John Taylor vs. Ryan Avent
By Arnold Kling
The Fed has effectively replaced large segments of the market with itself–it bought 77% of new federal debt in 2011. By doing so, it creates great uncertainty about the impact of its actions on inflation, the dollar and the economy. The very existence of quantitative easing as a policy tool creates uncertainty and volatility, as traders speculate on whether and when the Fed is going to intervene again. It’s bad for the U.S. stock market, which is supposed to reflect the earnings of corporations.
One of my favorite scenes from “the Bernank” was when it described how the Treasury, rather than selling bonds directly to the Fed, first sold them to “the Goldman Sachs” which then sold them to the Fed. It does seem like an unnecessary step, particularly now.
There is no overstating Japan’s economic disaster. Its real income per capita rose to 90% of America’s in the early 1990s, but has since fallen back to 70% of the current American level. This failure has inspired many idiosyncratic explanations: demography, a zombie banking system, a corrupt political class, and so on. But idiosyncratic explanations look much less compelling now, with the rich world’s large economies following on Japan’s heels.
Pointer from Mark Thoma. Read the whole thing. Actually, I had to check twice to make sure that the piece was not written by Scott Sumner. The Sumner-Avent view is that we should try monetary expansion. John Taylor’s view is that we should not.
I think that a necessary condition for taking Taylor’s side is a belief that much of the unemployment these days is structural. I take that view.
I was not persuaded by Avent’s argument concerning Japan. I do not find it implausible that Japan suffered structural problems that in some ways presaged ours. Japan had a property bubble; we then had a property bubble; Japan probably felt keenly the factor-price equalization effects of China’s rise before we did. Overall, in my view, the duration of Japan’s malady is hard to reconcile with a purely macroeconomic diagnosis.
On the other hand, a sufficient condition for taking Taylor’s position is a view that, other things equal, more monetary expansion will lead to more inflation. I do not take that view, because I believe that inflation in the United States ultimately is going to be driven by fiscal policy. Taking the fiscal path as given, we might be better off monetizing sooner rather than later. Especially if Sumner-Avent turns out to be correct on the macro side.
It would be much better if the Fed were buying less debt. But the inflationary threat, in my view, is the amount of debt being issued. What worries me is not the debt that the Fed buys today, but the debt that the Fed will be forced to buy in the future, even if inflation picks up. Eventually, the government is going to find a way to default, and high inflation is one way to do it.
One side note is that some folks argue that the low interest rate on government debt is a sign that the government should issue more of it. This argument might be more persuasive to me if the Fed were buying a much smaller share. But the fact that the Fed is buying most of it says that (a) the markets do not necessarily agree with the low interest rate and (b) that as taxpayers we are not really benefiting from the low interest rate, since we are buying back (via the Fed) most of what we are issuing.