Representative Tlaib asks a great question
In a recent Bridge post, I suggested that Congress should ask Jay Powell the following questions:
1. Do Fed officials believe that the Federal Reserve currently has adequate tools to achieve their mandate at the zero lower bound, without assistance from fiscal policy?
2. Would the Fed be more confident in its ability to achieve the dual mandate of stable prices and high employment if it were authorized to buy a wider range of assets at the zero lower bound?
3. Suppose the Fed were allowed to boost its capital by retaining several years’ worth of profits. Would this make the Fed more willing to provide adequate liquidity at zero interest rates, knowing that it is less likely to become insolvent if the assets on its balance sheet declined in value?
Yesterday, Rep. Tlaib asked Powell the following question:
What additional tools or authority do you need to prevent another downturn?
Great question!! Unfortunately, Powell didn’t provide a good answer:
I think we have the tools that we need. I think what we would hope for is support from fiscal policy.
If you are hoping for support from fiscal policy, then you most certainly do not have the tools that you need. There is no reason to expect any significant support from fiscal policy during the next downturn. The deficit has soared to nearly a trillion dollars during a boom period—does anyone seriously think Congress will run a $2 trillion deficit in the next recession? And does anyone think that a Congress where the two parties barely speak to each other will suddenly come together and agree on a tax cut during the next recession. (I’m not even considering government output, as there are basically no shovel ready projects in the modern world of infrastructure.)
And even if we did run a $2 trillion deficit, it would have little impact on GDP. Remember 2009? How about 2013?
Here’s what Powell should have said:
It would help if Congress gave us additional tools, or at the very least clarified that we were authorized to use current tools as aggressively as necessary to prevent a recession, even if that means buying unconventional assets, and even if it runs a small risk of capital losses for the Fed.
If Congress doesn’t want us to do whatever it takes to prevent the next recession at the zero lower bound, and would prefer to handle more of the load with fiscal policy, it would help if they clearly spelled out what they did expect from us. But I have to be honest with you, given the current budget deficit it’s very unlikely that fiscal policy will be effective in the next recession.
Powell did a good job discussing monetary policy, explaining why a rate cut is now appropriate.
The NYT reports that Powell is increasingly skeptical of the Phillips Curve:
Representative Alexandria Ocasio-Cortez, Democrat of New York, later asked, “Do you think it’s possible that the Fed’s estimates of the lowest sustainable unemployment rate may have been too high?”
“Absolutely,” Mr. Powell replied, adding that the Phillips curve, the statistical relationship between low joblessness and higher inflation that has been central to Fed policymaking for decades, is showing itself as but a “faint heartbeat.”
This is good news. Like all “reasoning from a price change” models, the P.C. is not reliable enough for policy purposes. The Fed needs to focus on NGDP growth, not unemployment, when looking for indicators of overheating.
I’ve been arguing that now is a perfect time for the Fed to ask for more power, as both parties would be on board with giving the Fed the tools to prevent a recession. Here’s the NYT:
It probably also helps that the Fed is now under pressure, from both conservatives and liberals, to increase economic growth.
The Fed needs to wake up.
HT: JW Mason
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11. July 2019 at 07:31
He said we can talk about the fed lending to municipalities. It would be a huge change.
11. July 2019 at 08:25
Not a fan of Fed lending money to individual municipalities. I’d be OK with them buying an index fund of S&L debt, but only if needed. Under a sound monetary policy it would never be needed.
11. July 2019 at 09:17
Professor Farmer’s idea for the Fed to buy equities in addition to government debt (Farmer calls his idea Prosperity For All) is an idea worth considering, and rejecting. The politics of it would destroy the Fed: whose equities would the Fed buy, and why? Powell’s response is the correct response, but Sumner’s point is correct too: monetary stimulus is all that we have in the event of another crisis. Sad, but true. The problem is that it’s expecting too much from monetary policy, and imposing too great a responsibility on the Fed (which risks its credibility). And then there’s my soap box: reliance on rising asset prices for prosperity is an eventual loser, a very big loser, as asset prices can’t rise forever. A day of reckoning lies ahead, and with each new monetary stimulus designed to raise asset prices, the reckoning becomes that much greater. The Austrians will have their day.
11. July 2019 at 09:21
I’m not sure how the Fed buying municipal debt during recessions would even work. Most states have balanced budget amendments, and that means they can’t deficit finance in a recession through issuing debt.
11. July 2019 at 11:26
Rayward, How is it asking too much of the Fed to simply do its job? They have a monopoly on money creation, and are perfectly capable of stabilizing the value of money.
Brett, That’s a different issue. The fact than local governments are issuing debt has nothing to do with whether or not they are running a budget deficit, as they define the term.
11. July 2019 at 15:49
I am surprised Scott Sumner rarely if ever mentions TLTROs, the European Central Bank tool.
I wrote an email to the ECB and asked where the ECB got the money to finance TLTROs. They politely answered, and said we print (digitize) the money. The short story on TLTROs is that the European Central Bank gives money to commercial banks if they lend the newly created money to businesses and consumers.
I think Scott Sumner gets closer in this post to the best solution. We must find a way for central banks to directly finance fiscal outlays. Not greater physical outlays, but lower taxes.
Ben Bernanke suggested money-financed fiscal programs for Japan as long ago is 2003. He had his tinfoil-hat day long before I ever did!
12. July 2019 at 06:25
Stabilizing the value of money? Really? I recall listening to a celebrity economist deliver his Okun lecture as the financial crisis was unfolding, and he faulted the Fed for not seeing “inflation lurking in the background”. What Inflation? That’s the reception he got for that remark, a remark that he hasn’t made since. What did he mean? Well, it’s obvious, although not obvious to the Fed. Then or now. To be clear, I’d much rather rather have Scott Sumner on the Fed than a gold bug like Ms. Shelton: Sumner knows monetary policy and economic history as well as anyone, and it is Sumner who should be credited with making NGDP targeting close to reality. I may question rising asset prices as the path to prosperity, but I’d prefer Sumner at the helm than most anybody else. Now, about that “inflation lurking in the background”.
13. July 2019 at 05:15
Maybe Powell thought he was leaving well enough alone before inviting the Congress to start writing more permission (followed by prescription, followed by prohibition etc) laws. I was not aware that Bernanke needed “permission” to buy securities—did he?
Could Fed pre-emptively buy some of the 8.1 trillion of unfunded IOUs owned by the various Federal “Trust Funds”—-it seems not technically possible—-there must be a difference between IOUs from another part of government and previously purchased securities from the public. I am joking, but…..just wondering.
Shoud’nt the Fed be keeping it as simple as possible? The appeal of NGDP is simplicity and transparency. The lawyer Powell follows the market——so it seems—-the technocrats think they know better than the market because……they have been trained to “know better”.
Free up Fed Funds—-one less thing for the Fed to spend thousands of tortuous hours about for no purpose——then again, who knows if the market sends signals in response to the Fed—-they may “need the Fed on that wall”
Is the function they perform an actual economic “externality”? If not, why are they there at all? A big giant illusion of comfort perhaps.
Didn’t Hayek once call Friedman—-“just another central planner”?