Readings on the economy have been sluggish and inflation has been slower than the Fed expected earlier in the summer. The situation warrants a response.
With the fed funds rate pinned at zero, the requisite easing action must take an unconventional form. For the reasons Chairman Ben Bernanke spelled out in his Jackson Hole speech in August, large-scale asset purchases seem to be the most promising.
Spending depends on the confidence of households and investors, and right now they seem legitimately worried both about near-term slack in the economy and longer-term overcommitment by the government. Moreover, as Carmen Reinhart and I documented at the Jackson Hole Symposium on Aug. 27, the performance of the economy may be impaired because of the financial crisis for a long time to come.
As a consequence, the Fed has to be both aggressive and nimble. The Fed should promise to purchase government and mortgage-related securities between its regularly scheduled meetings as long as activity is forecast to be subpar and inflation is low or headed down. Purchases of, say, $100 billion every six-to-eight weeks would add up to a number worthy of shock and awe for those with a somber economic outlook.
But those foreseeing a quick return to above-trend growth or expecting a slower trend would similarly be reassured that the Fed would not keep its foot on the accelerator for too long. Most importantly, by linking to economic conditions, the Fed would not be providing an open-ended promise to monetize the federal debt.
Vincent R. Reinhart is a resident scholar at AEI.