There is a recurring theme among the Fed’s critics (and its dissidents) which runs like this: “The economy has been living on extraordinary monetary stimulus due to QE and the has become addicted to this dangerous drug. It is time to wean the economy off of this dangerous drug in order to return to a more normal state.”
Those who express this view believe that the Fed has been providing the economy with extraordinary monetary stimulus since 2008. I can only ask that they look at the actual data, which show that money growth since the Crash has averaged in the mid-single digits, which is less than money growth in previous recoveries. The economy has received no “artificial stimulus”. The Fed’s futile machinations with QE1, QE2 and QE3 have failed to produce rapid monetary growth. Since 2008, the economy has not been on stimulants, it has been starved for oxygen.
I think this point bears emphasis: the modest recovery in economic growth and employment experienced since the Crash has not been accompanied by rapid money growth. I have to keep repeating this because it just doesn't seem to sink in. The economy hasn't been on cocaine; it's been on aspirin. There is no dangerous drug for the economy to get off of.
This is not because the Fed has not sought to get control of the money supply, but because it has failed to do so. The Fed has not had control of money growth since the Crash. The Fed has pursued radical balance-sheet expansion since the Crash; it has tripled its balance sheet buying bonds from banks. But this maneuver has failed to affect the money supply because all of that money is still on deposit at the Fed (see Samuelson*), where it does no good. The Fed may as well have been buying art for its offices for all the good that $2T in bond purchases has done. The monetary transmission vector is broken because the linkage between the Fed's balance sheet and the money supply (the money multiplier) has been severed (or never existed). To analogize: the Fed's foot is on the accelerator; the tachometer reads 5000 RPM; but the car is in neutral and the speedometer reads zero. It’s not the motor that’s broken; it’s the transmission.
I don't know why the FOMC thinks that if it keeps pushing hard on the accelerator that the car will start to move, when it hasn't moved in four years; saplings are now growing in the front seat. There is nothing in the minutes or speeches that I have seen that even acknowledges this problem, let alone suggesting an alternative option. I did come across a staff a paper* on the subject of the money multiplier which,using empirical analysis, concludes that the money multiplier does not exist. This should be pretty obvious from the experience of the past four years, when the M1 multiplier has declined from 180% to 60%. (You read that right: the Fed’s balance sheet is now bigger than M1; the Fed does not control M1 or M2.
Let's go back to basics (and to morality). It is the lawful responsibility of the Fed to maintain full employment. It has failed to fulfill this mandate for the past four years. Unemployment has remained high while nominal growth has remained low. Parents are out of work, and young people can't find work. The Fed has failed to perform its duty to these people.
Bernanke is aware that in the past half-century, the US economy has never delivered full employment with nominal growth of less than 5%. Indeed, during the good years (Johnson, Reagan, Clinton, Bush), nominal growth has tended to be in the 6-8% range, or even higher after recessions. Nominal growth at the pace experienced since the Crash (3-4%) has been stuck at what used to be considered a recessionary level. Thus, the Fed has not been guilty of nonfeasance, because it has tried, but of misfeasance, because it has failed, and there is no moral excuse for failure.
Let's all agree that 4% real growth is what is needed to achieve full employment, and that 4% real growth never has and never will be achieved with less than 6% nominal growth. Therefore, to fulfill its mandate the Fed must grow the money supply (not the monetary base) fast enough to generate 6% nominal growth. More of the same policy (QE) is not going to get there, because QE does not affect money growth, not lately anyway. It is not that the quantity theory is wrong, or that "monetary policy has lost its efficacy". It is rather that the Fed has not found the right lever to influence money growth.
We must acknowledge that this is the first time in history that the Fed has had to conduct monetary policy at the zero bound, and the only textbook on how to do this was written by Bernanke himself. It's not like Bush and Obama have picked the wrong guy for that job (and I shudder to imagine how things might have turned out with a different person in the chairman’s seat).
But, as I have said before, what Chairman Bernanke has been doing is different from what Professor Bernanke said we should do. When he went to Tokyo a decade ago to lecture the BoJ on how to operate at the zero bound, he did not tell them to grow their balance sheet. He did not even tell them to target inflation. He told them to target a price level, which would require higher than normal inflation. In other words, when you fall behind schedule, speed up in order to stay on schedule. Instead, the Fed has been targeting inputs ($85B/mo.) instead of outcomes.
The Fed is supposedly targeting employment, but you wouldn't know it from the unemployment rate. The Fed is supposedly targeting 2% inflation, but you wouldn’t know it from the data. The Fed is becoming a blue-eyed BoJ with endless reflationary campaigns that never work. If the Fed were really targeting employment, it would do something new until it got there. And tapering off QE is not trying something new; it’s giving up.
I am not going to revisit the sob story about how poor Ben has been stymied by those awful hawks on the FOMC. He's been chairman for eight years; it's his Fed; it's his policy; and it's his economy. He has failed as Fed chairman if he leaves office with his mandates unfulfilled and twelve million people out of work. I have lost any sympathy for his managerial challenges, or for his desire for a collegial consensus; they are no longer an adequate excuse. The measure of success is hitting your targets.
In a previous post, I offered a non-exhaustive list of things that the Fed could employ to grow the money supply. I will repeat them:
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 squawks from the G-7.
5. Buy anything you can find denominated in RMB. Turnabout is fair play.
6. Buy private-label RMBS and ABS.
*“By increasing the volume of their government securities and loans and by lowering Member Bank legal reserve requirements, the Reserve Banks can encourage an increase in the supply of money and bank deposits. They can encourage but, without taking drastic action, they cannot compel. For in the middle of a deep depression just when we want Reserve policy to be most effective, the Member Banks are likely to be timid about buying new investments or making loans. If the Reserve authorities buy government bonds in the open market and thereby swell bank reserves, the banks will not put these funds to work but will simply hold reserves.” Paul Samuelson, “Economics”, 1948.
**Carpenter and Demiralp, “Money, Reserves, and the Transmission of Monetary Policy: Does the Money Multiplier Exist?”, FRB, May 2010.