It Looks Like We’re Stuck With Low Inflation


Back in August I agreed with Brad DeLong that 4 percent inflation would be a good thing right now, but I was skeptical that the Fed could engineer this given current conditions. So I asked him what it would take. Today, I apparently made it to the top of the question pile:

I think the answer is: We don’t know whether it is in fact possible for a central bank today to hit a 4%/year average inflation target via conventional ordinary quantitative easing. It might well require other tools. For example:

  1. Miles Kimball’s negative interest rates.
  2. Helicopter drops–that is, allowing everyone with a Social Security number to incorporate as a bank, join the Federal Reserve system, and borrow at the discount window, with the loan discharged by the individual’s death.
  3. The Federal Reserve as infrastructure bank–an extra $500 billion/year of quantitative easing buying not government or mortgage bonds but directly-financing public investments.
  4. Extraordinary quantitative easing–buying not the close substitutes for money that are government bonds but rather the not-so-close substitutes that are equities.

I say: If we could win the argument about what the goal is, we could then begin the discussion about what policies would be needed to get us there.

That’s pretty discouraging. Of these, #2 and #3 are almost certainly illegal, and undesirable in any case. I may not like what Congress is doing, but disbursing money is certainly under their purview—and should be. I don’t want the Fed mailing out checks or contracting for new roads and bridges.

I don’t know if #4 is illegal. Probably not. But I’m not crazy about this either. The Fed shouldn’t be in the business of directly propping up the stock market, and certainly shouldn’t be in the business of directly propping up specific stocks.

So that leaves only #1. This one is perfectly OK, and a few European countries have adopted negative rates recently. But there’s probably a limit to how negative these rates can be. Individuals could avoid negative rates by deciding to hold physical cash, which pays zero percent, but banks and corporations almost certainly couldn’t. I’m not sure how long it’s sustainable to essentially have two different interest rates like that.

This is why DeLong mentions “Miles Kimball’s” negative interest rates. Kimball’s version depends on making the e-dollar into the unit of account, and this would allow negative rates of any level for any period of time. However, it would also require many years to make this transition. It’s not an option in the short term.

So if I’m reading DeLong right, it’s not clear that the Fed could engineer 4 percent inflation at all right now. Maybe Scott Sumner has a bright idea about how we could do this.