This post is US-centric because the topics are the “Great Recession” and US monetary policy. So skip the rest if those topics are not of interest.
For the third time I am listening to the 2 Jan 2012 Econtalk interview with monetary economist Scott Sumner. From time to time I read Scott’s blog The Money Illusion . It’s not easy going, at least for me, as I find the workings of central banking monetary systems difficult. The basics are easy, but the important subtle bits seem tricky.
Example: commonly in discussions of the effectiveness of fiscal policy, the control assumption is “holding monetary policy constant”. Scott argues that every economist thinks they know what that means, but if you interview them, you discover they hold many different views of “stable monetary policy”. E.g., some think it means stable interest rates, some stable money supply growth, etc. But the US Fed is constantly trying to adapt to market conditions, to the perceived track of the economy. So Sumner’s critical point is that the Fed can be expected to react to fiscal stimulus — if they think the economy is improving they tighten and inversely.
What about the Fed’s response to the Great Recession?
Through his articles, and three Econtalk interviews, Scott has convinced me that the monetary authority (the central bank) has the power to change nominal variables – e.g., inflation or nominal GDP growth. In the short term, that means influence on the business cycle. But the monetary authority has little if any influence on the long term real growth or health of the economy.
Why is the US still mired in slow growth and high unemployment? Scott’s analysis is this is due to the inadequate response of the Fed to the 2008 collapse: the slow growth of nominal GDP (NGDP) is the proof of his argument (if you accept that the Fed has policy tools that absolutely will increase NGDP growth). Which I do.
Russ asked Scott what he would do as Fed chairman? Scott says (paraphrasing): “…establish and publicize the Fed strategy as roughly “we will target NGDP at 7% until GDP growth has returned to trend” (he nuanced how close to trend, we’ll keep it simple here)”. And I thought Scott’s corollary idea was brilliant — for the NGDP measure targeted by the Fed to be a new class of futures – NGDP futures contracts. Transparency 100% – everyone can see how the Fed is doing and estimate what future policies the Fed will undertake.
I highly recommend this Econtalk discussion, and the Money Illusion as a resource. Please see also the Bank of England’s excellent Quantitative Easing Explained, the best concise explanation of QE that I have seen.