Banking
I feel under-informed to comment too much on monetary policy (maybe everyone is, for that matter), but it really seems to make sense that the government should be a lender rather than a granter. We know very well that lending money invokes a multiplier that enlarges the money supply, busts deflation, and stimulates GDP growth. And, despite what the kookie-head Paulies on Youtube say, that’s a Good Thing when times are tough.
Banks do this, but when they don’t do this you really shouldn’t force them to. I’m not a big believer in the decision-making capacity of banks. Any institution that relies on something as ridiculous as the American credit rating system could not be seen as very insightful or analytical in my eyes. But even if your standards are a little funky, if you’re not willing to lend it’s probably for a good reason; otherwise, your board of directors will be looking to have your head.
We can measure the risk capacity of the ordinary consumer in their relative debt level, the driver of which is basically related to the inverse of the marginal propensity to save. Banks take risk by allowing this to happen, by making interest rates attractive for lending and unattractive for saving (meaning, low). And willingness to lend is based on the bank’s cost of money and their view of lending risk. Cheap money allows for a higher risk appetite on the part of the banks. If this gets too out of hand, you start issuing no-doc loans to idiots. The Fed influences the cost of bank funds, so interest rates are certainly a huge policy tool when trying to influence private sector investment preferences.
If I’m the government and I start handing out massive grants (and sadly things like TARP seem to degrade to grants very often despite being sold to the taxpayers as loans or investments), I can’t rightly get this money back without just raising taxes and burning the money, which in implementation probably ranges from outright theft to hopelessly complicated (post-stimulus bonus tax, anyone?).
Classical economics education normally illustrates the creation and destruction of money via government debt (bonds). If you as the government pay off bonds (by printing/releasing cash), you grow the money supply. If you take on debt, you shrink the money supply. So the government works productively backwards to the rest of the public in the classical format. It makes sense, as people buy bonds (directly or indirectly) when they save, and savings sent to the government takes money out of the private sector.
But what happens when the government begins to produce cash outflows (increases to the money supply) without a bond trading hands the opposite way? You’ve just enlarged the money supply with no claim to reduce it when desired. You start looking like a bit of an indian giver when you try to tie strings to the funds (these are businesses, not states, for goodness sakes).
So the role of a debt-holder seems to make a heck of a lot more sense for the government. If the government grants money to a company, they start to look like a shareholder rather than a debt-holder. This is what happened to GM. The government injected capital without a bond changing hands, and the company effectively became government-owned. Maybe it was necessary to take the reins here, but it’s certainly not the standard case. This puts a lot of really non-business-savvy bureaucrats in the position of having voting rights in a company deemed quite important to the country’s prosperity.
If you’re a debt-holder, you have it pretty nice. You have no input into the daily operations of the company (unless covenants are broken), and you have first claim to the carcass if the company happens to fall over. The government can agree to restructure or extend the duration of the debt at will, but they also have the right to reclaim the money and have firmer control on inflation while operating directly in the private sector (rather than depending on the banks, which throughout the crisis have been quite loath to follow recommendations regarding the use of capital injections).
The central bank becomes a bit more like a regular bank, save the luxury of having the Federal Mint in the vault rather than time deposits.
Debt gives you the chance to make rules and carries with it implied limitations on the interactions between the two sides of the agreement.