Arnold Kling  

The Authority of Ben Bernanke

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In The Atlantic, Roger Lowenstein makes the case for bowing to the authority of Ben Bernanke. This a cover story, and the cover photo of Bernanke makes him look like a serene, benevolent emperor. There is no substantive argument to justify this beatification, other than the usual "things would have been much worse" mantra. If you didn't know better, you would think that liberal progressives take their moral stands solely on the basis of tribal loyalty and reverence for authority.

On the other hand, the classic video Quantitative Easing Explained (The Bernank), which seems to have been made by someone with libertarian inclinations, does not show reverence. It has two substantive points.

One is that "the deflation" was not a legitimate fear. Indeed, if you look at the deflator for personal consumption expenditures, it increased at an annual rate of 2.17 percent from 2000 to 2005 and 2.13 percent from 2005 to 2010. (By the way, Scott, if you take out "housing and utilities," inflation actually was slightly higher in the latter half of the decade than in the first half.) So, if you want to say that "the deflation" was a legitimate fear, you have to fall back on the mantra, i.e., that we would have had deflation were it not for Bernanke's heroics. (data source: 2012 Economic Report of the President and my calculations.)

The second point made in the classic video is that open market operations are a handout to the dealer banks. Suppose the government is going to spend an extra $100 that it does not have, and it will finance this by printing $100. In practice, it borrows $100 from "the Goldman Sachs" by issuing a bond, prints the $100, then pays "the Goldman Sachs" to get its bond back. This second method of funding the deficit is costlier to the government, but yields profits to "the Goldman Sachs." It also yields profits to the Fed, because the Fed is the agency printing the money, while the Treasury is the agency issuing the bonds. However, from a taxpayer's point of view, the Fed's profits are a wash (all of the Fed's gains come at the expense of the Treasury), and the only net impact is the income transfer to "the Goldman Sachs."

The Fed's response to the financial crisis was to massively increase the size of its balance sheet, thereby massively increasing the income transfer to private financial institutions. In addition, in order to keep this additional money from leaking to businesses or consumers in the form of loans*, the Fed introduced a policy of paying interest to banks on reserves. This increased the value of the transfer from taxpayers to financial institutions.

(*note that an increase in loans is what you would have wanted to happen if you were really worried about "the deflation.")

But do not try to tell the readers of The Atlantic that the benign emperor lacks clothing.


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COMMENTS (14 to date)
Fredrik writes:

2000-2005 compared to 2005-2010? Really? It's hard to take your argument seriously when you pick data points like that.

hwt123 writes:

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Trevor Adcock writes:

Why do you say that deflation was not a legitimate fear in 2008 the TIPS spread signaled deflationary expectations, although that figure is distorted by liquidity concerns and other distortions in the market. Also disinflation did in fact happen and is bad just like deflation.

I don't see why you keep trying to push this bizarre conspiracy theory about Ben Bernanke being a pawn of the banks, maybe he is just a government official trying to do monetary policy the best he can in a hostile environment, where pushing for expansionary policies that would restore the previous nominal path of the economy are heaped upon with scorn by people such as yourself.

And declaring your opponents positions as being the result of irrationality and group think does not make your own positions suddenly free of such biases.

rapscallion writes:

Frederick,

Here's the PCE data:

http://research.stlouisfed.org/fred2/graph/?s[1][id]=PCEPI

There was a sharp drop in the PCE in late 2008, but it was over by 2009, well before QE2.

Bill Woolsey writes:

The Federal Reserve act prohibits the Fed from buying bonds directly from the Treasury. Those writing the act thought that the Fed should lend to commercial banks using real bills as collateral. They thought that creating money and lending it to the government to spend was inflationary.

Today, most monetary economists believe that it doesn't really matter much whether the Fed creates money and lends it to banks with "real bills" as collateral, purchases existing goverment bonds from private investors, or purchases brand new government bonds to fund a current budget deficit. I think most monetary economists are right on this one.

However, that the Fed trades directly with dealers (like Goldman Sachs,) is significant in exactly what manner? Whether or not the Treasury is funding a deficit by selling bonds is irrelevant. The Fed buys bonds from a dealer directly, but the dealer is buying the government bonds from private investors. The new money might go to the dealer immediately, but it is actually going to the private investors who sell their government bonds to the dealer.

The notion that by having the Fed buy from dealers this means the money is somehow stuck at the banks (the dealers) is wrongheaded nonsense. The notion that the new money is somehow a gift to the banks (the dealers) is wrongheaded nonsense.

If the Fed directly purchased bonds from households and firms, that is, operated its own dealership, then it would cut out the primary dealers. Would that be cheaper? Could they get a lower bid ask spread than what the dealers offer for these trades?

Further, in reality, the Fed didn't benefit banks in 2008 by allowing them to earn a bid ask spread on government bonds. The Fed made massive loans to banks, though these have since been paid back.

I think Bermanke did a terrible job and the Fed needs to be replaced. But there are a variety of confusions and misrepresentations in the story that quantitative easing is about enriching Goldman Sachs.

Nearly all financial institutions, and pretty much everyone who isn't storing currency in a vault, would suffer if the Rothbardians had their way and the money multiplier (M3? MZM?) was reduced to 1, with base money stayed at its $800 billion level of 2008. That the "banksters" were "bailed out" from that ruination is the background of "the Bernank" video.

Balled up in it is the even more bizarre theory that the secret international bankers are profiting from their ownership of the Fed, as opposed to having the Treasury just print up money to fund deficits. In the intersection of Rothbardian/Patriot thought that runs through the popular Ron Paul movement, inconsistent elements of those views are combined.

Of course, that the Fed is paying interest on reserve balances _is_ paying a pittance to commercial banks. (What is Goldman Sach's reserve balance? It did get a commercial bank charter.) And one of the stated reasons for this is to keep interest rates above zero on money markets so that the traditional practices of the traders will not be disrupted. Still, I find it hard to believe that the real purpose is anything other than allowing investors holding short and safe assets like T-bills and FDIC insured deposits continue to earn something. Those risk adverse retirees have political influence.

Shayne Cook writes:

I read the Lowenstein ( the Atlantic) article, and it's very good - and honest. I didn't get the sense that the article portrayed, or even attempted to portray Bernanke as an "emperor", benign, benevolent or whatever.

All that aside, I've grown weary of Bernanke-bashers who have to resort to cartoons* and misinformation** to attempt to make their points.

* I don't debate with, or on the merits of, cartoons, so I'll just skip this one. Arnold, cartoons are for children and the weak-of-mind - you are neither, so leave the cartoons for the kiddies.

** Arnold, in your third paragraph it's argued that "deflation was not a legitimate fear" and that the only counter-argument is "there may have been deflation, had Bernanke (the Fed) not intervened". You are correct that the counter-argument is weak, but the claim that deflation was not, or would not have been, a factor is equally weak - and for the same reasons. Commenter Fredrik makes an excellent point - picking your data points is an exercise that would make Darrell Huff ("How to Lie with Statistics") proud.

In your fourth paragraph, the alleged "second point" of the cartoon, you state that the "government prints money". That's misinformation. The Federal Reserve - which does print money - is NOT the Federal Government. I noticed you also allude to the "profit"*** made by [ostensibly solely] the Federal Reserve in it's supposedly nefarious dealings. So in your fourth paragraph you allude to the Federal Reserve as the "government", but only the part that makes a "profit". Both are wrong.

Unless I'm mistaken, the original 1913 enabling legislation for the Federal Reserve specifically precluded the Federal Reserve from direct purchases of Federal Government debt sold by the Treasury. That was included in the enabling legislation in order to preclude the Federal Reserve from degenerating into the "piggy bank" of politically motivated Federal Government expenditures and excesses.

The Federal Reserve must buy whatever Government debt it owns from private holders, after they have purchased it from the U.S. Treasury. Granted, Goldman Sachs is a primary dealer. But it is not the only primary dealer from which the Federal Reserve can purchase Government debt. With some deference to David R. Henderson, there are even a couple of Canadian banks that have been designated primary dealers. (Bank of Montreal is one, if memory serves.)

*** The same 1913 enabling legislation stipulates that whatever "profit" that is made by the Federal Reserve in its various dealings must be returned to the Treasury (Federal Government, taxpayers) in the form of retired debt. So it seems the interest payments made by the taxpayers each and every year, on the debt holdings of the Federal Reserve, are paid to none other than those same taxpayers. Quite frankly, under current law, I'd love to see the Federal Reserve buy/own ALL Federal Government debt, irrespective of who they buy it from, or how much they pay for it.

But I'm not without (legitimate) criticism of Bernanke's Fed. As Lowenstein notes and discusses extensively in his article, Bernanke intervened in a specific market (housing) in his 2008 and subsequent actions. That's unprecedented and far outside the scope of the Fed charter. And it shouldn't have been done, in my opinion. But I would note that that specific (housing) market was then and still is in a deflationary mode - whether cartoon characters recognize that or not.

Sonic Charmer writes:

It's been fascinating to learn that (qua Bill Woolsey) increased Fed purchasing doesn't make dealers any money, because after all dealers don't make any bid-offer over and above what end-holder clients charge, (and certainly dealers can't and don't ever front-run what they know/suspect the Fed might do), and thus (one concludes) dealers should be indifferent to Fed activity or lack thereof.

Has anyone told the dealers all this?

Steve Waldman writes:

given all the benign emperors who lack clothing, i wish we had more empresses.

Arnold Kling writes:

@Bill Woolsey,
The point I was trying to make is that the Fed tried really, really hard *not* to add to the money supply while greatly expanding its balance sheet. That appears to me, and always appeared to me, to be primarily focused on subsidizing large financial firms. It is based implicitly on a trickle-down theory, in which distress at large financial firms trickles down to individuals in the economy.

My guess is that you do not subscribe to that trickle-down theory any more than I do.

Jim Glass writes:
... "the deflation" was not a legitimate fear. ... if you want to say that "the deflation" was a legitimate fear, you have to fall back on the mantra, i.e., that we would have had deflation were it not for Bernanke's heroics.
No, no, no.

Both CPI and PCE fell at a 13% annual rate(!) during 4th Q 2008, the crisis months. That's deflation as not seen since the worst "plunge" days of the Great Depression.

Deflation was real and here, as not since the worst of the very bad old days. Prices were falling like the proverbial rock in the second half of 2008.

The Fed's emergency QE1 starting in November stopped the fall in 2009 Q1 and then reversed it, exactly as Milton Friedman (or Scott Sumner) would have predicted.

Looking back at only year-over-year numbers *after* the Fed reversed the price fall, seeing only the effects after the reversal and thus concluding no price fall ever happened, is a big methodological mistake.

The deflation we had then would have continued but for Bernanke's actions.

foseti writes:

I've been arguing for a long time that the Fed really has a triple mandate (not a dual mandate). The third prong is the stability and soundness of large bank holding companies.

If you view Bernanke's actions in light of this additional mandate, all his actions make sense.

It's the 3rd mandate that really motivates Fed behavior, as Professor Kling seems to have noticed.

olde reb writes:

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Joe Eagar writes:

The Fed's profits are not "a wash." If the Treasury had to offer the bonds the Fed buys in the open market, it would have to pay market interest rates for them. In addition, the Fed earns significant income off it's mortgage-backed securities portfolio, which most definitely *are* a new gain to the Treasury.

The job of the central bank is the invest the risk-free base asset: currency and bank reserves. By holding currency or reserves, the public is in effect giving a loan to the government. This is why central banking is profitable, and capturing this profits is why Congress banned state banknotes during the Civil War.

Joe Eagar writes:

Ok Arnold, you blame the Fed for subsidizing financial firms during a *financial panic*? A panic that threatened to plunge the world into Great Depression 2.0?

Of course that was there goal. That's why central banks exist in the first place: to provide money (eww! bailouts!) during financial panics. They've done so for hundreds of years.

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