What might make monetary policy more effective in the future?
It increasingly looks like the U.S. Federal Reserve will raise interest rates in September. So this month might be a good time to look back at the Fed’s extensive monetary stimulus and whether it was effective at helping the U.S. economy recover from the Great Recession. We should also consider what other alternatives might be available in the future.
Economic growth is now at about a 2 percent annual rate, up from the depths of the recession in early 2009, and overall jobs growth is cutting into the remaining labor market slack. But these gains were achieved because of extraordinary monetary policy in the face of fiscal tightening beginning in 2010 after some initial fiscal stimulus in 2009. As Brad DeLong wrote last week, “central banks do not have the will and may not have the power to aim for full employment even in the medium run at the zero lower bound without the assistance of fiscal policy.” The zero lower bound refers to the short-term nominal interest rates stuck at zero percent, as they have been since December 2008.
So perhaps it’s time to consider an idea that would make monetary policy less dependent on fiscal policy.
In the United Kingdom there is now a running debate about monetary policy thanks to comments from Jeremy Corbyn, a politician running for the leadership of the country’s Labour Party. Corbyn has called for a “people’s quantitative easing,” referring to another part of the unconventional monetary policy pursued by the Bank of England and the U.S. Federal Reserve in which the two central banks purchased a set amount of assets in the open market, among them mortgage-backed securities, to help drive down interest rates. The potential Labour leader’s idea might have a new name, but it’s very much an old idea. It’s more commonly known as “helicopter money.”
The idea gets its name from a metaphor coined by the late University of Chicago economist Milton Friedman. The Nobel Prize winner envisioned central banks dropping money from helicopters directly to the population as a simple way to jumpstart consumer demand. The idea was revived in recent years in a 2002 speech by future Federal Reserve Chair Ben Bernanke, who proposed helicopter money as a solution to the deflationary situation in Japan. But instead of purchasing bonds from the market and paying with recently created money, the central bank would simply give the new money to households.
Corbyn’s specific proposal differs as it would have the money go toward funding infrastructure investments. After the several rounds of quantitative easing in the United States and the seeming inability of monetary policy to promote strong growth on its own, helicopter money as Corbyn envisions it or in the classic household-centered version seems like it might be an idea worth considering. As Matthew C. Klein points out at FT Alphaville, the problem with quantitative easing seems to be its transmission mechanism. When the central bank purchases a large quantity of bonds in order to push down interest rates, it hopes that the rate decrease will be enough to spur investment by businesses or consumption by households. By directly handing money to households, the transmission is much clearer and hopefully more effective.
Yet there are concerns about this blurring of lines between fiscal and monetary policy. University of Birmingham economist Tony Yates, a former Bank of England staffer, worries that helicopter money might prove to be a slippery slope. Policy makers might think they can simply solve all of their problems by “harvesting magic money trees.”
Of course, helicopter money isn’t the only way to deal with concerns about the effectiveness of monetary policy. University of Chicago economist Amir Sufi has highlighted the breakdown in the redistributive nature of monetary policy. In Sufi’s telling, the unequal distribution of debt and its inflexible nature have been impediments to more effective monetary policy. Offering another idea, Miles Kimball of the University of Michigan has called for the abolition of physical currency to allow for negative nominal interest rates, which would let central banks set interest rates below the “zero lower bound.” Laurence Ball of Johns Hopkins has proposed raising the inflation target to 4 percent.
These proposed reforms are, of course, outside the conventional wisdom when it comes to monetary policy. Nor are they necessarily in conflict with each other. The Federal Reserve might also want to try using its current toolbox to the best of its ability. But in light of the past few years, or more specifically the past 38 straight months—when the Fed has missed its inflation target of 2 percent, perhaps some unconventional thinking is needed.