QE Can Be Made to Work

Annie Lowrey writes for Slate that most economists are not hopeful about the prospects for a new round of “quantitative easing” to improve the economic outlook. As previously, I continue to be frustrated when people express a political skepticism about the Federal Reserve’s likely willingness to do what’s necessary as skepticism about the Fed’s ability in principle to help solve problems.

For example here:

Another hope is that by trading non-interest-bearing assets (cash) for interest-bearing assets (bonds), the Federal Reserve will reduce the supply of bonds and make them more expensive, prodding big institutional investors to invest less in government debt and more in the American economy. The problem with this theory is that the bond market is huge—really huge—and international. To have any sort of impact, the Fed would need to buy a lot of bonds. Economists worry it won’t buy enough. Paul Krugman, for one, says the Fed would need to buy $8 trillion to $10 trillion to have an effect.

I’m a political pundit, not an economist. But qua political pundit, it seems to me that if economists think the way to fix the economy is for the Fed to buy $8-10 trillion in bonds, then Ben Bernanke should say “I’m determined to fix the economy and am willing to buy as many bonds as necessary to make it work—if that means $10 trillion then so be it.”

One key point that Lowrey makes is that currently cash-rich firms are disinclined to invest and reserve-rich banks are disinclined to lend. She notes that this makes additional “credit easing” unlikely to work. But I think it also speaks to the importance of an attitude of gritty determination. If the Fed is saying “demand and the price level are going to rise, damnit, even if it takes $10 trillion in bond purchases” then maybe your cash-rich firms and reserve-rich banks are going to think about doing something. But if the Fed keeps saying “everything will suck for the foreseeable future and we’re okay with that” then of course businesses won’t expand and invest. Would you?

Last I note that some, including most recently Joe Stiglitz, seem to think that talking about this makes expansionary fiscal policy less likely. I don’t really see it that way. For one thing, the looming midterms make expansionary fiscal policy totally impossible politically so there’s no real way for it to get less possible. But more importantly, in policy terms fiscal policy only works if monetary policy accommodates it. One of the main motives for the United Kingdom’s looming dangerous experiment in fiscal austerity is fear that the Bank of England won’t stand for continued deficits. Signals from the Fed that it wants to see the price level pushed up are crucial to making any fiscal measures work.