Why monetary policy matters less every day
1. Resource misallocation and unemployment get “baked in” to some extent, due to hysteresis. I also would argue that some of the long-term unemployed are revealed as having been “baked in in the first place,” once the boom demand for their labor ended and their marginal products were more closely scrutinized.
2. Many nominal values end up reset, more and more as time passes and as new projects replace the old.
3. As banking and finance heal, debt overhang is less of an AD problem. The debt repayments get rechanneled into investment, rather than falling into a black hole.
4. The Fed, at least right now, is not able to make a credible commitment toward a significantly more expansionary policy for very long. Putting aside the more general and quasi-metaphysical issues with precommitment, just look at the key players. Bernanke leaves the scene in 2014 and is a lame duck at some point before then. Obama could be gone by the end of this year, and in any case is unlikely to be reelected with a thundering mandate. Romney’s actual views on monetary policy are a cipher. Either house of Congress could change hands. There is less public support for a consensus view of the Fed today than in a long time.
On this issue I feel Scott Sumner is insufficiently Sumnerian. He correctly stresses the role of expectations and credible commitments, but I still do not understand why he does not accept the implied pessimism in this, at least for May 2012. 2008-2009 was the time to act, in a Ludwig Erhard/Douglas MacArthur/Alexander Haig “I’m in charge now and we’re doing ngdp targeting try to challenge me in the chaos and confusion” sort of way.
5. The Fed already has failed to act, for whatever reasons. That makes it all the harder to achieve the credible commitment now. The market expectation has become “the Fed can/will only do so much.” It’s like a guy hemming and hawing on the marriage proposal for three or four years, and then trying to suddenly set it right and show real commitment to the woman. That’s hard to do, even aside from the points in #4.
I still believe in a looser monetary policy, I just think that what we can get for that now is much much less (a fifth? a tenth?) of what we could have received in 2008-2009.
Scott Sumner believes that Jim Hamilton somehow has changed his mind (and is puzzled by my approving link to Hamilton), but I don’t see that. I simply believe Hamilton realizes he is now writing for a world where the credible commitment from the Fed mostly isn’t there. Angus understands this well.
This will sound counterintuitive, but we should be debating real factors more and nominal factors less, all the more as time passes.
Circa 2012, monetary policy matters less every day. You might feel outraged by that reality, and by the policy omissions from the past, but still monetary policy matters less every day. That point follows from basic insights from Milton Friedman and Irving Fisher, or for that matter modern most mainstream neo-Keynesian models. By the way the labor force participation rate declined in the latest round of data, and will likely remain low for a good while, so I am not convinced by graphs which beg the question about the size of the output gap.
I also stress that I haven’t changed my views at all, not since 2008-2009, and not since my early column on Scott Sumner (someday I’ll do a post on why I wrote that column in terms of prices rather than ndgp). Same views, but I do see the clock ticking on the wall.
This entire point is hardest to grasp in a mental framework of “accumulated blame,” easiest to grasp within a disciplined, non-moralizing look at marginal products.
You also could write a post “Fiscal policy matters less every day.” It’s not a message that a lot of people want to hear.