I, for the life of me, can not understand where Stephen Williamson is coming from in the recent posts he’s done claiming that Quantitative Easing is ineffective, and that the Fed is completely out of tools which it can use to boost the economy. Here are the points he made from his most recent post, entitled “Mark, Brad, and Ben“:
- Accommodative monetary policy causes inflation, but with a lag. I think Brad’s inflation forecast is on the low side, as maybe Ben does as well. The policy rate has been at essentially zero since fall 2008. Sooner or later (and maybe Ben is thinking sooner) we’re going to see the higher inflation in core measures.
- Maybe Ben is more worried about headline inflation (as I think he should be) than he lets on.
- Maybe in his press conference Ben did not want to spend his time explaining why the Fed spends its time focusing on core inflation. What every consumer sees is headline inflation, and they are much more aware of the food and energy component than the rest of it.
- As with my comments on Thoma, there is really no current action that the Fed can take to increase the inflation rate. More quantitative easing won’t do anything, so the Fed is stuck with saying things about extended periods with zero nominal interest rates in order to have some influence through anticipated future inflation on inflation today.
Most of the list simply baffles me. First of all, accommodative monetary policy can cause inflation. And of course in the long run, a stable monetary policy only affects prices…but the blanket statement that monetary policy causes inflation is misleading, and highlights a problem with even talking about inflation. In a standard AS/AD model, the determinant of the composition of NGDP growth is the slope of the SRAS curve. In recessions, it is generally understood that the SRAS curve is relatively flat. In that case (arguably the case we are dealing with right now), an accommodative monetary policy which shifts the AD curve to the right would result in much higher output growth than inflation. As for the lag part, monetary policy has an almost immediate (< one quarter) impact on many markets; including interest rates, stock/commodity prices, inflation expectations, etc. Here is a chart of those market reactions to both QE's courtesy of Marcus Nunes:
[Click Image to Enlarge]
In each case, you can see that asset prices had a quite immediate response to quantitative easing. QE2 performing poorly doesn’t indicate that QE doesn’t work, it highlights problems with how the policy was implemented. Specifically, the Fed structured the policy around purchasing a specific quantity of Treasuries ($600bn) instead of setting a target level of nominal spending, or even a price level target, and then commit to purchases until that target has been reached.
Second, why would Ben Bernanke be worried about headline inflation when nearly every forecast from the Federal Reserve views the current rise in headline as temporary? Here is the SF Fed, which I posted earlier:
[Click Image to Enlarge]
Indeed, the FOMC’s own report states as much. Furthermore, we have a good idea of what is causing the bump in headline inflation, and that is the energy prices. We also have good reason to believe that this is due to rising demand in the briskly growing emerging markets, and the inability to ramp up supply. What in the world is monetary policy supposed to do about that? Is Williamson advocating tightening policy while NGDP is still FAR below trend, and we are not experiencing enough growth to catch up to the previous trend?
I don’t have many quibbles with the third point, but the fourth point is the one that floored me the most. I’ll outsource commentary to David Beckworth in a comment on Williamson’s post:
Steve,
Why do you keep saying there is nothing the Fed can do? You acknowledged in the comment section in your last post that the Fed could do something more via a price level or ngdp level target. By more forcefully shaping nominal expectations with such a rule the Fed could do a lot.
It is worth remembering that folks were saying the same thing about monetary policy in the early 1930s. They were certain there was nothing more the Fed could do and as a consequence of this consensus we get tight monetary policy and the Great Depression. Then FDR came along and change expectations by devaluing the gold content of the dollar and by not sterilizing gold inflows. His “unconventional” monetary policy packed quite a punch.
And here is my comment:
I’m with David on NGDP targeting. But even if the Fed didn’t do that, it has its interest on reserves policy, and the last I checked, it hasn’t set an explicit inflation level target, and there is ~$14 trillion in outstanding Treasury debt held by the public that the Fed does not yet own…something Andy Harless has pointed out on numerous occasions.
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Friday ~ April 29th, 2011 at 4:37 am
geaugailluminati
he never makes sense…
Stephen Williamson has made a name for himself by bashing the opinions well known bloggers, notably Krugman…
i’ll bet he mentions PK in half his posts…
Friday ~ April 29th, 2011 at 12:23 pm
Mark A. Sadowski
In Steve’s defense he doen’t believe in AS curves. However, that alone leaves me perplexed.
Friday ~ April 29th, 2011 at 11:21 pm
João Marcus Marinho Nunes
And now you´ve become “the baffled guy”!
http://newmonetarism.blogspot.com/2011/04/attempt-at-de-bafflement.html
He is to Plosser what DeLong is to PK. A defender of a different (and equally misguided) faith.
Sunday ~ May 1st, 2011 at 5:37 pm
mattrognlie
I am much more of a supporter of QE2 than Williamson is (and thus my practical policy view is probably closer to yours), but I think that he’s right in several ways in this particular discussion.
First of all, it is extremely difficult to talk about these issues in the guise of a Old Keynesian “AD/AS” model, since the mechanisms are buried under the surface. You make the ad-hoc assumption (within the context of the model) that QE will move the short-run AD curve to the right, but you don’t say exactly why that will happen. This is a pretty serious problem, since a more fully fleshed-out model will generally have interest rates as the transmission mechanism between monetary policy and demand, and at zero the interest rate obviously can’t have much effect anymore. (which is the premise of this whole discussion…)
I am not a huge fan of Williamson’s New Monetarist models, but there is an alternative that captures much of the Keynesian intuition within a more coherent framework: the canonical New Keynesian model. For a first taste of this model, I recommend reading Gali’s recent text.
In the New Keynesian model, once you’ve hit the zero lower bound the only feedback from monetary policy to current demand comes through expectations of the path of the nominal interest rate. If the Fed credibly indicates that it will hold the interest rate at zero for longer than expected, then inflation today will rise, real interest rates will fall, and demand (and asset prices) will improve. In addition, the commitment to holding the interest rate at zero for longer will decrease real interest rates in the near future, which further increases demand today. Finally, if you think that some kind of “financial accelerator” is important in explaining the impact of interest rates, the rise in asset prices represents its own very important channel, as corporation and household balance sheets improve and both (1) the “inside money” available for investment increases and (2) the agency problem that makes borrowing costly becomes less serious.
But none of these outcomes are caused by the increase in base money today: rather, they’re caused by the fact that (for some reason) an increase in base money is an effective signal of the desire to maintain low interest rates in the future. There are many reasons why this might be true, but it’s not some kind of direct impact.
Steve Williamson’s other point is that the alternative impact of QE2—the direct effect from bringing down long-term interest rates through asset purchases—might not even exist. Here he is essentially rediscovering an irrelevance result proven by Eggertsson and Woodford in their classic 2003 BPEA paper. This irrelevance result requires some reasonably strong assumptions, and it’s likely that in the real world the Fed’s asset purchases will have some direct effect—but given how small the Fed is compared to the market for long-term assets, there’s no reason to expect a large effect.
In a sense, I think everyone in this discussion might agree—by far the most substantial effect from QE2 comes through its ability to shape expectations about the future path of Fed policy. The difference is really one of tone and emphasis. Steve Williamson spends most of his time stressing the absence of any direct channels through which QE2 might have an impact (even if he acknowledges that there might be some mysterious signaling effect), whereas the quasi-monetarists often speak as if it’s overwhelmingly obvious that QE2 should make a difference.
I think QE2 has been a substantial boon to the economy, but I agree with Williamson that because QE2 can only make a difference through its impact on expectation-formation (a phenomenon whose internal workings are mysterious), the quasi-monetarist rhetoric is unjustifiably overconfident.
Wednesday ~ May 4th, 2011 at 3:58 pm
Herman Villemel
Fortunately, while you’re baffled actual economists aren’t. Keep to what you know, little Blanchard boy, and don’t bother the grownups while we’re busy.