Mysteries of the Monetary Offset  

Ben Bernanke

Photo by Brendan Smialowski/Getty Images

Scott Sumner became famous in the world of popular economics writing with the bold contention that even at the “zero bound” the Federal Reserve both could and should bring the economy back to full employment even in the face of contractionary fiscal policy. But he’s always paired this with a stronger claim, namely that the Fed does in fact bring about exactly the level of Aggregate Demand that it wants to have regardless of the tightening or loosening of fiscal policy.

And he’s become pretty testy about people like Larry Summers who think that looser fiscal policy would be a helpful means of restoring full employment more swiftly.

A curious issue that in my opinion he and other proponents of the full monetary offset thesis haven’t fully grappled with is that Federal Reserve officials keep saying it’s not true. I heard John Williams of the San Francisco Fed say it’s not true at the Brookings event this morning. I heard Ben Bernanke say it’s not true at the American Economics Association meeting in Philadelphia earlier this month. I separately heard William Dudley of the New York Fed say it’s not true in Philadelphia. Janet Yellen has repeatedly said it’s not true. And since full monetary offset isn’t just an abstract economic thesis, it’s specifically a thesis about the actual behavior of the Federal Reserve, the fact that nobody in a position of authority at the Fed believes in it seems like a big problem worthy of a more substantive response.

What I think clearly is true is that partial monetary offset is very real. The people who thought the tight fiscal policy of 2013 would crush the economy were wrong, and they were proven wrong precisely because of monetary offset.

But I think the same policymaker statements that confirm that partial monetary offset is the reason the economy grows despite austerity also confirm that full monetary offset isn’t true. The Fed’s view (which may be wrong) is that it needs specific instruments in order to target the growth path of demand, and that those instruments (primarily QE and “forward guidance” about interest rates) carry risks to financial stability. Away from the zero bound, the Fed has instruments that don’t pose these risks and therefore there is full monetary offset. But at the zero bound, there is only partial offset due to these (perhaps misguided) financial stability concerns.

Now maybe Fed officials are confused or lying or even fooling themselves in an effort to evade accountability. But this is what they say is going on, it’s a view they’ve articulated for years, and it’s a view that they’ve refined as time has gone on. Believers in full offset owe us a clearer account of why we should ignore the Fed’s testimony on this.