The Economist Dec. 31st issue includes an article on new ideas in economics titled 'Marginal revolutionaries'. The article spotlights 'Market Monetarism', an idea planted in 2009, by Economist Scott Sumner of Bentley University. Market Monetarism takes the view that the central bank has much more room than conventionally thought to expand its balance sheet, i.e. provide monetary stimulus. Nominal (money) GDP of prerecession (NGDP) levels ought to be targeted, instead of real GDP growth, and the policy maker should not worry if inflation is the channel by which the target is achieved.
This idea has received quite a bit of attention, first rebuffed and then embraced by Paul Krugman. The FED OMC recently debated the merits and drawbacks as well.
Ken Rogoff, former head of the IMF, has suggested something similar - that FED should announce a policy that generates 5% inflation for the next several years. This would help the US housing market out of its doldrums - where a quarter of the mortgages (almost all non-recourse) are substantially underwater. A friend of mine, currently at the IMF, says that they are
discussing the issue internally wrt the Eurozone.
If the central bank truly has more power than we previously imagined (don't we all), then it seems that those countries that adopted the Euro have an even stronger argument for exiting.
“With the slightest disturbance, the dream's going to collapse.”
Of course the question of whether inflation expectations can be so finely tuned without sparking a self-reinforcing rise in inflationary expectations is crucial. I am a sceptic. At a minimum, the possible adverse outcomes and global economic volatility would rise dramatically especially given the fragility of the global economy. The Eurozone and the US FED already have monetary bases above 20% of the nominal GDP of their respective economies. At grad school in Wisconsin, we talked about
the central bank potentially doing a one-time increase in the monetary base to achieve the desired price level and that this in theory need not set off inflationary expectations. My preference for radical central bank intervention would take this form.
“I'll tell you a riddle. You're waiting for a train, a train that will take you far away. You know where you hope this train will take you, but you don't know for sure. But it doesn't matter. How can it not matter to you where that train will take you?”
I see the incessant focus on the power of the central bank to manage an economy as being misguided and inappropriate. The world reached a financial crisis principally because of a lack of proper regulation and enforcement of the financial services industry. In addtion to this, the Eurozone reached their crisis because they gave up their currencies, and the global trade system shifted production to Germany for high valued manufacturing and China for low valued manufacturing. Regardless of the price level, these economies are not going to generate jobs for their unemployed. Many academics and market participants who view religion as nothing more than superstition, seem to have elevated the central banks to Christ-like status.
If we want to eat bread and wine, we need to start growing some wheat and grapes and stop asking the central bank to 'make do' with the water and loaf we left in the toilet.
"You remind me of someone... a man I met in a half-remembered dream. He was possessed of some radical notions."