Strong Medicine for the Economy

This Op-Ed was turned down by the New York Times, Wall Street Journal, and Washington Post, so we are publishing here

This week, congress passed a nearly $2 trillion rescue/stimulus package that will make for good headlines but which history shows won’t have much effect. Fiscal stimulus in 2008 and 2009 had very little effect on the economy, while monetary policy has been shown to be a far more effective tool. While the Fed recently announced a “do whatever it takes” approach to asset purchases, it isn’t aimed at a specific economic outcome.

Here, we suggest a five-step process to optimizing the recovery:

  1. Targeted relief for the unemployed, as well as programs to address the health care crisis. A check for $1200 won’t be adequate for the unemployed and won’t have an impact on those who still have jobs.
  2. Though there will be pain in a number of industries, we believe that monetary stimulus will improve business conditions more effectively than targeted bailouts. Monetary stimulus has a history of not being very effective. Furthermore, singling out industries for favors adds to the national debt and will involve choosing favorites without helping the overall economy.
  3. Monetary policy currently targets the inflation rate. An increasing number of economists, however, recommend that the Fed switch to a nominal GDP growth target, which is a measure of growth in both total spending and total dollar income for everyone in the economy. The Fed should immediately commit to a four percent nominal GDP growth target path.
  4. If, as seems likely, the economy falls short of this path in the short run, the Fed should commit to returning to that four percent growth rate trend line as soon as possible. This approach, called “level targeting”, is supported by an increasing number of prominent macroeconomists, as it makes monetary policy much more powerful when interest rates are near zero. A commitment to maintaining a target path of four percent growth assures consumers and businesses that the Fed will do whatever is necessary to get the economy back on track. This commitment is far more effective than announcing a one-time QE program every time it looks like the markets are shaky. Monetary policy involves no new borrowing; it does not add to the national debt.
  5. By sticking to a target of four percent nominal GDP, the Fed will have a chance to unwind the current purchases later, when liquidity returns. Anything more than four percent would trigger asset sales and the destruction of money to maintain the proper level.

Despite near-zero interest rates, the Fed is not close to being out of ammunition. In a technical sense, there is no limit to how much new money the Fed can create and inject into the economy. If done in a timely fashion, the economy will recover quickly enough to unwind those trades when the extra liquidity is no longer needed. If there are political or regulatory constraints, Congress should remove them. This will allow the Fed to inject as much new money as necessary to achieve four percent nominal GDP growth in 2021 and 2022. It will start to improve market sentiment the day it is announced.

Monetary policy cannot create a vaccine or immediately put Americans back to work. But within months, we will find that our problems are increasingly associated with a lack of overall demand, not barriers to commerce created by the virus. If left untreated, this will lead to a very sluggish recovery. The Great Recession began as a banking crisis but high unemployment continued far too long when nominal GDP growth fell sharply below the pre-recession trend line.

Once the immediate crisis is over, we cannot allow the recovery from this recession to drag on for years. Monetary stimulus — specifically, nominal GDP level targeting — is the shot in the arm our economy needs to get people spending and insure a rapid recovery from the recession.

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Scott Sumner is professor of macroeconomics at the Mercatus Center of George Mason University.

David Siegel is an author, speaker, and entrepreneur. Their recent in-depth conversation on this topic is right here:

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