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Remarks from Ben Bernanke indicate that the Fed is shooting itself in the foot:
“I have rejected any notion that we are going to try to raise inflation to a super-normal level in order to have effects on the economy,” [Bernanke] said.
In fact, the Fed should engage in level targeting, as I have been pushing in the last few posts. It should commit to a higher target for nominal expenditure in order to return to the previous trajectory from the Great Moderation. That requires a higher level of NGDP growth than is “normal” in order to catch up. One way to do this under the current monetary regime is to create higher inflation expectations. Do they need to be much higher? I don’t think so, but it’s not entirely unreasonable to disagree.
So we know that most members of the FOMC view 2% as the preferred inflation target. We now also know that the Fed is holding true to that target, come hell or high water. 2% is better than 1%, but a temporarily higher target would produce a much more robust recovery. Arguably, the Fed is in the business of providing stable NGDP growth consistent with high employment and low inflation. It allowed NGDP to plummet and now they should be trying to make up that lost ground as quickly as possible. This statement is clearly against that goal.
We’re in for a rocky road if our monetary authority sees it fit to tie its hands.
Update: I probably should have put “during the recession” in the title. Unfortunately it’s gone to press.
Chevelle, at Models and Agents, explains why the previous round of “quantitative easing” performed by the Fed did not have a [sufficient] expansionary effect:
By that metric, the Fed’s past LSAPs have probably fallen short. Clearly, measuring the counterfactual is impossible, but there are reasons to believe that the impact on aggregate demand was small. Why? First, because the reduction in mortgage rates boosted refinancings only by people who could refinance—i.e. people with jobs and some positive equity in their home. Not exactly the most cash-strapped ones who would have spent the extra cash.
Second, the portfolio-balance effect of the LSAPs on the prices of assets like corporate bonds or equities is at best weak, if not counterproductive. The reason (which I explained in detail here) has to do with the fact that US Treasuries and MBS are not “similar in nature” to corporate debt and equities. Unlike the latter, Treasuries/MBS have more of a “safe haven” nature—so that removing them from investors’ portfolios create demand for more “safe” assets, rather than boosting the prices of equities, high yield bonds, etc.
Luckily, one Benjamin S. Bernanke explained how to perform private asset purchases that would, in fact, have an expansionary effect:
If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.
If you see that guy around, tell him to talk to the Federal Reserve. I remember hearing a podcast with Scott Sumner a while back where he floated the idea of the Fed buying bonds off of the public (i.e. You and I), and paying for them with cash. Lets get to it!
