A moderate and pragmatic proposal for monetary stimulus

In March of 2009 I presented a proposal for monetary stimulus, in the form of a petition.  I think it’s fair to say that it didn’t attract much attention.  The commenter Benjamin suggested it’s time for a new and specific proposal.  After all, now that fiscal stimulus has failed to generate an adequate recovery, there is a renewed focus on the need for monetary stimulus.

There is no point in proposing my dream monetary policy–NGDP futures targeting and all.  The Fed would never contemplate anything so radical at this time.  Instead I am going to suggest something that just might be acceptable, should the Fed decide the economy needs more demand.  The term ‘moderate’ refers to the fact that I won’t ask the Fed to deviate from their 2% implicit inflation target, and the term ‘pragmatic’ refers to the fact that I won’t ask for risky and untested ideas such as negative interest rates on excess reserves and/or NGDP futures contracts.

Any monetary stimulus proposal has at most three primary components:

1.  A bigger supply of base money

2.  Less demand for base money

3.  A commitment for greater monetary stimulus in the future

I will try to use all three approaches, and do so in a synergistic plan that consists of more than merely the sum of the parts.

1.  Quantitative easing

The Fed should commit to doing as much quantitative easing as necessary to hit its macroeconomic objectives.  They might want to initially commit to a specific figure like $100 billion a month, but over time I believe they should adjust the amount of QE to reflect the demand for base money.  What makes this so tricky is that the demand for base money is itself very sensitive to expectations of NGDP growth, i.e. expectations about whether the policy will fail.  Thus QE will work much better if combined with other policy tools that increase the likelihood of success.  If the Fed does QE, and QE alone, it is very possible that it will be no more effective than the previous $1 trillion in reserves that were injected into the banking system in late 2008.

People like Andy Harless have suggested the Fed buy long term bonds.  I’d prefer just the opposite—the purchase of low risk T-bills and short term T-notes.  By doing so they avoid the risk of significant capital losses if (as I expect) the operations had to be reversed as a result of a robust economic recovery.  I understand that most people envision the transmission of monetary policy through the Keynesian lens of changes in interest rates.  And that it looks like the only interest rates that can now be significantly lowered are the longer term rates.  But I just don’t believe that we can get a robust recovery in NGDP growth without substantially higher long term rates.  Yes, it’s possible that long rates would fall sharply immediately after the Fed purchased lots of T-bonds, and then rise sharply a few months later as economic recovery picked up.  But I have trouble reconciling that scenario with rational expectations.  And I am reluctant to recommend a mechanism that seems to rely on sophisticated bond traders being too dense to understand what is going on.  In Andy’s favor, something like that quick reversal did seem to occur in the spring of 2009, but I think we’d be pushing our luck to rely on it happening again.  For me the transmission mechanism is higher asset prices (stocks, commodities, commercial RE, etc) as expectations of future NGDP growth rise.  That avoids the paradox that we seem to need lower long term interest rates, even as higher rates are associated with prosperity.  

Before proceeding to the other two policies, it might be helpful to use an automobile analogy.  Consider QE to be like the car’s engine.  If the transmission is not engaged, the car will not move.  In addition, the car needs to be steered, so that it doesn’t shoot off into a ditch.  The other two proposals are intended to do just that.  Lower IOR can serve as a sort of transmission mechanism, making sure the added QE actually drives the car forward.  And price level targeting will serve as both a transmission mechanism and the steering mechanism letting the Fed know if they have done too much or too little QE.

2.  Eliminate interest on excess reserves

At first glance this seems like a no-brainer.  Many people seem concerned about all the money the Fed has been printing.  Eliminating IOR would allow for the same amount of monetary stimulus with a far smaller monetary base.  Apparently the Fed is concerned about the effect on MMMFs, which might see their rates of return fall to near zero, and thus threaten again to “break the buck,” as occurred to one fund in late 2008.  In that case, I presume that my idea of negative rates on ERs (recently endorsed by Blinder!) would be even more problematic for the MMMF industry, so I won’t advocate that now. 

This is not my area of expertise, but the need for monetary stimulus is so great that I think the Fed should eliminate IOR on excess reserves and hope for the best.  Indeed the need is so great that I think they should proceed even if it necessitates the Fed engage in some sort of microeconomic intervention in the MMMF industry that is otherwise undesirable.

I would add that the proposal only applies to ERs, not required reserves.  Thus banks may still be able to profitably offer checking accounts, as each additional account creates a derived demand for more required reserves, which still earn interest.  If the Fed is worried about how removing IOR would impact the banking industry, they have several options.  They could actually raise the rate on required reserves.  This would still encourage banks to reduce their holdings of ERs, which would no longer earn any interest at the margin.  Or, they could “grandfather in” existing reserve holdings for each bank, and only eliminate IOR for the new money that is to be injected in my first proposal; the roughly $100 billion a month in QE.

By eliminating IOR, any additional QE is more likely to find its way out of ERs and into circulation.  But even that may not be enough.  The last proposal is by far the most important.  It provides additional impetus to getting the new money into circulation, and also calibrates how much is needed:

3.  A 2% price level growth path from September 2008, level targeting

Cutting edge monetary models by people like Woodford emphasize that in a liquidity trap you really need price level targeting, not inflation targeting.  The problem with inflation targeting is that it is “memoryless.”  That means if you miss your inflation target for last year, you “let bygones be bygones” and continue to shoot for the same inflation target next year.  Despite the name, “level targeting” doesn’t really mean keeping the price level constant (unless zero inflation is the target) rather it means trying to return to the planned price level trajectory anytime you temporarily diverge from the desired inflation rate.  The intuition is so appealing that none other than Ben Bernanke recommended that the Japanese do exactly that when their CPI had undershot their zero inflation target in the early 2000s.  Bernanke suggested they should temporarily aim for 3% or 4% inflation to catch-up to their original target path.

I am asking the Fed to do the exact same thing that Bernanke recommended for the Japanese.  The only difference is that the Japanese inflation target is 0%, whereas the Fed’s implicit target (they don’t have an explicit target) is believed to be about 2%.

[As an aside, some have argued that the implicit target is actually 1.5% to 2%.  On the other hand over the past two decades they have behaved as if their implicit target is a tad over 2%.  And you could argue that a period of 9.5% unemployment is not the best time to try to bring inflation down to 1.75%.  So you could just as well argue for 2.25% inflation, given actual Fed policy over recent decades.  My 2% proposal is a very reasonable and moderate compromise between their actual policy of slightly over 2%, and the oft-mentioned range of 1.5% to 2.0%, which centers on 1.75%.]

If we track core inflation since the liquidity trap started around September 2008, we find that the core CPI has fallen about 1.4% below the Fed’s implicit 2% target.  In that case, the Fed should commit to trying to raise prices by 2.7% a year over the next two years, and 2% thereafter.  Markets currently seem to expect about 1% annual inflation over the next two years (based on TIPS spreads.)  Why would an extra 1.7% inflation have such a big effect?  Because the SRAS curve is fairly flat when unemployment is high.  

After the 1982 recession, Paul Volcker engineered 11% NGDP growth over the first 6 quarters of recovery.  Real growth was 7.7%.  I am not claiming we could achieve the same.  After all, the supply-side fundamentals are not quite as strong as in 1983, as many right-wing economists have pointed out.  But only the most extreme RBC economist could claim the SRAS is vertical, and that moving inflation from 1.0% to 2.7% for 2 years would not substantially boost growth.  FWIW, I’d expect 2.7% core inflation to result from 7% to 10% NGDP growth, implying a real recovery of 4.3% to 7.3%.  That’s much better than we are currently getting. 

Now for the hardest part, how do we make it all happen?  A target is just an aspiration, isn’t it?  Not quite.  That is true of inflation targets, but not price level targets.  Importantly, price level targets are both goals, and commitments to do something later to catch up if you fail to meet your goal.  And that future commitment is also very important.  We won’t be at the zero rate bound forever, thus it’s important for the Fed to give markets some sense of the price level trend line they plan to return to when the recession is over.  If the trend line is about what TIPS markets currently expect, we’ll get a weak recovery.  If it is the one I suggest, we’ll get a much more robust recovery.  Would Congress object?  I doubt Barney Frank (a Congressional inflation target critic) would complain, if it was explained that prices had fallen short and that the proposal was aimed at boosting growth.

So what about my first proposal to do QE?  How do we know when we have done enough?  I believe we should follow Svensson’s maxim that we “target the forecast.”  The Fed should do QE until its internal forecast of core CPI growth two years out is on target.  Bernanke and Woodford once pointed out that sole reliance on market CPI forecasts (such as the TIPS market) would create a circularity problem.  There are ways to rely completely on market forecasts w/o a circularity problem, but they are too radical for the Fed, as the market would essentially become the FOMC.  But Svensson’s idea for targeting the Fed’s own internal forecast is eminently reasonable.  Set your steering wheel at a position where you expect to reach your destination.  Do the amount of QE that leads you to expect on-target core CPI growth.

I’m certainly not suggesting the Fed ignore market signals.  They should look at a wide range of market indicators.  Bernanke and Woodford acknowledged those could be helpful, as a supplement to the Fed’s internal structural models.  And let’s face it; QE is going into uncharted waters, so we can’t rely exclusively on structural models.  The Fed should not let market forecasts diverge too far from their policy goal.

4.  Summary

There is nothing radical in my proposal:

1.  QE with T-bills is a plain vanilla open market purchase.

2.  A zero IOR rate is the way the Fed operated for 98% of its history.

3.  Two percent core inflation is widely seen as the Fed’s implicit target.

4.  Level targeting has an impeccable pedigree, with strong support from people like Bernanke and Woodford

And let’s be clear about one thing.  I am not proposing any sort of dramatic change in Fed policy.  Their policy has generally been roughly 2% inflation (I’d prefer 5% NGDP growth.)  All I am saying is let’s stick to that policy.  It is the hawks who suggest policy settings likely to reduce inflation below the Fed’s traditional 2% target (despite 9.5% unemployment) that are the true radicals. 

In his public speeches Bernanke really has no choice but to advocate current policy.  And he is reluctant to change policy if it leads to a badly split FOMC.  That gives 3 or 4 hawks an effective veto on change, and insures the status quo hawkish policies continue.  But what does Bernanke believe in his heart?  Does he support the views of people like Charles Plosser, who seem to claim faster NGDP growth would not boost RGDP growth?  Does Bernanke now hold views that are completely inconsistent with his entire academic career, and his recent advocacy of fiscal stimulus?  Or would he prefer something closer to the plan that I have outlined.  Someday we’ll find out the truth.

HT:  Marcus, Liberal Roman, Benjamin Cole


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46 Responses to “A moderate and pragmatic proposal for monetary stimulus”

  1. Gravatar of Benjamin Cole Benjamin Cole
    2. September 2010 at 09:33

    Well! I am red-faced at seeing my name in a post, but I think this is an excellent set of proposals. Importantly, it gives “growth hawks” (that is what we should call ourselves) some talking points, a platform.

    I like the hard figure, the aggressive $100 billion a month of QE.

    I wonder what would be wrong with 3 percent inflation for a few years, which help us deleverage as well, but this is a quibble.

    Forward from here, armed with Sumner’s plan (which may become even a bit more concrete) we have as much a PR battle ahead as a tussle of economic arguments.

    It would be wonderful if issues were settled on their merits, not by who summons the best rhetoric.

    Be that as it may, for whatever reason, those people who favor Fed action now get tossed into the camp of “doves” and other weak-kneed types who cave into emotions, and who are not strong enough to tough it out to the zero-inflation high growth low-tax nirvana that awaits us, if only we manfully stand our ground.

    We must re-frame the argument. I suggest we call ourselves “growth hawks” (or better words, if anyone suggests). The people who favor doing nothing (monetarily) should be cast as “Japaners,” “timid do-nothings,” “fiddlers” or some other faintly dismissive phrase.

    “Timid fiddlers who fall back of conventional nostrums, while business and entrepreneurs lose traction every month.”

    We must define the other side as characterized by timidity, indecision, Ivory Tower-ness, faint of heartness etc.

    Jeez, I feel like forming a political action group, or organization to promote Sumner and his plan.

    This is important.

  2. Gravatar of ssumner ssumner
    2. September 2010 at 09:58

    Benjamin, Thanks. I should day that I’d prefer a 9% NGDP target, but I tried to frame this in a way where they’d have no good excuse not to act. How can they argue against something so moderate, and consistent with their overall strategy? And yet even this would give the economy a major boost.

  3. Gravatar of Silas Barta Silas Barta
    2. September 2010 at 10:12

    These look like some interesting, and perhaps clever, ideas. But the chief concern for me is, who really deserves to get the new money first, so that they can spend it before prices adjust? And which specific groups are most deserving of receiving low interest Fed loans so they can turn around and buy risk-free bonds at profit?

  4. Gravatar of marcus nunes marcus nunes
    2. September 2010 at 10:14

    Would this be helpful in implementing the program?

    http://macromarketmusings.blogspot.com/2010/09/right-kind-of-helicopter-drop.html

  5. Gravatar of Benjamin Cole Benjamin Cole
    2. September 2010 at 10:32

    Scott: I wonder if you should not be more aggressive, and just say what you think.
    I see your point in wanting to appear moderate and sober; after all this is not football punditry, it is monetary and macroeconomics.
    On the other, if whatever plan you propose gets trimmed back due to the innate conservatism of the Fed, you might advocate your full-throated plan, or even more.

    These PR=strategy thoughts may well be imponderables, and you can modify your plan for a while. The important thing is to get these ideas out onto the discussion table, and you have done so. Bravo.

  6. Gravatar of Liberal Roman Liberal Roman
    2. September 2010 at 10:45

    I still don’t understand why Bernanke cares if the Fed is split? Would anyone care? The market sure wouldn’t. The market would care about what actions are taken.

    Bernanke is the Fed chairman till 2014. No one will care that he got unanimity. People will care whether or not he gets us out of this mess.

  7. Gravatar of Joe Joe
    2. September 2010 at 11:45

    Professor Sumner,

    Just wondering, have you ever read Hayek Nobel Prize speech? Its called “The Pretense of Knowledge”?

    If you’re interested, its quite short, and I would argue that its the only legitimate argument why fiscal and even monetary stimulus cannot work. It has nothing to do with ABCT, but with his micro work. I agree with him in fiscal matters, still thinking about monetary matters. I think you would enjoy it.

    http://nobelprize.org/nobel_prizes/economics/laureates/1974/hayek-lecture.html

    http://thinkmarkets.wordpress.com/2010/04/26/hayek-after-35-years/

    Best wishes,

    Joe

  8. Gravatar of Gregor Bush Gregor Bush
    2. September 2010 at 12:02

    Scott,
    All great ideas – I would love to see this happen. The greatest pushback from the hawks will come on level targeting. They will argue that if inflation moves temporarily to 2.7% the Fed will lose all credibility and then will become unable to hit the level target. I agree with you that level targeting is better, particularly with short-rates at zero but I really don’t think the Fed or ECB will go for this, unfortunately.

    How do you respond to critics who claim that level targeting is less credible than inflation targeting because the public can understand a 2% inflation target but not a price level target? I live in inflation-targeting land and hear this argument quite a bit. To me, the public will simply always expect 2% inflation in the long-term so it’s a non-issue. But the majority of economists here seem to be adamantly against switching from an inflation target to a price level target.

  9. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    2. September 2010 at 12:03

    1. A bigger supply of base money
    To the extent that T-bills are more useful for facilitating transactions than ERs because of their role as a collateral, T-bill based QE could be harmful.
    The Fed should increase monetary base by lending to private sector, just like in the second half of 2008.

    2. Less demand for base money
    The Fed should set IOR to 0, but it should not abolish IOR. Milton Friedman advocated IOR in 1959, because artificial scarcity of reserves is harmful.

    3. A commitment for greater monetary stimulus in the future.
    100% agreed. Unfortunately there is a lot of resistance to such ideas, for example today I blogged about monetary tightening in Sweden.

  10. Gravatar of John Hall John Hall
    2. September 2010 at 12:18

    Scott,
    I thought that was a good post, especially the part where you describe your preference for price level targeting rather than inflation targeting.

    You had previously mentioned in replies to me that you prefer nominal GDP level targeting rather than nominal GDP growth targeting. When you justify this argument, do you appeal to Woodford also? If so, does Woodford only consider price level vs. inflation? If so, how would someone following in the footsteps of Woodford get from an argument in favor of price level targeting instead of inflation targeting to an argument for nominal GDP targeting instead of growth targeting?

  11. Gravatar of Andy Harless Andy Harless
    2. September 2010 at 12:22

    With the 1-year T-bill currently yielding only 23 basis points, I think the Fed could buy literally all the outstanding T-bills (or at least all that would be sold in a liquid market) and eliminate IOR and still not raise the expected inflation rate to 2.7% (or even 2%, for that matter). And if the Fed tried that and I turned out to be right, bond yields would go down even more and leave even less room for effective policies. That safe approach is too risky. We need shock and awe.

    (I’m curious what the Fed’s own models say about the policy of buying T-bills. I bet that their forecasts would agree with me, in which case the policy you advocate could not be implemented without either buying longer-term securities or participating heavily in private credit markets.)

    I just don’t believe that we can get a robust recovery in NGDP growth without substantially higher long term rates.

    Surely we could if the Fed were to peg long term rates (assuming that, before the peg is announced, rates are sufficiently high to give room to cut them significantly — and I think 2.5% for the 10-year note is probably sufficiently high, though it’s low enough that I’m not entirely confident about that). Eventually, presumably, the Fed would drop the peg, and (one certainly hopes) rates would rise above where they are now. But rational expectations don’t have to hold when one player with an infinitely deep pocket is cornering the market.

    Granted, the Fed would have to take losses (either by liquidating the bonds at a loss or by paying more interest on reserves), but the longer it waits to get out the big guns, the bigger losses it will have to take.

    If I had my druthers, I’d prefer that the Fed buy private sector securities, which would have more bang for the buck in terms of expected losses. (In fact, with private sector securities, the Fed might be able to engineer a recovery and end up with a profit as well, since a recovery would tend to narrow the credit spreads, and since the policy could be effective without taking as much duration.) But I gather there are particularly difficult political issues (as well as certain legal constraints) regarding that kind of policy.

  12. Gravatar of Benjamin Cole Benjamin Cole
    2. September 2010 at 12:41

    Remember: The board members who advocate doing nothing form the “Japan Wing” of the Fed.

  13. Gravatar of marcus nunes marcus nunes
    2. September 2010 at 14:13

    Scott, Cole, take note:
    “…but Scott has become ESSENTIAL reading”
    http://capitalgainsandgames.com/blog/bruce-bartlett/1925/where-monetary-debate-happening?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+CapitalGainsAndGames+%28Capital+Gains+and+Games+-+Wall+Street%2C+Washington%2C+and+Everything+in+Between%29

  14. Gravatar of Indy Indy
    2. September 2010 at 14:31

    Maybe there’s a way for the Fed to do some of these things while appearing even more cautious and conservative.

    Let’s go back a little and see what the Fed actually did with the first round of QE. They bought $1,100 Billion in Mortgage-Backed-Securities that are GSE, and now US Government, guaranteed liabilities.

    To the buyer, these are nearly as safe as treasuries except for the fact that the term is uncertain since they are “callable” at present-value on a contingency of prepayment or default of the underlying mortgage debts.

    To the surety (a government already deep in deficit), they represent two huge uncertainties – total liability (theoretically anything between 0 and 100%) and term (theoretically anything between all due tomorrow, and none due until the “natural” end of the term of the underlying mortgages).

    The worst-case Great-Depression-like scenario was that the government would have to raise a huge amount of additional money all of a sudden, which, ceteris paribus, would have raised rates. This didn’t go away until recently, when the Fed’s “QE 1.5″ announcement of “stable reserves” basically meant that they would absorb this risk by agreeing to immediately recycle MBS-payments into bonds really as a form of (potentially unending) “refinancing”.

    The Fed is essentially acting as the surety’s surety. So what the Fed could do is just be explicit about this 2nd-degree guarantee, and preemptively promise to absorb ANY government-backed liability in this fashion. Some new FHA-backed mortgage goes bust?

    The Fed just gives the cash to the bank and gets a long-term bond from the government and adds it to the balance sheet, under the condition that no interest will be paid to the bank to the extent it results in additional excess reserves. Early on, it wouldn’t look dramatic at all. Over time – I would guess it would achieve significant results.

    Oh well – I’m not counting on anything major, open or subversive, at this point.

  15. Gravatar of JimP JimP
    2. September 2010 at 14:46

    Exits can be hard:

    http://www.ft.com/cms/s/0/686b6978-b6ad-11df-b3dd-00144feabdc0.html

  16. Gravatar of JimP JimP
    2. September 2010 at 15:24

    Krugman on Rogoff on monetary policy and inflation:

    http://krugman.blogs.nytimes.com/2010/09/02/the-inflation-cure/

  17. Gravatar of Mark A. Sadowski Mark A. Sadowski
    2. September 2010 at 15:35

    Andy Harless wrote:
    “If I had my druthers, I’d prefer that the Fed buy private sector securities, which would have more bang for the buck in terms of expected losses. (In fact, with private sector securities, the Fed might be able to engineer a recovery and end up with a profit as well, since a recovery would tend to narrow the credit spreads, and since the policy could be effective without taking as much duration.) But I gather there are particularly difficult political issues (as well as certain legal constraints) regarding that kind of policy.”

    I’ve been rereading all levels of monetary economics textbooks recently and came across this interesting passage in Chapter 26 of Mishkin (Transmission Mechanisms):

    “A Keynesian could still counter Friedman and Schwartz’s argument that money was contractionary during the Great Depression by citing the low level of interest rates. But were these interest rates really so low? Referring to Figure 1 in Chapter 6 you will note that although interest rates on US Treasury securities and high-grade corporate bonds were low during the Great Depression, interest rates on lower-grade bonds such as Baa corporate bonds, rose to unprecedented high levels during the sharpest parts of the contraction phase (1930-1933). By the standard of these lower-grade bonds, then interest rates were high and monetary policy tight.

    There is a moral to this story. Although much aggregate economic analysis proceeds as though there is only one interest rate, we must always be aware there is are many interest rate, which may tell different stories. During normal times most interest rates move in tandem, so lumping them all together and looking at one representative rate may not be too misleading. But that is not always so. Unusual periods (like the Great Depression), when interest rates on different securities begin to diverge, do occur. This is exactly the situation in which a structural model (like the early Keynesians) that looks at only the interest rate on a low-risk security such as a US Treasury bill or bond can be very misleading.”

    We all know that Baa corporate bond yield spiked to over 9% in November 2008 when inflation expectations as measured by TIPS were -2%. Even now they stand at over 6%. I’m in favor of additional QE in any form but perhaps Andy is on to something (albeit with the caveats that he stated).

  18. Gravatar of Morgan Warstler Morgan Warstler
    2. September 2010 at 16:18

    Fisher in 1933:

    “The very effort of individuals to lessen their burden of debt increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed… The more the debtors pay, the more they owe.”

    Our new reality:

    http://www.newyorkfed.org/newsevents/news/regional_outreach/2010/an100817.html

    I think this is actually Scott the core disagreement I have with you…

    If as we are paying down our debt, liquidating our assets, bankrupting the losers…. we saw the value of the dollar soaring, things would be very different. But its not happening. The weight of the debt is not growing as we pay it off.

    All that is happening is that the price of rents is falling – while the the rest of rest of core runs over 2%.

    Taking 6M homes and putting them into new owners hands at “deal of a lifetime” prices, having 6M new renters no longer wasting their money sending it to a bank – this is nothing Fisher could complain about.

  19. Gravatar of Benjamin Cole Benjamin Cole
    2. September 2010 at 16:20

    Marcus–Thanks for that link.

    Through sheer merit, Scott Sumner is now ranked with very top economic commentators. In the entire country. Quite a feather in his cap.

    And Sumner now has a plan on the table, while the others are merely sniveling (did I say Krugman was sniveling? No, I did not mention him by name).

    All Sumnerians: Start banging the drums for the Scott plan. Comment in the blogs, write your regional Fed president, write letters to the editors of newspaper etc.

    Identify the do-nothing crowd on the Fed as the “Japan Wing.”

  20. Gravatar of Bill Woolsey Bill Woolsey
    2. September 2010 at 17:19

    Scott:

    The Fed owns 18 billion in T-bills and $720 billion in notes and bonds.

    http://www.newyorkfed.org/markets/soma/sysopen_accholdings.html

    The story of “open market purchase is the Fed buys T-bills” is a myth.

    When you hit the zero bound on T-bills, and the Fed buys more, the excess demand for T-bills created by their purchases (the reduction in everyone else’s holdings) is cleared by a matching excess demand for money.

  21. Gravatar of Bill Woolsey Bill Woolsey
    2. September 2010 at 17:22

    P.S.

    There is a difference between long shots like NGDP futures targeting and essential reforms like NGDP growth path targeting.

    By the way, it isn’t that hard to find the growth path of the price level.

  22. Gravatar of Mikko Mikko
    3. September 2010 at 01:36

    So now the next steps are to go on and form the coalition and figure out what is the biggest common ground. I sincerely hope, you have started sending emails, asking people to give their names at your blog, calling people, and asking their help in getting other people to sign on board and to finalize the proposal so that you can go public with it.

    Your proposal cuts across right vs. left divide, so you should have a decent chance of getting good representation of economists from both sides.

    Lots of work ahead it seems. But a great chance of actually making a difference.

    ps. I really like the term growth hawk!

  23. Gravatar of scott sumner scott sumner
    3. September 2010 at 05:22

    Silas, You said;

    “But the chief concern for me is, who really deserves to get the new money first, so that they can spend it before prices adjust?”

    There are some basic misunderstandings in the comment, but I’m gald you asked, as they are widespread.

    The group that initially receives the new money is bond holders. But they are not lucky, as old money is just as useful as new money in stores. So if you don’t sell your bonds to the Fed, you can sell them to another person, and use that money to buy things. Thus those receiving the “new money” do not have any special advantages.

    The second misunderstanding is the idea of buying things before prices adjust. Those things where profits are easiest to earn (commodities, etc) see their prices adjust immediately, as the Fed announces the new policy. There are sticky prices that adjust slowly, but all 300 million Americans have an equal shot at those. They can use new money or old money to buy things. Those lacking money can sell assets to get old money, and then buy the sticky price goods.

    Marcus, I also left an answer at the newest post. The short answer is that it would be OK, but there are easier ways. I left a comment at David’s post.

    Benjamin, That’s a good point, but:

    1. I do have lots of posts advocating NGDP targeting, level targeting, futures contract targeting, etc.

    2. I am trying to put them on the defensive. How can they not do something so moderate, when there is a clear need? There is nothing radical in my proposal, nothing the Fed hasn’t done before. They’ve already done QE, they’ve had zero IOR for 98% of their history, and 2% is their implicit target.

    Liberal Roman, I agree. I assume it is:

    1. fear of Congressional meddling if the split became public
    2. fear of disturbing markets with uncertainty.

    Both are bad arguments, as you and I would agree.

    Joe, That was written in 1974, and does not conflict with my views. He was arguing that monetary stimulus cannot lower unemployment below the natural rate for any extended period, and I agree. In the early 1970s he also said monetary stimulus should have been used in the Great Depression, and that is what I am proposing here. We both favor NGDP targeting, so our views are quite close.

    Gregor Bush; You said;

    “All great ideas – I would love to see this happen. The greatest pushback from the hawks will come on level targeting. They will argue that if inflation moves temporarily to 2.7% the Fed will lose all credibility and then will become unable to hit the level target. I agree with you that level targeting is better, particularly with short-rates at zero but I really don’t think the Fed or ECB will go for this, unfortunately.”

    You may be right about what they think, but the last 25 years around the world massively refutes the view that the Fed can’t prevent inflation expectations from rising. Virtually every developed economy has been successful in doing exactly that.

    The markets can certainly understand price level targeting, and that’s all you need. It makes no difference whether the man on the street can or cannot understand the concept. It is not true that high headline inflation feed into high wages. Otherwise we would have seen high wages negotiated in mid-2008, when headline inflation peaked at 5%. So wages behave as if workers look beyond headline inflation.

    123, I’m not crazy about the idea of them lending to the private sector, and I strongly disagree that OMPs of T-bills might be deflationary. High powered money is much more inflationary than T-bills. Also, check out my next post.

    John Hall, It’s the exact same argument for NGDP level targeting. It better stabilizes expectations if NGDP falls below target. Then the market expects future rises in NGDP, which is what you want in a recession.

    Andy, I’m afraid you underestimate the amount of T-bills and short term T-notes in circulation. It is many trillions. I’m not worried about them running out of ammunition. But if they did, they should buy long term T-notes. Then we are talking about the vast majority of the national debt. But it is all a moot point anyway, as after a month or two they’d find they needed to sharply reduce the monetary base to below $1 trillion, as demand for ERs would almost evaporate as nominal rates started rising under the influence of 2.7% expected inflation. BTW, my new post addresses you comment. I do indicate that I have no objection to buying long term bonds, if that’s what the Fed prefers. I assumed they were worried about capital losses.

    You said;

    “But rational expectations don’t have to hold when one player with an infinitely deep pocket is cornering the market.”

    Ratex always holds–I think you meant the EMH might not hold. But even that is wrong, as otherwise there’d be $100 bills on the sidewalk for me to pick up, something I don’t expect. Otherwise I’d go short on long term T-bonds, and make lots of money once the recovery took hold.

    You said;

    “If I had my druthers, I’d prefer that the Fed buy private sector securities, which would have more bang for the buck in terms of expected losses. (In fact, with private sector securities, the Fed might be able to engineer a recovery and end up with a profit as well, since a recovery would tend to narrow the credit spreads, and since the policy could be effective without taking as much duration.) But I gather there are particularly difficult political issues (as well as certain legal constraints) regarding that kind of policy.”

    Heh, That’s insider trading! Seriously, I discussed that last year in a post, and I think Nick Rowe did as well. it’s a tempting idea, and it might tend to boost inflation expectations, as the Fed would then have an incentive to inflate. I think Hong Kong once did that.

    more to come. . .

  24. Gravatar of scott sumner scott sumner
    3. September 2010 at 06:08

    Benjamin, “Japan wing” I like that idea.

    Marcus, Thanks, he left out Woolsey and Harless.

    Indy, Not sure I follow. Are you saying the Treasury has already made these guarantees, and the Fed can then backstop the guarantees?

    JimP, Yes, but note the real problem was exiting fiscal stimulus, not monetary stimulus.

    Rogoff needed to talk in terms of price level targeting, not inflation targeting.

    Mark, I agree Andy’s ideas would work, my point is that the Fed doesn’t even have to take on more risk to stimulate the economy.

    Morgan, I don’t agree that inflation is over 2%, properly measured.

    Bill, Yes, but is it not correct that they mostly buy T-bills and shorter term T-notes? Say less than 3 years?

    I agree on NGDP, but it’s not something the Fed is going to do in this recovery. Once we are out of he recession, it will be obvious we should have been targeting NGDP.

    Mikko, You said;

    “So now the next steps are to go on and form the coalition and figure out what is the biggest common ground. I sincerely hope, you have started sending emails, asking people to give their names at your blog, calling people, and asking their help in getting other people to sign on board and to finalize the proposal so that you can go public with it.”

    I hope someone will do this, I already spend almost 100% of my free time on the blog. And with school starting next week, I will have much less free time. (Last year I was on sabbatical.)

  25. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    3. September 2010 at 08:41

    Scott, you said:
    ” I’m not crazy about the idea of them lending to the private sector, and I strongly disagree that OMPs of T-bills might be deflationary. High powered money is much more inflationary than T-bills. Also, check out my next post.”

    First of all, I would support your whole proposal if it was presented as a “take it or leave it” package.

    The deflationary effect I have in mind is quite tiny, as monetary base has shorter duration, but less utility as a collateral.

    In your next post you said: “QE as just a method of accommodating the demand for base money at the new price level target.”
    The Fed has flooded the system with reserves, and the current level of reserves is compatible with all plausible paths of price level.

    I support lending to the private sector, because the Fed has done it before, so this is a realistic alternative. It is possible to design a new collateralized lending program that is safe for the Fed and is almost as good as outright purchases of private sector assets by the Fed.

  26. Gravatar of Mikko Mikko
    3. September 2010 at 09:59

    Scott, if you don’t have the time, please ask for volunteers to help in a blog post. You might be surprised that you find some (or that you don’t find any). Right now your post leaves the impression that you would actually send the thing around and ask people to support the proposal.

    Let people know that you encourage them to take it and ask other economists to voice their support.

  27. Gravatar of All I Want for Christmas is… : Invest My Money All I Want for Christmas is… : Invest My Money
    3. September 2010 at 23:41

    [...] have Scott Sumner’s modest proposal for more Fed action be implemented.  Please Santa Claus Ben, grant me this one Christmas [...]

  28. Gravatar of ssumner ssumner
    4. September 2010 at 05:24

    123, Cash has a much greater utility as a medium of exchange.

    You said;

    “In your next post you said: “QE as just a method of accommodating the demand for base money at the new price level target.”
    The Fed has flooded the system with reserves, and the current level of reserves is compatible with all plausible paths of price level.”

    I don’t follow. Are you saying banks would want to hold this much reserves if prices were expected to rise at 15% per year?

    Mikko, I actually did that with a post in March 2009 (which I recently linked to.) Unfortunately almost no one signed. I think it best to do this informally. A couple weeks ago Andy Harless publically endorsed my NGDP targeting proposal. A couple days ago David Beckworth endorsed the monetary stimulus proposal. So we are making progress.

  29. Gravatar of Mikko Mikko
    4. September 2010 at 07:09

    Scott, good luck with the endeavor. I really wish you succeed in US, since there’s really even less hope of getting some sense to European monetary policy…

  30. Gravatar of ssumner ssumner
    4. September 2010 at 11:20

    Thanks Mikko

  31. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    5. September 2010 at 02:12

    Scott,
    average unit of cash has a great utility as a medium of exchange, but a marginal unit of monetary base has only little.

    You said:
    “I don’t follow. Are you saying banks would want to hold this much reserves if prices were expected to rise at 15% per year?”
    If IOR doesn’t change and prices are expected to rise at 15% a year, real return on cash and reserves would be very negative, but we have seen even more negative rates in Zimbabwe. But of course IOR will be adjusted to the more reasonable level, and after three – five years the Fed will start increasing monetary base again.

  32. Gravatar of Charles R. Williams Charles R. Williams
    5. September 2010 at 05:58

    I support your proposal with respect to interest on excess reserves. It makes no sense to convert T-bonds owned by the public to excess reserves paying an above market interest rate.

    With respect to price level targeting. Core inflation is a bogus concept. It assumes that the price of energy and food is driven by exogenous factors rather than fed policy through the mechanism of the exchange rate. There is always the danger of another huge bubble engendered by loose monetary policy that drives up the prices for everything except the core CPI.

    Monetary policy is too tight, but not significantly so. The question is the trade-off between a slightly faster recovery and taking the opportunity to achieve a lower long term inflation rate.

    Our economic troubles are not rooted in poor current macroeconomic policies and there is no macroeconomic fix. Monetary policy can prevent a return of the Depression with 25% unemployment and there is no doubt that fed policies are sufficient to accomplish this. Creditworthy borrowers who want to borrow have plenty of access to credit. The fed cannot change the “want” and the fed cannot change the “creditworthy”.

    Consumer spending must fall. Government spending must be put on a lower long term trajectory. Investment must take up the slack. These adjustments will take time and stable investment friendly policies at the government level.

    Microeconomic policy is the key but by all means let’s stop paying above market interest on excess reserves.

  33. Gravatar of ssumner ssumner
    5. September 2010 at 08:24

    123, You said;

    “average unit of cash has a great utility as a medium of exchange, but a marginal unit of monetary base has only little.”

    Which is why additions to the stock of money are inflationary.

    I always have trouble understanding what you are holding fixed. Yes, if the IOR was raised to 15% then banks would hold onto the reserves. But I don’t see that assumption as being implicit in your previous comment.

    Charles, My preference is NGDP, not the CPI. Nevertheless, your comment about the core is debateable. Even in 2008, when the dollar was very weak, high oil prices were due more to a high real price of oil at the global level, then they were to the falling dollar.

    You said;

    “Monetary policy is too tight, but not significantly so. The question is the trade-off between a slightly faster recovery and taking the opportunity to achieve a lower long term inflation rate”

    I did some recent posts on opportunitic disinflation. It is a really bad idea, indeed in a sense it caused this crisis. It should NEVER be done in a recession, rather it should always be done during boom years.

    You said;

    “Our economic troubles are not rooted in poor current macroeconomic policies and there is no macroeconomic fix. Monetary policy can prevent a return of the Depression with 25% unemployment and there is no doubt that fed policies are sufficient to accomplish this. Creditworthy borrowers who want to borrow have plenty of access to credit. The fed cannot change the “want” and the fed cannot change the “creditworthy”.”

    You are confusing money and credit, two completely different things. Low interest rates are not “monetary policy.”

    You said;

    “Consumer spending must fall. Government spending must be put on a lower long term trajectory. Investment must take up the slack. These adjustments will take time and stable investment friendly policies at the government level.
    Microeconomic policy is the key but by all means let’s stop paying above market interest on excess reserves.”

    We should invest more, but the those adjustments can occur anytime. Right now we need more NGDP.

    I entirely agree about IOR.

  34. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    5. September 2010 at 08:45

    Scott, utility of a marginal unit of monetary base as a medium of exchange has dropped sharply in last three years. In 2007 reserves were very scarce, and a huge yield gap between reserves and T-bills was a clear indication that marginal unit of reserves was very useful as medium of exchange. Adding more reserves by taking T-bills out of circulation was very inflationary in 2007.
    Right now yield on 3 month bills is lower than IOR and is lower than the ffr. Why? It is because a marginal unit of 3 month treasuries has more utility as a medium of exchange than a marginal unit of monetary base. So replacing 3 month bills with monetary base does nothing good.

  35. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    5. September 2010 at 12:07

    Scott, you said:
    “I always have trouble understanding what you are holding fixed.”
    Sorry for that. As higher IOR is very likely to be the key part of Fed’s exit strategy, I usually consider scenarios with flexible IOR.

  36. Gravatar of Charles R. Williams Charles R. Williams
    5. September 2010 at 15:39

    Scott,

    My preference for a policy target would be a market basket of internationally traded commodities rather than the CPI or NGNP. The reasons are timeliness, accuracy and relevance in a world with a largely dollar based economy. Now let’s consider the period 2007-8 when the housing bubble was deflating and the oil bubble was booming. As Friedman said, monetary policy works with long and variable lags and this is true at the micro level as well as at the aggregate demand/macro level. Implementing monetary policy that targets commodity prices would have to be done during a stable period.

    With respect to confusing credit and money, my issue is when is monetary policy so tight that it is exacerbating a recession and creating an downward spiral into another Depression. When the economy softens, money supply will fall absent fed intervention; but we need to look to credit conditions to say if fed policy is pushing the economy down.

    With respect to opportunities to reduce the inflation rate, things are not so clear cut. I see no value in any inflation rate in excess of 0% on internationally traded commodities – which would mean slow deflation in everything else. A vast amount of resources are squandered on financial intermediation to protect against inflation by exploiting features of the tax code. We need to get back to the sort of world where a prudent man can stuff $100 bills in his mattress. What better use for fancy rags? I remember that Friedman addresses this issue in some paper or book and concludes that a slow rate of deflation is optimal.

    On balance the trade-offs favor a more expansionary monetary policy. My big issue with the premise of this blog is that macroeconomic policy will have only a marginal effect in addressing the structural issues that plague the economy and that are largely the result of misguided macroeconomic policies from the past.

  37. Gravatar of scott sumner scott sumner
    6. September 2010 at 10:02

    123, You said;

    “Scott, you said:
    “I always have trouble understanding what you are holding fixed.”
    Sorry for that. As higher IOR is very likely to be the key part of Fed’s exit strategy, I usually consider scenarios with flexible IOR.”

    Fair enough, but be sure to avoid this trap:

    1. I assume the Fed will later do something to neutralize monetary stimulus.
    2. If they do that, monetary stimulus will not work.
    3. Ergo, monetary stimulus cannot work

    I agree that adding more ERs paying 0.25% does nothing, unless the Fed signals that the injections are expected to be partly permanent. If it’s all temporary, nothing good will happen. T-bills and interest-bearing reserves are close substitutes. I was thinking about what would happen if the Fed added more cash to the system. They could do this if they wanted to.

    Charles, You said;

    “My preference for a policy target would be a market basket of internationally traded commodities rather than the CPI or NGNP. The reasons are timeliness, accuracy and relevance in a world with a largely dollar based economy. Now let’s consider the period 2007-8 when the housing bubble was deflating and the oil bubble was booming. As Friedman said, monetary policy works with long and variable lags and this is true at the micro level as well as at the aggregate demand/macro level. Implementing monetary policy that targets commodity prices would have to be done during a stable period.”

    Friedman was wrong about lags–I have done many posts on that, one just a few days ago.

    I favor targeting NGDP expectations, not actual NGDP. NGDP expectations respond immediately to monetary policy.

    I think inflation targeting of any sort is a bad idea, for all sorts of reasons that I have discussed in earlier posts.

    You said;

    “My big issue with the premise of this blog is that macroeconomic policy will have only a marginal effect in addressing the structural issues that plague the economy and that are largely the result of misguided macroeconomic policies from the past.”

    Actually, this blog is based on the premise that monetary policy cannot solve the economy’s structural problems, or at best can only do so indirectly (as would be the case if an economic recovery caused Congress to rescind the 99 week UI extension.)

  38. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    6. September 2010 at 13:34

    Scott, you said:
    “T-bills and interest-bearing reserves are close substitutes.”

    T-bills and reserves are close substitutes not because of IOR, but because the Fed has flooded the system with reserves.

    Let’s say the Fed cuts IOR to zero tomorrow. What will happen? Fed funds rate will fall approximately to zero. 3 month treasury bill rate will become negative 10 or 5 bps. You will still gain nothing by replacing 3 month bills with reserves.

    You said:
    “I was thinking about what would happen if the Fed added more cash to the system. They could do this if they wanted to.”
    Yes, the Fed should add more cash to the system. But the Fed should do this by purchasing something that is not cash-like.

    You said:
    “If it’s all temporary, nothing good will happen.”
    Yes, this is why level targeting is the most important thing.

  39. Gravatar of ssumner ssumner
    7. September 2010 at 06:53

    123, If the monetary injection is permanent, it will increase inflation expectations. That is because people don’t expect the liquidity trap to last for ever.

    I agree that if it is temporary it won’t do any good. But if permanent it will boost AD.

  40. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    8. September 2010 at 05:56

    Scott, nobody will believe that additional injection will be permanent. The Fed wants to reduce the balance sheet after the crisis. What we need is a better reaction function, under which the reduction of Fed’s balance sheet will happen under different economic circumstances.
    And permanently increasing the supply of dimes by destroying 100$ bills is a very poor way of sending the message that the reaction function has changed. The Fed should expand the monetary base some other way.

  41. Gravatar of What a Mess : Invest My Money What a Mess : Invest My Money
    9. September 2010 at 23:05

    [...] not fall. What a mess we are in.  So what can be done? My recommendation is (1) have the Fed take more aggressive actions to stabilize the macroeconomy which would make it easier to (2) do the structural changes needed to [...]

  42. Gravatar of TheMoneyIllusion » The other money illusion TheMoneyIllusion » The other money illusion
    11. September 2010 at 08:07

    [...] they didn’t plan to use them, but hinted they would if disinflation got worse.  I outlined a very modest proposal that would provide substantial stimulus.  The most important component of my proposal was a 2% [...]

  43. Gravatar of The Other Money Illusion The Other Money Illusion
    13. September 2010 at 01:59

    [...] now they didn’t plan to use them, but hinted they would if disinflation got worse.  I outlined a very modest proposal that would provide substantial stimulus.  The most important component of my proposal was a 2% [...]

  44. Gravatar of jazzbumpa jazzbumpa
    23. September 2010 at 07:08

    Why do you so blithely dismiss fiscal stimulus?

    For being too small, partly wasted on totally ineffective tax cuts, and, one might argue, poorly targeted, the stimulus package probably prevented – or at least deferred – a collapse into GD II.

    http://www.cbpp.org/cms/index.cfm?fa=view&id=3252

    We are still in very desperate times. I’m all for monetary solutions, but why be limited to them? Most especially since the fiscal plan – you know – worked.

    Cheers!
    JzB

  45. Gravatar of How to Stimulate Aggregate Spending How to Stimulate Aggregate Spending
    23. September 2010 at 09:56

    [...] Actually, this proposal is not that new as it was recently promoted by Greg Mankiw and William Buiter. This approach does create some serious problems as noted by Rajiv Shastri, but it would be highly effective in stimulating aggregate spending. My preference is to go with Scott Sumner’s proposal. [...]

  46. Gravatar of ssumner ssumner
    23. September 2010 at 16:45

    123, Sorry I missed this one earlier. They will believe the Fed if it makes an explicit promise to hit a P-level or NGDP target.

    jazzbumpa, I am the last person to dismiss things “blithely”

    Everyone complains my posts are too long, and I do have very long and detailed posts on why fiscal stimulus doesn’t work. Indeed by the 1990s fiscal stimulus had virtually dropped out of graduate textbooks–no one took it seriously. They still shouldn’t

    There is no way there was going to be a GDII w/o fiscal stimulus. Obama said unemployment would have risen to about 9% w/o fiscal stimulus, and I think that is pretty close. In my view it might have hit 10% w/o fiscal stimulus.

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