Abolishing cash would be the easiest way to eliminate the ELB (and would have the further benefit of taxing criminal activity), but there are other ways to achieve the same goal. Such a step would enable the Fed not only to cut policy rates when it otherwise would have been thwarted by the ELB, but also to lower the inflation target to the level consistent with a zero “true” inflation rate – likely below 2%.
The FOMC’s second major error of omission is the absence of any discussion of the Fed’s failure, since the outbreak of the COVID-19 pandemic, to enlarge and change the composition of its balance sheet to the fullest possible extent to support economic activity.
As of the week of January 6, 2020, the Fed had consolidated assets of $4.15 trillion, or 19.3% of US GDP in 2019. By the week of August 17, its balance sheet had grown to $7.01 trillion, or 32.7% of 2019 GDP. But this growth – equivalent to 13.4% of last year’s GDP in just seven months – seems less impressive when compared to the evolution of the European Central Bank’s balance sheet over the same period. Between January 3 and August 14, the consolidated Eurosystem’s total assets increased from nearly €4.7 trillion ($5.6 trillion), or 39.2% of the eurozone’s 2019 GDP, to €6.4 trillion, or 53.7% of 2019 GDP. The Eurosystem’s balance sheet thus grew faster than the Fed’s – by the equivalent of 14.5% of last year’s GDP – during the same period.
The Fed should convince the US Treasury Department to provide more equity and to guarantee more of the Fed’s risky assets on what should be a significantly larger balance sheet. As the issuer of the only viable global reserve currency, the Fed has an unequaled ability to enlarge its balance sheet and increase its risk, even without additional Treasury support. But it simply has not done enough during the pandemic.
The recent changes to the US monetary policy framework are ill-advised and potentially harmful. They also fail to address a number of other crucial problems. The Fed should scrap this new approach, and instead make full and effective use of the policy instruments it has – or could have – at its disposal.
Willem H. Buiter, a former chief economist at Citigroup, is a visiting professor at Columbia University.