Here is a guest post from Johns Hopkins University Professor Jonathan Wright, in which he proposes an option for economic stimulus by the Federal Reserve.
Following the Swiss Lead
by Jonathan Wright
On Tuesday, the Swiss National Bank (SNB) adopted a bold policy of pledging to sell Swiss Francs in an unlimited amount to ensure that the exchange rate viz-a-viz the euro is at least 1.2 Swiss Francs per euro. The exchange rate promptly jumped over 8 percent to a bit more than 1.2 Swiss Francs per euro. The SNB can clearly weaken its currency in this way, so long as its commitment is unwavering. The SNB did so, judging that this is the best available way of meeting its underlying macroeconomic objectives. Indeed, the SNB may not actually have to intervene heavily. It’s a nice case study in the power of credible commitment and rational expectations.The Fed could decide to do something similar at the next FOMC meeting, except with Treasury securities rather than the exchange rate. Concretely, the Fed could commit to buying any Treasury security with a maturity date in or before 2016 at a yield of (say) 25 basis points. The commitment would remain until the securities matured. This would reinforce and extend the existing commitment to keeping short rates low and would be a failsafe version of quantitative easing. It would be different from QE1 and QE2 in pegging a price, not a quantity. This strategy would be very likely to lower rates on other assets that are close substitutes. Fiscal policy would be a better tool, but of course that is not in the Fed’s domain. At this point, directly targeting longer-term interest rates is the most promising course for boosting demand available to the Fed (except perhaps for raising the short-run inflation target).
This post originally appeared at Econbrowser and is reproduced here with permission.