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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:

[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:


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.

From Brad Delong:

Hey! Obama! Recess-Appoint Somebody to Kevin Warsh’s and to Peter Diamond’s Seats on the Federal Reserve Board Already!

I recommend Joe Gagnon and Christie Romer. But any of a huge number of people would be good…

Joe Gagnon is famous in the mainstream for his proposal to buy $2 trillion in Treasury debt (7-year average portfolio maturity, I believe). The problem with this plan (to the point that it is a problem, relative to baseline) is that it stipulates a quantity. $2 trillion may be (or have been) enough to raise NGDP expectations to a level consistent with rapid recovery (i.e. forcing real interest rates negative)…but then again, it may not be (or have been). In my mind, there is no reason to engage in quantitative targets such as these, unless you’re looking to put yourself in handcuffs. It would be a wonderful world indeed if this was the press report from the Federal Reserve:

The Board unanimously concurred that the economy is at the beginning stages of recovery, but such a recovery remains fragile. The debt problems in the EU, as well as the unfolding disasters in Japan highlight a renewed demand for dollar-denominated debt. The Fed intends to fully accommodate this increased money demand by engaging in the purchase of Treasury securities until such time that expected NGDP growth is on target at the board’s long-run growth rate of 5%, plus 2% for the following two years. The Fed will be monitoring money demand and credit conditions, and adjusting policy accordingly to return to, and remain on, trajectory.

Will the Fed need to buy $2 trillion in securities…or even the entire national debt? I don’t know. That’s not the target. The target is the previous trend level of NGDP. As an analogy, do you need to fill *random swimming pool here* with 500 gallons of water? Oh, can’t answer because I didn’t give you the dimensions of the pool?! Better fill it with water until it’s full then…

Christina Romer has endorsed my plan above, and is, indeed (I believe), firmly (Suggestion II) in the “quasi-monetarist” camp:

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.


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.

While we’re at it, Scott Sumner and Paul Krugman would be excellent recess appointments, as well.

Think of any others, and why? List them in the comments!

P.S. For the record, I actually do have a strong inclination that the Fed wouldn’t have to purchase all outstanding Treasury debt.

P.P.S. How do I know that Paul Krugman could have “saved the world”? Well, this quote pretty much sums it up:

Krugman is always alert to the possibility of the extreme. “When things go crazy, my instinct is to go radical on policy.”

Better monetary policy than fiscal policy, in my mind. Get him out of the Times and into the Fed!

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!

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