The Size of Monetary Stimulus vs. the Length of Monetary Stimulus
Don’t miss Tyler Cowen’s excellent post on the size versus the length of fiscal stimulus. Key passages:
For all the talk of a “large stimulus,” you don’t hear much about a “longer stimulus.”… Ideally a stimulus employs some
idle labor, stops it from depreciating, and tides those workers over
until they can look for other jobs in fundamentally better economic conditions… If conditions are not improving
soon, the ability of the stimulus to “buy time” for those workers isn’t
worth much. The workers get laid off from the government projects and
their reemployment prospects are no better than to begin with. We end
up having spent a lot of money to postpone our adjustment problems,
rather than achieving takeoff…
In those cases a well-designed stimulus program should not be so
“timely.” For a given presented expected value sum spent on stimulus,
it is better to spread it out across the years. It is better to help a
smaller set of workers for five years (or however many years it takes
for most of the deleveraging to end), after which they are reemployable
, than to temporarily boost a larger number of workers for two years,
and then leave them back in the dust…
Oddly, there is not much discussion about the length of fiscal stimulus. But there should be.
Even in a dinosaur Keynesian framework, Tyler’s dead-on. There’s a multiplier, but the entire effect of stimulus on demand – direct plus indirect – vanishes as soon as the stimulus runs out.
Question: Is this size versus length distinction relevant for monetary policy, too? The answer initially appears to be yes. After all, interest rates only stay low for as long as the Fed keeps pumping money into the system. You can either pump in lots of money quickly, or a smaller amount for gradually. The former reduces interest rates a lot for a little while; the latter reduces interest rates a little for a long while.
However, this interest rate channel for monetary policy is only one among many. The most fundamental monetary transmission mechanism: When people (including banks) have more base money than they want, they spend it. And since everyone can’t reduce his cash holdings simultaneously, nominal income has to rise until people are willing to hold all the cash that exists.
Intuitively, the equilibrium effect of a one-shot helicopter drop that doubles the money supply is to permanently double nominal income. If this leads to a stealthy, stable reduction in real wages, then output and employment go up permanently, too. Otherwise the price level doubles. Either way, there’s no reason for nominal income to recede as time goes on.
In short, if you think that boosting nominal income is the cure for recession, here’s yet another reason to prefer monetary to fiscal stimulus. One burst of expansionary monetary policy increases nominal income forever. One burst of expansionary fiscal policy increases nominal income for as long as the extra spending continues. At best.