Why are Most Advocates of Unconventional Monetary Policy so Conventional ?

I associate the phrase “unconventional monetary policy” with Joe Gagnon. Here we were in 2008 with the conventional monetary instrument — the target Federal Funds rate — pedal to the metal and the economy stalling. Many people said it was time for fiscal stimulus (I think Gagnon agreed). He also suggested unconventional monetary policy, by which he really meant unconventional policy by the Fed, since the point wasn’t changing the money supply but rather changing demand for other assets. The Fed can create Fed liabilities (high powered money) and buy some assets driving up their prices. To Gagnon the point was the assets side of the Fed’s balance sheet. His proposal was to buy a whole whole lot ($5 trillion worth). That isn’t going to happen, so his new proposal is to buy assets which the Fed can buy which are perceived to be risky and are not close substitutes for money, that is Federal Agency issued mortgage bonds.

Oddly he is, as far as I can tell, the only advocate of unconventional monetary policy who focuses on which assets the Fed should buy (I don’t count myself and Brad DeLong occasionally sounds like Gagnon). Some other economists (I am thinking of Duncan Black) propose that the Fed ignore the Federal Reserve act and do things which it is clearly not allowed to do. Many more discuss unconventional monetary policy exactly as if it were conventional monetary policy.

Why ?

I will explain then much later provide evidence. It is agreed by all salt water economists that the Fed can normally stimulate demand in the short run by causing a price level higher than the one expected with sticky wages and prices were set. For decades the key issue in the debate has been the problem of subgame non perfection which was renamed dynamic inconsistency (forcing those of us interested in dynamic inconsistency to call it time inconsistency so then they decided to call subgame non perfection time inconsistency). The problem is that if price and wages setters know the monetary authority will try to cause a price level higher than the expected one, then the only subgame perfect equilibrium has socially costly inflation. So the discussion became all about pre-commitment and credibility and expectations and such. This always under the assumption that the Fed can get the price level it wants.

None of this has much to do with the current problem. Ben Bernanke has been saying he wants higher demand for years now. He’s practically been begging Congress for help. In 2010 and 2011, the FOMC made huge mega gigantic efforts to stimulate the economy and nothing much happened. Yet most salt water economists insist the the problem is that the FOMC has not decided to stimulate or has not communicated that intention.

Some people are extreme and discuss the problem under the assumption that there is no difference between monetary policy with a Federal Funds rate of essentially zero and one with a rate of 10%. They are very silly people and will not be named here.

Others are listed (with endorsement) by Brad DeLong (see above as the only semin Gagnonian I can think of) here

Jan Hatzius’s proposals that the Fed buy $50 billion of long-term bonds a week until expectations of prices and of nominal spending return to their pre-2008 growth path. They are the ones who ought to be adopting Christina Romer’s proposals for price-level targeting. They are the ones who ought to be adopting Olivier Blanchard’s proposals for a long-run inflation target of 3+%/year rather than 2-%/year. They are the ones who ought to be adopting Joe Gagnon’s proposals for–since the FHFA won’t do its job and rebalance housing finance–the Federal Reserve to fund vehicles to deal with the underwater-borrower problems that beset our mortgage and housing markets and are holding back recovery.

(the odd grammar is because he is saying that Bernanke et al should be adopting these proposals).

Which one here is not like the others ? Which one has a plan which will work even if it doesn’t affect the expectations of most economic agents ? Which plan works through supply and demand and the assumption that if some things (RMBS) have higher prices then people will produce more of them ?

I think the reason that Gagnon proposes a direct approach which does not work through the credibility of targeted expectational shifts of policy regimes is that he isn’t pathetically addicted to the decades of research which happen not to be very relevant at the moment.

The reliance of the others on the expected inflation imp (first cousin of the confidence fairy) is not due to the fact that only that imp can save us now. It is just because they have been its votaries for too long to see that static supply and demand curves can tell us what the Fed needs to know now.