However, the policy has been loose, i.e. expanding monetary base, but if the multiplier is falling off a cliff, M1 and M2 won’t expand much. That being said, M2 has expanded somewhat, though not as much as it should have. http://research.stlouisfed.org/fred2/series/M2

I think this discussion is relevant to the idea of a liquidity trap (though I’m not implying that you accept its existence, as I know many don’t accept it, like sumner). It seems to me like the equivalence between bonds and cash at zero interest rates is not really relevent. One could have equivalence, the fed buys bonds which are equivalent to cash, banks lend out the cash, -> monetary policy is effective. The main issue is that there is nothing that the banks want to lend to, or at least they prefer the liquidity of excess reserves to any investment they could make now. This does not need any “animal spirits” type argument either, as good investments may be difficult to find (or difficult to screen out, a la bernanke gertler gilchrist). But the end result is the same, diminished credit availability and liquidity trap.

I’ll post on fiscal policy in the more current post, since this one is a few days old. I disagree that fiscal policy is inflationary, as in this environment with significant slack, output can increase with little increase in inflation.

As for the political implementation, I agree with your argument, which goes back to Friedman, that fiscal policy is more difficult to implement than monetary. But in this case, I think the timing issue is less relevant, as the downturn will be longlasting, especially if it is a jobless recovery. As to its contents, I see the fiscal stimulus as much more than “half full”, but this is about the guts of the proposal, not the general theory of fiscal stimulus.

I don’t know about an independent fiscal authority, as fiscal stimulus will (hopefully) not be needed for a long time if ever. I think that’s one thing that’s important to point out, that I don’t like having to use fiscal stimulus. I would much prefer a world where all the crises can be dealt with monetary policy. Alas…

I don’t know enough about banks, but an alternative take on this policy is that its addressing the real problem. The real shock that precipitated this mess was to the banking sector… Bank’s balance sheets looked crappy all of a sudden and they were reluctant to lend. Reserves make their balance sheets look better. So the reserves policy undid the real shock.

This theory has a number of testable implications like was there a contraction in demand or supply of credit last Fall.

Regarding the policy trade-off… I meant to look into this more. Shooting from the hip, suppose the real problem is bank balance sheets. Fiscal policy causes expectations of inflation to rise (which is good), but it doesn’t fix the real problem. The Fed needs to fix the real problem and because it has an inflation target, it has to worry about that too. There’s also a risk that inflation expectations become unanchored, that Fed inflation policy will become incredible.

The other strand of thought here is that fiscal policy is practically ineffective. In theory it might work even if we forget about the timing issues, but the politics of it are a mess. Its hard to argue the type of spending done in the current policy makes sense. At the same time, its not hard, given the institutions involved, to see why we got such a bad fiscal policy. Believers in fiscal policy should be thinking of ways to fix the administration of it. Maybe an independent fiscal authority with a precisely defined policy instrument (e.g. stimulus checks and a consumption tax) and mandate (e.g. keep consumptions spending smooth)?

Because I agree that in almost all recessions, monetary policy is more effective than fiscal. I am also reluctant to say that monetary policy is ineffective, but given the massive amounts of excess reserves, I don’t really see how it can be otherwise.

For example, Fed does an open market operation, buys a bond, and the bank gets reserves from it. The bank doesn’t lend it out and keeps it as excess reserves. This should have no effect on the economy right? For me, this is the best evidence the monetary policy would be ineffective. See the fred database at: http://research.stlouisfed.org/fred2/series/EXCRESNS?cid=123 for excess reserves and http://research.stlouisfed.org/fred2/series/BOGAMBNS?cid=124 for money base. They seem to line up, though I should probably run the numbers.

I have another question: Given that the fed has had a loose monetary policy, do you think that the fed should further increase the money supply? For me, that would be fine, but I don’t think it will have much effect, as it will just go into excess reserves. What is the appropriate amount? The fed has added hundreds of billions of dollars of new money base. How much is enough?

Also, I think the monetary policy/fiscal policy dichotomy is a false one. There is not real choice between the two in the sense that you can have both a loose monetary and fiscal policy at the same time. I think there should be loose monetary policy, as do you, as does Brad de Long. I don’t see a large call for monetary tightening (though there are some extreme inflation hawks who seem kind of nutty imo). So the correct question (which you have also asked) is whether fiscal policy is the correct policy. But I don’t get why the discussion is still about monetary policy- it has been extremely loose, and rightfully so.

That being said, if you want 1 trillion dollars in added monetary base, I support you 100%

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I didn’t say sticky prices and search are important. I said we’re learning a lot about those things by…gasp… testing the theories of that long dead economist.

Anyway, why do you believe that a) sticky prices; and b) search unemployment are major/important/defining features of the US economy, given that 1) the median price reset duration is 4 months or so (and yes, I count sales, for obvious reasons) and 2) with search, people are unemployed because they choose to pass job offers in expectation of better ones, so it doesn’t capture the “keynesian” idea that low final goods market demand translates into low labor demand.

I would speculate that we won’t know what’s the optimal price change frequency (and therefore the degree of price setting inefficiency) until we figure out the major structural sources of inefficiency/deviation from a 2nd Welfare Theorem baseline, which I suspect are not search/matching and monopolistic competition.

Instead of bitching how great Keynes was and how ignorant people are for not worshiping his awesome Truth, I think people should work out the macro implications of new and promising setups: e.g. I really liked the recent Azariadis paper on capital misallocation due to endogenous borrowing constraints.

OTOH, I do agree that economists in general have have been total fan-boys for the Fed (Uuu, Bernanke, so dreamy!).