Larry Summers asked an audience a question a couple of weeks ago: Which alternative, he asked, would require the Swiss National Bank to print more money to lower the value of the Swiss franc:
- An announcement that they would print whatever it takes in order to get the franc to where they wanted it, or
- An announcement that they would print X francs, and then reassess the situation
You want to get the speculators on your side--you want them to think that there is money to be made by betting that your policy will be carried out, rather than that there is money to be made by betting that your policy will break down. Thus the costs of deciding to do whatever it takes and of standing ready to do whatever it takes and announcing that you are going to do whatever it takes will probably, probably be surprisingly low.
Scott Sumner applies this lesson to U.S. monetary policy:
It’s the target, stupid: Many people have argued that if QE2 didn’t have much effect, the amount of money required to provide adequate NGDP growth must be truly stupendous. But this gets things exactly backward…. The Fed has plenty of credibility, that’s not the problem. The problem is that they are using the credibility to assure investors that low inflation is here to stay. With the right target, there would probably be no need for massive quantitative easing, or other extraordinary policies. There are excellent posts by Josh Hendrickson, David Beckworth, and Marcus Nunes, that all explain this point in more detail.
The punch line is that the problem isn’t the Fed’s unwillingness to do enough QE, twists, or cuts in IOR, the problem is the Fed’s inadequate target, just like in Japan.
One of the great mysteries of this recession is how the Fed has been able to get away with doing “the wrong thing” for three years in a row. The BOJ would often claim to be unable to boost NGDP. It was wrong, but the explanation sort of made logical sense. But Bernanke could never make that claim, as his academic research showed the Japanese explanation was preposterous. For instance, why did the BOJ repeatedly tighten monetary policy in the 2000s?
Of course the Fed never claimed to be out of ammo; indeed they have argued the exact opposite. This makes the Fed’s public relations success an even bigger mystery. Why have they gotten away with this stance?