QE 3 skeptic and Philadelphia Federal Reserve President Charles Plosser gave a very strange speech outlining his opposition to monetary stimulus which I think can best be summarized as starting with concerns that it won’t work and ending with dire warnings that it might work. Perhaps the strangest part comes when he warns that aggressive monetary stimulus in today’s era might lead to consequences similar to those seen in the mid-1930s, when FDR’s stimulative monetary policies broke the back of the Great Depression:
With such a large balance sheet, our transition from very accommodative policies to less accommodative policies will involve using tools we have not used before, such as the interest rate on reserves, term deposits, and asset sales. Once the recovery takes off, long rates will begin to rise and banks will begin lending the large volume of excess reserves sitting in their accounts at the Fed. This loan growth can be quite rapid, as was true after the banking crisis in the 1930s, and there is some risk that the Fed will need to withdraw accommodation very aggressively in order to contain inflation.
This is, I think, totally accurate. In 1933, the Roosevelt administration and the Federal Reserve began a program of aggressive monetary stimulus. This worked really well and loan growth was quite rapid. Indeed, the economy in general grew at a furious pace for about four years as idle resources were put back to use. But there was no immaculate growth and the rapid expansion was somewhat inflationary. And then in 1937 policymakers felt they had to counter these trends and implemented contractionary policies. Indeed, in their fear they went too far and produced an unfortunate recession-within-the-depression.
But so what?
The normal interpretation of 1937 is that the lesson is “don’t implement contractionary policy too quickly” not “don’t implement expansionary policy in the first place.” And even if you choose to believe that, even in retrospect, the inflation fears of 1937 were correct that still doesn’t cast the expansionary policies of 1933 in a bad light. On a net-net basis, Americans were much better off during the ‘37 recession than they would have been in the counterfactual where we never boosted output from its deflationary depths.
But I feel like these central banking discussions always go in circles back to the same place: Do you think a years-long spell of mass unemployment, falling or stagnating wages, and a declining per capita stock of capital goods is a big problem? I think it’s a big problem. And you tackle big problems with tools that have some risk of negative consequences down the road. Obviously if it’s not a big problem then it’s not a big problems. Lots of people out there think central banks should simply be indifferent to labor market outcomes and real economic growth, and simply focus on low inflation in the context of a functioning banking system. Reading between the lines, I think that’s what Plosser really thinks. And, clearly, if you’re not interested in how wealthy the American people are or how many of them have jobs then monetary stimulus looks like a bad bet. But if you are interested, then warning we might repeat the successes of the ‘30s just seems crazy.