Sunday, November 22, 2009

The Dark Ages of Macro Engulf Princeton and Harvard

I respect Alan Blinder a lot less after this: Key graph is "But the Fed deserves extremely high marks for its work since then. It has hit the bull's-eye regularly under very trying circumstances."

This recession continues b/c the Fed has been doing little more than twiddling its thumbs since 12/31/2008, shrinking its balance sheet over that time. As Free Exchange points out, 10% unemployment and counting is not "hitting the bulls-eye", it's more like not hitting the broad-side of a barn. Blinder doesn't like the legislation. Fine. But to argue against it by saying that the Fed is making the right calls when the Fed clearly is not making the right calls is probably not going to convince a whole lot of people.

Robert Waldman writes that the Fed has been "pedal to the metal". But how is the Fed's contraction of the money supply over the past year "pedal to the metal?" This is a Fed that is habitually taking its foot off the gas (and tapping on the breaks), and has continually erred, over the past 20 months, on the side of doing too little.

Brad DeLong, Robert Waldman, and others are of the opinion that "the Fed can do nothing" given a Fed Funds rate near zero. Yet, there is surprisingly little logic or evidence that the Fed is now powerless. Yes, the Fed doesn't have as much power as it normally does, but if the Fed prints money, and buys long-term bonds, why wouldn't this: (a) increase the price, and lower the yield of long-term bonds, lowering borrowing costs generally, and (b) with more dollars in the economy (or perhaps just in Excess Reserves), reduce the value of the US Dollar, boosting net exports, or (c) when the Fed drops $80 billion plus of cash into the MBS market, as it did the week before last, this seems to buoy asset prices generally... For the life of me I can't imagine how at least (a) can't be true, and (b) and (c) must be true given enough billions are pumped into the market...

The picture we are left with is a Fed Chairman who is simply incompetent, and deserves to be audited. When it messes up, it's going to take some heat from the Congress. This isn't a 1982 style recession, when Volcker was doing the right thing...


  1. The Fed has substantially expanded its balance sheet until 12/08 though. What you're saying is that the increase from a balance sheet of ~900 billion in March 08 to over 2000 billion in 12/08 and its stayed over 2000 billion since then. If something was going to cause inflation, that should have done it. I agree that Bernanke shouldn't have tapped the brakes, but its hardly being an inflation hawk.

    In a liquidity trap, even QE won't matter. If the Fed buys assets and gives banks reserves, then they need to lend out those reserves to affect monetary aggregates and the price level. If the bank just puts those reserves back at the Fed, then this becomes excess reserves and has no effect on the money supply, and no effect on prices. QE might be worth it to monetize government debt, but if the intent is to increase money supply or lending, then it won't have an effect in a liquidity trap.

    Also, if you want to get rid of Bernanke, who should he be replaced by? (I stick by De Long)

    Also, how many reserves would be enough? The following chart should show that the Fed has been trying:

  2. If QE doesn't affect prices or the money supply, it won't affect the value of the dollar either. I guess it could change asset prices, but will this really aid a recovery? Fiscal stimulus works much better than monetary right now. (As I'd guess you agree)