Friday, August 13, 2010

Krugman on Bernanke

Paralysis at the Fed
Ten years ago, one of America’s leading economists delivered a stinging critique of the Bank of Japan, Japan’s equivalent of the Federal Reserve, titled “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” With only a few changes in wording, the critique applies to the Fed today.

At the time, the Bank of Japan faced a situation broadly similar to that facing the Fed now. The economy was deeply depressed and showed few signs of improvement, and one might have expected the bank to take forceful action. But short-term interest rates — the usual tool of monetary policy — were near zero and could go no lower. And the Bank of Japan used that fact as an excuse to do no more.

That was malfeasance, declared the eminent U.S. economist: “Far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism.” He rebuked officials hiding “behind minor institutional or technical difficulties in order to avoid taking action.”

Who was that tough-talking economist? Ben Bernanke, now the chairman of the Federal Reserve. So why is the Bernanke Fed being just as passive now as the Bank of Japan was a decade ago?

Now, America’s current economic troubles aren’t exactly identical to those of Japan in 1999-2000: Japan was experiencing outright deflation, while we aren’t — yet. But inflation is well below the Fed’s target of around 2 percent, and it is continuing to slide. And Americans face a level of unemployment, and sheer human misery, far worse than anything Japan went through.

Yet the Fed is doing almost nothing to confront these troubles.
What could the Fed be doing? Back when, Mr. Bernanke suggested, among other things, that the Bank of Japan could get traction by buying large quantities of “nonstandard” assets — that is, assets other than the short-term government debt central banks normally hold.

The Fed actually put that idea into practice during the most acute phase of the financial crisis, acquiring, in particular, large amounts of mortgage-backed securities. However, it stopped those purchases in March.

Since then, the economic news has grown steadily worse. And earlier this week, the Fed changed course — but barely. It now says that it will reinvest the proceeds from maturing securities in long-term government bonds. That’s a trivial change, basically the least the Fed could get away with without facing a firestorm of criticism — and far short of the major asset-purchase program the Fed should be undertaking.

Back in 2000, Mr. Bernanke also suggested that the Bank of Japan could move expectations by making announcements about its future policies. In particular, he argued that it could make private-sector borrowing more attractive by announcing that it would keep interest rates low until deflation had given way to 3 percent or 4 percent inflation — an idea originally suggested by yours truly. Since we are, if anything, in worse shape now than Japan was in 2000, an inflation target of at least 3 percent would very much be in America’s interest. But as chairman of the Fed, Mr. Bernanke has explicitly rejected any such move.

What’s going on here? Has Mr. Bernanke been intellectually assimilated by the Fed Borg? I prefer to believe that he’s being political, unwilling to engage in open confrontation with other Fed officials — especially those regional Fed presidents who fear inflation, even with deflation the clear and present danger, and are evidently unmoved by the plight of the unemployed.

And in fairness to Mr. Bernanke, discord among senior officials also makes it difficult for policy to change expectations: it would be hard to credibly commit to higher inflation if this commitment were constantly being undercut by speeches out of the Richmond or Dallas Feds. In fact, I’d argue that loose talk by some Fed officials is already having a negative economic impact. But while Mr. Bernanke doesn’t have the authority to stop that loose talk, he could make it clear that it doesn’t represent overall Fed policy.

Last, but not least, policy is suffering from an act of neglect by President Obama, who waited until his 16th month in office before offering a full slate of nominees to fill vacancies on the Federal Reserve Board. If he had filled those slots quickly — his nominees still aren’t in place — the Fed might be less passive.

But whatever the reasons, the fact is that the Fed — which is required by statute to promote “maximum employment” — isn’t doing its job. Instead, like the rest of Washington, it’s inventing reasons to dither in the face of mass unemployment.

And while the Fed sits there in its self-inflicted paralysis, millions of Americans are losing their jobs, their homes and their hopes for the future.

Thursday, August 12, 2010

Counting heads on the FOMC

My apologies for being radio silent for so long. There wasn’t much that grabbed my interest until yesterday’s FOMC meeting, which provides us with some limited visibility into how the Fed is thinking.

The FOMC voted (with one dissent, Hoenig of Kansas City) to replace maturing agency paper with Treasuries. This a compromise between the doves who want more quantitative easing and the hawks who want to start shrinking the Fed’s balance sheet now.

Readers will know that I am a student of then-professor Bernanke and thus a super-dove. Like Bernanke, I believe that the Fed should target nominal GDP growth, which means that the Fed should continue purchasing assets until real growth plus inflation are firmly in positive territory, so that deflation is averted and nominal income does not decline.

Unfortunately, the current makeup of the FOMC (including nonvoting members) is six hawks, five doves (if you count Bernanke) and five centrists. So Bernanke simply does not have the votes to get a compelling majority in favor of additional monetary stimulus.

Although Bernanke is a dove, the role of the chairman is to seek consensus, not close votes that hurt “institutional credibility”. Also, I think he also wants to see if there is a double-dip before taking additional action.

Here is the current line-up of hawks, doves and centrists on the FOMC:

Board of Governors (5, pending confirmation of Obama’s three nominees): One hawk (Warsh); two doves (Bernanke and Tarullo); and two centrists (Kohn and Duke).

Regional Feds (voting and nonvoting): Five hawks (St Louis, Kansas City, Richmond, Philly, Dallas); three doves (Boston, New York and San Fran); and three centrists (Cleveland, Chicago and Atlanta).

However, it is possible that the balance of power will shift leftward (dovish) when and if Obama’s three pending nominees are confirmed.

Kohn (vice chair), a centrist, will be replaced on the board by Yellen (SF) who is a dove, and the two vacancies will be filled by dovish-sounding governors (Raskin and Diamond). Presumably Yellen will be succeeded at the SF Fed by another dove.

So you would then have six hawks, three centrists, and eight doves. If the Bernanke/Yellen/Dudley dovish leadership is persuasive, and if the numbers keep coming in weak, there is a good chance of additional monetary stimulus this fall. Keep your eye on real GDP growth and the core CPI (in other words, on nominal GDP growth).

I might also add that, along with leftist economist Nouriel Roubini, I think that we are unlikely to see full recovery until the supply of credit starts rising. Right now, banks aren’t lending, the asset securitization markets are closed, perhaps for good. The credit aggregates are flat or declining, with the sole exception of federal debt.