LSAPs and Cynicism

9/12/2012 03:50:00 PM

Michael Woodford,
John Bates Clark Professor
of Political Economy,
Columbia University
So everyone and their mother is expecting QE3 tomorrow. This comes on the heels of Columbia Professor Michael Woodford's enlightening presentation at Jackson Hole. It was there Woodford argued that without any forward guidance regarding future policy decisions, the Fed's announcement to maintain low interest rates for the foreseeable future may be having only a contractionary impact, by way of further lowering expectations of real income growth and/or inflation. (See page 82 in the paper) Woodford, an academic heavyweight among monetary economists, even singled out nominal GDP (NGDP) level targeting as a "suitable target criterion" for future forward guidance from the FOMC, a suggestion which has already won the endorsement of economists across the political spectrum. 

For a GIF-illustrated guide to QE, expectations, and NGDP targeting, check out Mike Konczal's clever invention over on RortyBomb (the Amar'e Stoudemire imagery is especially apt).  Especially note the garbled message markets are hearing -- what the Fed has been telling us to expect has been anything but clear. With a commitment NGDP targeting, markets get a great sense of where to expect policy to go. Coupled with large-scale asset purchases (LSAP, or QE3), evidence of market movement is immediately visible, giving that commitment the credibility it needs to prove successful.

However Matt Yglesias, formerly of ThinkProgress, and a favorite blogger of mine, is of a different mind; if not of the capabilities, at least regarding the motives and likely actions of the Federal Reserve and its fearless captain, Ben (not Benjamin) S. Bernanke. According to Yglesias, Ben is so scared NGDP targeting would work, that he cannot adopt it as policy lest he tarnish his reputation. Indeed, part of Yglesias' premise is that Bernanke wants to do just enough to sate public demand for action without actually  producing robust recovery.

I don't buy this story for a number of reasons. Firstly it assumes Bernanke has little doubt of the efficacy of such a new targeting policy, which is far from obvious. Secondly, and perhaps most plausibly, it means Bernanke cares more about his reputation as Fed chairman the US and world economy. That means the continued suffering not only of all the workers and nations of the world, but also all of its investors banking on continued industrial growth. So while it's plausible Bernanke is just that callous, actually believing it to be the case that he would sabotage the world economy is a level of cynicism I'm not prepared to adopt just yet. After all, third and most important of my points is Yglesias's story means Bernanke not only thinks it will work, but will work so well it would doubtlessly be the toast of the town for its obvious efficacy. I dunno about you, but I'm envisioning heaps of praise rather than scorn for Ben if it were to work so splendidly (at least from those people who *do* want a healthy economy).

And even if there was some backlash for Ben's failure to act sooner, as Yglesias foresees, he could easily counter that a) he had already taken drastic steps in the QE 1 and 2 programs, and b) was only duly cautious in flexing his monetary muscle, one without any precedent at the Fed or analogous institution. It is for these same reasons that I doubt (along with a wide majority of econ bloggers) that NGDP will be appearing on the Fed's policy menu any time soon, primarily because I have learned to expect that excess caution from Bernanke, but also because the Fed already has made some historic moves since 2008, and a third round of QE would not come without substantial consternation. What I would like to see, which is far more likely and may yet be similarly effective, is some forward guidance accompanying the asset purchases. Whether or not there is some explicit nominal output target, there seems to be some consensus that giving markets a sense of the path of future rate policy, tied to economic performance and prices, along with an immediate credible movement is preferable to simply kicking the estimated date forward for a rate "lift-off".