Thursday, May 3, 2012

Has Ben Bernanke Been Consistent?

Back in the late 1990s and early 2000s, Ben Bernanke sharply criticized the Bank of Japan. He argued that even though the BoJ had cut its target interest rate to near-zero, it could and should do much more to end deflation and to stimulate Japan's economy. In the last few months, a number of critics have accused Bernanke of inconsistency: that is, the Ben Bernanke who has been leading the Fed in the aftermath of the Great Recession is not following the advice of the Ben Bernanke who was criticizing the Bank of Japan back in 2000-2003. To me, this criticism seems like pretty thin gruel: indeed, I think the accusation of inconsistency basically an attention-getting cover for a more mundane policy disagreement over whether the Fed should immediately start another round of quantitative easing. Here, I'll lay out the arguments here as I seem them.

Bernanke's Earlier Criticisms

Bernanke first became a member of the Fed's Board of Governors in 2002. Back in 2000, while still a professor at Princeton, he published an essay called: “Japan’s Slump: A Case of Self-Induced Paralysis?” In the essay, Bernanke sharply criticizes the Bank of Japan for taking the position that since it had lowered its target interest rate to near-zero, there was nothing more it could do. In contrast Bernanke argued that a central bank had a number of other options when confronted with deflation: a long-term commitment to a near-zero interest rate; setting an inflation target of 3-4 percent per year; intervention in exchange-rate markets to depreciate the yen; using money creation to finance deficit spending; and central bank purchases of long-term government bonds, corporate bonds, and other financial securities.

Bernanke made similar arguments after joining the Fed. For examples, see his November 21, 2002 talk to the National Economists Club in Washington, D.C. called Deflation: Making Sure "It" Doesn't Happen Here" or his May 31, 2003 talk to the Japan Society of Monetary Economics in Tokyo called "Some Thoughts on Monetary Policy in Japan."  These talks do differ a bit in emphasis. For example, after joining the Fed, Bernanke was careful to say that he was in no way contemplating interventions in exchange rate markets. But the general messages remained the same: namely, that a central bank has a lot of tools available even when it has cut its target interest rate to near-zero, and that the Bank of Japan should make more aggressive use of these tools.
Accusing Bernanke of Inconsistency

One of the most prominent voices accusing Bernanke of inconsistency is Paul Krugman, who  wrote an essay in the New York Times Magazine on April 24, 2012, called  “Earth to Ben Bernanke: Chairman Bernanke Should Listen to Professor Bernanke,”  Here's Krugman:

"Bernanke was and is a fine economist. More than that, before joining the Fed, he wrote extensively, in academic studies of both the Great Depression and modern Japan, about the exact problems he would confront at the end of 2008. He argued forcefully for an aggressive response, castigating the Bank of Japan, the Fed’s counterpart, for its passivity. Presumably, the Fed under his leadership would be different. 
"Instead, while the Fed went to great lengths to rescue the financial system, it has done far less to rescue workers. The U.S. economy remains deeply depressed, with long-term unemployment in particular still disastrously high, a point Bernanke himself has recently emphasized. Yet the Fed isn’t taking strong action to rectify the situation.
"The Bernanke Conundrum — the divergence between what Professor Bernanke advocated and what Chairman Bernanke has actually done — can be reconciled in a few possible ways. Maybe Professor Bernanke was wrong, and there’s nothing more a policy maker in this situation can do. Maybe politics are the impediment, and Chairman Bernanke has been forced to hide his inner professor. Or maybe the onetime academic has been assimilated by the Fed Borg and turned into a conventional central banker. Whichever account you prefer, however, the fact is that the Fed isn’t doing the job many economists expected it to do, and a result is mass suffering for American workers."
That's a heavy accusation, and Krugman isn't alone in making it. In a working paper for the National Bureau of Economic Research, Lawrence Ball argues that Bernanke has been inconsistent, and collects some other examples ("Ben Bernanke and the Zero Bound, WP #17836, February 2012).
For example, after discussing some of Bernanke's earlier writings, Christina Romer (formerly head of the Council of Economic Advisers at the start of the Obama administration) reportedly said: “My reaction to it was, ‘I wish Ben would read this again.’” Joseph Gagnon (a former Fed economist now at the Peterson Institute) uses the title of Bernanke’s criticism back in in 2000 of the Bank of Japan to criticize Fed policy: “It’s really ironic. It’s a self-induced paralysis.”

Bernanke Pushes Back

Bernanke pushed back against the criticism of inconsistency in his press conference of April 25, 2012. In particular, here's part of what he answered in response to the question: "[S]pecifically
could you address whether your current views are inconsistent with the views on that subject that you held as an academic?" Bernanke answered:
"So there's this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. Our--my views and our policies today are completely consistent with the views that I held at that time. I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation, that is falling prices. The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are no longer--are not exhausted, there are still other things that the central bank can do to create additional accommodation. Now looking at the current situation in United States, we are not in deflation. When deflation became a significant risk in late 2010 or at least a modest risk in late 2010, we used additional balance sheet tools to help return inflation close to the 2 percent target. Likewise, we have been aggressive and creative in using nonfederal funds rate centered tools to achieve additional accommodation for the U.S. economy. So the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation and clearly when you're in deflation and in recession, then both sides of your mandates, so to speak, are demanding additional accommodation. In this case is we are not in deflation, we have an inflation rate that's close to our objective. Now, why don't we do more? Well, first I would again reiterate that we are doing great deal, policy is extraordinarily accommodative, we--and I won't go through the list again, but you would--you know all the things that we have done to try to provide support to the economy. I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased reduction--a slightly increased pace of reduction in the unemployment rate? The view of the Committee is that that would be very reckless. We have--we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation which has proved extremely valuable in that we've been be able to take strong accommodative actions in the last 4 or 5 years to support the economy without leading to a unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do."
As someone without any dog in this fight, how well-founded is the criticism that Bernanke has been inconsistent? Two broad points are worth considering here: How much does Japan's situation in the late 1990s differ from the U.S. situation in the Great Recession and its aftermath? And how has the Fed reaction differed from the Bank of Japan's reaction?

Remembering Japan's Asset Bubble and the Policy Reaction

Japan's Nikkei 22 stock market index rose almost seven-fold in the from 6,000 in 1980 to peak at almost 40,000 at the end of 1989. It then dropped by nearly half in 1990, and had slid back to 8,000 by 2003. Similarly, average land prices for Japan doubled from 1980 to 1991, and then fell back to 1980 levels by about 2004. Banks suffered huge paper losses, but were not forced to reorganize: instead, they took the low interest rates from the Bank of Japan and continued offering loans to underwater "zombie" firms. Moreover, Japan had begun by about 1998 to experience deflation, so even near-zero nominal interest rates were actually positive real interest rates.

In comparison, the U.S. Dow Jones Average rose by about 50% from 2003 to 2007, then fell back to below 2003 levels in early 2009, but now has recovered back to near the 2007 peak. The U.S. housing price bubble has been real and painful, but it wasn't a doubling and then a halving for the average of all housing prices nationwide. The U.S. had very low inflation for a time, but it hasn't actually dipped into deflation. U.S. banks have been recapitalized, by hook and by crook, and forced to undergo stress tests.

In short, an implicit argument that an impartial policymaker should react in exactly the same way to Japan circa 2000 and to the U.S. economy circa 2012 is off the mark, because the situations are substantially different.

Central Bank Policy Reactions

Bernanke's criticism back in 2000 was in response to the fact that in the face of this situation, Japan's central bank had done almost nothing but reduce interest rates for an entire decade.  In contrast, the Fed under Bernanke reacted much more quickly.

  1. The Fed started reducing the federal funds interest rate in 2007, and took it down to near-zero in late 2008. It took the Bank of Japan about four years after the crash to move its target interest rate down to near-zero; the Fed made this change in about 18 months. 
  2. The Fed set up a number of temporary agencies to give short-term loans to all sorts of players in the financial industry in late 2007, including the Term Auction Facility (TAF), Term Securities Lending Facility (TSLF), Primary Dealer Credit Facility (PDCF), Commercial Paper Funding Facility (CPFF), Term Asset-Backed Seucurities Loan Facility (TALF), and others.  All of these agencies were about making short-term loans to get through the crisis, and they were all closed by mid-2010.
  3. The Fed carried out "quantitative easing" through the direct purchase of U.S. Treasury debt--essentially printing money to finance $1 trillion or so of federal borrowing.
  4. The Fed also carried out "quantitative easing" through the direct purchase of a $1 trillion or so of mortgage-backed securities--essentially printing money to provide finance in this sector.
  5. The Fed offered forward guidance about its plans, announcing that it would keep the target interest rate near-zero interest rate low through 2014.   
  6. The Fed now has the power to pay interest to banks on the reserves they are required to hold with the Fed, giving the Fed another monetary policy tool.
  7. The Fed has also changed its policies so that it doesn't just buy short-term Treasury debt, but also buys long-term securities. 

My point here is not to argue over whether each of these policies is effective or useful or appropriate. Instead, I'm listing the policies to emphasize that the Ben Bernanke who wrote back in 2000 has also deployed an unprecedented array of monetary policy tools. Back in 2007, it was reasonable to teach in an intro econ class that the Federal Reserve took action by affecting the federal funds interest rate through open market operations. By 2010, just three years later, the policy menu of the Fed had been transformed. The critics cannot plausibly accuse Bernanke or the Federal Reserve of following the Bank of Japan in the 1990s, cutting interest rates and then sitting on his hands. Instead, to the extent that their claim of inconsistency has any merit, the claim must be that Bernanke should lead the Fed toward even more aggressive use of these non-interest rate tools. But just what non-interest rate tools should be used

Back in his 2000 essay, Bernanke argued that one policy alternative for Japan was to intervene in foreign exchange markets to drive down the value of the yen. However, Bernanke's critics, when accusing him of inconsistency, often don't mention the policy alternative of driving down the U.S. dollar exchange rate. For example, Krugman doesn't mention this choice in his New York Times Magazine article.

Bernanke also recommended back in 2000 that the Bank of Japan announce an inflation target of 3-4 percent, but the Fed has not announced such a target for the U.S. economy. Part of the reason for this may be a matter of legality: the Fed has never announced an official target for the inflation rate, but instead has discussed its legal mandate to deliver "price stability." However, by announcing that the federal funds interest rate will stay near-zero into 2014, the Federal Reserve has in effect promised that even if the economy recovers, it will allow inflation to rise rather than raising interest rates. Of course, the Fed could renege on this promise: but it could renege on an inflation target, too. My guess is that the Fed believes that it has made plenty clear to anyone with eyes to see that as long as economic growth remains so sluggish, it would not clamp down on a low level of inflation.

The remaining dispute is over whether Bernanke should push the Fed to do more of what it has already done; in particular, should the Fed print money to purchase another trillion or two (or three or four) in Treasury debt or private-sector financial securities? One can disagree back-and-forth about the usefulness and risks of this policy choice in good faith. I happen to agree with Bernanke and the Board of Governors that the time isn't ripe for such a step just now. But even if one thinks that the Federal Reserve should be even more aggressive with quantitative easing just now, there is no serious inconsistency between Bernanke's 2000 essay about Japan and deciding not to double down on quantitative easing in the U.S. economy back in 2011 or right now.

There is considerable evidence that recovering from a deep financial crisis takes several years, as households and firms and financial institutions shed debt and rebalance their financial situations. The assertion that this recovery process would have been dramatically shorter if only the Fed would have financed an additional few trillion dollars in quantitative easing is a highly controversial claim--a hopeful theoretical prediction not based on any historical examples.   Bernanke's writings from 2000 to 2003 argue that a central bank confronted with a financial crisis should make aggressive use of unorthodox non-interest rate policies to avoid deflation, and the Fed under his leadership has done so. But Bernanke's earlier writings do not suggest that such non-interest rate policies are a cure-all for what ails an economy and for getting the unemployed back to work the aftermath of a financial crisis. The earlier writings do not suggest that these non-interest rate policies be pursued without limit even after an economy has started growing again, and without regard for balancing their  potential gains and losses.