The outcomes we desire from monetary policy are about as good as one could hope. Inflation is low and steady. Interest rates are lower than Americans have seen in generations. Unemployment, at 5.1%, has recovered to near normal. And banks and businesses sitting on huge piles of cash don’t go bust, a boon to financial stability.Opeds are real Haikus -- 950 words is torture for me. So lots of good stuff got left on the cutting room floor, especially acknowledgement of objections and criticisms.
Yes, economic growth is too slow, too many Americans have dropped out of the workforce, earnings are stagnant, and the country faces other serious challenges. But monetary policy can’t solve long-term structural problems.
Yes, I'm aware of recent empirical work that QE has some effect:
Even the strongest empirical research argues that QE bond buying announcements lowered rates on specific issues a few tenths of a percentage point for a few months. But that's not much effect for your $3 trillion. And it does not verify the much larger reach-for-yield, bubble-inducing, or other effects.Yes, I'm aware of lots of theory going on:
An acid test: If QE is indeed so powerful, why did the Fed not just announce, say, a 1% 10 year rate, and buy whatever it takes to get that price? A likely answer: they feared that they would have been steamrolled with demand. And then, the markets would have found out that the Fed can’t really control 10 year rates. Successful soothsayers stay in the shadows of doubt.
Granted, economic theories are always in flux. Advocates are ready with after-the-fact patches for traditional theories’ failures. Maybe wages are eternally "sticky" downward, so deflation spirals can't happen. Never mind. Also, researchers are busy adding “frictions” to modern models to try to make them generate huge QE effects. But for policy-making, all of this is new, hypothetical and untested.We lost an important warning
Economic theories are useful for working out logical connections. The forward-looking [new-Keynesian] theory predicts that an interest rate peg is only stable if fiscal policy is solvent, so people trust government debt. Past interest rate pegs have fallen apart when their governments ran in to fiscal problems. That’s an important warning.And we lost a lot of nice metaphors
The deflationary spiral story posits that the economy is inherently unstable, like a broom being held upside down. The Fed must actively move interest rates around, as you move the bottom of a broom to keep it toppling over. But when interest rates hit zero, the Fed could no longer adjust interest rates. The broom should have tipped over. The lesson is clear: In fact, our economy is stable. Small movements of inflation will melt away on their own. The Fed does not need constantly to adjust interest rates to avoid “spirals.”Later,
This forward-looking (new-Keynesian) theory predicts inflation is stable because it assumes that people are smart, and look ahead. Traditional theories assume that people form their views of the future mechanically from the past. Yes, if you try to drive a car while looking in the rear view mirror, your driving will be unstable, and a Fed sitting in the right seat telling you where to go would help. But if people look out the front window, cars stably converge to the road without direction.And on theory vs. practice
As Ben Bernanke wisely noted, “The problem with QE is that it works in practice, but it doesn’t work in theory.” That’s a big problem. If we have no theory why something works, then maybe it doesn’t really work. Doctors long saw that bleeding worked in practice— they bled patients, patients got better — but had no theory for it.I also had a lot more on the wonders of living the optimal quantity of money. $3 trillion of reserves means 100% reserve deposits are sitting before us. No inflation means no inflation-induced distortions of the tax code. You don't pay capital gains taxes on inflation, or return taxes on the component of return due to inflation. But all that will wait for the next one, I guess.
And the whole Neo-Fisherian question got left on the cutting room floor too. But if a 0% interest rate peg is stable, then so is a 1% interest rate peg. It follows that raising rates 1% will eventually raise inflation 1%. New Keynesian models echo this consequence of experience. And then the Fed will congratulate itself for foreseeing the inflation that, in fact, it caused.
I didn't go so far as to advocate this, back in draft mode. I don't like the way so many economists have a pet theory and rush to Washington to ask that it be implemented. But given that just how monetary policy works is so uncertain, a robust policy choice ought to put at least some weight on such a cogent view.
The word "normal" has many connotations. John Taylor likes return to "normal," meaning return to something like a Taylor rule. When the Fed says "normal," I sense they simply mean higher nominal interest rates, and a smaller balance sheet, but continuing lots of talk and lots of discretion. The "normal" I'm dubious of in the oped is the latter version.