The Fed’s Inaction on Economic Stimulus

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Monday, July 26, 2010 at 10:34 am

Bruce Bartlett writes that there is little the Fed or the Treasury can do to winnow down unemployment in the face of congressional intransigence on additional stimulus:

[T]hose who advocate a monetary helicopter-drop of money to stimulate growth concede that the Fed doesn’t have the capacity to do it without some action by Treasury to distribute the funds, which would be fiscal in nature. It would also require congressional action that is very unlikely in the current political environment.

That basically leaves two things that the Fed can do: buy longer term securities and buy very unconventional assets such foreign currency denominated bonds. The first it has already done some of without doing much to get money circulating. The second would put the Fed at war with the Treasury, which jealously guards its dominion over exchange rate policy.

Matt Yglesias counters that this is wrong:

[Treasury Secretary] Timothy Geithner has already received appropriations to buy printer paper and toner cartridges for the Treasury Department. If [Federal Reserve Chairman] Ben Bernanke is inclined to play along, there’s no bar stopping Geithner from literally firing up his word processor program and printing out pieces of paper that say “Take this to Ben Bernanke and he’ll give you $10,000.” [...]

But the larger point I would make is that focusing on the precise microdynamics of Fed action is a mistake. What’s more important is how the Fed frames what it’s doing. If the Fed says it’s determined to push the price level up, and will keep trying things until it gets up to such-and-such a point then that will probably work.

The latter point, I think, is the right context in which to view Bernanke’s testimony to Congress from last week. Bernanke might think the economy needs more stimulus, and almost certainly thinks the best way for that to happen is for Congress to authorize additional stimulus spending — jobs programs, public works projects, additional Supplemental Nutrition Assistance Program funding, state aid, expanding the unemployment insurance system, what have you — since interest rates have nowhere to fall.

He could have attempted to convince Congress to do that. He could have warned about the peril of rising unemployment leading to a double dip. He could have said, “Absent additional congressional action, the Federal Reserve, in accordance with its mandate to encourage full employment, will attempt to push up price levels using x and y methods.”

Instead, he opened his remarks stating, “The economic expansion that began in the middle of last year is proceeding at a moderate pace, supported by stimulative monetary and fiscal policies. Although fiscal policy and inventory restocking will likely be providing less impetus to the recovery than they have in recent quarters, rising demand from households and businesses should help sustain growth.”

Again, convincing Congress to do something and publicly contradicting any rosy reports out of Treasury would be the obvious first way to go. This implies to me that, rightly or wrongly, Bernanke does not think the economy needs more stimulus.

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Tony_wu_1
Comment posted July 27, 2010 @ 7:31 pm

According to Calculated risk, the Taylor rule implies a negative federal funds rate, even if you factor in all of the “extra” stuff that the Fed did last year. The core US inflation rate also implies looser monetary policy. So under either a “rules-based” or “inflation targeting” regime, both of which are accepted as legitimate alternatives to the Fed's current “expected outcomes” regime, the Fed's interest rate policy is too tight.

As for exchange rate policy, didn't the dollar swaps that the Fed set up with foreign central banks, and again this Spring during the euro crisis, basically amount of an exchange rate intervention? By providing dollar liquidity to foreign central banks this mitigated the surge in the dollar. So it seems they have already crossed that line. If something *really* bad happens over in Europe, like a Greek default, the Fed may have to intervene again to help European banks borrow in dollars.


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