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Stiglitz vs. the Fed

Nobel Prize-winning economist Joe Stiglitz does not think quantitative easing -- or further monetary policy in general -- is likely to work:

It should be obvious that monetary policy has not worked to get the economy out of its current doldrums. The best that can be said is that it prevented matters from getting worse. So monetary authorities have turned to quantitative easing. Even most advocates of monetary policy agree the impact of this is uncertain. What they seldom note, though, are the potential long-term costs. The Fed has bought more than a trillion dollars of mortgages and long-term bonds, the value of which will fall when the economy recovers – precisely the reason why no one in the private sector is interested. The government may pretend that it has not experienced a capital loss because, unlike banks, it does not have to use mark-to-market accounting. But no one should be fooled. ...

A final argument invoked by critics of fiscal policy is that it is unfair to future generations. But monetary policy can have intergenerational effects every bit as bad. There are many countries where loose monetary policy has stimulated the economy through debt-financed consumption. This is, of course, how monetary policy “worked” in the past decade in the US. By contrast, fiscal policy can be targeted on investments in education, technology and infrastructure. Even if government debt is increased, the assets on the other side of the balance sheet are increased commensurately. Indeed, the historical record makes clear that returns on these investments far, far exceed the government’s cost of capital. When, as now, there is excess capacity in the private sector, such public investments increase output and tax revenues in both the short term and the long. If markets were rational, such investments would even lead a country’s cost of borrowing to fall.

The column suffers, however, from a peculiar understanding of the politics of the issue. Stiglitz sets advocates of monetary policy on one side of the divide and advocates of fiscal policy on the other. But that's not the state of play, at least in America. Rather, there are advocates of fiscal and monetary policy on one side, and advocates of the government doing nothing at all on the other. And because the advocates of nothing have marshaled enough votes to stop the Senate from passing further fiscal stimulus, the advocates of doing something have turned in desperation to monetary policies like quantitative easing, as they don't have to overcome a filibuster.

I agree with Stiglitz that further fiscal stimulus would be preferable to quantitative easing (though combining fiscal and monetary policy would be even better), but we should be clear on why we're turning to the Federal Reserve rather than the Congress. This is the consequence of minority-driven congressional gridlock. The result isn't that nothing happens, but that the responsibility for action falls to independent institutions like the Federal Reserve, or executive agencies like the Environmental Protection Agency, and we get policies that are worse than what Congress could pass, but better than what you get if Congress is no longer able to pass anything.

By Ezra Klein  | October 19, 2010; 10:24 AM ET
Categories:  Federal Reserve  
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"Rather, there are advocates of fiscal and monetary policy on one side, and advocates of the government doing nothing at all on the other."

Not true. Despite my fear of it getting out of control, QE is the only way I can see of getting our real wages in line with those of the rest of the world without nominal pay cuts. The bigger risk is that it just won't work, since China can still maintain the peg, and Europe will be forced to play along.

What Klein will never admit is that fiscal stimulus is already in full swing. We're already deficit spending beyond the bursting point. We've been doing it for nearly 10 years. More would be suicidal.

Posted by: staticvars | October 19, 2010 10:58 AM | Report abuse

This has nothing to do with minority-driven gridlock. A stimulus plan could have gone through reconciliation by just spending now and taxing later. It didn;t due to bad leadership.

Posted by: endaround | October 19, 2010 11:15 AM | Report abuse


"In actuarial terms, government budgets are always balanced — the true burden of taxation is whatever the government spends. This means that if current expenditures by government are not covered by current taxes, the debts that are incurred will have to be paid either by higher future explicit taxes or by the implicit tax of debasing the currency through inflation.

Either way, households know that either their future paycheck will be smaller, or that it will buy less. That is, after taxes and/or inflation, they will be less well off than previously thought.

The factors that point in the direction of lowered lifetime consumption prospects induce both a greater reluctance to tap the credit markets for new borrowings and an enhanced incentive to pay down existing debts. Measured savings rates rise as a result of both the reduced household indebtedness and the accumulation of liquid financial assets such as low-yielding savings accounts.

Economists call this "Ricardian equivalence" — the more the government borrows and spends, the more rational households save.

In the business or entrepreneurial sector, the prospects of higher taxation — especially in combination with concerns about increased regulation — lower the expected real, after-tax, returns from new investments. Fewer new opportunities meet the "hurdle rate" necessary to justify going forward with new projects. With households saving more and business investing less, real interest rates fall, but this is not a reflection of a healthy, prosperous economy.

These dynamics explain why efforts by government to stimulate the economy by deficit-financed spending are utterly impotent. Attempts to maintain employment and consumption spending — financed by government borrowing — must be balanced against the reduction in employment and consumption of other people.

Worse, government transfer payments to people who are not working must be financed by taxing — in the present or in the future — those who are working. This is called "crowding out;" enlargement of the government sector relative to the private sector causes the total size of the economy to be smaller over time."

Posted by: staticvars | October 19, 2010 11:19 AM | Report abuse

"The column suffers, however, from a peculiar understanding of the politics of the issue."

I think that you are missing Stiglitz's point. He is not talking about the Congressional politics of the issue.

He is talking the political effect of conventional wisdom, namely the view (quite common among economists, policymakers and pundits) that monetary policy is preferable to fiscal policy--that the latter is ineffective at best, dangerous at worst.

Your own commenter staticvars exemplifies this view, with its "permanent income hypothesis" & "Ricardian equivalence" & "rational expectations" paraphernalia, quite well.

This sort of thinking is vastly more influential than you seem to believe it is. For instance, it is clearly shared by Ben Bernanke and most, if not all, members of the FMOC, as well, to all appearances, by the administration's top economic advisors.

Posted by: amileoj | October 19, 2010 2:09 PM | Report abuse

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