Friday, October 14, 2011

As Tyler Cowen says, the Fed moves last. So, how does the Fed move? Scott Sumner:
I don’t doubt that a WWII-style military build-up would more than offset Fed policy conservatism. But what about politically plausible stimulus, say another $400 billion? I see the most likely outcome as a modest boost to the economy, which pushes up oil prices and headline inflation, which frightens the Fed, which leads the Fed to refrain from additional unconventional stimulus that they would otherwise do.

How do I know that the Fed would otherwise do more monetary stimulus? I don’t, but that’s certainly been their pattern over recent years, whenever the economy faltered. And there are already rumblings of the possibility of additional stimulus. And the number of hawks on the FOMC drops from 3 to 1 in January.

None of this means I’m right–as I’m no mind-reader. But if you look at how the Fed actually behaves, rather than what Bernanke says or “really” believes, then you are forced to conclude that the 2009 stimulus was sabotaged. That stimulus was not enough to create a robust recovery, even with unconventional Fed moves. If they hadn’t done that stimulus, it looks like the Fed would have done a more aggressive stimulus, as they seem determined to keep core inflation in the 0.6% to 2.0% range. And thus if we’d never done the 2009 fiscal stimulus, we’d probably be about where we are now–9.1% unemployment and 2% core inflation. But with a much smaller national debt.

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