Scott Sumner  

Bernanke on monetary offset and monetary policy impotence

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Commenter Bill directed me to an interesting Ben Bernanke post:

As a general matter, Fed policymakers view economic or policy developments through the prism of their economic forecast. Developments that push the forecasted path of the economy away from the Fed's employment and inflation objectives require a compensating policy response; other changes do not. Consequently, to assess the appropriate monetary response to a new fiscal program, Fed policymakers first have to evaluate the likely effects of that program on the economy over the next couple of years.
Bernanke then correctly distinguished between the AD and AS impacts of fiscal policy:
Fiscal policy influences the economy through many channels. The econometric models used at the Fed for constructing forecasts tend to summarize fiscal effects in terms of changes in aggregate demand or aggregate supply. For example, a rise in spending on public infrastructure, or a tax cut that prompts consumers to spend more, increases demand. Fiscal policies also affect aggregate supply, for example, through the incentives provided by the tax code.
But he goes a bit off course in talking about monetary policy impotence:
The effects of a fiscal program also depend on the state of the economy when the program is put in place. When I was Fed chair, I argued on a number of occasions against fiscal austerity (tax increases, spending cuts). The economy at the time was suffering from high unemployment, and with monetary policy operating close to its limits, I pushed (unsuccessfully) for fiscal policies to increase aggregate demand and job creation. Today, with the economy approaching full employment, the need for demand-side stimulus, while perhaps not entirely gone, is surely much less than it was three or four years ago. There is still a case for fiscal policy action today, but to increase output without unduly increasing inflation the focus should be on improving productivity and aggregate supply--for example, through improved public infrastructure that makes our economy more efficient or tax reforms that promote private capital investment.
He's right that the fiscal authorities should focus on supply-side policies. But he's wrong about monetary policy being close to its limits when he was Fed chair, and I don't think he even believes that. Rather, what I think Bernanke meant to say is that monetary policy was near the limits that were acceptable to a majority of the FOMC, a very different proposition. And I don't think even that weaker claim was true. The Fed did monetary stimulus in late 2012 in order to offset expected fiscal austerity, which reduced the budget deficit from roughly $1,050 billion in calendar 2012 to about $550 billion in calendar 2013. The Fed was pessimistic about the impact of the fiscal austerity, and doubted that monetary policy would fully offset the effects. But it did offset, and then some--growth actually sped up between the 4th quarter of 2012 and the 4th quarter of 2013.

You might think it's kind of arrogant of me to suggest that I know that Bernanke misspoke, that he didn't actually believe that monetary policy was near its limits, and instead meant something else. I suppose I did so because monetary policy was clearly not near its limits, and Bernanke is a smart guy, so presumably he knows this. But how do I know it wasn't near its limits? Here's a simple explanation:

Contrary to the claims of at least some Japanese central bankers, monetary policy is far from impotent today in Japan. In this section I will discuss some options that the monetary authorities have to stimulate the economy. Overall, my claim has two parts: First, that--- despite the apparent liquidity trap---monetary policymakers retain the power to increase nominal aggregate demand and the price level. Second, that increased nominal spending and rising prices will lead to increases in real economic activity. The second of these propositions is empirical but seems to me overwhelmingly plausible; I have already provided some support for it in the discussion of the previous section. The first part of my claim will be, I believe, the more contentious one, and it is on that part that the rest of the paper will focus. However, in my view one can make what amounts to an arbitrage argument ---the most convincing type of argument in an economic context---that it must be true.

The general argument that the monetary authorities can increase aggregate demand and prices, even if the nominal interest rate is zero, is as follows: Money, unlike other forms of government debt, pays zero interest and has infinite maturity. The monetary authorities can issue as much money as they like. Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets. This is manifestly impossible in equilibrium. Therefore money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero. This is an elementary argument, but, as we will see, it is quite corrosive of claims of monetary impotence.


OK, that argument shows that monetary policy has no meaningful limits. But what makes me think that Bernanke is aware of this argument? Because he wrote it.

Another argument is that while the Fed could theoretically create more AD by buying up all the assets in the world, there are institutional barriers to it doing so. I have a counterargument to that as well:

Most of my arguments will not be new to the policy board and staff of the BOJ, which of course has discussed these questions extensively. However, their responses, when not confused or inconsistent, have generally relied on various technical or legal objections---objections which, I will argue, could be overcome if the will to do so existed.
Or how about this:
Japan is not in a Great Depression by any means, but its economy has operated below potential for nearly a decade. Nor is it by any means clear that recovery is imminent. Policy options exist that could greatly reduce these losses. Why isn't more happening? To this outsider, at least, Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced. Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn't absolutely guaranteed to work. Perhaps it's time for some Rooseveltian resolve in Japan.
PS. Instead of saying, "acquire indefinite quantities of goods and assets", I wish Bernanke had written, "acquire indefinite quantities of assets". That latter phrasing would obviously be an equally compelling reductio ad absurdum argument, and it would avoid confusion with fiscal policy.

Comments and Sharing






COMMENTS (12 to date)
Kevin Erdmann writes:

That's one of the strange things about the crisis week in Sept. 2008. While Congress was being asked to pass TARP, AIG was being taken over, massive emergency funds were released, etc., it doesn't seem like it even occurred to anybody to ask the FOMC why the FF rate was still at 2% if the world was about to end.

Market Fiscalist writes:

'The monetary authorities can issue as much money as they like. Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets. This is manifestly impossible in equilibrium. '

I see 3 objections to this line of reasoning:

1. If everyone really did want to hold all their wealth in the form of money then the authorities really could buy everything up without causing inflation. So this argument appears to assume this could never be the case and hence assumes its own conclusions.

2. If the authorities started buying up assets and other goods and services as describes it would at some (arbitrary) point start being described as fiscal policy by fisclaists which would vindicate those who say monetary policy has boundaries.

3. If the govt owned all non-money assets then this would lead to a huge inflow of revenue to the government. Either all the new money would return to the govt and back out whatever inflation had occurred , or (more likely) the govt would run huge deficits that fiscalists would argue was the true cause of the inflation.

bill writes:

@ Kevin, great point. And perversely the Fed sterilized that. The cash infusion of the AIG transaction - they sucked it back out by selling Treasuries.

@ Scott, off topic, would the GDP bonds Shiller is pushing help in implementing NGDPLT in the same way that TIPS help in inflation targeting? And thanks for the generous ht.

Greg Jaxon writes:

Despite its billing it as

an arbitrage argument--the most convincing type of argument in an economic context,
what Prof Bernanke next offers is a flat--equilibrium--use of the Quantity Theory of Money. It lacks any meaningful inter-temporal arbitrage. It's an argument from some divine right of monetary authority, not from actual actors engaged in actual arbitrage to establish prices and discover subjective values.

James Alexander writes:

The difficulty the Fed had got itself into by not acting was compounded by structural issues in the financial sector. Money market mutual funds promised not to "break the buck". If the promise were maintained then negative rates would have plunged their asset manager operators into losses creating a nasty additional loss of confidence in asset managers, when banks and AIG were already in deep trouble. If the promise were broken sudden withdrawals could have caused equal chaos as many assets were not easily liquidated.

I think Bernanke back then couldn't openly admit to these challenges of negative rates without causing additional stress.

Why he can't discuss them now is mysterious. Perhaps he's been bought off by all his post-Fed earnings from banks, asset managers and hedge funds. If so, hat is both sad favour him and for he world.
https://www.bloomberg.com/news/articles/2015-05-06/bernanke-inc-lucrative-life-of-a-former-fed-chairman

Matthew Waters writes:

But Bernanke's last argument is that the BOJ would have to rely on helicopter drops. And yes, the BOJ writing a check to every Japanese household would shift the AD curve at some point.

Bernanke notes this is of course not a political or legal possibility. So his helicopter drop was really FISCAL policy, where the tax rates cooperate with the BOJ until inflation levels are reached. Since it's tough to copy the text, the helicopter drop proposal is on pages 21-23. Bernanke explicitly says "intergovernmental cooperation" is required.

I don't know about Japan, but the mechanics of an automatic counter-cyclical tax cut in America would be very difficult. Would the Federal Reserve Act and the tax code both be amended for the FOMC to have power to lower marginal tax rates at the zero-bound?

There are other concrete steppes below the zero-bound, all of them politically difficult:

1. Negative rate targets with restrictions on physical cash printing, denominations, etc. or a negative rate charged on cash somehow.

2. Very large fiscal stimulus (I would prefer Bernanke's plan to Keynesian spending).

3. OMO's of private, risky assets.

The political will has to be there for one of three things ultimately. Expectations can't reliably bail out the Fed, especially if de jure and de facto banking backstops and regulation get significantly reduced.

Matthew Waters writes:

"I think Bernanke back then couldn't openly admit to these challenges of negative rates without causing additional stress.

Why he can't discuss them now is mysterious. Perhaps he's been bought off by all his post-Fed earnings from banks, asset managers and hedge funds. If so, hat is both sad favour him and for he world.
https://www.bloomberg.com/news/articles/2015-05-06/bernanke-inc-lucrative-life-of-a-former-fed-chairman"

Actually, financial sector VSP's at FT Alphaville, BIS and elsewhere have outright argued that higher rates are needed for "financial stability." The financial sector has tried to argue what you're saying: that banks need the spread from higher interest rates for "financial stability."

I can't speak for how Bernanke's contracts have influenced him. But the simple reason why negative rates are tough is the $100 bill and unlimited conversion from Fed deposits to physical currency. Negative rates have to be limited by the cost of insuring and storing large amounts of $100 bills.

Lorenzo from Oz writes:

Not sure I entirely agree with the point about goods and assets. Folk worry too much about the money-as-asset aspect of money as it is. As Nick Rowe says, the store-of-value aspect of money is the least important aspect of money.

Scott Sumner writes:

Market, It would be nice if the Fed could buy all the world's assets's without creating inflation. But we don't live in a utopia.

bill, Shiller's idea would help a little, but I still prefer NGDP futures markets.

Matthew, Bernanke is not relying on helicopter drops---buying assets is not a helicopter drop.

Lorenzo, I agree with Nick.

Market Fiscalist writes:

'It would be nice if the Fed could buy all the world's assets's without creating inflation. But we don't live in a utopia'

Bob - are you reading this ?

Declan writes:

Hi Scott,

A bit off topic but I just found that FDR started calling for nominal income targeting in 1938 in his state of the union and fireside chats. I sent an email to your Bentley address but don't know if that still works.

Matthew Waters writes:

"Bernanke is not relying on helicopter drops---buying assets is not a helicopter drop."

Yeah, I said OMO's of risky assets would also works. To my personal tastes, I would rather have helicopter drops through tax cuts than OMO's of risky assets. He did make that an option on pages 21-23 of the PDF.

I should have listed NGDP Futures with Fed counterparty as a fourth option at the zero bound.

My humble opinion is MM relies too much on expectations and pure expectations still doesn't graft in my mind without the Fed possibly exercising one of the four options.

And the Fed owning large amounts of private assets brings up so many issues for me. Is the Fed going to participate in proxies? Petition for bankruptcy? Authorize a haircut? It's extremely fraught compared to the other three options.

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