I'd like to get some opinions from the community about Dr. Stein's economic stimulus proposal to buy up student debt. I've commented in the past few days that I can't find much wrong with it, but I'm not much of a macroeconomist. My reading on the subject is limited to books like Piketty's Capital in the 21st Century and William Greider's Secrets of the Temple. This means that I may know just enough to be dangerous, and one of the reasons I hang out here is that there are a lot of smart people who can challenge my assumptions.

Keynesian Monetary Policy

First, let's have a quick primer on the subject matter. In the Keynesian model that has been in vogue for the last 80 years, there are two main policy tools that can be used by governments to stimulate the economy: deficit spending and interest rates. Spending is obviously stimulatory, but ever since the 80s neoliberal orthodoxy has decided that deficits are bad. Consequently, economic stimulus has been limited to interest rate manipulation.

How does this work? Typically, a country's central bank - such as the Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of Japan (BoJ) - will lower the interest rate they charge banks to borrow money. Banks need to borrow money so that when clients decide to withdraw cash, they can get it quickly without having to sell the investments they make to pay interest on the deposits. Lowering this interest rate effectively lowers the rate of interest that banks charge for loans. Businesses now find it cheaper to expand, and consumers find it cheaper to borrow money for purchases.

The problem with this approach is that interest rates can't really go below zero. The first time this became a problem for a large economy was in the 1990s when Japan fell into this "liquidity trap" - and they still haven't really recovered. The Fed found itself in this situation right after the great recession, and Congress was unwilling to authorise enough spending to properly stimulate the economy.

Quantitative Easing

To get around this problem, the Fed came up with a novel stimulus tool called Quantitative Easing (QE). Under QE, the central bank starts buying up debt in the form of bonds. The money to buy the bonds is created out thin air and paid to the former bond owners, who then can go and do something stimulatory with it.

Buying up lots of bonds like that has a secondary effect, which is to reduce the number of bonds available for sale. Reducing the supply of something increases it's price, which in the case of bonds reduces the effective interest rate paid to the person holding the bond (they paid more for it so that eats into the interest they earn). So it also acts like lowering interest rates.

Theory and Practice

The Fed stopped QE about two years ago, but the other central banks that didn't have the stimulatory benefit of the US's TARP program like the ECB and BoJ are still at it. I refer you to gjohnsit's excellent essay the other day for the gory details, but the gist is that it looks like all this financial jiggery-pokery is not being used in a stimulatory manner because the people receiving it are doing useless things like propping up their stock prices by buying up their own stock (this reduces the supply of that stock and drives up the price.) This is what is behind the current stock bubble: the supply of both stocks and bonds has been significantly reduced, and when the supply of something drops, the price goes up.

Another economically useless activity that all this debt is fuelling appears to be real estate. All those houses being bought up and rented out at unaffordable rates by various rentiers from mom-and-pop operations to large banks like Goldman are enabled by all these low interest loans.

So trying to stimulate the economy by giving money to corporations and the rich is not working. What else could we do within the current system that would have an immediate effect?

Demand Easing

Enter Jill Stein. What she proposes is that instead of buying corporate or government debt, we should use QE to buy up consumer debt - specifically student loan debt - and then either forgive it entirely or reduce the interest payments to the rates that banks get. (I'm not clear on this and the web site is no help.)

This would be stimulatory because it puts money back in the hands of the students. They can now use their interest payments (and maybe the principal payments) to move out of their parents' basement and start building a life.

The most interesting thing about her proposal is that it doesn't require congressional approval. All she has to do is convince the Fed to do it, and if she was elected, that could be a reasonable policy request from the executive. The President has a certain amount of leverage over the Fed in terms of appointments, and I expect that would be brought to bear if needed.

Poking Holes

At this point, I'd like to throw the floor open for discussion. I'll start off with two possible objections:

• By making college debt free, you could drive up the price of college. Colleges would see that anything they charge would be paid by the Fed, so why not start gouging students?
• What happens to entering Freshmen? This is of particular interest to me as my oldest would coincidentally heading off to college in the first year of a putative Stein administration.

We are suppose to be a reality-based community, and democracy is based on public discussion of issues. I'm a big Stein booster, but I also believe that letting her push policies that have serious flaws is not good for anyone. I can't see any big problems, but that is what friends are for!