Missed opportunities

Nicholas Craft has a nice post on Britain´s experience in exiting the ZLB in the early 1930´s:

The policy framework adopted from mid-1932 has a strong resemblance to the so-called ‘foolproof way’ of escaping from the liquidity trap (Svensson, 2003) and to ‘Abenomics’ in today’s Japan:

  • After the forced exit from the gold standard in September 1931, by the middle of 1932 the Treasury had devised the so-called ‘cheap-money policy’.

Initially, short-term interest rates were cut to around 0.6% – and stayed there throughout the rest of the decade (see Table 1).

  • Second, a price-level target was announced by Chamberlain in July 1932 which aimed to end price deflation and return prices to the 1929 level.

  • Third, the Treasury adopted a policy of exchange-rate targets that entailed a large devaluation first pegging the pound against the dollar at 3.40 and then against the French franc at 77 (Howson 1980), intervening in the market through the Exchange Equalisation Account set up in the summer of 1932 (see Table 2).

In the US the nature of the process was similar, a little over one year later. Like PM Chamberlain, President Roosevelt proposed a price level target and the Treasury abstained from sterilizing gold inflows.

Look at what happened to nominal spending in the UK and the US, noting that the crunch in the UK was much weaker than in the US (and similar to the 2008-09 recession with RGDP falling about 4.5% in both instances), so nominal spending in Britain flew high above the pre-crisis level. Also note that the 1937-38 recession in the US was in large part determined by the decision of the Treasury to sterilize gold inflows (the decision was reversed in April 1938).


This brings me to note the opportunities missed by the Fed over the last four years. The chart below indicates how powerful monetary policy can be. Even with QE1, introduced in March 2009, which had both a quantitative (dollar) and time limits, the trend reverses. (Other doses of QE were applied over the period, with the latest version substituting a time limit for a contingent (unemployment and inflation) commitment).




If something as weak as QE1 could have such a clear effect, imagine if the Fed had made a level commitment towards NGDP. The dotted lines provide alternative paths, indicating that deleveraging and the stock market would likely have progressed much differently. Now, just close your eyes and try to picture the behavior of unemployment/employment in this alternative world!

HT Patricia Stefani

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