All too often, the business class is ideologically reluctant to embrace the idea that public policy should aim at stabilizing adequate demand and ensuring something approaching full employment. But today’s Financial Times editorial steps up to the plate and hopefully people are listening:
First, and most immediately, Ben Bernanke could reverse the hawkish drift at the Federal Reserve and announce a third round of quantitative easing at the next Federal Open Market Committee meeting, later this month.
Pessimists have been forecasting runaway inflation since the start of the financial crisis in 2008. Clearly the markets do not agree. US Treasury yields continue to plummet – last week the 10-year bond hit a record low of 1.45 per cent. It is obviously impossible for the Fed to cut its discount rate to below zero. But if things deteriorate further, it could double its inflation target to 4 per cent.
Second, fiscal policy is turning into a drag on what little growth the US is generating. This is unnecessary and destructive. At these low yields, the US government is essentially being offered free money to invest in America’s future productive capacity. Indeed, as Brad DeLong and Lawrence Summers have recently argued, whatever is invested at these rates is likely to pay for itself in higher growth and revenues. The size and nature of the market for US sovereign debt means that bond buyers are no flight risk, unlike in many smaller economies. The US can and should, therefore, choose a more expansive fiscal policy. Budgets should ideally balance over the cycle. But they should also be counter-cyclical. One possible remedy would be to link the duration of another stimulus to the return to trend growth. That in turn would trigger a medium-term plan to reduce the US deficit along the lines set out by the Simpson-Bowles plan. In theory this should not be difficult.
I would not put this kind of emphasis on Quantitative Easing. I’m by no means opposed to additional asset purchases, and thinks they may in fact be necessary. But what’s important is less what and how much the Fed buys than what they say about their intentions. We need purchases paired with a clear statement of purpose (closing the gap between the total volume of nominal spending in the economy and its trend rate) and a clear commitment to steadily do more in order to achieve the target.