Saturday, March 13, 2010

Assorted Musings

Here are a few musings:
1. Reflationists receive a smackdown over at Naked Capitalism. There the guest blogger Washington takes to task all those observers who claim we can inflate our way out of the debt crisis. He notes that any inflation benefit will be offset by problems from higher interest rates and creditors fleeing the United States. I am not sure the reflationists of the world ever claimed we should (or even could) eliminate all of our debt problems with inflation, only that we could lighten the real debt burden enough to allow for faster economic recovery. The slightly higher inflation could also be part of a plan that would do more than just lower real debt burdens. It would also increase inflationary expectations--if the higher inflation were perceived to be permanent--and thereby increase current spending.

2. Speaking of smackdowns, George Selgin provides one to the central banks of the world. He argues central banks by default tend to create financial instability:
The present financial crisis shows how central banks can fuel the financial booms that make severe busts possible. Unfortunately, theoretical discussions of central banking badly neglect its role in fostering financial instability, in part because they ignore its history and political origins.
If you find this topic interesting see his talk last year at the CATO monetary policy conference.

3. Further evidence from Marco Del Negro, Gauti Eggertson, Andrea Ferrero, and Nobuhiro Kiyotaki that monetary policy does not run out of ammunition once the policy interest rate hits the lower zero bound:
This paper extends the model in Kiyotaki and Moore (2008) to include nominal wage and price frictions and explicitly incorporates the zero bound on the short-termnominal interest rate. We subject this model to a shock which arguably captures the 2008 US financial crisis. Within this framework we ask: Once interest rate cuts are no longer feasible due to the zero bound, what are the effects of non-standard open market operations in which the government exchanges liquid government liabilities for illiquid private assets? We find that the effect of this non-standard monetary policy can be large at zero nominal interest rates. We show model simulations in which these policy interventions prevented a repeat of the Great Depression in 2008-2009.
The authors conclude, then, that the Fed can have meaningful influence on the economy even when short-term interest rates are at zero percent. If so, then why did not the Fed do more in late 2008 and early 2009 to prevent The Great Nominal Spending Crash?

1 comment:

  1. David,

    The paper you cite seems to deal with illiquidity as opposed to aggregate demand. In other words, the Fed's unconventional policy saved us from a "fire-sale" driven collapse, and, as a result, Aggregate Demand is higher than it otherwise would have been. This, however, is different than concluding that unconventional policy stimulates growth in aggregate demand. The bulk of the Fed's MBS asset purchases occurred after the liquidity crisis had passed, and they arguably had zero impact on credit growth.

    Maybe its the case that in the absence of expectations setting, unconventional policy has little impact on stimulating AD. If so, one wonders why Bernanke is hesitant to commit to future nominal spending or inflation targets. I suspect his hesitation has to do with the concept of "by any means necessary". My sense is that this concept introduces a high degree of career and reputation risk to an office-holder and his institution, and they therefore logically resist adopting it. It seems that Sumner and others get around this issue by arguing, "the more you commit, the less you have to do, so in the end 'by any means' is just effective signaling, not something you actually have to resort to." However, it is one thing to conclude this as an observer, and another to take the risk as an officeholder.