Without fiscal policy, what’s the Fed to do? Part 1

All evidence suggests to us that when the FOMC finally takes its first long-anticipated step, it will be to take us away from the zero bound, not because they fear the economy is getting too hot, or that there is any real danger of wage inflation, let alone unaggregated healthy wage growth.

In the fall of 2012, current and former Federal Reserve officials, as well as closely affiliated academics, made it clear the central bank is currently “confronted…with a situation that was regarded a few decades ago as merely a theoretical curiosity”: the zero bound.

In one of those papers John Woolford, former member of the New York Fed’s Monetary Policy Advisory Council (and the source of that quote) raised questions about the effectiveness of balance-sheet policies, advocating instead for forward guidance, while acknowledging the danger in central bankers talking too much. Other papers questioned quantitative easing’s ability to do anything about the unemployment rate, noted that the Fed may have fewer options than it suggests, and rang the warning bell on trying to correct macro-economic problems that have historically been addressed through fiscal and monetary policy by monetary policy alone, a bell former Chair Bernanke starting ringing before he left office. Chicago Fed President Charles Evans urged the FOMC to articulate what needs to be done as a first step toward pushing for the fiscal and monetary policies he deemed necessary to get us past the zero bound.

Evans also urged the Fed to adopt a 7/3 policy, where they would maintain their current policy as long as unemployment remained above 7% and inflation below 3%, which he called “an important improvement on current communication policy.”

Better communication policy perhaps, but it would still have left the FOMC in the same position it finds itself in today: we’ve crossed the unemployment rate threshold, but not the inflation bar.

Only the most reckless daredevil would enjoy spending so much time pushed up against the zero bound, but the way out remains the subject of contentious debate and reams of research. The vehemence of the debate, perhaps more of a slugfest, is fueled by the fact that on the other side of the scale, the fiscal side, we have a largely dysfunctional and distrusted government. We’re trying to hash out what should be considered national priorities in a dust-up about fiscal policy.