Monetary policy for the present depression, not for the next recession

At Bloomberg View, Clive Crook has a pretty depressing piece – “Monetary Policy for the Next Recession”:

By pre-crash standards, the big central banks have made and continue to make amazing efforts to support demand and keep their economies running. Quantitative easing would once have been seen as reckless. The official term of art — unconventional monetary policy — tacitly acknowledged that.

But QE isn’t unconventional any longer. It mostly worked, the evidence suggests. The world avoided another Great Depression. Yet even in the U.S., this is a seriously sub-par recovery; growth in Europe and Japan has been worse still. Now imagine a big new financial shock. It’s quite possible that all three economies would fall back into recession. What then?

And concludes:

What if ordinary monetary policy isn’t enough? What if central banks can’t discharge their inflation-target mandate without a hybrid fiscal-and-monetary instrument? QE has already posed that question — it’s a hybrid too — but in a much more subtle way. When the discussion turns to the Fed sending out checks, the issue is impossible to ignore.

It needs to be addressed. Independence for central banks only makes sense if they have the means to do the job they’ve been given. At the moment, they’re dangerously under-equipped.

He shouldn´t be enquiring about monetary policy for the next recession. All should be focused on monetary policy for the present depression”.

It´s amazing how many have been sold on the idea that the Fed is “out of ammo” or, equivalently, “dangerously under-equipped”.

The fact is that the Fed is not working it´s “firehoses” as it could. The only plausible answer to the “puzzle” is “because it chose not to”!

The charts below depict inflation (headline & core PCE) over different periods. This is followed by the chart depicting nominal spending (NGDP) growth (the Fed´s “firehose”) over the same periods.

Firehose_1

Firehose_2

The “Great Inflation” goes hand in hand with high and rising NGDP growth, i.e., the Fed is “inflaming” the economy.. Thereafter there is the “Volcker-Greenspan Adjustment” leading to the “Great Moderation”, which extends to 2007, a period during which, for much of the time, the Fed provides the “right” amount of “liquidity”.

Bernanke´s Fed thought that amount was “too much”. First, it “closed the taps” and then opened them up but with much less “water pressure”, insufficient for the “spending grass” to grow to heights it had reached during the “GM”!

This very simple story is sufficient to guide monetary policy. First to enable the economy out of the depression and then keeping it from falling into another!

 

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