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Sunday, October 17, 2010

"Brad Delong and Mark Thoma Do Not Like the Communications Vehicle"

Just a brief response to this. I haven't argued that the Fed is powerless to affect long-term real interest rates. I think the Fed can lower rates through quantitative easing, though I don't think the effect will be large.

My doubts are about how much people and firms will respond to lower interest rates, i.e. whether they will increase consumption and investment in response. For example, firms are already sitting on piles of cash they aren't spending, and it's just not clear to me that a small downward tick in real rates will motivate them to buy a new delivery truck or build a new factory.

I also think that all of the focus on the Fed has led people to believe the Fed has more power to affect the economy than it actually has right now. Expectations for monetary policy are too high, and it lets fiscal policy authorities -- who actually have the ability to provide significant help the economy -- off the hook. Yes, it's probably true that Congress wouldn't have done anything further even if the administration and its allies had put more pressure on Congress. But we should be making it absolutely clear that monetary policy is a second best alternative right now, our expectations for it shouldn't be overly inflated, and we are turning to the Fed only because Congress has fallen down on the job.

Given the size of the problem we face, and the uncertainties over how effective any type of policy will be, we need both monetary and fiscal policy authorities working together to try to give the economy the lift it needs. Unfortunately, Republicans and a few misguided Democrats have taken further fiscal action off the table, and monetary policy is the only hope we have left, however meager that hope might be.

    Posted by on Sunday, October 17, 2010 at 10:10 AM in Economics, Fiscal Policy, Monetary Policy | Permalink  Comments (27)


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