“Ironically enough,” Bernanke is sounding increasingly market monetarist
A number of commenters have discussed Bernanke’s speech from nine days ago. There are market monetarist ideas throughout the speech, including:
1. Low long term rates do not reflect easy money.
2. Slower growth in AD could worsen the financial crisis.
3. We should address the risk of financial excess through better regulation, not tighter money.
4. The downward trend in long-term real interest rates reflects sluggish growth, and expectations of slower growth going forward (in developed countries.)
5. Tighter money could (paradoxically) lead to lower long term interest rates.
I certainly don’t believe that these are exclusively market monetarist ideas, but what struck me is how Bernanke seemed to emphasize the very same points that MMs tend to keep harping on.
If you were to boil the whole speech down to a couple paragraphs, I’d say these show what was really on Bernanke’s mind:
One might argue that the right response to these risks is to tighten monetary policy, raising long-term interest rates with the aim of forestalling any undesirable buildup of risk. I hope my discussion this evening has convinced you that, at least in economic circumstances of the sort that prevail today, such an approach could be quite costly and might well be counterproductive from the standpoint of promoting financial stability. Long-term interest rates in the major industrial countries are low for good reason: Inflation is low and stable and, given expectations of weak growth, expected real short rates are low. Premature rate increases would carry a high risk of short-circuiting the recovery, possibly leading–ironically enough–to an even longer period of low long- term rates. Only a strong economy can deliver persistently high real returns to savers and investors, and the economies of the major industrial countries are still in the recovery phase.
. . .
Conclusion
Let me finish with some thoughts on balancing the risks we face in the current challenging economic environment, at a time when our main policy tool, the federal funds rate, is near its effective lower bound. On the one hand, the Fed’s dual mandate has led us to provide strong support for the recovery, both to promote maximum employment and to keep inflation from falling below our price stability objective. One purpose of this support is to prompt a return to the productive risk-taking that is essential to robust growth and to getting the unemployed back to work. On the other hand, we must be mindful of the possibility that sustained periods of low interest rates and highly accommodative policy could lead to excessive risk-taking in some financial markets. The balance here is not an easy one to strike. While the recent crisis is vivid testament to the costs of ill-judged risk-taking, we must also be aware of constraints posed by the present state of the economy. In light of the moderate pace of the recovery and the continued high level of economic slack, dialing back accommodation with the goal of deterring excessive risk-taking in some areas poses its own risks to growth, price stability, and, ultimately, financial stability. Indeed, as I noted, a premature removal of accommodation could, by slowing the economy, perversely serve to extend the period of low long-term rates.
For these reasons, we are responding to financial stability concerns with the multipronged approach I summarized a moment ago, which relies primarily on monitoring, supervision and regulation, and communication. (emphasis added)
Regular readers of my blog know that I focus on counterintuitive ideas. It’s not because I like counterintuitive ideas (although I do), but because in the area of monetary policy I think they are correct. (In many other areas of econ I go with the conventional wisdom.) That’s why I bolded “ironically enough” and “perversely.” It really jumped out at me that Bernanke is becoming surprisingly counterintuitive for a Fed chairman. But then he’s already looking beyond this job to his legacy, and doesn’t want to see all his hard work destroyed by a repeat of the “Folly of 1937.”
Or the eurozone folly of 2011.
PS. David Beckworth, Joe Weisenthal, Ryan Avent, Jim Hamilton, and Marcus Nunes also comment.
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10. March 2013 at 08:20
Maybe it’s because I started learning economics in the heart of this crisis (and through blogs, not my IB econ textbook) but I don’t find much anything ironic about this.
It seems natural to me that interest rates capture both the present macroeconomy, as well as future expectations thereof. The low rates today are, sadly, a reflection of an era of slow growth to come. As I wrote in a recent post commenting on Sachs’ op-ed (http://ashokarao.com/2013/03/10/some-thoughts-on-public-investment),
“If a vedic astrologer told me that rates would be ‘normal’ later this decade (or, as the hawks claim, imminently) I would be thrilled. It means businesses aren’t hoarding cash, private investment is increasing, unemployment is falling and, as automatic stabilizers start slowing, decreasing deficits”
It then doesn’t seem perverse at all that if we tighten money supply, demand for investment will decrease even more, and we’ll have lower rates for even longer.
Not sure, but I think it was you who replied to Cochrane’s comment about paying billions because of higher rates (5%, was it?) noting that this is a sign of a robust economy. Here’s hoping more people buy that.
10. March 2013 at 08:50
Scott
It reminds me of the Johnny Rivers hit from the 60s: “It´s too late to say you´re sorry…”
Bernake´s delay in becoming a Market Monetarist has given rise to all sorts of ‘debates’, like this ‘slap-slap’ between Sachs and Krugman:
http://thefaintofheart.wordpress.com/2013/03/10/economists-clash-the-krugman-sachs-slap-slap/
10. March 2013 at 09:05
“We should address the risk of financial excess through better regulation, not tighter money.”
I don’t think anyone is in any position to claim what does and what does not constitute “financial excess”, apart from what financial activity would transpire in a context of respect for private property rights and concomitant economic freedom.
Financial crises are grounded in problems in the real structure of the economy as they pertain to sovereign consumer preferences. It is a great myth that the hampering of economic signals brought about by non-market money monopolies, which is often the underlying cause of widespread “financial crises”, can be controlled if not eliminated, by “regulation.”
Regulators lack the requisite knowledge to know the “correct” quantity of borrowing and/or equity issuance in industry X, or the “correct” extent that each industry is to expand relative to other industries.
What this MM belief boils down to is this: MMs are not relentlessly calling for an abolition of the government overruling free market activity in money production, and as long as MMs get what they want from the central bank, which is also an overruling of what the market would have generated (for price inflation, NGDP, etc), then any and all financial problems are allegedly curable through “regulation.”
It’s quite interesting, and typical of anti-anarchists, to read fromt small government, free market Chicago types that “regulation” is the answer, including the answer to problems of regulation in the monetary system.
10. March 2013 at 09:05
“The downward trend in long-term real interest rates reflects sluggish growth, and expectations of slower growth going forward (in developed countries.)”
If by “sluggish growth” you mean “sluggish inflation”, then maybe. But if you mean “sluggish real growth”, then absolutely not. Real productivity isn’t a causal component of nominal interest rates. If I predict that in the long run I will sell half the goods at double the prices, rather than double the goods at half the prices, then this isn’t going to alter my demand or supply of loans. The interest rate I will agree to pay when borrowing, and the interest rate I will agree to accept when lending, is going to be a function of my nominal profits, my nominal income, not my real productivity.
So it must be the case that “sluggish growth” really means “sluggish inflation.” So low long term rates signals low long term money growth expectations. But then this would only be true if long term bond market was purely laissez-faire. But it isn’t. Not by a long shot. The Fed is very active in the long term bond market. Hence, there is almost certainly a premium associated long term bond prices that is caused by the Fed being a long term “borrower of last resort.”
If there is any upward pressure on long term bond rates because of the Fed buying long term bonds, then this would be due to bond investors adding a final consumer price inflation premium to bond rates. This upward pressure on rates is not the only pressure on interest rates. There is also the downward pressure associated with “borrower of last resort”, for those particular bond investors who aren’t planning on holding the long term bonds until maturity. In these cases, the upward pressure on bond rates due to final price inflation expectations, is seriously challenged by, if not overwhelmed by, downward pressures from the Fed being in the long term bond market.
It is a mistake to infer from the small uptick in long term bond rates when the Fed engages in long term bond OMOs, that long term bond OMOs only put upward pressure on long term bond rates. The upticks on long term rates would be larger if the Fed instead bought things other than bonds, and the market really believed the Fed would only target NGDP through something other than bond purchases. In this case, then there would only be upward pressure on long term bond rates from the Fed’s activity. The borrower of last resort premium would be absent. The upticks from OMOs would otherwise be larger.
But because the world we’re living in is one where the Fed buys long term bonds, the upward pressure from final goods rice inflation must be matched up with the downward pressure from “borrower of last resort.”
Does anyone in their right mind believe that the long term bond investors expect price inflation to be as low as the long term rates now currently suggest? Which bond market investors are making the prediction that the Fed 20 years from now is going to be inflating only modestly? It’s crazy to infer from long term rates the single metric of long term price inflation expectations. It’s even crazier to infer expected real growth rates from long term bond rates.
10. March 2013 at 09:11
“Regular readers of my blog know that I focus on counterintuitive ideas. It’s not because I like counterintuitive ideas (although I do), but because in the area of monetary policy I think they are correct. (In many other areas of econ I go with the conventional wisdom.)”
Motivations aside, and this is not a slight, but an analysis: The reason why commensense and conventional wisdom and intuitiveness are upside down in “monetary policy” is because it is a property rights violating forced backed monopoly.
The economic logic that we use for computer production, labor, supply and demand, everything “micro”, all assumes a context of a respect for property rights and subjective individual values being free to manifest in prices and other variables. This logic can’t be used to characterize or describe monetary policy, because monetary policy assumes a state monopoly that overrules property rights (The state has to tax in dollars, in order for there to be a demand for dollars).
It’s the same with full fledged economic communism or fascism. There is no semblance of individual subjective preferences manifesting in prices for capital goods, because there is no market for capital goods. Everything is owned by the state. So basic economic logic and intuition cannot characterize or describe these economies. It can certainly be used to critique such societies however.
Back to money, there is no context of private ownership of the means of producing money, in our society. We live in a economically communistic/fascistic monetary system. The state imposes a monopoly.
Contrary to the belief that a rejection of commonsense, economic intuition in the realm of monetary policy somehow reveals a difficult to discern kink or wrinkle in the natural order of things, that only “true” intellectuals can access, like some headshrinker convention, what is actually happening here is a similar thing that happened on the top of the pyramid in that Mel Gibson Apocalypto movie. The witch doctor with the googly eyes uttering nonsensical grunts as he convinces himself, and the leaders around him, that he has some super secret access to the “true” reality, that leads to the “counter-intuitive” result of the leaders believing they are right to be chopping people’s heads off to make it rain.
It’s not that the witch doctor is the primal cause. It’s the brute, naked violence from the warlord chieftain and his goons. The witch doctor is only claiming to be intellectually justifying the brutality via some super secret “counter-intuitive” thinking that requires and is based on a disrespect for property rights. Commonsense rationality cannot even be used to characterize or describe the behavior of the chieftain and his goons. But the witchdoctor is there to give it an aura of intellectual respectability.
It is downright terrifying that counter-intuitiveness, illogic, and upside down intuition are being worn as a badge of honor. Instead, this irrationality that sanctions vicious and destructive behavior of naked violence wielding goons, should be annihilated.
MMs seem to be another generation in a long line of opportunistic witch-doctors. Rather than sanctioning the chopping off of heads, MM sanctions putting people in prison where they will likely be sexually assaulted, for daring to rebel against the monetary monopoly.
10. March 2013 at 09:43
Ashok, Good, but you are three years too late:
http://www.themoneyillusion.com/?p=1402
🙂
Marcus, I’m planning on commenting on that.
10. March 2013 at 09:45
I assume that the mentions of counter-intuitiveness (in both Bernanke’s comments and your post) are to be given a Straussian reading: it is all intuitive once you have the right mental model and it is idiots who insist in accusing the current monetary policy of being “too easy”.
10. March 2013 at 09:58
Thanks for the link, interesting read. Oh, I’m not claiming I’m early to any party. Just that many in this world have yet to join.
10. March 2013 at 12:54
Of course, “better regulation” doesn’t necessarily mean more regulation. Just better. It might even mean none.
Depositors might even have to take responsibility for choosing a safe bank, like they choose a car or what to eat. Some might choose to pay an extra fee for deposit insurance from a private or mutual insurance organisation.
Moral hazard is the key here, and the challenge is to not just outsource it to the state, with all the risks of market failure such abdication brings about.
10. March 2013 at 13:37
James in London,
Good point about regulation. I’m starting to consider what ends up as regulation (or lack thereof), as a potential series of interlocking stories and intentions for what people want to happen in coordinated economic scenarios.
10. March 2013 at 13:49
Hi, professor. I’m an Econ undergrad at GMU. Professors here speak very highly of your blog, and for good reason, since I think I’ve learned more from reading it than I have from many of my textbooks. I do have one question, though. I know that in theory (and in practice at the beginning of the Great Recession) any temporary monetary expansion should have no effect on prices, as people will just hoard the newly created money until it is taken back out of circulation. But I was wondering if this depends on the time frame of “temporary.” If the Fed doubled the monetary base and then made a (somehow) credible promise to remove all of that newly created money in 100 years, I can’t imagine that people would hoard the money for that entire time, especially since the eventual contraction 100 years from now would probably not be as significant in percentage terms as the expansion would be today. And if it’s true that an explicitly temporary monetary expansion has some inflationary effect for a term of 100 years, wouldn’t it also be to a smaller extent true for one of 20 or 30? I’m not advocating this as a policy we should undertake, just asking for the purposes of the thought experiment.
10. March 2013 at 14:32
Luis, ‘Idiots’ is too strong a word.
Ashok, Yes, I was just teasing you. It was a good comment.
James, Yes, no regulation would be much better. So would even more regulation, if the extra regulation banned sub-prime mortgages with taxpayer insured funds.
Jackson, That’s exactly right. For it to have no effect the Fed would have to promise to recall more currency than they issued. Which is obviously possible. But technically you are right.
10. March 2013 at 14:40
“Yes, no regulation would be much better. So would even more regulation, if the extra regulation banned sub-prime mortgages with taxpayer insured funds.”
I don’t get this how that is an example of “more” regulation.
Banning sub-prime mortgages that have taxpayer insured funds, is the same thing as banning taxpayer insured funds, which is the same thing as banning taxpayer paid insurance.
That would be a reduction in regulation, not an increase in regulation, wouldn’t it?
10. March 2013 at 14:50
James London:
“Of course, “better regulation” doesn’t necessarily mean more regulation. Just better. It might even mean none.”
Can you explain how “better regulation” isn’t more regulation, given that an elimination of a regulation would be de-regulation, not better regulation nor more regulation?
“Depositors might even have to take responsibility for choosing a safe bank, like they choose a car or what to eat.”
This would be an example of deregulation, i.e. abolishing FDIC.
“Moral hazard is the key here, and the challenge is to not just outsource it to the state, with all the risks of market failure such abdication brings about.”
There is moral hazard for entire countries, or optimal currency areas, with NGDP targeting. No matter what investments are made in a country, NGDP targeting ensures that maximally diversified portfolios (including the bad investments) will remain profitable, since any losses to some investments would have to be made up for by gains to other investments. If half the country goes broke and stops spending, then either the other half would end up spending whatever the broke half would have spent, or else the government would spend the remainder, since NGDP for the country is being targeted by the CB.
The moral hazard is of course less pronounced here than it is for less than total population “bailouts”, but it’s still positive.
11. March 2013 at 03:25
I don’t know. While the first paragraph you quoted seemed like things MM think, that Conclusion destroyed that (to me). I was literally squirming from frustration when reading things like:
“On the other hand, we must be mindful of the possibility that sustained periods of low interest rates and highly accommodative policy could lead to excessive risk-taking in some financial markets.”
For the love of God, please can you stop talking about low interest rates as “highly accomodative policy” already? Especially when you explicitly said that it may be exactly the opposite a few paragraphs before?
and this: “While the recent crisis is vivid testament to the costs of ill-judged risk-taking”
No, the recent crisis is (mostly)a vivid testament of ill-judged monetary policy. If there is somebody who may make that argument, it may be prime minister of Iceland as financial crisis had real supply-side impact on the economy in terms of unemployed bankers and other experts working for financial sectors. Any other spillovers into the rest of the economy lies solely on the shoulders of central bank.
I don’t know if Bernanke says all these things because he has to or because he thinks he has to or because he thinks that it is actually the truth. And frankly, I don’t care at this point. In the end I consider his presiding over the FED a failure – the one that I hope future economics students will shake their heads in disbelief. I admit, his failure is not in the same league as Trichet-Draghi, but it is still failure nevertheless.
11. March 2013 at 04:00
J.V. Dubois:
“”On the other hand, we must be mindful of the possibility that sustained periods of low interest rates and highly accommodative policy could lead to excessive risk-taking in some financial markets.”
For the love of God, please can you stop talking about low interest rates as “highly accomodative policy” already? Especially when you explicitly said that it may be exactly the opposite a few paragraphs before?”
For the love of God, can you stop making the universal, absolute, never can it ever ever be otherwise claim that it is impossible for interest rates to be low while monetary policy is loose?
Especially when Dr. Sumner has stated that it is possible, and that he doesn’t hold the relationship as absolute as you suggest?
It is not true that loose monetary policy is ONLY associated with higher interest rates.
Never reason from an interest rate (i.e. price) change.
11. March 2013 at 06:14
Geoff, Maybe, it’s a question of semantics.
JV, You need to read between the lines, and figure out where his heart is. Focus on the bolded portions.
11. March 2013 at 06:22
Dr. Sumner:
“Geoff, Maybe, it’s a question of semantics.”
Perhaps, but I think important enough to not say “meh, potato-potahto”.
More regulation is different from deregulation. If people confused this point, then it could mean the difference between more socialism or less socialism in society.
Imagine if everyone blamed deregulation for social problems, when in reality there was more regulation taking place.
Oh wait.
11. March 2013 at 07:20
Scott: I understand what you mean – all I am saying is that why should we care where Bernanke’s heart actually lies if everything he says can be also explained in exactly the opposite of what he is actually saying?
Imagine that Bernanke would say – “The sky is green because gas particles in atmosphere radiate light of the wavelength of 475 nm”.
“You have to read between the lines, says famous physics professor”. The fact that Bernanke mentioned wavelength of 475 nm – which is associated with blue color – clearly shows that he understands that the sky is blue. Fear not people, this guy is on our side in the end.
And WAPO science journalist cries with joy – “Do you see my fellow scientists? Even such a great figure as Mr. Bernanke admitted that the sky is green. You should pay more attention to my pet paper explaining how green sky invalidates most of the mainstream physics that passes as science nowadays.”
In my view things that go through Bernanke’s mind may be interesting for some writer working on Bernanke’s biography or people who study group decisions at top level. Maybe without him USA would now go through the same disaster as Eurozone goes now. But in the end I believe that he will be (rightly) remembered by history as a figure that was responsible for the recession. Maybe minutes will show that he was not his ignorance of the issues at hand, but his inability to stand up to what he thinks that caused it. But it will still be referred as failure.
12. March 2013 at 06:28
JV, I don’t have any problem with that–I was merely trying to show what I think he might believe privately. I found it interesting, that’s all.