May 24, 2024

Economix Blog: What Comes Next if Fed Action Isn’t Enough

The Fed is on the verge of expanding its stimulus policies. We learned that much during the meetings in Jackson Hole, Wyo. But what may be more interesting is the undercurrent of discussion about what happens when those measures prove insufficient.

There was broad agreement at the conference that the actions the Fed is considering, and may announce in two weeks, will not revive the economy. Indeed, given the magnitude of the looming “fiscal cliff,” they may not even be enough to prevent a recession.

Some economists and policymakers – notably the Fed’s chairman, Ben S. Bernanke – say they believe that the new Fed policies would still have significant benefits. Some are dubious. But no one seems to think it will suffice.

What more can be done? Well, pretty much everyone here is upset about the breakdown of fiscal policy, which is becoming a principal drag on growth.

Indeed, quite a few attendees regard that as the entire issue. They do not agree on what fiscal policies are needed. (The grab bag includes tax cuts and spending increases, household debt reduction and government debt reduction.) But they do agree that monetary policy has basically done (almost) all that it can.

Others, however, see opportunities to do more. The most concrete proposal, which I wrote about Friday, came from Michael Woodford, an economics professor at Columbia University, who told the conference that the Fed could lift growth now by announcing that it will tolerate higher inflation later, as the economy begins to recover. Professor Woodford sought to rebut two critiques of this idea, by presenting evidence that the Fed has the power to move inflation upward, and that it could do so temporarily without losing the credibility of its long-term commitment to maintain inflation at the 2 percent level it considers most healthy.

Adam S. Posen, an American economist who served until Friday on the Bank of England’s policy-making committee, urged central banks to consider providing cheap financing for areas of the economy that are starved for credit. The Bank of England has introduced such a program. And the Fed’s purchases of mortgage-backed securities – which would likely be expanded as part of any new program of asset purchases – are similar in spirit. Opponents view efforts like these as a form of fiscal policy, a position Mr. Posen derided as “a prehistoric way of thinking.”

Alan S. Blinder, a former vice chairman of the Fed’s board of governors, reiterated his suggestion that the Fed should start charging banks for the reserves they keep with it, reversing its current policy of paying them a modest rate of interest on those balances. As he wrote recently in The Wall Street Journal, “If the Fed reduces the reward for holding excess reserves, banks will hold less of them — which means they will have to find something else to do with the money, such as lending it out or putting it in the capital markets.”

But the Fed has shown little appetite for new measures. Mr. Bernanke appears focused instead on building a consensus for the expansion of existing policies, for reasons that Greg Ip ably described for The Economist.

The two main options under consideration are an expansion of the Fed’s asset purchases, and an extension of its prediction that it will maintain short-term interest rates near zero until late 2014, at least. Economists generally concur the benefits of such policies would be no more than modest.

Conservatives at the conference expressed opposition to even those efforts. Any benefits, they warned, are outweighed by the risk of inflation, and by the potential consequences to the Fed’s independence — for its ability to operate normally in normal times.

The Republican Party included a plank in its election platform calling for increased Congressional oversight of monetary policy, and there are perpetual rumblings that Republicans will push legislation instructing the Fed to focus solely on inflation, instead of its current dual responsibility for inflation and unemployment.

Lawrence B. Lindsey, a former Fed governor and adviser to President George W. Bush, said Friday that the experience of the last two decades should teach economists and central bankers, “Modesty in what we express and can do.”

That could serve as a motto for central bankers, who are cautious by nature and profession. Donald L. Kohn, a former Fed vice chairman, asked Saturday why the Fed’s unprecedented efforts so far had produced “so little growth.”

“The fact that we keep trying to bring spending from the future to the present with lower and lower interest rates, are there diminishing returns?” he asked. “There’s a lot we don’t understand and it’s hard to make policy if you don’t.”

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