I tend to oversimplify complex problems. So do lots of other people. It’s only since I started blogging that I realized how often I did this. That’s because on one day I might passionately believe X was important. On another day it seemed to be all about Y. And a week later Z seemed to be the key to everything. When I’m thinking about one of those things, the others get blotted out of my mind. But blogging leaves a paper trail, so now I realize that I’ve claimed “It all boils down to X,” with at least 10 different Xs.
In recent days three bloggers have tried to get to the core of the policy failure. Matt Yglesias has suggested it all boils down to the zero rate bound, Ryan Avent replied that the key problem is the reluctance of central banks to engineer sharply negative real rates, and Steve Waldman has countered that it’s the political power of older savers that is inhibiting monetary stimulus.
It’s pretty easy to show that none of these answers is adequate, nor is any monocausal explanation I’ve previously offered. So here’s 10 factors that contributed to the “perfect storm,” a list that is itself hardly exhaustive:
1. Yes, Matt’s right that the zero rate bound matters. If the US fed funds rate was currently 2%, and all the macro indicators were exactly as they are now, the Fed would cut its rate target. They are slightly more averse to unconventional stimulus.
2. Ryan’s also right that the need for especially low real rates matters. The real estate bust means that macro equilibrium requires unusually low real interest rates.
3. Steve’s right that the savers lobby plays a role. But I’m a big saver, and I feel that I’d be far better off if money had been much easier in 2008. Partly because tight money badly hurt the values of stocks and risky bonds. And partly because the resulting recession made real rates much lower than they’d be at full employment. It’s not a zero sum game. The “mistake theory” of policy failure is looked down on by sophisticated intellectuals, but if you think (as I do) that 99% if professional economists “got it wrong” in 2008, how much of a stretch is it to assume that the economists at the Fed also got it wrong?
4. Nick Rowe is right that interest rate targeting contributed to the problem by making the Fed “mute” at zero rates. It became harder to signal its future policy intentions.
5. Larry Ball is right that Ben Bernanke’s personal qualities played a role. He favored a more democratic decision process than Greenspan or Volcker, and on average that will get you better decisions. But in this particular case Bernanke’s expertise and instincts are superior to that of the median FOMC voter. And Bernanke’s not the sort of person who would demand that others follow his lead.
6. We are suffering partly because we just happen to have chosen rate targeting rather than level targeting, and prices rather than NGDP.
7. We are in this predicament partly because the public doesn’t understand the concept of “inflation” in the same way as Bernanke does, making for a PR nightmare. When Bernanke announced the need for more inflation in the fall of 2010 (QE2), he meant more demand-side inflation, i.e. higher real incomes for Americans. The public read it as more supply-side inflation, i.e. lower real incomes for Americans. The backlash made the Fed more cautious.
8. We are in this predicament because the median economist believes in intro textbook “liquidity trap” myths, and hence put no pressure on the Fed to stimulate, as they thought the Fed was out of ammo. The Fed usually follows the preferences of the median economist, so this cognitive failure was a really big deal.
9. We are in this predicament partly because the Fed already feels like it has done a lot (as does the profession.) That’s because they never absorbed Bernanke’s 2003 admonition that NGDP growth and inflation are the “only” way to ascertain the stance of monetary policy. They don’t know that ultra-tight money drives NGDP so low that interest rates fall to zero, which makes excess reserves surge. As a result ultra-tight money paradoxically ends up looking like ultra-easy money.
10. And now I’ll end up with a few cheap shots at liberals and conservatives (no single ideology could create such a monumental mess.) In America it’s hard to believe that the opposition of conservatives to monetary stimulus is unrelated to Obama being president. Inflation was higher under Bush, and yet the intensity of conservative Fed bashing was far less. In Northern Europe, conservatives see the crisis as an opportunity to force the southern tier to shape up. In both cases there is a fear that easy money could somehow ‘bail out” failed economy policies. In contrast, American liberals took office in January 2009 with grand dreams that this was a 1933-type opportunity to expand government, just as FDR did. Hence they mostly ignored monetary policy until the GOP took over the House of Representatives.
OK, what have I missed? I bet if you went through my nearly 1500 posts you’d find dozens of other explanations, which I can’t recall right now.
PS. After I wrote this I recalled one more—too much weight on historical inflation numbers (especially in September 2008), not enough weight on targeting the forecast.
PPS. I just noticed that Karl Smith has a related post.