Can the Fed Really do More?

By Stephanie Kelton

I’ve grown increasingly frustrated by the near universal cry for more action from the Fed.  My friend and fellow blogger Marshall Auerback has quipped that it’s as if every mainstream progressive received the same White House memo.  I imagine it looked something like this:


To:         Mainstream Media (TV, Radio, Print Media)
From:    Office of the White House
Date:     June 10, 2012
Re:         Messaging on the Recovery

The economic recovery is faltering.  The fiscal cliff is nearing.  Many nations have already fallen back into recession.  The net worth of a typical American family is down almost 40 percent since the start of the crisis. Unemployment is rising. People are worried about keeping their jobs,  holding onto their homes and paying down the enormous debts they accumulated over the last decade or more.  The bloodletting at the state and local government level continues unabated, and this is compounding our economic problems.  Consumer confidence is down, and small businesses are struggling to remain profitable.

Some of you have written about the mistakes of our past, pointing out the trauma that was inflicted in 1937, when FDR decided it was time to move toward a balanced budget.  Please stop that.  This is an election year, and I cannot afford to be viewed as soft on the deficit.  Besides, Congress will not support anything I put forward, so we’ve got to enlist the help of an independent body like the Federal Reserve if we’re going to improve things before November.  So here’s what I need you to do — scapegoat the Fed.  Call them out, repeatedly, for “sitting on their hands.”  Demand that they do more.  Tell them that “country trumps credibility.”

Message received!  Krugman, Baker, Yglesias, Hayes — everyone seems to have gotten the memo.  Ordinarily, they insist, the Fed could reach into its tool kit and deliver a powerful shot of economic adrenaline that would set off a frenzy of borrowing and spending.  But that typically potent transmission mechanism is said to be broken because borrowing costs are already essentially zero.  The curse of the so-called Zero Bound!  What to do?  The Fed must move into uncharted territory.  It must “do more.”

And so instead of building a powerful, unrelenting case for further fiscal easing, mainstream progressives are focused on the Fed, demanding that it do just as much to promote growth and employment as it does to promote price stability. How?  By following Krugman’s advice and “credibly committing to a higher inflation target,” which, it is argued, will stimulate spending by lowering the real rate of interest.  It’s a policy recommendation that only an economist (or someone with enough credit hours to be dangerous) could conjure up.  I almost hope the Fed tries it so that we can banish this proposal to the wasteland of failed policy recommendations (along with QE1, QE2 and Operation Twist).  But millions of Americans are suffering and so I really do not want to see us pursue a losing policy just because the alternative looks like a political nonstarter.

The zero bound isn’t the problem.  Brazil’s central bank has cut its policy rate by 400 basis points since August 2011. That’s 4 percentage points in under a year!  Meanwhile, growth continues to slow and inflation is falling.  Why?  Brazil isn’t up against the zero bound (far from it, rates are at 8.5 percent).  The problem is that monetary policy is a blunt instrument (at best).  Committing to a higher inflation target isn’t going to pull us out of the economic doldrums.

Dean Baker has argued that the Fed could push long-term rates down another 20-30 basis points, which could allow some Americans to refinance their homes, freeing up a bit of their take-home pay for other uses.  But I wonder how many people would do what I did when long-term rates fell to historic lows.  I refinanced from a 30-yr fixed to a 15-year fixed mortgage and consequently spend less on everything else!

In any event, we’re in a balance sheet recession.  We should be encouraging the private sector to borrow less, not taunting people with negative interest rates and encouraging them to leverage up.  And we should recognize that the government’s deficit is the key to helping the private sector de-leverage.

Reducing the government’s deficit means cutting the non-government’s surplus, which frustrates their efforts to pay down debt.

We need rising incomes to support a recovery that can be sustained by private sector spending, and the Fed isn’t the agency we should be looking to for help on this front.

30 responses to “Can the Fed Really do More?

  1. Well said, Stephanie.

  2. Thank you for writing this, Stephanie! I’ve been reading Krugman and thinking, “Dude, how is the Fed going to raise inflation when 13 million Americans are jobless? Every time they’ve tried to inflate, they’ve ended up causing deflation!”

    I’m starting to think the Fed should not have a mandate to maximize employment. Leave that to Congress.

  3. Krugman and Baker tend to piss me off. But they are among the few who are at least trying to help out. Maybe you could give the a lesson in sectoral balances?

  4. Detroit Dan

    Yes, yes. A thousand times yes…

  5. Baker is a lot closer to the reasoning here, than Krugman (I think).

    You can point this out endlessly but no one seems to listen. Used to post comments similar to this post on Brad Delong’s website whenever he was urging the Fed to do something … silence.

  6. Monetary Policy?

    If what we want is for the monetary system to be “the tool we use to achieve our real political and economic objectives”(Mosler), as it must be in an economic democracy, then we need to recognize the wall between any action by the Fed and any effective monetary policy.
    This is sort of a monetary system 101 issue for ‘modern monetary economies’.

    What is needed is growth of the M1 money supply, the part of the money supply where we all live and work. (OK, most of us). The nature of the Fed as a monetary policy “actor” is that it is incapable, systematically and institutionally, of serving anyone other than the banking sector.
    The Fed involves with banks and reserves.
    It does not involve with M1 and with Main Street.
    It is incapable of being an effective monetary system “tool user”.

    Given the “balance-sheet recession” nature of the national economy, M1 based spending power can only come from government expenditure.
    That’s why the Kucinich Bill is so important.

  7. It all begs the question: does Obama 1) understand that more stimulus is needed, and if he does 2) is it possible he’s actually opposed to improving the economy? Here’s a not so crazy conspiracy theory: the Eurozone is the testing ground for economic warfare, i.e. austerity for the (first) world? I forget if theirs a name for this: it’s like the opposite of when gas prices go up a lot, and then they come down just a little, everyone is happy about the price of gas even though it’s a lot higher than it was initially…

    Is the opposite but same trend happening? i.e. push living standards far enough downward, that when they finally come up a little bit, everyone will be happy with their lower standard of living (than pre crisis)?

  8. The President’s been spending money too slowly. But now he has $800 B in deficit spending left from here to the end of October and should be able to run big deficits every month. See here:

    • Joe,

      I’m confused by this: “The President’s been spending money too slowly.” To what extent does the President decide how much spending will occur in any given month (time period, etc)?

      • They can do various things to slow down deficit spending, including slow pay on contracts, take time to process new contracts, take time to get certain programs going or expand them. Remember last year when Geithner juggled funds for three months to provide enough time to get through the last debt ceiling crisis. When he did that we saw a decline in Federal spending for a quarter hurting the recovery then.

        Traditionally, the Government fixes things anyway to keep a cushion for the fourth quarter and then there’s a mad rush by the agencies to spend appropriations. But this $800 B in head room, leaves him enough money to get through the CALENDAR year running $109 B in deficits from now till then per month, and still have more cash on hand in their accounts on January 1, 2013 than they have today.

        • I think I was unclear. What I meant to ask is: how much control does Obama have over the process of fund disbursement? I didn’t mean “in what ways” can spending be shifted from one time period to another.

          Or when you say Obama… are you referring to him, his administration, and/or the Democrats in congress acting collectively?

          For example, you mentioned Geitner. So, Obama can direct Geitner to juggle funds around to allow for less spending earlier in the year and more spending later in the year? And he can make order these directions unilaterally?

          (I’m trying to understand how much ‘power’ Obama has over the disbursement of U.S.government spending)

          • I think Obama, Geithner, Jack Lew (head of OMB), Alan Blinder, the rest of the economic team, and people like Axelrod and now Plouffe can meet and arrive at a plan for spending the appropriations they have. Some appropriations must be spent on a schedule they don’t control, but can project. For example, SS payments, Food Stamps, Government paychecks, many other items must be made on schedule. But other payments can be delayed or slowed down. So, control is a mixed bag.

            Obama and the economic team can decide on a general spending plan with Geithner, and he executes that plan. Since the last debt ceiling deal was made, Geithner has certainly projected roughly how much money he would have that would not be covered by tax revenues, throughout the fiscal year, and it’s likely he developed a plan for dealing with that. It’s a reasonable assumption that Obama reviewed the plan and with his political people probably thought through its relationship to his campaign, and probably integrated his campaign plans with the spending plan of Geithner, Lew and the economic team.

            Blinder and the economic team know that deficit spending produces stimulus. The political team knows that September/ October is the critical time to get peak employment before the election, so I think they would want heavier spending to begin now so that by the end of the Summer the UE figures would start improving. If they get substantial improvements in UE stats in early September, early October and then can get BLS to produce a good result days before the election, then I think Obama may win going away.

  9. I’m in 95% agreement with Stephanie. My only quibble is with her last paragraph where she suggests we need “rising incomes” in the form of a higher share of GDP going to wages.

    Wage earners probably spend a larger proportion of their income that profit earners, so more equality would boost demand. And doubtless there are other arguments against the current large share of GDP taken by profits. But even if that excessive share persists, that wouldn’t stop a bigger deficit working in the sense of bringing full employment.

    I.e. the deficit is the crucial point. Income distribution is an important social issue, but gross income inequalities do not preclude full employment.

  10. What is the preoccupation with “credibly committing to a higher inflation target” just for the sake of it? Attempting to persuade consumers to consume out of fear that inflation will reward earlier purchases is an incredibly negative framework, and is not supported by the economic fundamentals in any case, which continue to point toward balance sheet repair in the context of low and unpredictable asset prices and a labour market that has been pretty much gutted. These types of arguments assume an incredible amount of precision in achieiving inflation outcomes, and then to do it via QE? Goodness. Why don’t they try a novel idea such as closing the output gap?

    • Dan Kervick

      And I believe the research on this phenomenon is mixed. The standard idea is that people respond to expected inflation by reducing savings and increasing spending, so as to get the most out of their money before it loses value.

      But here’s another theory: Suppose you expect your real income over the next several years to lag behind inflation by 50%. And suppose you expect 5% inflation per year – thus expecting your nominal income to go up 2.5% per year. And suppose your goal is to maintain a consistent level of real expenditure each year over that period of time? Then what will you do? Save! You expect life to be more expensive in the future, so you will save more of your income now so you can afford a consistent standard of living over time.

      • Only if you invest it and expect the earnings to exceed inflation IMO. Appreciation is not a good bet of late.

  11. Dale Pierce

    Krugman et. al. are sincere humanitarians. I feel sure that their grief for the suffering of regular people is genuine. They even understand – as well as expectations-based theorists can understand – that more fiscal stimulus would help ameliorate the masses’ suffering. But as self-identified political realists, they just can’t bring it up – because it is obviously not going to happen this year. And we shouldn’t kid ourselves that Keynesian economics (regular or post) can be rehabilitated in the public space right now either. It’s going to take time. And so I conclude that Team Obama has it about right. The one thing they really do understand is electoral politics. They avoid saying “stimulus” because the Right has irretrievably won that messaging war.

    So Team Krugman ask themselves what else might possibly help and come up with – well, what Stephanie explains in the post. Increasing inflation by raising inflationary expectations by setting higher Fed inflation targets. Mr. Krugman seems to think that this would both work make a big difference – and he seems to think that there is political space for a higher-inflation policy that is not there for a more-stimulus policy. I’m not sure what makes him think so, but that’s clearly what he thinks.

    For my part, I think we’re completely safe from this policy initiative. No one in the political sphere is going to volunteer to be the pro-inflation candidate.

    • I think people spend far too much time talking about what they think is “politically realistic,” and far too little time trying to change the politics themselves with appropriate messaging. The “so-called” left should be unified right now in advocating for deficit spending, job guarantees and reducing inequality quickly to prevent the further erosion of our democracy. We have few voices in the mainstream claiming to be progressive. Those with a weighty platform should be using it to advocate for measures that are highly likely to solve our problems. They should not be advocating for something they think is “more realistic,” but which is very unlikely to work. It just isn’t “realistic” to prose solutions that won’t solve problems. Over time you lose all credibility, and I think that is what’s happening to PK.

      • Good points. But the left simply does not have enough “weighty” pundits or otherwise who can carry the water here.

        • What are the criteria for deciding that someone is “a weighty pundit”?

          • Readership, MSM platform, invites to discuss your opinions and VIP noticing your work. I’m sure there are more. Krugmann has that to some extent. Within the MMT community there are many knowledgeable people but not so much in the political or financial worlds. The Fox news people are mighty weighty on almost anything they say.

          • OK, thanks. But I don’t see how that effects my point about PK. he may be ‘weighty’ in your sense; but I think he’s still losing credibility with other economists if he proposes solutions that won’t work.

          • $$ and connections? And an economy that is pretty much a cartel, as embodied in the power centralised in the top echelon.

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  16. Gary Goodman

    Neophyte here. When Mike Norman explained what QE really does, that was an eye-opener. Purchasing Tsy Bonds BACK from Banks, to boost their reserves and reserve ratios. But bank lending is not dependent on having excess balances in reserve accounts at the Fed. So it’s practically meaningless. Does everyone here agree?

    The Fed purchasing “toxic” credit-backed securities (like MBS) from banks to shore up their capital base, that’s different issue and different policy, with other implications. Yes, it makes sick insolvent institutions solvent, by taking bad debts on the Fed’s fictitious balance sheet (like Maiden Lane, LLC, I think). At least that’s the idea. If OTHER policies are not left in place that allow banks to increase their holdings of high-risk toxic debt in an effort to be more profitable, that should have helped.

    From Mosler, even though I don’t think he explained it in detail, now I understand that “the back end is not where market discipline ought to be applied” (sic), in other words, if executives of a power plant, hospital, or other vital institution commit fraud and destroy the balance sheet of that institution, it’s not smart to allow the entire institution to collapse as “punishment” of the CEOs who have already run off with the money in previous years or quarters. You don’t shut down the actual hospitals and power plants that serve people (nor do you destroy GM and the entire sub-industry around it). You PREVENT the fraud, at the front end, with sound regulation per Black, and by Mosler’s Fed/Tsy proposals that shut down systemic avenues that allow and encourage fraud.

    Libertarian (esp Left-Libertarian) “market discipline” ideas are attractive, but not the petulant “let’s kill big govt Corporatism by dropping bombs on the entire ‘progressive’ corporatist economic infrastructure, and then sift through the rubble to see what’s left”. That’s the Libertarian and Tea Party analogue of a total immediate destructive Bolshevik Revolution. Or it could be seen to mimic the destruction of a typical U.S. War, like the economy of Iraq or Libya or other countries that have gone from dictatorship to destitution where even basic infrastructure is destroyed and foreign capital is NOT investing in rebuilding that.

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