Monetary Theory Question

Great question Arnold. I think Scott Sumner's answer would be that Bernanke should enter the GDP futures markets and, in his best impression of Patrick Stewart, say, "Make it so."

That's a really hard question, because I've seen expansionary policy moves raise 10 year T-bond yields and I've seen expansionary policy actions reduce 10 year bond yields. An expansionary move on Jan 3 2001 caused long term rates to rise. It was a standard change in the Fed's fed funds target rate, which fell more than expected.

In March 2009 the Fed announced QE and long term rates fell. That is something I have trouble explaining. The most common explanation for the difference was that in March 2009 the Fed promised to buy lots of long term bonds. In 2001 they implicitly promised to buy short term bonds. But even so, I would have thought these assets would be pretty close substitutes. The market response to the QE announcement suggests some sort of segmented market, and I don't have a good feel for that case.

Of course I don't favor targeting long term rates in the first place, and hence don't worry about this issue. As long as the equity, commodity, and TIPS markets give an unambiguous signal, then long term nominal rates can do whatever they want.

If forced to come down one way or another, I'd say higher 10 year yields are bullish, so if the goal was lower 10 year yields, I'd tighten monetary policy and cross my fingers.

Easy. Purchases are the solution to both, but in the one-case the jawboning is about respecting the long-run inflation trend, and the second is about dramatically increasing the inflation rate in a sustained fashion.

Policy is about the interplay of actions and setting expectations.

1. The Fed cannot and should not try to affect rates at such a miniscule level.
2. Interest rates are prices that result from the interaction of supply and demand for loanable funds (as I'm sure you know). The Fed only affects long term rates through expected inflation, since their interventions are small relative to the size of the market for loans that long term. Therefore, raising rates that much would require creating 8% inflation for 10 years (assuming the natural rate is around 2.5%).

Interest rates are pernicious to the entire debate. Perhaps one economist in ten understands them and trying to fix a nominal rate is a fool's errand, especially in a recession. The Fed should just pick a mechanical target of one nominal variable and try to hit it (expected inflation or NGDP would be fine).

Ambiguous questions - not enough initial data. Do you want to do (1) or (2) because inflation is too high? Too low?
You should read Delong's note on Bullard, and specify the current state of the economy in the Delong's chart.
http://delong.typepad.com/sdj/2010/08/extremely-rough-a-note-on-bullards-interpretation-in-his-seven-faces-of-the-peril-paper-of-benhabib-et-al.html