My general sense is that in as much as I think that debt as a percentage of GDP is unsustainably high, and we need to de-leverage, and stay that way, loose monetary policy seems a reasonable means of maintaining price stability. In as much as I suspect that we lack the disclipline to not unsustainably relever the second economic conditions begin to improve, I am skeptical.
The crux of his argument is:
What if the Fed had not cut rates during the current crisis?
Tighter monetary policy -- by restraining consumer spending and business investment -- would have made it more likely that the economic downturn would be even more severe, which would result in even greater uncertainty about asset values. Tighter monetary policy would then have made an adverse feedback loop more likely: The greater uncertainty about asset values would raise credit spreads, causing economic activity to contract further, thereby creating more uncertainty, making the financial crisis worse, causing the economic activity to contract further, and so on.
If the Fed had not aggressively cut rates, the result would have been both higher interest rates on Treasury securities and a substantial increase in credit risk on other assets. Interest rates relevant to household and business spending decisions would then have been much higher than what we see currently.
I am not sure I buy his primary argument. It is certainly true that if the fed funds rate was set at 10%, consumer spending and business investment would be meaningfully restrained. I am not sure that this would be so at 3%, or 1.5%.
What I am sure about is that price instability meaningfully restrains consumer spending and business investment. Hyper-active monetary policy certainly can result in price instability. There is good reason to believe that the wild commodity price fluctuations we have experienced were an unintended consequence of the Fed's hyper-active monetary policy.
His secondary point seems more compelling. Since our government appears determined to try to borrow and spend its way into economic health, minimizing the rate it borrows at seems an incontrovertibly good idea.
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