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In an Economic Desert, the Monetary Policy Glass of Water Looks Like An Ocean

Felix Salmon rightly notices that the mild monetary easing offered by the Fed yesterday won’t really change much, because the bigger tools that the central bank can use have already been deployed:

This is tantamount to a very modest rate cut — not a full quarter-point, perhaps, but maybe half of that. Of course, when rates are at zero, basis points loom larger than they normally do, so these moves on the side of quantitative easing become very important. And more important still is the signal that the Fed is sending: we thought we were OK to tighten things up a little bit, but now we’ve changed our mind, and we’re getting a little bit looser instead. The recovery, in other words, still needs Fed support in order to maintain any semblance of sustainability or momentum.

The bigger picture, however, is one of the Fed largely having run out of ammunition. Most of what it’s doing now is symbolic: the real national response, as Mohamed El-Erian says, needs to come from the government rather than the central bank, and needs to be structural rather than monetary in nature. Given today’s decision, though, we can at least assume that any moves from the White House to try to bolster the national economy will be met with the strong support of Ben Bernanke.

There’s no question that the Fed is engaging in largely symbolic actions, although even on that point they could be doing more. The truth is that those actions are really all we’re going to get for the near future. Fiscal policy is stuck, the product of a deficit-obsessed political class. They managed to get $26.1 billion through the Congress yesterday in state fiscal aid, but it’s offset (at least some of it is offset correctly, a few years down the road, so that the immediate effect is stimulative), and anything beyond that would be near impossible, at least for the rest of the year. The White House has a few options – they’re still sitting on close to $50 billion from the HAMP program – but given the political environment, they aren’t likely to do much at this time.

That’s politically stupid, actually – only a positive economic trend will yield better results in November. But that’s the reality of the situation. The economics profession has woken up to the real dangers to the economy; the political class has not. And so with fiscal policy stuck, monetary policy is all we’ve got left.

UPDATE: None of this is to say that the Fed’s action yesterday made any sense at all. They recognized the scope of the problem and then took the least non-contractionary action possible.

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David Dayen

David Dayen