A slightly off-center perspective on monetary problems.
I’m not a huge fan of the Keynesian SRAS. I think many Keynesians overestimate how flat it is at less than full employment. But in recent weeks I have started to miss the SRAS, as the economics profession seems to have driven the IS-LM framework into an intellectual cul de sac. A couple posts back I cited a Financial Times story that mentioned a Fed study suggesting negative 5% real interest rates were needed to provide the desired level of stimulus.
One good thing about not having time to read the news recently is that I have been spared from some very silly and tiresome debates—such as whether the press has liberal bias. I don’t know which view is sillier; liberals who deny the liberal bias of the press, or conservatives who complain about it. Here is a news clip that reminded me of this issue. If most reporters weren’t obvious liberals, why would Obama’s joke even be funny? So am I taking the conservative side in this debate? Not at all. But first let’s back up a bit, and consider what it actually means to be “liberal.”
A recent FT piece discussed the progress of QE thus far, and the Fed’s view of what needs to be done next. Here is a key passage:
The last meeting saw the Fed buy long-term treasuries for the first time in decades. The large initial impact of the move on markets is no longer visible, but officials think the policy was reasonably successful.
Previous staff analysis suggested the $300bn purchase would reduce the yield on 10-year treasuries by 25-35 basis points, and officials think the rate today is about this much lower than it would have been if they had not started buying.
Further purchases are possible, particularly if the Fed again downgrades its economic forecasts. The staff analysis comparing unconventional operations to interest rate cuts suggests more might be needed anyway.
Bill Woolsey is very familiar with index futures targeting, but also knows the details of how futures markets actually work much better than I do. Thus I thought this letter from him would help clarify the nuts and bolts of the plan from the perspective of real world futures markets. I would also like to mention that the commenter “123” noted that the Fed might have to take a large long or short position if there was a sudden change in money demand during a financial crisis. Bill mentions that perhaps the Fed should be allowed to trade on its own account.
Back in 2006 I read an interesting post by Greg Mankiw, which advocated a monetary regime where the Fed would use market expectations to set the monetary policy instrument at the level expected to hit their inflation target. Given my longstanding interest in futures targeting, I was naturally encouraged to see a highly respected mainstream new Keynesian endorse this type of policy regime. Before looking at his specific plan, however, it will be useful to review his more recent essay on negative interest on money.
