Mankiw on Bernanke

Both are respected economists, both are professors at leading universities (Harvard & Princeton), both are authors of well regarded intermediate macroeconomics textbooks, both are former heads of the CEA and both are Republicans. Yes, a lot in common so no surprise that Mankiw weaves a nice defense of Bernanke´s record as Fed Head. First Mankiw reviews the complaints:

Critics on the left look at the depth of the recent recession and the meager economic recovery we are experiencing and argue that the Fed should have done more. They fear that the United States might slip into a long malaise akin to Japan’s lost decade, in which unemployment remains high and the risks of deflation deter people from borrowing, investing and returning the economy to its potential.

Critics on the right, meanwhile, worry that the Fed has increased the nation’s monetary base at a historically unprecedented pace while keeping interest rates near zero — an approach that they say will eventually ignite inflation. Some in this camp have gone so far as to propose repealing the Fed’s dual mandate of simultaneously maintaining price stability — that is, holding inflation at bay — while maximizing sustainable employment. Better, these people say, to replace those twin goals with a single-minded focus on inflation.

Then argues that fears on both sides have been exaggerated:

Mr. Bernanke became the Fed chairman in February 2006. Since then, the inflation measure favored by the Fed — the price index for personal consumption, excluding food and energy — has averaged 1.9 percent, annualized. A broader price index that includes food and energy has averaged 2.1 percent.

Either way, the outcome is remarkably close to the Fed’s unofficial inflation target of 2 percent. So, despite the economic turmoil of the last five years, the Fed has kept inflation on track.

And asks if the Fed could have done substantially more to avoid the recession and promote recovery:

Probably not. The Fed used its main weapon against recession — cuts in short-term interest rates — aggressively as the depth of the downturn became apparent. And it turned to various unconventional weapons as well, including two rounds of quantitative easing — essentially buying bonds — in an attempt to lower long-term interest rates.

He ends suggesting the Fed adopt a different strategy:

What the Fed could do, however, is codify its projected price path of 2 percent. That is, the Fed could announce that, hereafter, it would aim for a price level that rises 2 percent a year. And it would promise to pursue policies to get back to the target price path if shocks to the economy ever pushed the actual price level away from it.

Such an announcement could help mollify critics on both the left and right. If we started to see the Japanese-style deflation that the left fears, the Fed would maintain a loose monetary policy and even allow a bit of extra inflation to make up for past tracking errors. If we faced the high inflation that worries the right, the Fed would be committed to raising interest rates aggressively to bring inflation back on target.

MORE important, an announced target path for inflation would add more certainty to the economy. Americans planning their retirement would have a better sense about the cost of living a decade or two hence. Companies borrowing in the bond market could more accurately pin down the real cost of financing their investment projects.

Mankiw knows that PLT, although better than IT, has problems when there are price or real shocks to the economy which, incidentally, was an important factor in getting the Fed on the “wrong track” in 2008. But he also knows that Bernanke is an “avid” inflation targeter so that PLT would be closer to Bernanke´s taste.

But back in January 1993, presenting a paper titled Nominal Income Targeting with Robert Hall at a NBER conference they write in the set up of the paper:

This paper explores some of the issues raised by  rules for monetary policy. We  proceed as follows. Section 2.1 discusses the desirable properties of commitment and the characteristics of a good policy rule. We emphasize, in particular, rules aimed at stabilizing nominal income. Section 2.2 considers how  a government could implement a nominal income rule. We  discuss the role that the consensus forecast of nominal income could play in ensuring that the central bank not deviate from an announced target. Section 2.3 examines the time series properties of nominal income and its consensus forecast in order to evaluate how actual policy has  differed  from nominal  income targeting. Section 2.4 presents simulations using a simple model of the economy in order to consider how economic performance might have differed historically  if the Fed had been committed to some type of a nominal income target.

Conclusion. In addition to being a good economist Mankiw shows high political savvy!