Quantitative Easing and Monetarism

What to do when you find yourself pushing on a string?

Keep pushing!

I'm pretty sure that when I was a brand new economist at the Richmond Fed circa 1969 I was the first person to put a reference to the money supply in the draft of the President's FOMC remarks.

I really am sure of that; but others probably remember it differently, and I have no proof.

I was a young, newly-minted "monetarist," you see, having been raised on Milton Friedman's writings and been taught by Friedmanites once or twice removed. In addition to monetarism, I was also a believer in flexible exchange rates, the topic of my first Monthly Review article at the Richmond Fed. I wasn't the only believer on the staff, but we were still a minority  toiling in the wilderness.

Fast forward about a decade and we get to the famous October 1979 weekend when Paul Volcker came down from the mountain and declared that we were going to give monetarism a try and target the money supply directly rather than indirectly through interest rates. The Thursday afternoon money supply statistics came to be watched more closely than the weekly claims for unemployment insurance are today.

I don't think anyone rang a bell when the great monetarist experiment later faded away. As I recall, true believers, or even fair weather believers, didn't stop believing. It's just that the velocity of money became a little too unstable and too unpredictable to rely on to enable you to control income by controlling money. Maybe it was Goodhart's Law, according to which the behavior of an economic variable changes when it's targeted.

The Fed Funds rate was back in the saddle when I went to the Dallas Fed and started attending FOMC meetings as a participant in 1991. No one around the table, to my knowledge, believed that money was not important in the long run. I think everyone accepted, at least implicitly, Friedman's pronouncement that "Inflation is always and everywhere a monetary phenomenon."

It was accepted, but it wasn't discussed much. A one-time visitor or observer would probably have been misled.

We monetarists under the skin didn't worry much about what would happen if interest rates got too low to reduce much more. What would we do then? Just keep pumping out money, of course. That was the important part of what we were doing even though the conversation revolved around interest rates.

Fed people, however, are very inventive when it comes to finding things to worry about. This brings me to the "zero-bound" interlude or scare. Someone pointed out that, with inflation positive by a couple or three percentage points, a very low nominal Fed funds rate would be negative in real terms, which it often was during recession-fighting episodes. As inflation approached zero around 2003, especially if you adjusted for an upward bias in the inflation indexes, then a zero nominal Fed funds rate would also be a zero real Fed funds rate-hence the zero bound. With no inflation, the Fed couldn't get the real Fed funds rate to go negative. Those who thought the Fed funds rate was important separate and apart from the money-growth implications, worried about this zero-bound problem.

I must admit that my what-me-worry attitude was based only partially on my faith in monetarism; it was also based on recently enhanced cynicism. Not long before the zero-bound scare, seemingly serious people had worried about the string of budget surpluses soaking up all the outstanding government securities and leaving the Fed with nothing to purchase in its open market operations. I had put that one in the "oh, yeah, really" category, which made it easier to take the zero-bound worry with a grain of salt.

What I never understood, and still don't, is why they had to give a new name to Japan's open market purchases after interest rates had landed-namely, "quantitative easing." It seemed like simple monetarism to me. And, why the argument now over whether today's FOMC is engaged in a similar quantitative easing? They say not, apparently, because, unlike the Japanese central bank, they are not targeting bank reserves or monetary liabilities. They emphasize that they are focused, instead, on the assets being purchased and their efforts to unfreeze credit markets through those purchases. Seems like a good enough distinction to me if they want to make it. I wonder why their critics are so adamant about putting an old label on the new wine.