Will QEII Work?

As a follow up to the post below this one on whether QEII will work, here's Paul Krugman:

If I Were King Bernanke, by Paul Krugman: I’ve been asked by various people what I would do if I were Bernanke, and/or if I were in charge of the Fed. Those aren’t the same thing: Ben Bernanke isn’t a dictator, and the evidence suggests that he’d be substantially more aggressive in both his actions and his rhetoric if he weren’t constrained by the need to bring his colleagues with him.

So I don’t know what I’d do in his place. What I’d do if I were really in charge of the Fed, however, is the same thing I advocated for Japan way back when: announce a fairly high inflation target over an extended period, and commit to meeting that target.

What am I talking about? Something like a commitment to achieve 5 percent annual inflation over the next 5 years — or, perhaps better, to hit a price level 28 percent higher at the end of 2015 than the level today. (Compounding) Crucially, this target would have to be non-contingent — not something you’ll call off if the economy recovers. Why? Because the point is to move expectations, and that means locking in the price rise whatever happens.

It’s also crucial to understand that a half-hearted version of this policy won’t work. If you say, well, 5 percent sounds like a lot, maybe let’s just shoot for 2.5, you wouldn’t reduce real rates enough to get to full employment even if people believed you — and because you wouldn’t hit full employment, you wouldn’t manage to deliver the inflation, so people won’t believe you. Similarly, targeting nominal GDP growth at some normal rate won’t work — you have to get people to believe in a period of way above normal price and GDP growth, or the whole thing falls flat.

As I wrote way back, the Fed needs to credibly promise to be irresponsible — at least from the point of view of the VSPs.

The sad truth, of course, is that the chance of actually getting anything like this are no better than those of getting an adequate fiscal stimulus — at least for now. QE as currently contemplated is mild mitigation at best. What one has to hope is that as the reality that we’re in a liquidity trap sinks in (amazing how long that’s taking), as the fact that we’re doing worse than Japan starts to finally penetrate our arrogance, we’ll eventually get there. But it’s not going to happen this month.

Donald Kohn, who knows more than a little about the inside workings of the Fed, has something to say about whether the Fed is willing to promise to be irresponsible. He says the Fed is not about to let inflation get out of control, or even rise much:

The DNA of the FOMC [Federal Open Market Committee] is very focused on preventing a rise in inflation and inflation expectations that would be bad for the economy. I’m not worried about inflation getting out of control. Even if [the Fed] waits too long [to raise interest rates] when the time comes, they’ll be very alert and if necessary they’ll tighten up faster than they would have.

How is this policy going to generate an increase in expected inflation to the degree that is needed?