Sunday, April 05, 2009

Economists are Here to Help (heh)

Mark Thoma and Scott Sumner were on Blogging Heads talking about the financial crisis. They seemed to agree that taxing 'excess reserves' of banks was a good idea, because you want to incent lending, and get money flowing to alleviate the liquidity crisis.

However, banks are hoarding cash because they feel they need a bigger cushion. Indeed, the 'stress tests' of Geithner are looking at banks and evaluating whether they have sufficient capital to withstand some hit to their portfolios. Lower levels of capital would make them fail this test, and then they would be taken over.

In 1937 the US implemented a tax on retained earnings, which seemed like a good idea to economically incompetent Roosevelt because he assumed he was just taxing 'money', and unused money at that. The idea was, we wanted to get this money 'working'. Plus, taxes on capital are progressive (good). See here for a 1937 rationale, and note it mentions Henry Ford by name.

The 1937 recession was one of America's worst. Unemployment rose from 5 million to almost 12 million in early 1938. Manufacturing output fell off by 40% from the 1937 peak.

Taxing 'excess bank reserves' is just like taxing retained earnings in this environment. Luckily, Bernanke is very conversant with this episode, and the need for firms to have 'excess' cash.


Plamen said...

Erm, Eric, are you really pinning your hopes on Bernanke at this point? What he has proven so far is that he excels at creating zombie banks - I am waiting to catch some article on talent leaving Shittygroup in order to post it along with a picture/clip of a zombie groaning "Braaaainssss!"

What these folks will not get through their thick heads is that banks are lending, although not quite as much as they used to, which is a good thing. What is not lending is the securitization markets - they are a charred corpse. The banks cannot pick up that slack. American Express will have to re-learn to manage credit card loans, and Bank of America - mortgage portfolios, and Americans will need to learn to live with a bit less debt. The horror.

Dilip said...

Scott and Bill Woolsey have some comments about your post starting here:

(read the last paragraph of that comment)