Bernanke: interest rate junkie and inflation-targeting nutter

A James Alexander post

Seems like Ben Bernanke has tried to get the final word before the next FOMC meeting, as sort of ex officio member. In a blog post he strongly defends negative interest rates and rails against raising the inflation target as if people were proposing 10% inflation targets. It seems no more than 2% inflation or we are all doomed. He does mention NGDP targeting but misunderstands it badly.

His post is so full of errors that it has hard to know where to start.

Nominal interest rates are very low, and in a world of excess global saving, low inflation, and high demand for safe assets like government debt, there’s a good chance that they will be low for a long time.

What does “excess global saving” mean? In macroeconomics “saving” is part of an identity equal to “investment”. Like MV=PY. Saving can’t be in excess it has to equal investment.

Being generous, perhaps he means there is too much demand to hold money? In which case, central banks should supply more to bring demand and supply into balance; or threaten to do so until demand increases and more is spent.

Interest rates are my first love

When the next recession arrives, there may be limited room for the interest-rate cuts that have traditionally been central banks’ primary tool for sustaining employment and keeping inflation near target.

This is a very basic error. It is a view that sees interest rates as the primary tool, rather than a symptom of monetary policy. Interest rates react to nominal growth expectations and these are driven by central banks supplying more or less high-powered money. Interest rates are low in the US because nominal growth expectations are low. Yet US Base Money has been shrinking at between 3-6% for over a year now. Doesn’t he know this?

Gets the case for NGDP Targeting very wrong

Outside the United States, Mark Carney, governor of the Bank of England, has expressed openness to targeting nominal GDP (which essentially involves targeting a higher inflation rate when GDP growth is low)

Err, just no, that is not what it is. NGDP targeting asks for a stable growth of NGDP. It particularly targets expectations of growth as expectations drive action – just like in the theory of targeting inflation expectations. Targeting expectations also avoids near term noise in actual data, just like with inflation targeting. More generally, it provides nominal stability, thus preventing the occurrence of major demand shocks, especially those that flow from monetary policy reacting to supply shocks (like the one Bernanke himself presided over in 2008).

NGDP targeting does not target “higher inflation”. It is agnostic about inflation. Market Monetarists are often very sceptical that inflation can be accurately measured. And, they are certainly sceptical a central bank can target inflation. It is a sprite and it makes (Real) GDP equally hard to calculate, in real time or even forecast. People live and work in the nominal world, not the Real world.

Interest rates are best even when negative

The rest of the article is all about the pros and cons of negative interest rates (many pros) versus a higher inflation target (many cons).

The extended discussion on real rates leaves me cold. I don’t really understand what inflation is so I struggle to understand the meaning of a real interest rate and find it very hard to comprehend the neutral real rate.

I also know the public finds negative rates almost incomprehensible and regard such a policy as a total failure by “the authorities”, whoever they are. Bernanke’s strong support for negative rates shows just how out of touch he must be with real people. He claims Europeans and Japanese under these negative interest regimes are coping well. That is just not true.

He even suggests that negative rates are only temporary, and that everyone knows it, not realising that this renders them toothless, as it promises tightening around the corner.

Whoooo, don’t let the inflation genie out of the bottle

Higher inflation has costs of its own, of course, including making economic planning more difficult and impeding the functioning of markets. Some recent research suggests that these costs are smaller than we thought, particularly at comparatively modest inflation rates. More work is needed on this issue. Higher inflation may also bring with it financial stability risks, including distortions it creates in tax and accounting systems and the fact that an unexpected increase in inflation would impose capital losses on holders of long-term bonds, including banks, insurance companies, and pension funds.

It is hard to know what “higher inflation” he is talking about. 3%, 4%? The golden eras of the US economy usually had higher inflation than today. The lowflation, or rather low nominal growth, of the Great Stagnation he helped create is the thing making economic planning more difficult and impeding the functioning of markets. Economies need healthy nominal growth to be flexible enough in rewards to allow all to see growth in returns, some faster than others. At a crushing 3% or less nominal growth, at a depressed NGDP level (see chart below), this cannot happen.

ja-bernanke-junkie-nutter

Downwardly sticky wages are a massive problem causing recessions, but also constraining productivity growth  in a low nominal growth environment. Yet Bernanke calls for more work! What have the thousands of central bank-employed PhDs been doing all these years? Twiddling their thumbs.

Is Bernanke talking his own book and/or that of his employers?

Financial stability risks are worst in deflationary environments, no question, just look at the Great Recession or the Great Depression. Tax and accounting issues arise only when inflation is well above 10% or more, and then they are still quite theoretical rather than real. Bernanke seems to be fearing a return to the worst years of the 1970s. He can’t be serious.

And then he worries about his various new employers seeing capital losses from betting wrong on financial markets. Well, does he think they should be guaranteed winnings?

The article goes on and on with the familiar litany of worries about higher inflation hurting savers, needing political approval etc. etc. No one is proposing 10% inflation. Just 3 or 4%, or better still a commitment to a level target, an average target, and not constant undershooting. Or, better, a nominal income/NGDP level target.

He seems to be randomly firing at straw men. He even clutches at the idea of more fiscal activism, as if that could work without threatening the inflation target. He well knows the Fed would offset it at the first opportunity.

He never used to be quite this bad, as Scott Sumner tirelessly points out when Market Monetarists get fed up with these manias of the modern Bernanke.

Perhaps he’s worried about his lowflation legacy crumbling. It couldn’t happen soon enough for us. He seems to have become a caricature of things he may have ridiculed in the past: an interest rate junkie and an inflation-targeting nutter.

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At least Bernanke gets the grade order right

In a long interview with Freakonomics, Bernanke has the chance to self-grade:

DUBNER: Alright, so if you’re going to give yourself a letter grade for before and after, what are your letter grades?

BERNANKE: C- and A-, something like that.  But I don’t — it’s really not up to me.  I think that, you know, others have to make those judgments.  In the end, we did stabilize the system and the economy has recovered.  And the U.S. recovery, while not everything we would like, has been pretty good compared to other industrial countries.

He´s too easy on himself. He started bungling from day 1 at the job. The errors quickly accumulated, giving rise to “Great Recession”. So that´s not a C-, but a big F.

I think George Selgin would do the same. From his review of Bernanke´s The Courage to Act, we read:

…a central bank that allows the overall volume of spending to collapse has blown it, no matter how much emergency lending it undertakes…

Given his failing grade in the “first exam”, he should have strived for an A+ in the “second exam”. But no, he managed at best a C-. So overall, he failed BIG!  It appears Yellen wants to compound on the mistakes!

Crimes against the economy and, by extension, against its citizens

In 1997, Bernanke (with Gertler and Watson) wrote “Systematic Monetary Policy and the Effiects of Oil Price Shocks“:

THE PRINCIPAL OBJECTIVE of this paper is to increase our understanding of the role of monetary policy in postwar U. S. business cycles. We take as our starting point two common findings in the recent monetary policy literature based on vector autoregressions (VARs).’

…Put more positively, if one takes the VAR evidence on monetary policy seriously (as we do), then any case for an important role of monetary policy in the business cycle rests on the argument that the choice of the monetary policy rule (the “reaction function”) has significant macroeconomic effects.

…The results are reasonable, with all variables exhibiting their expected qualitative behaviors. In particular, the absence of an endogenously restrictive monetary policy results in higher output and prices, as one would anticipate. Quantitatively, the effects are large, in that a nonresponsive monetary policy suffices to eliminate most of the output effect of an oil price shock, particularly after the first eight to ten months.

…The conclusion that a substantial part of the real effects of oil price shocks is due to the monetary policy response helps to explain why the effects of these shocks seems larger than can easily be explained in neoclassical (flexible price) models.

…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.

In other words the explicit warning is: “Don´t impose a negative demand shock over a negative supply shock”.

Then I read this from Blanchard, Cerutti & Summers: Inflation and Activity – Two Explorations and their Monetary Policy Implications:

“We find that, indeed, recessions associated with either oil price increases or with financial crisis are more likely to be followed by lower output later. But we find that recessions plausibly triggered by demand shocks are also often followed by lower output or even lower output growth.”

Therefore, it appears that Bernanke (and the Fed) imposed a massive negative demand shock on a significantly negative supply shock, comprising both an oil shock and a financial crisis!

That´s the main cause of the Great Recession (which has morphed into the “New Normal” or “Secular Stagnation”). The house price boom and bust and the ensuing financial crisis, in addition to “second fidllers” in the drama, serve as the “strawmen” that exculpate the Fed and even helped turn its Chairman into Person of the Year, 2009, Hero and bestselling author!

The story is illustrated below.

We start in late 2003, when the oil shock (could call it the “China shock”) began. From then to mid-2008, the price of oil quadrupled. According to Bernanke, you shouldn´t “drink” from that fountain.

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From 2003 to January 2006, it was Greenspan´s show. It appears that Greenspan followed Bernanke´s advice, and didn´t allow monetary policy (gauged by NGDP growth) to tighten. But Bernanke forgot his own counsel, and chose a monetary policy rule (strong reaction to the rise in headline inflation) with significantly negative macroeconomic effects.

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As we know, that was only the beginning. Things became much worse during the next 12 months.

Let´s backtrack and ask the question: Was Greenspan lucky?

The answer to this question leads us to examine in greater depth the role of monetary policy in generating the “Great Recession”.

The Dynamic AS/AD model tells us that a negative (positive) AS (oil) shock will decrease (increase) real growth and increase (decrease) inflation.

Bernanke et al very sensible conclusion from 1997 was that monetary policy should not react to those shocks.

But how can we gauge the stance of monetary policy? As Bernanke, channeling Milton Friedman, once said:

“As emphasized by Friedman (in his eleventh proposition) and by Allan Meltzer, nominal interest rates are not good indicators of the stance of policy, as a high nominal interest rate can indicate either monetary tightness or ease, depending on the state of inflation expectations. Indeed, confusing low nominal interest rates with monetary ease was the source of major problems in the 1930s, and it has perhaps been a problem in Japan in recent years as wellThe real short-term interest rate, another candidate measure of policy stance, is also imperfect, because it mixes monetary and real influences, such as the rate of productivity growth

The absence of a clear and straightforward measure of monetary ease or tightness is a major problem in practice. How can we know, for example, whether policy is “neutral” or excessively “activist”?

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…”

[Note: Unfortunately, he preferred to concentrate on inflation, and worse, the headline variety, which was being buffeted by the oil and commodity price shocks! As indicated by the Dynamic AS/AD (DASAD) model, inflation is not always a good indicator of the stance of monetary policy.]

The chart below provides a view of the stance of monetary policy by looking at the NGDP gap. The NGDP gap is the deviation of NGDP from its stable trend path. Therefore, if, for example, NGDP is rising above trend, monetary policy is deemed “loose” and “loosening”. Other cases are illustrated in the chart. The unemployment rate stands as counterpart for the real effects of monetary policy.

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In the second half of the 1990s, the economy experienced a positive (productivity) supply shock. According to the DASAD model, inflation falls and real growth increases (unemployment falls).

The chart above tells us that Greenspan allowed monetary policy to loosen, magnifying the growth and employment effects of the shock. When unemployment dropped below 4%, the “Phillips Curve/Slack crowd” took over and monetary policy tightened.

The Fed “overtightened” monetary policy [note: despite interest rates falling fast], as NGDP continued to fall below trend.

In mid-2003, the Fed adopted “Forward Guidance”, in effect “loosening” monetary policy, so that NGDP began to climb back to trend. If you refer to the NGDP growth chart at the beginning, you will notice that NGDP was growing at the high rate of 6.5% from late 2003 to early 2006. That´s the only way NGDP can climb back to trend, i.e. by growing for a time at a rate above the trend growth rate of around 5.4%.

Greenspan was “lucky” because, when the oil shock hit, monetary policy was on a “correction” trend, and thus minimized the negative real growth effect of the shock, with the unemployment rate even turning down.

When Bernanke took the helm, NGDP was “on trend”, i.e. NGDP growth was “just right” to provide a “stable monetary background”. But he forgot what he had known for 10 years and adopted a monetary reaction function focused on headline inflation. With the ongoing and even strengthening oil shock, monetary policy was tightened with NGDP falling below trend at a fast pace.

Now, given the fragile financial economic environment, the tightening of monetary policy only made that environment more fragile

At that point, another Great Depression was in the making, so Bernanke, faithful to his credit channel view of the propagation of the Great Depression, came quickly to the rescue of banks.

Monetary policy, however, remained tight and was only weakly loosened with the introduction of QE1 in March 2009.

NGDP and RGDP growth recovered, but for the past five years have remained at a level well below the previous trend growth rates; no wander the monikers “New Normal” and “Secular Stagnation” have become household words!

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The Blanchard et all paper rationalize this state of affairs by indicating that “even recessions triggered by demand shocks are often followed by lower output or even lower output growth”.

That sort of reasoning forgets that one thing monetary policy can avoid, or at least minimize the effects of, are demand shocks! Moreover, as Bernanke told us in 1997, monetary policy can also minimize the output effects of supply shocks, particularly by not reacting to those types of shocks.

Monetary policy, however, does not participate in the discussions. In a recent paper, “Long-term damage from the Great Recession in OECD countries”, for example, Lawrence Ball writes:

“The global financial crisis of 2008-2009 triggered national recessions of varying severity. The hardest-hit economies include those in the periphery of the euro area, which experienced severe banking and debt crises. At the other extreme, Australia was almost unscathed because of factors including fiscal stimulus and strong exports to Asia.”

One did badly because of banking and debt crisis. The other did well because of fiscal stimulus!

Interestingly, the economies that didn´t experience a recession (or a financial crisis) in 2008-09, like Australia, Israel and Poland, are the ones in which monetary policy managed to keep NGDP growth close to trend! That seems to be just luck because Stanley Fischer, now Vice-Chairman of the Federal Reserve Board, at the time was head of the Bank of Israel, and from his recent utterances still has no idea why he was successful!

And when you hear someone like New York Fed president Dudley, who has a permanent vote at the FOMC, express himself so disjointedly:

“We hope that relatively soon we will become reasonably confident that inflation will return to our 2 percent objective,” he said at Hofstra University. Dudley said it was “very logical” to expect that the Fed’s inflation and employment conditions would be met “soon,” allowing policymakers to “start thinking about raising the short-term interest rates.”

You easily conclude that the economy will likely get worse!

Appendix

One point emphasized by both the Blanchard et al and Larry Ball´s article, is the concept of hysteresis (and super-hysteresis), which concerns the level (and growth rate) of real output following real or nominal shocks.

The chart below casts some doubt on the idea, at least for the US.

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Even the oil shocks of the 1970s or the demand shock from Volcker’s disinflation did not permanently reduce the level or growth rate of real output, which always returned to trend (the trend in the chart was formed from 1970 to 1997).

The more recent Bernanke/Yellen supply/demand shock has worked out differently, with both the level and growth rate of output forcefully reduced, i.e. denoting hysteresis/super-hysteresis!

As argued above, that comes mostly from the misconceived monetary policy adopted since Bernanke took over. That policy has drastically reduced both the target level of NGDP and its growth rate. The charts illustrate for the most recent period.

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The real damage is that now the much lower level and growth rate of real output have become the “New Normal”!

The chart below well describes the inadequacy of using interest rates to gauge the stance of monetary policy. Interest rates, in fact, say that monetary policy is loosening when it is tightening, and vice-versa! That is consistent with Friedman´s saying from 1968: “low interest rates indicate that monetary policy has been tight and high interest rates that it has been easy”.

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Another point often made, especially by the people at the FOMC, is that the unemployment rate is down to levels that indicate the economy is running out of slack (so policy must be “tightened”).

I find it wrong to reason from an unemployment change when unemployment at present means something possibly very different from what it meant in previous decades. The chart illustrates that at present, both unemployment and labor force participation rates are falling. In previous periods, a fall in unemployment went together with increasing or high labor force participation.

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The tight coincidence between the fall in participation rates and the deep drop of NGDP below trend also make me skeptical to attribute any significant share of the drop in participation to structural/demographic factors.

Here also, most of the damage to the labor market lies in the hands of the misguided monetary policy adopted by the Bernanke/Yellen Fed! They feel that “the time has come to “tighten” monetary policy”. By misunderstanding monetary policy, they ignore that for the past year monetary policy has been tightening, with implications for the dollar and oil prices!

The charts illustrate:

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And, being clueless, they think the low inflation is something temporary that is due to the oil and exchange rate effect. In other words, monetary policy is even absent from direct discussions of inflation!

How a myth is born

Bernanke HeroFirst, you get a “The Hero” magazine cover

 

Bernanke Person of the YearThen you get to be Person of the Year

Bernanke Hero1

And finally, you write a memoir titled “The Courage to Act”

 

 

and voilá, the myth is born!

The latest invocation comes from Simon Wren-Lewis:

Here is an extract from an interview with Ben Bernanke by George Eaton in the New Statesman:

Though a depression was averted in 2008, the recovery in the US and the UK has been slow. Bernanke partly blames the imposition of fiscal austerity (spending cuts and tax rises), which limited the effectiveness of monetary stimulus. “All the major industrial countries – US, UK, eurozone – ran too quickly to budget-cutting, given the severity of the recession and the level of unemployment.”

Partly thanks to Bernanke’s leadership (and knowledge), the Great Recession was not as bad as the Great Depression of the 1930s. Monetary policy reacted much more quickly, and financial institutions were (nearly all) bailed out. In 2009 we also enacted fiscal stimulus, but in 2010 we reverted to the policies of the early 1930s with fiscal austerity. That mistake was partly the result of panic following events in the Eurozone (see the IMF analysis discussed here), but it also reflected political opportunism on the right.

However, as Scott Sumner concludes in a recent post:

That’s why it’s so important to get the facts right. Just as the Abe government showed the BOJ was not out of ammo in the early 2000s, a close examination of what the Fed did and didn’t do, and a cross country comparison of monetary policy during the Great Recession and recovery, shows that monetary policy is always and everywhere highly effective.

What are the facts?

The chart shows that during the first few months of the Great Depression (GD) and the Great Recession (GR), the behaviour of NGDP was similar.

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After that, things were very different. What Bernanke´s knowledge did was to apply the results from his “made my name” 1983 article “Nonmonetary effects of the financial crisis in the propagation of the Great Depression”, by going on a bank bail-out spree, thus avoiding the propagation factors that were very “active” in 1931/32.

The charts from the Great Depression indicate what Bernanke avoided. They also show that to get the economy to “turn around” and take a path back to the previous trend, monetary policy has to be really expansionary. That was true even with interest rates at the ZLB, as happened when FDR made a significant change in the monetary regime, cutting the link to gold in March 1933, almost four years after the start of the depression! NGDP growth went up by enough to put the economy on the path back to trend.

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The next charts show what happened now. Notice that in the early 2000s, Greenspan also allowed NGDP to drop below trend, but that mistake was fully offset, and by the time Bernanke took the Fed´s helm. NGDP was back on trend.

Without going in to all the details, the fact is that Bernanke allowed NGDP to fall in “Great Depression style”. As mentioned, he avoided a second “GD” by bailing-out the financial system. In addition, by introducing QE in March 2009, monetary policy reacted much more quickly than in the “GD”.

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However, notice the difference. In Bernanke´s case, monetary policy was just sufficient to put the economy on a growing trend along a lower level path. It never tried, as happened after March 1933, to get back to the original trend path. Thus, the economy is stuck in a “lesser depression” a.k.a. “Great Stagnation”.

And that really has nothing to do with fiscal policy.

The low regard for things economic

In “Fed Speak on Main Street“, Carola Binder finds that:

Using polling data for the US documents that the US public lacks knowledge about monetary policy. In particular, only one in every three Americans was able to correctly identify the chair of the Federal Reserve System. Very few were able to predict low levels of inflation when asked about inflation over next ten years. Nor did they appear to display much eagerness to learn about the Fed and monetary policy.

In terms of social media, numbers of Twitter and Facebook followers of the Federal Reserve System do not appear remarkable. In fact, FBI, the CIA, and Paul Krugman, among others, have more followers than the entire Federal Reserve System. Google searches confirm this paucity of interest. Total online searches for macroeconomic variables like GDP, the unemployment rate, and inflation are consistently topped by online searches for puppies.

Nevertheless, Bernanke´s book seems to be doing well. According to Amazon:

Bernanke: “The man in the ‘irony’ mask”

To my mind, Bernanke is the living embodiment of irony. Irony has followed him closely through the last few decades. Below a small but diverse sample.

What Happens when Greenspan is gone? (Jan 2000):

U .S. monetary policy has been remarkably successful during Alan Greenspan’s 121/2 years as Federal Reserve chairman. But although President Clinton yesterday reappointed the 73-year-old Mr. Greenspan to a new term ending in 2004, the chairman will not be around forever. To ensure that monetary policy stays on track after Mr. Greenspan, the Fed should be thinking through its approach to monetary policy now. The Fed needs an approach that consolidates the gains of the Greenspan years and ensures that those successful policies will continue; even if future Fed chairmen are less skillful or less committed to price stability than Mr. Greenspan has been.

We think the best bet lies in a framework known as inflation targeting, which has been employed with great success in recent years by most of the world’s biggest economies, except for Japan. Inflation targeting is a monetary-policy framework that commits the central bank to a forward-looking pursuit of low inflation; the source of the Fed’s current great performance; but also promotes a more open and accountable policy-making process. More transparency and accountability would help keep the Fed on track, and a more open Fed would be good for financial markets and more consistent with our democratic political system.

He was what happened, and he did exactly what he said should be done. Was it a success? To be kind, not so much.

Systematic MP and the effects of oil price shocks (June/1997):

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

This finding may help explain the apparently large effects of oil price changes found by Hamilton (1983) and many others.

Soon after becoming Chairman of the BoG an oil shock materialized. What did Bernanke do? He forgot about his “findings” and tightened monetary policy (constraining NGDP growth (see below)).

On Milton Friedman´s 90th Birthday (Nov 2002):

Once Roosevelt was sworn in, his declaration of a national bank holiday and, subsequently, his cutting the link between the dollar and gold initiated the expansion of money, prices, and output.

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

He did it, albeit at a much smaller scale. Why? Because he acted on his “knowledge” of the “credit channel”. From his 1983 article Non-Monetary Factors of the Financial Crisis in the Propagation of the Great Depression:

A second possibility is that banking panics contributed to the collapse of output and prices through nonmonetary mechanisms. My own early work (Bernanke, 1983) argued that the effective closing down of the banking system might have had an adverse impact by creating impediments to the normal intermediation of credit, as well as by reducing the quantity of transactions media.

That was what propagated the depression. By “saving” the banks, Bernanke´s Fed “cut-off the propagation mechanism”, leaving only the deleterious effects of the monetary policy mistakes.

What were those mistakes? An idea comes from On the legacy of Milton and Rose Friedman´s Free to Choose (2003):

As emphasized by Friedman (in his eleventh proposition) and by Allan Meltzer, nominal interest rates are not good indicators of the stance of policy, as a high nominal interest rate can indicate either monetary tightness or ease, depending on the state of inflation expectations. Indeed, confusing low nominal interest rates with monetary ease was the source of major problems in the 1930s, and it has perhaps been a problem in Japan in recent years as wellThe real short-term interest rate, another candidate measure of policy stance, is also imperfect, because it mixes monetary and real influences, such as the rate of productivity growth

The absence of a clear and straightforward measure of monetary ease or tightness is a major problem in practice. How can we know, for example, whether policy is “neutral” or excessively “activist”?

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

Unfortunately, he preferred to concentrate on inflation, and worse, the headline variety, which was being buffeted by the oil and commodity price shocks! Apparently, inflation is not always a good indicator of the stance of monetary policy.

Japanese Monetary Policy: A case of self-induced paralysis (Dec 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.

It is true that current monetary conditions in Japan limit the effectiveness of standard open-market operations. However, as I will argue in the remainder of the paper, liquidity trap or no, monetary policy retains considerable power to expand nominal aggregate demand. Our diagnosis of what ails the Japanese economy implies that these actions could do a great deal to end the ten-year slump.

Japan is not in a Great Depression by any means, but its economy has operated below potential for nearly a decade. Nor is it by any means clear that recovery is imminent. Policy options exist that could greatly reduce these losses. Why isn’t more happening? To this outsider, at least, Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced. Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work. Perhaps it’s time for some Rooseveltian resolve in Japan.

Twelve years later, “Rooseveltian Resolve” was asked of him by Christina Romer in

Dear Ben: It’s Time for Your Volcker Moment (2011):

For evidence that adopting the new target could help fix the economy, look at the 1930s. Though President Franklin D. Roosevelt didn’t talk in terms of targeting nominal G.D.P., he spoke of getting prices and incomes back to their pre-Depression levelsAcademic studies suggest that this commitment played an important role in bringing about recovery.

President Roosevelt backed up his statements. He suspended the gold standard and let the dollar depreciate. He got Congress to pass New Deal spending legislation and had the Treasury monetize a large gold inflow.The result was an end to deflationary expectations , leading to the most impressive swing the country has ever seen from horrible contraction to rapid growth.

Would nominal G.D.P. targeting work as well today? There would likely be unexpected developments, just as there were in the Volcker period. But the new target would have a better chance of meaningfully reducing unemployment than any other monetary policy under discussion.

Because it directly reflects the Fed’s two central concerns — price stability and real economic performance — nominal G.D.P. is a simple and sensible target for long after the economy recovers. This is very different from Mr. Volcker’s money target, which was abandoned after only a few years because of instability in the relationship between money growth and the Fed’s ultimate objectives.

Desperate times call for bold measures. Paul Volcker understood this in 1979. Franklin D. Roosevelt understood it in 1933. This is Ben Bernanke’s moment. He needs to seize it.

Romer´s article was published Oct 29/11. Just 3 days later, the FOMC met. They discussed NGDPT, but rejected it and 2 months later Bernanke realized his longtime dream: IT became official @2%!

Again he forgot. This time his advice to Japanese monetary authorities. Final irony: when was inflation last at 2%? On the month (Jan/12) 2% became the target!

Mask of Irony

NGDP Targeting and FOMC discussions

Curiously, at the end of 1982 at the high point of unemployment and the low point of growth, with inflation below 6%, the lowest level reached since 1974, the Fed discussed NGDP targeting:

MORRIS. I think we need a proxy–an independent intermediate target– for nominal GNP, or the closest thing we can come to as a proxy for nominal GNP, because that’s what the name of the game is supposed to be.

During the December 1992 FOMC meeting there was a detailed discussion of NGDP targeting. An excerpt:

JORDAN. This question of when the time is going to come to change the [funds] rate–especially in an upward direction–and the criteria for doing so has been on my mind a lot, and I’m sure it has been in everybody’s thinking. This is my seventh meeting, and I thought it was time to go back and review the last year and to look at what actually has happened in terms of all kinds of economic indicators–monetary as well as economic indicators, nominal and real indicators–and Committee actions to see if I could deduce an implicit model. I read the newsletters, as I’m sure everybody does; and [unintelligible] and I don’t see it in the numbers, it’s certainly not inflation. It’s not the various money measures: Ml, M2, the base, or bank reserves. I don’t even think its real GDP. I put together a table–a big matrix of every forecast for as many quarters out as the Greenbook does it–for every meeting for the last year. What struck me was that it looked as if we were on a de facto nominal GNP target. When nominal GNP is at or above expectations, the funds rate is held stable; but when nominal GNP comes in below what has been expected, we cut the funds rate

In closing the discussion Greenspan says:

As I read it, there is no debate within this Committee to abandon our view that a non-inflationary environment is best for this country over the longer term. Everything else, once we’ve said that, becomes technical questions. I would say in that context that on the basis of the studies, we have seen that to drive nominal GDP, let’s assume at 4-1/2 percent, in our old philosophy we would have said that [requires] a 4-1/2 percent growth in M2. In today’s analysis, we would say it’s significantly less than that. I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal of which the money supply relationships are technical mechanisms to achieve that.

From Bernanke´s Book as tweeted by Neil Irwin:

The FOMC had a long, serious discussion of NGDP targeting in 2011. And soundly rejected it.

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Bernanke is really an inflation targeting freak! Note than in 1982 or 1992, no one said that by targeting NGDP the Fed “had suddenly decided it was willing to tolerate higher inflation, possibly for many years”. And just two months after this discussion, in January 2012, the Fed made the 2% target official policy!

Notice that in 1992, Greenspan said: “I’m basically arguing that we are really in a sense using [unintelligible] a nominal GDP goal…”

That said, I think it is worthwhile to check if Greenspan´s words were meaningful. The panel below pictures what went on in the NGDP, inflation and unemployment fronts from then to the end of his tenure.

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The next panel shows how those things continued into the Bernanke/Yellen era.

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One could say: “so what”? Inflation has remained low, even below the now official target, and unemployment has come down to a “comfortable” level. Bernanke has said the “Fed saved the economy – full employment without inflation is in sight”!

But, according to Bernanke:

Congress is largely responsible for the incomplete recovery from the 2008 financial crisisBen S. Bernanke, the former Federal Reserve chairman, writes in a memoir published on Monday.

Mr. Bernanke, who left the Fed in January 2014 after eight years as chairman, says the Fed’s response to the crisis was bold and effective but insufficient.

“I often said that monetary policy was not a panacea — we needed Congress to do its part,” he says. “After the crisis calmed, that help was not forthcoming.”

In a few instances, Mr. Bernanke also acknowledges, the Fed could have done more. He writes that the decision not to lower rates in September 2008, immediately after the collapse of Lehman Brothers, “was certainly a mistake.” The Fed’s benchmark rate then stood at 2 percent; by the end of the year, it had been cut nearly to zero.

By “incomplete recovery”, I´ll take it he´s referring to the “gaping hole” that´s observed in the NGDP chart (the distance to the trend NGDP level). But that cannot be attributed to Congress. It refers to what Friedman said almost 50 years ago: “A second thing monetary policy can do is provide a stable background for the economy.”

Bernanke gave a narrow interpretation to “stable background”, defining it in terms of “low and stable inflation”. If instead of low and stable inflation he had pursued a stable growth path for nominal spending (NGDP) he would have avoided the crash.

Inflation is low, unemployment is back (almost) at “full employment”. So what´s missing, allowing the gap to remain wide open?

As the charts show, the unemployment rate has a different “meaning” in the two periods!

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And the last chart provides a “summary statistic”.

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In the 2001 recession, NGDP growth slumped, but was brought back up so that the trend level of NGDP was regained.

In the 2007-09 recession, NGDP growth “caved” and has remained far below the trend growth, implying that there has been no “recovery”, with the economy remaining “depressed”!

And that´s no fault of Congress, but the result of Bernanke´s (and the Fed´s) obsession with inflation!

Bernanke´s Failure!

Bernanke´s book Courage to Act was released today. I´m not much curious about the backstage discussion of how best to rescue the financial system or the “excitement” about Lehman because I fear that much of that was a consequence of monetary policy mistakes, so I will mostly want to read about his views on the monetary policy the Fed was pursuing.

I have the feeling he forgot about Friedman´s first and second dictum about what monetary policy can do.

The first and most important lesson that history teaches about what monetary policy can do-and it is a lesson of the most profound importance-is that monetary policy can prevent money itself from being a major source of economic disturbance.

When a Governor of the Board in 2002, Bem Bernanke made a speech at a conference honoring Milton Friedman on the occasion of his 90th birthday. He concludes thus:

For practical central bankers, among which I now count myself, Friedman and Schwartz’s analysis leaves many lessons. What I take from their work is the idea that monetary forces, particularly if unleashed in a destabilizing direction, can be extremely powerful. The best thing that central bankers can do for the world is to avoid such crises by providing the economy with, in Milton Friedman’s words, a “stable monetary background–for example as reflected in low and stable inflation.

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.

I think Bernanke gave a too narrow interpretation of what was Friedman´s second dictum:

A second thing monetary policy can do is provide a stable background for the economy.

If instead of low and stable inflation he had pursued a stable growth path for nominal spending (NGDP) he would have avoided the crash.

And it´s not that Bernanke did not know that the level of the FF rate (“low” at the time) was not a good indicator of the stance of monetary policy. In 2003 he wrote on the Legacy of Milton and Rose Friedman:

As emphasized by Friedman (in his eleventh proposition) and by Allan Meltzer, nominal interest rates are not good indicators of the stance of policy, as a high nominal interest rate can indicate either monetary tightness or ease, depending on the state of inflation expectations. Indeed, confusing low nominal interest rates with monetary ease was the source of major problems in the 1930s, and it has perhaps been a problem in Japan in recent years as wellThe real short-term interest rate, another candidate measure of policy stance, is also imperfect, because it mixes monetary and real influences, such as the rate of productivity growth

The absence of a clear and straightforward measure of monetary ease or tightness is a major problem in practice. How can we know, for example, whether policy is “neutral” or excessively “activist”?

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

Unfortunately, he preferred to concentrate on inflation, and worse, the headline variety, which was being buffeted by the oil and commodity price shocks!

In looking at this

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He missed this

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And harvested mayhem!

BB makes me sick!

On the day that his book “Courage to Act” will be released, he writes an op-ed at the WSJ “modestly” titled How the Fed Saved the Economy – Full employment without inflation is in sight. The central bank did its job. What about everyone else?

For the first time in nearly a decade, the Federal Reserve is considering raising its target interest rate, which would end a long period of near-zero rates. Like the cessation of large-scale asset purchases in October 2014, that action will be an important milestone in the unwinding of extraordinary monetary policies, adopted during my tenure as Fed chairman, to help the economy recover from a historic financial crisis. As such, it’s a good time to evaluate the results of those measures, and to consider where policy makers should go from here.

He chooses to compare with Europe:

It is instructive to compare recent U.S. economic performance with that of Europe, a major industrialized economy of similar size. There are many differences between the U.S. and Europe, but a critical one is that Europe’s economic orthodoxy has until recently largely blocked the use of monetary or fiscal policy to aid recovery. Economic philosophy, not feasibility, is the constraint: Greece might have limited options, but Germany and several other countries don’t. And the European Central Bank has broader monetary powers than the Fed does.

Europe’s failure to employ monetary and fiscal policy aggressively after the financial crisis is a big reason that eurozone output is today about 0.8% below its precrisis peak. In contrast, the output of the U.S. economy is 8.9% above the earlier peak—an enormous difference in performance. In November 2010, when the Fed undertook its second round of quantitative easing, German Finance Minister Wolfgang Schäuble reportedly called the action “clueless.” At the time, the unemployment rates in Europe and the U.S. were 10.2% and 9.4%, respectively. Today the U.S. jobless rate is close to 5%, while the European rate has risen to 10.9%.

And wraps up with a bromide:

It is encouraging to see that the U.S. economy is approaching full employment with low inflation, the goals for which the Fed has been striving. That certainly doesn’t mean all is well. Jobs are being created, but overall growth is modest, reflecting subpar gains in productivity and slow labor-force growth, among other factors. The benefits of growth aren’t shared equally, and as a result many Americans have seen little improvement in living standards. These, unfortunately, aren’t problems that the Fed has the power to alleviate.

Noah Smith tweets a Q&A at the LSE in 20013:

LSE: What should economists and policymakers learn from the financial crisis?

Ben Bernanke: Well I was thinking about Olivier [Blanchard’s] comments. Certainly I agree that bringing financial markets into macroeconomics is obviously critical. I think back at the work I did–that I was involved with academically–and in some ways we had taken steps in that direction. I did work thirty years ago on the role of credit in the Great Depression. We had done work on the financial accelerator, and how financial factors could play a role in exacerbating a downturn, and so on.

But the point that Olivier made was very important: the details really matter. Here is a fundamental question: the decline in wealth associated with the tech bubble bursting [in 2001] and the decline in wealth associated with the decline in house prices as of, say, late 2008 was about the same–maybe even more on the [2001] stock [market] bubble. From a standard macro model or even one elaborated with financial factors, you would not have really thought that the housing bubble would have been more damaging than the stock bubble. Now the reason it was more damaging, of course, as we know now, is that the credit intermediation system, the financial system, the institutions, the markets, were far more vulnerable to declines in house prices and the related effects on mortgages and so on than they were to the decline in stock prices. It was essentially the destruction of the ability of the financial system to intermediate that was the reason the recession was so much deeper in the second than in the first. To understand that, you really have to know the details of how banks and individual institutions are exposed to housing and to mortgages, in ways that the institutions themselves did not fully understand at the time.

Apparently Bernanke missed out the fact of utmost importance in the 1930s – the very deep drop in nominal spending (NGDP) – and let it do a “moderated replay” in 2008-9! Moderated because he knew (from his research) that he couldn´t let the financial system implode. In 1987-88, nothing of the sort happened!