Yes, Monetary Policy is Important!

That's what markets are screaming right now. If monetary policy was out of bullets, the markets wouldn't react to a disappointing Fed meeting.

As I said previously,

Any kind of a long term anchor (explicit NGDP/CPI targeting) or adjustable policy (changing IOR or asset purchases monthly based on the latest data) will be more effective  than ambiguous and rigid policies (QE2, keeping the Fed Funds rate at 0% for "an extended period of time")

"Operation Twist" is even worse than QE2 or commitments to keep the Fed funds rate at 0%. Is it any wonder stocks, commodities, interest rates, and inflation expectations are plummeting?

We are in scary territory.

Why Yesterday's Meeting was so Disasspointing

Here's the full statement

Markets were hoping for lower interest on reserves, or a mention of other policies the Fed could enact at a future date. Instead, they got a policy most agree was previously ineffective and a very negative outlook about the economy, implying the Fed isn't willing to take the necessary steps to boost aggregate demand.

Krugman's double standard

Paul Krugman writes that even though monetary policy can work in theory, it won't work in practice

Now, in principle you can get traction by making money a less attractive store of value. In particular, if you can credibly promise future inflation, that will make the real return on money negative. But getting that kind of credibility is tricky, especially given the normal prejudices of central bankers.

The problem with this analysis is that it seems to imply that his preferred alternative, fiscal policy, does not have such issues. It does. Krugman himself admits policymakers won't ever do enough fiscal stimulus unless a world war breaks out (and that includes periods where all three branches of the government are controlled by democrats), so what is the advantage of fiscal stimulus then? It's much costlier, less proven, and even less likely than a commitment to inflation. Krugman simply isn't doing his job as a pundit if he's going to brush away monetary policy while continuing to advocate fiscal policy.

In addition, every believer in current fiscal stimulus should mention the low 2% implicit inflation targets as one of the largest policy mistakes leading up to the recession. If you really do believe that monetary policy only works through changes in short term interest rates, raising the inflation target to 4% is a virtually costless way to make monetary policy more effective. For reasons I can't explain, I have never seen this incredibly obvious implication of the liquidity trap argument made. They should be screaming it from the rooftops.

Fiscal policy is inferior from both practical and theoretical perspectives. Why advocate it and not monetary policy then?