The Fed’s Not ‘Out Of Ammunition’ — It’s Just Not Firing

I found an enormous amount to like in Alan Blinder’s column on America’s jobs crisis, but this bit on the Federal Reserve is wrong:

Creating jobs costs money—whether it’s via tax cuts or more spending. (The Federal Reserve normally can create jobs without budgetary costs, but with interest rates already near zero it says it’s out of ammunition.) If Congress and the president are fixated on reducing the federal budget deficit to the exclusion of all else, we are not going to make headway. So yes, let’s enact a major deficit reduction program right away, but start the cutbacks only in the future. For now, we need a jobs bill.

One point on this that I find a lot of progressive economists miss is that even if you think there’s nothing the Fed can do to boost job creation, this isn’t something the Fed has ever said. On the contrary, the Fed’s position is that both QE1 and QE2 boosted job creation, they’ve given no reason to think that they think QE3 wouldn’t work, and much of Ben Bernanke’s scholarship is dedicated to the idea that “zero lower bound” does not in fact bind. The Fed isn’t doing more because it doesn’t want to do more. As Bernanke put it in 2002: “A central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition.” What’s more, this seems to me to be obviously correct once you think about it. For one thing, it’s right there in the idea of an accustomed policy rate. A central bank can always force other interest rates lower. What’s more, by shaping inflation expectations, a central bank can push real rates lower. Last, per Blinder, “creating jobs costs money,” but the Fed can manufacture money.

In terms of specific ideas and leaving QE3 aside, perhaps the most overlooked lever in the Fed’s arsenal is the interest on excess bank reserves. Traditionally, the Fed has set a regulatory floor on how much money banks need to hold in reserve. And everyone’s understood that raising the reserve level is contractionary and lowering it is expansionary. And traditionally, if banks want to hold larger reserves than that, they’re allowed to, but they would earn no interest on it. In the fall of 2008, the Fed started paying a small amount of interest on excess reserves. Since that time, bank holdings of excess reserves have skyrocketed. This is contractionary for all the same reasons that a higher required reserve level would be contractionary. The Fed could bring this rate back down to zero or it could follow Sweden’s central bank and set it at a negative level. Either this strategy or a “helicopter drop” strategy seem to me to be absolutely guaranteed to increased nominal spending and thus employment.