Many observers have been making the case for fiscal policy by arguing that conventional U.S. monetary policy has exhausted all of its ammunition. For example, Brad DeLong says:
For those who are concerned that such a move would let the inflation genie out of the bottle I would (1) point you to this troubling figure that suggests deflation is more of a threat and (2) ask you to read Nick Rowe's discussions here and here. It is possible that banks would continue to hang on to the excess reserves in the absence of this policy, but given the improvements in credit markets it seems that at least some of these excess reserves would be put to good use. So I ask again is U.S. monetary policy really tapped out?
Update: See JKH's discussion in the comments section. Among other things, he explains that contrary to my assertion above the Fed's policy of paying interest on excess reserves is not consequential to the current excess reserve buildup.
...We need a big fiscal boost program because monetary policy is already tapped out--Treasury interest rates are at zero--and employment losses are about to be bigger than in any previous recession since the Great Depression.Other observers go on to say that even unconventional U.S. monetary policy, such as the Fed's quantitative easing, has its limits. Representing this view is Paul Krugman:
Yes, there are other things the Fed could do — and it’s doing them, on an awesome scale. But they’re controversial, precisely because, unlike conventional monetary policy, they involve picking and choosing among potentially risky investments. And there’s a much stronger case for fiscal policy than in normal times, because we don’t know how well these unconventional measures will work.So conventional monetary policy is not working and the efficacy of unconventional monetary policy is uncertain. Maybe so, but I have a few questions. First, how do we know that unconventional monetary policy is not working? On the credit crunch front there is evidence that the Fed's policies are working to some degree as pointed out at macroblog. Also, monetary policy's effect on the real economy typically occurs with a lag so it seems premature to pass judgment here. Second, are we even sure that unconventional monetary policy is being fully exploited? I say this because of the Fed's policy of paying interest on excess reserves. This policy seems highly counterproductive given the state of the economy. What would happen if the Fed dropped this policy and did not attempt to sterilize these reserves? I suspect we would not see pictures like this one (click on figure to enlarge):
For those who are concerned that such a move would let the inflation genie out of the bottle I would (1) point you to this troubling figure that suggests deflation is more of a threat and (2) ask you to read Nick Rowe's discussions here and here. It is possible that banks would continue to hang on to the excess reserves in the absence of this policy, but given the improvements in credit markets it seems that at least some of these excess reserves would be put to good use. So I ask again is U.S. monetary policy really tapped out?
Update: See JKH's discussion in the comments section. Among other things, he explains that contrary to my assertion above the Fed's policy of paying interest on excess reserves is not consequential to the current excess reserve buildup.
