In a post yesterday, Scott Sumner writes:
Bernanke claims money has been “extraordinarily accommodative,” based on the low interest rates and fast money supply growth. Thus he simply walks away from his 2003 definition of the stance of monetary policy. And no one in the press has called him on this inconsistency.
He has not walked away from his much more well-known denial of “liquidity traps” as preventing monetary stimulus, as that would make him look like a fool. Instead he’s consistently argued that the Fed could do more, but is held back by certain unspecified “risks and costs” of further stimulus.
This approach to the problem is wrong on all sorts of levels. There are no costs and risks of keeping expected NGDP growing along a 5% track, level targeting, all the “costs and risks” come from missing the target. To take just one example, the ultra-slow NGDP growth after mid-2008 drove nominal rates to zero, and greatly boosted the demand for base money. This forced the Fed to buy lots of assets, exposing them (allegedly) to risk of capital losses on those assets. But that “risk” is caused by tight money, not monetary stimulus. Even worse, it’s not really a risk at all, as the Fed is part of the Federal government. Any losses to the Fed from falling T-bond prices are more than offset by gains to the Treasury. Indeed that’s why inflation has traditionally been viewed as a boon to government coffers.
Coincidentally, today Sandra Pianalto, Cleveland Fed President discusses risks and costs:
Monetary policy should do what it can to support the recovery, but there are limits to what monetary policy can accomplish. Monetary policy cannot directly control the unemployment rate. It can only foster conditions in financial markets that are conducive to growth and a lower unemployment rate. At times, significant obstacles can get in the way.
… large-scale asset purchases can be effective. But our experience with these programs is limited, and as a result, they justify more analysis. For example, as the structure of interest rates has moved lower over time, it is possible that future large-scale asset purchase programs will yield somewhat smaller interest-rate declines than past programs. A related issue to evaluate is whether further reductions in longer-term interest rates would stimulate economic activity to the same degree as they have in the past.
The bottom line is this: I am supportive of actions that provide economic benefits with manageable risks. The FOMC’s policy actions to date have been important economic stabilizers and have acted to support the expansion(!). Yet today, we still find ourselves in a challenging economic environment – one in which we continue to rely on nontraditional policy tools. These new tools come with benefits and with risks … and we must constantly weigh both in our efforts to meet our dual mandate of maximum employment and stable prices.
I´m always surprised by FOMC participants concentration on interest rates and how the “programs have been successful in lowering them” and thus providing support to the expansion. It´s just the opposite as seen in the chart below. Every time a new “program” was announced or implemented, interest rates rose. And at the end of the programs they fell!
You see that rates fell when the financial crisis began with the Paribas announcement in early August 2007. With Operation Twist the effect was more muted: interest rates only stopped falling.
What they should want was a “program” that would give indications that the Fed was set in getting the economy back up. Interest rates, stock prices and inflation expectations would all go UP!