs not only QE, but also “helicopter money.” Helicopter money is a term first coined by Milton Friedman and alludes to a scenario where the Fed would make payments directly to households during a deflationary emergency. It is a mechanism that has been supported by Ben Bernanke, former chairman of the Federal Reserve, as well as other academics. Providing liquidity directly to households is important because, while in theory, the liquidity injection from the Fed to the banks should get passed on to households who need it, the reality is that banks’ lending requirements also get more rigid. When someone desperately needs the cash is when they are most likely not to qualify for a loan.   

Some will argue that helicopter money would be highly inflationary and therefore something to be avoided. It is true that we could get some inflation, but would that be so terrible in a crisis that threatens to push the economy into deflation? Inflation (excluding food and energy) has been perpetually below the Fed’s mean target of 2 percent for at least the last 20 years here in the U.S. The same is true for Europe, and Japan has not had the luxury of inflation worries for at least three decades. If there is anything to fear, it is deflation.   

Other opponents of direct payments to households will argue that monetary policy was never meant to replace fiscal policy; it is the place of Congress to increase spending in response to crises to drive job and wage growth. True, but if it is alright for the Fed to artificially inflate the stock market, why should it be so problematic to provide some needed support to working families? Furthermore, COVID-19 has taught us that our polarized political system is ill equipped to respond to crises in a timely manner.     

We can and must prepare our economy equitably in advance of deflationary shocks caused by climate catastrophes. The Fed must be equipped to handle the threat of deflation caused by widespread catastrophic natural disasters — without exacerbating inequities. We need a remodeled Fed that can step in with helicopter money. Allowing the Fed to do so could mitigate some undesirable side effects of QE, which bloats the assets of the rich and does little for wage earners.  

Bianca Taylor is a fellow with the OpEd Project and the Yale Program on Climate Change Communication. She is also the founder of the Tourmaline Group, an ESG research boutique serving institutional investors and a member of the Bretton Woods Committee.