I’ve been wondering for a while who it is on the White House economic time who failed to mention to Barack Obama that expansionary monetary policy is a crucial part of the recovery mix. Surely not Christina Romer (“A second key lesson from the 1930s is that monetary expansion can help to heal an economy even when interest rates are near zero” [“PDF”). But was the villain Peter Orszag? He has an item up at the NYT blog today arguing that additional quantitative easing might actually hurt the economy.
He builds the argument initially by citing Paul Krugman’s skepticism about QE2 while failing to note Krugman’s belief that monetary policy could work if the Fed was sufficiently determined about it. But he then pivots to a truly strange political economy argument:
Ironically, QE2 could make the right policy mix less likely. In particular, any substantial additional stimulus will probably not (and should not) be enacted without a medium-term deficit reduction package — and that medium-term deficit reduction package is less likely to be enacted when interest rates on long-term government bonds are so low.
In other words, by perpetuating an artificially low 10-year government bond rate, the Fed may be delaying (even if very modestly, given the modest impact of the action on long rates) the very fiscal policy action that the nation most needs, while doing little to boost an economy whose principal problem is not high long-term interest rates.
His view, in other words, is that the road to recovery starts with a spark in long-term interest rates. This is bad for the economy, but it leads to a renewed outburst of deficit panic. That panic leads to congressional support for long-term fiscal austerity. That, in turn, leads to increased congressional support (but how?) for short-term fiscal expansion. But if the Fed acts to hold interest rates down, then none of this will happen, and let’s just not pay attention to the fact that lower long-term interest rates might spur investment and growth.
In addition to being an implausible model of how congress works, I think this gets the interplay between fiscal and monetary matters backwards. The legitimate concern you would have with deficit-increasing stimulus is that it would “crowd out” private investment via higher interest rates. Commitment by the monetary authorities to not let them happen is necessary for fiscal policy to work.