The Fed Could Use Some Help

Glenn Hubbard says the Fed can't do it alone:

We're Asking Too Much of the Fed, by R. Glenn Hubbard, Commentary, WSJ: The combination of eye-popping headline inflation of 5% year over year and dramatic expansions of the Federal Reserve's lending activities to limit the credit crunch raise a key question: Are we asking too much of monetary policy?

The simple answer is yes. The expansion of the Fed's lending has been extraordinary in scale and scope. But it is not the best response to the present credit crunch, and may bring unwelcome side effects. ... moral hazard. ... ... inflationary pressures. ...surging commodity prices ... weakness in the foreign-exchange value of the dollar. ...

It is asking a lot for monetary policy alone to carry the burden of supporting aggregate demand. Fiscal policy can play a role. Congress and President Bush did pass an economic stimulus package centered on tax rebates. But clarity about a positive future for the 2001 and 2003 tax cuts which bolster collateral values -- along with a cut in corporate tax rates to promote investment -- would offer a much more potent tonic. ...

I agree that Fed policy alone may not be enough to get the economy back on track, I've argued that for a long time. But tax cuts are not the only option for stimulating the economy, government spending can also be used, and in theory on short-run stabilization policy, a one dollar increase in government spending has a bigger impact on GDP than a one dollar tax cut. Infrastructure is an obvious target for spending, it's surely needed, but there are other areas that could use help as well.

If the worry is that the spending will be permanent, Democrats can play the Republican game, but actually mean what they say. A stimulus should be temporary, so - just like the Republicans do with tax cuts - put clauses in the legislation that say the spending expires at a certain date. There will be x dollars per year for y years to do z, and that will be it. That way, there's no long-run impact on the budget (unlike the real intent of the tax-cut advocates who, once the economy gets better, will argue against reversing the stimulus measures). If the goal is to stimulate the economy, there's just no need to limit the policies under consideration to some type of tax cut.