Megan McArdle's Plea to Monetary Policy Critics
There is no such thing as a perfect Fed; it’s always going to err on one side or another. You said you wanted a Fed that didn’t err on the loose side; now you have it. This is what that looks like.
My view of the Fed is as as follows.
1. I don’t think that the Fed can fine tune the economy. I think that, at most, it can toggle between two regimes: a regime where inflation is high and variable; and a regime where inflation is low and stable.
2. I am not at all sure that (1) is the correct view of things. My views are certainly not mainstream. In case something closer to mainstream theory is correct, in which case expansionary policy might reduce unemployment, I would like to see the Fed try an expansionary policy now.
3. I think that the main effect of the Fed’s “non-traditional policies” of the past two years has been to transfer wealth from ordinary citizens to bank shareholders and executives. I do not think that the bailouts undertaken by the Fed and the Treasury helped the overall economy. I think that the message of the markets to the financial sector in 2008 was, “Shrink!” The Fed has been doing its best to fight against that message, in part because of institutional bias in favor of big banks, and in part because of a misguided analogy with the 1930’s, when the demise of banks hurt the economy. This is not 1932. In 1932, the banking sector shrank too much. In 2009, it shrank too little.
So, in the end, I do not blame Greenspan for the housing bubble. I don’t buy into the argument that we had a housing bubble because Greenspan messed up the Taylor rule.
Nor do I blame Bernanke for the weak economy today. I think that there is a good chance that, even if the Fed tried to do something, they would fail. I am not convinced that toggling to the high-and-variable inflation regime would reduce unemployment.
What I blame Bernanke for is carrying out and supporting the bailouts. I hate the bailouts.
Incidentally, I was quite surprised to see Scott Sumner’s answer in the comments to this post on a question of monetary theory. One of my three questions asked how the Fed could lower the long-term interest rate from 2.6 percent to 2.5 percent, and he responded,
If forced to come down one way or another, I’d say higher 10 year yields are bullish, so if the goal was lower 10 year yields, I’d tighten monetary policy and cross my fingers.
My bet is that Paul Krugman would give the opposite answer. So even two economists who agree that they would like to see the Fed do more to boost the economy might not agree on the mechanism by which open market operations affect long-term interest rates.