Can the Fed Really Do More?

I’ve grown increasingly frustrated by the near universal cry for more action from the Fed.  My friend and fellow blogger Marshall Auerback has quipped that it’s as if every mainstream progressive received the same White House memo.  I imagine it looked something like this:


To:         Mainstream Media (TV, Radio, Print Media)
From:    Office of the White House
Date:     June 10, 2012
Re:         Messaging on the Recovery

The economic recovery is faltering.  The fiscal cliff is nearing.  Many nations have already fallen back into recession.  The net worth of a typical American family is down almost 40 percent since the start of the crisis. Unemployment is rising. People are worried about keeping their jobs,  holding onto their homes and paying down the enormous debts they accumulated over the last decade or more.  The bloodletting at the state and local government level continues unabated, and this is compounding our economic problems.  Consumer confidence is down, and small businesses are struggling to remain profitable.

Some of you have written about the mistakes of our past, pointing out the trauma that was inflicted in 1937, when FDR decided it was time to move toward a balanced budget.  Please stop that.  This is an election year, and I cannot afford to be viewed as soft on the deficit.  Besides, Congress will not support anything I put forward, so we’ve got to enlist the help of an independent body like the Federal Reserve if we’re going to improve things before November.  So here’s what I need you to do — scapegoat the Fed.  Call them out, repeatedly, for “sitting on their hands.”  Demand that they do more.  Tell them that “country trumps credibility.”

Message received!  Krugman, Baker, Yglesias, Hayes — everyone seems to have gotten the memo.  Ordinarily, they insist, the Fed could reach into its tool kit and deliver a powerful shot of economic adrenaline that would set off a frenzy of borrowing and spending.  But that typically potent transmission mechanism is said to be broken because borrowing costs are already essentially zero.  The curse of the so-called Zero Bound!  What to do?  The Fed must move into uncharted territory.  It must “do more.”

And so instead of building a powerful, unrelenting case for further fiscal easing, mainstream progressives are focused on the Fed, demanding that it do just as much to promote growth and employment as it does to promote price stability. How?  By following Krugman’s advice and “credibly committing to a higher inflation target,” which, it is argued, will stimulate spending by lowering the real rate of interest.  It’s a policy recommendation that only an economist (or someone with enough credit hours to be dangerous) could conjure up.  I almost hope the Fed tries it so that we can banish this proposal to the wasteland of failed policy recommendations (along with QE1, QE2 and Operation Twist).  But millions of Americans are suffering and so I really do not want to see us pursue a losing policy just because the alternative looks like a political nonstarter.

The zero bound isn’t the problem.  Brazil’s central bank has cut its policy rate by 400 basis points since August 2011. That’s 4 percentage points in under a year!  Meanwhile, growth continues to slow and inflation is falling.  Why?  Brazil isn’t up against the zero bound (far from it, rates are at 8.5 percent).  The problem is that monetary policy is a blunt instrument (at best).  Committing to a higher inflation target isn’t going to pull us out of the economic doldrums.

Dean Baker has argued that the Fed could push long-term rates down another 20-30 basis points, which could allow some Americans to refinance their homes, freeing up a bit of their take-home pay for other uses.  But I wonder how many people would do what I did when long-term rates fell to historic lows.  I refinanced from a 30-yr fixed to a 15-year fixed mortgage and consequently spend less on everything else!

In any event, we’re in a balance sheet recession.  We should be encouraging the private sector to borrow less, not taunting people with negative interest rates and encouraging them to leverage up.  And we should recognize that the government’s deficit is the key to helping the private sector de-leverage.

Reducing the government’s deficit means cutting the non-government’s surplus, which frustrates their efforts to pay down debt.

We need rising incomes to support a recovery that can be sustained by private sector spending, and the Fed isn’t the agency we should be looking to for help on this front.

This post originally appeared at New Economic Perspectives and is posted with permission.

8 Responses to "Can the Fed Really Do More?"

  1. Bill Ellis   June 27, 2012 at 11:43 am

    Stephanie Kelton ,
    I agree completely with you that Fiscal stim is effective. I am not so sure that more aggressive Fed action can not be helpful. Your anecdotal example of Brazil is compelling, but Market Monetarist have many anecdotal examples of their own. (Israel, Switzerland )

    Altho a higher target by the Fed may or may not be helpful, it is clear that a stubbornly low target (2% inflation) could work to inhibit any of the expansionary effects of a fiscal stim.
    So putting pressure on the Fed now could act as a preventive in the case that new stim does become politically doable again.

    Bottom Line…There is NO reason for advocates of Fiscal and Moneritay Stim to be at odds.


  2. bubblesandbusts   June 27, 2012 at 12:28 pm

    I share the frustration over unrelenting calls for further "stimulus" from the Fed ( Credit is not being restricted by banks but rather by excessive private debt, which reduces demand.

  3. Tom   June 28, 2012 at 3:57 pm

    Post-Keynesians deserve a lot of credit for helping bring sectoral balance analysis into the mainstream, but they've also spread a lot of confusion by habitually confusing deleveraging with net lending. The fact that the world's net lending sums to zero and therefore we all can't net lend at once shouldn't be misconstrued as a requirement that the public sector must leverage up in order for the private sector to deleverage. Most private sector deleveraging goes on between the private non-financial and private financial sectors and has nothing to do with the private sector balance. Keep in mind also that the central bank is considered part of the private financial sector in national financial accounts aka flows of funds data. For example the Fed buying foreigners out of private-issue ABS was a big contributor to post-crisis "private sector" net lending.

    • Tom   June 28, 2012 at 10:49 pm

      Sorry, I mean public-issue ABS.

    • EEB   July 7, 2012 at 4:25 am

      Yes, Tom, it is true that the public sector does not "have" to leverage up in order for the private sector to deleverage. Of course they can all deleverage simultaneously, if you really like depressions!!! But if you want the private sector to clean up its balance sheet without a massive depression, then (unless you think the U.S. is a net export powerhouse!), the gov't. must lever up to satisfy "Kirchhoff's Law of Economics". There is just one caveat: the debt incurred must be productive debt- we must "get" something for it- better infrastructure, better capital stock, fuller employment, etc. We cannot afford any more dead- weight debt, such as the type created by bankster bailouts!!! Money for the real economy, not for the financiers!!!

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