The cover story in Time’s current issue summarizes what everyone already knows. The economic rebound has lost strength recently. The story goes on to report that the policy responses at this late date aren’t encouraging, largely because political support for more fiscal stimulus is weakening faster than the economy. Strangely, the article makes no reference to the possibilities for additional monetary stimulus. The not-so-subtle suggestion is that if the economy needs additional help, new government spending programs are the only game in town and this door is closing fast because of political considerations.
The chief problem, as the Time article presents it, is one of fading public support for more spending by Washington:
Polls show that voters either don’t understand — or don’t buy — the long-established economic theory of John Maynard Keynes, which calls for more government spending (even if it means running up deficits) to help the economy through hard times. Instead, the public is in the mood to smack big Washington spenders hard this November…A new Time poll reveals just how hard the task is: Two-thirds of respondents say they oppose a second government stimulus package.
But as many economists have been explaining recently, monetary policy options may not be a dead end at this point–despite the fact that nominal interest rates are at or near zero. Yet the so-called zero-bound problem inspires some economic pundits to conclude that fiscal stimulus is all that’s left, or so Time’s cover story this week counsels. But this is shortsighted, according to a number of dismal scientists. What’s more, the possibilities for additional monetary policy at the zero bound have been circulating for quite some time.
Late last year, the Peterson Institute for International Economics, for example, published a research report that reviewed some of the monetary policy options with very low short-term rates. And a recent working paper by economists at the New York Fed and Princeton University models the possibilities and finds that the impact of “non-standard monetary policy can be large at zero nominal interest rates.” Even Paul Krugman, the high priest of Keynesian fiscal stimulus, doesn’t ignore the potential of monetary policy at the zero bound (even though he tends to be skeptical of it), as he discusses in his blog post of July 14. And in another post on the same day, Krugman argues that the Fed isn’t targeting a sufficiently high level of inflation. In other words, the central bank needs to be more aggressive in its monetary policy now–even at the zero bound!
I’d be remiss if I didn’t mention Scott Sumner, an economist who arguably has done more than any one blogger over the past year to remind, reflect and otherwise explain how monetary policy is far from dead during the infamous liquidity traps. Spend some time reading his blog and you’ll be hard pressed to ignore monetary policy options at the zero bound. You may find reason to disagree, but Sumner’s detailed analysis over the last year or so remind that the topic of monetary policy at the zero bound is (or at least should be) a topic of discussion.
Yes, we can debate how effective the Fed and other central bankers will be when rates are this low. Expectations, for instance, are a key issue at this point. Simply targeting higher inflation might not work if the crowd thinks it’s temporary. Of course, some financial commentators (including this one) aren’t persuaded at all that printing more money at this stage, regardless of the details, will work.
Perhaps, but given the state of the economy at the moment it’s not clear that we still have the luxury of ignoring the case for an additional round of unorthodox monetary stimulus. Or perhaps the better way to put it is that we don’t have all that much to lose if the Fed goes the extra mile in the summer of 2010. The stakes are all the higher if, as Time tells us, that the political outlook for more fiscal stimulus is dead.