If you want a detailed argument for how the Federal Reserve has failed the American economy because of its timidity in considering and implementing unconventional policies against a background of rock-bottom interest rates and persistently high unemployment, read Ryan Avent’s passionate, informed screed for the Economist. If you want a more neutral reading on the Fed’s options, read Justin Lahart in the Wall Street Journal.
What’s interesting about Avent’s wonk-and-brimstone and Lahart is that both pieces start from a similar point: the Fed has been willing to step in with an unconventional policy measures when the economic picture has gotten particularly bad. But whereas Avent sees excess caution leading to calamity (“the Fed bears the greatest responsibility for America’s pathetic recovery”), Lahart voices the Fed’s possible concerns with more agressive policy, especially raising expectations of future inflation:
First, take targeting higher inflation. If investors believed the Fed would succeed, 10-year Treasury yields would likely surge, undermining a recovery. Capping yields in such a scenario might require an unfeasibly large expansion of the Fed’s balance sheet and scare off foreign creditors like China
To understand the debate Lahart is rehearsing, you have to understand one proposed unconventional policy measure.
Avent and other Fed-critics often call for using the “expectations channel” in order to stoke the economy. What this means is that the Fed would state that, as a matter of policy, it expects inflation to be a percentage point or two above its current two percent target and will engage in policy actions in order to get inflation to this higher rate. The idea here is that when the Fed is unable to stimulate the economy through cutting interest rates (interest rates directly controlled by the Fed are already basically at zero), it can resort to announcing — and affecting — future inflation. And since you don’t want to bet against the central bank, this gambit may very well work.
Now, the objections Lahart lists out make sense if you don’t see raising inflation expectations as either a policy that is likely to be effective in bringing down unemployment or if you don’t think that a possible decrease in unemployment is not worth the risk of expanding the Fed’s balance sheet (having the Fed buy more bonds) and all the attendant controversies.
What is so frustrating to Avent and many others is that the possible downsides of more agressive Fed action are exactly that, possible downsides. And all the while, unemployment remains stubbornly high and does not appear to be coming down anytime soon. In the eyes of its critics, the Fed has gained credibility, but a kind no one would actually want.
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