Recommendations for Economic Policy

An exchange I had last week with Econbrowser reader (and world-renowned scholar) Simon van Norden may be of interest to broader readers, so I lift it here from the comments:

Simon asked:

Under the current economic circumstances, what mix of fiscal and monetary policy do you think would be desirable?

And here’s the best answer I could come up with:

You ask an interesting hypothetical question, which I construe to be, if there were no constraints of political feasibility, what should the U.S. do? Although I think this question is worthy, I have trouble finding traction to analyze it. As far as monetary policy is concerned, the most fundamental ingredient is what the public expects to happen in the future– managing those expectations is the basic tool that the Fed could rely on in this situation. Given the way the Fed’s opponents have been reacting, I see no way the Fed could effectively approach this other than what I lay out above— namely, the Fed will have to wait for more convincing evidence of deflation or financial freeze-up before acting. But if you’ll let me wave a magic wand to dispense with that complication, the answer is easy– the Fed should credibly announce a 2.5% inflation target over the next 5 years.

As for fiscal policy, I’d give a similar answer. I see a dysfunctional political process and serious long-run debt management issues. I worry that the current actions of both the Fed and any fiscal stimulus could interact negatively with that for simple issues such as the logistics of weekly Treasury auctions and containing fears that are currently bouncing around Europe like a ping-pong ball. Again, if you give me a magic wand to dispense with all this, what I’d call for is a clear political consensus as to when and how the long-run debt problem is going to be controlled, and given that, I would favor a carefully targeted and explicitly temporary fiscal stimulus.

Given the lack of such wands, what I have instead proposed is that the President focus on the modest tools for job creation that are at his immediate disposal. Alas, this too seems too much to hope for.

This post originally appeared at Econbrowser and is reproduced here with permission.