The Corner

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The Washington Post vs. Sound Monetary Policy


Today’s Washington Post op-ed page includes a double dose of misguided analysis and advice for the Fed.

Let’s start with the editorial.

By buying $600 billion worth of Treasury bonds, [QEII] prevented deflation from taking hold but did not manage to kick off a self-sustaining growth cycle. QEII helped drive up stock prices as anticipated; that, in turn, created a “wealth effect” that might have persuaded some asset owners to spend more on consumer goods. But the stock market has fallen back to pre-QEII levels now that the program is over.

A lot of factors other than monetary policy affect the level of the stock market. We have received a lot of bad economic news over the last year, much of it not even arguably connected to expansive monetary policy. The thesis the Post needs to refute to advance its argument is that the market would have fallen without QE2. Counterfactual cases are notoriously hard to prove, but the Post doesn’t even try and instead issues a non sequitur.

Meanwhile, the core rate of inflation (price increases excluding food and energy costs) has crept up to within striking distance of the Fed’s 2 percent target. Printing more money might push it above that, unleashing dangerous inflationary expectations.

The point of an inflation target is to anchor long-term inflation expectations and make long-range planning possible. Someone who makes a transaction in year X ought to have a rough idea how much money will be worth in year X+10. But if that’s the goal, then if you overshoot the inflation target one year you need to undershoot it an equivalent amount the next — and vice-versa. Since we’ve had below 2 percent inflation we’d need catch-up inflation to maintain the target. (Now I myself prefer a nominal spending, nominal income, or nominal wage target. My point here is that the Post’s argument doesn’t make sense on its own terms.)

The fact is that cash is not exactly scarce — corporations and banks are awash in it. They just don’t see many profitable opportunities for deploying their money. . .

It’s a mistake to look at money supply without looking at money demand as well. And “profitable opportunities” don’t present themselves as frequently as they should when a) there’s a monetary disequilibrium caused by excess money-balance demand and b) there is vast uncertainty about the future path of nominal GDP.

And given the huge overhang of U.S. consumer and government debt, Europe’s problems, and continuing instability in the Middle East, it may take time for rapid growth to resume.

Might higher nominal incomes have some effect on the ability to pay that debt?

On to Robert Samuelson.

A deliberate policy of higher inflation risks compounding the uncertainty and poisoning psychology even more.

If the Fed were to announce and follow a nominal GDP target, it would probably have the short-run effect of higher inflation. But it ought to reduce uncertainty. For that matter, an announcement that the Fed is trying to maintain an inflation target that corrects for overshooting and undershooting ought to have the same effect.

That’s what happened in the 1960s and 1970s. Economists argued that modest increases in inflation (say, to 4 percent or 5 percent) would reduce unemployment. . . . But inflation wasn’t kept under control.

All the more reason to announce a rule and stick to it. Also, we have a market indicator of future inflation expectations we didn’t have in the 1960s and 1970s: the spread between inflation-indexed and non-indexed bonds. The Fed can tighten if it jumps too high (if it’s maintaining an inflation or price-level target).

[H]igher inflation represents a wealth transfer to debtors (who repay in cheaper dollars) from creditors (who receive cheaper dollars).

Only if it’s higher than the participants to the transaction expected when they made it. Otherwise it has been factored into the terms of the transaction.

The Fed has kept money too tight from 2008 onward, and it has been too ad hoc in its approach. It ought to commit to a rule that constrains its actions and keeps supply and demand in equilibrium as much as possible.