A Layman's Guide to the Next Big Stimulus

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Reading the news can sometimes be a frustrating experience. Too often, journalists use jargon they expect their readers to know, or they fail to give context because they imagine readers have been assiduously following previous stories. In our Flashcard series, The Atlantic aims to decode the concepts and terms readers encounter every day but seldom see explained. Today's installment: the case for and against more quantitative action by the Federal Reserve to boost the recovery.

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The News

Next week, Ben Bernanke and Federal Reserve are expected to take new steps to hasten our flat recovery. The U.S. central bank is often considered the government's Wizard of Oz, the mysterious behind-the-curtain manager of occult tools like "money supply" and "federal funds rate." It's true, the Federal Reserve's job is complicated. But it's not that complicated. Here's an easy way to understand the historic steps it has taken to help the economy -- and what it might do next.

The Gist

Some compare the Federal Reserve's role in the economy to the role of water in an irrigated farm (see: Chris Hayes). When we're growing, the Fed has to be careful not to drown us with too much money, which could trigger inflation. When the economy is dry, the Fed turns on the spigots to get money flowing.

Let's consider two ways for the Fed to "irrigate" the economy -- each with the final goal of growing spending and investment. First, the Fed controls the interest rate banks charge each other for loans. In 2008, it lowered that rate to nearly zero to keep money flowing between banks so that it can trickle to businesses and families that need credit.
Don't expect any miracles next round. The Fed can guarantee bad assets, but it can't guarantee new spending and investment.

Opening the valves wasn't enough, as some frozen investments still stuck to bank balance sheets. So the second strategy was to unclog the pipes by taking the gunky debt (everything from mortgage-backed securities to auto loans) from the banks in exchange for new money. The Fed replaced the securities clogging the system with liquid cash to encourage lending and spending to grow.

The Fed cleared out the pipes and opened the valves to let the flood in, but we still can't see much growth on the ground. Why? Well, look at the conditions. One in six Americans are underemployed. Home values are down 20 percent from their peak. Banks are shell-shocked by the credit crunch, and stingy. The economy still suffers from a demand and confidence crisis. The upshot is that the Fed can influence the amount of money in the economy, but it can't force consumers to consume, lenders to lend, or employers to hire.

The Debate

After months of resisting further action, the Federal Reserve will probably try something new. It can pledge crazy-low rates for an extended period to calm investors. It can also buy hundreds of billions of dollars of new, long-term securities off the market to put cash into the hands of investors. This might drag interest rates down even further, making it easier to buy a home or borrow to build a factory. (For a wonkier take on Fed options, click here.)

But most people doubt that the Fed will be as successful accelerating the recovery as it was reversing the recession. After all, the Fed can guarantee bad assets, but it can't guarantee new spending and investment. Two years ago, it had room to lower interest rates and buy sticky assets off bank balance sheets. But today, as Annie Lowrey points out in another explainer, banks and companies are already sitting on billions in excess capital and they're choosing not to lend and spend it. Why should we expect them to lend or spend the next batch of easy money?

Still, advocates for further action make a compelling point: We can't afford not to try something else. After all, what's the downside of more money? There is little risk of inflation, or flooding the system with money. In fact, a little extra inflation could spur spending. A cheaper dollar would make our exports more competitive. In short, if the benefit of new action is somewhat mysterious, the drawbacks of inaction are only too clear: more of the same.

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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