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“:

  1. 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.
  2. Maybe Ben is more worried about headline inflation (as I think he should be) than he lets on.
  3. 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.
  4. 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:


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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:


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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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