Patrick Sullivan directed me to Brad DeLong:
Contrary to the claims of at least some Japanese central bankers, monetary policy is far from impotent today in Japan...
Why is it not impotent? Because of:
what amounts to an arbitrage argument ---the most convincing type of argument in an economic context.... The monetary authorities can issue as much money as they like. Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets. This is manifestly impossible in equilibrium. Therefore money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero. This is an elementary argument, but... quite corrosive of claims of monetary impotence...
In Bernanke's arbitrage thought experiment the central bank is not just swapping one zero yielding government asset for another. If it were, the argument would not go through: the government could issue an indefinite amount of cash and acquire an indefinite amount of zero-yielding assets as the mirror to a private-sector balance sheet that has an indefinite amount of cash balanced by being short an indefinite amount of government discount bonds value at par, and the price level would not change. What makes the arbitrage argument work is the word goods. The government prints money, and buys roads, bridges, the bearing of duration risk, biomedical research, human capital for twelve-year olds--whatever. This is helicopter money.
But the price level is independent of money issuance if one raise the money supply via open market operations and the marginal dollar of cash is held as a savings vehicle...
DeLong is confusing two unrelated issues. One question is whether the central bank ever runs out of ammunition. The answer is no. The second issue is whether the central bank might ever need assistance from fiscal authorities at the zero bound. Again, the answer is no.
Bernanke is saying that if the BOJ had been serious about monetary stimulus, they could have bought up all of the financial assets in the world. Japan would then essentially own the world, and the Japanese could all retire, living a lavish lifestyle off the sweat of labor in other countries. That's all from just open market purchases with no assistance from the fiscal authorities in Japan.
For some odd reason, Keynesians have begun defining monetary policy in terms of the purchase of only a single type of asset---T-bills. (Nick Rowe also complains about this.) The purchase of any other asset; long term bonds, corporate bonds, municipal bonds, equities, etc., etc., is regarded as "fiscal policy". But it isn't, it's just another type of financial asset being purchased in open market operations. That's monetary policy.
This is not just a question of semantics. An actual helicopter drop worsens the fiscal authority's consolidated balance sheet. It is deficit spending. It leads to higher (distortionary) taxes in the future. An open market operation has no effect, on average, on the country's fiscal situation. Two assets (money and bonds) are swapped at equilibrium market prices. Yes, the central bank is exposed to a bit more risk, but that's a second order effect.
The inflationary effect of the BOJ buying up the entire world does not come from the BOJ absorbing risk (as Keynesians might tell you), but rather from the fact that the rest of the world does not feel too happy about selling off their entire stock of wealth for some dubious Japanese currency notes, denominated in yen. They would quite rightly smell inflation ahead, and thus the thought experiment would never actually be carried out. The mere intention to do monetary stimulus "à outrance", if necessary, would create any desired inflation rate. And that means that the policy even lacks its one supposed drawback---it does not in fact add risk to the central bank balance sheet. The balance sheet never gets very large (as a share of GDP), in a truly inflation policy regime.
People seem to miss the entire point of Bernanke's thought experiment. The point is not that central banks must buy up massive quantities of assets at the zero bound. Rather that it is not necessary to buy up lots of assets, if the central bank is truly committed to inflation. If BOJ officials unanimously said, "we will do this if necessary", it would not be necessary.
Originally published on EconLog