To QE, or not to QE, that is NOT the question (Reply to Simon Wren-Lewis)

We really ought to consider adopting a whole new monetary regime, NGDPLT.  But what if the Fed refuses. What then?  Then we are in the world of second best—QE and negative IOR.  These are not good policies, but they are less bad than deep depressions or wasteful government spending. Here’s Simon Wren-Lewis:

Perhaps these distortions are quite small. However this discussion illustrates a more serious problem with QE, which is that we still have no clear idea of its effectiveness, or indeed whether effects are linear, and what the best markets to operate in are. Announcements about QE clearly influence the market, but that could be because it is acting as a signalling device, as Michael Woodford has argued. Jim Hamilton is also sceptical. This strongly suggests that the uncertainty associated with the impact of QE is far greater than any uncertainty associated with either conventional monetary policy or fiscal policy.

Thinking about it this way, I cannot see why some people insist that unconventional monetary policy is always preferable to fiscal policy. In a comment on a recent Nick Rowe post, Scott Sumner writes “My views is that once the central bank owns the entire stock of global assets, come back to me and we can talk about fiscal stimulus.” What this effectively means is that it is better for one arm of the state (the central bank) to create huge amounts of money to buy up large quantities of assets than to let another arm of the state (the Treasury) advance consumers rather less money to spend or save as they like. This preference just seems rather strange, but maybe Lenin would have approved!

Of course I was joking, but I do seriously believe that Britain would be better off if it were able to acquire the entire stock of global wealth, at zero cost. That would be even more impressive than the “pink bits” on the map acquired under Queen Victoria.  However if I had my way the Fed would have adopted a policy closer to that of the Reserve Bank of Australia (a monetary base of 4% of GDP), rather than the BOJ (a monetary base of more than 20% of GDP.) QE is both a sign of a failed policy, and at the same time (paradoxically) is better than not QE, combined with the same failed policy.

Debates over monetary policy should not be debates over QE.  The discussion should focus on what policy regime is optimal.  An optimal policy regime would probably not involve any QE at all. And even if it did, it would still be less inefficient than fiscal stimulus. That was my point.  (Remember that the “advance to consumers” must eventually be clawed back via distortionary taxes.)

One way of stimulating demand when interest rates are stuck at zero is to promise a combination of higher than ideal inflation and higher than ideal output in the future. (This can be done either explicitly or implicitly by using some form of target in the nominal level of something like nominal GDP. For those not familiar with how this works, see here.) The cost of this policy is clear: higher than ideal future inflation and output. Once again, these costs can be worth it because of the severity of the current recession, which is why nominal rates are stuck at zero. Whether these costs are greater or less than the cost of changing government spending is debatable: a paper by Werning that I discussed here suggests optimal policy may involve both.

Given that inflation doesn’t matter at all, it is hardly possible for it to be above or below “ideal” levels.  People who talk about the welfare costs of inflation are confusing inflation with NGDP growth.  There are welfare costs of excessive long run NGDP growth, primarily excess taxation of nominal returns on capital. But inflation by itself does not have important welfare costs.  The only possible inflation cost is the “menu costs” of price changes, but even that is unclear, given that nominal wage changes also involve menu costs.  Thus a NGDPLT policy minimizes both the “welfare cost of inflation” and the problem of suboptimal output fluctuations.  There is no trade-off. NGDPLT also reduces financial sector instability, relative to inflation targeting.  It’s a win-win-win policy.

HT: Marcus Nunes, who also has a post.


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10 Responses to “To QE, or not to QE, that is NOT the question (Reply to Simon Wren-Lewis)”

  1. Gravatar of Major.Freedom Major.Freedom
    7. September 2014 at 17:56

    We ought to consider the ideal money as that which is run by a superhuman perfect predictor.

    If we can’t have that, then a second best would be a free market in money run by imperfect humans.

    Hey neat, I just became a pragmatist.

  2. Gravatar of Brian Donohue Brian Donohue
    8. September 2014 at 04:20

    “Thinking about it this way, I cannot see why some people insist that unconventional monetary policy is always preferable to fiscal policy.”

    That’s not it. Despite ‘savage austerity’ it would appear that the fiscal throttle has been out for the entire current recovery:

    http://www.usdebtclock.org/

  3. Gravatar of J Mann J Mann
    8. September 2014 at 05:18

    SWR writes: “What this effectively means is that it is better for one arm of the state (the central bank) to create huge amounts of money to buy up large quantities of assets than to let another arm of the state (the Treasury) advance consumers rather less money to spend or save as they like.”

    I agree that *if* we learned that 100 million in fiscal stimulus was likely to have the same effect as 100 billion in QE, then I think I might go for the fiscal stiumulus. I think Scott makes a pretty good case that this isn’t the worlkd we live in.

    I do think you have to live in the real world, so I don’t think we’re going to get the fiscal stimulus SWR describes – a payroll tax cut would probably qualify, or you could just give everyone a one time $2,500 tax credit. Instead, fiscal stimulus turns out to be (1) transfers to the states, which them use that money to reduce their existing deficits; (2) the wish list of the party in power, which in practice means that the money is spent unpredictably, both in terms of who gets it and when and where it is spent.

    If you had a real world fiscal stimulus that was actually designed specifically to stimulate the economy, you would still have to deal with Scott’s offset argument, but we don’t even have that.

  4. Gravatar of TallDave TallDave
    8. September 2014 at 05:54

    QE is both a sign of a failed policy, and at the same time (paradoxically) is better than not QE, combined with the same failed policy.

    Perhaps not surprising people have a lot of trouble understanding this. It combines monetary offset (which few people understand) with the paradox of low nominal rates (which even fewer people understand).

  5. Gravatar of Prakash Prakash
    8. September 2014 at 21:44

    I think the “buy the world” strategy would have an awesome demonstration effect. Though I think that making the government of the day debt-free would be enough (by buying up all the debt). The only fiscal policy needed would be the cutting down of the most distortionary taxes to the extent that the interest paid on all those all loans is no longer needed.

  6. Gravatar of Prakash Prakash
    8. September 2014 at 21:48

    Obvious caveat to previous post, an announced NGDP target is way, way better than “buy the world”. It just doesn’t have the drama that the latter does. Switzerland announcing its target for the frank against the euro was swift and without drama, except for a few options markets. Switzerland buying up the world would have triggered a thousand conspiracy theories.

  7. Gravatar of James in London James in London
    8. September 2014 at 21:57

    TallDave:
    It is indeed paradoxical that massive unconventional monetary policy (QE) seems preferred to a small tweak to conventional monetary policy (moving from IT to NGDPLT).

    Why is this? The Inflation Bogeyman. He’ll come in the night and steal all your money. He needs to be slayed. A glance around the world or into relatively recent history shows inflation of 5% or 10% even happily co-existing with strong RGDP growth.

    IT is a form of the modern madness of crowds. Corral ourselves into a <1% inflation world and we'll all be equally safe: just when we couldn't be more in danger.

    Admittedly, NGDPLT is a horrible mouthful. WT, average wage-targeting, would be simpler for the crowds. It's not that difficult, even the UK's BoE seems too be getting there.

  8. Gravatar of ThomasH ThomasH
    9. September 2014 at 03:55

    QE should be seen as an alternative to sub-optimum “fiscal” policy, that is, fiscal policy that fails to carry out investments with positive NPV’s when evaluated at the opportunity costs of the inputs into the investments when resources are unemployed.

  9. Gravatar of Mike Sax Mike Sax
    10. September 2014 at 16:13

    An advance doesnt necessarily have to be paid back in full in taxes unless maybe youre assuming full Ricardian Equivalenve. We have other choices like maybe higher growth giving us higher revenue like after WW 2 or having the Fed ‘monetize’ it.

  10. Gravatar of Scott Sumner vs. Simon-Wren Lewis on Monetary vs. Fiscal Policy | Last Men and OverMen Scott Sumner vs. Simon-Wren Lewis on Monetary vs. Fiscal Policy | Last Men and OverMen
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