What The Fed Can Do

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I wrote earlier this week that based on his own analysis of the situation, Ben Bernanke has an obligation to provide more monetary expansion. A bunch of people responded to that by asking what, exactly, the Fed can do and I didn’t have a great explanation of the details for them. But the answer was well-put by Brad DeLong in a post from last week:

Quantitative easing—pouring a whole bunch of cash in the system with the idea of never reversing the money stock expansion could boost spending and employment considerably by creating expectations of inflation and so reducing the spread—but the Federal Reserve is not going there, and regards the idea with horror, shock, and shame.

We can’t be sure that would work, but there’s some decent theoretical reasons to think it would. It’s also arguably the available step that’s most similar to what really worked for FDR in 1933—dropping the gold standard.

Brad, and Paul Krugman who also agrees with this analysis, seem to have made the political calculation that it makes sense to sort of mention this as an aside, say it’s not going to happen, and then move on to trying to persuade congress to enact more fiscal policy expansion. I think that’s backwards. I don’t want to let congress off the hook, but like Ryan Avent “I think it will probably be easier to sway Fed officials (who are more likely to be impressed by economic arguments) than it will be to convince Congress to pass any kind of fiscal package large enough to have an effect despite the too-tight nature of monetary policy.”

DeLong comments:

I do wonder how much good would be done if the FOMC were simply to stand up and announce that they were raising their long-term GDP-deflator inflation target from 2% to 3%. It might do a lot of good. And it is certainly something the Fed could do without cracking its credibility as committed to low inflation.

But they won’t. We would need a very different FOMC than the one we have to consider such a move.

By the same token, however, I think we would need a very different US congress to get further fiscal stimulus. And I don’t think we should reconcile ourselves to the idea of “third best” direct labor market interventions . . . there are much better possibilities out there and Bernanke hasn’t so much as tried to address why he isn’t moving in this direction.