The world has a number of public intellectual economists who comment frequently on public affairs. Columbia’s Michael Woodford isn’t really one of them. He is, however, one of the very top people in monetary theory. So when he stoops to the op-ed pages, people should pay attention to what he’s saying. His argument is that additional quantitative easing by the Federal Reserve is probably neither necessary nor sufficient to boost the economy. What’s needed instead is clarity from the Fed about the nature of its policy. That’s because with interest rates at zero, monetary policy works largely by shaping expectations and “expectations can be shaped far more effectively by speaking directly about future policy, rather than leaving it to be inferred from actions that have no definite implications for the future.”
In particular, the point about which people need clarity is the Fed’s attitude toward a little bit of “catch-up” inflation. Right now, if growth were to spurt up a bit and unemployment to start dropping, it’s likely that we’d see some inflation. In particular, we’d see headline inflation because oil prices would rise. But we’d also likely see shortages of some classes of housing in some areas, pressure on a few other commodities, and maybe even a wage increase or two. If that happens, is the Fed going to freak out and slam on the breaks? Or are they going to say “it’s fine, we had a lot of near-deflation for a while and unemployment’s still super-high”? That makes all the difference. If the slightest hint of inflation is going to prompt tighter money, then people will bet on sluggish growth and the prophesy will be self-fulfilling. If the Fed expresses determination to get the economy moving again and willingness to tolerate a little inflation along the way, then expectations will coordinate around a higher-growth trajectory.
Either way, the Federal Reserve owes it to us to explain what they’re trying to do.