The Mystery of Bernanke Solved
Ben Bernanke was my teacher, and a major influence on my macroeconomic thinking. When he became Fed chairman, I expected the best of him. I was sorely disappointed. His behavior as Fed chairman seemed utterly disconnected from his lectures and writing. In 2008, I kept wondering why he backed the madness of TARP instead of following his own long-standing prescriptions.
Most of the economists I talked to simply dismissed this path not taken. Amidst the chaos, something had to be done. Why couldn’t that “something” be Bernanke’s inflation targeting? Oh, the zero nominal bound. But what about Bernanke’s dismissive writing about the zero nominal bound? You don’t understand, Bryan: We have to do something or the world will end. Eventually the noble Scott Sumner came along, explained my original position better than I ever could, and changed a lot of minds that originally dismissed me.
Still, a mystery remained. If Sumner’s right, why on earth did Bernanke act as he did? Why discard a lifetime’s worth of insight into monetary policy when the world economy was on the line? Many conclude that, as persuasive as Prof. Bernanke’s academic writings were, Chairman Bernanke must have discovered subtle but devastating flaws in his earlier analysis. Appearances notwithstanding, Bernanke’s actual course of action was the best available.
A wonderful, careful, and brave new NBER paper by Laurence Ball offers a compelling solution to this mystery of Bernanke (ungated). Part intellectual history, part public choice, part social psychology, Ball’s “Ben Bernanke and the Zero Bound” argues that:
1. Until mid-2003, Bernanke held precisely the views people like me and Sumner ascribe to him:
In the “Preventing It” speech, Bernanke assures the American public that they have little to fear from the zero bound. At the time of the speech, inflation and interest rates were both approaching zero. Yet Bernanke says “the chance of significant deflation in the United States in the foreseeable future is extremely small.” “I am confident,” he says, “that the Federal Reserve would take whatever means necessary to prevent significant deflation” and that “U.S. policymakers have the tools they need to prevent, and if necessary cure, a deflationary recession.”
If it is easy to cure a deflationary recession, then there is something wrong with a central bank that fails to do so.
2. In a mid-2003 FOMC meeting on the zero bound, Bernanke abandoned his earlier views for totally unconvincing reasons provided by Vincent Reinhart and others:
But why did Reinhart’s briefing have such dramatic effects? Of course, someone can change his mind as a result of new evidence or arguments; Bernanke could simply have found Reinhart persuasive. Yet it is questionable that this simple explanation is the whole story. In 2003 Bernanke was one of the world’s most eminent monetary economists, and he had written extensively about zero-bound policy. Given his expertise and the strong views he had expressed, one might expect Bernanke to take a leading role in the FOMC discussion, to put forward his ideas, and not to change his mind quickly. Even if Reinhart’s arguments were strong, it is puzzling that Bernanke accepted them immediately.
In addition, Bernanke apparently dropped some of his old positions without hearing arguments against them. Reinhart’s briefing and the FOMC discussion emphasized the drawbacks of targeting long-term interest rates, one of Bernanke’s early proposals. But Reinhart cryptically dismissed Bernanke’s ideas about money-financed tax cuts and depreciation, and he completely ignored the idea of 3-4% inflation–and no FOMC member brought up any of these proposals. On these issues, rather than agreeing with persuasive arguments, Bernanke accepted his colleagues’ implicit position that his old ideas were off the table.
3. Bernanke’s change of mind reflects his shy personality plus groupthink:
We can interpret the June 2003 FOMC meeting as an example of groupthink. The recommendations in Reinhart’s briefing were presented as the views of a unified Fed staff. In the FOMC discussion, nobody, including Chairman Greenspan, seriously questioned Reinhart’s focus on his three preferred policy options. By the time Bernanke spoke, a consensus had emerged on a number of points, such as opposition to targets for long-term interest rates. Groupthink may have discouraged Bernanke from shaking up the discussion with his past ideas for zero-bound policy.
It’s not often that an economist writes a Whydunit. “Ben Bernanke and the Zero Bound” had me on the edge of my seat. We’ll never know for sure why Bernanke fatefully changed his mind in the face of flimsy arguments. But after reading Ball’s paper, it’s hard not to quote Sherlock Holmes: “How often have I said to you that when you have eliminated the impossible, whatever remains, however improbable, must be the truth?”