I might have said joins the “4% Club”, however, I think we may have won that battle. When the President of the New York Fed starts discussing what the dynamics of a temporarily higher inflation target might look like we are in the closing stage of that campaign.
So, now we turn to a second battle, how do we make sure that markets are convinced that the Fed can indeed generate the inflation it wants? On the whiteboard a strong commitment is enough. When we see how markets hang on the Fed’s every word I tend suspect that it will be enough.
However, there are millions of unemployed workers on the line here. There is no reason to take chances. Hence, the second battle is to convince policy makers to warm up the choppers and prepare to deliver cash into the hands of American citizens.
Ezra adds much needed support
The answer is obvious: "explicit (though temporary) cooperation between the monetary and fiscal authorities." In practice, that would mean Bernanke gets John Boehner, Nancy Pelosi, Harry Reid and Mitch McConnell in a room and says the politics and specifics of this are their job, but the economy needs more fiscal stimulus if it’s going to recover, and the Federal Reserve stands ready to make that not only possible but also virtually costless. Inasmuch as Republicans aren’t big fans of further government spending right now, the best option could be the exact one that Bernanke recommended to Japan: a Fed-financed tax cut. Perhaps a payroll-tax holiday for the next year or two.
I have endorsed a payroll tax holiday. Some economists have raised concerns about that particular strategy. We might have to adjust it a bit. I welcome that debate. However, what is important at this stage is that we know who are enemy is
As we move towards a legislative effort we may be tempted to turn the guns on one another. We may be tempted to push for a solution that favors our long term priorities. However, such wrangling jeopardizes the fate of our citizens.
We must understand that this can go very, very badly. If anything good can come out of the Japanese Depression it is a reminder of just how horribly things can turn out.
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Friday ~ October 22nd, 2010 at 8:09 pm
Andy Harless
To the extent that Ricardian equivalence applies, in order to have a proper helicopter drop, the Fed would have to agree to shift its price level target. Otherwise it’s implicitly promising to do a helicopter vacuuming in the future. (That is, taxes will have to be raised to service the additional debt that the Fed will sell back into the market in the future to maintain its intended price level path — or else to make up for the loss that the Fed will suffer by paying more interest on bank reserves if it chooses not to sell debt back into the market.)
Since the Fed doesn’t currently have a price level target, shifting it may be difficult. To be more precise, the Fed would have to commit to a higher path for the monetary base, but it has no way to do so if we have no reference point to describe the (contingent) path that it currently intends. How much credibility would it have if the Fed were to say, “We promise to allow the price level to go permanently X% higher than we otherwise would have”? Indeed, can one even imagine the FOMC agreeing to make such a commitment publicly if it could do so?
Maybe you can imagine that, but if so, then you can also imagine the Fed simply setting a higher set of price level targets in the first place. Maybe the Fed would be willing to do so as part of a deal with fiscal authorities. But in any case, the substance of the Fed’s side of the deal has to be an unexpectedly aggressive price level path, or something equivalent. If the Fed were to promise merely to finance the additional deficit, that would be a commitment with no substance to it, since the Treasury can already finance itself with near-zero-yield T-bills, which is more or less the same as being able to print the money itself.
Friday ~ October 22nd, 2010 at 8:54 pm
Karl Smith
Andy -
So the core is that the Fed is committing to a higher price level, I think we agree here.
In terms of communicating that to the public that means the Fed will target inflation above its comfort zone.
The fear is that people might think the Fed will not reach that inflation target.
So we restructure the problem this way. We say ok
We are going to give people a bunch of money and we promise not to stop inflation from rising.
That way people can observe the checks going out. They don’t have to believe that the Fed’s promise will in and of itself will create more inflation. They simply have to believe that the Fed won’t stop inflation from occurring.
If we don’t even have this much credibility then I would be shocked.
The only option at that point would be to begin government purchases of items that could not plausibly substitute for consumption.