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Home Publications Blogs Beat the Press David Wessell Is Seriously Wrong, There Is Much More That the Fed Could Do

David Wessell Is Seriously Wrong, There Is Much More That the Fed Could Do

Friday, 05 August 2011 05:18

David Wessel, the Wall Street Journal's economics editor, badly misled NPR listeners this morning when he told them that there is little that the Fed could do to boost the economy. This is not true.

The Fed could do another round of quantitative easing, although this is likely to have a limited impact. It could also target a long-term interest rate, for example putting a 1.0 percent interest rate target on 5-year Treasury bonds.

Alternatively, the Fed could pursue a path that Bernanke himself had advocated for Japan when he was still a Princeton professor. It could target a higher rate of inflation, for example 4 percent. This would have the effect of reducing real interest rates. It would also lower the debt burden of homeowners, which could allow them to spend more money.

This policy has also been advocated by Paul Krugman and Olivier Blanchard, the chief economist at the IMF. It would be amazing if Wessel was unaware of this policy proposal.

Comments (7)Add Comment
We Know One Thing
written by Hugh Sansom, August 05, 2011 9:41
The one thing the Fed will not do is target a higher interest rate. We've had knee-jerk moderate and right-wing know-nothings raving about 2% inflation being too high. And we know The Oligarchs -- the Bill Gates, Warren Buffett, Lloyd Blankfein brigands -- are loathe to see the debt owed them decline in value.

A higher inflation rate is arguably the single thing that would best aid the American economy. It's the one thing that will be strictly ruled out altogether (much as single payer was both in the Clinton and Obama administrations).
Inflation should be mentioned as an option
written by ieJasonW, August 05, 2011 9:48
Even though the current politics wouldn't allow for a higher inflation rate target, it is important for liberals, policy makers and the media to mention it as a reasonable option to confront our current woes. If sensible people don't mention good policies going forward, then we have no hope for chaning the current politics...
Not Amazing At All
written by Paul, August 05, 2011 10:58
It would be amazing if Wessel was unaware of this policy proposal.

Wessel obviously only reads conservative claptrap and has no idea what Keynesian solutions might be.
How does that function, exactly?
written by BruceMcF, August 05, 2011 11:33
Say the Fed raises its interest rate target band to 3% to 5%.

Then? So when as a result of sliding slowly back into recession, demand-driven inflation ... OK, that won't happen. Its pushing on the string of a helium balloon that is resting against the ceiling ~ its not the string that is keeping the balloon from rising further.

Ah, so it'll be cost push inflation? If the inflation rate that is targeted omits Food and Fuel ... we already have the ability to have 5% cost push inflation from an oil price spike without requiring Fed intervention to counter it, since under depressed demand conditions the impact of an oil price spike will be primarily in the flex-price sector.

But ... first we have to engineer that oil price spike, and second is the question whether the cure is worse than the disease.

In these conditions, monetary policy can be vary effective in accommodating a strong fiscal policy response. But it has very little grip as far as a free-standing policy response.

Unless the Fed directly bought troubled mortgages and implemented an own to rent policy on those mortgages to stabilize the housing crisis ~ its hard to see any other intervention that would have any impact.
I have to part company on this point ...
written by jm, August 05, 2011 11:37
But Dean, the only area in which the Fed might be able to increase the inflation rate is commodities costs, through fueling speculation by pumping more free money to Wall Street. And the consequence of that would not be general inflation, because wages wouldn't rise, and employed consumers would consume even less in real goods and services as their buying power drops; the reaction among retirees and the very numerous soon-to-be-retired would be even greater -- already they are cutting back on consumption as they realize that their real investment rates of return will not be the positive values all those "retirement calculators" led them to expect, but rather will be negative, because they can see that going forward the Fed will never let them get a positive rate of return on any relatively safe investment.

As you well know, much of the "great moderation" was just a result of the seemingly inexorable rise in private indebtedness fueled by loose lending secured with real estate -- the housing ATM -- and whereas circa 2000 the nation had $10 trillion in nominal housing value with $5 trillion in mortgage debt, it now has over $10 trillion in mortgage debt with housing value headed back toward $10 trillion and likely to drop even below that. In 2000 it also had younger age cohorts with some savings ready to be suckered into home ownership by the myth that housing is always a great investment, and that if they didn't buy they'd be priced out forever -- now, they've lost all their equity -- their life savings.

Money is debt, and debt is money, and when so few credit-worthy entities want to borrow, and so many debts are going bad, removing from existence the money they represent, there's no way for the Fed to expand the real effective money stock -- except if the government uses Fed-printed money to pay people to work, and politically that now cannot be done.
written by skeptonomist, August 05, 2011 2:42
Certainly we could appeal again to the inflation-expectation fairy - that's all that setting a higher target does. Bernanke has already said that rates will be kept low for the "foreseeable future". If he says they will be kept low for longer than that, or promises higher inflation which doesn't come, there is danger (as he has said himself) that people will lose faith entirely in the inflation-expectation fairy. Who wants an end to childhood?

As for QE3, interest rates are just now getting back to where they were before QE2. Rates also went up after the announcement of QE1. Would anyone like to bet which way they would go if Bernanke announces QE3?

What needs to be done now is concentrate on fiscal policy, not constantly pass the buck to the Fed. And for the future it would be best if curtailment of bubbles is not left to the Maestros, and if it is clearly realized that the Fed can't put Humpty back together again after a fall.
written by jamdox, August 05, 2011 6:46
A number of economists have also been proposing price-level targeting, i.e. set a price level target that "makes up for" prior below-target inflation. Woodford proposed this like a year ago, and Rogoff and Mankiw recently came out for it too (Rogoff might have been for it a while ago, and just reiterated...). Of course, how do you actually execute a price-level target when monetary policy is barely effective?

Plus, QE2 seemed to mostly increase stock and commodities prices. So an inflation or price-level target would probably primarily be effective by bubbling commodity prices: we'd be getting "cost-push" inflation, i.e. stagflation. This seems like the worst possible way to lower debt levels.

Personally, I'm more interested in whether the Fed can set up "facilities" to directly relieve consumer debt, somehow. I know they took an enormous amount of crap onto their balance sheet, but is there something preventing them from finding a way to do something similar with underwater mortgages?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.