Friday, August 7, 2009

Unconventional Monetary Policy Works After All

Scott Sumner alerts us to the fact that unconventional monetary policy is working in Great Britain and notes that had the United States followed suit there would have been far less need for a major fiscal stimulus package here. He points out that even Paul Krugman, who argued for a large fiscal policy because monetary policy was allegedly tapped out, is admitting as much. Here is Sumner:
A few months ago I got into a series of arguments with some old-styleKeynesians who kept insisting that monetary policy is ineffective once nominal rates hit zero. “Period. End of story.” I kept trying to explain that unconventional monetary policy could still be highly effective; the problem was that we needed to be much more aggressive. I pointed to FDR’s currency devaluation in1933 as an example of how an aggressive monetary policy could boost NGDP rapidly, even with interest rates near zero and much of the banking system shut down for months.

Finally my views are getting some respect.... and now there is this post from the Time’s Nobel Prize winning columnist:
Two months ago I wrote that there were hints of a relatively quick economic turnaround in Britain. Now those hints have gotten much stronger. Basically, aggressive monetary policy and the depreciation of the pound are giving Britain a boost relative to other advanced countries.
If only the US had followed a similar course, instead of relying almost completely on costly fiscal expansion, which has only a modest impact on the path of NGDP over time. Still, it’s not too late for US to learn some lessons from the Brits.
Yes, we should have been more aggressive with monetary policy last year and less reliant on fiscal policy. For a primer on how unconventional monetary policy can be effective even when there is a liquidity trap see this piece from the BIS or this article from the NY Times. For empirical evidence that the Fed could have done more last year rather than sitting by and letting monetary policy effectively tighten see here.


  1. Although of course, Britain already has a much greater ongoing long-term "fiscal package" in the form of larger state share of the economy, greater unemployment compensation/welfare state acting as an automatic stabilizer. Nor is it constrained by federalism.

  2. May I add that the UK is extremely leveraged to the world of finance, so the worldwide stimulus to help the banks has been a massive indirect stimulus to the UK (a point I seldom see mentioned)...

  3. aren't many of the Fed's "unconventional" policies actually more fiscal in nature.....?