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Alan Reynolds's avatar

The analysis is well done, persuasive and clear. But the policy prescription at the very end assumes skilled expertise by an omniscient FOMC staff in manipulating undefined Fed tools. It also assumes the staff's willingness to ignore their precious Phillips Curve models (which never predict anything).

The Fed controls the quantity of bank reserves and currency, not what banks and the public do with them. The Fed cannot regulate the stock or flow of specific Ms (which depend on choices of households, firms, and banks), and they cannot predict velocity (ditto).

If given a mandate to somehow make sure "NGDP growth rises at a 4%-5% click" the Fed would put the IOR rate much higher than that to raise unemployment, curb bank lending, shrink investor wealth, and thwart private borrowing. That can indeed create recessions, but the Fed always eases like crazy in recessions, so the result is more instability, not stability.

Countries with sustained low inflation like Switzerland or Japan never have high interest rates, while countries with high inflation always do. But the Fed is Wicksellian not Fisherian. Whatever target you give them, they'll try to hit it hard with their beloved sledgehammer - the fed funds rate.

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Benjamin Cole's avatar

I like this post.

I would like to see discussion about what the Fed should do about its balance sheet.

Given the proclivities of US politics and the Congress, I guess annual federal deficits are permanent.

Should the Fed build its balance sheet, like the Bank of Japan, and the Bank of Indonesia, which, in effect, deleverages the US taxpayer? I also wonder about the fiscal theory of the price level. John Cochrane never answers my questions if a larger Fed balance sheet is disinflationary, under the FTPL.

In the real world (not the perfect world) should the Fed build its balance sheet and shoot for 3% annual inflation? This would prevent an over-leveraged US taxpayer.

To call for a balanced budget is useless. What should monetary policy be given the realities?

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