Tuesday, October 18, 2011

more more stimulus!

chicago fed president charles evans just blew my mind:

I largely agree with economists such as Paul Krugman, Mike Woodford and others who see the economy as being in a liquidity trap: Short-term nominal interest rates are stuck near zero, even while desired saving still exceeds desired investment. This situation is the natural result of the abundance of caution exercised by many households and businesses that still worry that they have inadequate buffers of assets to cushion against unexpected shocks. Such caution holds back spending below the levels of our productive capacity. For example, I regularly hear from business contacts that they do not want to risk hiring new workers until they actually see an uptick in demand for their products. Most businesses do not appear to be cutting back further at the moment, but they would rather sit on cash than take the risk of further expansion.

Rather than fighting the inflation ghosts of the 1970s, I am more worried about repeating the mistakes of the 1930s. As in the 1930s, today we see a lack of demand for loans and a resistance of lenders to take on risk — factors that mean the high level of bank reserves is not finding its way into broader money measures. As in the 1930s, today’s low Treasury interest rates in good part reflect elevated demand for low-risk assets — we see investors run to U.S. Treasury markets every time they hear any bad economic news from anywhere in the world. Consider another metric for interest rates, the well-known Taylor Rule, which captures how monetary policy typically adjusts to output gaps and deviations in inflation from target. Its prescriptions would call for the federal funds rates to be something like –3.6 percent now, well below the zero lower bound the funds rate is currently stuck at. Our large-scale asset purchases have provided additional stimulus, but by most estimates not enough to bring us down to the Taylor Rule prescriptions. Also, I should note that in 1998, Friedman gave a similar recommendation to the Japanese, advocating that the Bank of Japan undertake more accommodation by buying government bonds on the open market.

I believe that we can substantially ease the public’s concern that monetary policy will become restrictive in the near to medium term and, hence, reduce the restraint in expanding economic activity. This can be done by clearly spelling out in our policy statements the conditionality of our dual mandate responsibilities. What should such a statement look like? I think we should consider committing to keep short-term rates at zero until either the unemployment rate goes below 7 percent or the outlook for inflation over the medium term goes above 3 percent. Such policies should enable us to make progress toward our mandated goals. But if this progress is too slow, then we should move forward with increased purchases of longer-term securities. We might even consider a regime in which we reevaluate our progress toward our policy goals and the rate of purchase of such assets at every FOMC meeting.

I would also highlight that while I believe that optimal policy would be consistent with inflation running above our 2 percent target for some time, this policy does not abandon the 2 percent target for long-run inflation. Indeed, I would support combining this policy with a formal statement of 2 percent as our longer-run inflation target in conjunction with reaffirming our commitment to flexible inflation-targeting. Furthermore, I see a 3 percent inflation threshold as a safeguard against inflation running too high for too long and thus unhinging longer-run inflation expectations. It also is a safeguard against the kinds of policy errors we made in the 1970s. If potential output is indeed lower and the natural rate of unemployment higher than I currently think, then resource pressures would emerge and actual inflation and the outlook for inflation over the medium term would rise faster than expected. If this outlook for inflation hit 3 percent before the unemployment rate falls to 7 percent, then we would begin to tighten policy.

I understand that some may find such a policy proposal to be hard to understand, or even risky. But these are not ordinary times — we are in the aftermath of a financial crisis with massive output gaps, with stubborn debt overhangs and high degrees of household and business caution that are weighing on economic activity. As Ken Rogoff wrote in a recent piece in the Financial Times, “Any inflation above 2 percent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures.” The Fed has done a good deal of thinking out of the box over the past four years. I think it is time to do some more.

ya mon, i couldn't agree more. until now, i thought that maybe i was the only person in the world that supported radical amounts of further fed intervention, but at a time when politics are paralyzed, the fed is not. by my measure, operation twist has been both economically effective and a giant fuck you to the republicans. i'm happy about both, now let's do it again.

the timing of operation twist was just too perfect. it came so soon after the republican no-more-stimulus letter that the letter might as well've been marked return to sender. but there were clues... bernanke tipped his hand in jackson hole, and while my language wouldn't be quite so careful, again, i couldn't agree more.

Fiscal policymakers can also promote stronger economic performance through the design of tax policies and spending programs. To the fullest extent possible, our nation's tax and spending policies should increase incentives to work and to save, encourage investments in the skills of our workforce, stimulate private capital formation, promote research and development, and provide necessary public infrastructure. We cannot expect our economy to grow its way out of our fiscal imbalances, but a more productive economy will ease the tradeoffs that we face. -bernanke

at a time when it seems like the whole universe is anti-fed no matter what, fed credibility is a funny justification for further fed stimulus. central banking is a dismal science people would normally rather not be bothered with, but right now it's center stage and everyone's a critic. i would actually argue that the further fed stimulus evans and i both hope for would actually damage fed credibility in the short-term, but fed credibility and protests be damned. i just want to see the economy recover.

(personal opinions, not the fed's. they make me say that.)