QE Has Failed; Try Something New
"This country needs, and unless I mistake its temper, the country demands bold persistent experimentation.It is common sense to take a method and try it. If it fails, admit it frankly and try another. But above all, try something."
The Year Ahead 2018
The world’s leading thinkers and policymakers examine what’s come apart in the past year, and anticipate what will define the year ahead.
I have been blogging about the failure of QE to achieve its objectives: 2% inflation and 6.6% unemployment (currently .8% and 7.6%.) Additionally, both real (1.8%) and nominal (3.4%) growth are subpar for three years into a “recovery” . The economy is growing, but is stuck in second gear, which is insufficient to clear the labor market. By now we should be seeing precrash growth of 6-7% nominal and 3-4% real, and unemployment should be close to 5%. We are far from these numbers, and this failure is having real-world consequences.
I have discussed the failure of the Fed to increase inflation expectations, the failure of bond-buying to grow the money supply due to liquidity hoarding by banks, and the attenuation of the linkage between the money supply and nominal growth due to the broken credit system.
It is clear that the Fed cannot simply continue to do what it is doing, or even worse, to stop trying. As FDR said, it is a time for bold experimentation. The status quo is riskier than unconventional policy experiments.
The crux of the problem is low inflation and low inflation expectations. Statements by the FOMC no longer have any credibility with respect to the formation of inflation expectations. The time has come for the Fed to stop fooling around and raise the rate of inflation to 4%, now. The best way to raise inflation expectations is to raise inflation.
Bernanke has advocated inflation-targeting, which is to target the price level which would have been reached if previous policy had been successful. In other words, when you fall behind your target, you speed up and create above-target inflation. I’m not going to whine about the hawks who would squawk if inflation went above 2%; that’s politics and I’m talking policy.
The only way that we can get to 4% real growth is via 6-7% nominal growth, which will initially require around 4% inflation. Since we know that inflation is always and everywhere a monetary phenomenon, we cannot accept the FOMC’s excuses about why we are running far below the Fed’s target. Any schmo off the street can create inflation. I am holding in my hand a half-inch stack of one hundred trillion dollar notes, issued by the Reserve Bank of Zimbabwe in 2008. That’s one hundred times one hundred trillion or ten quadrillion dollars, in the palm of my hand. If Mugabe can create hyperinflation, we can create 4% inflation.
Mugabe created hyperinflation by monetizing massive fiscal deficits. But it does not require massive fiscal deficits to create inflation. All a central bank has to do is to buy stuff with newly-printed money until the price level begins to rise at the desired pace or to the desired level. Let’s remember that the FOMC succeeded in creating double-digit inflation in the 1970s--without even trying!
So here is my laundry list of ideas for the fed to experiment with:
1. Stop buying bonds from banks, and monetize the entire deficit by buying bonds directly from the Treasury. Ditto with agency paper.
2. Buy nonbank assets, such as precious metals and ETFs.
3. Stop paying interest on reserves and, if necessary, charge a custodial fee for holding reserves.
4. Buy foreign government bonds of all denominations and ignore the resulting noise.
5. Buy anything you can denominated in RMB. Turnabout is fair play.
6. Buy private-label RMBS and ABS.
But above all, try something.