Roger Lowenstein has a very revealing portrait of Ben Bernanke in The Atlantic:

But his restrained manner belies a forcefulness and a willingness to take political heat. Early in 2008, the Fed was mulling a small interest-rate cut to ease the escalating mortgage crisis; cutting rates was controversial because hawkish economists, of whom there were many, feared inflation. Bernanke decided to cut rates by three-quarters of a point””a very big move. As he told a colleague, he was going to be pilloried for whatever he did, so there was no sense holding back.

One of my very first blog post discussed that move.  The tone of the entire article suggests that Bernanke is rather dismissive of critics that claim he’s creating an inflationary time bomb (although you have to read between the lines to fully appreciate his attitude.)  Here’s a couple paragraph’s that show he leans in a dovish direction:

I pushed him, in one of our interviews, to elaborate, and he said, “There is a thesis that the only way to restore the economy is by a necessary purging of previous excesses. In disagreeing, I am not saying there are not imbalances that need to be fixed. That said, there is still scope for policy to ameliorate the effects of necessary rebalancing on the public, to help shorten the recession. A massive decline in employment slows the rebalancing and deleveraging processes rather than speeds them; people don’t have the income to pay their debts. So the argument is: where you can, you try to short-circuit the process by urging banks to take losses and modifications, and recapitalize. Obviously, you need to get bank balance sheets healthy, and individual consumers healthy””but subjecting the system to high unemployment and high rates of bankruptcy and foreclosure is a very inefficient way to get there.”

Bernanke is more conservative than his Republican critics imagine, but as he has stated publicly, he finds the prospect of millions remaining unemployed “unacceptable.” He is particularly worried about the many people who have been out of work for more than six months. Like FDR, he is willing to try what works, or what might work, and this puts him at odds with the economic originalists. He sees no evidence of inflation, but he does see economic distress, and so the latter is a greater concern. Though he recognizes the potential for inflation, he told 60 Minutes in December 2010 that he was “100 percent” certain of his ability to control it (a surprising, and troubling, certitude for a normally humble banker). When I brought up the argument that the purchase of mortgage-backed assets””inflationary impact aside””amounts to inappropriate “credit allocation,” Bernanke gave a tired frown, as if the fine points of monetary theory cannot hold water against the concrete fact of unemployment. “I would argue the mortgage-backed securities we purchased probably moved the market closer to an efficient state rather than away from it,” he told me.

When it comes to his critics on the left, his attitude seems quite different.  Here’s Bernanke responding to proposals to raise the inflation target:

Bernanke has given serious thought to the Krugman-Rogoff argument. One obstacle is practical. Fed policy works, in part, by getting the market to do the Fed’s work (if the Fed is buying bonds, traders who want to be on the same side of the markets as the central bank will buy bonds too). But any policy adopted by less than a 7-to-3 majority by the Fed’s Open Market Committee would not be viewed by markets as a credible policy, likely to endure, and Bernanke is not guaranteed to get this margin today. . . .

This might seem to support Krugman’s thesis that Bernanke would like to boost inflation but has chickened out. But after talking with the chairman at length (he was generally not willing to be quoted on this issue), I think that, although Bernanke appreciates the intellectual argument in favor of raising inflation, he finds more compelling reasons for not doing so. . . .

My sense is that Bernanke is too much a sober central banker to want to risk the Fed’s credibility on inflation. His view represents a serious break from many of his fellow academics because, according to the world as left-leaning scholars depict it, raising inflation is the only thing that will work when the economy has hit dead air. Bernanke thinks he has other tools. One, of course, is quantitative easing.

My takeaway from the article is this:

1.  Bernanke is strongly opposed to the idea that money needs to be tighter.

2.  Bernanke is supportive of the notion that the Fed needs to do more, but is uncomfortable with the idea of arbitrarily changing the inflation target, for reason such as credibility.

3.  Bernanke prefers to raise AD using other tools such as QE.

Now let’s contrast that with market monetarism:

1.  MMs strongly oppose to the idea that money needs to be tighter.

2.  MMs are supportive of the notion that the Fed needs to do more, but are uncomfortable with the idea of arbitrarily changing the inflation target, for reason such as credibility.  We prefer a steady 5% NGDP target, level targeting, under any and all conditions.

3.  MMs prefer to raise AD using other tools such as QE and level targeting.  BTW, Bernanke once recommended the BOJ try level targeting.

Bernanke is certainly no market monetarist, but I see quite a few areas where our views overlap.  Go back to that first quotation.  Why did Bernanke insist on a 75 basis point cut in January 2008?  (A cut that occurred during an emergency Fed meeting, which is very unusual.)  After all, just a few weeks earlier the Fed had agonized between a 1/4% and 1/2% cut in the fed funds target, and opted for 1/4%.  What explains the dramatic turnabout?  The answer is that markets crashed minutes after the December 2007 meeting, signaling  the onset of recession.  Bernanke read the various market indicators and by early January realized that the Fed had made a mistake.  So he demanded a 3/4% cut, and about 10 days later another 1/2% cut.  That’s getting ahead of the curve.  That’s market monetarism.  Unfortunately, CPI inflation rose much higher in the first half of 2008 (for reasons unrelated to monetary policy–NGDP growth was slow), and this put the doves on the defensive.  They did not cut rates in the meeting after Lehman went bankrupt in mid-September.  They never recovered that aggressiveness, that ability to get ahead of the curve.  It’s been catch-up ever since.

PS.  Did you cringe like I did when Lowenstein called QE an alternative to creating more inflation?  In fairness, he might have meant an alternative to raising the official inflation target.  BTW, Bernanke arguably did raise the target slightly, from a range of 1.7% to 2.0%, up to simply 2.0%

My research on the Great Depression convinced me that sticky nominal hourly wages and government attempts to prop up wages were both factors that contributed to high unemployment.

Unemployment in Spain has now reached levels comparable to America during the Great Depression; 23% of the workforce is idle, and the rate is heading still higher.  This made me wonder what was wrong with the Spanish labor market.  Why weren’t wages adjusting to restore equilibrium?

Here’s The Economist:

Germany may have pursued wage restraint, but that is no easy route to prosperity. Indeed, dual labour markets are more likely to have the opposite effect. Permanent workers fearlessly seek higher wages, confident that job losses will fall first on temporary workers. Soaring Spanish unemployment has produced little wage moderation. During 2009 the pay of permanent workers rose by 4% in real terms.

And attractive as the German model is now, across decades American jobless rates are tough to match. The Anglo-Saxon preference for little or no employment protection may be the most effective at herding workers from declining industries to growing ones, driving job creation and innovation. Dyspeptic bond markets are now pushing Spain and others towards reforms that make it easier and cheaper to lay off workers again. Not before time.

So what should we blame; the ECB or Spanish labor laws?  The correct answer is both.

PS.  Those interested in European issues should check out a new blog called Bruegel.

This is a follow up to the earlier post on Ezra Klein.  I think one issue that gets lost in the “does fiscal stimulus work” debate is the question of how the answer depends on the type of fiscal stimulus.  It seems to me that the actual Obama fiscal stimulus was based on the Eggertsson/Krugman view that there is a paradox of toil.  That supply-side initiatives to boost employment are self-defeating—they merely drive prices even lower, which negates the impact of lower costs on business.  Hence we ended up cutting payroll taxes for employees.

This model might have been plausible in 2009, but has performed very poorly over the past few years.  Inflation is higher than NK models predict, and doesn’t seem to be falling.  In addition, after dropping the ball in 2009, the Fed seems committed to keeping inflation expectations from falling very far below 2%.

Under that sort of monetary policy the logic behind traditional fiscal stimulus disappears, and the argument for a new kind of fiscal stimulus becomes much stronger.  What type of fiscal stimulus?  Read Christy Romer to find out:

“We need to realize that there is still a lot of devastation out there,” Romer said, calling the 8.9% unemployment rate “an absolute crisis.”

“If I have a complaint about policy these days, it’s that we’re not doing enough,” she said. “That goes all the way up to the Federal Reserve, [which] could be taking more aggressive action. It goes to the Congress and the Administration – there are fiscal policy actions they could be taking.”

“And don’t tell me you can’t [take those actions] because of the deficit because I think there are fiscally responsible ways,” she said.

Romer suggested that extending the payroll tax break to the employer side of the payroll tax could spur the economy;

Ezra Klein argued that Romer was a supporter of fiscal stimulus, and that’s true.  But ask yourself why a Keynesian like Romer would recommend that particular type of fiscal stimulus.  After all, don’t we normally see Keynesians argue that the most effective tax cuts are those that boost spending, which means given money to lower income consumers who have a high propensity to spend?  Why give money to big corporations?  I can’t be certain, but it’s hard to imagine that Romer would have chosen the employer-side approach unless she had been thinking along the same lines as I am.  That the Fed is targeting inflation, and hence will have to boost AD to the right to keep up with any increases in aggregate supply.

Please note that I am not arguing that “Romer agrees with me” in any broader sense than this narrow question.  I don’t doubt that she is considerably more Keynesian than me, and also considerably more pro-fiscal stimulus.  But at a minimum, her comments suggest that we need to carefully consider which types of fiscal stimulus are likely to be most effective in a world where the Fed is holding inflation expectations at 2% or slightly below.  And once you start thinking about the issue that way, it’s not hard to imagine how someone could end up being even more skeptical of conventional fiscal stimulus than Romer ended up being.  In other words, her policy conclusions obviously differ from mine, but her thought process is remarkably similar.

Sloppy use of terminology leads to sloppy analysis.  One of the things that really drives me crazy is when people equate “spending” with consumption.  Why does this matter?  Consider whether you’ve ever heard the something like the following:

“Around the middle of the decade Americans went on an orgy of spending on new homes; it’s time to tighten our belts and cut back on consumption.”

There is an argument for cutting consumption, but it has nothing to do with building too much housing, and it’s probably wrong in any case.

1.  Spending on new homes isn’t consumption, it’s investment.  Period.  End of story.  Some commenters will insist that new homes are not capital goods.  That’s crazy, I live in a 90 year old home.  How many factories last for 90 years?  How many trucks?  How many jetliners?  Homes aren’t just capital goods, they are super capital goods, the most capital-like of all capital goods.  And no, the fact that they are often owner-occupied, and not rented out, makes no difference.  If you insist homes are consumers goods I will regard you as economically illiterate.  You’ve been warned.

2.  Suppose we built way too many houses in an frenzy of irrational exuberance.  What then?  Let’s first consider a closed economy model.  We should increase non-housing production.  We should probably also increase total production, as poorer people generally want to work harder.  But let’s suppose I’m wrong, and use the worst-case scenario for my argument.  No extra work effort.  In that case, if we decide to produce say $400 billion less in housing, we might decide to build another $400 billion in non-housing goods, i.e. consumer and non-housing capital goods (private or government.)  It might be another $250 billion in business capital and another $150 billion in consumer goods.

3.  Thus the optimal response to a spending frenzy on housing isn’t tightening our belts, it’s loosening our belts.  The housing frenzy involved too much investment, and hence too much saving.  Yes, saving really, really does equal investment.  To make up for too much saving, we need to save less and spend more.  We should have had a monetary policy that makes that happen, but of course we didn’t.

4.  I’m sure by now you are screaming at the monitor that I forgot the current account deficit.  That could change things, but I doubt it.  It’s certainly true that if we made two mistakes, a housing orgy and an current account fiasco, then we should fix both problems.  But what makes people think there was any big problem with our current account?  I predict it will go back into large deficit as the economy recovers.  Why shouldn’t it?  As long as the US can run up massive debts, and yet face no net outflow of investment income, I’d expect us to keep doing that.  For my entire life I’ve been told that the day of reckoning is coming for the current account, and it never happens.  I’ll believe it when I see it.

5.  If I’m wrong about the current account, we’ll want to re-allocate that $400 billion to business investment, exports, and consumption, in some combination.  So the net effect on consumption is ambiguous.  But if I’m right that the US current account will continue to be all talk and no action, and that we’ll keep running deficits, then my analysis in parts 1-3 still holds, with the proviso that the excess saving was done by both Americans and Chinese.  But we’ll still want to loosen our belts by saving less.

Why does everyone else get this wrong?  Perhaps it’s nothing more than confusing the terms ‘spending’ with ‘consumption.’  One can spend on either consumer or investment goods.  When you spend on investment goods, it’s called saving.

There should be nothing controversial about this post–it’s all straight out of econ101.  But then we know that our profession likes to abandon textbook economics whenever it conflicts with their prejudices.  So I wouldn’t be surprised to get a bit of push-back in the comment section.

PS.  Krugman’s right that we should not react to the housing bust by spending less.  But this is not because the individual family is unrepresentative of the macroeconomy.  What’s right for the individual is right for the overall economy.

PPS.  I still think we save too little.  But for tax distortion reasons, not because of the housing bubble.

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.