In the course of his column today on the politics and economics of a second economic stimulus bill, Paul Krugman offers a useful analogy:
When there’s an ordinary, garden-variety recession, the job of fighting that recession is assigned to the Federal Reserve. The Fed responds by cutting interest rates in an incremental fashion. Reducing rates a bit at a time, it keeps cutting until the economy turns around. At times it pauses to assess the effects of its work; if the economy is still weak, the cutting resumes.
During the last recession, the Fed repeatedly cut rates as the slump deepened — 11 times over the course of 2001. Then, amid early signs of recovery, it paused, giving the rate cuts time to work. When it became clear that the economy still wasn’t growing fast enough to create jobs, more rate cuts followed.
Normally, then, we expect policy makers to respond to bad job numbers with a combination of patience and resolve. They should give existing policies time to work, but they should also consider making those policies stronger.
Monetary policy adjustments, of course, are reasonably simple, and don’t involve the lumbering machinery of House and Senate committees and floor action, or the ambitions of 435 politicians. Still, if the Obama adminstration does come back to the well for a second cup of fiscal stimulus, howling critics should be reminded that this course would be a no-brainer if we were talking about interest rate cuts.