I think the point is a fairly simple one, and it has to do with the question of why the central bank purchases should be able to move the market price anyway, which, again, people thought was kind of obvious. They said if you’re buying more of something, surely that will tend to make it more expensive. But when you ask whether that should actually happen with a lot of sophisticated traders out there in the market that are also trading against the central bank, what we argue is that if the other traders in the economy aren’t constrained in the financing they can mobilize to take the positions that make sense for them, they will tend to automatically have an incentive to trade against the central bank and to neutralize then the effects of the central bank’s trades.
The case where that won’t happen is if the people who would have an incentive to trade against the central bank are financially constrained. In particular, if people who would wish to shift out of the particular kind of assets that the central bank is buying aren’t able to reduce their exposure to those kinds of risks as much as they would like to, you can have the market valuation changing.
But what may very well be happening is then you’re forcing, in fact, parts of the economy to bear types of risk that they don’t want to. You’re pushing them more tightly against their financial constraints and saying that that’s a victory because you’re changing market prices. You’re doing something, but you have to ask whether you’re doing something that’s making the financial markets function more the way you want them to, or making financial constraints have even more perverse effects because they’re constraining people even more.
Pointer from Alex Tabarrok.
Woodford’s conclusion is very anti-Sumnerian when it comes to monetary offset.
I wish the Fed were speaking more about the need for fiscal policy to take on more of the burden of trying to get the economy moving. I’m afraid that, to some extent, the Fed’s desire to stress the fact that we still have tools, we haven’t used all of our ammunition, has had unfortunate effects. Of course, the intention of that is to reassure the public. The feeling is that letting people be scared that maybe we’re out of ideas would itself create uncertainty about the future that would be undesirable for the economy. And that’s understandable. But I worry that it’s had the undesirable effect of letting Congress off the hook a little too easily by letting them say, “The Fed still has lots of things they can do to take care of the situation, so we can play other games.” And I think maybe the Fed would have helped the public debate if it had pushed back a little more on the view that everybody should be assuming the Fed will save everything.
I am sympathetic with Woodford’s skepticism of monetary policy, but I am at least as skeptical of fiscal policy.
“I am sympathetic with Woodford’s skepticism of monetary policy, but I am at least as skeptical of fiscal policy.”
Surely there is an optimal monetary policy, and many degrees of departure from the optimum, with bad consequences of different magnitudes–some quite large (such as we saw in The Great Depression). The main reason to be skeptical about the efficacy of tweaking monetary policy in the present circumstances is that you think the Fed’s actual policy is already pretty close to optimal. Is that your view?
Skepticism about *fiscal* policy could go hand in hand with general skepticism about government. It seems to me that instituting a fiscal policy that really succeeded in stimulating the economy would require resources of knowledge and motivation that governments, at least *big* governments, evidently lack. (Stimulative monetary policy seems to be much easier to achieve.) Is that the basis for your own skepticism?
Woodford’s complaint about the Fed is quite odd. He says the Fed has allowed Congress to say: “The Fed still has lots of things they can do to take care of the situation . . . .” But he does not deny that that is *true*. Why does he not complain that the Fed has *refused to use* the extra ammunition it has?