The driving image for policymakers of secular stagnation is the idea that the monetary policy pedal is to the floor, and yet we are not getting much forward motion, in terms of response of macroeconomic outcomes.
It is worth at least noting regarding the welfare effects of secular stagnation, though, that so long as the economy does not fall into recession, having a nominal flatness is not the worst thing in the world.
Sometimes pundits claim the liquidity created is driving up asset prices. Importantly, though, two decades of very low interest rates and QE have not resulted in obvious bubbles or financial instability within Japan.
But we should not ignore the warning that arises from how ineffective Japanese monetary policy has been in terms of raising price inflation. I think policymakers should be troubled by this.
If we were to fall into recession, we also should worry about the inability of monetary policy to get us out. And it is evident that old assumptions about inflation and monetary policy do not hold.
If you think about the wishlist that Ben Bernanke or Paul Krugman or I put out for the Bank of Japan 15-plus years ago, they have by now done it all. The BOJ announced a positive inflation target. They made public commitments to reach it. They undertook QE on longer term bonds rather than shorter term bonds. They undertook QE on private sector assets.
There was a sustained depreciation of the Japanese yen against the dollar from its 2012 peak. There was, according to some people, an erosion of central bank independence, at least in perception. And the inflation rate has thankfully gone above deflation, but has not risen, has not accelerated, has not stayed up.
Now, I do not want to run the experiment of what would have happened in Japan if the Bank of Japan had not done all that. And so I would certainly support the Federal Reserve or European Central Bank or other major central banks engaging in these kinds of policies, when faced with deflation. But I think it is wise to be cautious and assume that even aggressive monetary policy measures will no longer be as effective as we used to think they would be for inflation or stabilization.
As a result, we need to think about practical ways of doing fiscal-monetary coordination when monetary policy is ineffective. Certainly there has been active coordination of the BOJ with the expansionary fiscal policy by the Japanese government, particularly since early 2013 -- and this has been a success for the real side of the economy. It has done so without causing strong inflationary pressures, which is both frustrating narrowly and helpful overall.
While many in the central banking community agree that fiscal policy stimulus will be needed for at least the next downturn, most of the proposals for how to coordinate with it are unnecessarily complex.
They either shift fiscal authority to the central bank under some specified trigger, or they have state contingent rules for changing monetary regimes, or they rely on a change in target from inflation to something more abstract on its own moving expectations substantially. I am actually quite skeptical that any of these will work.
Instead, I think that the Bank of Japan has basically gotten it right for the last few years. The yield curve control approach is a success story. Yield curve control simply says the Bank of Japan will target a given rate on the 10-year government bond and will do so until further notice. And they can set further notice in terms of desired macroeconomic outcomes or the inflation target or a period of time, whatever the BOJ chooses and can justify.
This has enormous advantages in that it is credible, it is achievable, it is transparent. While the central bank is enabling fiscal policy, it is in no way having the central bank judge fiscal policy. Yield curve control is not in any way conditional on the specific measures of the fiscal policy or the allocation of it. And for an independent central bank, it is always credible that they can stop at any time.
So, rather than making things complex, we should all be thinking about the yield curve control as the way forward. And if you think about the mid 20th century U.S., for example, with the Treasury-Fed Accord of the 1930s through the early 1950s, that is effectively what the Fed did when we had need for large-scale fiscal financing -- which we do again now.