The U.S. economy has been growing for almost a year now, but it hasn't felt like growth for much of the country. Unemployment continued to rise, home prices continued to fall and Americans continued to doubt the government's role in the recovery.
Today the Federal Reserve meets and will almost certainly decide to keep its benchmark rate at a historic low. But is there something more the Fed could do to make the recovery feel like a recovery?
As David Leonhardt explains, the Fed's benchmark interest rate, which has been zero-bound since 2008, pulls down other short-term interest rates, but it has a weaker impact on long-term rates, such as 30-year fixed mortgage rates. They could buy bonds backed by long-term interest rates to bring to bring down long-term rates as well.
Here's what Bernanke could do:
If Mr. Bernanke and his colleagues decided to take further action, their most likely move would be to bring down long-term rates. They could do so by buying the bonds that backed longer-term loans. With lower borrowing costs, households and businesses would probably spend more money. The Fed did precisely this during the financial crisis, and the drop in rates seemed to help spending.
Here's why it might make sense for central banks to keep printing money:
If governments need to run deficits, to support demand at a time of private sector weakness, they can always borrow from central banks. Yes, this is "printing money". It is also an insanely radical policy recommended by no less insane a radical than Milton Friedman, back in 1948. His view was that the government could expand the money supply during recessions and contract it in the subsequent booms. A country with a fiat currency and a floating currency could, thus, stabilise the economy without destabilising credit markets. The neat thing about this proposal is that one does not have to decide whether fiscal policy or monetary policy is doing the heavy lifting: they are two sides of one coin.
The argument for aggressive monetary expansion remains strong, though not equally everywhere, since the growth of broad money and nominal GDP is weak (see chart). So Friedman's policy of "quantitative easing", as it is called, still makes good sense. n this environment, monetary policy must be aggressive. When the economy recovers, the monetary effects should be withdrawn, via budget surpluses obtained via long-term control over spending. In the short term, changes in reserve requirements can offset the impact on monetary expansion of the rise in deposits of commercial banks at the central bank.
And here's why a dash of inflation wouldn't be so bad:
The answer is that inflation is less costly now than it usually is. Inflation would alleviate some damage done by the housing market to the wider economy. Specifically, inflation would raise prices of homes, among other things. Higher housing prices would pull a number of mortgages out from under water - the case when more is owed on a mortgage than the market value of the house that collateralizes it - and thereby reduce the number of foreclosures.