Follow the Fed – Macroeconomic News for Monetary Policy Enthusiasts
Macroeconomic news for students and teachers of Monetary Policy
Janet Yellen and Ben Bernanke wrote an oped (2020.03.19) in the Financial Times: How the Fed can lessen lasting damage from the pandemic
Corporate bond buying comes back as potent monetary policy tool. Is the real enabler of using such unprecedented quantitative easing the extremely low inflation in the US? Has the Fed shifted its focus from inflation targeting to unemployment or growth? What if the US had 5-6% inflation right now, would the Fed still be able to inject more than two trillion dollars in the economy to help the financial markets? These are all some very interesting questions that we should ask as students and tutors of macroeconomics.
Why can’t developing economies have similar injections in their economy through quantitative easing? What is possible for the U.S. is not necessarily possible for say Brazil, or Turkey or India. Is the role of US dollar what allows such mass printing of money. Economic theory would suggest that an injection of this scale should depreciate (lower the value of) US dollar. However, we have seen a marginal appreciation in US dollar against a basket of currencies. How is it possible that despite such lax monetary policy the US dollar is still strong? Certainly, students of economics will see a number of conventional economic concepts flipped on their head in reality. Again, making for a great classroom discussion!
Intervening in credit markets, buying bonds, offering guarantees is going to have its limits. No matter how power a Central Bank is, it cannot give guarantee to every business or credit out there. The big rhetoric question is, who will bail out the Fed?
Christine Lagarde of the ECB also wrote (2020.03.20) in the Financial Times: The ECB will do all that is necessary
The ECB has taken a similar stance to the Fed of an emergency fund of €760 bn. The overall mantra is that whatever is necessary will be done. This more assertive tone has now become a norm and also points towards slight desperation or heightened challenge facing the global economy. It would be disingenuous to say that Central Bankers of the previous generation did not do whatever that was necessary or was in their power to mitigate economic crises of the past. However, they did not commit to doing ‘whatever it takes‘ and definitely did not go around frequenting this term.
Mario Draghi, the former President of the ECB has also written (2020.03.27) in the Financial Times: We must deal with Corona of war footing
Similar to the previous opinions, Mr. Draghi is also an advocate of aggressive and speedy spending to stop this recession from turning into a depression. The idea is to use a mix of government spending and monetary expansion to bridge the spending gap at the cost of high public debt and massive central bank balance sheet. The bond market is ten times as large as the stock market, and the bond market is exposed to a systematic risk that can lead to a collapse of the entire credit market. Draghi points out that the fiscal stress due to high debt is not as alarming as the loss of output and productivity will be from inaction. To borrow from Barack Obama, the cost of inaction will be higher.
Andrew Bailey, the governor of the Bank of England, has written (2020.04.06) that the BoE is not doing monetary financing of the crisis
Clearly, BoE is not taking the same stance as the Fed and as the ECB. The idea of an unlimited monetary injection seems less attractive to the BoE. “To that end, the Monetary Policy Committee voted last month to increase the bank’s bond holdings by £200bn to support the needs of the British people.” This opening line from the governor says a lot about the Bank’s mandate. It is clear that the Bank is not interested in financing large spending as it would “damage credibility on controlling inflation” in the long-run. Governor Bailey reminds the readers that the law requires the Monetary Policy Committee to deliver price stability, targeted at about 2 percent. He goes on to highlight that the effects of monetary policy on the real economy are ultimately temporary. This is the money neutrality in the long-run which students and teachers of macroeconomics are very familiar with. Without mincing words, Mr. Bailey also points out that monetary easing cannot increase output above potential output in the long-run and so any attempt to do this would permanently raise inflation expectations in the long-run. Implicit in this is the idea that the cost of higher inflation expectations in the long-run will be more costly than the benefit of shortening a potential depression using monetary policy tools. This is a decidedly different understanding of macroeconomic policy.
It will be very interesting to see how the consequences of monetary and fiscal spending in terms of GDP growth, unemployment, inflation, and public debt will be in the short to medium, and medium to long-run. The contrasting views and ownership of different central banks provide a natural experiment for economists and students of macroeconomic policy.
Edmund Phelps, a 2006 Nobel Laureate in economics has previously written (2018.10.30) on the fantasy of fiscal stimulus.
Mr. Phelps has written that the Keynesian idea that an increase in demand can fix a recession is not true in reality. He found Keynesian policies to be correlated with slower, not faster, economic growth. He further points out that a country’s fiscal stimulus is a spread out over the global economy so it is hard to see the impact on any one country. He does not, however, address the possibility of a global joint fiscal expansion. Mr. Phelps goes further and says that the evidence on monetary policy speeding up the recovery is also flimsy at best. The overall idea is that countries with innovation, investor confidence, and productivity growth ultimately recover from a slowdown with or without a massive fiscal or monetary expansion. It would certainly be very interesting to see Mr. Phelps write an article on the current monetary and fiscal expansion being undertaken globally.
Can governments afford the debts they are piling up to stabilise economies? Stephanie Kelton and Edward Chancellor
Really confusing for students of macroeconomics to see totally opposite views on debt and using it as a fix for short-run.