personally i think this prescription is insane, but it’s clearly what they are going to try
To generate increased growth in aggregate demand, some sector of the economy must be willing to pro-actively lever its balance sheet. And that must be the fiscal authority, if the private sector is intent on delevering. Yes, I know all about the perils of long-term fiscal unsustainability. But I also know that in the long run, we are all dead. I see no reason to die young from fiscal-orthodoxy-imposed anorexia.
While the Fed has not sounded the horn on QE2 (Quantitative Easing), it has declared that the band will keep playing at the same volume on QE1. That decision was and is important, I think, not for any meaningful direct simulative effect on the economy, but rather because it signals that the Fed is no longer on an exit strategy from QE1 – the unconventional, presumed to be temporary, has morphed into the conventional.
This is a profound change, because it means the intellectual and institutional hurdle for QE2 has been dramatically lowered. The textbook monetarists wrapped around the inflation axle of a bloated monetary base have been defeated: Money is as money does and the bloated monetary base ain’t doing anything, because the economy is in a liquidity trap of private sector delevering.
It is especially sweet that St. Louis Fed President James Bullard led the public charge for keeping the band playing at the same volume on QE1. When the head of the regional Fed bank with the greatest tradition of textbook monetarism helps re-write the textbook to reflect liquidity trap realities, it’s a good day, a very good day, in the macroeconomics neighborhood.
So, do I think QE2 will be pulling into the harbor quickly? The honest answer is that I do not know. I actually hope not, because I believe that QE2, if she is going to sail, should sail with a meaningful fiscal expansion on board, on the back of Chairman Bernanke’s cogent analysis back in 2002–2003. The Fed can’t turn deflationary milk into a reflationary milkshake by itself. It needs the fiscal authority to show up with a proactive blender, sweetened with bigger-deficit sugar.
This should not be hard. Indeed, the irony of ironies is that the fiscal authority, from time immemorial, has craved a monetary authority that would be openly cooperative. And to Congress’ credit, recognizing the inflationary potential of such a craving, it wisely extended independence to the monetary authority. But, right now, Congress has a once-in-a-lifetime (we hope!) opportunity to exploit that craving. But it isn’t seizing the moment.
This is not only irony; it is sad. The nation deserves better, especially the 8 ½ million Americans who have lost their jobs. When deflation is the fat tail risk, when the Fed is willing to monetize deficits, there is no excuse for the fiscal authority to resist running bigger deficits to directly finance job creation.