EK:You’ve also criticized the Federal Reserve for not doing more. What would you like to see them doing?
CR:I’m teaching a course this semester on macro policy from the Depression to today. One thing I had the class read was Ben Bernanke’s 2002 paper on self-induced paralysis in Japan and all the things they should’ve been doing. My reaction to it was, ‘I wish Ben would read this again.’ It was a shame to do a round of quantitative easing and put a number on it. Why not just do it until it helped the economy? That’s how you get the real expectations effect. So I would’ve made the quantitative easing bigger. If you look at the Fed futures market, people are expecting them to raise interest rates sooner than I think the Fed is likely to raise them. So I think something is going wrong with their communications policy. They could say we’re not going to raise the rate until X date. Those would be two concrete things that wouldn’t be difficult for them to do. More radically, they could go to a price-level target, which would allow inflation to be higher than the target for a few years in order to compensate for the past few years, when it’s been lower than the target.
All kidding aside, this is policy advice gold. I can broadly agree with all that Romer is saying in the whole thing. I’m not gung-ho about using fiscal policy and expecting it to “work” in the sense that it raises NGDP to a level which is consistent with returning to trend quickly (especially with a conservative central bank), however I don’t see anything wrong with smoothing the edges of recession by helping people through the tough time using fiscal policy (mostly simple transfers), and of course reducing employment during a recession. As prescribed here (not by Mark Thoma, but by a paper circulated by John Boehner), is asinine.
P.S. I think that the level of suffering an economy would have to deal with as the result of sharp deficit reduction is directly related to the willingness of a central bank to accommodate the policy.