Why do progressives believe Ben Bernanke?

Probably because he’s obviously a good guy.  But he’s also a key policymaker—and policymakers have to lie.  Here’s Felix Salmon:

. . . the Fed is, simply, out of credible ammunition right now. And so Ben Bernanke is being rather sensible when he says that if you want to create jobs, then fiscal policy is going to be a lot more effective than monetary policy.

Salmon may believe the Fed is out of ammo, but I don’t, Bernanke doesn’t, and Paul Krugman doesn’t.

Here’s Brad DeLong, who uses Bernanke’s words to criticize Ramesh Ponnuru’s claim that the fiscal multiplier is effectively zero because the Fed would sabotage fiscal stimulus:

Ben Bernanke:

Bernanke news conference on Fed policy: With respect to the current economy we are currently continuing our accommodative monetary policy. We are trying to do our best to support economic growth and job creation. It would be helpful if we could get assistance from some other parts of the government to work with us to help create more jobs. But certainly we are doing our part to create more jobs, more opportunities in America…

If Ponnuru has any reason to believe that Bernanke is lying, I would like to see the evidence. If not, he should not claim that Federal Reserve policy is different from what Bernanke says it is.

I’ll provide the evidence in just a moment.  But first let’s stop to consider Bernanke’s statement, which is absurd, laughable, preposterous.  How could a sophisticated fellow like DeLong, who is a much shrewder observer of the political scene than I am, fall for something like this?  I mean seriously, we have Bernanke’s entire career to look at.  We have all his statements on monetary policy over the past year, which claimed the Fed was providing the “appropriate” amount of stimulus, and that more stimulus would be unwelcome.  Does DeLong seriously expect us to believe that the Fed couldn’t provide more stimulus? Couldn’t have made QE2 ten times bigger?  Couldn’t have cut IOR?  Couldn’t have raised the inflation target?  Indeed DeLong asked Bernanke directly and Ben said that’s a lousy idea.  And what about NGDP targeting?  What about level targeting?  And who is “we?”  Is Plosser “doing his best” to boost AD?  Is Fisher doing his best to boost AD?  Is Kocherlakota doing his best to boost AD?  Aaaaargh.

Now I can already anticipate the responses.  People will say that the Fed is doing all it can within its political constraints, including a 2% inflation target.  I don’t think even that is true.  But let’s say it was.  It would merely prove Ponnuru is right.  If the Fed is targeting inflation at 2%, then the fiscal multiplier is precisely zero in every NK model that I’ve ever seen.  That’s because both monetary and fiscal policy affect AD (and hence both prices and output) but the split is determined by the slope of the SRAS curve.  So the Fed will boost inflation when it falls below 2%, and restrain it when it rises above 2%.  Now just to be clear, I don’t think the Fed is slavishly targeting inflation at 2%.  But that’s precisely why I don’t believe the Fed is “doing all it can.”  Politicians must say things like that.  Brad DeLong of all people should understand that fact.

Oh yeah, the “evidence” of lying.  Here’s Ben Bernanke last year:

The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation. We do. As I will discuss next, the issue is instead whether, at any given juncture, the benefits of each tool, in terms of additional stimulus, outweigh the associated costs or risks of using the tool.

I hope I don’t need to translate that.  In the speech Bernanke goes on to discuss all sorts of things the Fed could do, such as more asset purchases, lower IOR, more explicit communication about Fed goals, a higher inflation target.  Bernanke’s famous for believing the Fed never runs out of ammo.

The real problem is either that Bernanke lacks the votes, or Bernanke’s become more conservative, or Bernanke prefers the Fed not mess around with unconventional stimulus, and wants fiscal policymakers to do the dirty work.  I’m not a mind reader.  But believe me, Bernanke doesn’t believe the Fed is doing all it can to raise AD.  Not a chance.

Bernanke’s not intentionally sabotaging fiscal stimulus.  But the actions of the Fed over the past two years, which are consistent with an inflation-targeting central bank, have effectively sabotaged much if not all of the fiscal stimulus.

I wish the media would just once pay attention to what the Fed actually says.  They say they could boost AD, but simply choose not to.  Every DC reporter should be forced to read the quotation I provided, and repeat Bernanke’s words 100 times over:

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

We do. We Do. We do. We do. We do. We do.

So why doesn’t the Fed?  Melville asked that question 160 years ago with Bartleby the Scrivener.  And we still don’t have an answer.



35 Responses to “Why do progressives believe Ben Bernanke?”

  1. Gravatar of Leigh Caldwell Leigh Caldwell
    5. November 2011 at 18:53

    I wonder whether Bernanke would prefer to have the (elected) political authorities tell him it’s OK to use those unconventional tools. Does he feel constrained to expand the Fed’s toolbox without more overt political endorsement?

    This might still count as “assistance from some other parts of the government”. Everyone has interpreted that as meaning more fiscal stimulus, but perhaps that isn’t what he intended by it. After all, do we think Bernanke actually believes in fiscal stimulus?

  2. Gravatar of Cassander Cassander
    5. November 2011 at 19:32

    If progressives admitted, and I mean really admitted and internalized the idea that public officials lie as a matte of course it would undermine their belief in the nobility and utility of a political technocratic elite. Since the belief in the utility and nobility of that elite is just about the core of progressive thinking, accepting it would mean either embracing an alternative ideology or admitting they are nothing more than power grubbing charlatans. As has been said, it is difficult to get a man to understand a thing when his salary depends on him not understanding it.

  3. Gravatar of Lorenzo from Oz Lorenzo from Oz
    5. November 2011 at 20:06

    Maybe he wants to force Obama to fill those empty Federal Reserve Board of Governor positions. If Obama can get folk appointed to the Supreme Court, he could get them appointed to the Federal Reserve. If he could be bothered to try seriously.

  4. Gravatar of John Thacker John Thacker
    5. November 2011 at 20:29

    Indeed, Scott, Bernanke’s statements are literally contradictory. I suppose that’s no problem if you’re the sort of progressive who prefers fiscal stimulus (perhaps because you like a government-directed economy), but Bernanke’s statements are impossible to reconcile with each other with believing in some preference like that.

    Ben has made it clear that he thinks more monetary stimulus is possible. It is therefore difficult to avoid believing that additional fiscal stimulus makes monetary stimulus less likely, and vice versa.

  5. Gravatar of John Thacker John Thacker
    5. November 2011 at 20:31

    The public (and thus, politicians) hating inflation with an irrational passion is something that I understand. But I don’t understand Ben.

  6. Gravatar of Morgan Warstler Morgan Warstler
    5. November 2011 at 20:40


    You aren’t being complete. or you aren’t being honest.

    Fisher says we shouldn’t cover up bad fiscal policy with monetary – this is a fact.

    There is a REAL logical option, that Ben AGREES, or is afraid to disagree with Fisher, and to be politically correct Ben just says fiscal could do more.

    You’d have to agree, Ben can’t say, “eat it donkeys, until you FIX Fiscal (spend less and tax less to stimulate), we’re not going to remove the smell from your shit.”

    Fisher is getting his way, and if you just say his thinking in a politically acceptable way, it sounds like JUST LIKE ben.

    The question isn’t if I’m right, the question is why you don’t put your brain to the most likely answer.

  7. Gravatar of JKH JKH
    6. November 2011 at 03:46

    “The issue is instead whether, at any given juncture, the benefits of each tool, in terms of additional stimulus, outweigh the associated costs or risks of using the tool”

    You can call it lying, but the key word is risk. That’s why he rejects NGDP targeting. The “inflation” component of an NGDP target becomes a risk when RGDP is too low, in his view. (I don’t think his press conference answer indicated any further seriousness consideration of NGDP targeting.)

    And you don’t need explicit NGDP targeting to ask the same question – why does he view “inflation” as such a risk when RGDP is so low?

    Political risk is part of it – people at the Fed with different views on risk.

    Separately, I don’t understand the nature of this (perceived) risk in interaction with fiscal policy. Does every fiscal policy action that increases AD have to be inflationary to the point that a Fed offset would be necessary and would necessarily undo its net benefits? If fiscal policy were actually more “effective” at the margin, doesn’t that mean less expected inflation per unit of new RGDP? Is there no constructive synergy at all even with a Fed that might try to limit “inflation”?

  8. Gravatar of Fmb Fmb
    6. November 2011 at 03:48

    What happens if the fed accommodates, but those on the margin fail to respond to the new incentive? Maybe accommodating more doesn’t work, but attempting to correct irrationality might.

  9. Gravatar of Becky Hargrove Becky Hargrove
    6. November 2011 at 04:42

    Bernanke really needs a stronger president, right now. Like my Dad said, Obama needed to be a bit more like LBJ to do any good, nevermind Clinton who was not exactly Chuck Norris either. One barometer for presidents could well be their wives. Mrs. Obama is strong, right? Nevertheless, her campaign for healthier food has not really translated into changing the direction where food subsidies actually go. Obama, are you listening?

  10. Gravatar of John Thacker John Thacker
    6. November 2011 at 06:53


    Does every fiscal policy action that increases AD have to be inflationary to the point that a Fed offset would be necessary and would necessarily undo its net benefits? If fiscal policy were actually more “effective” at the margin, doesn’t that mean less expected inflation per unit of new RGDP?

    As Scott says in the post, the degree to which increases in AD affect inflation is determined by the slope in the Short Run Aggregate Supply curve.

    It doesn’t matter whether fiscal policy or monetary policy is more “effective” in raising AD per “unit of new RGDP” or “unit of spending” (whatever that means), inflation should rise the same for the same rise in AD.

    Inflation *is* more money/more demand chasing the same goods. If you raise AD, then you raise inflation to the extent that the extra AD does not raise AS– but according to all the models that support any idea of stimulus, it doesn’t matter how you raise AD, only the shape of the (Short Run) AS curve.

  11. Gravatar of John Thacker John Thacker
    6. November 2011 at 06:59


    So in other words, if raising NGDP to increase AD by a set amount carries the risk of inflation, then increasing AD by that same amount through fiscal policy carries *exactly* the same risk of inflation.

    The “efficiency” of raising AD is determined by factors that are not affected by which method you use.

  12. Gravatar of Bill Woolsey Bill Woolsey
    6. November 2011 at 07:03

    Why lie?

    1. The Fed must make sure that markets don’t expect even more disinflation, much less deflation, because that will raise real interest rates. It is an artifact of interest rate targeting. Claiming that they have secret weapons that will prevent this (as opposed to things they hope will prevent this) is a Nobel Lie. In fact, suppose they try to do them to create an expansion and they don’t work? Then, everyone will no what the Fed knows–they might not be able to prevent deflation. (The economy should be recovering strongly according to their models.. what do they know?)

    2. The Fed is never wrong. If fiscal stimulus does raise nominal expenditure and this causes excessive inflation, then it won’t have been the Fed’s fault. It would be the fault of fiscal policy. Of course, the Fed could have prevented that consequence, but, you know, long and variable lags. Whatever. All that counts is, “It isn’t the Fed’s fault.” Why the Lie? Because if it was the Fed’s fault, then its indpendence would be in danger. And so, constant evasion of responsibility by the Fed is a “Nobel Lie” aimed at protecting the Fed’s idependence. Otherwise, the politicians would be timing booms to coincide with elections or just printing money and spending it.

  13. Gravatar of Russ Anderson Russ Anderson
    6. November 2011 at 09:00

    Scott, one thing that could advance the debate is to more directly address Felix Salmon’s concern about credible steps the Fed could/should take (to back expectations). You briefly mentioned a couple (“more asset purchases, lower IOR”) but more details may help address Felix’s concerns.

    For example, I get the impression few people know about the Fed paying IOR (starting Oct 2008) and the tightening effect of that policy change. With your success in raising the profile of NGDP targeting, perhaps raising the issue of IOR would have similar success.

    The case against IOR can be made from both liberal and conservative viewpoints. From the liberal side it is another example of big banks taking advantage of the system. From the conservative side it is a waste of taxpayer money to pay banks to not lend money. It is an easy place to cut spending.

    When you say “more asset purchases” providing more detail about types of assets and amounts would be useful. I’m sure you know what you mean, but the message isn’t getting across to people like Felix.

    Hammering on tangible steps the Fed can take to back up expectations would go a long way to convince people that the Fed really could do more (if they wanted to).

  14. Gravatar of ssumner ssumner
    6. November 2011 at 09:42

    Leigh, Good point.

    Cassander, Good point.

    Lorenzo, Yes, I hadn’t though of that–but it makes sense.

    John, I don’t understand either.

    Morgan, That just doesn’t seem like Bernanke to me. He has recommended fiscal stimulus on occasion.

    JKH, If anything, fiscal policy is more inflationary (for a given increase in AD) because it hurts the supply side of the economy.

    And there are far bigger risks with fiscal stimulus, as the Greeks are discovering.

    FmB, How do you correct irrationality?

    Becky, Good point.

    Bill, Maybe, but of course then DeLong is still wrong.

    Russ, That’s precisely the problem. If the Fed targets P or NGDP, then there is no way of knowing how much in asset purchases are required. The market will determine that. It’s quite likely that no asset purchases will be required, expectations might do all the needed stimulus.

    I have talked a lot about IOR, but not recently as it seems a lost cause.

  15. Gravatar of Morgan Warstler Morgan Warstler
    6. November 2011 at 12:12

    Scott, then you agree with me.

    I said ben could be saying it because he is afraid of the Fisher crowd, not because he believes it outright.

  16. Gravatar of Benjamin Cole Benjamin Cole
    6. November 2011 at 12:28

    Fighting inflation has become a moral cause, like genuflecting to gold in the minds of gold-nuts. Ergo, to “fight” inflation is to be honorable, and firm. Think of heroic martial music playing in the background.

    The fact that we are 13 percent below trend NGDP and at 9 percent unemployed and unit labor costs are declining?

    Monetary asceticism is powerful.

  17. Gravatar of anon anon
    6. November 2011 at 12:30

    Bill Woolsey, (1) is quite easy to solve. The “secret weapon” would be money-financed fiscal policy, aimed at pulling the “natural rate” above the ZLB. As for (2), all the Fed needs to do is choose a sensible target for the long run, gain political consensus around it, and stick to it. They can’t be blamed for sticking to their target.

  18. Gravatar of Russ Anderson Russ Anderson
    6. November 2011 at 13:33

    > Russ, That’s precisely the problem… there is no way of knowing

    Is there? Assuming the Fed has zero credibility (no expectations) what order of magnitude asset purchases would it take to get 5% NGDP trend growth? The Fed would have to be willing to spend that much (maybe more) to be seen as credible. $1-2 trillion, maybe? At a minimum they would have to announce they are buying a significant amount of assets (hundreds of billions) and follow through to establish some credibility.

    > It’s quite likely that no asset purchases will be required, expectations might do all the needed stimulus.

    That sounds like wishful thinking, especially initially. It took took Volker several years of action (limits on monetary growth and an bad recession) to establish credibility on fight inflation. Bernanke would need to do something significant before the market will take his word for it. It won’t happen instantaneously. And think of the political backlash is he did.

    > I have talked a lot about IOR, but not recently as it seems a lost cause.

    NGDP targeting was a lost cause when you first started talking about it.

  19. Gravatar of flow5 flow5
    6. November 2011 at 14:29

    On Feb. 28, Bernanke told the House Budget Committee he could see no single factor that caused the market’s pullback a day earlier”.

    You have to be both stupid & a liar to make such a statement. It was entirely Bernanke’s staff’s fault. And so was the depth of this Great Recession. It is literally a job requirement to be able to lie at the FED. All technical staff positions there should be limited to a maximum of 2 years. And hard copy should be an audit requirement. The guilty parties now days simply cover up their errors with data revisions.

    Expectations have nothing to do with targeting nominal gDp.

  20. Gravatar of Anonymous Anonymous
    7. November 2011 at 00:21

    First, I need to think of a good alias if I’m going to start commenting more often…

    I’ve been thinking about your insistence that IOR be cut; it’s the classic case of works-in-theory-not-in-practice. In this case, you might get a boost of 10 bps (it trades around 10-20 bps right now). But you close out all profit opportunity for those desks that still trade in the Fed Funds market. There’s such low demand for reserves right now and with GSEs being banned from earning IOR, the cost-benefit analysis doesn’t really add up.

    IOR is supposed to function as a floor for Fed Funds, but it’s so porous a floor in this environment that it should be the last thing the Fed should be thinking about if they want to provide more accommodation. If effective Fed Funds starts floating closer to .25, the case is much stronger. Virtually shutting down a market has fixed costs that go along with it; the opportunity cost alone makes my case given what else the Fed can do. (As you know, I’m with you on more QE, more commitment, NGDP level targeting, etc).

    In my ideal world, I’d like to have a negative IOR, but for that to have any teeth, so many other things need to happen:
    First, start jawboning. Easiest thing the Fed could do is just talk about what it would take for them to reduce IOR further, preferably in a neutral manner. If they signal to markets the possibility of going negative (a reserve tax per se), I’ve gotta think long term yields go down very quickly.
    Second, GSEs either need to be banned from the Fed Funds Market or be treated like all other participants. Both are nightmares but at least one or the other must be possible. If nothing changes though, then you get this mess of a Fed Funds market where effective Fed Funds is not within discount and IOR.
    Third, make sure negative IOR could be applied to all equivalents of required reserves (excess reserves, vault cash, etc) so as to remove any obvious arbitrage opportunities.
    Fourth, figure out how to deal with the tail risks (the people-withdraw-their-money-to-stuff-under-their-mattress-scenario that’s so ridiculous I shouldn’t bother mentioning it). I believe Irving Fisher and Milton Friedman had some ideas for how to go about this. I also imagine that negative interest rates don’t look nice to the average Joe…although 9% unemployment is far more disgusting to my palate.
    As I said before, if markets even sense that the Fed has the tools to make IOR and effective Fed Funds go negative, EMH will kick in and yields will plunge. Unfortunately, there are so many political hoops to jump through to make such a policy seem credible to the markets that I doubt the Fed will ever go down this road.

  21. Gravatar of Conservative Krugmanite Conservative Krugmanite
    7. November 2011 at 07:04

    (aka Anonymous)
    After my long comment last night, that can be read above, I’ve started to think about whether all of our efforts should be channeled into executing some kind negative IOR and discount rate policy. The political hoops are massive, but also one-time in nature. The problems are largely in execution and the political/reputational risks. I’m not sure why, but I suspect most NK economists would consider a negative nominal interest rate to be effective if it could actually be enforced properly.
    I’m growing increasingly skeptical of the Fed doing any sort of explicit targeting of inflation or nominal income, even if only a temporary shift during this liquidity trap period. Beyond the political risk, the Fed holds its independence to act as the most valuable. They’d rather not tie their hands; they’d rather not risk their independent funding; they’d rather not scare Congress into enforcing greater accountability.
    The purpose of an independent central bank is to take decisive actions in precisely these kinds of moments, yet revealed preference tells us that many at the Fed are interested in Fed independence for its own sake in large degree. It’s such a tragedy but Bernanke isn’t the man for the job anymore. He knows he can do more but he has failed to frame the debate adequately. By low-balling on QE, he’s made the same mistake as President Obama on the fiscal side (if you look at it purely in terms of political terms). It seems like Bernanke gets what he wants; if he shows no dissatisfaction with the minuscule scale of past Fed actions (MEP, LSAP II, etc), everyone will indeed assume that this is all the Fed can do.

  22. Gravatar of flow5 flow5
    7. November 2011 at 07:22

    “IOR is supposed to function as a floor for Fed Funds”

    No, IOeRs’ are the functional equivalent of required reserves. They are a credit control device. IOeRs’ were used to offset Bernanke’s liquidity funding programs (expansions), on the asset side of the FED’s balance sheet. I.e., quantitative easing, or the FED’s POMOs, were sterilized by using a remuneration rate (after several trial adjustments), that restricted bank lending & investing. For the sterilization process to work, IOeRs by definition, must be contractive.

    However, it would seem at some future date, the FOMC will not be able to smoothly re-adjust the remuneration rate, & the frbNY’s “trading desk” will not be able to conduct a sufficient volume of offsetting open market operations necessary to stablize expanding credit markets.

  23. Gravatar of Brent Brent
    7. November 2011 at 07:46

    It’s strange to defend a Ben Bernanke on the grounds that he’s doing all he can within political restraints. At the very same time he’s calling on Congress for more fiscal stimulus… because Congress is any less politically restrained?

    If serious deflation seemed to be around the corner again, we all know more QE happens regardless of “political restraints.”

  24. Gravatar of Conservative Krugmanite Conservative Krugmanite
    7. November 2011 at 07:57

    Nope…IOR was in the works for a while because academics beginning largely with Milton Friedman were claiming that parking your money at the Fed was virtually a tax since it earned nothing. It’s almost the same reason the discount rate should function as the Fed Funds rate ceiling. Why lend reserves in the Fed Funds market if they yield less than what the Fed is paying me? Why borrow reserves at a higher rate than what the Fed is offering me? The financial crisis might have made IOR more necessary (rather than simply desirable) on a purely technical level, but the idea was in the works for a long time.
    I’m not sure I fully follow what you’re saying but your first point seems to be about excess reserves more so than IOR. Excess reserves have to equal all of the balance sheet expansion that came from the facilities. Now raising IOR is indeed contractionary and I think they were able to push through IOR because they felt they needed it as an exit tool. It’s a q&d way to soak up some excess liquidity if we enter a rising environment. Nevertheless, given that GSEs don’t earn IOR, the more reserves sloshing around, the harder it is for IOR to actually function as a floor on the Fed Funds market. That’s why the FOMC will indeed have a hard time re-adjusting the remuneration rate during an exit without reverse repos, time depositing, and possibly some bullying.

  25. Gravatar of Contemplationist Contemplationist
    7. November 2011 at 08:12

    Morgan Warstler

    The really funny thing is that Bernanke was pushing for fiscal stimulus in 2009. Now, where does that fit into your political model? Let’s see those epicycles!

  26. Gravatar of flow5 flow5
    7. November 2011 at 08:55

    Bernanke’s incompetent. He should have known the economy was slowing. Bernanke should have began boosting nominal-gDp before the NBER established the onset date of the Great Recession (Dec 07).

    Bernanke continued to drain liquidity despite its 7 reductions in the FFR (which began on 9/18/07). I.e., despite Bear Sterns two hedge funds that collapsed on July 16, 2007, the FED maintained its “tight” money policy (i.e., credit easing, not quantitative easing or open market operations of the buying type). Easy money is here defined as a growth rate of aggregate monetary demand (money times velocity) in excess of the growth rate of product, and service output.

    Bernanke didn’t initiate an “easy” money policy until Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. The problem was that nominal gDp was falling sharply at the same time Bernanke was still tightening credit. Bernanke drove the economy into a recession/depression. That’s one reason why the FED should target nominal gDp.

    This was my forecast in June:

    #1 06-28-07, 04:09 PM
    Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

    The rate-of-change in the proxy for real-gdp (monetary flows MVt) peaks in July. The rate change in the proxy for inflation (monetary flows MVt) peaks in July. Therefore it should be obvious: Interest rates peak in July.


    A group of professionals has no excuse.

  27. Gravatar of flow5 flow5
    7. November 2011 at 09:31

    “academics beginning largely with Milton Friedman were claiming that parking “your money at the Fed was virtually a tax”

    Milton Friedman was an outstanding human being from all accounts, but as an economist, he was God awful.

    IORs are not a tax. A brief “run down” will indicate just how costless, indeed how profitable – to the participants, is the creation of new money. If the Fed puts through buy orders in the open market, the Federal Reserve Banks acquire earning assets by creating new inter-bank demand deposits. The U.S. Treasury recaptures about 97% of the net income from these assets. The commercial banks acquire “free” legal reserves, yet the bankers complain that they are not earning any interest on their balances in the Federal Reserve Banks.

    On the basis of these newly acquired free reserves, the commercial banks can, and do, create a multiple volume of credit and money. And, through this money, they acquire a concomitant volume of additional earnings assets. How much is this multiple expansion of money, credit, and bank earning assets? Thanks to fractional reserve banking (an essential characteristic of commercial banking) for every dollar of legal reserves pumped into the member banks by the Fed, the banking system can, and does, acquire about 93 dollars (last time I checked), in earning assets through credit creation.

    Initially, all credit creation involving dealing with the non-bank public results in a concomitant expansion of means-of-payment money.

  28. Gravatar of flow5 flow5
    7. November 2011 at 09:40

    “Why lend reserves in the Fed Funds market if they yield less than what the Fed is paying me? Why borrow reserves at a higher rate than what the Fed is offering me?”

    Our excessive rates of inflation (especially since 1965), has been due to irresponsibly easy monetary policies. Our monetary mis-management has been the assumption that the money supply can be managed through interest rates.

    Between 1965 and June of 1989, the operation of the NY Fed’s “trading desk” was dictated by the federal funds “bracket racket”. Even when the level of non-borrowed reserves was used as the operating objective, the federal funds brackets were widened, not eliminated.

    Ever since 1989 this monetary policy procedure has been executed by setting a series of creeping, or cascading, interest rate pegs.
    This has assured the bankers that no matter what lines of credit they extend, they can always honor them, since the Fed assures the banks access to costless legal reserves, whenever the banks need to cover their expanding loans – deposits.

    We should have learned the falsity of that assumption in the Dec. 1941-Mar. 1951 period. That was what the Treas. – Fed. Res. Accord of Mar. 1951 was all about.

    The effect of tying open market policy to a fed Funds rate is to supply additional (and excessive, & costless legal reserves) to the banking system when loan demand increases.

    Since the member banks (when reserves were binding), operated without any excess reserves of significance (since 1942), the banks had to acquire additional reserves, to support the expansion of deposits, resulting from their loan expansion.

    Apparently, the Fed’s technical staff either never learned, or forgot, how Roosevelt got his “2 percent war”. This was achieved by having the Fed stand ready to buy (or sell) all Treasury obligations at a price which would keep the interest rate on “T” bills below one percent, and long-term bonds around 2 -1/2 percent, and all other obligations in between.

    This was achieved through totalitarian means; involving the control of total bank credit and the specific rationing of that credit we had official price stability and “black market” inflation.

    The production of houses and automobiles was virtually stopped, and credit rationing severely reduced the demand for all types of goods and services not directly connected to the war effort. This plus controls on prices and wages kept the reported rate of inflation down.

    Financing nearly 40% of WWII’s deficits through the creation of new money laid the basis for the chronic inflation this country has experienced since 1945. Interest rates, especially long-term, would have averaged much higher had investors foreseen this inflation. This was reflected in the price indices as soon as price controls were removed.

    There were recently 5 interest rates (ceilings tied to the Primary Credit Rate @.50%), that the Fed could directly control in the short-run; the effect of Fed operations on all other interest rates is still INDIRECT, and varies WIDELY over time, and in MAGNITUDE.

    It is a long-standing historical fact. The money supply can never be managed by any attempt to control the cost of credit (i.e., thru interest rates pegging governments; or thru “floors”, “ceilings”, “corridors”, “brackets”, etc). IORs simply exacerbate this operating problem. I.e., Keynes’s liquidity preference curve is a false doctrine.

    As long as it is profitable for borrowers to borrow and commercial banks to lend, money creation is not self regulatory. This observation would be valid even though the Fed did not use interest rates as a guide to open market operations.

    With the use of this device the Fed has actually pursued a policy of automatic accommodation. That is, additional costless reserves, & excess reserves, were made available to the banking system whenever the bankers and their customers saw an advantage in expanding loans. The member banks, lacking excess reserves, would just bid up the federal funds rate to the top of the bracket thus triggering open market purchases, free-gratis bank reserves, more money creation, larger monetary flows (MVt), higher rates of inflation – and higher federal funds rates, more open market purchases, etc.

  29. Gravatar of Conservative Krugmanite Conservative Krugmanite
    7. November 2011 at 10:09

    @flow5 Stop misreading what I write. When you couldn’t earn IOR at the Fed but had to park money their by requirement…that’s when Friedman called it a tax. Friedman wanted IOR because he saw required reserves earning nothing at the Federal Reserve as a tax.
    My point about IOR functioning as a floor and discount as a ceiling was merely to point out that the channel/corridor isn’t working in practice as it should in theory. I outlined the reasons it doesn’t work in practice under current laws.
    None of what I’m saying regarding short-term interest rate targeting implies that it’s the way I’d go about monetary policy. I think explicit targeting, with no holds barred on direct action, is far more efficient monetary policymaking. I’m just thinking about how to get more accommodation within the political constraints .

  30. Gravatar of flow5 flow5
    7. November 2011 at 10:47

    “I think explicit targeting, with no holds barred on direct action, is far more efficient monetary policymaking”

    The evidence overwhelmingly supports that view. Bernanke & his team are completely unaware of this though:

    To: @stls.frb.org
    Subject: As the economy will shortly change, I wanted to show this to you again – forecast:
    Date: Wed, 24 Mar 2010 17:22:50 -0500

    Dr. :

    It’s my discovery. Contrary to economic theory and Nobel Laureate Milton Friedman, monetary lags are not “long & variable”. The lags for monetary flows (MVt), i.e., the proxies for (1) real-growth, and for (2) inflation indices, are historically, always, fixed in length. However the lag for nominal gdp varies widely:

    Assuming no quick countervailing stimulus:

    jan….. 0.54…. 0.25 top
    feb….. 0.50…. 0.10
    mar…. 0.54…. 0.08
    apr….. 0.46…. 0.09 top
    may…. 0.41…. 0.01 stocks fall

    Should see shortly. Stock market makes a double top in Jan & Apr. Then real-output falls from (9) to (1) from Apr to May. Recent history indicates that this will be a marked, short, one month drop, in rate-of-change for real-output (-8). So stocks follow the economy down.

    Bernanke’s mis-calculation casued the 1,000 point flash crash.

    flow5 Message #10 – 05/03/10 07:30 PM
    The markets usually turn (pivot) on May 5th (+ or – 1 day).

  31. Gravatar of Morgan Warstler Morgan Warstler
    7. November 2011 at 13:11


    You assume Ben has a very different views of “stimulus” – because you stop listening at the punch line.

    Ben ALWAYS couches his “stimulus” chatter at minimum in idea the outright statement of long term cuts are necessary.

    Wat’s that mean?

    1. Public employees eat it.
    2. Entitlements eat it.
    3. If you want to cut some military, do that too.

    Look, the numbers don’t lie, if we just kept pubic employee compensation (F, S and L) growing at the rate of inflation since 1998, we’d have $7T+ hanging over our heads on debt, and this year we’d have $500B that would pay 20M unemployed $25K a year to rub my back.

    Finally, I ABSOLUTELY PROMISE you Ben would call flattening / simplifying the tax code bu keeping it revenue neutral would be “stimulative.”

    Do you disagree? GE paying more taxes is stimulative. Entrepreneurs paying less or no taxes is stimulative.

    I’m pretty sure Ben would call ending Davis-Bacon stimulative, and to be contentious if you gave me that + silencing the EPA, I’d support a slew of infrastructure spending right now – I think most libertarian leaning conservatives would.

    Frankly, if they ran the whole government like Wal-Mart, I’d be willing to see if it can grow out of consumer demand.

  32. Gravatar of Morgan Warstler Morgan Warstler
    7. November 2011 at 13:12

    $7T less debt…

  33. Gravatar of Contemplationist Contemplationist
    8. November 2011 at 06:45


    That may be the case but you forget that your hated “DeKrugman” was also using the exact same language – “stimulus now, cuts later” Also you did not address Scott’s point that McCain was doing fine in the polls till the economy tanked – which, if you believe Scott’s model WAS DIRECTLY CAUSED BY THE FED!

    Lets hear some more epicycles!

  34. Gravatar of ssumner ssumner
    9. November 2011 at 14:06

    Morgan, It would make things less confusing if you stuck to one Bernanke story.

    Ben, I agree.

    Russ, I don’t agree about Volcker–see my post on the myth of the Volcker disinflation, from a few weeks back.

    It seems like your comment supports my claim that there’s no way of knowing how much would be needed, as we don’t know how credible the Fed promise would be.

    Anonymous, Actually, IOR has not been a high priority for me in recent posts–NGDP targeting is. But I’m not convinced by your analysis, as it seems to imply monetary policy works through interest rates.

    And I don’t see how you can say there is a low demand for reserves right now–banks are holding nearly 2 trillion, which is an incredibly high demand. The goal is to reduce demand, and a lower IOR might do that.

    I don’t have any problem with the rest of your ideas–I’ve proposed many myself (such as including vault cash in the negative IOR.)

    Conservative Krugmanite, You may be right about the political infeasibility of NGDP targeting, but negative IOR also would seem to be politically indfeasible. QE is more feasible than either.

    flow5, I agree that IOR is sort of like required reserves.

    Brent, Good point.

    C.K, I agree that Friedman supported IOR, but that’s unrelated to the question of whether they made sense right on the midst of a crash. Friedman also opposed required reserves, but he wouldn’t have favored their removal in the middle of a hyperinflation.

    Late in his career Friedman probably opposed required reserves (I’m not sure). In that case IOR would be unneeded.

  35. Gravatar of TheMoneyIllusion » What does Bernanke really believe? Part 376. TheMoneyIllusion » What does Bernanke really believe? Part 376.
    7. June 2012 at 07:08

    […] year I had this to say: The real problem is either that Bernanke lacks the votes, or Bernanke’s become more […]

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