Should the Fed coordinate with Congress?
New Series 2001 one dollar bill notes pass through a printing press November 21, 2001 at the Bureau of Engraving and Printing in Washington, DC.
As we saw last night, politicians will strenuously debate the extent of the economic recovery, but just about everybody can agree it is sluggish. Some economists fear the recovery is so sluggish, it is possible we might not climb out before the next recession comes along. Which is why some economists are speculating on what you might call "nuclear option" scenarios for new stimulus policies.
The University of Oregon's Tim Duy is one of those economists, and he laid out his thoughts in a recent blog post called "Why I Agonize about the Zero Bound."
"The issue, the zero bound, is that interest rates are very low," Duy says. Typically, the Federal Reserve uses the interest rate, which is now very close to zero, as its primary tool to drive the economy. "The challenge is: How do you stimulate the economy when your normal tool has pretty much used up all the capacity it has."
Duy suggests that the Federal Reserve, Congress, and the president work together to get around this issue.
"One of the ideas that we know would probably work is if you managed to do a monetary-financed tax cut or monetary-financed government spending," says Duy, "the idea there is that you'll literally end up printing the money in order to finance that tax cut or spending increase."
However, by law this sort of cooperation is not supposed to happen. The Federal Reserve is set up as a wholly independent institution from Congress and the president to prevent potential inflationary consequences of such a partnered effort. But, says, Duy, it might be time to start thinking about this "in case we are still at the 'zero bound' when the next recession hits," and are out of other standard options.