Tossing coins: The Vaccine v The Fed

AstraZeneca, Pfizer, Moderna and other drug makers are finalising their ‘warp speed’ vaccine trials in order to stop the infection and spread of the dreaded Covid 19.  Simultaneously, the Federal Reserve in the US is set to roll out its new Monetary Policy operating procedures for all to behold. Both the vaccine designers and the Fed risk abject failure.  Which of these actors have the best chance of success?

Success?  Vaccine design and Monetary Policy are surprisingly similar when it comes to delivering real results.  Comforting both may be when it comes to the collective security blanket that ‘…the government is doing something…’, but in terms of actual results, Vaccines and Monetary Policy often fail to deliver.  Success is better measured in terms of bedside manner…

Lets flip a coin and deal with what comes up first… heads for Vaccine, tails for Monetary Policy.  Heads!

The anecdotal evidence is that the Oxford vaccine elicits an immune response in 40-60% of recipients.  This means its a coin toss! Should we celebrate a vaccine that fails half the world’s population?  Of course, simply because a vaccine is needed primarily to provide policymakers with an escape hatch from the straitjacket that they have gotten the world into.  Covid 19 is a problem, the magnitude of which should not be underestimated, but neither should it be a reason to inflict undue economic pain on society. Governments have drawn lines in the sand that they can only cross once a vaccine is approved. Get innoculated and get back to normal.

The Fed, on the other hand, has a tough job. Some of the most basic questions in economics – what causes inflation? what causes unemployment? – have left policymakers stranded for the last 30 years.  Back in the 1970s and 1980s, the Economics community had pretty much decided that prices were determined by the money supply in the long-run while there was disagreement over whether employment could be stimulated or not in the short-run.  This led most Central Bankers to adopt stable monetary rules over the long run experimenting with short-term stimulatory policies.  The problem is that the policymakers have neither achieved their long run inflation objectives nor have they been able to systematically influence short term employment or output.  The success of a monetary action is a coin toss!

The Fed’s new approach unveiled on Friday would seem to focus more on achieving the long run inflation objective, now targeted at 2%, as opposed to focusing on short term fine tuning.  I don’t claim to understand this but the link between money and inflation has failed us for 3 decades so why should it suddenly just appear again because the Fed wants it to?  The popular press interprets the new approach as a justification for keeping interest rates at zero for a long time.  Again, I don’t understand this.  The empirical evidence in my view is that the ability of the Fed to impact the real economy through monetary activity depends on how the banking system responds to the event provoking the policy action.  The Fed gives money to the banking system and then the banks decide whether to lend or not.  If they don’t, which seems to be the pattern, then the money flows straight back to the Fed.  A better way would be to simply increase everyone’s bank account directly.  (A contractionary policy action would reduce everyone’s bank balance – imagine the riot that would cause!)

Success?  It would seem that a Covid 19 vaccine has a better chance of returning society to ‘normal’ than does the Fed’s policy rule have of returning the economy to ‘normal’.  This is because the vaccine only has to convince a small number of regulators to ease up restrictions on travel and interaction whereas the Fed’s job is to convince hundreds of millions (actually billions) of people to do something different.

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