Quantitative easing: Walking the walk without talking the talk?

The extremely sharp Joe Gagnon is approaching the edge of shrillness: He seeks to praise the Bank of Japan for what it has done, and yet stress and stress again that what it has done is far too little than it should and needs to do:

Joe Gagnon: The Bank of Japan Is Moving Too Slowly in the Right Direction: “Bank of Japan Governor Haruhiko Kuroda’s bold program…

…has made enormous progress, but it has fallen well short of its goal of 2 percent inflation within two years. Now is the time for a final big push… The government of Prime Minister Shinzo Abe could help by raising the salaries of public workers and taking other measures to increase wages…. But the BOJ should not make inaction by the government an excuse for its own passivity…. The BOJ needs to make a convincingly bold move now… lowering its deposit rate to -0.75 percent… step up purchases of equities to 50 trillion yen…. The paradox of quantitative easing… is that central banks that were slowest to engage in it at first (the BOJ and the European Central Bank) are being forced to do more of it later…. If the BOJ does not move boldly now, it will have to do even more later.

Those of us who are, like me, broadly in Joe Gagnon’s camp are now having to grapple with an unexpected intellectual shock. When 2010 came around and when the “Recovery Summers” and “V-Shaped Recoveries” that had been confidently predicted by others refused to arrive, we once again reached back to the 1930s. We remembered the reflationary policies of Neville Chamberlain, Franklin Delano Roosevelt, Takahashi Korekiyo, and Hjalmar Horace Greeley Schacht gave us considerable confidence that quantitative easing supported by promises that reflation was the goal of policy would be effective. They had been ineffective in the major catastrophe of the Great Depression. They should, we thought, also be effective in the less-major catastrophe that we started by calling the “Great Recession”, but should now have shifted to calling the “Lesser Depression”, and in all likelihood will soon be calling the “Longer Depression”.

Narayana Kocherlakota’s view, if I grasp it correctly, is that in the United States the Federal Reserve has walked the quantitative-easing walk but not talked the quantitative-easing talk. Increases in interest rates to start the normalization process have always been promised a couple of years in the future. Federal Reserve policymakers have avoided even casual flirtation with the ideas of seeking a reversal of any of the fall of nominal GDP or the price level vis-a-vis its pre-2008 trend. Federal Reserve policymakers have consistently adopted a rhetorical posture that tells observers that an overshoot of inflation above 2%/year on the PCE would be cause for action, while an undershoot is… well, as often as not, cause for wait-and-see because the situation will probably normalize to 2%/year on its own.

By contrast, Neville Chamberlain was very clear that it was the policy of H.M. Government to raise the price level in order to raise the nominal tax take in order to support the burden of amortizing Britain’s WWI debt. Franklin Delano Roosevelt was not at all clear about what he was doing in total, but he was very clear that raising commodity prices so that American producers could earn more money was a key piece of it. Takahashi Korekiyo. And all had supportive rather than austere and oppositional fiscal authorities behind them.

But, we thought, monetary policy has really powerful tools expectations-management and asset-supply management tools at its disposal. They should be able to make not just a difference but a big difference. And yet…

There are three possible positions for us to take now:

1. In a liquidity trap, monetary policy is not or will rarely be sufficient to have any substantial effect—active fiscal expansionary support on a large scale is essential for good macroeconomic policy.
2. In a liquidity trap, monetary policy can have substantial effects, but only if the central bank and government are willing to talk the talk by aggressive and consistent promises of inflation—backed up, if necessary, by régime change.
3. We are barking up the wrong tree: there is something we have missed, and the models that we think are good first-order approximations to reality are not, in fact, so.

I still favor a mixture of (2) and (1), with (2) still having the heavier weight in it. Larry Summers is, I think, all the way at (1) now. But the failure of the Abenomics situation to have developed fully to Japan’s advantage as I had expected makes me wonder: under what circumstances should I being opening my mind to and placing positive probability on (3)?

(AP Photo/Koji Sasahara)