Ezra Klein has a long rebuttal to Ramesh Ponnuru’s recent critique of fiscal stimulus. It contains lots of the usual talking points, but seems to sort of waver between the “Fed can’t” and the “Fed won’t” defenses of fiscal stimulus. I’ll focus mostly on the “Fed can’t” argument:
Ponnuru nods at this toward the end of his column, but all he says about the difficulty of a policy that would have driven interest rates to negative 6 percent is that “our government was perfectly capable of pursuing a highly expansionary one in 1933, when interest rates were low.”
As far as 1933 goes, part of the expansionary policy was driven by Europeans sending gold to America because they were afraid of Hitler, and part of it came later, when we went off gold altogether. We really can’t do that again. And note that quite a bit of the research on the Fed’s stimulative policies in the 1930s was done by Christina Romer and Ben Bernanke, both of whom happened to be in office in 2009, and both of whom called for massive fiscal stimulus.
There are a number of problems here. Let’s start with the “we can’t do that again.” The only reason the gold flows to America mattered is that they allowed a larger money supply. We don’t even need gold to do that today, we can just print money. As for going off gold, he’s right that we can’t do that, but what really mattered about going off gold was that FDR used it as a way of hitting a price level target. And here’s where Klein is giving readers the wrong impression. Romer is a very strong advocate of the position that monetary policy does not run out of ammunition at the zero bound. Indeed Romer has recently been calling for NGDP targeting, level targeting. Bernanke said the BOJ could definitely increase prices if they wanted to, and called on them to show “Rooseveltian resolve.” He clearly thought the lessons of 1933 had relevance for today. Bernanke has repeatedly said the Fed is not out of ammunition.
Ezra Klein is right that both Romer and Bernanke have called for fiscal stimulus. Far enough, but we need to take one issue at a time. Most of the Klein column is devoted to criticizing Ponnuru’s argument that monetary policy is still effective at the zero bound. That criticism may correct, but on that issue there is no dispute that both Romer and Bernanke firmly agree with Ponnuru, not Klein.
[BTW, the European gold flows to America occurred well after we left gold, not before. Indeed we were back on gold by the time they occurred.]
Ezra Klein continues:
Ponnuru concludes that “Obama would have been better off pushing for more Fed action in 2009” and “skipping the unpopular stimulus.” It’s not clear what this would have meant in practice. The Federal Reserve is independent of the president. So Obama couldn’t have ordered Bernanke around in 2009. He potentially could have replaced him with a much more radical Fed chair when Bernanke’s term was up, but by that point, the Republican Party had turned decisively against expansionary monetary policy — Ponnuru fought this turn, I should note — and any attempt to stock the Fed with leaders who would have pushed a vastly more inflationary course would have been quickly blocked by the Republican Party.
Readers of this blog know that I criticized Obama in 2009 for leaving two seats empty on the Board of Governors. Obama didn’t need to replace Bernanke; he needed to give him allies. Instead he brushed aside Romer’s argument that monetary policy could do a lot, even at zero rates. But don’t take my word for it, here’s Ezra Klein in the NYR of Books:
But if the White House couldn’t go through Congress, perhaps it could have done a better job going around it. A major omission in Suskind’s book—which is also a major omission in political punditry more generally—is that it makes little mention of the Federal Reserve. But the Fed is arguably more powerful than Congress when it comes to setting economic policy, and it is certainly more powerful than the president.
The White House made two major mistakes here. One was leaving two seats on the Fed’s Board of Governors unfilled. Congress certainly deserves some of the blame for this—Senate Republicans filibustered Peter Diamond, a Nobel laureate economist whom the Obama administration nominated to fill one of the open slots—but the truth is that the White House was slow to nominate Diamond, passive once it did nominate him, and seemingly lost once his nomination failed. At the moment, the two seats on the Fed’s Board of Governors remain open, and the White House has not put forward any new candidates. Those seats matter because the Federal Reserve is a cautious institution that is more comfortable fighting inflation than pursuing full employment, and if you want it to act with more vigor, you need to bring that energy in from the outside.
Of course, the most straightforward path to energizing the Fed isn’t adding two new members to its Board of Governors, but replacing its chairman. And the White House had an opportunity to do so in 2010, when Ben Bernanke’s term expired. Instead, Obama chose to renominate Bernanke. . . .
This raises the question of whether the Obama administration made a mistake in reappointing Bernanke. If it had managed to install a more activist chairman at the Federal Reserve, then its inaction might have been more effectively offset by the Fed’s actions.
Exactly my argument. The Fed’s more powerful than Congress, and Obama blew it by not doing more in that area. And it’s even worse than Klein suggests, as the Diamond filibuster didn’t occur until well into 2010, when Scott Brown’s election gave the GOP the opportunity to filibuster. But there were two empty seats in early 2009, and Obama didn’t even nominate anyone for them until around mid-2010. Even now a majority of the Board are Obama appointees, but it should have been an overwhelming majority, not a narrow majority.
I don’t know why Bernanke favored fiscal stimulus. Perhaps he aims for a 2% inflation target, but would prefer that Congress did the heavy lifting. In that case Ponnuru is right. Or maybe he’s committed to X amount of QE, and thinks that even more stimulus is needed. In that case Klein is right. But as I watch the Fed zig zag from QE1, to talk of “exits,” to QE2, to more talk of exits, to Operation Twist, to lengthening the duration of zero rates to 2013, then 2014, and always seemingly in response to the ups and downs in the economy, I can’t help but think that Ponnuru’s got the much stronger argument.
Maybe someone should ask Bernanke why he keeps insisting that the Fed is not out of ammunition, and yet also favors fiscal stimulus. How would the Fed react if Congress did less stimulus? Would the Fed do more, if Congress doing less reduced inflation below 2 percent? If not, why not? All good questions for members of the Washington press corp, and Ezra Klein’s one of the very best.