Covered in the 621 course: Topic 6: Monetary policy in the US

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ECON621
Topic 6
Policies to improve competitiveness and
development

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Introduction
• One big hairball of risk (an institutional crisis?):
• China
• Europe
• The US is the most perplexing
• The comeback kid?
• Or heading for a growth-destroying fiscal cliff?
• Only the Fed can do more.
• Can they, should they?
• "open mouth operations"?
• This weekend Bernanke is at Jackson Hole…

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The US economy
• Backsliding since March, deleveraging continues.
• Growth is slow, or slowing.
• Employment growth is slow and unemployment high.

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The latest numbers
• Chicago purchasing managers' index (PMI) rose slightly.
• National factory orders have been rising 2.5% in July.
• The S& P/Case-Shiller home prices index rose in the second
quarter.
• The National Association of Realtors' pending home sales
index at a 2-year peak.
• The Conference Board's August consumer confidence index
declined in August.
• Revised gross domestic product (GDP) figures show that the
economy expanded at an annualised rate of 1.7% in the
second quarter.
• And some expectations: Weekly jobs claims flat at 370 000,
July's personal incomes rising 0.3% and consumer spending
rising 0.5% in July.

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Then there is the fiscal cliff
• It is a fiscal policy story:
• Bush-era tax cuts are set to expire in January, and
• Automatic spending cuts are due in December – part of the 2011
debt ceiling deal.
• This would push the US into recession.
• Even if the cliff is avoided, there is still a clifflet:
• the expiration of the payroll tax cut,
• the expiration of extended unemployment insurance benefits,
• imposition of a new 3.8% Medicare investment tax on the wealthy.
• ISI Group projects $220 billion of fiscal tightening in 2013,
or 1.4% of GDP.
• JPMorgan, puts the hit at a slightly higher $266 billion, or
1.7% of GDP.

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The views
DeLong has "been arguing for four years that our business-cycle problems call for more
aggressively expansionary monetary and fiscal policies, and that our biggest problems
would quickly melt away were such policies to be adopted. That is still true. But, over
the next two years, barring a sudden and unexpected interruption of current trends, it
will become less true.
The current balance of probabilities is that two years from now, the North Atlantic’s
principal labor-market failures will not be demand-side market failures that could be
easily remedied by more aggressive policies to boost economic activity and
employment. Rather, they will be structural market failures of participation that are not
amenable to any straightforward and easily implemented cure".

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Can / should the Fed do more?
• What do we mean "do more"?
• How would they "do it"?
• Will it work?
• Should they do it?

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More…
• Monetary stimulus.
• Demand-siders, like Krugman, sees the slump as being
caused by inadequate spending: thanks largely to the
overhang of debt from the bubble years, aggregate
demand fell, pushing the US into a classic liquidity trap.
• Stimulus should increase investment, (also in housing),
consumer spending.
• a higher general inflation rate
facilitates relative price
adjustments

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How to do it…
• The aim would be to keep
long-run rates low:
• Open-ended QE3
• Ryan Avent makes the case
for "inflation targeting plus"
• NGDP targeting
• Conditional inflation targeting.
• The key is to set benchmarks for the stabilisation process
and set expectations for which policy levers will be used
to push the economy toward the benchmark.
• "the easiest way to accomplish that will often be to convince
everyone that they're serious about coordinating expectations for
stable demand growth".

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Will it work…
• It will depend on the actions of consumers and markets.
• And to the extent that there is in fact, already, a liquidity
trap.
• Some argue:
• Since bond yields are already at record lows, could it be that Fed
officials have concluded that the only transmission mechanism they
have left between monetary policy and the economy is the stock
market?
• With QE2: “Stock prices rose and long-term interest rates fell when
investors began to anticipate the most recent action. … And higher
stock prices will boost consumer wealth and help increase
confidence, which can also spur spending."

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But not everyone agrees
• But many people insist that the slump was actually some
kind of supply shock instead.
• Either they have an Austrian story in which the economy’s
productive capacity was undermined by bad investments in the
boom,
• or they claim that Obama’s high taxes and regulation had
undermined the incentive to work.
• Their fear is that monetary stimulus will fuel inflation –
leading to hyperinflation.
• (Have a look at the blogs and tweets of Zerohedge, or in SA: Chris
L Becker, Russell Lamberti and the Mises blog.)

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But…
• Even with substantial QE,
there has not been much
inflation.
• "If we’d had 2% inflation over the past 4
years, I believe the recession would
have been far milder. I don’t favor a 2%
target, but we aren’t failing because the
Fed is targeting inflation at 2%, we are
failing because they are running 1.1%
inflation at a time when the dual
mandate and the Taylor Principle
suggest they should be temporarily
overshooting their 2% flexible inflation
target."

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Conclusions
• These are interesting times.
• Keep an eye on the news this weekend to see what
happens at Jackson Hole.
• And remember, what happens in the US are linked to
what happens in the EU and China.
• Next week:
• The International Trade students take a road trip.
• The rest of us have a class debate:
This house holds that the banks caused the
Financial crisis and should be held accountable
The Prof takes all comers.