Bernanke on monetary policy options
By Scott Sumner
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.