Scott Sumner  

A review of DeLong's review of Bernanke

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In my view, old Keynesianism was based on the cognitive illusion that money doesn't matter, at least when interest rates were near zero. By the 1980s that spell was broken, and we had almost all pretty much rejected old Keynesianism, and moved on. By "all" I mean Brad DeLong, Paul Krugman, myself, and most other macroeconomists. New Keynesianism included many monetarist ideas, a point that DeLong himself made in a Journal of Economic Perspectives article around 2000.

By 2009, however, old Keynesianism was back. In the 1980s we had no idea how powerful those cognitive illusions are. By early 2009 only a few market monetarists had resisted the idea that the Fed was out of ammo. Monetary policy looked ineffective, but it was all a cognitive illusion.

Here's Brad DeLong reviewing Bernanke's book:

Indeed, back in 2000 it was Ben Bernanke who had written that central banks with sufficient will and drive could always, in the medium-run at least, restore full prosperity by themselves via quantitative easing. Simply print money and buy financial assets. Do so on a large-enough scale. People would expect that not all of the quantitative easing would be unwound. Thus people would have an incentive to use the extra money that had been printed to step up their spending. Even if the fraction of quantitative easing that thought permanent was small, and even if the incentive to spend was low, the central bank could do the job.

It is to Bernanke's great credit that the shock of 2007-8 did not trigger another Great Depression. However, what came after has been unexpectedly disappointing. Central banks in the North Atlantic--including Ben Bernanke's central bank, the Federal Reserve--went well beyond the outer limits of what we had thought, back before 2008, would be the maximum necessary to restore full prosperity. And full prosperity continued and continues to elude us. Bernanke pushed the US monetary base up from $800 billion to $4 trillion--a five-fold increase, one that a naïve quantity theory of money would have seen as enough stimulus to create a 400% cumulative inflation. But that was not enough. And Bernanke found himself and his committee unwilling to take the next leap, and do another more-than-doubling to carry the monetary base up to $9 trillion. And so, by the last third of his tenure in office, he was reduced to begging in vain for fiscal-expansionary help from a closed-eared Congress, which refused.


I think this is wrong in a very revealing way. Under the leadership of Ben Bernanke, the Fed did not adopt the sort of policies that Bernanke recommended the Japanese adopt a decade earlier. However to his credit he pushed the Fed in the right direction, and I'm not sure I could have done even as well. The biggest problem was Bernanke's failure to sell the Fed on level targeting, for which there is (based on what I've read) enormous institutional resistance at the Fed. Without the level targeting that he recommended to the Japanese, QE is far less effective. And this should be no surprise, as the Fed had done something similar in the 1930s:

Date--------Monetary Base------Interest rates
Dec. 1929----$6,978m------------About 5%
Dec. 1941---$23,738m-----------About zero

Even so, QE was effective enough so that by late 2013 the Fed believed that aggregate demand was essentially on target, and they began tapering. Note that this was despite a sharp reduction in the federal deficit, which fell by $500 billion in calendar 2013, due to tax increases and the sequester. So contrary to what DeLong claims, Bernanke did not finish up his term begging for fiscal support, but rather he finished up with a monetary offset of austerity that was so powerful (contrary to the prediction of people like Paul Krugman) that the Fed felt it was time to taper. Now they are likely to raise rates next month. DeLong and I may think that's unwise, but the problem has never been a Fed that was short of ammo, but rather a Fed that lacked "Rooseveltian resolve." An insufficiently aggressive target path.

DeLong concludes:

But I do think that the debate over this question is the most important debate within macroeconomics since the debate--strangely, a very similar debate, at least with respect to its policy substance--that John Maynard Keynes had with himself in the decade around 1930 that turned him from a monetarist into a Keynesian.
I agree that we have returned to the same sort of debate we had in the 1930s. I'm probably more disturbed by that than DeLong. I see people like Summers and Krugman abandoning 1990s New Keynesianism and returning to the discredited old Keynesianism of the 1930s, and I see many on the right abandoning the wisdom of Milton Friedman, and returning to the head-in-the-sand conservatism of the 1930s ("AD problem, what AD problem"?)

That's why it's so important to get the facts right. Just as the Abe government showed the BOJ was not out of ammo in the early 2000s, a close examination of what the Fed did and didn't do, and a cross country comparison of monetary policy during the Great Recession and recovery, shows that monetary policy is always and everywhere highly effective.

We just need to use it properly. As Yoda said:

Screen Shot 2015-11-06 at 8.02.07 PM.png
I am almost done with Bernanke's memoir, and will review it next week.


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COMMENTS (20 to date)
marcus nunes writes:

Link to DeLong´s JEP 2000 article:
https://www.aeaweb.org/articles.php?doi=10.1257/jep.14.1.83

E. Harding writes:

I responded to that DeLong review with much more anger and cursing. Your restraint is admirable.

Richard A. writes:

As Hummel shows over at Alt-M, the standard definition of the monetary base broke down when the Fed began paying interest on reserves.

The Monetary Base and Total Reserves: Fed Confusions and Misreporting

Lorenzo from Oz writes:

And then there is the, Australia missed the entire thing and is still in the Great Moderation, point. With a worse hit to export income (as you have previously pointed out) and much milder fiscal policy shifts.
http://stats.oecd.org/#
https://data.oecd.org/gga/general-government-deficit.htm

marcus nunes writes:

Scott, Bernanke does whine a bit about fiscal policy:
"Though a depression was averted in 2008, the recovery in the US and the UK has been anaemic. Bernanke partly blames the imposition of fiscal austerity (spending cuts and tax rises), which limited the effectiveness of monetary stimulus. “All the major industrial countries – US, UK, eurozone – ran too quickly to budget-cutting, given the severity of the recession and the level of unemployment.”
http://www.newstatesman.com/politics/economy/2015/11/ben-bernanke-austerity-went-too-far-uk

Scott Sumner writes:

Marcus, Thanks for the links. Bernanke did complain, but in the last part of his tenure he believed AD was on target. That's why he thought tapering was appropriate.

Lorenzo, Yes, Australia is a good counterexample.

Richard, That's right, and it further weakens DeLong's argument.

Andrew_FL writes:

"New Keynesianism included many monetarist ideas"

Indeed, it was Leland Yeager's view that New Keynesianism was merely a rediscovery of Old Monetarism. (See, for instance, his essay "New Keynesians and Old Monetarists")

Jj writes:

Strangely enough, if the Fed had switched to a 1% inflation target in 2008, the monetary base would be even higher. Delong describes (a) QTM as naive but I don't know if he sees that himself.

ThomasH writes:

I think Scott is straining pretty hard not to see that he and Delong and Krugman pretty much agree. I think most of the "Fed is out of ammunition" talk came from the mediaamacro types, not NK's. And when it did come from them, it was simply recognizing the intellectual/political constraints that the Fed faced (the ones that Bernanke unfortunately does not explain) in showing "lack[ing] 'Rooseveltian resolve'" as Scott puts it of "unwilling to take the next leap, and do another more-than-doubling to carry the monetary base up to $9 trillion." as DeLong puts it.

And if the Fed recognizes that such a constraint does apply, then an increase in the deficit from "fiscal policy" in which governments undertook activities with positive NPVs when looked at using borrowing rates and differences between market prices and marginal costs of inputs to those activities will not be offset by (even tighter) monetary policy, so it makes sense to "beg" for Congress to go allow such "fiscal policy" or at the lease not to go in exactly the opposite direction.

The real monetary policy debate has not been between MMs and NKs but between them and the collection of gold bugs, inflation hawks and others who have pressured for less/zero QE and raising ST rates now, now, now.

There ARE differences between NK. and MMs and neither has gotten it wholly right.

The failing of NKs has been in failing to more explicitly and vigorously to hold the Fed to account for failing to do whatever it takes to keep the price level on a steady trend (and prevent market expectations anchored on that trend). Eliding the difference between monetary policy and moving ST interest rates and between an inflation rate ceiling and a price level trend target has been very confusing.

The failing of MM's has been in not bringing to light the political constraints that have let to Fed failures. Nor have they recognized that there is a role for "fiscal policy" (not abandoning an NPV expenditure rule) when the economy is off the Fed's supposed target.

That the Fed ought to have been targeting NGDP rather than the price level + unemployment is correct in my view, but a side issue or one of how politically to relax the constraints on Fed actions. I don't see how the Fed's unwillingness/inability to follow an NGDP target would have been worse in practice than unwillingness/inability to follow an NGDP target.

marcus nunes writes:

On How a myth is born. Bernanke and the facts:
https://thefaintofheart.wordpress.com/2015/11/08/how-a-myth-is-born/

ThomasH writes:

That Bernanke was a "hero" for having the "courage to act" and avoid the Great Depression is, as Numes recognizes, no myth. It is's possible that he was "heroic" and acting "courageously" in opposing the inflation hawks, godbugs, and mediamacro types who were pushing for even tighter monetary policies straight through from opposing "bailouts" in 2008, QE in 2009-10, to urging increases in ST rates in 2015. Unfortunately he does not explain the political dynamics either inside or outside the Fed that would show this courage or heroism.

That Bernanke thought he could persuade Congress to stop harming long run growth by failing to undertake activities with greater discounted present values than costs during a recession was mistaken but beside the point. I see no evidence that monetary policy was tighter because of a mistaken belief that fiscal policy would make up the difference if monetary policy failed to be stimulative enough to keep the price level (and market expectations thereof) on its supposed 2% trend.

maynardGkeynes writes:

I thought Anna Schwartz, who I think was closer to Friedman's thinking than anyone else, said in effect that Milton Friedman would be deeply opposed to even the current expansion of the monetary base, let alone further expansion.

Scott Sumner writes:

Thomas, I would recommend that you read Bernanke's book---the Obama appointees were pressing for less QE.

And, no, I do not think the solution was doubling the base to 9 trillion, it was setting a different target.

As far as agreeing with Krugman, he's the one that rejects my views on monetary policy effectiveness at zero, you'll have to ask him why.

You said:

"The failing of MM's has been in not bringing to light the political constraints that have let to Fed failures. Nor have they recognized that there is a role for "fiscal policy" (not abandoning an NPV expenditure rule) when the economy is off the Fed's supposed target."

I've never rejected sensible fiscal policy, can you show me where I have? And I've done many posts on the political constraints faced by Bernanke.

I would add that in his memoir Bernanke says the Fed was engaging in monetary offset of the austerity of 2013.

Maynard, I think I am far closer to Friedman's thinking that Schwartz was, at least late in her life. Her comments around 2008 sounded Austrian. Friedman complained the BOJ policy was too tight in the late 1990s, he certainly would have supported QE. He supported QE in the 1930s.

ThomasH writes:

Scott thanks for amplifying your views and for the new information.

Thomas, I would recommend that you read Bernanke's book---the Obama appointees were pressing for less QE.

Disappointing, but perhaps not surprising. Media macro thinking is all over the place. As someone sympathetic to the Obama Administration, on many issue, I'm sorry his appointees were mistaken in this way. [You are right that I have not read the book. Who were those QE Obama appointed QE opponents? They should be "named and shamed."]

And, no, I do not think the solution was doubling the base to 9 trillion, it was setting a different target.

I agree, but being unwilling to double the base (or quintuple it if necessary) was part and parcel of the constraint on going above the 2% inflation rate ceiling and was inconsistent with the inflation target they supposedly had, much less an NGDP target.

As far as agreeing with Krugman, he's the one that rejects my views on monetary policy effectiveness at zero, you'll have to ask him why.

I don't see much to ask about. He flails against the same media macro guys you do, just more colorfully :). I think he also sees the same group as opponents of sensible fiscal policy. I'm not sure if you agree on that part.

I've never rejected sensible fiscal policy, can you show me where I have? And I've done many posts on the political constraints faced by Bernanke.

My impression is that when you mention fiscal policy it is always in a negative way, as if it cannot be helpful when Fed policy is constrained, that is will necessarily be offset by monetary policy. I think it is a very important didactic point -- one that NKs fail to make -- that unconstrained monetary policy CAN offset the macroeconomic effects of fiscal policy. But it is also a mistake, I think, to leave people with the impression that monetary policy always sufficiently unconstrained that it WILL off set bad fiscal policy.

Actually I have somehow missed your explanation of why the Fed seems constrained by a 2% inflation rate target if it is not constrained by being unable to buy the assets in sufficient quantity it thinks would be necessary to achieve a 2% inflation target (which I think is better expressed as a 2% target trend of the price level). Which do you think it is? Or is it something else like unwillingness to raise ST rates sharply (because banks do not like big changes in rates or for some other reason) if the PL was above its target?

I would add that in his memoir Bernanke says the Fed was engaging in monetary offset of the austerity of 2013.

This only adds to the mystery of the political dynamic that allowed the Fed to offset contractionary fiscal policy but did not allow it to let inflation exceed the 2% ceiling as its inflation target and the slow recovery would have required.


Michael Byrnes writes:

Nice article from Justin Wolfers:

http://www.nytimes.com/2015/11/07/upshot/is-the-economy-overheating-heres-why-its-so-hard-to-say.html?smid=tw-upshotnyt&smtyp=cur&_r=0

Reminded me of a recent post of yours about the Phillips Curve.

Kevin Erdmann writes:

If I had an intellectual neutron bomb that could remove an "overheating economy" from macro conversation , boy would I use it. Is there any empirical support at all for the idea that irresponsible inflationary monetary policy is related to low risk premiums in financial markets?

The 1970s are an extreme refutation of that idea.

ThomasH writes:

Slightly off topic but isnt this explanation over on Money Illusion exactly backwards?

Yet inflation targeting has its shortfalls. For example, technological innovation tends to raise real GDP and lower inflation. Under an inflation-targeting regime, the central bank would lower interest rates, which is exactly the wrong prescription.

This seems like exactly the RIGHT prescription: RGDP starts growing faster than before, NGDP growth speeds up less or none, and inflation trend falls. The CB reacts by lowering ST rates (or LT rates or interest paid on reserves or buying foreign exchange or whatever instrument it uses) to assure that the initial fall in inflation is made up by higher inflation later to bring the price level trend back to target and both RGDP and NGDP are growing faster. [The same would be true for a one time positive shock to the RGDP level. Un-off-set changed in RGDP would create uncertainty about the future price level]

NGDP targeting might have the CB tighten monetary policy to force the price level onto a slower growth trajectory to prevent the trend rate of NGDP from increasing. This seems wrong but since real technological shocks are pretty rare, we don't worry about NGDP targeting's failure in this case.

Michael Byrnes writes:

Thomas H wrote:

This seems like exactly the RIGHT prescription: RGDP starts growing faster than before, NGDP growth speeds up less or none, and inflation trend falls. The CB reacts by lowering ST rates (or LT rates or interest paid on reserves or buying foreign exchange or whatever instrument it uses) to assure that the initial fall in inflation is made up by higher inflation later to bring the price level trend back to target and both RGDP and NGDP are growing faster.

No, Scott has it exactly right and inflation targeters have it backwards.

It helps to consider both positive and negative real shocks, and to consider supply vs demand shocks.

Let's say that the economy is humming along steadily (stable inflation and NGDP growth) and then oil prices rise leading to higher inflation. An inflation targeting central bank will now be under pressure to tighten policy. In effect, this takes an economy that is already experiencing an adverse real shock (high oil prices) and adds a monetary shock on top of it (tight policy). The central bank cannot target the real price of oil (an impossibility), it can only force all nominal prices down to offset the effect of high oil prices on the overall price level. And the way tight money forces prices down is by reducing spending (aka, by reducing NGDP). That makes no sense, it is like trying to put a fire out with gasoline. To maintain on target inflation in the face of an adverse real shock requires pulling NGDP growth below trend (an adverse monetary shock).

Flip the situation around. The economy is on target and along comes a positive real shock. Real growth increases and inflation falls. Now, the only way a central bank can return inflation to target is by loosening policy and driving NGDP growth above tren, causing spending and thus prices to rise. But what is the point of this? The economy was already doing fine, why the need to drive prices up?

Relative to an NGDP target, an inflation target is procyclical, calling for looser money and more spending in booms and tighter money and reduced spending in busts. That's not a good idea. Taylor rules try to address this by factoring estimates of the output gap into policy. A negative supply shock will lead to a higher output gap and therefore less monetary contraction than a target of the inflation rate alone would call for.

Jose Romeu Robazzi writes:

I am amazed how certain people have a way with words that make them seem very reasonable, but in fact are very deceitful. What is "full prosperity" ? What is that supposed to mean? RGDP growing at trend? Real wages growing at trend? If so, what trend? Unemployment at or near NAIRU ? If so, what NAIRU? The list can be very long if someone is thorough ...

Jose Romeu Robazzi writes:

The quotes from DeLong are very revealing. "Keynes debated with himself". Of course, there was nothing else worth debating... But that is clearly wrong, there were plenty of other ideas around at that time, and there are today. Those other ideas just do not lead to the old-keynesian solution of choice, deficit spending. Readers should notice that this is an attempt to prevent discussing other ideas.

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