Must-Read: David Beckworth: It Takes A Regime Shift to Raise an Economy
…as the best way to deal with the zero lower bound (ZLB) problem….
The second possible direction of change for the monetary policy framework would be to keep the targets-based approach that I favor, but to change the target… [to] raising the inflation target, targeting the price level, or targeting some function of nominal GDP… to deal more effectively with the zero lower bound on interest rates. But economically, it would be preferable to have more proactive fiscal policies and a more balanced monetary-fiscal mix when interest rates are close to zero. Greater reliance on fiscal policy would probably give better results, and would certainly be easier to explain, than changing the target for monetary policy.
So Bernanke wants the Fed to keep its inflation target of 2% and complement it with more aggressive use of fiscal policy…. What could possibly go wrong? A lot, actually…. Fiscal policy would [only] have had 60 basis points [of inflation] on average with which to work over the past six years in closing the output gap. Do we really think that would be enough for the level of aggregate demand shortfall experienced over this time? What was needed was a monetary policy regime shift… a permanent increases in the non-sterilized portion of the monetary base to spur rapid growth in total dollar spending. It was never going to happen with a 2% inflation target…. To get the kind of robust aggregate demand growth needed to close the output gap back in 2010, there needed to be a sustained (but ultimately temporary) period of higher-than-normal inflation…