Mike Konczal has a fascinating interview up with Joe Gagnon, a former high-level Federal Reserve staffer and proponent of monetary stimulus, that provides a useful insider’s critique of why the central bank isn’t delivering the full employment goods.
One key point is that the Fed staff puts much more emphasis on the literal mechanics of asset purchases and much less on the expectations channel than I think is warranted. A second is that Gagnon doesn’t really think that “political” issues are operating as a major constraint here. Rather, there are legal barriers as to what can be done in terms of asset purchases that interact with the somewhat myopic focus on purchases per se rather than expectations to create an unnecessary sense of constraint. The third is that the Federal Reserve has constructed a very asymmetrical risk function for itself, where years and years and years of elevated unemployment is considered unfortunate but even a brief span of above-target inflation is worrysome. This is an issue for a separate post, but I think people need to realize that as long as that’s the case neither monetary nor fiscal policy can be very effective. At this point in the game it would be extraordinarily difficult to have rapid job growth without some price spikes.
But one issue I wished Gagnon had expanded on more is foreign exchange:
In terms of the asset purchases, the Fed is limited by law to the Treasury, agency, and agency MBS markets plus foreign exchange. Buying foreign exchange would be viewed as economic warfare by many countries, so it is probably ruled out even though it reflects rank hypocrisy on the part of foreign governments that are massively buying dollars.
This “economic warfare” issue strikes me as more of an opportunity than a problem. For an economy as large as the United States to stimulate itself purely through foreign exchange purchases isn’t very practical, but if a determined program of monetary expansion via FX purchases prompted massive foreign retaliation then we’d be getting somewhere. After all, right now the European Central Bank is refusing to engage in the volume of monetary activism that the European Union needs and the Fed is refusing to engage in the volume of activism that the United States needs. But if both central banks start racing to outgun each other in terms of purchasing each other’s assets, then that’d be a win-win in which both continents get some much-needed stimulus.
