Monday, April 18, 2011

Ramesh Ponnuru Responds to His Critics

Ramesh Ponnuru had a thoughtful piece in the National Review where he argued that the Fed needed to do QE2.  Predictably, he was criticized for not advocating hard money, not being Austrian enough, favoring central planning, and a host of other sins.  Ponnuru patiently replies to the criticisms:
Looser monetary policy hurts savers. That’s often true. But when the federal government is holding the supply of money below the demand for money balances, expanding that supply can raise the long-term return on savings by stimulating economic growth.

I ignored Hayek and am unfamiliar with the Austrian School. Actually, I came to my views through Austrianism. Read Josh Hendrickson for an explanation of why the view that we have been in a monetary disequilibrium caused by excessively tight money “is consistent with Austrian business cycle theory.”

Official statistics underestimate inflation. We don’t need to rely on official statistics. We can look to prices to see the market’s expectations for inflation. TIPS spreads suggest that the market sees annual inflation averaging below 2 percent for the next decade.

Rising commodity prices signal a dangerous increase in inflation. Other factors affect commodity prices, such as rising Asian demand. Those factors don’t influence TIPS spreads, which are thus a better market indicator.

I support central planning of money, which cannot possibly work. I will plead guilty to thinking that, to the extent we have central planning of money, we should make it work as well as it can. But I think we could and should radically reduce the discretionary power of central banks by tying them to a market rule, as Scott Sumner has proposed.

“[M]onetary policy has no medium- or long-term effect on real economic growth.” If a central bank is holding the supply of money below the demand for money balances, though, an expansion of that supply can increase real growth in the short run, and it can do so without negative long-term effects.

“[V]elocity has been down because the demand for money has been tamped down by all the uncertainty around Obama’s policies.” Probably so, although that’s not the only reason. Whatever the causes, a decline in velocity is an increase in money demand that the money supplier should accommodate. Listen to the market rather than second-guess it.

“[You make no] mention of the Fed’s purported reasoning for QE– i.e reduce long-term rates to help the US housing market and improve US homeowner balance sheets . . . . [L]ong-term/mortgage rates are up since QE especially QEII– so if that was the real reason, QE has been [an] epic fail.” As I mentioned in the article, several arguments of varying plausibility were made for QE2. The better argument for it hoped it would increase expectations of economic growth and thus long-term interest rates.

I would encourage his critics to wrestle with the figure in this post.   It demonstrates many of the points Ponnuru makes in his article.

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