Zero Bound Smackdown

Paul Krugman argues in his latest column that monetary policy is out of gas because the policy interest rate has hit the zero bound. Not so says Scott Sumner, Ryan Avent, Ben Bernanke, Micheal Woodford, Gauti Eggerston et al., and Paul Krugman's alter ego. I couldn't agree more with them. Monetary policy can still meaningfully alter aggregate demand by modifying expectations. All it needs to do so is the desire. Ryan Avent makes this point well:

I am increasingly convinced that it is the commitment of a central bank to continue stimulating that is important, rather than the room that central banker has to cut rates. The determined central banker doesn't blink at 0%, he or she simply switches policy tools. And if this is right, then perpetuation of zero lower bound idea simply provides cover to central bankers who aren't willing to continue easing. That's a decision which should be justified on policy grounds, not chalked up to some imagined constraint.

An important implication of this is that the Great Nominal Spending Crash of late 2008, early 2009 could have been ameliorated had the Fed been more aggressive. And, as a result, it is likely fiscal deficits would have been far less. The bottom line is the Fed can and should be doing a better job stabilizing aggregate demand.