George Selgin appraises QE and Fed policy more generally over the past decade. I think it’s fair to say that he’s not a big fan. The way he frames the discussion might lead some readers to think he sharply disagrees with my views, but this is more a stylistic difference in emphasis.  On the core issues we agree:

1.  The Fed policy during the Great Recession should not be viewed as a great success.  Yes, we did better than Europe, but the recovery was still quite disappointing in an absolute sense.

2.  A policy of stable NGDP growth would have been far superior to actual Fed policy.

3.  With a better policy (such as NGDP targeting), it’s quite possible that little or no QE would have been needed, and there would have been less Fed intervention into credit markets.

Keep those three points in mind if it seems like he’s less in favor of QE than I am. George also favors a somewhat lower NGDP target than I favor, which leads him to put more weight on policy errors that occurred before 2008.  I like the way he ends the post:

Am I suggesting that the Fed could not possibly have done worse? Of course not. Only someone with a severely defective imagination could suppose so.  Whatever his shortcomings, Ben Bernanke was far from being an incompetent central banker.  In suggesting that we might have done better than Bernanke’s Fed did, I don’t mean that we could have used a better discretion-wielding central banker. I mean that we might have been better off avoiding seat-of-the-pants-style central banking altogether.

I struggle, moreover, to understand why more people don’t take the same view.   For if it takes a stunted imagination to suppose that things couldn’t have been worse, it takes a no-less defective one to suppose that we couldn’t possibly improve upon the presently-constituted Fed. Far [from] supplying grounds for celebration, or warranting complacency, the events of the last decade or so ought to make it more evident than ever that our monetary system is very far from being the best of all possible alternatives.

George links to a paper by Yi Wen with the following abstract:

We use a general equilibrium finance model that features explicit government purchases of private debts to shed light on some of the principal working mechanisms of the Federal Reserve’s large-scale asset purchases (LSAP) and their macroeconomic effects. Our model predicts that unless private asset purchases are highly persistent and extremely large (on the order of more than 50% of annual GDP), money injections through LSAP cannot effectively boost aggregate output and employment even if inflation is fully anchored and the real interest rate significantly reduced. Our framework also sheds light on some longstanding financial puzzles and monetary policy questions facing central banks around the world, such as (i) the flight to liquidity under a credit crunch and debt crisis, (ii) the liquidity trap, and (iii) the low inflation puzzle under quantitative easing.

Someone needs to explain to me the phrase “even if inflation is fully anchored.” Obviously if inflation is fully anchored then it’s almost logically impossible for expansionary monetary policy to boost RGDP.  (Unless the SRAS was 100% flat, which it isn’t.)  So why would an empirical result of this sort be at all interesting?

Obviously I’m missing something.  But what?

In the previous post I sort of hinted that Ryan Avent might be a bit more negative about the Summers/Krugman/Bernanke debate than he was letting on, when I suggested that he was being polite.  Marcus Nunes pointed me to a great Avent post from 2013 that makes this criticism much more explicit:

I think it’s important and welcome for someone of Mr Summers’ stature to point out how serious a problem the zero lower bound is and to note that it is not going away any time soon. But this discussion sorely needs a dose of real talk, and soon. Or nominal talk, I should say.

Just why the real natural rate of interest is so low is an interesting question. Maybe it’s down to a global savings glut, spurred by emerging-market reserve accumulation and exchange-rate management. Maybe it is a transitory symptom of widespread deleveraging. Maybe its roots are more structural in nature: a product of demographic or technological trends. I have my own suspicions, but the important thing to point out is that for the purpose of this discussion and this crisis it doesn’t matter.

The zero lower bound is a nominal problem. However low the real interest rate, an economy can keep nominal rates safely in positive territory by running a sufficiently high rate of inflation. Back in August, another eminent economist, Robert Hall of Stanford University, contributed a paper on the zero lower bound to the Kansas City Fed’s Jackon Hole conference, in which he estimated that the market-clearing real rate of interest is -4%. Now again, just why the real, natural rate of interest is currently -4% is an interesting question, but it’s irrelevant to the challenge of closing the output gap. All that matters there is that expected inflation is between 1% and 2% instead of near 4%. That’s the problem; that’s what’s keeping tens of millions of people out of work and hundreds of millions languishing in a perpetually weak economy: a couple of percentage points of inflation.

And central banks are entirely to blame for that.

So basically Ryan is saying that the real problem is nominal.

PS.  Off topic, Robin Hanson has an excellent post discussing a graph on intangible corporate assets, which played a role in my recent post on how regulation may be increasing inequality.

Ryan Avent has a long and characteristically thoughtful post on the recent debate over global stagnation.  He focuses on the views of Paul Krugman, Ben Bernanke and Larry Summers, three intellectual heavyweights.  In the end I think Ryan’s a tad too polite, although maybe that’s my own frustration showing through.  After all, these aren’t just any three economists; they are two of the most influential policymakers in recent years, and the world’s most famous economic pundit.

Here’s my problem.  After nodding in the direction of inadequate monetary policy, Ryan basically accepts the framing of the demand deficiency debate—it’s all about saving/investment imbalances.  But as Ryan himself acknowledges, that’s only a problem because monetary policy is not behaving normally:

Normally a central bank would try to fix the imbalance between saving and investment by reducing interest rates (which should discourage saving and encourage borrowing). But in a weak enough economy with low enough inflation the interest rate needed to balance saving and investment might become negative””maybe even really negative. Given the difficulty of achieving a negative nominal interest rate, the central bank might find it hard to push an economy out of that sort of trap once it fell in.

Ryan understands (but doesn’t mention in this post) that one way to fix this problem is by raising the inflation target. Many economists (including Krugman) have recommended raising the target to 4%.  In my view 3% would be plenty high for the US.

So why don’t we do this?  I can’t imagine that any serious economist believes that the harm done by an extra 1% in fully anticipated inflation is worse than the damage (supposedly) done from decades of secular stagnation.  One answer is that there are better alternatives, like NGDPLT. That’s true, but we are also not adopting those better alternatives.   Another is that “using monetary policy” would create bubbles.  But we always use monetary policy; not using monetary policy is not an option. What Larry Summers actually objects to is having the private sector allocate increased investment spending, at a time he prefers more public investment on infrastructure.

And yet Summers is obviously not typical of the opponents of higher inflation, who are most often on the right.  The argument that I hear most frequently is that 3% inflation would “let the inflation genie out of the bottle.” We saw in the 1960s that once we let inflation rise to 3%, it rose to 4%, then 5%, then eventually 13%.

And yet . . . prior to the 1960s the Fed had no experience in inflation targeting. Now they’ve shown they can keep inflation close to 2% or slightly lower for as long as they wish. They’ve learned the Taylor Principle.  I know, you are thinking; “Still we can’t really know the effect of a higher inflation target until it’s been tried.” Don’t be a stupid American, the type who pays no attention to the rest of the world.

A few years ago the Japanese raised their inflation target from “stable prices” to 1% inflation.  Then at the beginning of 2013 they again raised their inflation target to 2%.  And what did the mean, scary Japanese inflation genie do once it got out of the bottle?  Well the Japanese CPI was about 99 at the beginning of 2013, and now it’s about 103.  I’ll let you do the math.

More recently the ECB has sharply depreciated the euro.  The Fed is planning on raising interest rates soon, which means they don’t see any demand deficiency—mostly because the Bernanke Fed did more monetary stimulus than the ECB in previous years.  Monetary policy works at the zero bound.

Here’s how central bankers envision the scary Japanese inflation genie:

And here’s what it actually looks like:

PS.  I do not favor raising the inflation target, I favor NGDPLT.  But if the choice is between decades of “demand deficiency” and/or billions spent on Japanese style bridges to nowhere, and 3% inflation, I’ll take my chances with the scary inflation genie.

PPS.  Perhaps I’m not afraid because as a child I watched the TV show “I Dream of Jeannie.”

[Update:  Since Tyler linked to this I should clarify that I do understand that NGDP growth is a demand-side concept.  In earlier posts I’ve suggested that RGDP trend growth is now about 1.2% and trend inflation about 1.8%.  So the drop in NGDP growth from a 5% trend to 3% trend is mostly a RGDP (supply-side) story.]

For several years I’ve been arguing that we are in a Great Stagnation, and that trend NGDP growth is about 3%, not the 5% to 5.5% from before the crisis.  Just to be clear, I am referring to Tyler Cowen’s supply-side theory, not the Summers/Krugman demand-side secular stagnation, which I do not accept.

The NGDP futures price in the Hypermind prediction market has fallen from the 4.0% to 4.5% range earlier in the year, to its current value of 3.6%.  The 10 year bond yield has also been trending lower in recent weeks (although it’s quite erratic.) You might argue that 3.6% is still higher than 3.0%, but that’s the wrong way to think about it.  The 3.6% forecast is for an expansion year, a year when the unemployment rate is expected to decline.  The trend rate of growth includes both expansion years like 2015 and recession years like 2009, and the next recession. Thus if the nominal economy is expected to grow by 3.6% in an expansion year, the actual trend rate of growth is surely lower.  My 3.0% estimate is probably not far off from market forecasts.

Some implications:

1.  Very low nominal rates are the new normal, as I’ve been saying for many years.

2.  The Fed policy regime is bankrupt, as it is based on interest rate targeting and growth rate targeting, a combination which simply doesn’t work at the zero bound. They need to do NGDPLT.

3.  The Fed needs to raise wage inflation to 3% to hit its 2% PCE inflation target. Although wage growth has accelerated a tiny bit in recent months, it is still at only 2.136% over 12 months, far below the wage growth required to hit their inflation target. (Of course I oppose inflation targeting, but if they are doing it then they should do it.)

4.  While the Fed says they target 2% inflation and unemployment near the natural rate, their actions are not consistent with that target.  They run low inflation during period of high unemployment, whereas their mandate calls for the exact opposite.

Bob Murphy directed me to a Brad DeLong post bashing Milton Friedman:

In A Monetary History of the United States, published in 1963, Friedman and Anna Jacobson Schwartz famously argued that the Great Depression was due solely and completely to the failure of the US Federal Reserve to expand the country’s monetary base and thereby keep the economy on a path of stable growth. Had there been no decline in the money stock, their argument goes, there would have been no Great Depression.

I can’t understand how a brilliant economic historian like DeLong could make such a totally erroneous statement.  Milton Friedman and Anna Schwartz clearly documented the fact that the Fed increased the monetary base sharply during the Great Depression. They discussed the Fed’s QE policy of 1932.  So the preceding statement is flat out wrong.

And indeed the entire post is confused.  DeLong argues that the Great Recession was partly caused by the influence of Friedman’s ideas.  Actually, one could argue that the Great Recession happened because we did not pay enough attention to Milton Friedman.  Indeed this Friedman insight from 1998 was totally ignored in late 2008 by all but a tiny band of market monetarists:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

.   .   .

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.

In early 2009 I wrote a piece sharply criticizing DeLong for claiming that monetary policy was ineffective at the zero bound and that we therefore needed fiscal stimulus. He finally got the message, and a few years later he was bashing the Fed for letting NGDP growth plunge.  Now he’s back to claiming there was nothing the Fed could do at the zero bound.

When I was in grad school in the 1970s, anyone claiming a fiat money central bank would be unable to debase its currency would have been laughed at.  As recently as the early 2000s mainstream economists like Mishkin, Bernanke, Svensson, etc., were still scoffing at that idea.  It’s a sad comment on modern macro that this bizarre theory has suddenly become mainstream without a single shred of evidence in support.  Even worse, most macroeconomists don’t even seem to know what evidence in support of monetary policy ineffectiveness would look like.

PS.  Bob Murphy also has a post on the same topic.  David Glasner criticizes the DeLong post for other reasons.

PPS.  I strongly believe that if the FOMC had been composed of 12 Brad DeLongs, the Great Recession would have been considerably milder.  Which means Brad is wrong.  🙂