The Too-Narrow Monetary Policy Debate

As the Obama administration deliberates over who will succeed Ben Bernanke as Fed chair, there has been a steady crumbeat of criticism against Larry Summers, the former NEC chair and Treasury secretary who is perhaps the most distinguished, and controversial, Democratic economic policymaker of his generation. A bloc of Democratic senators has voiced its opposition to Summers in a letter to the White House, and leading members of the left-liberal intelligentsia has been sharpening their knives. Ezra Klein, among others, has raised the specter of sexism, the argument being that Janet Yellen, a highly-regarded academic economist who currently serves as vice chair of the Fed, has lost ground to Summers in part because she is a woman. The battlelines have been drawn under the assumption that while Yellen is closely aligned with Bernanke in her support for the Evans Rule and the successive rounds of quantitative easing, Summers is more skeptical. Wonkbook quotes Robin Harding of the Financial Times:

“Lawrence Summers made dismissive remarks about the effectiveness of quantitative easing at a conference in April, raising the possibility of a big shift in US monetary policy if he becomes chairman of the Federal Reserve. “QE in my view is less efficacious for the real economy than most people suppose,” said Mr Summers according to an official summary of his remarks at a conference organised in Santa Monica by Drobny Global, obtained by the Financial Times.”

To champions of quantitative easing, these are fighting words. Scott Sumner, a leading advocate of nominal output targeting, is among those who’ve been very critical of Summers. Matt Yglesias juxtaposes Summers’ skepticism about monetary stimulus, which Summers believes will lead private firms to undertake costly, inefficient boondoggles, and his enthusiasm for fiscal stimulus, which suggests a perhaps misplaced belief that the public sector is better about making decisions about long-term investments than the private sector. It’s a smart critique, and it does seem as though the extent of anti-Summers sentiment has undermined the former Treasury secretary’s prospects.

What I find interesting, however, is that there is a neglected position in our monetary policy debates, which is that we may well need inflation as part of a broader strategy of accelerating deleveraging and returning to full employment, but that quantitative easing is not the best way to achieve this goal. I associate this view with Ashwin Parameswaran:

[U]nlike most Fed critics who tend to be conventional “austerians”, I’m a strong critic of asset-price based monetary policy and an equally strong advocate for combined monetary-fiscal stimulus in the form of direct cash transfers to households. I support helicopter drops not just because it is fairer and more “neutral” in its impact on income distribution than quantitative easing. I support helicopter drops because it is the parachute that prevents the hard landing if we stop quantitative easing. I support helicopter drops because it is the most free-market of all macro-stabilisation policies. Rather than bailing out banks and firms and propping up asset prices, helicopter drops simply mitigate the consequences of macroeconomic volatility upon the people. I support helicopter drops because it helps us build a resilient economic system as opposed to chasing the utopian aim of perfect macroeconomic stability. [Emphasis added]

As Ashwin explains, however, central banks are worrying of helicopter drops for several reasons:

1. If the central bank simply prints money out of thin air and credits it to the people, then it suffers a loss. If the helicopter drop is sufficiently large, then the central bank may even become technically insolvent. Although this has very few technical implications for the functioning of a central bank, the political implications are significant. Opponents of the stimulus will latch on to the losses as a sign of monetary irresponsibility. The political implications and fear of loss of central banking independence may even have a negative impact on the economy. Understandably, central banks prefer to avoid such a situation. By buying financial assets, central bank governors can at least postpone losses for long enough that it becomes the next governor’s headache.

2. If the helicopter drop is financed by a bond issuance by the government, then many market participants fear that the government debt will increase to unsustainable levels that cannot be paid back.

3. If the helicopter drop is financed by a bond issued by the government and bought by the central bank, then some commentators fear that we will have crossed the rubicon into the dangerous world of monetised fiscal deficits.

And so he suggests that a helicopter drop be financed in the following manner:

The helicopter drop should be financed by a perpetual bond issued by the government and bought by the central bank. The perpetual bond pays an overnight floating interest rate equivalent to the Federal Funds rate.

Two conflicting potential dangers arise, the first of which is that governments might grow addicted to this form of fiscal-monetary stimulus and the second of which is that despite the perpetual nature of the bond, this proposal will raise the federal debt, leaving it vulnerable to the debt limit. Rajiv Sethi thus offers a modified proposal for the United States:

I would prefer the following: (i) create an account at the Fed for every US citizen with a valid social security number, including minors, (ii) stop transferring profits on Fed assets directly to the Treasury, (iii) credit all accounts in equal measure to dissipate all profits, (iv) restrict withdrawals from these accounts to tighten monetary policy, and remove restrictions to ease, (v) continue open market operations as necessary, especially in a liquidity crisis, lending at high rates against good collateral to solvent institutions in accordance with the Bagehot rule.

This last policy should result in windfall gains after a crisis. The direct transfers to account holders will boost aggregate demand when most needed.

Suffice it to say, this kind of thinking is well outside the economic policy mainstream. But it is a reminder that skepticism about the virtues of QE as practiced by the Fed doesn’t necessarily translate into opposition to fiscal-monetary stimulus. 

P.S. One political virtue of Ashwin’s approach is that while QE raises the specter of inflation, helicopter drops in the form of direct cash transfers are likely to be prove very politically popular. And unlike more targeted efforts like mortgage modifications, it’s hard to see how universal direct cash transfers create perverse incentives for individuals (as opposed to governments). 

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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