Recently Ryan Avent at the Economist blog wrote:
And then there is the Fed. Ben Bernanke has managed to innoculate himself against charges of doing too little, among much of the press anyway, by stepping in repeatedly when things look particularly bad. Yet the Fed bears the greatest responsibility for America’s pathetic recovery. Mr Bernanke has systematically avoided his own good advice about how to stimulate at the zero lower bound. The Fed’s interventions have been limited and seemingly designed to ignore the powerful expectations channel; at no point have breakevens shown inflation expectations steady at even pre-crisis levels when expectations above pre-crisis levels are what the current situation demands. Despite the obvious importance of inflation expectations for recovery at the ZLB, the Fed has behaved as if it’s operating under a 2% inflation ceiling, rather than a target. It repeatedly stops pushing the economy forward as soon as it seems likely that the economic trajectory will carry inflation toward 2%. With plenty of slack remaining in the American economy, this strategy inevitably produces a return to disinflation at the slightest breath of trouble from abroad.
To which Robert Waldman says:
Given the demonstrated (again) effectiveness of fiscal stimulus and the almost compete absence of any evidence that the Fed’s efforts since the crisis have had much effect, I have no idea how Avent can possibly think that the Fed bears greater responsibility than Congress. I can see an argument for more aggressive monetary policy on the grounds that it certainly won’t hurt, but I think Avent’s blind faith that it is as effective now as in normal times is based on a refusal to deal with the evidence.
I have no idea what Waldman means when he says “given the demonstrated (again) effectiveness of fiscal stimulus…” I didn´t know it had been demonstrated before, let alone now.
Contrary to what he says there´s a lot of evidence that the Fed´s actions have been limited and designed, not to ignore, but to avoid letting the powerful expectations channel to come into play. Both QE1 and QE2 raised inflation expectations which were dropping to dangerously low levels, but as soon as they reached the Fed´s “desired” level the QE button was “switched off”.
And that´s the reason behind the fact that for the past three years we´ve had moments when the ‘patient’ pepped up, but was quickly ‘tucked’ underneath the bed sheets again.
As Anon/Portly writes in the comments of this Scott Sumner post:
This is another amazingly insightful post, but I wonder if it doesn’t kind of underestimate the sociological dilemma of the smart Keynesians. Yes, it’s hard not to be suspicious that they like fiscal policy simply because of the win-win of stimulus and more G, but then think of all of the hand-wringing about not having foreseen the Great Recession. I mean all the “we didn’t see this coming/failure of Macro” stuff. It all focused on not having foreseen the financial crisis, not having read enough Kindleberger and Minsky.
Then market monetarism comes along and it turns out they all missed not only the significance of the NGDP drop, but its plain fact. So now not only their analysis but their meta-analysis are in tatters.
It’s not easy to have to admit something like that – if nothing else, what if not only your analysis and your meta-analyis but also your meta-meta-analysis turn out to be wrong? 3 strikes and you’re out?
But 80 years ago another President ‘bit the bullet’. As Mark Sadowski notes in his comment in the same post:
One can turn that on its head and ask where did Franklin Delano Roosevelt get the crazy notion that monetary stimulus was an option? Certainly based on Krugman’s interest rate reasoning a much stronger case could have been made in 1933 that fiscal stimulus was the “only game in town.”
Well, the short answer is that he got it from agricultural economist George Warren who sold Irving Fisher’s “compensated dollar plan” to FDR in early 1933. FDR was so taken with Warren’s ideas that he pursued his dollar devaluation plan over the strong opposition of many of those within his own administration, such as William Woodin, Dean Acheson (yes, that Dean Acheson), Oliver Sprague, James Warburg and Henry Morgenthau, all of whom, with the exception of Morgenthau resigned in protest.
It’s hard for me to imagine Obama fighting for monetary stimulus in opposition to all those puffed up egos much less going to the trouble of seeking out and listening to the seemingly hair brained schemes of a lowly rumpled bespectacled agricultural economist.
Central banks have a strong influence on market expectations. Actually, they have as strong an influence as they want to have. Sometimes they use quantitative easing to communicate what they want. Sometimes they use their words. And that’s where monetary policy basically becomes a Jedi mind trick.
The true nature of central banking isn’t about interest rates. It’s about making and keeping promises. And that brings me to a confession. I lied earlier. Central banks don’t really buy or sell short-term bonds when they lower or raise short-term interest rates. They don’t need to. The market takes care of it. If the Fed announces a target and markets believe the Fed is serious about hitting that target, the Fed doesn’t need to do much else. Markets don’t want to bet against someone who can conjure up an infinite amount of money — so they go along with the Fed.