The old rules still apply (What the rest of the profession could learn from Ben Bernanke)
By Scott Sumner
During the days of William Jennings Bryan it was pretty well understood that deflationary monetary policies helped bondholders and inflationary monetary policies helped debtors. That’s why the rich favored the gold standard and lots of indebted farmers and small merchants favored a bimetallic system (which would have been slightly more inflationary.)
The Federal Reserve may help in boosting the net worth position of households. But does it boost household net worth where it is needed the most? Unfortunately, quite the opposite is true. The Fed directly controls short term interest rates, and hence has the strongest and quickest influence on bond prices. Bond prices are inversely related to interest rates because lower future interest rates make the future coupon payments paid by existing bonds worth more today. The value of long-term bonds can increase substantially if the Fed can lower expectations of future interest rates.
The chart below shows that at the outset of the Great Recession, both house prices and stock prices tanked. As we have done in the past, we index the values to be equal to 100 in 2006, and so the percentage change from 2006 to any year is just the point for that year minus 100.
While stock prices later recovered, house prices remained depressed for an extended period. However, the one asset that did remarkably well was long term bonds. Those holding long term bonds profited handsomely from the decline in interest rates.
Unfortunately for the macro-economy, the gains in long-term bonds were a unique benefit to creditors. Debtors with a levered claim on house prices remained stuck. This was one of the great limitations of how effective the Federal Reserve could be in the midst of the Great Recession.
Many have placed much blame on the Federal Reserve for increasing wealth inequality. That is unfair — it is not the Fed’s fault that only the very rich hold bonds and other financial assets. But it is true that a by-product of looser monetary policy is a rise in wealth inequality-the Fed was unable during the Great Recession to boost the net worth of debtors.
This is a common view–the Fed’s easy money policy helped wealthy bondholders. But is it true, or is the 19th century view more accurate?
The modern view is based on people looking to either interest rates or the money supply as an indicator of the stance of monetary policy. And by those criteria policy was indeed quite loose. But in 2003 Ben Bernanke said neither criterion was reliable, and investors instead needed to look at NGDP growth and inflation. If one averages Bernanke’s two criteria, then monetary policy in the 5 years after mid-2008 was the tightest since Herbert Hoover was president. So there is no mystery that needs to be explained. The reason easy money seemed to defy orthodox economics and help creditors is that monetary policy after 2008 was in fact not easy. Indeed it was highly contractionary.
People sometimes roll their eyes at my endlessly repetitive harping on how monetary policy was not expansionary after 2008. They say it doesn’t really matter what you call it, the Fed did what it did. But the Mian and Sufi post shows it does matter. They draw conclusions about the effect of loose monetary policy on income inequality that are quite misleading. And as an aside this has nothing to do with me being a “conservative” who “doesn’t care about inequality.” Matt Yglesias is quite progressive, and has frequently complained that the Fed’s policy was too tight and was hurting the working class by keeping the job market slack.
Faster NGDP growth (easier money) after 2008 would have helped borrowers. The old rules still apply.
Economists need to take Bernanke’s 2003 claim more seriously. And that includes Ben Bernanke himself, who no longer says what he said ten years ago. When an economist has been both an academic and a policymaker, trust what they say when they have their academic hat on. That’s when they are free to say what they really believe.
Off topic: I’d like to recommend this FT piece by Tim Harford. I believe that an NGDP futures market would provide the sort of real time information that he calls for.