Sunday, October 30, 2011

Who Said This?

The following are some excerpts from a paper on the problems Japan faced in the 1990s. If one were to replace Japan with the United States you might think you were reading a Market Monetarist article.  Consider first, this paragraph:
As already suggested, I do not deny that important structural problems, in the financial system and elsewhere, are helping to constrain Japanese growth. But I also believe that there is compelling evidence that the Japanese economy is also suffering today from an aggregate demand deficiency. If monetary policy could deliver increased nominal spending, some of the difficult structural problems that Japan faces would no longer seem so difficult.
Sounds very Scott Sumnerian.  But it gets better.  The author also makes the Market Monetarist claim that low interest rates can actually be a sign of tight monetary policy:

The argument that current monetary policy in Japan is in fact quite accommodative rests largely on the observation that interest rates are at a very low level. I do hope that readers who have gotten this far will be sufficiently familiar with monetary history not to take seriously any such claim based on the level of the nominalinterest rate. One need only recall that nominal interest rates remained close to zero in many countries throughout the Great Depression, a period of massive monetary contraction and deflationary pressure. In short, low nominal interest rates may just as well be a sign of expected deflation and monetary tightness as of monetary ease.
 And there is this flippant dismissal of liquidity traps like there are a walk in the park:
It is true that current monetary conditions in Japan limit the effectiveness of standard open-market operations. However, as I will argue in the remainder of the paper, liquidity trap or no, monetary policy retains considerable power to expand nominal aggregate demand. Our diagnosis of what ails the Japanese economy implies that these actions could do a great deal to end the ten-year slump.
 Finally, this critique of the uncertainty created by the vagueness of the Bank of Japan's policy objective seems almost eerily similar to the Market Monetarists' critique that the Fed lacks a clear policy objective and that in turn creates more macroeconomic uncertainty:
A problem with the current BOJ policy, however, is its vagueness. What precisely is meant by the phrase “until deflationary concerns subside”? Krugman (1999) and others have suggested that the BOJ quantify its objectives by announcing an inflation target, and further that it be a fairly high target. I agree that this approach would be helpful, in that it would give private decision-makers more information about the objectives of monetary policy. In particular, a target in the 3-4% range for inflation, to be maintained for a number of years, would confirm not only that the BOJ is intent on moving safely away from a deflationary regime, but also that it intends to make up some of the “price-level gap” created by eight years of zero or negative inflation.
In other words, the author is saying here that the Bank of Japan needs do price-level targeting to restore aggregate demand.  In such circumstances, that also amounts to an argument for nominal GDP targeting. But the author is no Market Monetarist. No, he just happens to be Federal Reserve Chairman Ben Bernanke, back when he was an academic.  If Chairman Bernanke ever needed a reason to adopt a nominal GDP level target it is his own work in this paper.  I encourage him to sit down, replace all the Japan references with United States in the above paper, and then ponder its implications for the Fed today.


  1. as much potential as this policy has, could it be that they aren't doing this because they think it will make Ron Paul president?

  2. Not only Ben Bernanke. John Taylor went to Japan in 2006, and gushed about a QE program they were undertaking at that time, and pronounced it a success. Japan quickly regressed back into its old ways, but Taylor's paper is on his website.

    And Milton Friedman went to Japan, and in 1998 wrote that Japan should engage in QWE until it saw inflation.

    And you know what Bernanke wrote.

    So Bernanke, Friedman, and Taylor all agree that sustained QE is necessary when interest rates and inflation are very low but the economy is limping.

    So just as 2+2 equals 4, so the USA should go to sustained QE and rules-based nominal GDP targeting---no?

    No, evidently.

  3. Excellent post David...what we are facing is not a liquidity trap, but are "institutional liquidity trap" - central bankers know exactly what to do, but they won't do it due to political and institutional and maybe even mental limitations...but sure you are right - Ben Bernanke should know what to do.

  4. Lars Christensen,

    It is easy to sneer when you are not responsible. I have no doubt that sufficiently aggressive monetary policy easing excused by an NGDP target would solve many of the present US economic problems, such as raising employment by engineering a stealth cut in real wages, but the question I would ask is "and then what?". Having reduced debt revulsion and raised inflation risk premiums, market interest rates would probably be elevated, and the central bank would be under pressure to keep intervening to keep interest rates down, NGDP target or not. After all, the central bank had a policy rule before and it abandoned that.

    There are often good reasons for institutional limitations.