Thursday, September 27, 2012

Fed's Plosser is Worried QE3 Might Work

Via Matt Yglesias:
QE 3 skeptic and Philadelphia Federal Reserve President Charles Plosser gave a very strange speech outlining his opposition to monetary stimulus which I think can best be summarized as starting with concerns that it won't work and ending with dire warnings that it might work. Perhaps the strangest part comes when he warns that aggressive monetary stimulus in today's era might lead to consequences similar to those seen in the mid-1930s, when FDR's stimulative monetary policies broke the back of the Great Depression:
With such a large balance sheet, our transition from very accommodative policies to less accommodative policies will involve using tools we have not used before, such as the interest rate on reserves, term deposits, and asset sales. Once the recovery takes off, long rates will begin to rise and banks will begin lending the large volume of excess reserves sitting in their accounts at the Fed. This loan growth can be quite rapid, as was true after the banking crisis in the 1930s, and there is some risk that the Fed will need to withdraw accommodation very aggressively in order to contain inflation.
This is, I think, totally accurate. In 1933, the Roosevelt administration and the Federal Reserve began a program of aggressive monetary stimulus. This worked really well and loan growth was quite rapid. Indeed, the economy in general grew at a furious pace for about four years as idle resources were put back to use. But there was no immaculate growth and the rapid expansion was somewhat inflationary. And then in 1937 policymakers felt they had to counter these trends and implemented contractionary policies. Indeed, in their fear they went too far and produced an unfortunate recession-within-the-depression."
For those of you who wanted to see a graph of Plosser's dreaded 30's recovery, here's real GDP growth:

And here's inflation during that same exact period:

Not seeing anything catastrophically inflationary there, are you? In fact, the inflation that the U.S. did get was critical in fostering the robust growth that we saw during the mid-30s, since it worked to end debt deflation, etc. In any case, I'm short on time and Matt said everything that I would have said, but better, so I'll leave it at that.