The issue of the need and the design of a QE3 operation by the Fed is a matter of debate (see for instance, the Financial Times, Sep 9, 2012, Global economy: Not so different this time, by Robin Harding and Chris Giles). Chairman Bernanke devoted good part of his speech at Jackson Hole to analyze the costs and benefits of non-conventional approaches to expansionary monetary policy, particularly what he called “large-scale asset purchases” (LSAPs), and left the door open (with caution) to another potential round of Q3 if conditions do not improve.
He noted that “In using the Federal Reserve’s balance sheet as a tool for achieving its mandated objectives of maximum employment and price stability, the FOMC has focused on the acquisition of longer-term securities–specifically, Treasury and agency securities, which are the principal types of securities (my emphasis; I will get back to this below) that the Federal Reserve is permitted to buy under the Federal Reserve Act.”
He also concluded that in regards to the benefits of non-conventional operations (basically LSAPs) “a balanced reading of the evidence supports the conclusion that central bank securities purchases have provided meaningful support to the economic recovery while mitigating deflationary risks.” And with respect to costs, Bernanke argued that “when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant.”
Nonetheless, the Chairman recognized that “the economic situation is obviously far from satisfactory,” and that “unless the economy begins to grow more quickly than it has recently, the unemployment rate is likely to remain far above levels consistent with maximum employment for some time.” He disagreed with those that think that this relatively subdued response of the US economy to the strongly expansionary monetary policy was due to the financial crisis causing “structural damage to the economy,” but, rather, he attributed the economic weakness to “a number of headwinds.” He then goes on to enumerate those headwinds:
“First, although the housing sector has shown signs of improvement, housing activity remains at low levels and is contributing much less to the recovery than would normally be expected at this stage of the cycle.”
“Second, fiscal policy, at both the federal and state and local levels, has become an important headwind for the pace of economic growth…”
“Third, stresses in credit and financial markets continue to restrain the economy… and tight borrowing conditions for some potential homebuyers and small businesses remain a problem today.”
Finally, he refers to the situation in Europe.
Reading all this, I have a “déjà vu all over again” moment (with due respect to Yogi Berra): old debates about developmental central banks, came back rushing to my mind. The problem is that development and monetarist economists do not talk to each other. Therefore, most of the debates among the latter and central bankers seem to have focused on the question of targeting nominal GDP, and variations of the approaches followed up to now in LSAPs. The article mentioned by the FT also centered on those topics, and when referring to other options mentions that “a raising number of voices… suggest central bankers could become more radical still. Central bankers are being urged to buy assets other than government bonds, breaking a taboo that they should not accept credit risk on to their balance sheet.” And then considers, and dismisses, a “helicopter drop,” through which Central Banks would simply put money into the bank accounts of the people of a country.
It may be just me, but recalling the debates about developmental Central Banks (such as Arthur Bloomfield’s “Some Problems of Central Banking in Underdeveloped Countries” The Journal of Finance, May, 1957; and Andrew Brimmer’s “Central Banking and Economic Development: The Record of Innovation” Journal of Money, Credit and Banking, November, 1971), there seem to be more alternatives than only buying government bonds or dropping money into the accounts of unsuspecting (but probably elated) citizenry.
First, the issue of buying assets “other than government bonds,” which may break “a taboo that they should not accept credit risk on to their balance sheet,” at least regarding the Fed, is not a taboo anymore: its balance sheet has credit risks that go beyond government bonds.
Second, and this is where developmental central banking comes in, the menu of instruments to expand and manage credit by central banks has been far larger historically, and not only in developing countries (see the discussion in “Central Banks as Agents of Economic Development” by Gerald Epstein. PERI working paper 104. September 2005). The process of creating “modern” central banks has been one of restricting those instruments, mainly because of concerns about their past use (and abuse) leading to high inflation in many developing countries (see Brimmer, 1971), that they may amount to “industrial policy,” picking winners and losers, and, perhaps, because of distributive effects. The latter effects (of generating winners and losers, and, therefore, distributive effects) are unavoidable with any monetary mechanism, however indirect. So the main questions are whether the misuse of those instruments may lead to inflation, and how to design the interventions.
But precisely Chairman Bernanke is telling us that there are substantial headwinds holding back growth and employment, and he identifies three specific areas: housing, fiscal conditions (federal, state and local levels), and credit to small business.
In policy debates it is always very useful to keep in mind both the Tinbergen Rule (“On the Theory of Economic Policy” 1952) that a government cannot attain two objectives with one instrument, and what I would call the Bhagwati Rule (“The generalised theory of distortions and welfare” 1971) that the policy intervention must point directly to the problem, because the further away and more indirect the policy intervention, the more likely that other distortions and unwanted effects will occur (my loose rendition of a more complex argument) (in the case of traditional instruments of monetary policy one may recall Milton Friedman’s reference to “long and varying lags” leading to uncertain effects).
Going now to the design of a new LSAP, if we put together the discussion on instruments from the debate on developmental central banks, with the Tinbergen and Bhagwati Rules, it seems reasonable to argue that if there is a QE3, this should focus directly on assets related, separately, to a) credit to small business, b) housing, and c) financing infrastructure investment, but the latter through private sector operations or public-private partnerships (because of fiscal sustainability, operational, and political reasons, there are limits to direct government funding of infrastructure projects; this is a longer discussion that I am not going to get into here). More generally, what is needed is financing to the private sector in those areas, which could be done without the Fed interacting directly with the final borrowers (as it has been done in many programs of developmental central banks).
I do not have time now to discuss how this approach may be operationalized. But let me close by addressing the issue mentioned by Chairman Bernanke at the beginning, that the Fed buys “longer-term securities–specifically, Treasury and agency securities, which are the principal types of securities that the Federal Reserve is permitted to buy under the Federal Reserve Act.”
The Chairman has been careful to say “the principal types” not “the only types.” In fact, the powers discussed in the Federal Reserve Act 13(3) have been utilized to create the different facilities now in operation, which go beyond buying only Treasury and agency securities. The Fed Board exercised its authority under that section, arguing the presence of “unusual and exigent circumstances” (as required by 13(3) of the FR Act), and worked with the Fed of New York and Boston to establish the lending facilities’ policies, terms and conditions.
If the conditions continue to be “unusual and exigent” and before taking the helicopter out of the hangar, it may be useful to study the instruments and lessons of developmental central banking in greater detail, and to focus the interventions more directly on the private sector related to the three headwind issues mentioned (I may discuss these issues in a further note). After all, we in developing countries have a long experience in generating and weathering the types of crisis now affecting the developed world. It is true that sometimes we tended to print too much money (which created inflation and balance of payment problems), but here we are talking about “quantitative easing,” which sounds much more civilized, and, as we all know, printing dollars is not the same as printing pesos.