Chairman Bernanke has not listened to Professor Bernanke

Today Caroline Baum tweeted:

Caroline Baum ‏@cabaum14h

Krugman is being nice to Bernanke, perhaps sensing BB will be his boss in the near future?

She was referring to PK´s column at the NYT:

For one important subtext of all the recent bubble rhetoric is the demand that Mr. Bernanke and his colleagues stop trying to fight mass unemployment, that they must cease and desist their efforts to boost the economy or dire consequences will follow. In fact, however, there isn’t any case for believing that we face any broad bubble problem, let alone that worrying about hypothetical bubbles should take precedence over the task of getting Americans back to work. Mr. Bernanke should brush aside the babbling barons of bubbleism, and get on with doing his job.

But Krugman gets it ‘wrong’ being ‘nice’, because Bernanke deserves a lot of flak.

Catherine Johnson sent me this presentation from late 2006 by UC Santa Barbara professor Henning Bohn: “Ben Bernanke at the Federal Reserve: What Can We Expect?”

Interesting points:

How will he run the Federal Reserve? Easy to answer: Read his writings!

Do the academic writings matter? – Yes, for credibility. And in New Keynesian theory Credibility is crucial.

So I decided to take a look at Bernanke´s writings and advice given.

It has been well established that in late 2007 and 2008 the Fed was very worried about the inflationary impact of rising oil prices. As late as June 2008 the Fed was thinking that soon interest rates would have to be increased. That was a major reason behind the tight monetary policy being pursued, which is reflected in nominal spending falling below trend. The contractionary impact of both the house price fall (which peaked in early 2006) and oil prices took second fiddle to Bernanke´s inflation (targeting) concerns.

Interestingly, in a paper written with Mark Gertler and Mark Watson in 1997: Systematic Monetary Policy and the Effects of Oil Price Shocks, he said:

Substantively, our results suggest that an important part of the effect of oil price shocks on the economy results not from the change in oil prices, per se, but from the resulting tightening of monetary policy.

This finding may help to explain the apparently large effects of oil price changes found by Hamilton and many others.

Likely the Fed didn´t think it was tightening because until April 2008 the FF rate was being reduced. But even here Bernanke knew better because in 2003 in a speech celebrating Milton Friedman he said:

Do contemporary monetary policymakers provide the nominal stability recommended by Friedman? The answer to this question is not entirely straightforward. As I discussed earlier, for reasons of financial innovation and institutional change, the rate of money growth does not seem to be an adequate measure of the stance of monetary policy, and hence a stable monetary background for the economy cannot necessarily be identified with stable money growth. Nor are there other instruments of monetary policy whose behavior can be used unambiguously to judge this issue, as I have already noted. In particular, the fact that the Federal Reserve and other central banks actively manipulate their instrument interest rates is not necessarily inconsistent with their providing a stable monetary background, as that manipulation might be necessary to offset shocks that would otherwise endanger nominal stability.

Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation. On this criterion it appears that modern central bankers have taken Milton Friedman’s advice to heart.

But the chart above shows that nominal stability was being lost! Soon it would be completely forsaken!

And eerily ironic has been his long standing advice to Japan:

In 1999

Before discussing ways in which Japanese monetary policy could become more expansionary, I will briefly discuss the evidence for the view that a more expansionary monetary policy is needed. As already suggested, I do not deny that important structural problems, in the financial system and elsewhere, are helping to constrain Japanese growth. But I also believe that there is compelling evidence that the Japanese economy is also suffering today 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.

In 2003

What Objective for Japanese Monetary Policy?

Before setting off on a trip, one should know one’s destination. In that spirit, a discussion of Japanese monetary policy should begin with some discussion of the policy objective. I leave until later how the objective can be achieved.

For Japan, given the recent history of costly deflation, however, an inflation target may not go far enough. A better strategy for Japanese monetary policy might be a publicly announced, gradually rising price-level target.

A successful effort to eliminate the price-level gap would proceed, roughly, in two stages. During the first stage, the inflation rate would exceed the long-term desired inflation rate, as the price-level gap was eliminated and the effects of previous deflation undone. Call this the reflationary phase of policy. Second, once the price-level target was reached, or nearly so, the objective for policy would become a conventional inflation target or a price-level target that increases over time at the average desired rate of inflation.

On the Central Bank Balance Sheet

Heated and unproductive debate over the impact of capital losses on the BoJ’s balance sheet would interfere with the rational conduct of monetary policy. Japan’s central bank was insufficiently aggressive in its response to deflation because it had one eye wrongly trained on an accounting issue.

On previous history

Reflation–that is, a period of inflation above the long-run preferred rate in order to restore the earlier price level–proved highly beneficial following the deflations of the 1930s in both Japan and the United States. Finance Minister Korekiyo Takahashi brilliantly rescued Japan from the Great Depression through reflationary policies in the early 1930s, while President Franklin D. Roosevelt’s reflationary monetary and banking policies did the same for the United States in 1933 and subsequent years. In both cases, the turnaround was amazingly rapid. In the United States, for example, prices fell at a 10.3 percent rate in 1932 but rose 0.8 percent in 1933 and more briskly thereafter. Moreover, during the year that followed Roosevelt’s inauguration in March 1933, the U.S. stock market rallied by 77 percent.

Now Japan has apparently subscribed to Bernanke´s advice. It´s time Bernanke listens to himself!

Update. Forgot to mention that in one point Bernanke was true to his writings. That´s his belief in the ‘credit channel of the monetary transmission, which he developed in his classic 1983 article “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression”, later writing a primer on the subject. And he went all out with financing programs to save the banks.