The two Ben Bernankes

I have so many long rambling posts on Ben Bernanke that I thought I should summarize my thoughts in a shorter post, for those of you with better things to do than reading my seemingly endless essays.  This was my summer grant application:

In 1999 Bernanke wrote a paper discussing Japan’s lost decade.  His description of this period sounds very much like the current situation in the US: 

  1.  Output far below potential
  2.  Inflation below the target rate
  3. A banking crisis 

Bernanke argued that this represented a failure of monetary policy.  He suggested that the central bank had both the ability and responsibility to keep aggregate demand increasing at a satisfactory rate.  At one point he recommended that Japan aim for 3% to 4% inflation as a way to catch up to the previous shortfall in AD. In another paper he recommended price level targeting, which would also call for a catch up period if prices or nominal spending fell below target. 

Bernanke cited numerous indicators of inadequate AD: 

  1. A strong yen
  2. Persistently falling land prices
  3. A very weak stock market 

He ridiculed the idea that low interest rates in Japan were a sign that monetary policy was expansionary.  Nominal interest rates have been shown to be a poor indicator of the stance of monetary policy, and he suggested that even real interest rates could be unreliable.  He emphasized that the Bank of Japan made a huge mistake in allowing the yen to appreciate strongly as the economy was turning sharply lower in late 1998 and early 1999.  He argued that the BOJ should stick to the traditional tools of monetary policy, and leave bailouts to the fiscal authorities.  He suggested that monetary policy should be forward-looking, not just reacting to past changes in inflation. 

Bernanke also argued that many of the structural problems in banking and real estate were actually a symptom of tight money and falling AD, not a cause.  He was dismissive of the argument that monetary policy could do no more once nominal rates hit zero, arguing that all sorts of other options were available: 

  1. Currency depreciation
  2. Quantitative easing
  3. Price level targeting 

One of the great mysteries of this economic crisis is what happened to the Ben Bernanke of 1999.  On virtually every point mentioned above, Bernanke has done a 180 degree turn.  Oddly, almost no one in the press or the economic profession seems to have noticed this.  In this crisis Bernanke treated the banking crisis as a cause of the problem, not a symptom of falling AD.  He allowed the dollar to soar in value against the euro in the midst of the economic meltdown between July and November 2008.   He let real interest rates on 5 year Treasury bonds rise from 0.5% to 4.2% between July and November 2008.   And yet he argued that monetary policy was expansionary.  He did undertake some quantitative easing, but then sterilized it with a policy of paying interest on excess reserves.  The Fed even admitted that the purpose of the interest payments was to prevent the QE from having any stimulative effect.  When asked why he didn’t favor setting a 3% inflation target to boost AD, he acknowledged that this policy would in fact boost AD, but worried that inflation expectations could become unanchored.  He stubbornly refused to engage in price level targeting.  He focused on the banking problems rather than the sharp fall in nominal spending.  He refused to push for a “catch-up” in AD, even when demand had fallen far below target, instead adopting the sort of “memory-less” policy that he had criticized the Japanese for adopting.  He said monetary policy needed help from fiscal policy; a view that only makes sense if monetary policy had become ineffective due to a liquidity trap.  He implemented a backward-looking monetary policy, which reacted to past levels of inflation, not sharply falling forecasts of future inflation. 

So there are two great mysteries to be investigated.  Why did Bernanke’s views seem to change so dramatically?  And, given the importance of this issue, why did almost no one seem to notice?

Part 2.  The financial press and the crisis

In the newest “Big Think” interviews I asked an editor at the Financial Times why the press seemed to ignore many of these issues:

Question: When the crisis hit, monetary policy did not adopt many of the unconventional techniques recommended for deflation such as price level targeting in the U.S., or currency depreciation in Japan.  Was the financial press aware of these options? (Scott Sumner, The Money Illusion)

Chrystia Freeland: I would disagree with part of Scott’s premise, which is, implicit in the question is the notion that we are in a period of deflation, and also implicit in the question is that a lot of the unconventional tools of monetary policy weren’t used.  I do think, actually, a lot of unconventional tools of monetary policy were used.  And one of the most creative players in the crisis turns out to have been Ben Bernanke with Mervin King not too far behind.  So, we did have and continue to have all sorts of unconventional forms of liquidity being injected into the markets by the world central bankers. 

Once they hit that zero rate where they couldn’t use interest rates to gen up the economy, we have seen them using many, many unconventional tools to try to pump more money into the economy.  So actually, I do think we have seen all sorts of unconventional monetary policy responses.  And I do also think, and certainly journalists at the Financial Times are very well aware of the two economic arms that government has, monetary policy and fiscal policy.  And I think we’ve written with real sophistication about the monetary debate and then also about the fiscal debate. 

So actually I think both.  That we’ve had more creative policies than Scott would imply in his question.  But also that at the moments of decision I think that we were quite thoughtful and explicit in talking about what those options were. 

I find her answer demoralizing on several levels.  Yes, we are not currently in deflation, but we did experience some deflation.  And my question clearly referred to that period.  Second, she seems to imply that the Fed had a policy of injecting money to prevent deflation, sometimes referred to as “quantitative easing.”  But even the Fed denies this.  When the injections took place in late 2008 the Fed started paying interest on reserves to prevent these injections from depressing interest rates.  In terms of “Fed speak,” saying you are trying to prevent any decline in interest rates as money is injected, is exactly the same as saying you are trying to prevent the injections from boosting AD.  And yet almost no one in the press seemed to pay any attention, or even understand what was going on.  In fact, Bernanke’s policies are very similar to those of the BOJ.  In the end I think the slightly higher inflation target may save us from the extended liquidity trap experienced by the Japanese, but that is the only silver lining that I can see.

I think I have been focusing on Bernanke too much.  It is very possible that the hawks on the FOMC are the biggest problem.  After all, Bernanke is just one vote, and he doesn’t have a particularly intimidating personality.  Please send me any dirt, I mean any information, on the hawks on the FOMC (now or in 2008.)  Someone needs to shine a light on their views and votes.  I don’t care if it hurts the University of Chicago’s reputation.

Part Three.  Expert opinion

Since I am discussing the latest “Big Think” interviews, how about this Q&A?

Question: How bad would someone’s understanding of the economy have to be before you decided the person was no longer a good source for assessments on the economy and financial markets? (Dean Baker, Beat the Press)

 Andrew Ross Sorkin:  That’s a terrific question, because unfortunately, in the world of sort of Wall Street prognosticators, they only happen to be right once or twice.  So right now Nouriel Roubini, for example, who called the crisis, seems to be the guy that you’d want to hear from.  

I agree that Nouriel Roubini is someone that you would want to talk to if you were doing a study of what caused the crisis.  He deserves great acclaim for seeing not just the bubble (lots of people saw that) but the entire picture of how the bubble could damage the banking system.  I happen to think, however, that even the best predictions involve a bit of luck.  As you know I have argued that the forecasting reputation of people like Buffett and Keynes is somewhat overblown, although they were both clearly very bright and impressive individuals.

One reason Roubini did better than others is that he was so relentlessly bearish.  He did accurately see the weakness in the financial system during 2007 and the first half of 2008.  And his predictions continued to come true in the second half of 2008 and early 2009.  But I think the latter success was partly luck.  It wasn’t caused by the severity of the sub-prime crisis, but rather by bad monetary policy.

Eventually even the best prognosticators will eventually run out of luck.  I recall reading some Roubini predictions from the spring of 2009.  I don’t recall the exact wording, but he was very skeptical of the stock market rally.  I am so happy I ignored his advice.  My 401k is up 80% since March.  In nine months I have made as much money (in unrealized cap gains) as I did in my first 15 years of teaching.  If I had taken his advice I would now have a horrible pit in my stomach.  (I am not saying he advised selling, I just mean if I had sold on the basis of his bearish views.)

For the most part markets are efficient.  Paying attention to those with successful track records of prediction is about as useful as paying attention to the predictions of those who won at roulette.  But sometimes markets are not perfectly efficient.  Sometimes a bright individual will spot something the market missed.  Nouriel Roubini is one such individual, and therefore any study of the sub-prime fiasco would do well to consult his expertise.  But markets are so efficient that even a “wise man” is unlikely to make such a prediction more than once in his or her life.  Thus we should use their expertise for understanding that single event, but not for predicting future such events.  The market is like a blob that absorbs everything, and it has now absorbed everything valuable from Roubini’s writings.

After WWII Winston Churchill was voted out of office. The British voters said; “Job well done, now get lost.”




21 Responses to “The two Ben Bernankes”

  1. Gravatar of JimP JimP
    8. January 2010 at 10:29

    On Bernanke

    Clearly he did not just go insane and suddenly become the BOJ. He knew he was not doing what he should do. How could he know that and still not do it?

    And everyone on here knows my answer –

    1. He lacked the nerve.
    2. He lacked the votes on the Board.
    3. He did not think he could go directly for inflation without a statement from the President supporting the policy.

    Bush could not make such a statement because he knew less about economics than my pet bird.

    Obama lacks the nerve. He thinks he is managing decline. Summers has probably told him that, and that is what he believes. They quiver at the thought of the infinitely strong China and a falling dollar. This administration will not call for higher inflation. They lack the nerve. And soon enough they will also lack the Presidency.

  2. Gravatar of thruth thruth
    8. January 2010 at 10:34

    Another thought experiment: Switch the roles of Ben “no subsidy” Bernanke and Henry “no strings” Paulson. Paulson would gladly go where other men fear to tread with Bernanke egging him on from the sidelines. Moreover, as Treasury secretary, Bernanke would be tight fisted with the fiscal support based on all those years of monetary policy research.

  3. Gravatar of JimP JimP
    8. January 2010 at 10:37

    And then we will get the charming Republicans – with their three p’s policy.

    1. Palin
    2. Populism
    3. Protectionism

  4. Gravatar of JimP JimP
    8. January 2010 at 10:53

    I mean – what does Obama have to lose by making such a statement? The election?

    “Mr. Bernanke: You will either create higher inflationary expectations using price level targeting – or I will withdraw my renomination and put in someone who will. Price level targeting will create employment – as you yourself said a few years ago about Japan. Fine. We need employment here. You will either do that or you are fired”

    How hard would that be?

  5. Gravatar of pct pct
    8. January 2010 at 12:25

    I wonder if institutional pressures on the central banker have not been radically underestimated. Consider the case of Ben Bernanke. One would think that we were enormously lucky to happen to have as Fed chairman in Autumn 2008 someone who (1) was one of the foremost academic experts on the Depression and (2) not ten years before had extensively studied and understood the shortcomings of the BOJ in dealing with Japan’s worryingly similar crisis. Yet look what happened. I hypothesize that if tomorrow morning Scott Sumner were wake up and find himself transformed into — worse than a giant cockroach — the Chairman of the Federal Reserve, we would suddenly develop a grave concern about the looming possibility of inflation.

  6. Gravatar of Doc Merlin Doc Merlin
    8. January 2010 at 12:57

    “And then we will get the charming Republicans – with their three p’s policy.

    1. Palin
    2. Populism
    3. Protectionism”

    No, the republicans are most definitely anti-protectionism and pro-free trade. All the tariffs and such lately have been pushed by the dems.

    Everyone is talking about how Ben isn’t being aggressive enough with monetary policy, but I disagree. He has been incredibly aggressive with monetary policy, but he needed some way to reel it back in without raising interest rates. They didn’t want to raise interest rates later because that would trigger an ARM and banking collapse. This is why they started paying for reserves, so they could quickly reduce inflation when it started again. Bernanke has been buying up as much debt of all forms as he possibly can, sometimes even paying more than face value for the debt. Its not as if he hasn’t been doing huge QE. The only think lacking is the expectation that the monetary stimulus wont be reeled back (which you have argued before is important, Scott.)

    Now, I don’t think Ben has done a good job either, but it is not his fault. It is an impossible job, because central planning simply doesn’t work.

  7. Gravatar of Doc Merlin Doc Merlin
    8. January 2010 at 13:01

    Yet another reason, central planning fails. The coordination problem makes good centralized planning impossible, politics and institutional pressures just add to the impossibility.

  8. Gravatar of pct pct
    8. January 2010 at 14:32

    @Doc Merlin
    OOPS, bad proofing. Last sentence is supposed to read “HE would suddenly…” Scott’s proof is stronger than he seems to realize. What turned Bernanke1 into Bernanke2 ? Would someone else have been able to resist the transforming force? Anna Schwartz? Benjamin Strong?

  9. Gravatar of Doc Merlin Doc Merlin
    8. January 2010 at 15:05

    I figured.

  10. Gravatar of ssumner ssumner
    8. January 2010 at 19:20

    It’s late so I will answer all the comments at once. I have been getting a lot of information from people about the FOMC, and I now realized that I should have studied the issue earlier. My initial reaction is that you’ve got some people who understand how powerful monetary policy is, but are inflation hawks, and some people who are inflation doves, but don’t understand how powerful monetary policy is.

    Bernanke seems to be viewed as a moderate in ths stuff I have read. But I agree with Jim that he isn’t that forceful. He also spent a lot of his political capital on banking fixes, and perhaps had little left to deal with AD and inflation.

    pct is probably right that the institutional barriers are formidable. I am actually not as naive as I seem, I just figure I must press ahead as if the world is not deterministic, and that something I say might make a difference, however unlikely that seems.

    thruth’s comment makes sense to me, although of course it is hard to know.

    Doc Merlin, I think we have a problem that is so intellectually complex that government bureaucracies can’t get a handle on it. The best they can do is prevent the worst failures, like another 50% fall in NGDP. There still too obsessed with interest rates. It’s like homeland security, too bureaucratic to stop lone terrorists, but competent enough so that they won’t let 19 guys through all at once again.

  11. Gravatar of Manny C Manny C
    8. January 2010 at 19:29

    On forecasting, Philip Tetlock has done some excellent research. Here’s a snapshot:

    His book is available here:

  12. Gravatar of Marcus Nunes Marcus Nunes
    9. January 2010 at 10:01

    Hawks and Doves at the FOMC

  13. Gravatar of Marcus Nunes Marcus Nunes
    9. January 2010 at 10:25

    More detailed classification of Hawks and Doves at the Fomc

  14. Gravatar of JimP JimP
    9. January 2010 at 11:42

    lifted from the wsj article above

    begin quote
    The four presidents of regional Fed banks joining the rotation this year are James Bullard of St. Louis, Thomas Hoenig of Kansas City, Sandra Pianalto of Cleveland and Eric Rosengren of Boston. They’ll join the eight permanent voters on the FOMC “” seven governors of the Federal Reserve Board (two of those positions are now vacant) and the New York Fed president. Every Fed policymaker, including presidents who are not voting this year, gets a voice at the table. But regional bank presidents tend to draw a bit more attention when they’re voters.
    end quote

    As I have said, there are two voting positions vacant. If the board is evenly balanced between the hawks and doves then these two votes could make the difference.

    Why does Obama not nominate two doves?

    And – if the reason given is because he cant get them past the hawks in the US Congress, then why does he not fight these hawks in an open political contest. That would be a contest he at least has a chance of winning and at the same time increasing his own popularity (as Roosevelt did early in his term). Health care does not not strike me as being that kind of contest.

    I continue to believe this all comes down to a lack of political vision on Obama’s part – which means it is changeable and fixable. I very much doubt he wants to lose the next election.

  15. Gravatar of ssumner ssumner
    9. January 2010 at 11:52

    Manny, thanks for that info.

    Marcus, Thanks. Statsguy also gave me some useful info. The FT article is probably worth a post.

    JimP. You said;

    “I continue to believe this all comes down to a lack of political vision on Obama’s part”

    Yes, I agree. But in fairness few politicians really understand monetary policy.

  16. Gravatar of JimP JimP
    9. January 2010 at 11:54

    I confess I don’t actually know if these two voting positions have to get through the Senate. If they don’t, then act Mr. Obama. Act.

  17. Gravatar of JimP JimP
    9. January 2010 at 11:55


    Roosevelt didn’t understand it either. But he acted anyway.

  18. Gravatar of scott sumner scott sumner
    10. January 2010 at 18:16

    JimP, I think they do need confirmation.

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