I’ve put some more thought into NGDPLT and I think I understand it better as more of a psychological process than any kind of concrete thing. I would guess that in concrete steps, the Fed probably has done enough but because of failure to overcome a sort of paralysis from not being able to wrap its culture around anything other than the FF rate approach it has been ineffective and most of the by product is just sitting around as excess reserves.
For a recap of how it got to this point I would say that some key turning points were missed in the events leading up to the 2008 financial crisis and they are:
A broken link of continuity between the Greenspan Fed and the Bernanke Fed put more of a risk factor in loaning money (which is still present, by the way). Greenspan had an approach to heading off market volatility that perhaps Bernanke found distasteful, but the basic point here is that the Bernanke Fed missed several opportunities to head off the collapse of the MBS market by not providing a backstop for Countrywide liabilities after that firm got into trouble. Anything the Fed could have done to prevent the collapse of the MBS market would have been an ounce of prevention to prevent NGDP from contracting and the demand for liquidity skyrocketing.
The market volatility from allowing unsterilized liability from Countrywide unquestionably took down Bear and E-Trade. And then everyone else started to get spooked while Bernanke played the fiddle. I think that Countrywide needed to go down, and perhaps Bear too as a matter of making examples out of them to restore some sense of discipline to the mortgage and CDO markets. That should have been the end of it, but it wasn’t. The relief the Fed provided later, like opening the discount window, was too little too late because once the markets get spooked, that horse is out of the barn and the Fed was standing in front of a tsunami with a broom. Greenspan understood the Chuck Norris effect which is why he had very little problem keeping things that started out small from turning into a tsunami.
So now the question is what should we do about where we are now?
The first thing the Fed needs to do is stop obsessing about inflation, at least in public. We all get the 2% target and don’t really need to be reminded of it constantly because we don’t have to worry about it right now. The most important thing is to get markets functioning normally.
The Fed needs to start open-ended QE based on some economic goal, perhaps one linked to unemployment. Monthly asset purchases do not need to be large, but it needs to be well understood that it will be adjusted if the goal isn’t coming close in the time allotted for attaining it. If people believe that the Fed is serious about solving that particular problem, the markets will do most of the heavy lifting.
Whether people like it or hate it, we have to take some of the risk of lending out of the equation. The current machinations of the Treasury Secretary and some at the Fed about leaving banks on their own are not helpful. TARP was quite a mistake for two reasons. The first reason is that it was unnecessary for fiscal solutions to the problem and it politicized the crisis more than needed. The second reason is that it was the Fed’s job to control market damage because it is nearly costless. We want banks to have to learn some lessons, and they can do that by examples given from time to time without the need to let the entire financial system to go belly up. They get the point very clearly that way and we don’t need this big economic mess to go with it.
We need some control over the nominal environment given that the ability to control inflation expectations via the FF rate is at least temporarily out of commission if not completely dead. We need a substitute because leaving the current market conditions in place due to fear of having no control over inflation is not an acceptable trade off. We don’t want to live in fear and despair, and so we need a pathway out of the trough of financial despondency. Some kind of nominal level target is needed, like yesterday.
PS: I don’t think Bernanke is a global warmer and population explosion freak or that he has any other sinister motives for tight money. I think he is addicted to tight money because it allows him to meet his target. He doesn’t understand that it is unacceptable to not have thriving, prosperous markets because he fears inflation becoming unanchored without being able to communicate his intentions via the FF rate, so he does nothing to solve the problem while talking the markets down as a way to keep inflation under the target. He is successful in meeting his target this way and considers it his only responsibility even though the law disagrees with him, and so he believes his mission has been accomplished.