I sort of feel like with the standoff we have between right and left, plus with Bernanke at the Fed, we can actually get exactly the fiscal stimulus you are talking about.

The right is fiercely against tax increases of any kind. The left is fiercely against spending cuts of any kind. Witness its almost complete unwillingness to take that tiniest of baby steps, addressing earmarks.

So where does that leave us? With a huge *already existing* unaddressed structural deficit that is paid for directly out of thin-air fed money, day after day, year after year until the bond market vomits and goes into siezure. That is as though there is a giant Friedmanite new-money-financed tax cut every year until ________.

QE looks bad at the moment, but when there is a crisis of some kind (I think a bond crisis, but maybe a crisis in risk assets a-la March of 2009) a further round or two of Q.E. won’t meet as much protest.

That’s my view and so I shun bonds.

In theory, I agree, but my point is that it would be politically impossible. Look at the slightly deranged international reaction to the latest round of QE, the Tea Party caucus, and the Japanese experience. Physically printing money and spending it would likely have politicians and the public up in arms. And how would the Fed spend it? Not on financial assets — that isn’t the point. And a few extra staff parties, however lavish, wouldn’t really move the needle. The spending would have to be done by the fiscal authorities — but that is fiscal stimulus, which is already off the political agenda on the spurious grounds that “we can’t afford it.”

It is really very far from easy to get out of persistent deflation.

Still, I can totally see were Bernanke is coming from. A dollar devaluation helps with American jobs quite a lot. Study the Great D to see when happens when currencies strengthen a lot into the teeth of a recession.

Yes, yes, I know manufacturing does not account for that many jobs any more. But there are 1000 service sector jobs that benefit from devaluation.

- US vacationers spend their dollars locally
- Foreign vacationers come here
- Gas prices which feel higher curtail our consumption and reduce the capital we send to OPEC
- The appeal of outsourcing is greatly reduced, both presently and in terms of expectations
- The drive to automate, which is largely due to costly workers and cheap capital, is reduced.
- Jobs which use rising asset prices as lubricant (real estate, finance, construction) see better employment
- Companies which are safely sitting on huge cash hoards in a deflationary world must invest in R&D and otherwise seek returns not otherwise available (a huge effect!)
- Drive foreign purchases of our assets (stocks, buildings, etc.) to stimulative effect.

@JDB — The Fed is definitely not powerless against deflation. Unsanitized printing can achieve it, if it really were to become a serious problem. So far it hasn’t been. Ask Mugabe: print, spend, repeat! I don’t recommend a huge amount of that, but the recipe is simple if you *need* inflation.

Even Felix Salmon is against QE, on the grounds that it will do nothing to help the employment situation. This was the reason why I thought, back in the summer, that more QE was unlikely.

But I don’t think the latest round of QE is about employment. It is about inflation (and indeed, that is how the idea was originally presented in board members’ speeches, with employment coming in later). This is what I think is happening. Ben Bernanke sees a real risk of deflation in the US. Deflation is very hard to escape: yes, in principle, the Fed could buy the equity market, or the housing market, or raise its inflation target, or who knows what else. But these things are politically impossible. And if deflation took hold, the employment situation could get even worse than it is today. In addition, with the normal rotation of FOMC voting positions, there will be more hawks on the board next year, which will make it harder for Mr. Bernanke to embark on QE then.

It therefore makes sense for QE2 to start now. The idea is to raise the price of financial assets, and through a wealth effect (US households own a lot of equities and know how they are performing) to depress the savings rate (i.e. get consumers to spend rather than paying down debt), and to encourage investment, in order to tide the economy over until the deflation threat recedes. That will not necessarily reduce unemployment compared to its level today, but it will reduce unemployment compared to what it would otherwise have been, had deflation taken hold.

This policy is not sure to work, but given the downside risk inherent in our present situation, it makes sense to do something rather than nothing. If it fails to prevent deflation, we can only hope that the political environment is receptive to more radical solutions when the times comes. If, on the other hand, it works so well that it creates excessive inflation, the Fed has the tools to deal with that problem, in the form of short-term interest-rate increases and the payment of interest on reserves. And there is sure to be no shortage of political support for rate hikes in the face of high inflation.

In summary, the Fed’s current action comes from two asymmetries in its situation.

1. Political support for tightening is much more likely than political support for easing, so you have to ease when you can.
2. If you have deflation, you can be trapped; if you have inflation, you can just do a Volcker. So you need to do everything in your power to prevent deflation.

Anybody complaining about the drop in “nominal spending” is missing the point, because things COULD NOT continue the way they had been going from 2002-2006. It was essentially a Ponzi scheme, and like all Ponzi schemes it eventually toppled hard.

The fundamental problem is that our production costs are uncompetitive due to high wages and an artificially strong dollar (propped up by China). Other countries can’t afford to buy from us because the dollar is so expensive. *WE* can’t afford to buy our own goods because they are so expensive (and thus we outsource jobs and import manufactured goods). So we end up with an economy that is largely a closed circle of services, fed by a steady inflow of imports and credit.

You have to fix the fundamental problem, and that requires a devaluation of the dollar (since China refuses to allow the yuan to appreciate significantly) and reduced consumption. Rising productivity will help, but that isn’t something you can order up overnight.

What does “nominal” spending mean? Is that spending on a credit card? And its OK if you don’t pay it back – just keep spending???
“in the absence of any 12% decline in prices and wages,…” – really? Had wages declined 12 we would be OK? OH, if wages and prices declined! Isn’t QE specifically designed to prop up prices? Or is it just to lower interest rates? By how much? How much effect will a fall in interest rates of 0.2% have on employment? And the problem is the goods “We could produce” – like houses? We seem to produce lots of them, except we couldn’t sell them at their real cost. Or somebody was charging far more than they were really worth? – why don’t we let them sell at a price people can afford? (a “nominal’ price, or is it a “real price” the price that people can afford???)

It’s perfect! It will work! We’ll all be better off!

Why are you all laughing? Didn’t Alan Greenspan intervene to make sure tax and spending policy was what he in good faith thought it should be for the health of the country? Stop laughing!

You asked, however, how this is different from what they do daily. The difference is in the quantity of bonds being purchased.

If I were snarky, I would note that their mandate requires them to hold top-quality assets (no junk bonds). So why are they buying US Treasuries?

The Fed’s book has grown dramatically.

The letter in the WSJ and the blowback coming from foreign leaders is merely politics. No more, no less.