The Seduction Of Ben Bernanke
FDR was elected to correct Hoover’s budget deficits. Kennedy was elected to close a missile gap. Nixon was elected to end the Vietnam war. Obama was elected to restore civil liberties. Ben Bernanke ran for Fed Chairman on a platform of price-level targeting. In DC, you never get what you voted for.
Bernanke ran for office as a radical, but has run the Fed like a Fairfield County Republican. As Krugman, Romer, Ball and others have observed, Chairman Bernanke acts like he never met Prof. Bernanke, that crazy “helicopter” guy at Princeton.
In his wilderness years in academia, Prof. Bernanke demanded that central banks think outside the box to prevent deflation and stagnation when conventional policies fail. However, when Bernanke took office as Chairman in 2006, nominal growth, inflation and inflation expectations were substantially higher than they are now, as he leaves office. The US economy is once again balanced on the cliff of deflation. The economist with the Christmas list of outside-the-box policies has implemented only two of them and not very successfully. Prof. Bernanke would give Chairman Bernanke a C+.
Bernanke has gone from being the Prophet of Doom in 2002 to being the Bartender of Doom in 2013. He changed his monetary philosophy, or failed to persuade the FOMC, or perhaps was “captured” by the Fed’s policy staff, as Laurence Ball has argued. They serve a strange kind of Kool-Aid at the Eccles Building; one sip and wild-eyed radicals become “responsible” and a guardians of “institutional credibility”.
Why Ben Bernanke changed his mind about monetary policy we may never know; that he changed his mind is a matter of public record. It appears that radicalism cannot survive high office.
Permit me to take you back to the early years of this century. A number of bad things happened in succession: the World Trade Center was destroyed by passenger aircraft, killing thousands and paralyzing the financial system; Enron was revealed to be an accounting invention; WorldComm had gone bankrupt; and both the telecom and merchant energy sectors were under massive creditor attack. The US experienced a brief but sharp financial crisis, due to disruptions in the credit markets. In 2002 a lot of companies went bankrupt or almost did. Everything was falling: stock prices, growth, inflation. Nominal growth fell to its lowest level since 1937, and real growth stalled out completely.
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For the first time since 1937, people were using the D-word: deflation. A prominent scholar on the subject was a Princeton professor named Ben Bernanke. Bernanke was a student of Fisherian debt-deflations and of monetary policy at the zero bound, and had devoted his attention to the Great Depression and to Japan's deflation problem. He was vocal about the need for Japan to aggressively reflate, recommending that the BoJ experiment with unorthodox policies. He accused the BoJ of intellectual paralysis. At this time, he also began to express concerns about the outlook for deflation at home, and he pushed the FOMC (which he joined in 2002) to begin to think about the conduct of monetary policy at the zero bound.
In 2002, the newly-appointed Governor Bernanke gave his famous “Helicopter Speech” in which he outlined what a central bank can do to fight deflation after the funds rate has fallen to zero. The speech included this often-quoted passage:
“The U.S. government has a technology, called a printing press, that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. Under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”
Bernanke’s reflationary preachings served him well: Bernanke and Bernankeism were much in favor at the Bush White House. Bush serially appointed Bernanke to the Board of Governors in 2002, to head the CEA at the White House in 2005, and to replace Greenspan as chairman in 2006.
Shortly after Bernanke’s accession to the chairmanship, the subprime crisis exploded and blew a big hole in the financial system; the economy staggered. Prices actually fell, as did both nominal and real growth. It certainly looked fortuitous that the man in charge at the Fed was a world-renowned expert on unconventional monetary policy.
In his academic work, Bernanke had criticized the Fed's policies during the Great Depression, and the BoJ’s policies during Japan’s Great Deflation. Bernanke's answer to the challenge of rates at the zero bound was aggressive unconventional policy to prevent deflation, such as price-level targeting. In other words, forget about conventional levers such as interest rates and money growth, and instead focus on a nominal target, the price level.
Bernanke learned about price-level targeting from President Franklin Roosevelt. FDR, with no formal economics training (an advantage, as it turned out), chose to ignore economic orthodoxy, and decided to target a price level closer to that which had prevailed before the 1930-33 deflation. It worked like magic, and laid the groundwork for Fisher’s “Debt-Deflation Theory of Great Depressions”, which remains the basis for understanding the importance of reflation in an indebted economy.
Bernanke on Roosevelt:
A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly.
Bernanke was highly critical (1999) of the Bank of Japan for its complacent acceptance of a decade of monetary and economic stagnation after the bursting of the Bubble Economy:
“Bank of Japan officials would not necessarily deny that monetary policy has some culpability for the current situation. But they would also argue that now, at least, the Bank of Japan is doing all it can to promote economic recovery. For example, in his vigorous defense of current Bank of Japan policies, Okina applauds the “BOJ’s historically unprecedented accommodative monetary policy”. He refers, of course, to the fact that the BOJ has for some time now pursued a policy of setting the call rate, its instrument rate, virtually at zero, its practical floor. Having pushed monetary ease to its seeming limit, what more could the BOJ do? Isn’t Japan stuck in what Keynes called a “liquidity trap”?
“I argue, to the contrary, there is much that the Bank of Japan, in cooperation with other government agencies, could do to help promote economic recovery in Japan. Most of my arguments will not be new to the policy board and staff of the BOJ, which of course has discussed these questions extensively. However, their responses, when not confused or inconsistent, have generally relied on various technical or legal objections—-objections which, I will argue, could be overcome if the will to do so existed. My objective here is not to score academic debating points. Rather it is to try in a straightforward way to make the case that, far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism...
“There is compelling evidence that the Japanese economy is suffering from an aggregate demand deficiency. If monetary policy could deliver increased nominal spending, some of the difficult structural problems that Japan faces would no longer seem so difficult.”
Bernanke offered the BoJ (and later the Fed) a menu of unconventional policy options including:
1. Price-level targeting.
2. Conventional and unconventional asset purchases.
3. Explicit and direct deficit monetization.
4. Pegging long-term rates.
5. Forward guidance about the path of the funds rate.
6. Currency depreciation.
7. Government purchases of private assets financed by the Fed.
Once in power, that long list of unconventional policy options got chopped down to this:
1. Forward guidance.
2. Conventional asset purchases.
All the other options were gone. And Bernanke has never explained why.
I think Bernanke should be judged by the yardstick of his mandate: full employment and adequate inflation to achieve it. I’d feel better about his legacy if he left office with 2% inflation; at least you could say he was trying. But with 1% inflation, he has given up.