Hummel on Fed
By David Henderson
Monetary economist Jeff Hummel has posted today a detailed exposition of recent Fed policy. The two most interesting things to me are:
(1) The money supply is increasing. This fact undercuts one part of the “monetary policy is impotent” view of “ultra-Keynesians” (what a great term) like Krugman. In other words, the money supply is increasing in response to the increase in the monetary base. Of course, we still need to be concerned about a decline in velocity and so Krugman’s “monetary policy is impotent” view could still hold if the velocity falls by the same percent as the money supply increases. I’m not sure what’s happened to velocity, although the decline in real GDP combined with zero or negative growth in prices do imply an even bigger fall in velocity than the increase in money supply. (Remember the most important equation in macroeconomics, the one that was on the late Milton Friedman’s license plate: MV = Py.) So Krugman could be right, at least about the last few months.
(2) The Fed moved ahead with its plan to pay interest on reserves, a policy that makes monetary policy less potent, at the same time that it needs monetary policy to be most potent.
I hasten to add, in case Bob Murphy is reading, that I’m not advocating that we have a Fed. But since we have one, I would much rather have it increase the money supply than have bailouts and huge increases in unjust and wasteful government spending. And just as the Fed could have prevented the Great Depression by acting as lender of last resort, I would like the Fed to do so this time and then, when we’re on the other side of this recession, be abolished.
We know that the shift to paying interest on reserves has been in the works for a while. My speculation, given what I know about bureaucracies, especially government ones, is that some Fed employees were tasked to do this, Bernanke was busy with the crisis, and so things are proceeding without Bernanke having had much recent input into the decision. This is a problem with central planning.