Two articles on Fed policy
By Scott Sumner
Just today, I have two new articles on monetary policy. At The Hill, I argue that monetary policy has been too slow in adjusting to changing circumstances, and too reluctant to reverse previous decisions:
Given modern technology, there is no reason why the Fed can’t adjust its settings far more frequently. FOMC members could, for example, email their preferred interest rate target to Chairman Powell each business day, and the actual Fed target could be set at the median vote.
Instead of quarter-point increments, FOMC members could select an interest rate target to the nearest “basis point”—which is 1/100th of 1 percent. Daily movements would look more like a financial asset price, moving up and down each day in a sort of “random walk” as new information about the economy comes in.
If that regime had been in place in early 2016, the Fed could have reversed its previous rate increase without suffering any embarrassment once it become clear that monetary policy had been set too tight. The job market would have healed at a faster rate, and inflation would have returned to the 2 percent target more quickly.
Read the whole thing. At Mercatus, I have a new paper explaining QE, which is aimed at policymakers, journalists and others interested in monetary policy. This is from the introduction:
QE policies were implemented in the United States in the aftermath of the 2008 financial crisis, a period dubbed the Great Recession. At that time, many pundits wrongly predicted that these policies would lead to much higher inflation. Their mistake was confusing one type of QE, inflationary QE, which has infamously plunged many countries into extremely high inflation, and the other type, defensive QE, which is generally not highly inflationary.
With the first type of QE, when nominal interest rates are positive and the central bank does not pay any interest on bank reserves, large purchases of assets amount to large injections of cash into the economy. Under these conditions, the public tries to get rid of these excess cash balances as quickly as if they were holding a hot potato. The act of spending excess cash balances pushes up aggregate demand. In some cases, the expanding demand will far outrun the growth in production, pushing inflation sharply higher. In fact, this sort of QE has historically led to hyperinflation. Germany in the early 1920s, and Zimbabwe and Venezuela in more recent years are good examples of what I call “inflationary QE.”
The second type is what I call “defensive QE.” When nominal interest rates are close to zero, base money and safe assets such as Treasury bills can become very close substitutes. Under these conditions, banks are willing to hold large quantities of excess reserves, beyond the reserve requirement. Because the “hot potato effect” is no longer operative, these monetary injections typically do not lead to dramatically higher inflation.
I also wanted to follow up on my recent post on the strange durability of neoliberalism. Do you recall when Syriza won the Greek elections back in 2015. The party was seen as far to the left of Greece’s Socialist Party. They were resolutely heterodox, and rejected the consensus policy views of the EU. Here’s how the Financial Times describes the party today:
But the risks involved in the break-up of the single currency are likely to remain a powerful constraint on the radicalism of the populists. The EU retains a remarkable ability to turn outsiders into members of the club. Witness the transformation of Alexis Tsipras, the prime minister of Greece, who in three years has changed from socialist firebrand to smooth-talking, tax-cutting, European federalist.