We really ought to consider adopting a whole new monetary regime, NGDPLT. But what if the Fed refuses. What then? Then we are in the world of second best—QE and negative IOR. These are not good policies, but they are less bad than deep depressions or wasteful government spending. Here’s Simon Wren-Lewis:
Perhaps these distortions are quite small. However this discussion illustrates a more serious problem with QE, which is that we still have no clear idea of its effectiveness, or indeed whether effects are linear, and what the best markets to operate in are. Announcements about QE clearly influence the market, but that could be because it is acting as a signalling device, as Michael Woodford has argued. Jim Hamilton is also sceptical. This strongly suggests that the uncertainty associated with the impact of QE is far greater than any uncertainty associated with either conventional monetary policy or fiscal policy.
Thinking about it this way, I cannot see why some people insist that unconventional monetary policy is always preferable to fiscal policy. In a comment on a recent Nick Rowe post, Scott Sumner writes “My views is that once the central bank owns the entire stock of global assets, come back to me and we can talk about fiscal stimulus.” What this effectively means is that it is better for one arm of the state (the central bank) to create huge amounts of money to buy up large quantities of assets than to let another arm of the state (the Treasury) advance consumers rather less money to spend or save as they like. This preference just seems rather strange, but maybe Lenin would have approved!
Of course I was joking, but I do seriously believe that Britain would be better off if it were able to acquire the entire stock of global wealth, at zero cost. That would be even more impressive than the “pink bits” on the map acquired under Queen Victoria. However if I had my way the Fed would have adopted a policy closer to that of the Reserve Bank of Australia (a monetary base of 4% of GDP), rather than the BOJ (a monetary base of more than 20% of GDP.) QE is both a sign of a failed policy, and at the same time (paradoxically) is better than not QE, combined with the same failed policy.
Debates over monetary policy should not be debates over QE. The discussion should focus on what policy regime is optimal. An optimal policy regime would probably not involve any QE at all. And even if it did, it would still be less inefficient than fiscal stimulus. That was my point. (Remember that the “advance to consumers” must eventually be clawed back via distortionary taxes.)
One way of stimulating demand when interest rates are stuck at zero is to promise a combination of higher than ideal inflation and higher than ideal output in the future. (This can be done either explicitly or implicitly by using some form of target in the nominal level of something like nominal GDP. For those not familiar with how this works, see here.) The cost of this policy is clear: higher than ideal future inflation and output. Once again, these costs can be worth it because of the severity of the current recession, which is why nominal rates are stuck at zero. Whether these costs are greater or less than the cost of changing government spending is debatable: a paper by Werning that I discussed here suggests optimal policy may involve both.
Given that inflation doesn’t matter at all, it is hardly possible for it to be above or below “ideal” levels. People who talk about the welfare costs of inflation are confusing inflation with NGDP growth. There are welfare costs of excessive long run NGDP growth, primarily excess taxation of nominal returns on capital. But inflation by itself does not have important welfare costs. The only possible inflation cost is the “menu costs” of price changes, but even that is unclear, given that nominal wage changes also involve menu costs. Thus a NGDPLT policy minimizes both the “welfare cost of inflation” and the problem of suboptimal output fluctuations. There is no trade-off. NGDPLT also reduces financial sector instability, relative to inflation targeting. It’s a win-win-win policy.
HT: Marcus Nunes, who also has a post.