Sunday, August 14, 2011

Monetary Policy Stimulus at the Zero Bound is Hard...

Except when it was done in Sweden over the past few years or when it was done between 1933 and 1936 in the U.S. economy.  In both cases short-term interest rates were at 0% and almost all the other characteristics of what a New Keynesian like Matt Rognlie would call a liquidity trap were present.  Monetary policy stimulus, however, proved to be very effective in both economies.

In Sweden, monetary authorities were aggressive with quantitative easing--their central bank's balance sheet rose to 25% of the GDP versus the Fed's 15%--and had an explicit inflation target.  This was enough to push nominal spending back to its pre-crisis, long-run growth path.  FDR also used aggressive monetary stimulus--arguably the original QE program--in conjunction with a price level target to spark a robust recovery that saw real GDP growth average around 8% per annum between 1933 and 1936. And it occurred despite a massive deleveraging by an indebted household sector. Unfortunately, this recovery was cut short by a tightening of monetary and fiscal policy in 1937.

So maybe monetary policy stimulus at the zero bound really isn't that hard after all.  Maybe we have made monetary policy harder than it really needs to be.


  1. Excellent commentary.

    But, ouch, is luck against us?

    Imagine trying to tell the braying Chicken Inflation Littles and gold-fetishists that it was Sweden--the popular code word for weak socialism--that had success with NGDP and QE. Sweden!

    Why can't it be Germany or some Friedman-advised jackboots down in Chile?


    I remember a boxing promoter long ago saying, "We should've stood in bed."

    When your best punch is Sweden...

  2. Benjamin, but we keep on swinging. Or, as I mentioned in an earlier post if you are going to go down, go down swinging.

  3. Maybe our knock-out punch is Japan. Tell people their real estate and equity portfolios will go down by 80 percent in the next 20 years, and maybe carnal interests will trump ideology.

  4. Both of the cases you cite were accompanied by massive currency devaluations, which is why they worked (according to Lars Svensson, deputy governor of the Swedish central bank). That is harder to do when your currency is the world reserve currency. Still, we should keep trying ...