Scott Sumner  

Bernanke on monetary policy options

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Rajat directed me to a series of posts by Ben Bernanke, discussing monetary policy options if the US once again hits the zero rate bound. Bernanke thinks this problem is likely to occur in the next recession, and I agree. Here's the punch line:

To anticipate, I'll conclude in these two posts that the Fed is not out of ammunition, and that monetary policy could help cushion a possible future slowdown. That said, there are signs that monetary policy in the United States and other industrial countries is reaching its limits, which makes it even more important that the collective response to a slowdown involve other policies--particularly fiscal policy. A balanced monetary-fiscal response would both be more effective and also reduce the need to use unconventional monetary tools.
In a recent post, I quoted from a 2004 Bernanke paper, where he indicated that if monetary policy is less effective at the zero bound, then the Fed might need a higher inflation target. Here he suggests fiscal stimulus as the relevant alternative. I prefer his 2004 approach, as I think a higher inflation target would be far less costly than fiscal stimulus. However I also think that NGDP targeting, level targeting, is superior to either fiscal stimulus or a higher inflation target.

The first post in Bernanke's series focuses on negative interest on reserves. Bernanke thinks this is an attractive option, but suggests that it's unlikely that the Fed could push rates as far below zero as Switzerland (minus 0.75%) without either technical or political complications.

Nonetheless, I am heartened by Bernanke's endorsement of the basic concept. Although market monetarism is often associated with NGDP targeting, that idea actually pre-dates market monetarism by several decades. On the other hand negative interest on reserve truly is a market monetarist idea, which was originally greeted with great skepticism. If it's now catching on, that suggests that we (MMs) might know something useful about monetary economics. On the other hand our motivation (reducing the demand for the medium of account) is very different from the justification of more mainstream economists (reduce market interest rates.)

In the second post in the series Bernanke focuses on a long-term bond yield peg, such as the 2.5% cap on long term Treasury bond yields maintained by the Fed during and after WWII. Here again Bernanke takes a more interest rate-oriented approach than I would prefer, viewing low rates as easy money. In contrast, NeoFisherians might view a low bond yield peg as a policy that actually lowered inflation expectations, i.e. a contractionary policy.

Market monetarists take an intermediate position. A promise of low interest rates well into the future might be viewed as an easy money policy, or it might be viewed as "promising to be like Japan", in other words a very pessimistic forecast for the US economy. I'm not saying Bernanke's proposal would not work---the focus on 2-year bond yields makes it more likely that it will be viewed as expansionary than would a 10-year promise---but there are dangers. I'd prefer a promise to buy assets until NGDP (or inflation) forecasts rose to the Fed's target path.

In the two posts, Bernanke occasionally alludes to the difficulty in getting the FOMC to accept ambitious policy initiatives, and I think his statements about the need for fiscal support need to be viewed in that context. In my view a sufficiently determined central bank can always inflate, at least up until it owns the entire global stock of assets. And if that happened there'd be no need to inflate in any case, as the entire country's population could stop working and simply live off the sweat of foreigners.

Of course I'm half-joking, but only to show how absurd is the concept of a central bank running out of ammo. That's not a criticism of Bernanke, I can easily imagine that he is picturing what it would like to be Fed chair once again, and he may well be right that it would be impossible to sell the FOMC on the needed stimulus, and hence that fiscal stimulus would help.

But it's very unlikely that fiscal stimulus would ever come to the rescue, at least in the sort of quantity that would be needed. Japan's national debt soared in the 1990s and 2000s, and yet their NGDP actually fell over two decades (1993-2013)---the worst performance by NGDP for a developed country in world history. If even Japan's huge deficits were not enough to boost AD at all, just imagine getting a future GOP Congress to do what it takes. In my view we need a conversation about changing the Fed's target, to a new target which makes the zero bound much less of a problem---something like NGDPLT.

I hope that Bernanke will speak out on this issue in the future, even if he opposes NGDPLT. There are other options, such as a slightly higher inflation target. I don't know for sure that my preferred policy target is optional. But there is one thing of which I am certain. If the current 2% inflation target is going to lead to future monetary policy failures so severe that a fiscal rescue is needed, then the current 2% inflation target is definitely not optimal. If Bernanke is right that we might again hit the zero bound during the next 10 years, then Janet Yellen and the Fed made a mistake raising rates in December, even if not doing so would have pushed inflation above the 2% target.

You can argue for monetary policy ineffectiveness, or you can argue for a 2% inflation target. You cannot argue for both. I'm not seeing enough Keynesians loudly and forcefully making that point.

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COMMENTS (12 to date)
bill writes:

I don't mean to offend Bernanke, but his Fed didn't even lower IOR back to zero. That would seem to me to be the minimum a Fed could do and not doing so costs a lot in credibility (i.e., regarding the Fed's desire to grow the economy. Inflation fighting credibility has never been stronger).

I concur on buying up the entirety of world assets. We should be so lucky [smiley face]. And I'd even agree that once the Fed owns all the assets in the world, we can cut US tax rates to zero as part of some fiscal stimulus [more smiley faces].

Brian Donohue writes:

Good post. The US Federal Deficit is again increasing and will top $500 billion again soon, six years into the economic recovery.

Fiscal stimulus compared to what?

Benjamin Cole writes:

Excellent blogging and I can scarcely believe Bernanke's dismissal of robust QE. Let alone cutting IOER, or NGDPLT or even an IT band of 2% to 3%.

There something about the institutionalization of a person in a central bank that converts them to certain policy positions. It must be like taking the job of Secretary of Defense or Agriculture. Inevitably, one's perspective changes.

No one at the Fed ever says, "We did more than $3 trillion dollars in QE, and we are still below a very low inflation target. Ergo, there is lots of room to pay down more of the national debt without consequence, or only postive cnnsequences."


Rajat writes:

Thanks for the HT, Scott. Any further thoughts on the likely effect of Bernanke's bond yield-peg proposal? Are you really saying it could potentially go either way?

Another comment you may be interested in, from Krugman, made in a recent meeting with Japanese officials: (HT Giles Wilkes). Krugman talks up the case for more fiscal stimulus as a very important "aid to monetary policy in breaking out of deflation". He almost seems a bit MMT-like.

Scott Sumner writes:

Bill, Brian and Ben, I agree.

Rajat, Yes, it could go either way, but as I said a peg of rates as short term as the 2 year yields suggested by Bernanke is likely to be expansionary, just as he suggests. But the longer the peg, the more likely the NeoFisherian result occurs.

Suppose the BOJ promised to keep rates at zero for 50 years. And suppose it was credible. I'd take that as evidence that the BOJ intends to keep the yen gradually appreciating against the dollar, for many decades.

J.V. Dubois writes:

I really do not understand this talk about "unconventional monetary policy tools".

Bank of Japan keeps interest rate between 0% - 0.5% for over two decades. So it is safe to assume they used some kind of "unconventional" monetary policy tools to steer nominal economy given their excellent track record of keeping price level stable up until very recently.

How longer untill these alternative monetary policy tools are going to be considered as conventional? When the last japanese economist who remembered using conventional tools as a todler dies at his 100 in 2096? This is absolutely ridiculous.

I cannot imagine any other government organization being so rigid in their tool selection. Imagine army generals tasked to fight modern asymmetric terrorist threats dreaming about "normalizing" so they can return to nuclear warfare doctrine from the cold war.

James Hanley writes:

5 or 6 years ago I asked on some econ blog (perhaps here, perhaps at your money illusion blog), about negative interest rates, primarily because I didn't know enough about macro to not ask, was curious about whether zero was really a bound, and because it seemed easily done technically. It was the actual effects -- particularly side effects -- I wondered about.

I don't remember the exact reply (or who replied), but it wasn't positive.

So I've found it surprising that the idea is now being bandied about seriously. Maybe Bernanke read my comment. ;)

Bob Barrett writes:

Mr Sumner,
This is the second time that I can recall Bernanke suggesting that fiscal policy would be helpful. The strongest argument that I know against fiscal policy is monetary offset, which is a very strong argument. However, having the chairman of FRB stating that fiscal policy would be helpful tells me that he would not have offset monetary policy. At some point, shouldn't we take him at his word? And more importantly, if the MMs and Keynesians were able to reach a compromised, although less than perfect, stance on how to restore NGDP, wouldn't the world be a better place?

Scott Sumner writes:

JV, I agree.

James, I believe I was the first to publish an article advocating negative IOR, back in January (and again in March) 2009.

Or maybe he read your comment. :)

Bob, He has often recommended fiscal stimulus. But you can also find statements indicating monetary offset. So then you must decide which statements are correct. I believe that actions speak louder than words, and that the Fed's fiscal offset of 2013 pretty clearly indicates that fiscal offset is the policy.

ThaomasH writes:

We certainly cannot know if a 2% inflation target (as the "prices" half of the Fed's dual mandate) is optimal or not because it has not been tried. We do know that the 2% inflation rate ceiling target is sub optimal. On the other hand, we do not know if "fiscal policy" is inadequate either because governments during recessions have been reluctant to borrow and invest at anywhere near the levels that a NPV rule would suggest; apparently in the EU it is against the law.

As a practical matter, I'll place my money on an NGDP level trend target. But If the Fed footnotes that to mean that the 2% inflation rate ceiling is still binding or if there are arbitrarily limited amounts of non-ST, non-government assets that can be purchased, NGDP targeting may be no better than inflation targeting was.

Nick Bradley writes:

Japan's 25-54 population is shrinking and is the same size as it was in 1975; I really don't know what you expect...

Denys writes:

I'm a businessman wondering whether to invest. I'm a consumer wondering whether to consume. Am I stimulated by negative interest rates or further QE? I don't think so.
Because everyone else is sitting on their hands like me.
But if someone decides to set up a nearby factory, stimulated by a fiscal grant of some type, then I might indeed decide that the extra demand in the local area will make it worthwhile to invest or, as a consumer whose wages might be increased, buy that new car.
That said, neither low interest rates nor fiscal deficits seemed to make any difference in Japan. Indeed they may have been a negative influence net net. So maybe the answer is to stay out of the way and let animal spirits do what they will - with the occasional fiscal tweak from government to help as a mild catalyst.
Oh, ......that's what they are doing in the US right now!

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