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Green New Deal Won't Enjoy a Free Lunch at the Fed

The Wall Street Journal. logo The Wall Street Journal. 2/20/2019 Greg Ip
a person holding a sign© saul loeb/Agence France-Presse/Getty Images

When advocates of a Green New Deal are asked how the U.S. can afford its lavish promises of 100% renewable energy, millions of high-paid jobs and Medicare for all, they have a ready reply.

“We will pay for the Green New Deal the same way we paid for the original New Deal, World War II, the 2008 bank bailout, extended quantitative easing programs, all our current wars,” said a blog post that appeared earlier this month on the website of Rep. Alexandria Ocasio-Cortez (D., N.Y.). “The Federal Reserve can extend credit to power these projects.”

The Fed extending credit is a euphemism for printing money. To critics, it sounds like a guarantee for inflation. Not necessarily: the Fed prints money all the time without creating inflation. The problem is that once you work through the mechanics, it doesn’t save any money. At the end of the day, the Green New Deal will face the same constraints that all such undertakings do: They can’t spend more than the economy can produce. Ignoring those constraints will either lead to inflation, a politically weakened Fed, or both.

By law, the Fed can buy any obligation issued by the Treasury or a federal agency such as Ginnie Mae. From the end of 2008 through 2015, the Fed, via quantitative easing, bought nearly $4 trillion of Treasurys and securities backed by mortgage agencies Fannie Mae and Freddie Mac, which Treasury took over in 2008.

So the Fed could certainly buy federally-guaranteed Green New Deal bonds, provided doing so helped it reach its own monetary-policy goals. Quantitative easing, for example, was designed to pull down long-term interest rates, thereby propping up growth and staving off deflation—not to help the federal government borrow.

Similarly, the Fed lent to banks and other financial companies during the 2008 crisis as their lender of last resort. To be sure, it stretched the boundaries of that authority, but it didn’t need any prodding; the alternative, Fed officials figured, was a complete collapse of the financial system.

There have been times, though, when the Fed subordinated its usual goals to help the Treasury. During World War I, it kept interest rates low and lent to private banks to ease the sale of war bonds. During World War II, it agreed to cap Treasury yields and buy debt to support the war effort. On both occasions, wartime spending pressures fueled inflation that the Fed had to beat back after peace returned.

Sarah Binder, a political scientist at the George Washington University who has studied the Fed, says the episode most relevant to the present was Congress’ decision in 1966 to authorize the Fed to buy federal-agency debt for the purposes of supporting the housing market. In Congressional hearings, “the Fed was vocal about not wanting to make those purchases.” It saw them, she said, as “choosing winners and losers and crossing the boundaries into fiscal policy.”

Suppose a future president or Congress similarly pressures the Fed to buy Green New Deal debt. Since the Fed would ultimately return any interest it earns on such bonds to the Treasury, this might sound like a big money-saver. But it isn’t. To buy a Green New Deal bond, it wouldn’t buy an equivalent amount of Treasury bonds, so the net savings would be effectively zero. To absorb the extra Treasury debt, investors might have to charge other borrowers more, potentially “crowding out” private investment.

What if it bought the bonds by printing money, as quantitative easing involved? As a practical matter, the Fed doesn’t literally print new currency, it electronically creates reserves—money that commercial banks keep on deposit at the Fed. If it did so when the economy was depressed, then interest rates would already be zero and the Green New Deal debt could be sold to private investors almost as cheaply.

If the Fed bought the bonds in normal times, when interest rates are above zero, it would have to pay interest on the reserves it issues to banks, offsetting the income earned on the bonds, as it has done since 2015. Indeed, between 2014 and 2018, its remittances to Treasury fell by a third.

So the Fed can’t make a Green New Deal cheaper without compromising its control of interest rates and thus inflation. Green New Deal advocates think inflation risks are exaggerated. A massive increase in the deficit, whether financed by the Fed or private investors, could create many millions of jobs without exceeding the economy’s productive capacity, they say.

It isn’t impossible—unemployment has already fallen lower and employment grown faster than many economists thought possible without triggering inflation. But to run up the deficit on a bet those trends can go considerably further looks unnecessary and risky. Unnecessary because the Fed is already probing how low unemployment can drop without spurring inflation. Risky because if inflation does take off, so will interest rates, and all that Green New Deal debt will start to snowball.

Unless, of course, the Fed is pressured not to raise rates. It wasn’t purchases of housing debt in the 1960s and 1970s that sent inflation up, says Ms. Binder, but a “whole range of political pressures on the Fed to keep down rates from Lyndon Johnson continuing through Richard Nixon.” Will some future president similarly feel that inflation should be subordinated to remaking society through a Green New Deal?

Write to Greg Ip at greg.ip@wsj.com

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