It’s rather disgraceful that one must read the British press to find out about the most important thing going on right now in America. Commenter JimP sent me this story from The Telegraph:
Ben Bernanke needs fresh monetary blitz as US recovery falters
Federal Reserve chairman Ben Bernanke is waging an epochal battle behind the scenes for control of US monetary policy, struggling to overcome resistance from regional Fed hawks for further possible stimulus to prevent a deflationary spiral.
Fed watchers say Mr Bernanke and his close allies at the Board in Washington are worried by signs that the US recovery is running out of steam. The ECRI leading indicator published by the Economic Cycle Research Institute has collapsed to a 45-week low of -5.7 in the most precipitous slide for half a century. Such a reading typically portends contraction within three months or so.
Key members of the five-man Board are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed’s balance sheet from $2.4 trillion (£1.6 trillion) to uncharted levels of $5 trillion. But they are certain to face intense scepticism from regional hardliners. The dispute has echoes of the early 1930s when the Chicago Fed stymied rescue efforts.
“We’re heading towards a double-dip recession,” said Chris Whalen, a former Fed official and now head of Institutional Risk Analystics. “The party is over from fiscal support. These hard-money men are fighting the last war: they don’t recognise that money velocity has slowed and we are going into deflation. The only default option left is to crank up the printing presses again.”
Mr Bernanke is so worried about the chemistry of the Fed’s voting body – the Federal Open Market Committee (FOMC) – that he has persuaded vice-chairman Don Kohn to delay retirement until Janet Yellen has been confirmed by the Senate to take over his post. Mr Kohn has been a key architect of the Fed’s emergency policies. He was due to step down this week after 40 years at the institution, depriving Mr Bernanke of a formidable ally in policy circles.
Wow! If this article is correct the implications are mind-boggling:
1. As I have been speculating, the Fed suffers from the same sort of paralysis as it did in the Great Depression.
2. This answers Tyler Cowen’s query about why the Fed isn’t doing what people like me suggest. Tyler noted that Bernanke is a pretty smart guy. Yes, he’s a much more knowledgeable economist than I am, so it’s good to know he is on my side.
3. Commenter JimP has been hammering Obama on monetary policy almost since the beginning of this blog. I suppose at times people might have thought JimP was a bit of a crackpot. But guess what, Jim gets the last laugh. Perhaps you didn’t notice a very telling fact presented in the article. Look at the phrase “Key members of the five-man Board.” That refers to the Board of Governors. If you remember your money and banking classes you might think “doesn’t the Board have seven members?” Usually it does, and it usually dominates the 12 man FOMC (which includes 5 regional bank presidents.) But two seats were empty when Obama took office. Did Obama rush to fill the seats so that monetary stimulus could provide support for fiscal stimulus? No, he waited for over a year to even nominate anyone to the Board. From this article, I infer that the recent nominees have not yet been confirmed by the Senate. Ironically, the financial regulation bill agreed upon last night is far less important than getting those two nominees on the Board of Governors. The buck stops at the President, but I also assume he has not been getting good advice from advisors like Summers and Romer. Why else would he have waited so long if his economic advisers had been telling him how important it was to fill those seats?
4. I’ve said this before, but I’ll reiterate. Yes, the Greek crisis is the deep cause of the current slowdown (perhaps along with Chinese moves to slow investment.) But the direct effects are tiny compared to the indirect effects. The indirect effect was to increase the demand for dollars, thus putting deflationary pressure on the US. The US could have offset that shock if only Bernanke had supplied more dollars. Now we know why he didn’t.
5. I’ve been very schizophrenic with my blog. Half of the time I’ve blamed Bernanke for seeming to forget what he told the Japanese to do. The other half I’ve speculated that he wants to do more, but he can’t drag the neanderthals on the FOMC along with him. This article has the ring of truth (although I don’t doubt the info was fed to the Telegraph by doves wanting to look good.) Unless someone can convincing refute this story, I’m going to assume it’s accurate and I will stop bashing Bernanke. I’ll go back to my earlier position, expressed in posts such as “Let Bernanke be Bernanke.” However, even if the article is correct, he is not entirely blameless in this crisis:
Mr Bernanke has fought off calls from FOMC hawks for moves to drain stimulus by selling some of the Fed’s $1.75 trillion of Treasuries, mortgage securities and agency bonds bought during the crisis. But there is little chance that he can secure their backing for further purchases at this point. “He just has to wait until everybody can see the economy is nearing the abyss,” said one Fed watcher.
Gabriel Stein, from Lombard Street Research, said the US is still stuck in a quagmire because Mr Bernanke has mismanaged the quantitative easing policy, purchasing the bonds from banks rather than from the non-bank private sector.
“This does nothing to expand the broad money supply. The trouble is that the Fed does not understand broad money and ascribes no importance to it,” he said. The result is a collapse of M3, which has contracted at an annual rate of 7.6pc over the last three months.
Mr Bernanke focuses instead on loan growth but this has failed to gain full traction in a cultural climate of debt repayment. The Fed is pushing on the proverbial string. The jury is out on whether or not his untested doctrine of “creditism” will work.
“We are now walking on deflationary quicksand,” said Albert Edwards from Societe Generale.
The article also tells us who the villains are:
Kansas Fed chief Thomas Hoenig dissented from Fed calls for ultra-low rates to stay for an “extended period”, arguing that loose money risks asset bubbles and fresh imbalances. He recently called for interest rates to be raised to 1pc by the autumn.
While he has been the loudest critic, he is not alone. Philadelphia chief Charles Plosser says the Fed has blurred the lines of monetary and fiscal policy by purchasing bonds, acting as a Treasury without a legal mandate. Together with Richmond chief Jeffrey Lacker they represent a powerful block of opinion in the media and Congress.
Just like in the Great Depression, the regional bank presidents are the biggest problem. And just like in the Great Depression, the British press had a better understanding of the deflationary impact of US monetary policy than did the American press. Funny how things never seem to change.
Read the entire article.
Part 2: The Finreg bill
And speaking about how nothing ever seems to change, has there ever been a major crisis that led Congress to enact regulation that actually addressed the root problems that caused the crisis? Obviously I haven’t read the bill, but the press summaries are certainly not promising. There was no mention of outlawing low down-payment mortgages made with federally-insured deposits, nor an mention of abolishing Fannie and Freddie. Is there something in the bill that addresses these problems?
Part 3: Fiscal policy in the Depression
A few commenters asked me about a recent paper, which claimed fiscal policy actually was effective during the 1930s, but wasn’t applied in anywhere near the needed amounts. This is from a Brad DeLong post, which quotes from the paper:
http://www.nber.org/papers/w15524.pd: [F]iscal policy made little difference during the 1930s because it was not deployed on the requisite scale, not because it was ineffective…. [T]he first set of VAR exercises suggested that [multipliers] were 2.5 on impact and 1.2 after one year. Where significant fiscal stimulus was provided, output and employment responded accordingly.
Individual country experience with large fiscal stimulus was rare in this period, but where it occurred the evidence points in the same direction. One of the biggest fiscal stimuli in this sample occurred in Mussolini’s Italy during 1936-7, as a result of the war in Ethiopia. Italy ran a deficit in excess of 10 per cent of GDP in 1936 and 1937. Italian GDP grew by 6.8 per cent in 1937, by a marginal amount in 1938, and by 7.3% in 1939. According to Toniolo (1976), the Italian economy moved to full employment during this period. In France, the budget deficit increased substantially beginning in 1935, and GDP grew by 5.8 per cent in 1936. The deficit exploded in 1939, during which year the economy grew by no less than 7.2 per cent.
My views on fiscal policy are complicated. First, I think it is less powerful than monetary policy. Second, I think it is wasteful, as it incurs future tax obligations that hurt the supply-side of the economy. But most importantly, I think the effect cannot be quantified because it depends on whether the central bank tries to accommodate or sterilize the fiscal stimulus.
In the two examples cited in DeLong post, France and Italy, monetary policy was extremely accommodative. Both countries were on the gold standard until 1936, when they sharply devalued their currencies. That’s not to say that fiscal policy has no effect, it might have forced the central banks to devalue. My point is that fiscal stimulus must always be examined in the context of monetary policy. If you have conservative central banks that are rigidly targeting the price level, then fiscal stimulus may be ineffective. But in fairness to the other side, I’m sure you could build a plausible argument that under the sort of dysfunctional Fed described above, it might have a stimulative effect. Perhaps Bernanke is not strong enough to take any unconventional policy initiatives, but is strong enough to prevent the conservatives from inhibiting fiscal stimulus through a premature exit strategy. But as I said, I don’t think fiscal policy is very powerful even if there is no push-back from the Fed.
The more important point is that if Obama and the Congressional Democrats knew all this, there would have been a much greater sense of urgency about monetary policy, and especially the need to fill those seats. They might also pressure the Fed (in Congressional hearings) to actually fulfill their dual mandate.
BTW, I don’t like dual mandates; I prefer NGDP targeting. But right now a dual mandate approach (inflation and unemployment targets) would be better than the status quo.