The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

The Fed’s Gas Pedal


On Saturday, Mike Konczal argued that the Evans Rule — under which the Federal Reserve has committed itself to purchasing $85 billion in assets per month as long as unemployment levels exceed 6.5 percent and the inflation rate is below 2.5 percent (AKA QE3) – offers a perfect test case of whether or not “market monetarists” are right to believe that monetary expansion can offset fiscal consolidation, in light of recent tax increases and spending reductions. Several market monetarists and fellow travelers, including Scott Sumner, David Beckworth, and the market monetarish Matt Yglesias, have replied to Konczal and Paul Krugman, who endorsed the Konczal thesis. I particularly enjoyed Beckworth’s post, and not just because he is an occasional co-author of National Review’s Ramesh Ponnuru:

QE3, then, is like taking a road trip and applying the same pressure to the gas pedal regardless of whether one is driving up a hill, down a hill, or on a flat terrain. The trip’s length would depend on the changing terrain of the road (the shocks) and would be hard to know ahead of time even though you know your trip’s destination (the target). This is better than taking a QE2 road trip, where you don’t know your destination, but there is still much uncertainty about how long the QE3 trip will take. Now imagine you turn on cruise control at 70 MPH so that your car automatically adjusts the amount of gas based on the terrain. There would be much more certainty about the trip and much better expectations management. This would be much closer to a NGDPLT and provide the real test of whether monetary policy can offset fiscal austerity. It could be operationalized by conditionalizing the size of the QE3 asset purchases each month so that constant progress to the Fed’s targets were being maintained. QE3, therefore, is farm from ideal and, as Matt O’Brien observes, it is not even clear the Fed is fully on board with it.

Beckworth, like Sumner and Yglesias, emphasizes that the Fed does appear to have counteracted the effects of fiscal consolidation — it just happens that the tool it is using is very crude relative to NGDPLT, and is thus unlikely to yield a sufficiently strong result. 


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