John Cochrane on Stephanie Kelton's New Book: ‘The Deficit Myth’ Review: Years of Magical Thinking

John Cochrane has a review of Stephanie Kelton's new book, "The Deficit Myth". Here it is, for those who don't have access, with a few comments from me, on what I agree with and don't agree with.  I haven't read the book myself, but I've also posted favorably about aspects of MMT in the past, so I felt I should defend at least parts of the doctrine.

Modern monetary theory, known as MMT, erupted suddenly into the public consciousness when it won the attention of high-profile politicians including Bernie Sanders and Alexandria Ocasio-Cortez and their media admirers. Its central proposition states that the U.S. federal government can and should freely print money to finance a massive spending agenda, with no concern about debt and deficits. 

OK, I agree with Cochrane, I don't think government should have "no concern" with debt and deficits. However, when you're in a liquidity trap or a severe recession, or just growing slowly with below-target inflation, it's not time for austerity at the Treasury.

What is MMT? Its advocates have told us in essays, blog posts, videos and tweets what MMT says about this and that, but what is its logic and evidence? As a monetary theorist who is also skeptical of conventional wisdom, I looked forward to a definitive exposition from Stephanie Kelton’s “The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy.” 

Ms. Kelton, a professor of economics at Stony Brook University and senior economic adviser to Bernie Sanders’s presidential campaign, starts with a few correct observations. But when the implications don’t lead to her desired conclusions, her logic, facts and language turn into pretzels. 

True, the federal government can spend any amount by simply printing up the needed money (in reality, creating bank reserves). True, our government need never default since it can always print dollars to repay Treasury bonds. But if the government prints up and spends, say, $10 trillion, will that not lead to inflation? Ms. Kelton acknowledges the possibility: “If the government tries to spend too much in an economy that’s already running at full speed, inflation will accelerate.”

What does Cochrane disagree with here? Kelton seems to say the government shouldn't spend so much that it causes inflation to accelerate. I haven't read the book, but it seems she too is concerned with debt and deficits to the extent it is inflationary when the economy is at full employment, does it not? This is a crucial point to me, and it's not exactly clear to me how Kelton phrased it from Cochrane's retelling. Is she saying print and spend all the time and become Zimbabwe (it seems not), or is she saying print enough to actually hit your inflation target (which probably needs to be raised a bit)? These are quite different, and the latter seems to be a reasonable position that is actually also implied by standard Keynesian economics.

So how do we determine if the economy is running at full speed, or full of “slack,” with unemployed people and idle businesses that extra money might put to work without inflation? Ms. Kelton disdains the Federal Reserve’s noninflationary or “natural” unemployment rate measure of slack as a “doctrine that relies on human suffering to fight inflation.” Even the recent 3.5% unemployment is heartlessly too high for her. “MMT urges us to think of slack more broadly.” OK, but how?

Various other obvious measures of labor market slack, such as the prime-age employment to population ratio, wage growth,GDP growth, and inflation were all pointing at a different conclusion.

 She offers only one vaguely concrete suggestion: When evaluating spending bills, “careful analysis of the economy’s . . . slack would guide lawmakers. . . . If the CBO [Congressional Budget Office] and other independent analysts concluded it would risk pushing inflation above some desired inflation rate, then lawmakers could begin to assemble a venue of options to identify the most effective ways to mitigate that risk.” She doesn’t otherwise define slack or even offer a conceptual basis for its measurement. She just supposes that the CBO will somehow figure it out.

OK, but I think there is some logic in looking at a variety of obvious measures, and not just saying "unemployment is low, let's ignore labor force exits or wage growth".

She doesn't mention that the CBO now calculates a measure, potential GDP, which does not reveal perpetual slack. And she later excoriates the CBO for its deficit hawkishness. Really her answer is: Don’t worry about it. She simply asserts that “there is always slack in the form of unemployed resources, including labor.”

We’re not talking about a little slack either. Ms. Kelton’s “people’s economy” starts with the full Green New Deal and moves on to a federal job for anyone, free health care, free child care, the immediate cancelation of student debt, free college, “affordable housing for all our people,” national high-speed rail, “expanded Social Security,” “a more robust public retirement system,” “middle-class tax cuts,” and more. How much does this add up to? $20 trillion? $50 trillion? She offers no numbers. How is it vaguely plausible that the U.S. has this much productive capacity lying around going to waste? 

In a book about money, the inflation of the 1970s and its defeat are astonishingly absent. History starts with Franklin Roosevelt—a hero for enacting the New Deal but a villain for paying for it with payroll taxes rather than fresh dollars. Ms. Kelton praises John F. Kennedy, too. He “pressured unions and private industry, urging them to keep wage and price increases to a minimum to avoid driving inflation higher. It worked. The economy grew, unemployment fell sharply and inflation remained below 1.5 percent for the first half of the decade.” 

The second half of that decade—Lyndon Johnson’s Great Society and Vietnam War spending, inflation’s breakout, Richard Nixon’s disastrous price controls—is AWOL. Did we not try MMT once and see the inflation? Did not every committee of worthies always see slack in the economy? Did not the 1970s see stagflation, refuting Ms. Kelton’s assertion that inflation comes only when there is no “slack”? Don’t look for answers in “The Deficit Myth.”

 OK, good point. I agree that spending a bunch of money is not the ideal response to an adverse commodity price shock. I would prefer nominal GPD growth be kept relatively constant during such periods. This would presumably mean tight fiscal and monetary policy, and causing a recession to reduce inflation.

Victory over inflation under Ronald Reagan and Margaret Thatcher goes likewise unmentioned. History starts up again when Ms. Kelton excoriates Thatcher for saying that government spending has to be paid for with taxes. She insinuates, outrageously, that Thatcher deliberately lied on this point in order to “discourage the British people from demanding more from their government.”
If spending can be financed by printing money, “why not eliminate taxes altogether?” Ms. Kelton begins consistently. She criticizes Sens. Bernie Sanders and Elizabeth Warren for claiming that they need to raise taxes to pay for spending programs. But then why raise taxes? Taxes exist to decapitate the wealthy, not to fund spending or transfers: “We should tax billionaires to rebalance the distribution of wealth and income and to protect the health of our democracy.”

I agree with Cochrane here --  taxes are necessary, in part, to finance useful spending. The entire tax and transfer system is necessary in part for redistribution, and thereby increase political support for a capitalist system that does tend to create vast inequalities. If you just try to do it by printing money, you'll end up like Zimbabwe.

She offers a second answer, more subtle, and revealingly wrong. She starts well: “Taxes are there to create a demand for government currency.” This is a deep truth, which goes back to Adam Smith. Soaking up extra money with fiscal surpluses is, in fact, the ultimate control over inflation. But then arithmetic fails her. To avoid inflation, all the new money must eventually be soaked up in taxes. The new spending, then, is ultimately paid for with those taxes.
What about the debt? Ms. Kelton asserts the government can wipe it out. Again, she starts correctly: The Fed could purchase all of the debt in return for newly created reserves. She continues correctly: The Fed could stop paying interest on reserves. But in conventional thinking, these steps would result in a swift inflation that is equivalent to default. Ms. Kelton asserts instead that these steps “would tend to push prices lower, not higher.” She reasons that not paying interest would reduce bondholders’ income and hence their spending.
The mistake is easy to spot: People value government debt and reserves as an asset, in a portfolio. If the government stops paying interest, people try to dump the debt in favor of assets that pay a return and to buy goods and services, driving up prices.

I agree with Cochrane here. Not paying IOER would likely be inflationary. Fed buying debt and returning it to the Treasury would be too.

What about all the countries that have suffered inflation, devaluation and debt crises even though they print their own currencies? To Ms. Kelton, developing nations suffer a “deficit” of “monetary sovereignty” because they “rely on imports to meet vital social needs,” which requires foreign currency. Why not earn that currency by exporting other goods and services? “Export-led growth . . . rarely succeeds.” China? Japan? Taiwan? South Korea? Her goal posts for “success” must lie far down field.
The problem is that “the rest of the world refuses to accept the currencies of developing countries in payment for crucial imports.” Darn right we do. Her solution: more printed money from Uncle Sam—a “global job guarantee.” 

She also advises small and poor countries to cut themselves off from international commerce. They should develop “efficient hydroponic and aquaponics food production” and install “solar and wind farms” rather than import cheap food and oil. They should refuse international investment, with the “classical form of capital controls” under Bretton Woods as an ideal. “We share only one planet,” she writes, yet apparently that planet must have hard national borders.

I don't agree that small and poor countries should cut themselves off from international commerce. I would very much go in the other direction, a la East Asia.

By weight, however, most of the book is not about monetary theory. It’s rather a recitation of every perceived problem in America: the “good jobs deficit,” the “savings deficit,” the “health-care deficit,” the “infrastructure deficit,” the “democracy deficit” and—of course —the “climate deficit.” None of this is original or relevant. The desire to spend is not evidence of its feasibility.

I would probably agree with most what Kelton has to offer here. I'd spend on infrastructure and a green new deal in the current climate, given the past decade of slow growth, and looming problem of climate change.

Much of “The Deficit Myth” is a memoir of Ms. Kelton’s conversion to MMT beliefs and of her time in the hallways of power. She criticizes Democrats, including President Obama and his all-star economic team, for their thick skulls or their timidity to state her truth in public.

I think many observers think the Obama admin. should have been more bold on fiscal policy, including a lot of former members of the Obama administration. Also, I recall one John Cochrane changed his mind on fiscal policy, and went from recommending austerity to stimulus in 2009/2010... Net of state and local austerity, there was basically no overall fiscal stimulus during that recession.

...

In a revealing moment, Ms. Kelton admits that “MMT can be used to defend policies that are traditionally more liberal . . . or more conservative (e.g., military spending or corporate tax cuts).” Well, if so, why fill a book on monetary theory with far-left wish lists? Why insult and annoy any reader to the right of Bernie Sanders’s left pinkie?
Writing the book to “defend” an immense list of left-wing spending policies destroys what’s left of her argument. If you could only feel her singular empathy for the downtrodden, if you could, as she does, view the federal budget as a “moral document,” if you could just close your eyes and need it to be true as much as she does, your “Copernican moment” will arrive. Logic and evidence will no longer trouble you.
That effect is compounded by her refusal to abide by the conventional norms of economic and public-policy discourse. She cites no articles in major peer-reviewed journals, monographs with explicit models and evidence, or any of the other trappings of economic discourse.

OK, good point. Note that standard Keynesian models do have some MMT-like implications in a liquidity trap though. Here's Jordi Gali on the topic, although he doesn't use the words MMT. Kelton should cite him. Here's me.

The rest of us read and compare ideas. Ms. Kelton does not grapple with the vast and deep economic thinking since the 1940s on money, inflation, debts, stimulus and slack measurement. Each item on Ms. Kelton’s well-worn spending wish list has raised many obvious objections. She mentions none.
Skeptics have called it “magical monetary theory.” They’re right.
—Mr. Cochrane is a senior fellow at the Hoover Institution and an adjunct scholar at the Cato Institute.

Debate Over Covid Fatality

So, first came this horrendous WSJ article by a Stanford couple claiming the true Coronavirus death rate may be much less than what people think. They suggest that perhaps the real rate may be as low as .01%, and thus, that maybe we should just let the disease run. After all, if just between 20,000 and 40,000 Americans die, what is the harm? 

Of course, now, with 37,000 Americans already dead from Covid-19, and the body counts still rising daily (some 2,500 just yesterday), this estimate now looks foolish. Not to say, "I told you so", but the WSJ looked problematic to me in real time, so I tweeted about it: https://twitter.com/TradeandMoney/status/1243215666297044995

In retrospect, my response looks prescient, in part since China's own government revised up its estimates of death in Wuhan.

Debraj Ray, an economist who I respect a lot, and who is an editor of the American Economic Review, also posted some interesting thoughts about the Covid-19 death rate here, influenced by the Stanford couple's WSJ article. He argued we should rethink lockdowns given the uncertainty over the fatality rate. I posted a response on his blog, which I'll repost here:

Hello Debraj. Thought provoking post. I see some potential problems in your logic, however. Why are you ignoring the growth in deaths (or lack thereof) in New York before March 14th? If it's true that there were no deaths before then, then why wouldn't it follow that cases before then were scarce? Of course, likely there were few deaths before March 14th because there was little testing -- if you die of flu symptoms with no test for Covid available, it's likely you are not marked as dying of coronavirus. To the extent this is true, the growth rate of deaths is slower that what you have merely assumed. And, if it turns out that the rate of growth doubles every four days, then that would imply that either New York had it's first case before Wuhan did, or the death rate is even higher than 1%.

Lastly, Bhattarchaya's stuff has already been debunked. The death rate in Vo was 1%. The Chinese data should not be taken at face value. The NBA is not a random sample of the US. The Stanford couple mention .01% as a plausible death rate. But, some Italian provinces have death rates already as high as .065%, and that is assuming a 100% infection rate, which can't be right, as these provinces are still recording masses of new cases despite a draconian quarantine. In other Italian towns, already .1% of the population has died, and many people have also tested negative. 

After all this, I should mention that I'm actually in agreement that the death rate could well be much less than 1%. .4-.6% seems plausible to me, but spreads easier since there is no vaccine. On the other hand, .1% seems ruled out by what we know already. This could explain why Italian hospitals were overwhelmed so early, why they are not by the flu. 

Also, you write that people have freaked out too much. Have you paid any attention, at all, to what has happened in Italy? The freak out there has not prevented ICU units to become completely overwhelmed. They are essentially letting people over the age of 65 die for lack of ventilators. You really think this mass "freaking out" in Italy makes no sense?

Very Respectfully Submitted,Doug Campbell

Debraj then provided a thoughtful response.

Hi Doug, thanks. I wish we knew the truth behind fatality rates. You are right that it could be as high as 0.4%. My post is not written with a sense of dramatic certainty. That said (1) could you give me references to the Vo fatality rate? (2) I don't know what you mean by trusting the "Chinese data" --- the data has to do with airlifts out of Wuhan where everyone was tested, (3) the flu rate is for a particular distribution of ages (say, the US distribution), and we need to correct for that age distribution when studying regions with a high proportion of elderly, and (4) please read carefully before commenting on my interpretation. My post is perfectly consistent with OVERALL deaths being higher by a factor of 3 or more. I don't know what you want to include under the term "freaking out," but I am not including the terrible sense of sorrow that people feel for losing their loved ones. I simply refer to one's *own* fear of being fatally sick. Thanks.

He agrees that a death rate as high as .4% is plausible.  In response to his point:

    (1) I actually don't see the Vo fatility rate that I had seen earlier when I was just googling, although they had like 89 people test positive when they tested the first time, and they had a high-profile early death: https://www.theguardian.com/commentisfree/2020/mar/20/eradicated-coronavirus-mass-testing-covid-19-italy-vo

   (2) Bhattarcharya's first piece of evidence, using Chinese data, takes the fatality rate in Wuhan at face value, while making an adjustment to the infection rate. I was suspicious of the Chinese fatality rate. Lo and behold, under pressure, China has now revised up its fatality estimates for Wuhan by 50% -- and many people, me included, suspect it even could be higher than that. I won't try to claim I'm any sort of a genius here -- it was obvious the Chinese data were fake. Still is. It was troubling to see the Stanford duo take them at face value.

   (3) I agree we need to adjust for ages. Also, in Italy, Wuhan, and Iran, the hospitals were clearly overwhelmed. But, the death rate in Lombardy is now at .12%. Over two-thirds of the people there tested, tested negative, and they only test high-risk people. In addition, they have undoubtedly missed a lot of deaths, and people are still dying. You add all this to the info that their hospitals were overwhelmed by the end of February, and it's clear this is vastly more deadly than the flu. You had written: "That calls for a fatality rate around 0.1%". Even in New York City, the death rate is already around .1% of the population (that is, % of the population before the exodus), and over half of the people tested there have tested negative. And this came in the US, without any overwhelmed hospitals and likely a similar population structure, if healthier and wealthier than average. Even if we assume that 20% of the New York City population has already been infected, then we get a fatality rate of around .5%. If 25%, then .4%. Given the exodus of people out of the city, and 60% negative test rate of those with severe symptoms or direct exposure, it's probably tough to make an argument that more than 25% of NYC residents could have been infected.

   (4) I still don't see a lot of evidence that people are freaking out way too much. For example, I just went to a church where old people were still packed en masse and kissing icons. At least some of New York's bars were reportedly packed before they were closed. Boris Johnson shook everyone's hands in the Covid Ward. Rudy Gobert made sure to touch every microphone. People are protesting to open the economy back up. The draconian restrictions put into place have only modestly lowered the rate of infection. Even in Italy, six weeks of quarantine have only halved the daily rate of infections. To change people's behavior, you need them to "freak out" to certain degree.

   In any case, I am also opposed to a prolonged shutdown. Only, my alternative is Vo-style ubiquitous testing, or at least doing a vigorous "Test and Trace", plus some surveillance testing, ramping up N-95 mask production to wear in public, and other kinds of surveillance (cops with temperature helmets, like in China), etc. Nevertheless, it's clear now that Covid-19 poses a significantly higher danger in terms of mortality than the flu does.

How to Respond to the Next Recession: Central Bank Fiscal Support

Now that it looks like like the next recession may be coming sooner rather than later, it's time to lay out what I think is clearly the best path forward for monetary policy in a liquidity trap (we should be more creative than we have been). This is an issue I've been thinking seriously since long before I worked in the Obama CEA in 2011 -- I wrote my undergraduate thesis on Japan's liquidity trap in 2003. And Japan is still in a liquidity trap. Some things never change...

Fiscal Support
My idea is simple: Fiscal Support from the Fed to the Treasury (some might call it Fiscal QE, a name I oppose, "Treasury remittances", or simply seigniorage, although I see this as slightly different). The Federal Reserve should print money, buy government bonds, and then -- crucial second step -- return those bonds to the Treasury! That's it. (Well, in fact, there are several more steps I'll discuss below, but these are the key ones...) In fact, the Fed already returns interest on the bonds it holds to Treasury. Over ten years after the first QE, in total, this has actually added up to be a substantial amount of money, and thus it is an ignored modest side-benefit of the QE program (in addition to lowering US government borrowing costs, and thus the debt).

Mechanisms
Why would this work? I can see several channels. First, smaller deficits, or even surpluses, would encourage governments to do fiscal stimulus. (How many politicians do you know who couldn't figure out a way to spend a surplus?) In fact, most countries in liquidity traps run such large deficits that after a few years, all but the most ardent keynesians/MMT people recommend fiscal austerity to counterbalance the deficits. Fiscal stimulus is likely to carry a bit more "oomph" than merely QE alone, particularly since this is a policy with an unlimited ceiling.

Secondly, this QE + fiscal transfer is likely to be more effective even if the government doesn't enact fiscal stimulus today. Why? First, it is a bit more difficult for the central bank to unwind. In addition, if the Fed just wanted a temporary stimulus, they would just go with normal QE rather than tying their hands by transferring these bonds to the Treasury. Thus, it is a signal of looser future monetary policy, and also a signal that the Fed is serious about getting the economy on track. Recall, a key problem in a liquidity trap is that the central bank needs to "credibly promise to be irresponsible" -- to convince the public that it will generate higher inflation, even after the crisis is over. What better way to do that than with "permanent QE"? One thing to note is that the central bank will still be able to raise interest rates later on, or increase reserve requirements, and so I don't think this will, in fact, inhibit the Fed from responding to inflation later on if it is so inclined, but it's a signal that the Fed believes it needs to bring in the big guns. 

A third mechanism, albeit less important, is that, even if fiscal policy is non-reactive today, it will have to be reactive at some point in the future. This implies that people will, at minimum, expect to be taxed less in the future, or have government spending decreased by less.

A fourth mechanism is the classic QE mechanism: purchasing long-term bonds will lower long term interest rates mechanically. A fifth mechanism is that long-term interest rates imply a devaluation of the currency. However, in this case, I'll say full stop that these mechanisms are likely to be modest, but for good reasons -- fiscal policy can be expected to be expansionary and thus raise future interest rates.

Fiscal Support + Communication: 
Were I a central banker, I would not just do this policy quietly (in which case it's likely no one would notice). I would also publicly encourage the government to engage in fiscal stimulus. I would also assure market participants that the policy will be in place and ratcheted up each month, until, at a minimum, the inflation target has been hit (even better would be to raise the inflation target, and in fact price level target, or switch to a 6% NGDP target, but this can be debated elsewhere). This is akin to telling the market you will do "whatever it takes". In fact, committing to potentially doing more at first will likely allow you to do less later on.

Alternative Options:
Of course, this is not the only policy option on the table. Short term interest rates are 1.5%. It makes sense to cut them first. However, the market is smart, and it probably realizes that the Fed only has a few arrows left in this quiver. The closer the Fed gets to zero without a credible plan for what to do next, the less effective each successive rate cut will be.

Next, the Fed could go negative.  I think they should. I think this could be an effective policy particularly if the Fed subsidizes new bank loans (a la TLRTO -- the ECB's program) in addition to taxing reserves held in excess. To prevent a negative effect on total bank profits, the Fed could simultaneously provide banks with a higher positive interest rate on required reserves while taxing some smaller fraction of excess reserves over a target threshold. CBs could also tax large cash holdings of banks. I am not necessarily opposed going this route. But, I also think it will be problematic to pass along negative interest rates to depositors. I also suspect that negative interest rates, absent bank subsidies and taxes on cash holdings, could be problematic, and may be limited in how low a central bank can go (although subsidies of course are unlimited). Also, since I'm a liberal who see value in many forms of public spending, I would prefer more public spending to higher bank subsidies. (Alternatively, since I'm a capitalist who values my hard-earned money, I'd prefer receiving a tax cut to a bank subsidy.) Also, many smart economists think that negative interest rates might be contractionary. Also, are very large bank subsidies, if needed, politically feasible? I have my doubts. Still, if I were Fed Chair, I would include negative interest rates, including new loan subsidies in particular, in the arsenal. I still believe it is a crime that the Fed did not go all the way to zero in the last crisis.

The Fed can also use forward guidance. Of course they should, but talk is always cheap. If the economy and inflation recover, of course the Fed will raise interest rates, and markets know this. Also, both this policy, and plain old vanilla QE, while beneficial overall, also tend to reduce the spread between short-term and long-term interest rates. This reduces bank profits, and may make banks more likely to wait to make loans. The Fed can promise to keep interest rates zero, or at minus one, for one or two years, but can it credibly do it for 5 or 10 years? Most of the FOMC members won't even be around in five years. And the FOMC committee itself rotates every year.

This leads me to vanilla QE. Why not just do more QE? Well, yes, the Fed should. Also, after an announcement that X amount of bonds will be bought each month, if the Fed's growth and inflation targets are not met, the Fed should increase the monthly amount of bond purchases. This is what they did not do last time around, and what the BoJ has also refused to do. One argument against QE is that it was a public relations disaster. Many economists still believe it did not work. And, even though the Fed did QE last time, the economy was very slow to recover. Thus, if the Fed does merely resort to QE this time, they need to do it much more aggressively than before. They could, for example, promise to double the bond purchases every month until NGDP hits a certain target. They also would need a new way to market it.  Instead of calling it just "QE", add a name that every day bond trader bros on Wall Street can relate to: "QE on steroids", or "QE on cocaine".

How about raising the inflation target too? Of course the Fed should. That the Fed continues to maintain a 2% inflation target (that it rarely even hits), now that we know what a problem the ZLB is can be thought of as a badge of incompetence. However, the problem circa 2009-2017 was that, although the Fed had an inflation target, it did not appear to have any ability to actually hit its own target. This almost certainly damaged the Fed's credibility.

Objections:
This will never happen!  Response: It already has! In fact, the Fed already remits interest payments to the Treasury, and other stuff associated with its operating profits. I've heard they have also remitted bond principal before, although I can't find a link and haven't seen any hard proof of this myself. (Update: A commenter on twitter suggests that the Bank of Japan and Bank of Sweden return principle to their govt's, but I cannot verify this.)

The ECB will never do this! Response: The ECB has also already implemented this before. The ship has sailed.

This will encourage governments to overspend. Response: That's a feature of the plan, not a bug. Indeed, if central banks do not to this, central governments likely will. The only thing stopping Trump from doing this himself is that he doesn't know he can. Indeed, this is the one drawback: if the Fed does it first, Trump will learn that it's possible, and likely do too much. However, as mentioned above, the Fed will still be able to raise interest rates and increase reserve requirements.

Would Fiscal Policy Actually Work? Response: Yes it would. I actually lean toward the low side on fiscal multiplier estimates. However, I also don't think there is any serious doubt that large fiscal stimulus is expansionary. If a government sends everyone a $10,000 check (financed by the printing press), spending and inflation will go up.

What if it Fails to generate growth? Response: Let's say for a second it had no effect at all on the economy. In that case, the only effect would be to lower the national debt with nothing lost! That's still a pretty good deal.

Conclusion:
The Fed has the power to create money. In a downturn, the Fed should simply print money, buy the bonds, and then return those bonds to the Treasury. For the very reason that this policy can be unlimited, it's likely to be more effective than any other option. This is simply an idea whose time has come.

PS: If any of you Macro theorists out there want to write this up into a "serious" paper, I'd be interested.