Passing the buck
By Scott Sumner
The Fed has a legal mandate for price stability and high employment. Their mandate does not instruct them to stop trying if things get a bit difficult. It does not instruct them to pass the job on to the fiscal authorities. And yet that’s exactly what we are seeing. Here’s Greg Ip:
Research by John Williams, president of the Federal Reserve Bank of San Francisco, and Fed economist Thomas Laubach suggests the equilibrium rate could be as low as 2%, or zero when adjusted for inflation. This means the Fed may have only two percentage points of interest-rate cuts available to fight the next recession (compared with 5.25 points in 2007).
“I am worried that a very low equilibrium rate makes it harder for monetary policy to do the full job of counter-cyclical stabilization policy in downturns,” Mr. Williams said in an interview. That, he said, means fiscal policy will need to play a bigger role.
This is discouraging for many reasons. As recently as 2007, belief in liquidity traps was the sign of economist not being well informed about monetary theory. Leading macroconomists were dismissive of the idea that Japan was stuck in a liquidity trap, and blamed passive policymakers for the deflation. (Since 2013, Japan has averaged about 2% inflation, coincidently this began at the moment they adopted a 2% inflation target. So we now know that this 2007 skepticism was justified.)
But now we find Fed officials starting to claim monetary policy is ineffective at the zero bound, and needs to be augmented with fiscal stimulus. Keep in mind that:
1. Fed officials are not elected
2. Fiscal policy has enormous implications for the Federal budget.
If John Williams is correct, then the Fed plans to hold a gun to the head of Congress next time the US falls into recession. Williams is saying that the Fed will refuse to take any of the many possible steps that are well understood to solve the zero bound issue (such as level targeting) and instead plans to threaten Congress with a recession if they don’t step up and implement fiscal stimulus, which will once again cause the national debt to balloon upwards (as it did during 2008-12.)
I don’t expect anyone in the GOP to complain about this, as they seem to lack an even rudimentary knowledge of monetary economics. But they ought to be especially outraged, as they opposed the previous fiscal stimulus. On the other hand, it wouldn’t surprise me if most Republican officials also opposed monetary stimulus, and preferred a deep recession (except in the very unlikely event that they occupy the White House.)
But the Dems should also be outraged by this comment, as it makes another recession more likely, and since they occupy the White House (and are likely to continue doing so) they will be blamed for the next recession. That’s not fair, but it’s how politics works. And of course the GOP will still control the House, making it very unlikely that there will be another round of fiscal stimulus the next time we fall into recession.
I suppose we should not be surprised that the Fed has not learned much from its recent failures; the economics profession is equally behind the curve. I’ve consistently argued that the Fed follows the zeitgeist—to change the Fed we first need to educate the economics profession.
By the way, Greg Ip’s article has a nice graph showing the extent of fiscal stimulus or austerity, in terms of changes in the budget deficit. Of course 2013 was the year of Krugman’s famous “test” of market monetarism, which we passed with flying colors. Keynesians later explained away the acceleration of growth in 2013 by denying that there had been austerity in 2013. I’m glad to see that Ip does not agree with them.
I’m not sure what’s more depressing, their failure to admit they were wrong, or the fact that they now admit that while fiscal policy is their preferred policy tool, they do not even know how to ascertain the stance of fiscal policy in real time, and must wait for the results to come in before figuring out whether it was expansionary or not. (The same thing occurred in Britain.)
HT: Marcus Nunes