The annual Fed meeting at Jackson Hole will soon begin. I hope they discuss how to fix monetary policy. I fear they will be distracted by impractical fiscal/monetary schemes.
The recent discussion about monetary policy has been horribly confused. Here are a few examples:
1. Prior to adopting a 2% inflation target, there was lots of discussion about where to set the target. I recall almost universal agreement that the target had to be at least high enough to prevent a zero bound problem. Now that we have experienced a zero bound problem, has that view changed? If so, why?
2. I see a lot of discussion to the effect that the Fed is unable to hit its inflation target, because it’s out of ammunition. That’s not just wrong, it’s a freshman economics level error. The Fed raised rates in December (and refused to cut them a few weeks ago), precisely because they are worried about overshooting their inflation target. Indeed at least since the taper tantrum of 2013, the Fed hasn’t believed the US economy needed any more monetary stimulus than they are already providing. This discussion of the Fed being out of ammo shows a profession that is deeply confused on some of the most basic ideas in monetary economics. It’s not a pretty sight.
3. When I discuss the possibility of reforms such as level targeting, or NGDP targeting, the response is often that the proposal is “politically unrealistic”. Then the naysayers turn around and recommend fiscal/monetary coordination, which shows an almost laughable naïveté about the actual way that fiscal policy is implemented in the US. And even if by some miracle the GOP Congress would agree to countercyclical policy, the proponents don’t even seem to know what it is. They propose fiscal stimulus right now, even though doing so at a time of 4.9% unemployment would constitute a procyclical policy, and hence would make the US economy even more unstable.
I hope the economists at Jackson Hole discuss possible ways to fix monetary policy, and don’t get distracted by hopeless fiscal/monetary chimeras, but what I read in the opinion sections of elite media and blogs makes me very pessimistic.
Anand sent me to a post by Paul Krugman:
And I realized something not too flattering about myself: I’m feeling nostalgic for 2011 or so.
Liquidity-trap macroeconomics — which I didn’t invent, but did play a role in bringing back into the mainstream — had become the story of the day. And the basic message of the models — that everything changes when you hit the zero lower bound — was being overwhelmingly confirmed by experience.
The thing is, it was all beautifully hard-edged: a crisp boundary at zero, a sharp change in the impact of monetary and fiscal policy when you hit that boundary. And the predictions we made came out consistently right.
Yes, except for all the things they got wrong, which the market monetarists got right. Like the 2013 austerity. Or the removal of extended UI in 2014. Or whether the BOJ would be able to devalue the yen.
But now things have gotten a bit, well, murky.
Now Krugman is being much kinder than I was at the top of this post. Since we exited the “liquidity trap” the discussion has been borderline incoherent.
The zero lower bound is not, it turns out, quite as hard a boundary as we thought.
Does “we” include the guy who twice recommend negative IOR in published papers in early 2009, and was scoffed at?
More important, probably, is the fact that two of the major advanced economies — the US and, believe it or not, Japan — are arguably quite close to full employment. We don’t know how close, because we don’t know how much pent-up labor supply is still waiting on the sidelines. But you can no longer argue that supply limits are no longer relevant.
Correspondingly, you can also no longer argue with confidence that there can be no crowding out, because the Fed won’t raise rates.
Yes, before you had to argue they’d do less QE to crowd out the fiscal stimulus.
We are, if you like, half-out of the liquidity trap, with one foot on dry land — but the other foot is still hanging over the edge, and it wouldn’t take much to topple us right back in.
What I would argue is that in this murky, fragile situation we should be conducting policy largely as if we were still in the trap — because we badly need to get both feet firmly on dry land with some distance between us and the quicksand.
(The link advocated fiscal stimulus.) He seems to be arguing that we need fiscal stimulus because we need to raise rates so they we can cut them again if we get into trouble in a few years. That’s 100 times better than arguing the Fed should raise rates so that it can cut them again (an insane idea you sometimes see in the business press), but I still don’t quite buy it.
Fiscal stimulus is a demand-side policy. It’s not going to have a significant impact on trend RGDP or trend NGDP. So if we do more fiscal stimulus when unemployment is 4.9%, we probably won’t see dramatically higher nominal interest rates. I will concede that it’s possible the Fed would have a bit more “conventional” ammo the next time a recession hit (from rates being a bit higher), but that additional monetary ammo would come at the expense of less fiscal ammo. In Krugman’s view, fiscal stimulus doesn’t come from high G, it comes from rising G. If we already have high G when we go into the next recession, it’s going to be that much harder to get rising G. If fiscal stabilization policy is to work it must be countercyclical, that means don’t do it now. This new “fiscal stimulus forever to put sand under the tires of monetary policy” (my words, not his) seems more than a bit ad hoc to me, a proposal from people who want shiny new airports and high speed rail, and will grasp any half way plausible model to justify that preference. I put Larry Summers in that camp, maybe even more so that Krugman.
So I don’t think more fiscal stimulus today would make the US economy any more stable in the long run. Instead we’d just be:
Another day older and deeper in debt