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September 13, 2010

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Paul Krugman: China, Japan, America

Posted: 13 Sep 2010 01:17 AM PDT

What should the US do about China's currency policy?:

China, Japan, America, by Paul Krugman, Commentary, NY Times: Last week Japan's minister of finance declared that he and his colleagues wanted a discussion with China about the latter's purchases of Japanese bonds, to "examine its intention" — diplomat-speak for "Stop it right now." The news made me want to bang my head against the wall in frustration.
You see, senior American policy figures have repeatedly balked at doing anything about Chinese currency manipulation, at least in part out of fear that the Chinese would stop buying our bonds. Yet in the current environment, Chinese purchases of our bonds don't help us — they hurt us. The Japanese understand that. Why don't we?
Some background: If discussion of Chinese currency policy seems confusing, it's only because many people don't want to face up to the stark, simple reality — namely, that China is deliberately keeping its currency artificially weak.
The consequences of this policy are also stark and simple: in effect, China is taxing imports while subsidizing exports, feeding a huge trade surplus. ... And in a depressed world economy, any country running an artificial trade surplus is depriving other nations of much-needed sales and jobs. Again, anyone who asserts otherwise is claiming that China is somehow exempt from the economic logic that has always applied to everyone else.
So what should we be doing? U.S. officials have tried to reason with their Chinese counterparts, arguing that a stronger currency would be in China's own interest. They're right about that: an undervalued currency promotes inflation, erodes the real wages of Chinese workers and squanders Chinese resources. But while currency manipulation is bad for China as a whole, it's good for politically influential Chinese companies — many of them state-owned. ...
Time and again, U.S. officials have announced progress on the currency issue; each time, it turns out that they've been had. ... Clearly, nothing will happen until or unless the United States shows that it's willing to do what it normally does when another country subsidizes its exports: impose a temporary tariff that offsets the subsidy. So why has such action never been on the table?
One answer, as I've already suggested, is fear of what would happen if the Chinese stopped buying American bonds. But this fear is completely misplaced: in a world awash with excess savings, we don't need China's money...
It's true that the dollar would fall if China decided to dump some American holdings. But this would actually help..., making our exports more competitive. Ask the Japanese, who want China to stop buying their bonds because those purchases are driving up the yen.
Aside from unjustified financial fears, there's a more sinister cause of U.S. passivity: business fear of Chinese retaliation.
Consider a related issue: the clearly illegal subsidies China provides to its clean-energy industry. These subsidies should have led to a formal complaint from American businesses; in fact,... "multinational companies and trade associations in the clean energy business, as in many other industries, have been wary of filing trade cases, fearing Chinese officials' reputation for retaliating ... and potentially denying market access to any company that takes sides against China."
Similar intimidation has surely helped discourage action on the currency front. So this is a good time to remember that what's good for multinational companies is often bad for America, especially its workers.
So here's the question: Will U.S. policy makers let themselves be spooked by financial phantoms and bullied by business intimidation? Will they continue to do nothing in the face of policies that benefit Chinese special interests at the expense of both Chinese and American workers? Or will they finally, finally act? Stay tuned.

"All I Got was This Lousy T-Shirt"

Posted: 13 Sep 2010 01:08 AM PDT

Why do people believe that the stimulus was ineffective even though there's considerable evidence pointing in the other direction?:

Second Helpings, by James Surowiecki: When President Obama unveiled an array of new tax-cut and spending proposals last week, one word was noticeably missing from his speeches: "stimulus." Republicans, meanwhile, energetically set about decrying the plan as "more of the same failed 'stimulus' "... as if the word itself were a damning indictment. ... This wouldn't be surprising if we were talking about a failed program. But, by any reasonable measure, the $800-billion stimulus package ... was a clear, if limited, success. ...
Politically, however, none of this has made any difference. Polls show that a sizable majority of voters think that the stimulus either did nothing to help or actively hurt the economy, and most people say that they're opposed to a new stimulus plan. The hostility has numerous sources. Many voters conflate the stimulus bill with the highly unpopular bailouts of the banking sector...; Republicans have done a good job of encouraging such misconceptions... Also, the ... Administration's forecasts about the recession ... were too optimistic, and so its promises about what the stimulus would accomplish set the public up for disappointment.
But the most interesting aspect of the stimulus's image problems concern its design and implementation. Paradoxically, the very things that made the stimulus more effective economically may have made it less popular politically. For instance, because research has shown that lump-sum tax refunds get hoarded rather than spent, the government decided not to give individuals their tax cuts all at once, instead refunding a little on each paycheck. The tactic was successful at increasing consumer demand, but it had a big political cost: many voters never noticed that they were getting a tax cut. Similarly,... the billions of dollars that went to state governments ... helping the states avoid layoffs and spending cuts ... didn't get much notice..., saving jobs just isn't as conspicuous as creating them. Extending unemployment benefits was also an excellent use of stimulus funds... But unless you were unemployed this wasn't something you'd pay attention to.
The stimulus was also backloaded, so that only a third was spent in the first year. This reduced waste, since there was more time to vet projects, and insured that money would keep flowing into 2010, lessening the risk of a double-dip recession. But it also made the stimulus less potent in 2009, when the economy was in dire straits, leaving voters with the impression that the plan wasn't working. More subtly, while the plan may end up having a transformative impact on things like the clean-energy industry, broadband access, and the national power grid, it's hard for voters to find concrete visual evidence of what the stimulus has done... That's a sharp contrast with the New Deal legacy of new highways, massive dams, and rural electrification. Dramatic, high-profile deeds have a profound effect on people's opinions, so, in the absence of another Hoover Dam or Golden Gate Bridge, it's not surprising that the voter's view is: "We spent $800 billion and all I got was this lousy T-shirt." ...

A little over a year ago, I talked about why it's so hard to tell if the stimulus worked:

This sounds familiar:

Ecology is one of the hardest branches of biology, possibly of all science. Real ecological communities are fantastically complex ... and hard to dissect and understand. Experiments in the wild are difficult to control, and important variables are often hard to measure. ... Experiments in the laboratory are problematic too. ...

Much of the uncertainty in economics derives from our inability to do laboratory experiments, and that includes uncertainty about which model best describes the macroeconmy. 

When the present crisis is finally over, those who advocated fiscal policy, those who advocated monetary policy, and those who advocated no policy at all will all say "I told you so" based upon their reading of the evidence.

Some New Keynesians will cite fiscal policy as the important policy response, and the timing of the policy relative to the recovery will likely support that argument. Other New Keynesians along with Monetarists (e.g. Lucas and others who believe monetary policy can help, but fiscal policy is ineffective) will insist it was monetary policy that saved us. The timing of the monetary policy response will support their position as well.

Still others, those such as Prescott who believe in Real Business Cycle models, will say the economy recovered despite policy, and would have recovered all that much faster if government hadn't gotten in the way. Without a baseline to refer to showing what would have happened without policy, it would be hard to refute this argument.

Once this is all over, there will be ways to tease this out of the data, e.g. the pattern of the response of key macroeconomic variables may be most consistent with one of the policies, but there will still be considerable uncertainty due to the high correlation in the timing of the monetary and fiscal policy responses (cross-country studies could help too since the policy response varied by country, but other differences across countries that are difficult to control for making these estimates uncertain as well).

Ideally, we would go to the lab and run the economy with the same initial conditions, say, 1,000 times with no policy intervention at all to establish the average non-intervention response (and its variance), i.e. the baseline, an important missing piece of information when all you have is non-experimental data. Then, we would run the economy again with a monetary policy response to the crisis 1,000 times (or do several experiments with different monetary policy responses to see which is best), and yet again 1,000 more times with fiscal policy (or, as with monetary policy, perhaps several fiscal polices involving different levels of spending and taxes), then compare the results to see how well each policy attenuates the cycle. (I would also want to run the economy with several combinations of the two polices in case there are important interaction effects the experiments with individual treatments might miss.)

That would probably give us a pretty good idea about which policy works best. However, without the ability to do experiments, the best we can do is to build a model of the economy based upon historical data, and then use the model to simulate the experiments above. That is, estimate the model based upon actual data, then run it with various combinations of monetary and fiscal policy and see how the outcome varies with differences in policy. Unfortunately, the answers you get are only as good as the model used to get them, and considerable uncertainty remains over which macroeconomic model is best (which is why we have Real Business Cycle, New Keynesian, and Monetarist type macroeconomic models along with all their various sub forms).

Here's another way to think about it. Macroeconomists know all of the major historical episodes and correlations that a model must explain. We can't do experiments, so there is just one set of data, and of course any model that is built will be able to explain how these data evolve over time. And it's possible to build different models that explain the data equally well. If we could do experiments, we could test these models in ways that would potentially rule some of them out, but with just one set of data and models built specifically to explain the data such testing is not possible.

So we have to wait for time to bring us more data and then see if the model can explain them, test the models across countries, find things we didn't know about when we built the model and test the model against those -- and there are other ways to get at this -- but for the most part it's time that settles these issues. The models either do or do not continue to explain new data as they arrive (e.g. an unexpected Great Recession).

But at any point in time, it will be difficult to distinguish between different models because those models are built to explain everything that is known about the historical macro data. Perhaps some time in the distant future when we have much more data than we have now, it will become more difficult to construct competing models and we will begin to converge on a common theoretical structure -- it seemed like we were headed in that direction prior to the recent crisis -- but for now we are stuck arguing about which model is best without the means to turn to the data and clearly distinguish one from the other.

Fed Watch: The Fair

Posted: 13 Sep 2010 12:42 AM PDT

Tim Duy:

The Fair, by Tim Duy: A man takes his son to the county fair; the lights and sounds of the amusement rides are like a magnet to the boy. The boy, however, is penniless. His father, seeing the longing in his son's eyes, hands the boy a dollar for the rides, but quizzically adds "if it looks like you are about to have any fun with that dollar, I will take it back from you." The boy is puzzled. First, a dollar only buys three tickets, and the least expensive ride is four tickets. Plus, Dad said he would take the dollar back if he went to buy tickets. So what is the point of even trying to buy any tickets?

Consequently, the father and son stand at the edge of the midway, the father wondering why his son simply stands there while the son wonders why his dad doesn't want him to have any fun. They are soon joined by the boy's grandfather, who, assessing the situation, says that the father should never have given the son a dollar in the first place. "He will just buy candy, which will cost you more later when you have to take him to the doctor to treat diabetes." The father neither agrees or disagrees. Along comes a trusted uncle, who says to give the boy another dime, but " then if he looks like he will have any fun, take back a quarter."

The grandfather and uncle start bickering, loudly, in public, about what to do with the boy and his dollar. Soon another uncle rushes into the fray, proclaiming it is pointless to give the boy a dollar because all the workers are already busy helping other fairgoers. "He can't buy anything anyway, and if he tries, he will just drive up prices for all his cousins." The discussion becomes increasingly heated, drawing the boy's cousins away from the rides. The lights and noise of the fair fade as lines dwindle and the rides grow silent.

All the while, the confused boy is wondering why his father just stands there, refusing to criticize the grandfathers and uncles even as the argue increasingly silly positions. Finally, the father, realizing the boy's confusion, turns to him and says "Reaching consensus in the family is always more important than the fair." The arguing continues as employees begin to turn off the rides, one by one.

This, I believe, is an apt analogy of the current state of monetary policy. A policy that is supporting disinflationary expectations simply because it lacks a credible commitment to any other outcome.

Why does policy lack a credible commitment? First, as I think has been clear from day one of the Fed's quantitative easing policy, policymakers eagerly await the opportunity to reduce the balance sheet - the expansion of the balance sheet was never intended to yield a permanent increase in the money supply, and as such should have had little impact on long run expectations. As recently as Federal Reserve Chairman Ben Bernanke's July Congressional testimony, policymakers were stressing the ability of the Fed to reduce the balance sheet, clearly much more concerned about the inflationary potential of their actions than the ongoing disinflationary impact of being stuck at a subpar equilibrium. Only recently has attention turned to the possibility of additional action, and then only under critical pressure. When additional action is taken, it will almost certainly be in the context of a temporary action, the Fed will stand ready to withdraw the stimulus should it look like economic agents are having any fun with that infusion of cash.

Moreover, I do not believe the swelling of the balance sheet - albeit massive in the eyes of policymakers - sufficed to convince market participants that the Fed was committed to maintaining inflation expectations. St. Louis Federal Reserve Chairman James Bullard, in his "Seven Faces" paper, claims that the suggestions that the appropriate Federal Funds target should have been negative 6% are "nonsensical." And, of course, in a sense they are - zero is indeed the lower bound. But economists also suggested estimates of the quantitative equivalent of negative 6%, perhaps something on the order of a balance sheet expansion to $10 trillion, far beyond what Fed policymakers found tolerable. And I think that big number was important - it gave an indication of the size of monetary commitment consistent with previous policy response. The failure to meet that commitment could reasonably be interpreted by market participants as an indication the Fed was willing to accept the disinflationary impact of the Great Recession, perhaps so far as seeing the event as another opportunity for opportunistic disinflation.

Moreover, any sense that the policy action to date was acceptably insufficient was reinforced by the Fed's own forecasts, which undeniably reveal an expectation that policymakers anticipate an agonizingly long recovery, yet decline to add additional stimulus. Recall that the most recent FOMC decision only prevents premature tightening of policy, not a stimulus boost. Moreover, consider Bullard's remarks Friday:

"The consensus is developing in the forecast community that we've got a slower economy in second half of this year," said Bullard, who is known to be an outspoken hawk on monetary policy. "But we will pick up in 2011, probably back to trend growth, or even better."

Note that this is this forecast remains in the context of current policy:

"I think we have to be prepared to move, and I think the committee is much closer to being prepared than we were, say in June, or May of this year," Bullard said, although he added, "I don't think it will be necessary to take additional action."

It is important to note that a return to potential growth does little more than prevent the output gap from expanding further, little more than absorbing the natural expansion of the labor force, with little hope of reemploying the millions who lost their jobs in 2008 and 2009.

In short, policymakers feel no urgency to engineer a V-shaped recovery, to return output to potential. They won't provide enough to buy tickets for the rides, and they know it.

Now, Bullard is currently one of the most rational policymakers, and is at least willing to intellectually entertain the need for additional stimulus. But even here, he is not willing to offer policy of the magnitude necessary to rapidly return to potential. From his response to my earlier piece:

When we make 25 basis point moves on the federal funds rate, those are small viewed in isolation, but they have important effects for macroeconomic stabilization because they imply an expected interest rate path over the coming years. The same is true for QE. A move on a particular day may seem small, but it implies a path for future policy, and a series of smaller moves may add up to a very large move if the incoming data are consistent with such an outcome. The "shock and awe" view, if applied to interest rate targeting, would suggest very large interest rate movements in response to relatively small changes in incoming data, a policy that most would view as destabilizing for the macroeconomy. The same is true for QE. So the point is that QE moves should be commensurate with the incoming data (a.k.a. "state contingent"). Of course we can argue about the incoming data--and I know you have strong views on that--but I think my position on a "disciplined" QE program is correct and that the dangerous policy is to make destabilizing moves out of line with the incoming data.

This sounds like the uncle who advises giving the boy another dime. Still not enough to buy tickets for the rides, and with the explicit warning that what was given will soon be taken away.

The problem here, I have come to realize, is that Bullard and I are talking across each other, not to each other. In the context of the Fed's forecast, his position is reasonable. He is looking at incremental changes, give some here, take some back there, to manage expectations along the current trajectory, one that everyone acknowledges will only reduce the output gap at an agonizingly slow pace. Whereas I feel an urgency to close that gap, policymakers, in my opinion, exhibit a sense of complacency about the gap.

But the gap itself is important to managing disinflationary expectations. By not specifically targeting the gap, the Fed is implicitly accepting the disinflationary consequences. If the US falls into a Japan-style malaise in the wake of this, or what I think is more likely, the next recession, I believe it will be attributable a clear unwillingness of Fed policymakers to view potential output as a relevant policy objective

Instead of making incremental changes to the level of the balance sheet, I would prefer incremental changes to the rate of growth of the balance sheet. Make an explicit promise to keep feeding the kid at the fair quarters until it looks like he's about to throw up while riding the Ferris wheel.

And, next, we come to the issue of consensus - the public bickering of the boy's elders. I do believe consensus is important, or that at least in private, all decision makers believe they have had adequate opportunity to define their positions. I do not, however, believe it is conducive to good policymaking to air vast policy differences in public. Seriously, we have a regional Fed president running around loose claiming that low interest rates will only entrench deflationary expectations, seemingly unable to grasp the concept that those deflationary expectations are driving rates lower. And has any Fed official offered an explicit response?

Talking points exist for a reason. They are important. They help manage expectations. They provide at least a veneer of policy consistency. Federal Reserve Chairman Ben Bernanke appears to see no need to enforce a set of talking points. This, I think, is a mistake, as it lets policy expectations be driven by the likes of Minneapolis Fed President Narayana Kocherlakota , Dallas Fed President Richard Fisher, and Kansas City Fed President Thomas Hoenig.

Coming clean, I admit that basic public consistency was something I appreciated during the reign of former Federal Reserve Chairman Alan Greenspan. I recall an incident, back in the day, when a regional Fed president made a comment that was decidedly out of line with the public stance of policy at the time. The press grabbed it, as they should have. I can't remember the comment itself, and it really is not important now. What was important was that a few days later, former Governor Edward Gramlich made a countervailing remark that was particularly notable because it was out of context with his presentation. It was a clear effort to reinforce expectations around the current policy. Soon thereafter I had an opportunity to talk with Gramlich, and ask him if he had been asked by Greenspan to set the record straight. He indicated that this was indeed the case.

Some would call this dictatorial; I just think it is good policy. Particularly good for an agency that claims managing expectations is an important element of conducting policy.

Finally, I would add that it is not clear the father should even given the boy money to buy tickets. Why not just cut out the middle man and give the boy tickets directly? Quantitative easing is arguably simply trading one ultra safe asset for another, hoping to induce others to acquire riskier assets. Unfortunately, the avenues by which the Federal Reserve can acquire riskier assets, like an outright portfolio of equities, are limited. The Fed, however, could buy foreign sovereign debt, thereby driving down the value of the Dollar. Predictably, Bullard dismisses the notion:

Bullard also noted large countries with very low interest rates and weak pricing environments, like the U.S., Japan, Europe and potentially the U.K., cannot use their exchange rates to boost inflation away from deflationary levels. He said such an action "might not be prudent, and it might not be possible."

Bullard also noted that in this time of anxiety about currency levels, the evidence on the effectiveness of central bank interventions is "mixed," even though those are the sort of moves "traders seem to pay attention to." Bullard also added, "The dollar, obviously, is and will remain a reserve currency for a long time."

Policymakers always revert to the "interventions are not effective" straw man when discussing currencies, ignoring the elephant in the room - China appears perfectly capable of targeting very specific levels of the exchange rate. And we seem to believe that such a policy contributes to inflation in China. Yet the same is not true for the US?

The issue is simply one of commitment. In the absence of crisis, Federal Reserve policymakers refuse to look at policy via any lens beyond interest rates and the most simple exercise of balance sheet expansion. They could very well anchor inflation expectations against a steady depreciation of the dollar or other assets prices. They could stop thinking of foreign exchange purchases as one-time events, and instead acquire at a fixed rate, say $1 billion a day. Virtually every other nation believes prudence demands the establishment of large foreign currency reserves. Why should the US differ?

Bottom Line: Although the Federal Reserve is poised for another round of quantitative easing, it is important to recognize their ultimate objective. It is not to pursue an a rapid return to potential output in order to rapidly alleviate unemployment. It is simply to maintain policy expectations in the context of a return to potential growth. Thus, one should expect the actual easing to be commensurate with such a policy. In other words, pay attention to what Bullard is saying - "measured" policy action. This, in my opinion, will be too little too late, as I am more concerned with an aggressive assault on unemployment and believe that using potential growth as a policy reference effectively locks the US into a suboptimal equilibrium.

links for 2010-09-12

Posted: 12 Sep 2010 11:02 PM PDT

Boehner Signals He’s Open to Obama Tax Cut

Posted: 12 Sep 2010 11:50 AM PDT

Is Boehner backing off his position that the tax cuts for the wealthy must be extended?:

House G.O.P. Leader Signals He's Open to Obama Tax Cut, by David Herszenhorn, NY Times: The House Republican leader, Representative John A. Boehner of Ohio, said on Sunday that he was prepared to vote in favor of legislation that would let the Bush-era tax cuts expire for the wealthiest Americans if Democrats insisted on continuing the lower rates only for families earning less than $250,000 a year.
Speaking on "Face the Nation" on CBS, Mr. Boehner made clear that he supports continuing the lower tax rates at all income levels and that he believes the Democrats would be making a mistake by increasing taxes on anyone, given the weak economy.
Mr. Boehner ... said... "I think raising taxes in a very weak economy is a really, really bad idea," ...

That's very Keynesian of him to have the concern that "raising taxes in a very weak economy is a really, really bad idea," and there's an easy response for Democrats, one I discuss here. The Democrats say okay, if that's your concern, why not transfer the tax cuts, temporarily, to lower income groups who are much more likely to spend the money, or use it to backfill state and local budgets to stop further job losses? There are all sorts of ways to use the money that would be more stimulative than continuing the tax cuts for the wealthy, so if your objection is that raising taxes in a recession is "a really, really bad idea," then transfer the tax cuts where they will do the most good.

One more note. I am not expecting that Boehner will support the bill when it comes time to actually cast a vote. This is political posturing that is probably based upon polling data showing that most people do not support his original position. If and when it comes time to cast his vote, he will likely find some other provision in the bill, or some consideration he will claim was not present when he made this statement, to rationalize a no vote.

Williamson: Monetary Policy Issues

Posted: 12 Sep 2010 10:29 AM PDT

Stephen Williamson discusses the Wall Street Journal Symposium on monetary policy. He reacted much as I did, though as noted below I at least found one statement I could support:

Two days ago, the Wall Street Journal published a "symposium," titled "What Should the Federal Reserve Do Next," with short pieces by John Taylor, Richard Fisher (Dallas Fed President), Frederic Mishkin, Ronald McKinnon, Vincent Reinhart, and Allan Meltzer. The WSJ picked a group of conservative economists with a considerable amount of accumulated policy experience among them, and including one sitting Federal Reserve Bank President (Fisher). One would think we could get something useful out of these guys. Well, apparently not.

While I mostly agree with what he says, I have a few quibbles. Stephen Williamson says:

Many central banks focus on "core" measures of inflation. I think that's nonsense. The idea is that we should ignore volatile prices when we think about inflation targeting, which seems akin to ignoring investment and consumer durables expenditures during recessions. Some people draw distinctions between prices that are "sticky" and those that are not, which seems like a related, and equally bad, idea. Since the costs of inflation are related to the fact that we write contracts in nominal terms, which makes inflation uncertainty bad, it seems we should aim for predictability in the rate of change in the broadest possible measure of the price level, which for me is the implicit GDP price deflator.

Monetary policy works with a lag, so we need to know about inflation in the future -- that's the target we are trying to hit. There is evidence core inflation is better than headline inflation at predicting future headline inflation. Here's Mike Bryan of the Cleveland Fed (see here too):

Michael Bryan, an economist at the Cleveland Fed, says the bank's trimmed mean consumer price index does a better job in the short term at predicting future overall inflation than core inflation does. "It's really reducing the noise and improving the signal," Bryan said. "There's almost no signal in the overall month-to-month CPI."

The same is true for inflationary expectations. I should add that the evidence is a bit more mixed than this implies, e.g. there is one paper that argues the core inflation rate produces a biased estimate of future inflation, but my point is that there isn't an open and shut case against the use of core inflation even if you think headline inflation is the right quantity to target. We also differ on which price measure to use, I prefer the PCE index rather than the nominal GDP deflator since I think it produces a measure closer to what we have in mind in our theoretical models.

I should also add that the objection to using a weighted price index, perhaps one that includes wages and asset prices in addition to the usual components -- where the weights are based upon the degree of stickiness -- is really an objection to the underlying mechanism used to model price stickiness (the "Calvo Fairy"). If you accept the mechanism, then this approach has theoretical support (see here for a discussion from Woodford on this point).

He also objects to the use of the output gap in the Taylor rule, partly based upon measurement issues, and calls for pure inflation targeting. However, while I agree measurement is always a difficult issue, one that goes beyond concerns about how to measure the gap (e.g. which inflation measure is best?), that concern is not uncommon and not enough to pose an insurmountable objection. More importantly, the literature on divine coincidence (here and here) suggests that there can be advantages to a rule that includes gap measures. That is, a pure inflation target does not do as good a job of maximizing welfare as a rule that includes both inflation target and and output gap components.

But I have no disagreement at all with his (mostly negative) comments regarding the contributions of Fisher, Taylor, and Meltzer. On Fisher he says:

Let's start with the low point. Fisher should win the bad analogy contest with this:
One might assume that with more than $1 trillion in excess bank reserves and significant amounts of cash held by businesses, the gas tank of those who have the capacity to hire is reasonably full. One might also conclude that the Fed, having cut the cost of interbank overnight lending to near zero and used quantitative easing to coax the entire yield curve downward, has driven the cost of gas to virtually nil for businesses that are creditworthy. And yet businesses still aren't hiring.
So, the gas is in the tank, the Fed has done all it can by making the cost of gas zero. So why won't the car go? Fisher says:
If businesses are more certain about future policy, they'll release the liquidity they're now hoarding.
He's talking about fiscal policy:
Fiscal and regulatory authorities share significant responsibility for incentivizing economic behavior through taxes, spending and rule making.
So, apparently the person driving the car, which is full of cheap gas, is paralyzed with fear - he or she might get stopped at the toll both, have to obey speed limits, etc. If Fisher is worried about policy uncertainty, he should probably clean his own house first (to use another analogy). What does the Fed intend to do with the more than $1 trillion in mortgage-backed securities (MBS) on its balance sheet. Will it hold those forever? Will they be sold off slowly? If so, when, and at what rate? What's with that "extended period" language in the FOMC policy statement? How long is that period? How do we know when it is time for the Fed to tighten? When the time comes to tighten, how does the Fed intend to do it - raise the interest rate on reserves, sell Treasuries, sell MBS?

Finally, Williamson doesn't discuss the contributions of Reinhardt, McKinnon, and Mishkin, and while Mishkin and McKinnon deserve to be ignored, I thought Reinhardt had the most reasonable answer, one I could support:

The Fed should promise to purchase government and mortgage-related securities between its regularly scheduled meetings as long as activity is forecast to be subpar and inflation is low or headed down. Purchases of, say, $100 billion every six-to-eight weeks would add up to a number worthy of shock and awe for those with a somber economic outlook.
But those foreseeing a quick return to above-trend growth or expecting a slower trend would similarly be reassured that the Fed would not keep its foot on the accelerator for too long. Most importantly, by linking to economic conditions, the Fed would not be providing an open-ended promise to monetize the federal debt.

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