Home' Policy Magazine : Policy Vol 30 - No 2 Contents SCOTT SUMNER
POLICY • Vol. 30 No. 2 • Winter 2014
continually made by Fed officials. We never hear
them explicitly say they’ll sabotage fiscal stimulus,
but we do hear them say they will calibrate the
level of monetary stimulus to the health of the
economy. For instance, the recent Evans Rule
commits the Fed to hold interest rates close to
zero until unemployment falls to 6.5%, or core
inflation rises above 2.5%.
13 Because fiscal stimulus
would presumably make this happen sooner,
it would also, ipso facto, cause the Fed to raise
interest rates sooner than otherwise. Thus, fiscal
stimulus would lead to tighter money over time.
Of course, that doesn’t necessarily fully offset
the effects of fiscal stimulus, but it’s an explicit
admission by the Fed that if the fiscal authorities
do more, they will do less.
An even better example occurred in late 2012,
when the Fed took several steps to make monetary
policy more expansionary, including adoption of
the Evans Rule and additional quantitative easing
(QE), or injections of bank reserves through bond
purchases. Why did the Fed take such bold steps?
Some Fed officials pointed to the looming fiscal
cliff, which was widely expected to lead to steep
tax increases. A possible spending sequester was
also lurking in the background. Fed officials were
determined to do enough stimulus to keep the
recovery going, despite headwinds from both
fiscal austerity and recession in Europe.
And so far it looks like they’ve succeeded.
Job growth during the first six months of 2013
was running at more than 200,000 new jobs
per month, which is actually faster than the pace of
2012. That’s not to say that a much sharper drop
in government spending wouldn’t have some
impact on measured GDP; after all, the Fed’s
policy initiative was calibrated to reflect the sort
of fiscal austerity they expected in late 2012.
Much greater austerity would have a short-term
effect on growth, but over longer periods of time,
the Fed sets the agenda. The Fed’s ability to produce
almost unlimited amounts of fiat money, without
running up large budget deficits, ultimately
makes monetary policy much more powerful than
Because Fed officials continue to stress the risks
of excessive austerity, the monetary offset argument
seems counterintuitive to many economists. Many
will ask, ‘Surely you don’t think Ben Bernanke
would offset fiscal stimulus?’ But this isn’t really
asking the right question. The question that
should be asked is, ‘Will Ben Bernanke do what is
necessary to keep nominal spending on a path
consistent with low inflation and stable growth?’
which is roughly the Fed’s mandate. (Actually,
the mandate speaks of inflation and employment,
but jobs and growth are closely linked.) The real
question is whether the central bank will do its job,
regardless of what is happening on the fiscal front.
When viewed this way, estimates of fiscal
multipliers become little more than forecasts of
central bank incompetence. If the Fed is doing
its job, then it will offset fiscal policy shocks and
keep nominal spending growing at the desired
level. Bernanke would deny engaging in explicit
monetary offset, as the term seems to imply
something close to sabotage. But what if he were
asked, ‘Mr Bernanke, will the Fed do what it can
to prevent fiscal austerity from leading to mass
unemployment?’ Would he answer ‘no’?
Another debate revolves around the Fed’s
willingness to engage in unconventional monetary
stimulus. They do seem somewhat uncomfortable
with doing large amounts of QE. In my view, this
is the best argument against monetary offset. The
Fed might be afraid to use these more extreme
measures to offset fiscal austerity, even if they’d be
willing to use conventional tools (such as cuts in
short-term interest rates) if those were still available.
And yet we continue to hear Fed officials talk of
cutting back on QE as the economy strengthens.
This implies they will do more QE under
conditions of austerity than if fiscal policy were
more expansionary. Perhaps without even fully
understanding their role in this complex policy
game, the Fed has acted very much like a central
bank that was determined to keep the recovery
proceeding at a steady pace but would back
off whenever inflation or growth seemed to be
The question that should be asked is,
‘Will Ben Bernanke do what is necessary to
keep nominal spending on a path consistent
with low inflation and stable growth?
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