Dajeeps is a frequent commentator on this blog and the other Market Monetarist blogs. Dajeeps also writes her own blog. Dajeeps’s latest post – The Implications of the Sumner Critique to the current Monetary Policy Framework – is rather insightful and highly relevant to the present discussion about whether the Federal Reserve should implement another round of quantitative easing (QE3).
Here is Dajeeps:
“How I came to understand the meaning of the Sumner Critique was in applying it to the question of whether the Fed should embark on another round of QE. I agree with the opponents of more QE, although violently so, because under the current policy framework, the size, duration or promises that might come with it do not matter at all. It will be counteracted as soon as the forecast of expectations breach the 2% core PCE ceiling, if it not before. But in ensuring that policy doesn’t overshoot, which it must do in order to improve economic circumstances, the Fed must sell some assets at a loss or it needs some exogenous negative shock to destroy someone else’s assets. In other words, it has no issue with destroying privately held assets in a mini-nominal shock to bring inflation expectations back down to the 48 month average of 1.1% (that *could be* the Fed-action-free rate) and avoid taking losses on its own assets.”
Said in another way – the Fed’s biggest enemy is itself. If another round of quantitative easing (QE3) would work then it likely would push US inflation above the quasi-official inflation target of 2%. However, the Fed has also “promised” the market that it ensure that it will fulfill this target. Hence, if the inflation target is credible then any attempt by the Fed to push inflation above this target will likely meet a lot of headwind from the markets as the markets will start to price in a tightening of monetary policy once the policy starts to work. We could call this the Dajeeps Critique.
I strongly agree with the Dajeeps Critique and for the same reason I am quite skeptical about the prospects for QE3. Contrary to Dajeeps I do not oppose QE3. In fact I think that monetary easing is badly needed in the US (and even more in the euro zone), but I also think that QE3 comes with some very serious risks. No, I do not fear hyperinflation, but I fear that QE3 will not be successful exactly because the Fed’s insistence on targeting inflation (rather than the price LEVEL or the NGDP LEVEL) could seriously hamper the impact of QE3. Furthermore, I fear that another badly executed round of quantitative easing will further undermine the public and political support for monetary easing – and for NGDP targeting as many wrongly seem to see NGDP targeting as monetary easing.
Skeptical about QE3, but I would support it anyway
While I am skeptical about QE3 because I fear that Fed would once again do it in the wrong I would nonetheless vote for another round of QE if I was on the FOMC. But I must admit I don’t have high hopes it would help a lot if it would be implemented without a significant change in the way the Fed communicates about monetary policy.
A proper target would be much better
At the core of the problems with QE in the way the Fed (and the Bank of England) has been doing it is that it is highly discretionary in nature. It would be much better that we did not have these discussions about what discretionary changes in policy the Fed should implement. If the Fed had a proper target – a NGDP level target or a price level target – then there would be no discussion about what to expect from the Fed and even better if the policy had been implemented within the framework of a futures based NGDP level target as Scott Sumner has suggested then the money base would automatically be increased or decreased when market expectations for future level of nominal GDP changed.
For these reasons I think it makes more sense arguing in favour of a proper monetary target (NGDP level targeting) and a proper operational framework for the Fed than to waste a lot of time arguing about whether or not the Fed should implement QE3 or not. Monetary easing is badly needed both in the US and the euro zone, but discretionary changes in the present policy framework is likely to only have short-term impact. We could do so much better.
Steve Horwitz on why he oppose QE3. I disagree with Steve on his arguments and is not opposing QE3, but I understand why he is skeptical
David Glasner on why Steve is wrong opposing QE3. I agree with David’s critique of Steve’s views.
My own post on why NGDP level targeting is the true Free Market alternative – we will only convince our fellow free marketeers if we focus on the policy framework rather than discretionary policy changes such as QE3.
My post on QE in the UK. In my post I among other things discuss why Bank of England’s inflation target has undermined the bank’s attempt to increase nominal spending. This should be a lesson for the Federal Reserve when it hopefully implements QE3.
See also my old post on QE without a proper framework in the UK.