Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

An Alternative to QE2

QE1 hasn’t worked, and now the Fed wants to continue its policy of “pushing on a string” to stimulate the economy via QE2.  Monetary policy indirectly influences demand through lowering interest rates and the dollar, and raising asset prices, but its impact is uncertain.  The Fed has already pumped $2 trillion into the banking system with very little impact on output and prices (with the exception of commodity and precious metal speculation), so a better way to accomplish the goal would be a combined fiscal-monetary policy action. 
 
Many have criticized Obama’s stimulus package for wasteful spending with little impact on jobs.  If most people don’t trust government with increased spending, then any new stimulus should focus on cutting taxes. And, that tax cut better be directed toward those who will definitely spend it. 
 
Currently, workers and businesses both pay 6.2% in Social Security taxes, but the tax only applies to income less than $106,000. That’s an onerous tax on lower and middle class workers and small businesses. So a better option (than QE2) is a temporary 50% cut in Social Security taxes. Based on current SS revenues, this would reduce taxes by a little over $400 billion over the course of a year, which is two-thirds of what Bernanke proposes.
 
The big question: how can the tax cut be financed (and maintain current SS benefits) when the deficit is currently $1.3 trillion? Here’s where the Fed comes in. The Social Security trust fund has accumulated a surplus of about $2.5 trillion over the past 25 years, because the taxes paid in have been greater than the benefits paid out each year, and government (borrows and) spends the excess—government treats SS taxes just like income taxes, and, in exchange, it gives Social Security an IOU in the form of a treasury bond. When that bill comes due, government will have to pay itself back, and it will do so by either borrowing more, increasing taxes, cutting benefits, or printing money.
 
If the Fed is going to buy $600 billion worth of government treasury bonds anyway, then why not have the Fed buy them from the trust fund instead?  Rather than hoping investors will use the funds from QE2 to buy stocks and indirectly try to influence demand, the Fed can buy bonds directly from the trust fund and “finance” the funding gap in social security caused by the tax cut.    
 
This solution has more benefits than the Fed’s plan, and it would force policymakers into some very uncomfortable discussions about both social security and monetary policy. Some of the benefits: 1) it directly benefits those most in need by increasing take home pay and small business profits; it directly increases spending; 3) households and businesses will decide how to spend the funds, not government; 4) it is easily manageable, as you simply reduce the amount taken out of paychecks from 6.2% to 3.1%, then gradually raise it as the economy recovers; 5) the Fed won’t have to pay fees to its “dealers” when it buys $500 billion worth of bonds in the “open markets”; 6) it does not raise the gross national debt, because it simply transfers bonds from one government entity (SS trust fund) to a semi-government entity (the Fed); and 7) it gives the Fed the extra ammo (treasury bonds) it will need when the time comes to restrain inflationary pressures and pull reserves out of the banking system.
 
QE2 is a huge risk with an uncertain outcome. The one thing we know for sure is that the Fed’s dealers will earn millions of dollars worth of fees acting as the agents for the bond sales, and investors will benefit by increased bond and stock prices (no guarantee on the last one). 
 
The policy proposed here is a way to implement Abba Lerner’s idea of functional finance. It would “force” government to be transparent on social security funding and taxation, and given that the Fed is going to buy treasuries anyway, it would force a serious discussion on the transmission of monetary policy and inflation—I hope.