Fed Chairman Ben Bernanke was asked yesterday in the post-FOMC press conference whether the Fed's response to the current economic crisis is consistent with his views as an academic. The context for this question was Paul Krugman's recent article where he noted that Bernanke was not following his own advice in the late 1990s where he argued that Japanese monetary authorities should be doing more to restore aggregate demand. Here is how Bernanke answered the question:
So there’s this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time.
I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation, that is, falling prices. The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are no longer — are not exhausted. There are still other things that — that the central bank can do to create additional accommodation.
Now, looking at the current situation in the United States, we are not in deflation... So the — the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation.
So Bernanke responds that he is being consistent because in Japan there was deflation whereas currently there is none. But as Ryan Avent notes, his research on Japan was about more than deflation--it was about a shortage of aggregate demand. This point can be easily seen by looking at his 1999 paper where he discusses Japan's economic problems. The first section after the introduction reads as follows:
Diagnosis: An Aggregate Demand Deficiency
Before discussing ways in which Japanese monetary policy could become more expansionary, I will briefly discuss the evidence for the view that a more expansionary monetary policy is needed. 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.
If the section header is not obvious enough, the first paragraph makes clear that Bernanke believed there was a serious "aggregate demand deficiency" problem in Japan. Deflation is nowhere in that lead paragraph. It only appears later as one of several indicators of the AD deficiency. Bernanke even mentions in the paper that using deflation as indicator of weak AD can be problematic:
Perhaps more salient, it must be admitted that there have been many periods (for example, under the classical gold standard or the price-level-targeting regime of interwar Sweden) in which zero inflation or slight deflation coexisted with reasonable prosperity.
Deflation is tricky because it can be caused by both a negative aggregate demand shock or a positive aggregate supply shock. In other words, deflation is only a symptom of the underlying problem Bernanke is concerned about. And, as Bernanke reports, outright deflation occurred only a few years in the 1990s, with most of the deflation instances falling just shy of 0%. In other words, the1990s Japan was not a decade of sharp deflation. This decade actually had a slightly positive rate of inflation on average:
Source: IMF WEO
That is why Bernanke turns to other indicators in his paper to support his story of AD deficiency. For example, here he turns to direct measures of AD to make the case:
Alternative indicators of the growth of nominal aggregate demand are given by the growth rates of nominal GDP (Table 1, column 4) and of nominal monthly earnings (Table 1, column 5). Again the picture is consistent with an economy in which nominal aggregate demand is growing too slowly for the patient’s health.
In short, Bernanke's interest in the troubled Japanese economy was not motivated by deflation concerns, but by AD deficiency concerns. And by this criteria, the Bernanke Fed is not following Bernanke's monetary policy prescriptions for Japanese monetary authorities. This can be seen in the table above that shows average NGDP growth in the United States since 2008 is similar to the low average NGDP growth rate in Japan over the time period covered in Bernanke's paper. Moreover, the deviation of U.S. NGDP growth from its expected path in 2011 is not too different from the deviation of Japanese NGDP growth from its expected path in the late1990s.
In other words, Bernanke's Japanese AD deficiency problem in 1999 is very similar to the current U.S. AD deficiency problem. And contrary to the claims of some Fed officials, this current AD deficiency could be addressed without risking the Fed inflation-fighting credibility by adopting a price level or NGDP level target. Sigh.
P.S. A big thanks to Binyamin Applebaum of the New York Times for asking Bernanke the question.
You are certainly more fair towards Bernanke than I was.
His Japan paper was written for presentation at the AEA meetings of January 2000, so he has to cover "all the bases".
I still believe he is a "rabid" inflation targeter and is also "terrified" of deflation (any deflation).
my daughter would say: "get it, girlfriend!"ReplyDelete
what happened to the Bernanke on Jan 25th press conference (or the tv interview) who said there was a case to be made for more stimulus.
sigh, what we have now is a defacto inflation targeting policy with 2% as the ceiling. what happened to the dual in mandate and all that crap about balanced.
I felt like sighing after reading this post too. But not because I agree with you or Ben.
Sorry I made you feel like sighing. I am sure using the crude term "aggregate demand" was a big part of it, but hey I am speaking the language of our Fed chairman :) Thanks for stopping by anyways.
I agree that he's backtracked significantly from his Japan papers. But he's also backtracked since January, when the "longer-run" goals announcement promised compensatory deviations in inflation. I wrote a blog post this morning, and if you have a minute I'd encourage you to take a look.
- Evan Soltas
I don't get this obsession with deflation. NGDP targeting strikes me as an extremely bad idea.ReplyDelete
A price stability mandate--a zero inflation target or some price averaging target--strikes me as socially desirable.
Would love to read Andolfatto's thoughts on the matter.
P.S. I would love to hear Bernanke and other FED chairs talking more about wealth and social capital.ReplyDelete
It is unfortunate, certainly ironic, that at the same time the US central bank continues to try to solve structural problems with negative real overnight borrowing rates, the television is saturated in advertisements for erectile dysfunction.
Westslope, there is no obsession with deflation. There is concern, however, with a lack of AD. And nowhere has the Fed claimed it is trying to solve structural problems.ReplyDelete
A strict price stability target is problematic because it responds to supply shocks. That's why in practice most inflation-targeting central banks use flexible inflation targeting. However, flexible inflation targeting can create too much wiggle room and remove the discipline of a strict rule. That is why NGDP level targeting is so attractive. See here for more: http://macromarketmusings.blogspot.com/2010/11/why-ngdp-level-target-trumps-price.html
That is interesting. Given the way the Fed currently operates, it is very difficult to make good conditional forecasts. It would be a big step forward if the Fed would follow a rule such that make it easier to do conditional forecasts.
David Beckworth: Fine, and thanks for the reference.ReplyDelete
That said high US unemployment rates that continue to drive radical, desperate FED policy are the result of deep structural problems.
To give a couple of examples:
- under the rubrique of insecure property rights there is kill-take behaviour notably violent colonialism, ethnic cleansing, demographic flooding, etc.
- naive growth ideology
- a broadly-based rent-seeking culture that supports mendacious behaviour
- popular cheap energy entitlement
- illegal immigration
- incredibly disparate educational results between various groups of Americans
As for NGDP targeting, here's a metaphor that might help. Why don't you convince your colleages to put up a nominal output target such as 3 peer-review published articles a year. Journal ranking is not important. If they fail, as a condition of employment, they must ingest lots of stimulants that will hopefully prod them into reaching the publication target.
For the more prolific colleages who mistakenly exceed 3 articles per year, oblige them to smoke strong marijuana or take over-the-counter tranquilizers.
Now if the departmental NGDP target is 3 articles on average per colleague, either oblige everybody to do stimulants if the target is missed or oblige everybody to consume tranquilizers if the target is surpassed.
BTW, I wonder about the Fed's reputation, which must be more for inconsequential dithering than for inflation-fighting.
The public does not know what is the central bank, or who is Bernanke. They only know can they get higher prices for their product or services, and/or sell more.
They do not care about the Fed's reputation.
If sales are robust, maybe businesses can raise prices. If sales are limp, they dare not raise prices, although they may be forced to by higher costs.
They are not reading the indecipherable gibberish put out by the Fed. The Fed has not reputation.
Nice article, thanks for the information.ReplyDelete
Westslope, it is the other way around. There is no "radical" FED procedures. Unemployment simply isn't that bad and is improving. This looks like to me, a typical modern recovery similiar to the early 90's or 00's but from a deeper trough and higher joblessness. Means longer recovery timeframe.ReplyDelete
The 79-83 recession wasn't completely recovered to late in 86. These bigger ones take longer to recover from. I think Bernanke understands this. What he is saying, the current inflation level is consistant to what the economy can produce. NGDP targetting to him would be very unwise and he may be right.
Higher government purchases could change things with the right political group in power, but that isn't likely to happen until 2017 at least.