The bounds of monetary policy on Planet Earth
I read too much from monetarists and quasimonetarists and progressive monetarists and what not that monetary policy is what we need, that fiscal is unnecessary.
For the moment, let’s put aside the big disputes about whether macro demand-side remedies are a good idea. Let’s stipulate that they are, that increasing aggregate demand or accommodating people’s elevated demand for the medium of exchange or whatever would be a good thing. Woo hoo!
Here’s Bryan Caplan
Arnold Kling, stipulating exactly that, despite some skepticism:
Intuitively, the equilibrium effect of a one-shot helicopter drop that doubles the money supply is to permanently double nominal income. If this leads to a stealthy, stable reduction in real wages, then output and employment go up permanently, too. Otherwise the price level doubles. Either way, there’s no reason for nominal income to recede as time goes on.
In short, if you think that boosting nominal income is the cure for recession, here’s yet another reason to prefer monetary to fiscal stimulus. One burst of expansionary monetary policy increases nominal income forever. One burst of expansionary fiscal policy increases nominal income for as long as the extra spending continues. At best.
I’m not sure Caplan is right on the economics here. His post seems to assume a world in which base money and bonds are imperfect substitutes. Some people might say that’s normal, and call the other situation a liquidity trap. But if so, liquidity trap is probably the new normal. The Fed has signaled (ht Aaron Krowne) they may pay interest on reserves at the overnight interest rate indefinitely under a so-called “floor” regime. I wish more economists would update their models for a world in which interest is paid on reserves as a matter of course. Interest on reserves represents a permanent policy shift that had been planned since 2006. It was not an ad hoc crisis response that can be expected to disappear. If interest is paid on reserves at the overnight rate and short-term bond markets are liquid, then short-term bonds and base money are perfect substitutes and a helicopter drop performed by the Tim Geithner dropping bonds from an F-16 would be as effective (or ineffective) as Ben Bernanke dropping dollar bills from his flying lawnmower.
But there is one big difference. Timothy Geithner is legally allowed to give away money for nothing. He does it all the time! He writes checks to Social Security recipients, gives money to welfare recipients and oil companies and big pharma. He even writes checks to me when my accountant or George W. Bush decide I’ve paid too much in taxes! Ben Bernanke, on the other hand, would go to jail for stuff like that. Sure, he has the printing press. “Operationally”, as the MMT-ers like to put it, he is entirely unconstrained. His checks never bounce. Why can’t he devalue the dollar, or use the threat thereof to upgrade inflation expectations? The economic law of supply an demand has not been repealed, but neither has US law. By law, the Federal Reserve can only engage in financial asset swaps. It shoves money out the door in exchange for some financial asset that colorably has the same value as the money it has dished.
Helicopter drops by the Federal Reserve are illegal. Helicopter drops by the Treasury happen all the time. Every law ever passed that overpays for anything, that has some manner of a transfer component, is a helicopter drop. I think all of us, left and right, delightful-smelling and stinky, can come together in a big Kumbaya and agree that most Federal spending has a transfer component, and is therefore a helicopter drop to some degree. It would not be a big deal for Congress to pass some law with even bigger, badder transfer components. They love to outdo themselves.
I think on the technocratic right, monetarists tend to think that helicopter drops by the Fed would be fairer than fiscal policy that launders transfers through expenditures. On the left and hard-crank right are people who don’t see the Fed as very fair at all, and emphasize the institution’s inclination to support certain interest groups when it does find ways of sneaking transfers through its legal shackles. My view is, a pox on both your houses, but it sucks that we are roommates. Macroeconomic policy by fiscal expenditures directed to politically favored groups is awful, unfair, and corrosive of the body politic. Macroeconomic policy by asset swaps that are quietly mispriced is awful, unfair, and corrosive of the body politic.
That’s the way it is here on Planet Earth (or at least on Planet USA, which is arguably at some remove from Planet Earth). Of course, we could change things. We could enact a law that instructed the Fed to engage in fair, perfectly transparent, helicopter drops as an instrument of macroeconomic policy. And boy would I support that! We could, as Matt Yglesias suggests (riffing on the work of Beowolf and the MMT-ers), have the Treasury issue some giant platinum coins and give them out to everyone. The difference between those two policies would be, well, no difference at all.
To the degree that our problem is on the demand-side and stems from private-debt-overhang-induced risk aversion or a desire to hoard money, we know the solution. That problem, if it exists, will go away if we give everyone money. But giving everyone money is not conventional, authorized, monetary policy. It requires new law. Politically, the law it requires would be hard law, because it shifts the distribution of risk in our very unequal polity. If we were to give everyone $20,000 tomorrow, whether it’s Ben or Timothy signing the checks, debt-overhang goes away as a macroeconomic concern. I believe, to some degree, in the demand-side story, so I’d wager that real GDP and employment would rise as well. But we would risk a step up in the price level, and therefore a devaluation in real terms of fixed-income claims and bank equity. Under status quo policy stagnation, near-term macroeconomic risks are borne primarily by the poor and marginally employed. With demand-side stimulus, whether designed by Scott Sumner via the Fed or Matt Yglesias via the Treasury, those risks would shift to financial savers, who in aggregate hold the bulk of their portfolio in the form of fixed-income securities, and who also hold the testicles of members of Congress.
The fiscal vs. monetary policy debate has gotten tiresome and distracting. If you think we need demand-side action, say specifically what you think we should do. If it’s a helicopter drop, whether by Fed or Treasury, then we need new law. Push it, and tell the self-styled realists and pragmatists to fuck off. If you think the Fed’s existing toolkit of running asset swaps and controlling the rate of interest on reserves would be enough if only they set expectations properly, then we still need new law. The Fed is not going to target NGDP or a price level path over any relevant time frame without a change in governance structure or mandate. People on the left and right and especially the technocratic center who like to see the Fed as a loophole through a dysfunctional Congress are kidding themselves. The Fed is a political creature, not some haven for philosopher-economists in togas who will openly consider your ideas. Get over it and get your hands dirty.
Update: Oops! I originally confused one of the excellent bloggers over at Econlog for another, misattributing Bryan Caplan’s post to Arnold Kling. Huge apologies to both, and many thanks to @derridative for pointing out the error.
- 31-Aug-2011, 12:45 a.m. EDT: Added update noting my group-blog dyslexia re Bryan Caplan & Arnold Kling, thanks @derridative! Updated text to Caplan, but left Kling struck through once to emphasize the error. Added ht to Aaron Krowne for Fed “floor” article. Changed “an institional” to “the institution’s”.