There were some interesting manifestations in the last few days. Justin Wolfers argues that things are worse than they appear, with the US economy already half way to a lost decade. His argument is based on showing that the income-based measure of RGDP indicates the recession started in late 2006 (not late 2007) and has dropped significantly more than the expenditure-based measure. The difference between the two measures has been greater than “normal” and it may be that over the next few years the BEA revisions will show that the expenditure-based measure will look more like the income-based measure. The figures below show the discrepancy and how they have increased.
Those are certainly interesting details, but no matter when the recession began, it only became “great” after mid 2008 when the Fed allowed nominal spending to crash!
Than there was Bernanke´s speech on the US Economic Outlook. If it were an exam essay he would get an F! As he´s been doing since early this year, he spends a lot of time defending the Fed from accusations of “promoting food riots and inflation” across the world! This post discusses his early defense.
In “Is QE2 a Savior, Inflator, or a Dud”? John Cochrane starts from the (wrong) premise that the goal of QE2 was to lower interest rates and stimulate the economy. To him it was a failure because interest rates didn´t fall. Also, he thinks it´s no use Bernanke arguing that equity prices have risen significantly as well as inflation expectations.
The figures below show that QE2 had positive effects. The bars indicate the first hint of QE2 in late August 2010, the actual announcement in early November and the indication in late April 2011 that it would end as scheduled in June. It seems that unless the Fed communicates an explicit target (preferably a nominal spending target level) “stimulus” effects will be week and short lived!
Cochrane in essence adopts the New Keynesian view that sees the monetary transmission mechanism working (exclusively) through interest rates. So he concludes that the Fed is “basically helpless” and that Bernanke should admit to Congress that “there´s nothing the Fed can do”! And then says that “QE2 distracts us from the real microeconomic, tax and regulatory barriers to growth”!
He should read this post by Nick Rowe which argues that “New Keynesians have this precisely backward. Interest rates are neither necessary nor sufficient for the monetary policy transmission mechanism. Money/velocity is both necessary and sufficient”! In effect that´s how the “Great Moderation” was attained. Money supply for the most part offset velocity changes, keeping nominal spending evolving close to a stable level growth path. In mid 2008, when the Fed allowed nominal spending to crash the “Great Moderation” became the “Great Recession”.
Update: Interview with Joe Gagnon on Quantitative Easing, its Criticisms and the Argument for QE3:
In the wake of recent bad employment numbers, people are looking for options to boost the economy. Some have proposed another round of quantitative easing to get us back to the normal rate of growth. I interviewed Joe Gagnon, Senior Fellow at the Peterson Institute for International Economics, about this program. He recently spoke at the Future of the Federal Reserve conference, co-hosted by the Roosevelt Institute and New America Foundation, about what we need to do now to get the economy re-started. He outlines some basics about monetary policy, discusses whether the first rounds of QE worked, and address criticisms of the program and whether a third round of QE will help.