Must-Read: Ryan Avent: How should recessions be fought when interest rates are low?: “ONE day… bad news will blow in… a new recession will begin…

…During the next recession, the “zero lower bound” (ZLB) on interest rates will almost certainly bite again…. Broadly, economists see two possible ways out…. One is to change monetary strategy. Ben Bernanke, chairman of the Federal Reserve during the crisis, proposed a clever approach: when the economy next bumps into the ZLB, the central bank should quickly adopt a temporary price-level target. That is, it should promise to make up shortfalls in inflation resulting from a downturn…. If credible, that promise should buck up animal spirits, encourage spending, and drag the economy back to health…. Less clear is whether a central bank could fulfil its promise. The Fed has failed to hit its 2% inflation target for the past five years, after all….

The constraints facing central banks suggest better hopes for the second way forward—greater reliance on fiscal policy. This was the theme of a contribution to the conference from Olivier Blanchard and Lawrence Summers…. Fiscal and monetary policy would have to be closely co-ordinated—amounting, in all likelihood, to a loss of central-bank autonomy…. Just how troubling a loss of independence would be is intensely debated. Messrs Blanchard and Summers are themselves at odds on it….

Central-bank independence was an institutional response to the inflation of the 1970s, just as government business-cycle management was a response to the Depression. But the rules that underpinned the conditions of the 1970s seem no longer to apply…. In the 1970s, an intellectual shift within economics took place in tandem with the change in policy practice. The discipline could explain why predictable monetary policy set by independent central banks was preferable to a government’s attempts to spend its way to full employment. Yet things need not unfold that way this time. With economists at odds as future ZLB episodes loom, the example of the 1930s might be more apt. Then populist politicians struck out in unorthodox new directions, for better and occasionally much worse. It was only later that experts could settle on a coherent narrative of the crisis and recovery. That is not the ideal way forward. Yet it may be the only option available.