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That is the title of today’s Wall Street Journal Symposium [Gated]. And the overwhelming answer from preeminent monetary economists? Nothing.
Not that they didn’t answer the question. Most of the panelists’ answers amount to the Fed remaining passive. Here is John Talyor:
To establish Fed policy going forward, the best place to start is to consider what has worked in the past. During the two decades before the recent financial crisis, the Fed employed a reasonably rule-based strategy for adjusting the money supply and the interest rate. The interest rate rose by predictable amounts when inflation increased, and it fell by predictable amounts during recessions.
Fairly predictable. John Taylor has made this point numerous times, and is a very hard rules-based guy. I’m a rules-based guy as well…but I don’t see the inherent virtue in the Taylor rule, however defined. Essentially Taylor seems to want the Fed to stabilize NGDP growth around a Taylor rule at the current (reduced) output level, which puts us permanently behind the previous trend rate of output. As far as I can tell, he doesn’t care to make up the slack…which of course means elevated unemployment for an extended period of time.
Richard Fisher, who is a predictable hawk, lived up to expectations as well:
One might assume that with more than $1 trillion in excess bank reserves and significant amounts of cash held by businesses, the gas tank of those who have the capacity to hire is reasonably full. One might also conclude that the Fed, having cut the cost of interbank overnight lending to near zero and used quantitative easing to coax the entire yield curve downward, has driven the cost of gas to virtually nil for businesses that are creditworthy. And yet businesses still aren’t hiring.
This is a mind-bogglingly insane statement. When suffering an immediate deficiency of aggregate demand, supply-side factors are second order. Yes, we should streamline regulatory hurdles…but that has nothing to do with why firms aren’t hiring. Fisher must have missed a lot of economics, and apparently doesn’t understand that demand for safe assets (which in developed countries equates to cash) drives most recessions (especially during a time where there is a lack of supply of safe [private] assets), and that the Fed decided to pay banks to hoard cash…and so they did. I’m having a hard time figuring out how Fisher landed his current position.
On to the most depressing, Frederic Mishkin:
Purchasing long-term Treasurys might suggest that the Fed is accommodating the fiscal authorities by monetizing the debt—thereby weakening the government’s incentives to come to grips with our long-term fiscal problems. In addition, major holdings of long-term securities expose the Fed’s balance sheet to potentially large losses if interest rates rise.
Such losses would result in severe criticism of the Fed and a weakening of its independence. Both the weakening of its independence and the perception that the Fed is willing to monetize the debt could lead to increased expectations for inflation sometime in the future. That would make it much harder for the Fed to contain inflation and promote a healthy economy.
Expanding the Fed’s balance sheet through large-scale asset purchases can be necessary in extraordinary circumstances, such as during the depths of the recent financial crisis. But in relatively normal times, the costs of using this tool are sufficiently high that it should not be used lightly.
9.5% unemployment, falling CPI and inflation expectations, and exploding national debt due to the political anxiety to “do something” is now ‘normal times’? This amounts to saying that the Fed has the tools, but shouldn’t use them unless we’re in the Great Depression. The Fed’s job is to keep us out of financial panics like the Great Depression, not make its job significantly harder by passively waiting until the depths of the abyss, and then acting. I don’t agree with that at all.
I don’t really know anything about Robert McKinnon, but he is worried about international currency flows, asset bubbles in China, and thinks that the Fed should mediate interbank lending to stabilize the yield curve at “normal interest rates”. I’m fairly confident that China can sterilize any dollar inflows that happen upon its shores…so I don’t see this as a problem that needs to be addressed by anyone but Chinese policymakers, and I happen to think that the Fed should be much more aggressive than stabilizing yield curves AAAAAND raising interest rates now is, of course, insane punditry. Apparently so does the Vincent Reinhart believes the Fed should be more aggressive as well:
As a consequence, the Fed has to be both aggressive and nimble. The Fed should promise to purchase government and mortgage-related securities between its regularly scheduled meetings as long as activity is forecast to be subpar and inflation is low or headed down. Purchases of, say, $100 billion every six-to-eight weeks would add up to a number worthy of shock and awe for those with a somber economic outlook.
All-in-all a very depressing symposium. They should have interviewed Scott Sumner, Bill Woolsey, David Beckworth, Nick Rowe, and Paul Krugman. Then, perhaps, the world could be saved.
Update: Beckworth seems to have beaten me to the punch, linking to Mark Thoma, who did as well…a