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.