Responding to my argument that Obama's stimulus was a qualified success, Ramesh Ponnuru argues it was anything but — and that I completely missed the Fed's role in making it worthless. The stimulus didn't work, he says, because it was undercut by the central bank:

On the fifth anniversary of President Barack Obama's fiscal stimulus, defenders of the policy were out in force making the case that it worked. Most of their arguments failed to address the strongest reason for doubting that it did much good.

That reason has to do with the Federal Reserve. To the extent that the central bank has a target for inflation (or nominal spending), and has the power to hit that target, the Fed constrains the power of fiscal policy. If Congress tries to stimulate the economy during a slump, for example, the Fed will offset that stimulus by loosening money less. Some of this offsetting will actually be automatic, based on market expectations that the Fed will stay on target.

It's likely that if Congress hadn't enacted a large stimulus, the Fed would have done more quantitative easing early on, lowered interest on reserves or taken some other expansionary step. [Bloomberg]

But Fed policy wasn't exactly tight during the stimulus. First, by the time the stimulus was enacted, the Fed had already dropped interest rates to zero, and it kept them there. Second, the Fed engaged in quantitative easing throughout the stimulus. By March 2009, it held $1.75 trillion of bank debt, mortgage-backed securities, and Treasury notes, reaching a $2.1 trillion in June 2010. That's hardly tightening.

Now, Ponnuru's argument isn't that the stimulus caused the Fed to tighten, but that it would have been looser had there been no fiscal stimulus. But with the economy deeply, deeply in the dumps in early 2009, with unemployment soaring and consumer prices deflating, the Fed was already throwing the kitchen sink of experimental monetary policy at the economy and was doing so before the fiscal stimulus started. The hypothesis that the fiscal stimulus limited the Fed in any way is just not supported by the real world record of what the Fed did.

In other words, the Fed's power to offset fiscal policy changes is limited to the Fed's desire to offset it. If the economy is booming, and unemployment low, inflation rising, and government spending increasing, then Fed policymakers would probably try to offset the growth in government spending by raising rates or selling assets from the Fed's balance sheet. But in a huge, once-in-a-generation slump, offsetting expansionary fiscal policy just isn't on the agenda — and it certainly doesn't happen automatically as Ponnuru suggests.

If deflation sets in, it's the Fed's job to do whatever it takes to reverse it. This means that if the Fed has already lowered rates to zero and the economy is still in a deflationary slump, the Fed would be glad for help from expansionary fiscal policy.

Want proof? Here's Ben Bernanke speaking last month. He specifically calls fiscal policy excessively tight:

To this list of reasons for the slow recovery — the effects of the financial crisis, problems in the housing and mortgage markets, weaker-than-expected productivity growth, and events in Europe and elsewhere — I would add one more significant factor--namely, fiscal policy. Federal fiscal policy was expansionary in 2009 and 2010. Since that time, however, federal fiscal policy has turned quite restrictive...

Although long-term fiscal sustainability is a critical objective, excessively tight near-term fiscal policies have likely been counterproductive. Most importantly, with fiscal and monetary policy working in opposite directions, the recovery is weaker than it otherwise would be. But the current policy mix is particularly problematic when interest rates are very low, as is the case today. Monetary policy has less room to maneuver when interest rates are close to zero, while expansionary fiscal policy is likely both more effective and less costly in terms of increased debt burden when interest rates are pinned at low levels. A more balanced policy mix might also avoid some of the costs of very low interest rates, such as potential risks to financial stability, without sacrificing jobs and growth. [Business Insider]

In other words, Ben Bernanke was glad that in 2009 and 2010 expansionary fiscal policy was sharing the heavy lifting and was explicitly calling for a return to looser fiscal policy in order to help the Fed bring down the unemployment rate and maintain low and steady inflation.

Yes, if Ron Paul or Grover Cleveland or Heinrich Bruning had been President in 2009 and there had been massive fiscal cuts instead of stimulus, then the Fed would have had to do a lot more lifting than it did to reverse the slide into deflation and mass unemployment. With conventional monetary policy out of bullets, the Fed would have had to rely entirely on untested and unconventional monetary policy to get the economy back out of deflation, a riskier and more difficult task than the pretty Herculean task it faced in the real world. Ponnuru may believe that a central bank is smart and forward looking enough to offset all and any changes in fiscal policy. But central bankers, like all humans — especially operating in experimental domains like unconventional monetary policy — get things wrong. Falling into a Japan-style trap of years of deflation — something the United States has avoided — would have been a much larger possibility without the relatively small amount of fiscal stimulus the United States had.