In my previous post I suggested that the Fed was looking for an excuse to ease. Here is some evidence from the WaPo:
Federal Reserve officials, increasingly concerned over signs the economic recovery is faltering, are considering new steps to bolster growth.
And here is the connection to fiscal policy:
With Congress tied in political knots over whether to take further action to boost the economy, Fed leaders are weighing modest steps that could offer more support for economic activity at a time when their target for short-term interest rates is already near zero. They are still resistant to calls to pull out their big guns — massive infusions of cash, such as those undertaken during the depths of the financial crisis — but would reconsider if conditions worsen.
God I hope QE isn’t the “big guns.” The real “big guns” would be a higher price level target.
Top Fed officials still say that the economic recovery is likely to continue into next year and that the policy moves being discussed are not imminent. But weak economic reports, the debt crisis in Europe and faltering financial markets have led them to conclude that the risks of the recovery losing steam have increased. After months of focusing on how to exit from extreme efforts to support the economy, they are looking at tools that might strengthen growth.
Hmmm. I seem to recall that a few months back it was us no-nothing bloggers who were saying we don’t need an exit strategy; we need an entrance strategy. On the other hand those “scientific” economists at the Fed were ignoring market signals and pressing ahead with their anti-inflation strategies. It looks like we were right.
And how about this:
One pro-growth strategy would be to strengthen language in Fed policy statements that the central bank’s interest rate target is likely to remain “exceptionally low” for an “extended period.” The policymakers could change that wording to effectively commit to keeping rates near zero for even longer than investors now expect, perhaps adding specifics about which economic conditions would lead them to raise rates. Such a move would be opposed by many members of the Fed policymaking committee who are wary of the “extended period” language, arguing that it limits their flexibility.
Those are actually two very different policy ideas, although it might not look so at first glance. Low interest rates as far as the eye can see is actually tight money, as Nick Rowe pointed out in the comment section of one of his recent posts:
Scott: thanks! I know what you mean about the difficulty of expressing one’s views when the “dominant narrative”(? Oooh!) makes them sound nonsensical. “I want the Bank of Canada to loosen monetary policy by doing things that would raise nominal interest rates”. What?!
Exactly, and I want the Fed to raise interest rates by setting a much higher price level or NGDP target. But alas, the Fed seems horribly confused about this issue. Only if the period of zero rates was linked to economic conditions in such a way as to increase inflation expectations, would the policy have any stimulative effect. I’ll address this issue in another post later today. Fortunately, they do have some good ideas:
Another possibility would be to cut the interest rate paid to banks for extra money they keep on reserve at the Fed from 0.25 percent to zero. That would give banks slightly more incentive to lend money to customers rather than park it at the Fed, although it also could cause technical problems in the functioning of certain credit markets.
For 18 months I have been bashing the Fed’s interest on reserve program. And a zillion commenters have insisted I don’t know what I am talking about. “The Fed knows what it is doing better than you Sumner.” “They would never adopt a contractionary policy during a severe recession.” “It’s all in your imagination.” OK, but isn’t this an admission that a lower IOR would be expansionary? Robert Hall and Susan Woodward were right last year. The Fed’s policy was contractionary, and still is. But perhaps this is just the WaPo, do we have any evidence that the Fed thinks that unconventional tools might help?
Fed officials express confidence that they have tools to address the economy further if conditions worsen.
“I think we do have a variety of tools available, and we shouldn’t rule any tool out,” Eric Rosengren, president of the Federal Reserve Bank of Boston, said in an interview. “If we’re uncomfortable with how long it’s going to take us to reach either element of our dual mandate [of maximum employment and stable prices], we’ll have to make some adjustments to policy.”
. . .
“If the economic situation changes, policy should react,” James Bullard, president of the Federal Reserve Bank of St. Louis, said in an interview Wednesday. “You shouldn’t sit on your hands. . . . I think there’s plenty more we could do if we had to.”
I agree, but also find the Bullard quotation to be rather strange. The executive and legislative branches are literally pulling out their hair trying to think of stimulus packages that won’t blow up the deficit. And here is Bullard basically saying, “Yeah, we could do “plenty” more to boosting AD without increasing the deficit by one cent, but we don’t want to. How did the world’s greatest power get into a position where there appeared to be an easy way out of 9.5% unemployment, but we weren’t doing it solely because of an independent central bank? And don’t tell me there are other reasons why AD might not solve our problems. That’s not what I said. I said Congress and the president think more AD would solve our problems. If they could boost AD without increasing the deficit they would do so in a heartbeat. The US isn’t refraining from additional stimulus because Obama, Reid and Pelosi are sudden converts to freshwater economics, we are refraining from boosting AD because they do not control the only policy tool that is able to do so without blowing up the deficit.
PS. I don’t like to use profanity here. But if Obama and Congress understood the meaning of Bullard’s statement (which is unlikely) they would probably interpret it as the Fed blowing them a giant F*** ***. I’m sure Bullard didn’t mean it that way, but I don’t see any other interpretation.
HT: JimP, malavel