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“I beseech you in the bowels of Christ to consider that you may be wrong” – Oliver Cromwell, 1650
I think it’s safe to say consensus center-right opinion is that the Bernanke Fed’s program of quantitative easing has been and continues to be a monumental monetary mistake. The Wall Street Journal editorial page, The Weekly Standard, and The Washington Examiner provide recent examples of this view. So does economist Brian Wesbury of First Trust Advisors in a pretty good summation of the center-right case:
Last week the Fed invented another quantitative easing program out of whole cloth. We guess it figures that printing even more money (talking even louder and more emphatically) would help. The Fed has already taken its balance sheet from $900 billion to $2.8 trillion with little impact, so why would a bigger, $4 trillion, balance sheet make the difference?
The problem is that QE has not worked. Banks have responded by increasing their excess reserves – holding assets as deposits at the Fed rather than lending them and allowing the money multiplier to work its magic. In fact, excluding excess reserves, the Fed’s balance sheet is smaller than it was in late 2008, in the immediate aftermath of the collapse of Lehman Brothers. …
The reason QE hasn’t worked is not that the Fed hasn’t been clear enough about its intentions, but because tight money is not the reason for tepid economic growth. There is no lack of liquidity in the US economy. It is the huge expansion in government and the failure to address long-term entitlement issues that are the problem. Spending robs the economy of its potential, while the threat of higher future tax rates undermines value.
A few explanations, observations, declarations, and thoughts:
1. What I — and others including Scott Sumner, David Beckworth, and Ramesh Ponnuru — have been proposing is that the Federal Reserve target the pre-Great Recession growth path of nominal gross domestic product. If you target NGDP to grow at, say, 5% a year, and it grows 4% one year, you play catch up and shoot for 6% the following year.
2. Targeting NGDP can be done by raising and lowering the Fed funds rate. When that rate is essentially at zero, the Fed can engage in bond buying as it currently is doing. Here is Milton Friedman speaking about Japan in the 1990s — though he could have been as easily talking about America today:
Defenders of the Bank of Japan will say, “How? The bank has already cut its discount rate to 0.5 percent. What more can it do to increase the quantity of money?”
The answer is straightforward: The Bank of Japan can buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan, what economists call high-powered money. Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand their liabilities by loans and open market purchases. But whether they do so or not, the money supply will increase.
There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so. Higher monetary growth will have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately. A return to the conditions of the late 1980s would rejuvenate Japan and help shore up the rest of Asia.
3. Many folks are quite taken back by this chart showing a huge expansion in the monetary base by the Bernanke Fed:
Here is Beckworth:
Our fellow conservatives have this tendency to see only the supply of money and ignore the demand for it. The fact that banks have not leant out the excess reserves indicates they still have an elevated demand for them. (Though we have to acknowledge here that some of that demand comes from the fact that the Fed is paying them more than they could get from holding treasury bills. How big this effect is is not clear to me. Even in the absent of IOR, banks would still be holding some excess reserves as long as the economy was weak.)
Also, it is odd to claim to there is no lack of liquidity of in the U.S. economy. Treasury yields are at historic lows and have been trending down since 2007. If we were satiated with sufficient liquidity this would not be happening, interest rates would be increasing as we tried to get rid of excess liquidity (i.e. we sell off treasuries which lowers their price and raises their interest rates.) Also, one can look to broader measures of money like M4 that show a decline since the crisis that has not fully recovered.
5. The Fed’s bond buying has not been effective as it could have been because it has been ad hoc, stop-and-go, and poorly communicated. By finally setting some clear numerical thresholds — though not yet, unfortunately, an NGDP target — and making its future actions dependent on the state of the economy, the Fed will lend certainty to expectations. Again, Beckworth:
It makes very clear to the public that the Fed will not stop until these targets are hit. Markets, in turn, should respond in anticipation of these goals being hit. That is, the elevated demand for liquid assets should start declining as households and firms start moving their funds into higher yielding assets. This rebalancing should raise asset prices, help repair balance sheets, and ultimately spur nominal spending. In other words, by better managing expectations, the Fed should cause the public to do the heavy lifting–and they already have started. If all goes according to plan, the Fed may not have to actually purchase that many additional assets. Ironically, this means that had the Fed been doing this all along its balance sheet would be much smaller now.
6. Monetary policy can be too tight even with low interest rates and lots of supposed liquidity. Sumner:
Interest rates are a very misleading indicator of monetary policy. Both in the early 1930s and late 2008, falling rates disguised a tight money policy. The rates were actually falling for two reasons. Expectation of recession led to less borrowing and thus lower real interest rates. And inflation expectations also fell sharply. … During periods of deflation and near-zero rates, there is a much higher demand for non-interest bearing cash and bank reserves.
7. It’s not just Uncle Miltie. Here’s Friedrich Hayek on targeting nominal income: “The moment there is any sign that the total income stream may actually shrink, I should certainly not only try everything in my power to prevent it from dwindling, but I should announce beforehand that I would do so in the event the problem arose.”
If you are going to have central bank, how do you want it to run monetary policy? NGDP level targeting would be a vast improvement. But it is no magic bullet that will alter the growth potential of the U.S. economy. For that we need supply-side, pro-growth tax, regulatory, immigration, and education reform.
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