Lee has a new post on Modus Tollens on quantitative easing that makes a point I had never thought of before and that I don't think I've read anywhere else (he's probably made it a million times and it's just finally clicking for me).
I've noted elsewhere that I see three arguments for QE2 - all good ones, I might add. It can:
1. Lower long-term rates to boost investment demand (classic Keynesian)
2. Boost nominal expenditures (classic monetarist, widely adopted Keynesian)
3. Increase inflation to deal with wage and price rigidties (New Keynesian)
One thing I haven't comprehended, though, is how simply increasing nominal income guarantees any substantial impact on employment. To put it bluntly "we're in a liquidity trap" (I think we probably are), but to put it more accurately and less controversially, we simply have very high liquidity preference - which will do the trick of getting you below full employment even if you're not in a liquidity trap. What does handing people money really do when liquidity preference is a problem? It might help, but there's no guarantee even a substantial portion of it is going to be put to work.
The answer is quite obvious in retrospect. Longer term bonds don't simply have higher rates that have more flexibility to be pressed down. Longer term bonds don't simply play a role in long-term inflation expectations. The other thing about longer-term bonds that gives a boost to nominal expenditures traction is that long-term bonds aren't all that great for satisfying liquidity preference - they are not as close substitutes for money as short-term bonds. Lee writes:
"Short term bonds with near zero interest rates are extremely close substitutes for money, and so purchasing short term bonds may increase the money supply, but is also likely to increase money demand in proportion, and so any excess demand for money will remain unchanged. Purchasing longer term bonds with higher interests rates, however, exchanges quite different assets. Households and firms that sell long term bonds are unlikely to hold their new money, but instead they will begin spending it on various consumer and capital goods. (Initially, they likely will be reluctant to lend for the same reasons as banks)."
OK - one more (probably dumb) question. Long-term bonds are not like cash in the way short-term bonds are (and even short-term bonds, as Scott Sumner regularly points out, aren't perfect substitutes). But long-term bonds do afford a liquid market. If the problem is a demand for liquidity - an increase in liquidity preference - might it be plausible that people who sell their long-term bonds were still holding them for liquidity purposes, and therefore would still be unlikely to go out and spend? Or am I still misunderstanding something.
Anyway - I've inched closer to the "eh - fiscal policy seems to be more trouble than it's worth" position. Not there yet. But an inch closer.