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A public policy blog from AEI
Most folks who identify as market monetarists have been in favor of the Fed’s bond-buying, or “quantitative easing,” program. They don’t think it’s been executed perfectly, however. If the Fed’s actions had been accompanied by a stated intention to target the level of nominal GDP, there’s a strong case that QE could have been far smaller yet far more effective. Still, as I write in my new National Review column, QE has likely helped the economy and thus been worth doing.
Every day this week, I will present answers to some common QE criticisms from a market monetarist perspective. Question #1 was Monday. Here is #2:
Maybe the Fed is having a positive economic impact, but isn’t it just a sugar high, papering over or propping up a bad economy with easy money? Even the hint of pulling back on QE causes markets to tank. That can’t be healthy.
Scott Sumner, economist at Bentley University and blogger at The Money Illusion:
If it were causing a sugar high, it would be leading to high inflation, but it isn’t. When the economy is depressed, higher nominal spending will tend to boost RGDP. The main problem in the US economy is too little demand, too little nominal spending. Monetary policy cannot fix many problems, but one problem it can fix is too little demand.
Michael Darda, chief economist at MKM Partners:
If nominal GDP is growing at a slow rate (too slow) and inflation is low (perhaps too low), by definition, there’s no sugar high. Yes, equities have responded to the Fed’s QEs. But that’s not the whole story since profits have grown significantly during his cycle even though output and employment (so far) have grown slowly. Moreover, expectations of Fed tapering were fully in the market before the September Fed meeting, with stocks close to cycle highs.
David Beckworth, economist at Western Kentucky University and blogger at Macro and Other Market Musings:
Again, the Fed is buying a lot of treasuries but relative to the total stock it is not holding much more than it did during the pre-crisis. Similarly, the amount of monetary base it is creating is modest compared to the demand for it. In other words, if the Fed were truly creating too much monetary base relative to the demand for it, we would be seeing inflation expectations taking off and interest rates rapidly rising. All of this means the Fed has not been adding that much stimulus relative to the slump state of the economy.
Recall that unemployment is still elevated and the economy is operating below potential. The US economy is still weak, sick, and lethargic. And just like giving a weak, sick, and lethargic person given a sugar shot really wouldn’t make much difference the same is true for the US economy now. Sugar highs really do something (in a pejorative manner) when the economy is healthy and running a full capacity. That is when distortions on a large scale emerge. Another way of saying this is that sugar highs come when the Fed lowers its target interest rate below the natural or neutral interest rate level. Right now, this is not the case. It is more plausible the opposite is true: market interest rates are above the natural interest rate.
Josh Hendrickson, economist at the University of Mississippi and blogger at The Everyday Economist:
I think that this “sugar high” view of policy comes from the experience of stop-go monetary policy that Milton Friedman highlighted throughout his career. Historically, the Federal Reserve has tended to overreact to fluctuations in the economy and fail to take into account the various leads and lags associated with monetary policy.What would basically happen is that the Fed would see rising unemployment, for example, and decide to conduct expansionary monetary policy. After a few months, they would continue to expand because of the little observed improvement in unemployment. Unemployment would begin to decline, but inflation would start to rise substantially and the Fed would immediately reverse course to lower inflation.However, due to the lag in policy, they would continue to contract until they saw changes in the inflation rate. By failing to take into account the lags of policy, they would tend to overreact to their indicators thereby generating wild swings in the monetary aggregates and ultimately, nominal income and real economic activity.This experience seemed to create the view that all monetary policy does is create a “sugar high”, a temporary improvement in the economy followed by a quick contraction. In reality, the “high” of this scenario was the over-expansionary policy and the “crash” was over-contractionary policy. This is not an inherent feature of monetary policy. It is an inherent feature of bad monetary policy.
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