“Neutrality” will only allow that things “limp along”

Just keep static, like a statue. That´s what many are saying explicitly or merely implying about the Fed: That It should be conscious of its impotence. This is the bottom line of Tim Duy´s post today:

Bottom Line: Both monetary and fiscal policy suffer from the same impediment – the numbers needed to be effective, in both the size of the Fed’ balance sheet and the magnitude of the federal deficit, are so big that policymakers view them as potentially destabilizing, while the magnitude to which they might be willing to commit would leave them open to criticism that their policies are failures. The obvious fallback position is to embrace the devil you know, which in this case is an economy simply limping along.

That´s because Quantitative Easing – QE – has become the new catch word with a
numerical suffix attached. This Bloomberg article indicates that more “bad stuff” is in store:

Federal Reserve officials are discussing whether to adopt an explicit target for inflation, a strategy long advocated by chairman Ben S. Bernanke and practiced by central banks from New Zealand to Canada, according to people familiar with the discussions.

The talks coincide with Fed efforts to spur growth and reduce unemployment without fueling higher prices. An inflation target could help quiet critics of record monetary stimulus and anchor public expectations for consumer prices should the Fed in coming months try to spur the recovery by keeping interest rates close to zero for longer.

Which would be done to assuage agents that inflation is uppermost in the Fed´s mind despite keeping rates close to zero for “eternity”! But inflation targeting is a bad choice once inflation has been “conquered”, and the FF rate target is a bad “instrument”.
Not that long ago the Fed has shown that it can be “smart”. During the September 2010 meeting it came out from the discussion that:

With short-term nominal interest rates constrained by the zero bound, a decline in short-term inflation expectations increases short term real interest rates (that is, the difference between nominal interest rates and expected inflation), thereby damping aggregate demand. Conversely, in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy. Participants noted a number of possible strategies for affecting short-term inflation expectations, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP.

In my previous post I showed that QE2 mostly affected inflation expectations (temporarily). Adopting a NGDP Level Target would strongly affect spending, which is what is needed.

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