The “Dajeeps” Critique and why I am skeptical about QE3

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.

—-

Related posts:

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.

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6 Comments

  1. dkuehn

     /  July 23, 2012

    If we had an unemployment rate target like we have an inflation target, this would not be as big of an issue, for much the same reason that monetary stimulus with some kind of level target would work a lot better. I am not personally sure whether I agree on the profundity of NGDP level targeting, but I\’m certainly on board with the fact that it\’s a level we\’re interested and not some rate of change.

    Any level will probably do better than no level: NGDP, price level, employment. I don\’t think discretion is the problem so much as getting a sensible goal in place (not that I have anything against policy rules – I just don\’t think that\’s the silver bullet. Even when we talk about \”discretion\” what we\’re really talking about is some kind of implicit policy rule – not throwing a dart at a board or anything like that).

    Essentially, right now, the Fed\’s dashboard gives readings on acceleration while the road signs are asking it to go a certain velocity. That\’s no way to drive a car and it\’s no way to run an economy.

    Reply
  2. Daniel,

    I certainly agree that nearly any level target would be better than the present fuzzy target(s) and lets say the fed announced that it would target some Mankiw rule then that undoubtedly would work better than the present policy.

    To me a major advantage of NGDP level targeting compared to for example a Mankiw rule or something similar is that there is no conflict between the short-run target and the long-run target. We all agree that the Fed in can not do anything to increase employment in the long-run. That makes me quite skeptical about any targeting of non-nominal variables. But you know that…

    Reply
  3. Thank you for the attention. I am not completely opposed to QE3 for the here and now because the destruction is going to get bad this time around, I think, and it might make the bad medicine easier to take. It seems like a choice between being shot in the leg or having 3 ribs broken.
    I was looking at it more from the point of view of the Fed needing inflation to naturally go down as a means of meeting its targets instead of being able to adjust interest rates. It’s a terrible incentive to not do anything but leave the economy hanging on the razor’s edge as dis inflation arbitrarily destroys assets. We cannot go on like that forever and we won’t get away from the ZLB that seems to be a component of this deranged behavior that way either. It’s a cycle that feeds on and folds into itself that can’t end well.

    Reply
  4. Becky Hargrove

     /  July 24, 2012

    We need more market monetarist gals so they won’t get confused, huh! Like one commenter told Scott not long ago, he would know market monetarism had arrived when everyone’s grandmother was posting about it on Facebook!

    Reply
  5. Jim Glass

     /  July 29, 2012

    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.

    Exactly. Inflation predicted by the 5-year TIPS spread is 1.7%. IMHO, the Fed should commit to something like: “Our employment mandate target is (say) 6% unemployment, our price stability mandate target is 2% inflation, as we are much further from our employment target than our price-level target logic compels us to ‘give’ a bit on the latter, so we will run QE3 until the five-year TIPS spread expectation of inflation reaches (say) 2.75% and keep it there until unemployment falls to 7% … As inflation during the 25 years prior to 2008 averaged 3.2%, fears that this will cause inflation expectations to become ‘unmoored’ are implausible. This is our policy from now. Period. Done”.

    Reply

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