Do Reinhart and Bernanke owe the Japanese an apology?

Here’s Vincent Reinhart testifying at the FOMC in June 2003:

An alternative would be to make a promise linked not to the calendar but to some economic event. Under a conditional commitment, the Committee could pledge to hold short rates at a low level until some event y happens. Possible triggering events would include posting sustained economic growth, making progress in trimming economic slack, and recording inflation above a specified floor. The yellow warning sign along the road to a commitment strategy is that words ultimately have to be matched by deeds for the public to believe the Committee””that is, shaping expectations does not introduce another policy instrument in the long run. Moreover, the Committee might be concerned about its credibility in delivering on its promise. As one example, you might be concerned about establishing a target range above the current rate of inflation if you thought there was a reasonable risk that the actual outcomes for inflation will move lower for the next few years. As another example, the Committee might be worried about its credibility in the other direction if a focus on a backward-looking indicator of economic progress induced overshooting.

And here’s a response by Ben Bernanke (p. 45) at the same meeting:

What I think has been missing from the discussion we have had here today so far is that working on expectations of future short-term interest rates can be done through a comprehensive package. There are many different ways to approach expectations management. One is communications of the type we’ve been doing through our statements. There are various targeting procedures for inflation or price level targeting. Eggertson and Woodford talk about some reasons for price level targeting, which is their favorite approach. There is also signaling through various kinds of market interventions of the kind Dino has talked about””options, purchases of bonds, discount window lending, and so on. In particular, to those of you who have argued against trying to “target” long-term interest rates””if by that you mean that we specify a target for the five-year bond and then try to enforce it by buying five-year bonds””I must say that I agree with you 100 percent that that’s not going to work. But if the policy is one in which we essentially try to lower the whole path of long-term interest rates and we enforce that with a package of complementary actions that includes trying to manage expectations along the term structure and taking a series of other actions such as purchasing long-term bonds and other kinds of instruments, I think that’s one of the first things we ought to be doing. I believe that would actually work and would in fact be a good approach.

So my answers to Vince’s four questions are, in short, that I agree with Bill Poole and Don Kohn that short-term nominal interest rates should be brought down quite low. I don’t have much sympathy or forbearance necessarily for protecting small segments of the financial markets. I believe our first approach should be the continuation of our current policy of working on the management of expectations. And then I think we should consider packages of policies that support each other to try to manage expectations in the market and thereby affect longer-term interest rates.

Maybe I’m reading too much into this exchange, but here’s my takeaway:

1.  In 2003, when Bernanke’s not in the public spotlight, he shows real enthusiasm for a Woodfordian approach.  And I’d add that the Fed seems to be currently taking baby steps in that direction.  Not level targeting, but at least moving toward tying interest rate projections to economic outcomes.

2.  I read Reinhart as being somewhat less enthusiastic about that approach.

I’m not certain about either assertion, so feel free to correct me if I’m wrong.  Now here’s Reinhart in March 2011, all but apologizing to the head of the Bank of Japan:

In 2002, Ben Bernanke, then a member of the Federal Reserve’s Board of Governors, spoke at a conference honoring Milton Friedman. Gov. Bernanke offered a public apology for the Fed’s role in the Great Depression. Judging from the lengthy interview of the head of the Bank of Japan published in the Wall Street Journal on March 1, Gov. Masaaki Shirakawa is probably also expecting an apology from his Fed counterpart for second-guessing the BOJ’s conduct of policy.

I was one of Bernanke’s co-authors for an academic paper published in 2004 that did some of that criticizing. After seeing how other major central banks, including the Fed, handled similarly trying circumstances, I admit that Gov. Shirakawa has reason to feel aggrieved. In particular, the main point of contention, quantitative easing, is a policy that looks good on paper but has a flaw when implemented by a democratic central bank.

.   .   .

Second is the problem. Market participants have to be convinced that the central bank is committed to the policy for quantitative easing to be effective. If investors think the authorities will stop or reverse soon, then long-term yields will not move much nor will the extra reserves be used. Underappreciated in the theory (and the criticism) is that the monetary policies of major central banks, such as the BOJ, are decided by committees. Individual members do not usually see the world exactly in the same way. Because the balance of judgments may change over time, a decision at one meeting cannot presume the outcome of the democratic process at future committee meetings. As a consequence, policy statements tend to be hedged to foster compromise, making them tentative and undercutting the effectiveness of policies relying on a credible long-term commitment.

Ill effects of this drawback of democracy can be tempered if the central bank follows a policy rule. The BOJ ultimately did so, with the promise made in 2001 to keep the policy rate at zero as long as the price level was declining. The Fed has not yet seen fit to do so.

Evidently, getting from paper to practice is harder than it looks.

That’s quite an eye-opener.  It could be viewed as Reinhart criticizing the Fed (and by implication Bernanke?) for not being sufficiently Bernankian.  He’s hinting that they should consider adopting the policy Bernanke discussed at the 2003 meeting.

[BTW, I see no reason why Reinhart should apologize to the BOJ.  He’s right that these policies only work if the public doesn’t think the BOJ will reverse course before achieving its objective.  If you view “inflation” as the objective, then the BOJ did reverse course too soon; not once, but twice.  The Japanese people didn’t trust the BOJ to inflate, and they were right not to trust them.  On the other hand you could argue that deflation was the objective.  After all, Reinhart points out that the BOJ suggested they’d tighten monetary policy when deflation ended.  What other goal could there be for doing that other than pushing Japan right back into deflation?  I’m not sure if that was their goal, but they acted like it was, and it “worked.”  After each tightening, Japan would slip back into deflation.]

Eight days later he seemed to criticize the Fed as being too expansionary:

This basic lesson of history from the North Atlantic is going unheeded by Federal Reserve Chairman Ben Bernanke and his colleagues on the Federal Open Market Committee (FOMC). On March 15, they issued a statement that their ongoing second experiment with quantitative easing, the expansion of the central bank’s balance sheet known as QE2, would continue full-speed ahead. A prudent course would have been to slow, but not stop, QE2.

But the criticism seems to be more about procedure than policy stance, as six days after this statement he switched to a clearly dovish position:

Thus, Fed officials have reason to seek to make monetary policy more accommodative. With its nominal policy rate already at zero, expanding the balance sheet by purchasing assets with newly created reserves, quantitative easing (QE), is the obvious tool. The Fed’s asset of choice is Treasury securities, the safest of them all.

.   .   .

QE has risks. On one side, the Fed’s competence might be called into question should there be no apparent benefit from the latest round. On the other, QE might work too well in restarting inflation if the Fed is slow to remove its accommodation when resource slack dissipates. These risks could be mitigated if the Fed were rule-like in applying QE. If the change in its Treasury holdings were linked to its outlook, the public could understand that asset purchases would last only as long as necessary.

For now, the Fed seems dead-set on retaining discretion by relating that its asset purchases will be routinely reviewed rather than relying on a rule. This clouds its commitment, undercutting effectiveness.

Now Reinhart is clearly echoing Bernanke’s arguments from the 2003 meeting.  Maybe he was there all along (and playing the devil’s advocate), but I read his 2003 testimony as being a bit skeptical of this policy.  In any case, the recent moves by the Fed probably reflect Bernanke’s frustration with the pace of recovery, and a renewed determination to implement the ideas he discussed in 2003.  And Reinhart is standing on the sidelines giving him encouragement.

I doubt Bernanke will be able to implement a full-fledged Woodfordian policy.  But if the Karl Smith/Matt Yglesias hypothesis is correct (about the recovery gradually picking up momentum), then it’s possible he’ll be able to do enough to get a robust recovery by 2013.

I wish we had an NGDP futures market, so we knew who was right.



18 Responses to “Do Reinhart and Bernanke owe the Japanese an apology?”

  1. Gravatar of JimP JimP
    14. February 2012 at 16:34

    Scott debated Cochrane.I guess he didn’t convince him.

  2. Gravatar of Benjamin Cole Benjamin Cole
    14. February 2012 at 16:37

    Amazing blog about a fascinating topic.

    Right now, there is no one playing at Sumner’s level. He is the Best Economist.

    The other economists are slogging along with muddled thinking about fiscal policy, or developing scare-mongering vignettes about inflation.

    I must be missing a lot when I so simply state this situation–but what? You have the Krugmans calling for fiscal policy, and the monetarists calling for tight money.

    And both camps seem obviously wrong.

    Bernanke knows both camps are wrong, and so does the newly prominent Reinhart.

  3. Gravatar of Morgan Warstler Morgan Warstler
    14. February 2012 at 17:21

    This reminds me of a question I have for the gang:

    Hypothesis: You are Ben and WANT to see the economy turned around and head the right way by Nov 2012.

    Rule: you are the conflicted Ben described above, meaning you’d like to make it happen, but you won’t go pulling Sumner’s level targeted NGDP.

    Game PLAY: You are going to take one serious bite at the QE apple sometime before Nov 2012 to try and keep Obama in office.

    1. What does Ben do under the constraints of Real Ben?
    2. When exactly do you announce it?

    My thinking is this is an interesting contrapositive approach to my position that everything changes in the Fed’s mind when Obama is out of office.

  4. Gravatar of StatsGuy StatsGuy
    14. February 2012 at 17:54

    Years ago I said – and still agree – you have to mean it, and sometimes you have to prove you mean it. Reinhart’s critique was correct in this regards:

    Even if you do mean it _now_, if market participants doubt your ability to commit to the future, then a mere promise might not be sufficient. Only action suffices.

    Let’s get our heads out of monetary policy – consider this from a fiscal perspective. Many have said that what we need is short term fiscal stimulus and a long term plan to contract. On paper, yes. Unfortunately, the people in charge won’t be in charge in 20 years – and if they were they might change their mind. The entire repeated game back-solved equilibrium falls apart when there’s doubt. That means the “costless” approach fails, and CBs will be from time to time called out and compelled to rely on brute force.

    The risk is they hesitate, hoping that markets believe them and they won’t be forced to act. If they hesitate, showing how much they are terrified of being forced to take visible action, those who bet on the CB in the markets will lose their shirts, and those who bet against CBs will gain resources (as well as political clout and power) and will be emboldened. This will make the CB’s job that much harder in the next round, and that’s where we are today.

  5. Gravatar of StatsGuy StatsGuy
    14. February 2012 at 17:57


    “Hypothesis: You are Ben and WANT to see the economy turned around and head the right way by Nov 2012.”

    You are missing a key element – you only want Obama to win if the alternative is not Romney. If Romney is the challenger, you want Romney to win. Since Romney is tripping over himself… severely… he may lose, particularly if Gingrich backers defect to Santorum (wither went our texan with the great hair?).

    So Ben’s REAL goal is to keep his options open until he finds out who’s going to take the nomination. If Santorum is it, he will QE, but if Romney, he’ll under-deliver. Until we have clarity, Bernanke is likely to do everything he can to keep a perfect balance so he has the option to tilt it either way when more information comes along.

  6. Gravatar of Bonnie Bonnie
    14. February 2012 at 19:00

    No, they owe America an apology, and much more to make up for the destruction their incompetence has wrought. There is always plenty of room for debate, but when it comes right down to matters of policy, these guys are supposed to know the difference between theorycraft and practicality as a professional and ethical matter. They don’t, therefore we have lots of collateral damage right here. Forget Japan, let them manage their own affairs, while we go find real professionals who can take the log out of our own eye.

  7. Gravatar of Tommy Dorsett Tommy Dorsett
    14. February 2012 at 19:41

    Scott – I can’t post the chart here, but I think the Fed’s three year rate pledge (while conditional and somewhat clumsy) is having a Woodfoordian effect nonetheless. One test of this is to see the astonishing de-linking of the Citigroup Economic Surprise Index from long Treasury yields. Economic surprises and long rates moved together until this summer, and now have decoupled. In Woodfordian terms, the Fed has lowered expected future short rates and thus long rates. In Summarian terms, the Fed has boosted the gap between expected future NGDP and the interest rate structure. We may also be seeing the early signs of a positive feedback loop whereby a pickup in economic momentum exerts upward pressure on the the Wicksellian natural rate relative to the expected future policy rate.

  8. Gravatar of Benjamin Cole Benjamin Cole
    14. February 2012 at 20:10

    Tommy Dorsett–

    From your lips to G-d’s ears.

  9. Gravatar of Morgan Warstler Morgan Warstler
    14. February 2012 at 21:44

    Stats I agree completely.

    But I’m trying to imagine the action and timing if and only if, you are timid Ben AND you have already decided today you want Obama.

    Other assumptions yield different strategies, I wanted to start with this one.

  10. Gravatar of Max Max
    14. February 2012 at 22:30

    “those who bet on the CB in the markets will lose their shirts, and those who bet against CBs will gain resources (as well as political clout and power) and will be emboldened.”

    Q: How do you bet against a CB trying to inflate?

    A: By buying long term government bonds.

    Q: What asset does the CB purchase to demonstrate its commitment to inflation?

    A: Doh!

  11. Gravatar of StatsGuy StatsGuy
    15. February 2012 at 08:23

    “How do you bet against a CB trying to inflate?”

    By simultaneously shorting leveraged stocks/high yield debt and buying the commodity carry trade (to cause real inflation), which decreases real growth and thus forces the CB to either

    A) Accept significant input-cost-driven inflation (sending commodities up)

    B) Tighten to stop inflation to hold down commodity prices, but killing equities even harder

    The proper CB response is to hold to the level NGDP target – eventually (3+ years) higher input prices will drive substitution away from those inputs and additional investment in input production (more mines coming online) creating a commodity glut in key commodities (e.g. copper, oil) and drive down input prices, allowing equities to gain and investment to restart.

    If the CB blinks, however, ouch…

  12. Gravatar of StatsGuy StatsGuy
    15. February 2012 at 08:37

    @ Morgan – to answer your initial question, I think Ben teases. And teases. And teases until people think he isn’t going to do something. Then does something. Given the time profile for QE2 as a pattern for QE3, he needs an excuse – but oil price is not cooperating (Iran, natch). Also, we have the ECB with the massive liquidity injections (@3% rate) which is more or less free money to buy up depressed euro debt – but the ECB doesn’t want to absorb the risk and keeps insisting privates own all the greek losses. But no one wants the solvency risk, and since the CB won’t take it, the risk of solvency increases because the nominal gdp target comes in low.

    I think Ben will “communicate” a lot about their intention to provide a fall back if things get worse, but won’t actually do anything until the evidence is solid that things are getting worse, or until august (jackson hole) if things are starting to look bad for Obama and Santorum has the nomination.

  13. Gravatar of D.Gibson D.Gibson
    15. February 2012 at 09:27


    While we cannot predict who will be in Congress 20 years from now, we can predict what kind of people will be. The same as now. Defer all pain. Demagouge. Cronyism….


    I like the idea of the Bernanke-dilemma question. If 100% FOMC expects 2% GDP growth, and 50% of FOMC wants 2% inflation, and 50% of FOMC wants 0% inflation, what should BB say? (Are words Bernanke’s only unilateral action?)

  14. Gravatar of Steve Steve
    15. February 2012 at 11:11

    Completely off-topic, but reporter Rick Santelli on CNBC just said Richard Fisher is the only central banker he agrees with. That’s the crux of the problem: the everyman view of monetary policy is also the wrong view, but it keeps dragging us back into the mud.

  15. Gravatar of TheMoneyIllusion » Where Bullard is right and where he is wrong TheMoneyIllusion » Where Bullard is right and where he is wrong
    15. February 2012 at 11:29

    […] soon as FDR adopted a (Woodfordian) price level target, the economy turned around on a dime.  Even Vincent Reinhart, the guy who (according to Lawrence Ball) turned Bernanke from a bold advocate of monetary stimulus […]

  16. Gravatar of MW MW
    15. February 2012 at 11:42


    Can you post links to your other posts on Japan? I’m interested in your hypothesis that the BoJ is actually targeting 0% inflation.


  17. Gravatar of ssumner ssumner
    16. February 2012 at 06:49

    JimP, It’s not easy to convince Cochrane.

    Thanks Ben.

    Morgan, It looks like Obama will be in office until 2017.

    Statsguy, I’ve never been convinced the “time-inconsistency problem” is a big deal. I don’t sense the Fed wants to do more. Recent articles suggest that the jobs number in January has caused them to turn against QE3. They seem satisfied. (At least some of them.)

    Bonnie, Good point.

    Tommy, You make a strong argument, and I’m not willing to rule it out, but then why are long term rates so low? Perhaps the answer lies in my argument in earlier posts that we are in a new era of permanently lower long term rates. In that case we really, really need an NGDP futures market.

    Steve, Yup. The people who are the mostly clueless about monetary policy are the people who use their common sense.

    MW, Unfortunately I’m not organized. I have 1000s of pages of posts and have trouble finding them. I plan to get organized this summer.

    The short answer is that The BOJ acts like they have a 0% target. They raise interest rates whenever inflation rises to 0%. (2000 and 2006) That keeps inflation out of the positive range. They recently boosted their inflation target to 1%; there is a NYT article from a few days ago discussing the change. I’ll do a post soon.

  18. Gravatar of ssumner ssumner
    16. February 2012 at 06:51

    MW, Check this one out:

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