The New Fed Chair Debate

By Chandrashekar (Chandra) Tamirisa, (On Twitter) @c_tamirisa

Flattr this

In a 2012 co-authored paper, Lawrence Summers, former Secretary of the Treasury and contender for Chairman of the Federal Reserve to replace Ben Bernanke, restated the central tenet of John Maynard Keynes: that fiscal policy is more efficacious during depressed economic conditions.

Keynes had not regarded monetary policy to be an effective tool likening monetary easing at very low interest rates to “pushing on a string.” Summers takes the same tack in his paper.

It is, however, clear that under the risk of being stuck in a liquidity trap during depressed conditions, bond-buying programs at the zero bound a.k.a Quantitative Easing (QE) can indeed prop up economic growth as evidenced by U.S. data since 2010.

Getting out of the liquidity trap requires unorthodox and unconventional monetary policy as the Fed has demonstrated in the housing market by purchasing Mortgage Backed Securities (MBSs). A similar approach to other markets may be necessary in lieu of government bond-buying which lowers both short and long rates expecting broadly to increase domestic investment and job growth. The Fed must play the role of a portfolio manager if monetary policy is not to have the effect of pushing on a string.

In the current global economic environment, fiscal policy has no room to promote economic growth which only a portfolio-based monetary policy can. For example, in the United States, structural reform of government by gradually phasing-in fiscal consolidation is necessary to at least hold the federal budget at the current level over time to reduce it as a fraction of the national output. Such a discretionary optimal fiscal policy will still not promote growth though it could add to growth over the short run by not cutting back on government expenditures unlike the Sequester. Only more spending promotes growth but the political reality of more spending is antithetical to fiscal consolidation in the long run.

Lawrence Summers rehashing John Maynard Keynes singularly disqualifies him to be Chairman of the Fed, for the bully pulpit of the Fed is not for increasing government spending lest the United States find itself in Japan’s situation a decade from now with an ultra-easy monetary policy and very high government debt.

Advertisements

About Chandrashekar (Chandra) Tamirisa

http://www.thecommonera.com/Common_Era/Me.html
This entry was posted in Economics, Monetary Policy and tagged . Bookmark the permalink.

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s