So Why Doesn't the Fed Just Do NGDP Targeting Already?

     Krugman recently sounded a rather pessimistic note. While we've had endless debates of the effectiveness and desirability of monetary vs. fiscal policy, he argued that policy has failed on both fronts and maybe he's ready to rethink some things-even the Neoclassical Synthesis:

     "But the experience of the past 6 years, since the financial crisis began, has blown apart not just Friedman’s position but much of Samuelson’s as well."

     "First of all, the liquidity trap is real; conventional monetary policy, it turns out, can’t deal with really large negative shocks to demand. We can argue endlessly about whether unconventional monetary policy could do the trick, if only the Fed did it on a truly huge scale; but the fact is that the Fed hasn’t ever been willing, or felt that it had sufficient political room, to do that experiment."

     "Second, while the evidence from austerity programs strongly suggests that fiscal policy does in fact work, with multipliers well above one, the political economy of policy turns out to make an effective fiscal response to depression very difficult."

    "So the neoclassical synthesis — the idea that we can use monetary and fiscal policy to make the world safe for laissez-faire everywhere else — has failed the test. What does this mean?"

    "At the very least it means that we need “macroprudential” policies — regulations and taxes designed to limit the risk of crisis — even during good years, because we now know that we can’t count on an effective cleanup when crisis strikes. And I don’t just mean banking regulation; as the authors of the linked paper say, the logic of this argument calls for policies that discourage leverage in general, capital controls to limit foreign borrowing, and more."

     "What’s more, you have to ask why, if markets are imperfect enough to generate the massive waste we’ve seen since 2008, we should believe that they get everything else right. I’ve always considered myself a free-market Keynesian — basically, a believer in Samuelson’s synthesis. But I’m far less sure of that position than I used to be."

      http://krugman.blogs.nytimes.com/2013/08/12/synthesis-lost/?_r=0

    Sumner often argues that the fact of monetary offset means fiscal policy won't work. However, the question is why hasn't his unconventional monetary policy worked. His answer would be it hasn't been used which is what a Keynesian would say regarding fiscal policy. 

    Sumner likes to say the Fed should not 'try to stabilize NGDP' but simply 'stabalize NGDP'-it's all very Star Wars: Do there is no try. 

    If it's so simple then, why won't the Fed do it? MMers see it as just colourlessness or politics. Unlearning Econ suggests another explanation: their proposals might undermine the place of money in the economy.

    "The problem here is that their suggestions, which imply transcending ‘traditional’ monetary policy, may simply undermine the role of money in the economy. Market monetarists sometimes display a tendency to believe that those who conduct monetary policy simply don’t ‘get it‘, or are just constrained by petty politics. I’d instead suggest that policymakers just realise they’ve come up against some fundamental, inescapable constraints, implied by the nature of monetary policy itself."

    http://www.pieria.co.uk/articles/examining_the_case_for_ngdp_targeting

    On the face of it, that seems almost alarmist-surely, whether it works or not the effect wouldn't be this dire. Yet he provides an example of this:

    "One unconventional monetary policy tool was suggested by commenter J P Koning: negative interest rates on reserves. When I said that this would simply induce people to hold cash, he suggested that the central bank could stop 1:1 conversion of cash to deposits, making cash just as unattractive as deposits as the ‘price’ between cash and deposits adjusted to reflect the negative rates. Yet one of money’s fundamental roles is a store of value, and you undermine that by charging people to hold it. If you charge people to hold money, they will no longer see it as a desirable asset and will simply reject it. It is also worth noting that ‘floating’ deposit conversion rates could potentially play havoc with the value of bank’s balance sheets (bubble in deposits anyone?), as if these didn’t need more disruption."

     "Another suggestion, which I’ve seen before, is that the central bank could buy other assets than government bonds. First, I don’t really see why this would result in actual spending rather than people simply depositing or (assuming J P’s idea is not in play) holding cash. Second, this seems to undermine what it means to have somebody invest in your business – why bother having a business plan if the central bank will just buy up your bonds? I could set up ‘Unlearning Economics PLC’ and sell millions of pounds worth of bonds to the central bank – free money! Obviously this would quickly undermine the scarcity of, and trust in, money."

      Of course, this leads us back to the question of why not just do fiscal policy of we're willing to have the Fed do all this anyway. At the end of the day, I think UL gets it here: the trouble is a belief in the utter omnipotence of monetary policy:

     "My basic view is that that monetary policy can primarily alter the costs in the economy, but not the demand conditions. This is why it can often effect changes in NGDP and other variables, albeit indirectly. However, when those costs go as low as they can go (0), beginning to tamper with the fundamentals only risks completely undermining the term ‘monetary policy’ and how it should ensure that money retains its traditional roles, including that as a reliable store of value."

     Part of the trouble is that monetary policy is a victim of its own success. In the postwar era-till now, it's always been able to deal with any downturn but that's because we the system didn't have the financial implosion it has now. Monetary policy has its role but MMers want to believe its role is to lead everything. 

    Meanwhile, Bernanke seems to agree with UL on the matter of whether the Fed can do everything.

    http://diaryofarepublicanhater.blogspot.com/2013/05/the-fiscal-multiplier-sumner-vs-bernanke.html