Rooseveltian Resolve

Let’s revisit the famous DeLong question to Bernanke:

D. Brad Delong, University of California at Berkeley and blogger: Why haven’t you adopted a 3% per year inflation target?

The public’s understanding of the Federal Reserve’s commitment to price stability helps to anchor inflation expectations and enhances the effectiveness of monetary policy, thereby contributing to stability in both prices and economic activity. Indeed, the longer-run inflation expectations of households and businesses have remained very stable over recent years. The Federal Reserve has not followed the suggestion of some that it pursue a monetary policy strategy aimed at pushing up longer-run inflation expectations. In theory, such an approach could reduce real interest rates and so stimulate spending and output. However, that theoretical argument ignores the risk that such a policy could cause the public to lose confidence in the central bank’s willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy going forward. The anchoring of inflation expectations is a hard-won success that has been achieved over the course of three decades, and this stability cannot be taken for granted. Therefore, the Federal Reserve’s policy actions as well as its communications have been aimed at keeping inflation expectations firmly anchored.

The commenter Marcus Nunes just sent me this quotation from a 11 year old scholarly paper where Bernanke tells the Japanese everything they are doing wrong:

With respect to the issue of inflation targets and BOJ credibility, I do not see how credibility can be harmed by straightforward and honest dialogue of policymakers with the public.  In stating an inflation target of, say, 3-4%, the BOJ would be giving the public information about its objectives, and hence the direction in which it will attempt to move the economy. (And, as I will argue, the Bank does have tools to move the economy.) But if BOJ officials feel that, for technical reasons, when and whether they will attain the announced target is uncertain, they could explain those points to the public as well. Better that the public knows that the BOJ is doing all it can to reflate the economy, and that it understands why the Bank is taking the actions it does. The alternative is that the private sector be left to its doubts about the willingness or competence of the BOJ to help the macroeconomic situation.

Yeah, those sorts of doubts would be a really bad thing.  I thought this one was also kind of amusing:

In thinking about nonstandard open-market operations, it is useful to separate those that have some fiscal component from those that do not. By a fiscal component I mean some implicit subsidy, such as would arise if the BOJ purchased nonperforming bank loans at face value, for example (this is of course equivalent to a fiscal bailout of the banks, financed by the central bank). This sort of money-financed “gift” to the private sector would expand aggregate demand for the same reasons that any money-financed transfer does.

Although such operations are perfectly sensible from the standpoint of economic theory, I doubt very much that we will see anything like this in Japan, if only because it is more straightforward for the Diet to vote subsidies or tax cuts directly. Nonstandard open-market operations with a fiscal component, even if legal, would be correctly viewed as an end run around the authority of the legislature, and so are better left in the realm of theoretical curiosities.

That’s right, stick to monetary policy and leave those bank bailouts to the fiscal authorities.  Of course some of this can be explained by changing circumstances, or crisis conditions.  But not all.  Recall that I  am always harping on the huge rise in the dollar against the euro during the crucial period of July to November 2008.  That was the period when inflation expectations and stock prices crashed.  When a very mild recession turned into the Great Recession.  You have to admit that it is a bit odd to see a currency strongly appreciate against the euro when the country is in the midst of a financial crisis.  Aren’t currencies supposed to collapse in that situation?  What else beside tight money could have caused that perverse dollar appreciation?  In any case, it seems that Bernanke sees things exactly the same way as I do.  Unfortunately, only for Japan:

We saw in Table 2 that the yen has undergone a nominal appreciation since 1991, a strange outcome for a country in deep recession. Even more disturbing is the very strong appreciation that has occurred since 1998Q3, from about 145 yen/dollar in August 1998 to 102 yen/dollar in December 1999, as the Japanese economy has fallen back into recession. Since interest rates on yen assets are very low, this appreciation suggests that speculators are anticipating even greater rates of deflation and yen appreciation in the future.  (emphasis added.)

Yeah, I’d say that was even more disturbing.  And I agree that the strong yen in the face of low interest rates suggested that investors expected more deflation.  But maybe central banks have no control over their currency’s value:

I agree with the recommendations of Meltzer (1999) and McCallum (1999) that the BOJ should attempt to achieve substantial depreciation of the yen, ideally through large open-market sales of yen. Through its effects on import-price inflation (which has been sharply negative in recent years), on the demand for Japanese goods, and on expectations, a significant yen depreciation would go a long way toward jump-starting the reflationary process in Japan.

BOJ stonewalling has been particularly pronounced on this issue, for reasons that are difficult to understand. The BOJ has argued that it does not have the legal authority to set yen policy; that it would be unable to reduce the value of the yen in any case; and that even if it could reduce the value of the yen, political constraints prevent any significant depreciation.

Bernanke quickly dismisses these technical objections and then adds:

The important question, of course, is whether a determined Bank of Japan would be able to depreciate the yen. I am not aware of any previous historical episode, including the periods of very low interest rates of the 1930s, in which a central bank has been unable to devalue its currency. Be that as it may, there are those who claim that the BOJ is impotent to affect the exchange rate, arguing along the following lines: Since (it is claimed) domestic monetary expansion has been made impossible by the liquidity trap, BOJ intervention in foreign exchange markets would amount, for all practical purposes, to a sterilized intervention. Empirical studies have often found that sterilized interventions cannot create sustained appreciations or depreciations. Therefore the BOJ cannot affect the value of the yen, except perhaps modestly and temporarily. 

To rebut this view, one can apply a reductio ad absurdum argument, based on my earlier observation that money issuance must affect prices, else printing money will create infinite purchasing power. Suppose the Bank of Japan prints yen and uses them to acquire foreign assets. If the yen did not depreciate as a result, and if there were no reciprocal demand for Japanese goods or assets (which would drive up domestic prices), what in principle would prevent the BOJ from acquiring infinite quantities of foreign assets, leaving foreigners nothing to hold but idle yen balances? Obviously this will not happen in equilibrium. One reason it will not happen is the principle of portfolio balance: Because yen balances are not perfect substitutes for all other types of real and financial assets, foreigners will not greatly increase their holdings of yen unless the yen depreciates, increasing the expected return on yen assets. It might be objected that the necessary interventions would be large. Although I doubt it, they might be; that is an empirical question. However, the larger the intervention that is required, the greater the associated increase in the BOJ’s foreign reserves, which doesn’t seem such a bad outcome.

In short, there is a strong presumption that vigorous intervention by the BOJ, together with appropriate announcements to influence market expectations, could drive down the value of the yen significantly. Further, there seems little reason not to try this strategy. The “worst” that could happen would be that the BOJ would greatly increase its holdings of reserve assets.

Do you feel you are reading my posts from last spring?  The reductio ad absurdum  arguments.  The observation that the needed increase in the monetary base would be much smaller than most people think (but that’s before they started paying interest on reserves.)  I should just turn my blog over to Bernanke.  He nailed every point.  Except that the Bernanke of 1999 doesn’t seem to exist any longer, except in old photocopies of academic papers that look like they were composed on a typewriter.

[PS.  I am focusing here on late 2008, when the Fed made a huge mistake in allowing the dollar to appreciate strongly while inflation expectations plummeted.  Bernanke is right that this was something a central bank can and should have prevented.  I am not saying the Fed should target the exchange rate today.  As with interest rates, the damage has already been done.  Once we went into a deep recession the dollar fell, just as you would expect.]

How many times have I mentioned the need for the Fed to show the sort of boldness FDR exhibited in 1933.  And how many times did my readers roll their eyes and think “Sumner’s living in the past, those sorts of reckless actions don’t fit into the modern policy-making approach, which is all about Taylor Rules, not dramatically cutting the gold content of the dollar.”  I wonder what Bernanke thinks.  Let’s look at the conclusion of the paper, where authors usually state their most important idea:

Needed: Rooseveltian Resolve

Franklin D. Roosevelt was elected President of the United States in 1932 with the mandate to get the country out of the Depression. In the end, the most effective actions he took were the same that Japan needs to take—-namely, rehabilitation of the banking system and devaluation of the currency to promote monetary easing. But Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and to experiment—-in short, to do whatever was necessary to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done.

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.

Over to you, JimP.

HT:  Obviously a huge thanks to Marcus, this was a soft pitch over the fat part of the plate.


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27 Responses to “Rooseveltian Resolve”

  1. Gravatar of pushmedia1 pushmedia1
    5. January 2010 at 14:00

    Bernanke assumes in the US circa late 2009 expectations are anchored but in Japan circa the late nineties, they weren’t. There’s no contradiction in the first two quotes. The Bernanke of 1999 lives today.

    Of course, you can disagree with Bernanke, but that doesn’t mean he has a split personality.

  2. Gravatar of ssumner ssumner
    5. January 2010 at 15:20

    pushmedia1, Of course there is a contradiction. In one case he says a 3% inflation target is too high. In another very similiar case he says a 3% inflation target should be adopted. Why does he think 3% is too high today?

    Read the entire paper. There is hardly a single sentence that couldn’t have been written by me. In fact, almost every single paragraph contains ideas that have appeared in this blog. (I’m not trying to get credit, BTW, obviously he got there first.) My question is, why did he abandon these ideas?

  3. Gravatar of pushmedia1 pushmedia1
    5. January 2010 at 15:39

    Professor, the first quote is about raising the (implicit) inflation target when expectations are anchored. The second quote is about having a credible (even if implicit) inflation target period.

    There’s no contradiction.

  4. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    5. January 2010 at 16:08

    I’ve seen some pretty ingenious sophistries in my time, pushmedia, but you really take the cake.

  5. Gravatar of pushmedia1 pushmedia1
    5. January 2010 at 16:28

    Patrick, the distinction I’m making goes to the core of modern thinking of monetary policy.

  6. Gravatar of JimP JimP
    5. January 2010 at 16:41

    Yes – why. What is going on. It makes me crazy. It seems so clear. But not DeLong – not Krugman – no-one sees this. Just you and me.

    There is no urgency. 10% unemployment is fine – lets pass an idiotic health care bill and lose the next election. Look what is going on here in Mass. – That 60th vote might be lost. Would there be the remotest chance of that happening if Obama was fighting the deflationist Republicans over jobs? No indeed not. Does the Obama administration care? No indeed not.

    Bernanke can advise the BOJ to increase inflation in Japan because he did not have policy authority in Japan – and all his nice advice did was zero. Japan lusts after deflation. They like it and they are getting it. If they didn’t like it they would not have it. But they don’t know how to fight. They don’t have a political tradition of fighting the deflationists. In theory, we do. Remember the Cross of Gold speech? Where is that now? The current owners of the currency always want deflation. No shock there. But I always thought the Dems represented the people who DON’T own the currency. Clearly that is false.

    Obama does not want to fight anybody about anything. What then is he doing in politics?

    Bernanke KNOWS WHAT HE IS DOING. It is not a lack of theory. He wants what we have. What can we do to be rid of him?

    Obama delegates everything to the experts. The experts have told him this is the best we can do. Remember your story about Roosevelt just telling all the experts to kiss off when he came in? Obama is not capable of that. He lacks Roosevelt’s confidence and life experience. As I said in another post – Roosevelt knew the deflationists personally – because he was raised among them – and he loved to fight them. Obama, and Summers, and Bernanke, were raised as servants, not owners, – and that is how they are acting.

    I have said that it comes down to expectations. Roosevelt expected success and that is what he got. Carter expected failure and that is what he got. Obama expects decline – as does DeLong with his new book and his cynical little jokes. And so does Krugman. And so does Obama. And that is what they are delivering.

    How can we fight this? There must be a way.

  7. Gravatar of JimP JimP
    5. January 2010 at 17:00

    Let me add – I voted for Bush – twice in fact.

    I liked him – I still do in fact – because he was a fighter. There was no quit in him.

    Of course, it does help to know what you are doing. Bush did not. But I always enjoyed watching him get up there and lie his head off. I thought it was fun.

    Obama is just no fun at all.

  8. Gravatar of scott sumner scott sumner
    5. January 2010 at 17:04

    Pushmedia1, In the first quote he says it would be a bad idea to raise inflation expectations up to three percent from there current level of 1% over the next few years and a bit over 2% after that. In the second quote he says the BOJ should raise inflation expectations up to 3%. I have no idea what “anchored” means in this context. Inflation expectations are what they are. They needed to be higher in Japan, and they need to be higher here.

    JimP, I am mystified by all this. Some of what you say is right, but Summers seems like a pretty smart and aggressive guy to me. I think the power of Keynesian thinking is also a factor here. The coupon clippers can’t be that powerful, but they have an ally in old-school Keynesian defeatism about monetary stimulus. Keep up the fight.

  9. Gravatar of pushmedia1 pushmedia1
    5. January 2010 at 17:12

    I take “anchored expectations” to mean Fed policy has an effect on expectations. In Japan that wasn’t (isn’t?) the case. In the US it is. The difference is that American public believes the Fed takes actions to control inflation and the Japanese public believes the BOJ when they say they don’t have control over inflation. In both cases, there’s an expected level of inflation, but the central bank only has a role in setting them in the US.

  10. Gravatar of pushmedia1 pushmedia1
    5. January 2010 at 17:15

    Sometimes I’m dumb and I use “the Fed” to mean central bank. Obviously, the Fed has less a role to play in controlling the value of the Yen than the BOJ. The first line of my previous comment should have read: “I take “anchored expectations” to mean CENTRAL BANK policy has an effect on expectations.

  11. Gravatar of Matthew Yglesias » Bernanke on Japan Matthew Yglesias » Bernanke on Japan
    6. January 2010 at 06:14

    [...] Scott Sumner notes that in the late 1990s Bernanke’s recommendations to the Bank of Japan evince a clear belief that central banks stuck in this kind of situation can, in fact, take action [...]

  12. Gravatar of Philo Philo
    6. January 2010 at 10:54

    Scott asks what “anchored expectations” of inflation or NGDP growth are, and what relevance they have. Perhaps the point is that if expectations were “anchored”–say, at 5% for NGDP growth–then a Fed announcement that it will try to generate 8% NGDP growth *over the next twelve months* would not change expectations *for the long run*. But if expectations were not “anchored,” such an announcement would lead to a long-run expectation of more than 5%–up to as much as 8%.

    Scott’s attitude seems to be that medium-short-term expectations for NGDP are important (12-18 months seems to be the favored time-period, though I have no idea why), while long-run expectations may be ignored. Therefore, “anchoring” or the lack thereof is quite unimportant. If that is correct, I’d appreciate more explanation and defense.

  13. Gravatar of scott sumner scott sumner
    6. January 2010 at 14:13

    pushmedia1, I still think you are thinking about ‘anchors’ in the wrong way. I have more confidence in my 10-year forward forecast for the Japanese CPI than I do for the US CPI. For Japan, I predict 10 years from now the CPI will be about the same as today. For the US, about 20% percent higher, but with more uncertainty. So I think the BOJ has anchored inflation expectations better than the Fed. But perhaps at too low a level, and they’d be better off targeting NGDP.

    Philo, Long run expectations also matter, but becasue we are in a recession the first priority is to get closer to the trend line. Then set the trend line where you want to go, it could be 3% NGDP growth or 5%. The key is level targeting. Expectations are much more likely to become unanchored with growth rate targeting. For instance, I expect at some point we will retun to 2% inflation; but when? That timing uncertainty for a return to 2% inflation creates great price level uncertainty for the future.

  14. Gravatar of Philo Philo
    6. January 2010 at 14:31

    The Fed can target only one thing at a time. If they target expectations of NGDP one year in the future, they can’t target expectations of NGDP ten years in the future. Which should they choose (or should it be a weighted sum of these, or should some other time-period be added to the mix), and *why*?

  15. Gravatar of pushmedia1 pushmedia1
    6. January 2010 at 17:25

    Professor, if you took a look at Yglesias’s post where he comments on this post, do you think the analogy he makes between the BOJ and Bernanke’s Fed makes any sense at all?

    He says “[Bernanke] knows that unemployment is a problem now and he believes that he could fight it, but that fighting it more aggressively would elevate the risk of inflation in the future and he thinks that reducing the possibility of future inflation is more important than reducing the reality of current unemployment. I think that’s nuts. But it’s an attitude the Bank of Japan has consistently maintained since the 1990s.”

    The problem in Japan was that they put too much weight on inflation when trading off between inflation and the output gap? No. The problem was the BOJ didn’t think it had the tools (political or otherwise) to meet an inflation target, so it didn’t even set one or communicate its desire to reach one.

    This is not the problem the Fed has. This whole exercise — Delong’s question and you comparing Japan in 1999 to the Fed today — is leading commentators like Yglesias astray in their criticisms of the Fed.

    Let me put it a different way: We agree that the Fed should adopt an error-correcting policy. If the Fed were to increase the inflation target, would this get us closer to to our preferred policy?

  16. Gravatar of Wonk Room » Some Fed Members Pushing For ‘More Policy Stimulus’ Wonk Room » Some Fed Members Pushing For ‘More Policy Stimulus’
    7. January 2010 at 09:39

    [...] Yglesias, Scott Sumner pointed out that Bernanke used to believe that the central bank can take action to boost growth, and even recommended that Japan take such [...]

  17. Gravatar of ssumner ssumner
    7. January 2010 at 19:19

    Philo, Good question. They can set out a target trajectory from here to infinity. It might be 5% NGDP growth. And then have a consistent policy of targeting that pre-determined trajectory 12 months out. Thus the 12 month goal is a true “target”, the others are “intend to target in the future.” Does that make sense?

    pushmedia1, I think the BOJ had a zero CPI inflation target. They usually either hit it or fell a bit short. But that was the wrong target. If they had targeted stable prices, their price level would be considerably higher right now. So I think the cases are similar. The Fed doesn’t say this, but I think they’d be happy with about 5% NGDP growth over the next two years, whereas I think it should be higher to catch up (part way) for the earlier shortfall.
    So for me the problem is two-fold. Lack of explicit target in the US (Japan I’m not so sure.) And wrong implicit target.

  18. Gravatar of himaginary himaginary
    2. April 2010 at 20:36

    Sorry for commenting to old post, but I wanted to chip in some information about Japan.

    Bernanke’s above paper is translated to Japanese and included in a book published in 2001. So, almost all Japanese macro-economists (and non-economists interested in economics like me :) know about it. Particularly, the reductio ad absurdum argument is kind of famous in Japan, known as “Bernanke’s reductio ad absurdum”. In fact, just a few days ago, some commotion stirred up on net when a professor of economics tried to trash that logic in his blog, and a reflationist politician called him names on twitter.

    BTW, JimP described us as “They don’t have a political tradition of fighting the deflationists”, but that isn’t necessarily true. The following is what I once wrote in Worthwhile Canadian Initiative comment, but I think it’s worth repeating.

    “Before the Great Depression, Japan was already in crisis since 1920, as an aftermath of the bust of boom during WW I. GDP deflator went negative since 1925 (1925-29 average=-2.3%). And foolishly, it returned to international gold standard in Jan 1930 with pre-war parity level. Naturally, deflation aggravated (1930=-10.7%, 1931=-9.8%), and there was a change of government. New government stopped gold standard in Dec 1931, and took a reflationary policy including fiscal stimulus. Then the economy recovered. The minister of finance of the new government, Korekiyo Takahashi, is said to have conducted Keynesian policy before Keynes, and is still revered in Japan.”

    “Let me add a few episodes about Japanese pre-WW II history. It may help to understand current seemingly strange Japanese policy.

    Korekiyo Takahashi’s reflational policy I mentioned in my previous comment caused currency depreciation, too. But it also caused frictions with other countries. Then, those other countries such as US and UK, organized bloc economy and tried to shut out Japanese import. So Japan tried to shape its own bloc, and invaded China and east Asia. You know what happened after that. Maybe the memory of those dark ages, along with images of US labors smashing Japanese goods with hammer in 80′s, is one of the reasons why Japanese policymakers are so reluctant to depreciate its currency.

    And, Takahashi’s reflational policy also included direct BOJ underwriting of government bonds. When Takahashi tried to balance budget and slash military expenditures after economy recovered, he was assassinated by army. Thereafter, BOJ became almost a wallet of army, which prepared the ground for hyperinflation after WW II. Many people say that trauma is the main reason BOJ takes too conservative policy nowadays.”

    Takahashi served the minister of finance several times (He also served prime minister once). At one point, he printed money one side only to supply money as quick as possible, and subdued a financial crisis. He was the politician who fought deflation and deflationists.

  19. Gravatar of scott sumner scott sumner
    3. April 2010 at 05:07

    himaginary, Thanks for that info. Your response does raise one question however. The problem is not just that the Japanese have refrained from depreciating their currency, they have also appreciated it. Why did they let the currency appreciate? (Especially during late 2008)

  20. Gravatar of TheMoneyIllusion » What if Ben Bernanke were in charge? TheMoneyIllusion » What if Ben Bernanke were in charge?
    24. May 2010 at 06:37

    [...] This is a shorted version of a much more complete analysis of Bernanke’s 1999 views here and here.  The differences are startling.  BTW, I hope these posts don’t sound too [...]

  21. Gravatar of TheMoneyIllusion » No we can’t TheMoneyIllusion » No we can’t
    21. July 2010 at 17:56

    [...] to hear what you commenters think.  How about it JimP?  Did Bernanke exhibit the sort of “Rooseveltian Resolve” that (in 1998) he insisted the Japanese needed in order to get out of their Great [...]

  22. Gravatar of No We Can’t No We Can’t
    21. July 2010 at 23:20

    [...] to hear what you commenters think.  How about it JimP?  Did Bernanke exhibit the sort of “Rooseveltian Resolve” that (in 1998) he insisted the Japanese needed in order to get out of their Great Recession?  [...]

  23. Gravatar of TheMoneyIllusion » Gone fishing TheMoneyIllusion » Gone fishing
    6. August 2010 at 12:31

    [...] the Federal government responding?  Ben Bernanke once recommended that the Japanese show ”Rooseveltian resolve.”  Are our leaders in Washington emulating FDR’s first 100 days?  Here is Bloomberg: [...]

  24. Gravatar of TheMoneyIllusion » Strange new respect from Krugman TheMoneyIllusion » Strange new respect from Krugman
    23. August 2010 at 10:16

    [...] half dozen similar posts, going over Bernanke’s writings on Japan with a fine tooth comb.  (Here and here and here, from January 2010, for instance.)   Krugman ends his post with this sarcastic [...]

  25. Gravatar of TheMoneyIllusion » Mr. Bernanke: You are playing Wii, not mini golf TheMoneyIllusion » Mr. Bernanke: You are playing Wii, not mini golf
    27. October 2010 at 05:06

    [...] Bernanke doesn’t choke under the pressure.  I hope he remembers what he told the Japanese a few years back: Needed: Rooseveltian [...]

  26. Gravatar of Needed: Rooseveltian Resolve « The Market Monetarist Needed: Rooseveltian Resolve « The Market Monetarist
    31. October 2011 at 23:20

    [...] As I finnish writing this I realised that Scott Sumner in fact wrote the same story (and I guess Marcus Nunes had alerted him to the Bernanke paper). Share this:TwitterFacebookLike [...]

  27. Gravatar of TheMoneyIllusion » NGDP, NGDP, NGDP . . . TheMoneyIllusion » NGDP, NGDP, NGDP . . .
    2. November 2011 at 04:25

    [...] a mysterious closet market monetarist; see if you can guess who.  BTW, I did some similar posts (here and here) a year ago, based on articles sent to me by Marcus Nunes.  But I had forgotten the heavy [...]

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