do if the economy needed more stimulus, Ben Bernanke was noncommittal: “We are going to continue to monitor the economy closely and continue to evaluate the alternatives that we have.”
Mark Thoma (here and here) is dismayed that Mr Bernanke, given the time the Fed has had to study this, doesn’t seem to know what he’ll do. Robin Harding says Mark is unfair: what Mr Bernanke does will depend on what happens, and then on developing a consensus with his colleagues.
Mr Harding is right that what the Fed would do differs depending on whether it faces a liquidity crisis or a shortfall in aggregate demand and rising threat of deflation. Yet Mr Thoma is also right that this does not exonerate Mr Bernanke. That he knows what to do in a liquidity crisis ... is of small comfort since such a crisis is not in anyone’s forecast. To echo Mr Thoma, the question is, how will you deal with the plausible forecast of inadequate demand, disturbingly high unemployment and low inflation bordering on deflation? That the Fed has a plan for when another fire breaks out on its drilling rig is fine, but where's the plan for capping the well that's already spewing oil into the ocean?
I think the reasons for Mr Bernanke’s reticence are twofold. First, he’s genuinely optimistic the economy will be okay, in part because he’s sanguine about the expiration of fiscal stimulus.
If it becomes clear ... that that optimism is misplaced, I think the Fed will swing into action quite quickly. ... Only a minority of FOMC members are opposed to more quantitative easing (QE), but because they’re so vocal, it gives the impression of more opposition than really exists. ...
The Fed is not helpless; it has two powerful tools left—but both are politically toxic. One is unsterilized foreign exchange intervention: buying foreign currencies with newly printed dollars... This would both stimulate net exports by pushing down the nominal value of the dollar, and alleviate deflation pressure by pushing up the price of tradable goods. ... But the Fed won't do this without the Treasury’s approval, which for its part doesn't want the rest of the world accusing it of exporting its deflation.
The other tool is a money-financed fiscal expansion..., buying newly issued bonds specifically to enable the federal government to spend more money would be a powerful boost to demand. But this needs the federal government to agree to a lot more fiscal stimulus and the Fed to set aside concerns about being the Treasury’s hand maiden. Neither looks likely.
Mr Bernanke described both those options as hypothetical in his famous 2002 speech on deflation. Eight years later, it’s apparent they are just that: hypothetical.

Posted by Mark Thoma on Saturday, July 24, 2010 at 01:17 AM in Economics, Monetary Policy | Stumble, Digg, del.icio.us, Reddit, Tweet, Share, Like | Permalink Comments (24)

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beezer said...
It doesn't appear that the problem is liquidity.

Sterilization, however, might help. Heck, we might as well join the currency manipulation game. It certainly is being widely used by some very major economic players.

Reply Saturday, July 24, 2010 at 02:38 AM

ken melvin said...
It's possible that Bernanke looks at the leaks to China and says it's a bad investment to try and stimulate the economy, that there has to be other social and economic adjustments made to compensate for the effects of offshoring and automation. Hell most of the stimulus went to China.

Reply Saturday, July 24, 2010 at 04:11 AM

john personna said...
Could the Fed buy state (California) bonds?

Reply Saturday, July 24, 2010 at 06:18 AM

Michael Cain said in reply to john personna...
A possible problem with this is that many states can issue bonds only under limited circumstances and/or for limited purposes. California is such a state, although they have been able to stretch their rules quite a bit over the last decade. In addition, the California constitution puts repayment of debt obligations very high on the priority list; if California had to choose which obligations it would default on, its bonds are not really one of the options. At some future point, the state might find itself making additional program cuts in order to pay off those bonds.

There are two things that could be done to effectively help the states, and the US Senate seems unwilling to do either: (1) direct payment of large sums of cash into state General Funds, and (2) long-term extension of much higher Medicaid reimbursement rates.

Reply Saturday, July 24, 2010 at 08:56 AM

bakho said...
The problem is not just money supply. The problem is velocity. Velocity has collapsed. The credit channels for credit to flow to those on the bottom rungs of our economy (where there is much unmet demand) have collapsed. Income has declined and will decline further with State government cutbacks. The current very stimulative Fed policy is not increasing velocity because the credit channels are broken and there is no reason for those who have excess cash to give away their money to the poor or hire workers they do not need or give loans to people who cannot repay. The one entity that can reap return on investment by giving money, jobs and credit to the bottom rungs of the economy is BigG.

No discussion of the current Fed quandary is complete without a discussion of inadequate labor and industrial policy and BigG job creation.

Reply Saturday, July 24, 2010 at 06:47 AM

bakho said in reply to bakho...
Our wealthy elites do not want to help the poor. They are too busy chasing even more financial separation from the rest of us as the next post discusses. That is why the politicians that do the bidding of the wealthy elite are opposed to UI and further stimulus.

Reply Saturday, July 24, 2010 at 06:49 AM

paine said in reply to bakho...
help the poor ???

a macro policy that puts lots of folks back on the job
hardly amounts to helping the poor

like velocity poor is a problematic word to use
for all those looking for a job these days

Reply Saturday, July 24, 2010 at 08:44 AM

Goldilocksisableachblonde said in reply to paine...
"poor is a problematic word to use"

Yes , especially for slimeball Limbaugh , who has pronunciation difficulties : " the pooer "

Still , the long-term unemployed are on the fast-track to chronic poverty if we don't do something soon.

The answer , for all of them , is universal employment at a living wage , or even at a slave wage with EITC that makes it a living wage.

It's a stain on this country's character that we haven't already done this.

Reply Saturday, July 24, 2010 at 11:53 AM

Min said in reply to bakho...
"The problem is not just money supply. The problem is velocity. Velocity has collapsed."

And that is why quantitative easing is called pushing on a string, right?

Reply Saturday, July 24, 2010 at 07:14 AM

paine said in reply to Min...
exactly

Reply Saturday, July 24, 2010 at 08:44 AM

paine said in reply to bakho...
bakho
i know i've written this b4 but why
use the word "velocity"
behind it is a completely discredited notion
you sound like a recovering monetarist

the current fedral spending level
is not "very stimulative"
it was from inception designed
to be preventative only

to stop a contraction
not restore full employment

the credit channels are not broken
some are by choice at low net out flow
others still on net inflow
they are functioning as they desire to function

and most big firms aren't borrowing
because they don't need additional funds

small firms and state and local gubmints
could really use the funds but either can't borrow (gubs)
or get turned down (many small firms)

and most households fit your tapped out verdict perfectly
often both unable and unwilling to increase their borrowings

are many outfits voluntarily paying back principal ???
i bet less then you'd think
its mostly to meet required terms

not a pretty sight any of it

and QE wouldn't modify this dynamic much at all

though i'd have the fed buy up all outstanding
treasury debt and have the gse's buy up all the mortgages
then of course i'd nationalize
the banking system
declare a debt jubilee
and
draft everyone of our banks "employees"
above the teller window level
into the peace corps
and send em all toward haiti
on rubber rafts

"don't worry logistical support
will be waitin for ya ...
when you dock at port au prince ""

Reply Saturday, July 24, 2010 at 08:42 AM

anne said...
http://www.cepr.net/index.php/blogs/beat-the-press/goldman-sachs-finds-cutting-government-spending-slows-growth-post-columnist-michael-gerson-says-opposite?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+beat_the_press+%28Beat+the+Press%29

July 24, 2010

Goldman Sachs Finds Cutting Government Spending Slows Growth, Post Columnist Michael Gerson Says Opposite

The folks who thought the housing bubble was cool are now working overtime to make the victims of its collapse suffer as much as possible. This presumably explains the reason that Washington Post columnist Michael Gerson claimed that a Goldman Sachs study of 44 countries found that a study of 44 countries found that: "reducing government expenditures by one percentage point, in contrast, increases average annual growth by 0.6 percentage points."

What the study actually found was that a one percentage point decline in government consumption expenditures was associated with a 0.63 percent increase in growth. However, it found that a one percentage point decline in government investment expenditures (spending on education, research, infrastructure etc. ) was associated with a 1.25 percent increase in growth. This would mean, for example, that a one percentage point decline in spending that was split evenly between cuts to government consumption and cuts to investment would lead to 0.31 percent decline in GDP growth.

There are reasons that this study is inapplicable to current circumstances. Most notably, the bulk of the benefit from spending cuts appears to come through the channel of lower interest rates inducing more investment. This is unlikely to be a important channel given that interest rates are already extremely low, however, even ignoring this issue, Gerson has seriously misrepresented the findings of the study that he cited.

* http://www.washingtonpost.com/wp-dyn/content/article/2010/07/22/AR2010072204028.html

** http://www2.goldmansachs.com/ideas/global-economic-outlook/limiting-the-fallout-doc.pdf

-- Dean Baker

Reply Saturday, July 24, 2010 at 07:55 AM

anne said...
I can imagine no possible action by the Federal Reserve to directly influence American foreign policy. That is not the purpose of the Fed. The Fed will intervene in foreign currency markets only if asked by the President and Secretary of the Treasury. I do wish analysts could think a little about what the Fed can and cannot do, and the Fed cannot make foreign policy nor can the Fed determine fiscal policy. Fiscal policy is made by the President and Congress and the Fed can facilitate fiscal policy but not make the policy.

Reply Saturday, July 24, 2010 at 08:03 AM

paine said in reply to anne...
anne
you sound like a school teacher reciting hall and playground rules

the fed can do anything it finds a way to do
until the congress stops it

since 1951 the fed has been playing by rules so loose it can call itself independent

it may not get to monetize new issues of treasuries directly but it can fully off set any new issuse by buying up an equivalent amount of existing issues etc

the fed can buy any currency it wants so long as there's a willing seller

of course the rmb supply is rstricted so using the purchase of rmb at sat three to the dollar won't do much but privilege a few fortunate holders of rmb
without changing the rate set by the BoC

Reply Saturday, July 24, 2010 at 09:24 AM

anne said...
http://krugman.blogs.nytimes.com/2010/07/24/monetary-and-fiscal-policy-a-clarification/

July 24, 2010

Monetary and Fiscal Policy: A Clarification
By Paul Krugman

Some readers are clearly confused about my stance on unconventional monetary policy. In some posts I have expressed skepticism about how effective the Fed can be; * in others I have called on the Fed to do more. **

But these aren’t contradictory positions.

I believe that given the grim economic situation, all players in the game should be trying to do whatever they can. There are other things the Fed can do; they would help; uncertainty about how much they would help shouldn’t be a reason not to try.

But it would be a big mistake to count on monetary policy alone. The zero lower bound on short rates really does matter, even if longer-term rates are positive. The Fed can control short-term interest rates, it can influence long rates — there’s a world of difference between those two statements. So it’s not safe to assume that the Fed can, for example, hit any target for nominal GDP that it chooses.

What that means is that while the Fed should be doing more, so should other actors: unconventional monetary policy should go along with fiscal stimulus. The Fed deserves to be chastised for not doing more; that’s not the same as saying that the Fed should be the only target of criticism.

* http://krugman.blogs.nytimes.com/2010/07/14/nobody-understands-the-liquidity-trap-wonkish/

** http://krugman.blogs.nytimes.com/2010/07/22/joe-gagnon-is-right/

Reply Saturday, July 24, 2010 at 08:08 AM

anne said...
http://krugman.blogs.nytimes.com/2010/07/14/nobody-understands-the-liquidity-trap-wonkish/

July 14, 2010

Nobody Understands the Liquidity Trap (Wonkish)
By Paul Krugman

Sigh. In an otherwise useful article about divisions in the Fed, Jon Hilsenrath says this: *

"The Fed is better equipped to solve some economic problems than others. As Mr. Bernanke noted in a now-famous 2002 speech, the Fed has the power to fight deflation—or falling wages and prices—by printing money.

"But the bank’s tools aren’t perfectly suited to reducing unemployment, which is influenced by a range of factors including fiscal policy, regulation and global demand."

Sorry, but that’s totally wrong. The question is whether, at the zero bound, the Fed has the ability to increase aggregate demand — full stop. If it can increase aggregate demand, it can fight both deflation and unemployment; if not, not.

In a way, the problem with Bernanke’s speech was that he made increasing demand and fighting deflation sound too easy. The Fed can print money, if you increase the supply of something its price will fall, end of story.

But as I tried to point out a long time ago, ** this simple story breaks down when short-term interest rates are near zero.

Here’s one way to think about it: when the Fed conducts an open-market operation, buying short-term debt with newly printed money, this normally affects the short rate because bonds and money are imperfect substitutes: money yields less, but has the advantage of being something you can use directly to make payments, that is, it’s more liquid.

But when you have bought so much debt and created so much money that rates are near zero, the public is saturated with liquidity; from that point on, they’re holding money simply as a store of value, which makes it no different from bonds — and hence a perfect substitute for bonds. And at that point further open-market operations do nothing — they just swap one zero-interest asset for another, with no effect on anything.

So why not forget about open-market operations, and just drop the stuff from helicopters? Well, remember that at this point cash and short-term bonds are equivalent. So a helicopter drop is just like a temporary lump-sum tax cut. And we would expect people to save much or most of such a tax cut — all of it, if you believe in full Ricardian equivalence.

In my simple 1998 model, there’s only one way the Fed can affect things at all: by promising, credibly, to print more money in the future, when the zero lower bound no longer binds.

In practice, things are more complicated, because long-term bonds aren’t perfect substitutes for short-term — so the Fed can get some traction by buying at longer maturities. But I always felt than Ben was overstating the effectiveness of such purchases. It’s worth noting that in his “it” speech *** Bernanke’s more-or-less specific proposal was to set a ceiling on the yield on two-year securities. How much would that accomplish now, when even the 2-year yield is only 0.67 percent?

Anyway, back to the original point: it’s depressing to realize that two years into liquidity trap economics, the Wall Street Journal still doesn’t seem to understand the basic point of why the zero bound is a problem.

* http://online.wsj.com/article/SB10001424052748703834604575365052129874156.html

** http://web.mit.edu/krugman/www/japtrap.html

*** http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021121/default.htm

Reply Saturday, July 24, 2010 at 08:08 AM

anne said...
http://krugman.blogs.nytimes.com/2010/07/22/joe-gagnon-is-right/

July 22, 2010

Joe Gagnon Is Right
By Paul Krugman

He calls on the Fed * to implement a plan based on the ideas of someone the central bank seems to have been ignoring — a macroeconomist by the name of Ben Bernanke.

We don’t know how well the Gagnon plan would actually work — but there’s no harm in trying, and large potential benefits. The only possible reason for the Fed not to be more aggressive now is fear of embarrassment, of not getting big results. And that’s no reason to sit still while the Fedfail Index keeps deteriorating.

* http://www.huffingtonpost.com/joseph-e-gagnon/time-for-a-monetary-boost_b_654944.html

Reply Saturday, July 24, 2010 at 08:10 AM

anne said...
http://economistsview.typepad.com/economistsview/2010/07/time-for-a-monetary-boost.html

July 22, 2010

First, the Fed should lower the interest rate it pays on bank reserves to zero. This is a small step, as the current rate is only 0.25 percent, but there is no reason to pay banks more than the rate paid by the closest substitute, short-term Treasury bills. Three-month Treasury bills currently yield 0.15 percent, and that rate, too, should be brought down to zero.

Second, the Fed should bring down the rates on longer-term Treasury securities by targeting the interest rate on 3-year Treasury notes at 0.25 percent and aggressively purchasing such securities whenever their yield exceeds the target. That is a 65-basis point reduction from the current rate of 0.90 percent. This step would ... reduce a wide range of private borrowing rates, encouraging business investment, supporting the housing market, and boosting exports through a weaker dollar. Moreover, pushing down yields on short- to medium-term Treasury securities is precisely the strategy for fighting deflation recommended by Ben Bernanke in 2002.

Finally, the Fed could bolster the stimulative effects of these actions by establishing a full-allotment lending facility to enable banks to borrow (with high-quality collateral) at terms of up to 24 months at a fixed interest rate of 0.25 percent....

-- Joe Gagnon

Reply Saturday, July 24, 2010 at 08:11 AM

Serious Implications said...

Regarding debt and liquidity, does Ralph Musgrave at Ralphonomics have a reasonable argument? What if the Fed prints money to buy back some of the debt?

http://printingmoneyisgood.blogspot.com/2010/07/david-blanchflower-doesnt-answer-64k.html

He says:

" The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A (than) B. Or for more deflation while buying back, apply more of B relative to A.

As the title above implies, the most common questions are or will be listed below. Additional questions welcomed. Please put them as comments at the bottom.

Abbreviations: ML = Musgrave’s Law. QE – Quantitative Easing.

_______________

1. ML will be inflationary because it involves printing money big time.

Answer. Wrong: ML has its own infinitely variable deflationary element (the “raise tax and/or reduce government spending” element) to deal with any inflation.

Secondly, there was an astronomic and unprecedented increase in the US monetary base in 2009. No inflation ensued.

Third, there is no sharp dividing line between money and non-money. The fact of increasing the monetary base does not necessarily mean that in total, the money supply has risen. Indeed, one of the causes of the credit crunch, as several economists have been repeating till they are blue in the face, is that in 2008 – 10 there was a dramatic drop in the total money supply.

The U.S. money supply fell from $14.2 trillion to $13.9 trillion in the first three months of 2010: an annual rate of contraction of $1.2 trillion.

There is more on this point in a Credit Suisse paper.

2. ML simply converts national debt to monetary base; given that the two are quite similar, does ML amount to much?

Answer: There are significant advantages in converting national debt to monetary base and having done that, having any subsequent government deficits or surpluses alter the base rather than the debt. One is that when running a deficit which is funded by increased debt, there is widespread disagreement on how much crowding out takes place. That is, uncertainty is involved. Policies that involve uncertainty are not desirable.

Indeed, if the amount of crowding out is very high, that means a huge increase in national debt is required for relatively little stimulus: hardly desirable.

Second, (to be cynical), the world at large is getting hysterical about debt, national debts in particular. If national debts can be made to disappear, or at least decline significantly, large numbers of simpletons (many of them in Congress and the U.K. House of Commons) will be much happier.

Replacing national debt with monetary base has other advantages over conventional policies. One is simplicity: it cuts out some well-paid middlemen in the world’s financial centres and for the following reasons.

Conventional stimulus consists of the following. 1. Treasury borrows $X. 2. Treasury gives $X worth of securities to lenders. 3. Treasury spends $X. Where national debt is replaced with monetary base, stage 1 and 2 become obsolete. (This simple illustration assumes that the Treasury incorporates central bank functions, of course.)

A second advantage is that the likelihood of owing money to other countries is reduced. Third, government is less in thrall to ‘bond vigilantes’ because there are fewer government bonds or none at all.

3. ML implies abolishing or vastly reducing the national debt; who else advocates or has advocated this?

Answer:

a) Milton Friedman.

b) Warren Mosler. (See 2nd last para in particular.)

c) Abba Lerner.

d) Advocates of the Monetary Reform Act in the U.S. This proposal actually combines two ideas: paying off the debt with printed money and full reserve banking. These two ideas (both of which I favour) do not actually NEED to go hand in hand.

e) Toby Baxendale of the Cobden Centre. As far as I can see, Baxendale’s proposal has similarities to the above Monetary Reform Act proposal.

Finally, for some much more detailed reasons as to why national debts are largely a nonsense, see this paper of mine.

4. Inflation in the UK as of June/July 2010 seems stuck at over 2%. In that ML involves stimulus, this isn’t the time for stimulus, is it?

Answer: ML does not necessarily involve stimulus: not if the effect of the deflationary element exceeds the effect of the stimulatory element.

Second, where ML does involve stimulus, the "inflation" criticism can also be levelled at any other stimulatory measure, thus this is not a criticism of ML as such.

ML is hopefully an improvement to the theory. Moreover, while mid 2010 in the UK may not be the time for massive stimulus, it is certainly not the time for big scale deflation and a massive increase in unemployment either. Put that another way, ML reveals some big flaws in finance ministers' thinking, both in the UK and elsewhere.

5. An expanded monetary base (i.e. more bank reserves) would enable banks to go on a wild lending spree.

Answer. This idea has hardly been born out in the last year or so. We’ve had a massive base increase, and politicians are tearing their hair out at the FAILURE of banks to lend.

Second, it is a basic principle of banking that “banks are capital constrained, not reserve constrained”. (Anyone not acquainted with the latter phrase in inverted commas, just Google it.)

An increased monetary base does not increase banks’ capital, thus it does not enable them to lend more.

6. Given that U.S. and U.K. national debts were well over 200% of GDP (over double their present levels) just after WWII and without any big problems, is there any real need to reduce national debts?

Answer. On the basis of the above 200% point obviously not. Put another way, the present clamour for debt reduction is mostly hysteria. Or to put it yet another way, beware of anyone who advocates debt reduction for the sake of it. In contrast, several good reasons are given above for reducing or abolishing national debt.

Reply Saturday, July 24, 2010 at 10:02 AM

paine said in reply to Serious Implications...
taxes are disinflationary not deflationary
use this in your musgrave gag

Reply Saturday, July 24, 2010 at 12:15 PM

Ennis W Cosby said...
Just make sure your car is in top condition !

Reply Saturday, July 24, 2010 at 02:21 PM

mrrunangun said...
Unless the demand leak is plugged, banks will have few borrowers with promising domestic opportunities to whom to lend and further fiscal stimulus will leak out to imports. In President Obama's first year, $1.5 trillion in bankster bailouts, additional tax cuts, and subsidies to state and local government had almost no effect on private employment. These measures were expected to improve the economic picture in general and employment in particular in the summer of 2010 running up to the midterm elections. The result of those policies has been to benefit only the direct recipients of those funds. Those proposing additional fiscal stimulus ought to show how the cost/benefit balance looks with and without curbing the demand leak. Historical comparisons to times when the demand leak was small have been misleading.

Reply Saturday, July 24, 2010 at 02:56 PM

Fred C. Dobbs said...
http://voices.washingtonpost.com/political-economy/2010/07/what_the_fed_wont_be_doing_to.html

What Bernanke and the Fed won't be doing to stimulate economic growth - Neil Irwin

(Thankfully, it's a pretty short list.)

Reply Saturday, July 24, 2010 at 03:18 PM

Serious Implications said...
So far, no "refutiation" of Musgrave's Law. Krugman actually lends support, as follows

"But the message of Mr. Bernanke’s 2002 speech was that there are other things the Fed can do. It can buy longer-term government debt. It can buy private-sector debt. It can try to move expectations by announcing that it will keep short-term rates low for a long time. It can raise its long-run inflation target, to help convince the private sector that borrowing is a good idea and hoarding cash a mistake."

Source:
http://www.nytimes.com/2010/07/12/opinion/12krugman.html