Have We Blown Our Load?

Krugman blogs that any further actions by the Federal Reserve Bank may be ineffective.

Sigh. In an otherwise useful article about divisions in the Fed, Jon Hilsenrath says this:

The Fed is better equipped to solve some economic problems than others. As Mr. Bernanke noted in a now-famous 2002 speech, the Fed has the power to fight deflation -- or falling wages and prices --- by printing money.

But the bank’s tools aren’t perfectly suited to reducing unemployment, which is influenced by a range of factors including fiscal policy, regulation and global demand.

Sorry, but that’s totally wrong. The question is whether, at the zero bound, the Fed has the ability to increase aggregate demand -- full stop. If it can increase aggregate demand, it can fight both deflation and unemployment; if not, not.

In a way, the problem with Bernanke’s speech was that he made increasing demand and fighting deflation sound too easy. 

But as I tried to point out a long time ago, this simple story breaks down when short-term interest rates are near zero.

...

In my simple 1998 model, there’s only one way the Fed can affect things at all: by promising, credibly, to print more money in the future, when the zero lower bound no longer binds.

In practice, things are more complicated, because long-term bonds aren’t perfect substitutes for short-term -- so the Fed can get some traction by buying at longer maturities. But I always felt than Ben was overstating the effectiveness of such purchases. It’s worth noting that in his "it" speech Bernanke’s more-or-less specific proposal was to set a ceiling on the yield on two-year securities. How much would that accomplish now, when even the 2-year yield is only 0.67 percent?

Mark Thoma isn't convinced either that the Fed can help on the demand side. I say we find out.

The danger is that the bond vigilantes will come calling. But that doesn't seem likely at the moment. As Krugman writes in an interesting blog post on delusions about debt dynamics:

So the debt dynamics coming out of interest payments on existing debt aren’t anything like the explosive force the austerity crew would have you believe. Even after all these years of borrowing, the overwhelming determinant of growth in Japan’s debt is still the primary deficit, not interest payments on past debt.

By the way, in an earlier post discussing Tim Duy, Felix Salmon and the Federal Reserve, I linked to Duy's blog post where he writes

Salmon believes that Federal Reserve Chairman Ben Bernanke - a Republican - will not break from that party's consensus that too much has been done already. 

Would a loyal "party man" write an "it" speech that breaks from party consensus? Would he write a speech that is even more slutty about debasing the currency than Krugman or Thoma? I doubt it.