# Jon Hilsenrath, Brian Blackstone and Lingling Wei on Monetary Policy: Low Rates and QE "Didn’t Cause the Hyperinflation or Obvious Asset Bubbles that Some Lawmakers and Critics Feared"

The well known gap between the Wall Street Journal news pages and editorial pages is well illustrated today in this passage from the article “Central Banks in New Push to Prime Pump” by monetary policy reporters Jon Hilsenrath, Brian Blackstone and Lingling Wei:

The Fed pursued low-rate, QE experimentation for half a decade. It pushed U.S. short-term rates to near zero in December 2008 and promised to keep them there for long periods. Convinced that wasn’t enough, it then launched several rounds of bond purchases that helped push its portfolio of securities, loans and other assets from less than $900 billion to more than$4 trillion.

The policies didn’t cause the hyperinflation or obvious asset bubbles that some lawmakers and critics feared. The fact that the U.S. economy is now doing better than Europe’s or Japan’s suggests the policies helped boost growth, although the degree of support is a matter of great disagreement among economists.

I fully agree with that assessment. I disagree with two other places in the article where they quote Eswar Prasad and Liaquat Ahamed without quoting any contrary views. Here are my contrary views.

Jon, Brian and Lingling write:

Global economic weakness creates a dilemma for the U.S. If the Fed pulls away from easy money as other central banks ramp up money-pumping policies, it could drive up the value of the U.S. dollar, straining U.S. exports. It also could put downward pressure on U.S. inflation and on commodities prices, which are typically denominated in dollars.

Eswar Prasad, a Cornell University professor and former International Monetary Fund economist, said those developments would make it harder for the Fed to move ahead on rate increases.

This is not a dilemma for the US at all. What happens in the rest of the world matters a great deal for the US economy; the greatest dangers the US economy faces in the next few years are bad news about how other nations’ economies are faring. Given this stake we have in the world economy, when the rest of the world is struggling with low aggregate demand and the US central bank is thinking of raising interest rates to rein in aggregate demand, the thing one should hope would happen is that the countries that are struggling depreciate their currencies to boost their aggregate demand, while the US tolerates appreciation of the dollar to rein in its aggregate demand at that juncture rather than reining in aggregate demand by raising interest rates. In other words, when the world as a whole still needs more monetary stimulus, it is good thing for the Fed to stay relatively stimulative, while exchange rate movements are allowed to help steer that stimulus to other countries that need it most.

## Liaquat Ahamed’s Views: “Central banks have done about as much as they can”

Liaquat Ahamed articulately expresses an idea that sounds plausible, but is wrong. Here is the quotation from Jon, Brian and Lingling’s article:

“Central banks have done about as much as they can,” said Liaquat Ahamed, author of “Lords of Finance,” which documented the mistakes global central bankers made before and during the Great Depression.

I have been taking many of the Wall Street Journal monetary policy reporters to task before for this error:

(I recently updated my bibliographic post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide” to add a “News and Trends” section for posts likes this.)

Until central banks have employed negative interest rates, including negative paper currency interest rates (implemented by a time-varying paper currency deposit fee), they have not done all the monetary stimulus they can.

Of course, it is possible to have too much monetary stimulus. So there are indeed situations in which a central bank has done “all it can” in the sense that more monetary stimulus would be a bad thing. And in the long run, standard models (which I essentially agree with) imply that a central bank can only affect inflation, not real economic activity. (See my post “The Deep Magic of Money and the Deeper Magic of the Supply Side.”

Applying these principles to current events, a central bank can reasonably be said to have “done all it can” to foster economic growth in only two situations:

1. Additional monetary stimulus would create a genuine danger of a serious, undesirable increase in inflation (that is greater than the danger of too little monetary stimulus).
2. The central bank has done all it can to raise equity requirements to a level that will make the financial system safe, but has failed in these macroprudential efforts, so that additional monetary stimulus would create a serious danger of a bubble that would endanger the financial system.

One might argue that the first case applies to the Bank of England or to China’s central bank, but it does not yet apply even to the Fed, and is nowhere close to applying to the European Central Bank or the Bank of Japan.

No central bank has yet qualified for the second case. I have written two Quartz columns on monetary policy and financial stability:

And I address some of the key issues in my all-time most popular blog post so far: “Contra John Taylor.”

The Fed actually has a great deal of authority over equity requirements that it has not fully used yet. On equity requirements, see my recent post “The Wall Street Journal Editorial Board Comes Out for a Straight 15% Equity Requirement” and other posts in my Finance and Financial Stability sub-blog. Of just Quartz columns about equity requirements, see these two:

## Liaquat Ahamed’s Views: Supply-Side Reform, not Monetary Stimulus

The account of Liaquat Ahamed’s views continues:

Japan, he said, is burdened by a highly inefficient domestic economy, and Europe by a fragmented and fragile banking system. Pumping cheap credit into these economies won’t directly fix those problems, he said. “They may be just copying the U.S. when they have different problems,” he said. “The world has relied too much on central banks.”

Supply-side reforms are crucial, but as I wrote in my slate article “Governments Can and Should Beat Bitcoin at Its Own Game” about empowering monetary policy by eliminating the zero lower bound:

… every time one set of problems is solved, it allows us to focus our attention more clearly on the remaining problems. It is time to step up to that next level.

People sometimes argue that good monetary policy will distract governments from pursuing supply-side reforms. But because optimal monetary policy keeps output close to its natural level, it would actually make supply-side issues much more salient, since only supply-side forces change the natural level of output.

Fostering long-run economic growth is a many-sided issue. Writing this post inspired me to add a “Long-Run Economic Growth” sub-blog link to my sidebar. I had some difficulty categorizing posts. I didn’t want to duplicate what I had in my “Long-Run Fiscal Policy” and “Education” sub-blogs too much, but included some of my favorite posts in those categories. And I consciously included many posts about things that could contribute to economic growth correctly measured, even if they wouldn’t contribute to GDP as currently measured.

## Monetary Policy vs. Fiscal Policy vs. Credit Policy

Jon, Brian and Lingling continue, in what may also be a reflection of Liaquat Ahamed’s views:

In the U.S., Fed officials have been frustrated that they were being relied on to spur growth while the Obama administration and Congress feuded over fiscal policies that slowed growth in the short-run without addressing projected long-run budget deficits.

My view is that monetary policy is exactly what we should be using to keep GDP at its natural level. And except for our unfortunate policy of imposing a zero lower bound on interest rates with the way we now handle paper currency, that would work well. On the issue of monetary vs. fiscal policy, these two posts are a good start:

Overall, in the absence of a zero lower bound, I don’t see traditional fiscal policy (beyond automatic stabilizers) as a good way to deal with fluctuations away from the natural level of output.

However, credit policy, which lies somewhere between monetary and fiscal policy, can have a useful role to play in stabilization, simply because National Lines of Credit to consumers can have a faster effect on aggregate demand than interest rate changes (which typically take 6-12 months to have their effect). Here is what I wrote in my academic working paper “Getting the Biggest Bang for the Buck in Fiscal Policy” (pp. 3, 9):

… for the sake of speed in reacting to threatened recessions, it could be quite valuable to have legislation setting out many of the details of national lines of credit but then authorizing the central bank to choose the timing and (up to some

limit) the magnitude of issuance. Even when the Fed funds rate or its equivalent is far from its zero lower bound at the beginning of a recession, the effects of monetary

policy take place with a significant lag (partly because of the time it takes to adjust investment plans), while there is reason to think that consumption could be stimulated quickly through the issuance of national lines of credit. …

… A big advantage of national lines of credit is that, once triggered, the details of spending are worked out through

the household decision-making process, which is relatively nimble compared to corporate and government decision-making processes.

## Conclusion

The bottom line is that the conventional wisdom about monetary policy (on the left as well as on the right) is somewhat off target. To the extent that what people say seems reasonable, it is in important measure a self-fulfilling equilibrium: because the conventional wisdom is what it is, only certain policies are thinkable, and therefore what is said in the conventional wisdom makes sense. The concept of the Overton window is very helpful here. There is great value in working to expand the Overton window of policies that can be discussed among “very serious people” rather than just arguing about policies within the Overton window.