Ben Bernanke has been assailed from all sides in the economic debate in recent times. Perhaps that happens to all Fed Chairmen (except, remarkably, to Alan Greenspan, whom almost no-one criticized while he was in office). But in Chairman Bernanke’s case, the criticism has been strident, reflecting the polarization of views on economic policy in general.
In particular, the Keynesian side has accused Mr Bernanke of doing far too little to address the problem of unemployment after short rates reached the zero bound in 2009. They are very disappointed about this, because Mr Bernanke was a very strong proponent of drastic monetary action to address comparable problems in the Japanese economy a decade ago.
In three well-known speeches between 2000 and 2003, he presented a “menu” of non conventional measures to eliminate the output gap in Japan, and accused the Bank of Japan of being trapped by “paralysis which is largely self-induced”. This is exactly what his Keynesian critics are saying about him today.
So it is important to understand why Mr Bernanke has changed his mind. Laurence Ball of Johns Hopkins University has written a fascinating paper on this subject, chronicling every nuance of Mr Bernanke’s statements on unconventional monetary easing since 2000. He reaches a very interesting conclusion, which is that Mr Bernanke decisively changed his view on this subject in 2003, and has not budged at all since then. If this is true, it raises some questions about what the Fed might do next, especially if there is a further need for unconventional easing of policy.
Professor Ball outlines the now famous menu of policy options which Mr Bernanke (then a professor) proposed in 2000. The measures he has since adopted as Fed Chairman (quantitative easing by buying treasury bonds, and communications about future short rates) were certainly among them. But so were a series of other more drastic measures, including a ceiling on bond yields, an increase in the inflation target, intervention to devalue the exchange rate, explicit monetization of fiscal expansion (“helicopter money”) and purchases of private sector assets including equities. This set of nuclear options has not been adopted by the Fed since 2008.
Many economists, including myself, have assumed that Mr Bernanke saw this group of proposals as a continuum, in which case he would proceed into the nuclear list if he needed to do so. However, Professor Ball’s work implies that this conclusion might be wrong. He shows that Mr Bernanke actually jettisoned all of the nuclear options in June 2003, after a critically important FOMC meeting on policy at the zero bound.
The full minutes of this meeting have now been published, so we can see exactly what was said. Mr Bernanke, by now a Fed governor, argued in favour of QE and communications policy, but conspicuously did not argue for any of the nuclear options, and has never mentioned any of them since then. In fact, the reverse. He has now pinned his colours firmly to the mast of an unchanging 2 per cent inflation target, despite calls for a price level or nominal GDP target which would force the Fed to act more aggressively if inflation fell below target.
Professor Ball says that Mr Bernanke was persuaded by the economic analysis presented by Fed staff, notably Vincent Reinhart, at the critical FOMC meeting. This rejected the nuclear options on the grounds that they would “smack of desperation”, and “would change how we are viewed by the markets”. Subsequent joint speeches by Mr Bernanke and Mr Reinhart show that the future chairman quickly adopted the Reinhart view, clearly persuaded by the Fed staff’s analysis.
Gary Player used to say that many golfers suffer from “paralysis by analysis”. Perhaps this also applies to the Fed Chairman. Professor Ball says that he was too easily influenced by the “groupthink” which was such an unfortunate feature of the Greenspan Fed, a condition which was exacerbated by his “shy and retiring” personality. But this gives little credit to Mr Bernanke’s unparalleled knowledge of monetary policy at the zero bound, and his willingness to adopt audacious measures in the crisis of 2008.
I prefer an alternative explanation, which is that Mr Bernanke was persuaded in 2003 that the nuclear options were simply too risky for the Fed to adopt, except in extreme conditions where Irving Fisher-style debt deflation was gripping the economy. In the Japanese example, that seemed to be the case from 2000-03, when deflation took hold. In the US examples of 2003/04 and after 2008, unconventional policy was intended to prevent deflation from occurring, and so far it has succeeded in doing so. It did not need to go nuclear.
There is also another possibility, which is that Mr Bernanke’s view of the Japanese experience in 2000-03 may look rather different with a decade of additional hindsight. At the time, Mr Bernanke said that the output gap in Japan was around 14 per cent, which justified emergency monetary action. That estimate was made by comparing actual GDP with the long term trend line extrapolated from the 1980s onwards. But it now seems more likely that the Japanese trendline broke downwards in the late 1980s, so the output gap might not have been as large as was once thought.
I have no evidence for this, but it is possible that Mr Bernanke believes that there is also some doubt about whether the GDP trendline line in the US can be safely extrapolated from pre-2007 experience.
Faced with this uncertainty about the GDP trendline and therefore the output gap, he has latched onto an explicit inflation target to tell him whether to ease or tighten policy. If inflation projections do fall below target, then any further Fed easing would probably remain within the range of non nuclear options which have been used so far.
What I have concluded from Professor Ball’s analysis is that the famous “Bernanke menu” of policy options is not a continuum at all. He would only press the nuclear button if the economy were threatened with outright deflation, which is a long way from here.