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2003 Redux, or, Why Market Monetarists Had Better Start Talking About the Dangers of QE3

In the title of a recent post Scott Sumner jokingly wonders whether, having been credited by the press for badgering Ben Bernanke's Fed until it at last cried "uncle!" by announcing QE3, he now needs to worry about going down in history as the guy who gave the U.S. its first episode of hyperinflation.

Well, probably not. But if Scott and the rest of the Market Monetarist gang don't start changing their tune, they may well go down in history as the folks responsible for our next boom-bust cycle.

I'm saying that, not because, like some monetary hawks, I'm dead certain that no substantial part of today's unemployment is truly cyclical in the crucial sense of being attributable to slack demand. I have my doubts about the matter, to be sure: I think it's foolish, first of all, to assume that 8.1% must include at least a couple percentage points of cyclical unemployment just because it's more than that much higher than the postwar average; and (as I noted in a previous post), I'm far from convinced that NGDP is still substantially below where it should be given both the extent of the actual increase in spending since 2009 and the fact that there has surely been at least some downward adjustment in demand expectations since that time. Still, for for the sake of what I wish to say here, I'm happy to concede that some more QE, aimed at further elevating the level of nominal GDP to restore it to some higher long-run trend value to which the recession itself and overly tight monetary policy have so far prevented it from returning, might do some good.

But although QE3 is in that case something that might do some real good up to a point, it hardly follows that Market Monetarists should treat it as a vindication of their beliefs. On the contrary: if they aim to be truly faithful to those beliefs, they ought to find at least as much to condemn as to praise in the FOMC's recent policy announcement. And yes, they should be worried–very worried–that if they don't start condemning the bad parts people will blame them for the consequences. What's more, they will be justified in doing so.

So what are the bad parts? Two of them in particular stand out. First, the announcement represents a clear move by the Fed toward a more heavy emphasis on employment or "jobs" targeting:

If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.

Yes, there's that bit about fighting unemployment "in a context of price stability," and yes, it's all perfectly in accord with the Fed's "dual mandate." But monetarists have long condemned that mandate, and have done so for several good reasons, chief among which is the fact that it may simply be beyond the Fed's power to achieve what some may regard as "full employment" if the causes of less-than-full employment are structural rather than monetary. The Fed should, according to this view, focus on targeting nominal values only, which can serve as direct indicators of whether money is or is not in short supply. Many old-fashioned monetarists favor a strict inflation target because they view inflation as such an indicator. Market Monetarists are I think quite right in favoring treating the level and growth rate of NGDP as better indicators. But the Fed, in insisting on treating the level of employment as an indicator of whether or not it should cease injecting base money into the economy, departs not only from Market Monetarism but from the broader monetarist lessons that were learned at such great cost during the 1970s. If Market Monetarists don't start loudly declaring that employment targeting is a really dumb idea, they deserve at very least to get a Cease & Desist letter from counsel representing the estates of Milton Friedman and Anna Schwartz telling them, politely but nonetheless menacingly, that they had better quit infringing the Monetarist trademark.

The second, even more troublesome part of QE3 consists of the FOMC's implicit promise to keep the federal funds rate near to its present, unprecedentedly low level for a very long period of time:

the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.

What's wrong with that? It is well to remember the Fed's response to the last slow recovery–the one that followed the bust. Having kept the federal funds rate at 1.75 percent for a year after the economy began to recover in November 2001, the Fed lowered it to 1.25 percent in November 2002, and to 1 percent in June 2003. Then, in August 2003, the FOMC, still unhappy with the sluggish pace of the recovery, and especially with the high unemployment rate, announced that the f.f.r. was "likely" to remain low for an "extended" period of time. Not for the first time, the Fed in its zeal to assist recovery was in fact setting the next boom in motion. And how! And it did so, by the way, without having ever substantially exceeded its inflation target. Of course, so long as the boom lasted, the FOMC was confident that everything was just dandy.

The two aspects of QE3 that I think Market Monetarists had better start complaining about have nothing to do with targeting either the level or the growth rate of nominal income. On the contrary: both imply a risk, and perhaps a very substantial risk, that QE3 will devolve into a policy that leads to excessive nominal income growth instead of being terminated before that can happen. And though the excessive growth is hardly likely to be such as might lead to hyperinflation, and may not even be such as might lead to any considerable overshooting of the Fed's favorite (2 percent) inflation rate, that doesn't mean that it won't be capable of generating another serious asset price bubble, whether in the real estate market or elsewhere.

So, Market Monetarists: quit gloating and start complaining, loudly, about the dangerous aspects of the Fed's latest move–aspects that, far from reflecting your beliefs, are quite contrary to those beliefs. If you fail to do so now (and especially if you appear to endorse those aspects of the Fed's new policy), you may not have much to gloat about (though you may well end up getting lots more press coverage!) following the "long and variable lag" that started a few days ago and that may end, for all we know, sometime after 2015.

P.S.: To be fair, Scott in particular, and other MM's as well, haven't really been doing all that much gloating–they are in truth a remarkably modest bunch. But quite a few others have been doing plenty of gloating on their behalf.