Randall sent me a perplexing Financial Times piece by Joe Stiglitz. He begins by comparing the proponents of monetary stimulus to the monetarists of the 1980s:
A quarter-century ago proponents of monetary policy argued, with equal fervour, in favour of monetarism: the most reliable intervention in the economy was to maintain a steady rate of growth in the money supply.
In fact, a better comparison would be with the Keynesians of the 1980s, or the Keynesians of today. It is Keynesians that favor monetary stimulus in recessions, monetarists advocate stable money growth. Stiglitz knows this, which makes me wonder why he is warning his fellow progressives that monetary stimulus is a dangerous monetarist idea.
This was followed by the discredited pushing on a string idea:
Traditionally, monetary authorities focus policy around setting the short-term government interest rate. But, leaving aside the fact that with interest rates near zero there is little room for manoeuvre, the impact on the real economy of changes in the interest rate remains highly uncertain. The fundamental reason should be obvious: what matters for most companies (or consumers) is not the nominal interest rate but the availability of funds and the terms that borrowers have to pay. Those variables are not determined by the central bank. The US Federal Reserve may make funds available to banks at close to zero interest rates, but if the banks make those funds available to small and medium-sized enterprises at all, it is at a much higher rate.
Then there is this:
It should be obvious that monetary policy has not worked to get the economy out of its current doldrums. The best that can be said is that it prevented matters from getting worse. So monetary authorities have turned to quantitative easing. Even most advocates of monetary policy agree the impact of this is uncertain. What they seldom note, though, are the potential long-term costs. The Fed has bought more than a trillion dollars of mortgages and long-term bonds, the value of which will fall when the economy recovers – precisely the reason why no one in the private sector is interested. The government may pretend that it has not experienced a capital loss because, unlike banks, it does not have to use mark-to-market accounting. But no one should be fooled.
So the Fed might suffer some modest capital losses if QE works, and promotes a faster than expected recovery. Wouldn’t that be a tragedy! And he ignores tax revenue gains to the Treasury from a fast recovery. And what makes Stiglitz think he can predict the future movements of bond prices better than the market? Is he telling me I’ll get rich if I short T-bonds right after QE2? Should I believe him?
But all this is nit-picking. Here’s what really bothers me about Stiglitz’s article. It’s not that he favors a different monetary policy than I do; it’s that he seems to oppose the Fed having any monetary policy at all. (Hence the connection with those “abolish the Fed” elements within the Tea Party.) I defy anyone to read the article and find any monetary policy being advocated. Indeed I don’t see any evidence that Stiglitz even knows what monetary policy is.
There is no discussion of any nominal target, whether prices, the Taylor Rule, or NGDP. He seems to think of policy in terms of interest rate changes, but interest rate targets are not Fed policy, they are a tool to implement Fed policy. If you use interest rates as THE policy, the price level becomes undefined–it shoots off to zero or infinity. For instance, he indicated interest rates were too low back in 2002-03. That suggests to me he thinks money was too easy. Maybe so. But inflation was below the Fed target at that time. This suggests that if money had been tighter, inflation might have slowed even more, and a dangerous deflationary spiral could have developed. That’s why most economists support something like the Taylor Rule, or inflation targeting. Interest rates aren’t enough.
Here ’s how modern macro works. Economists assume the Fed has some policy goal or goals. They choose a nominal target to help implement those goals. Then they set their various monetary policy tools (such as fed funds rate, IOR, QE, etc) at a level most likely to achieve that nominal target.
But Stiglitz seems oblivious to all this. He doesn’t advocate a different monetary policy; he suggests we shouldn’t be relying on monetary policy at all. But the Fed can never be “doing nothing.” Any policy is an affirmative decision. The Fed can set policy at a level expected to succeed, or it can set policy at a level expected to fail.
I anticipate some people will argue that Stiglitz does favor more AD, he just wants to “use” fiscal stimulus. Fair enough. But once fiscal stimulus is done, what is the Fed supposed to do with monetary policy? And this is hardly an academic question, in all of American history fiscal policy has never been more “done.” Even this Congress can’t pass more fiscal stimulus—just imagine the next one. So it comes down to a basic decision about monetary policy; what is to be done? And Stiglitz dodges the question, or perhaps implies he’s happy with a monetary policy that is likely to leave unemployment in the 9% to 10% range for several years. I can’t quite tell.
I have no objection to people criticizing the Fed; I do it all the time. But then suggest an alternative policy. What is your nominal target? How do you think the Fed should try to improve the macro economy? My problem with Stiglitz is not that I disagree with his answer; it is that I suspect he doesn’t understand there is a question that needs to be answered.