Robert Lucas on Non-Standard Monetary Policy

Robert Lucas writes:

Ben Bernanke Is the Best Stimulus Right Now: The Federal Reserve's lowering of interest rates last Tuesday was welcome, but it was also received with skepticism. Once the federal-funds rate is reduced to zero, or near zero, doesn't this mean that monetary policy has gone as far as it can go?...

Financial markets are in the grip of a "flight to quality" that is very much analogous to the "flight to currency" that crippled the economy in the 1930s. Everyone wants to get into government-issued and government-insured assets, for reasons of both liquidity and safety. Individuals have tried to do this by selling other securities, but without an increase in the supply of "quality" securities these attempts do nothing but drive down the prices of other assets....

When the Fed wants to stimulate spending in normal times, it uses reserves to buy Treasury bills in the federal-funds market, reducing the funds' rate. But as the rate nears zero, Treasury bills become equivalent to cash, and such open-market operations have no more effect than trading a $20 bill for two $10s. There is no effect on the total supply of "quality" assets. A dead end? Not at all. The Fed can... buy securities other than Treasury bills.... The flight to quality means exactly that many are eager to trade private paper for non-interest bearing (or low-interest bearing) reserves and with the Fed's help they are doing so every day.

Could the $600 billion in new reserves be called a bailout? In a sense, yes: The Fed is lending on terms that private banks are not willing to offer. They are not searching for underpriced "bargains."... We don't care about the quality of the assets the Fed acquires in doing this. We care about the quantity of its liabilities....

[M]onetary policy as Mr. Bernanke implements it has been the most helpful counter-recession action taken to date.... It is fast and flexible. There is no other way that so much cash could have been put into the system as fast as this $600 billion was.... It entails no new government enterprises, no government equity positions in private enterprises, no price fixing or other controls on the operation of individual businesses, and no government role in the allocation of capital across different activities. These seem to me important virtues.

It is clear how Lucas's policy would help if the government buys assets for more than their market value--but then a reserve-financed tax cut seems to be a much better policy: a reserve-financed tax cut distributes the new liquid wealth created broadly, rather than reserving it for those who have made bad investments in toxic securities. Moral hazard considerations and utilitarian equity would militate against Lucas's proposal.

It is also clear how Lucas's policy would help if the government bought assets at their current market values but intervened on a large enough scale to change asset prices--to boost wealth and accelerate spending by reducing the supply of risky assets and thus reducing the risk premium on assets. But in this case we do "care about the quality of the assets the Fed requires."

So I am left concluding that Lucas has something in mind that I don't understand: that his piece is undertheorized.