Note to Self: Modern Monetary Policy

Conventional monetary policy:

• Rescue the economy in a liquidity panic by dropping the safe interest rate via open market operations, and flooding the economy with liquidity.
• Rescue the economy in a solvency crisis via inflation to reduce the value of nominal debt to levels at which debtors can pay.

Bernanke-Paulson economic policy:

• Reduce the size of risk premia to normal levels and raise the value of risky assets to normal levels and so restore solvency to the financial system by having the government buy up risky assets, and so shrink the supply of outstanding risky assets for the private sector to hold.

The problem is to keep Bernanke-Paulson economic policy from becoming:

• Restore solvency to the financial system by taking tax money and using it to buy underwater assets for more than they could ever be worth.