Previewing his upcoming book The Courage to Act: A Memoir of a Crisis and Its Aftermath slated to come out the next day, Ben Bernanke discussed recent monetary policy history and general principles of monetary policy in the October 4, 2015 Wall Street Journal op-ed “How the Fed Saved the Economy.” He said a number of important things very well. Here are my favorite passages. I added headings, but the words in the indented bits are Ben’s. After quoting Ben, I give my take on his record at the Fed.
The Limits of Monetary Policy
Fed critics sometimes argue that you can’t “print your way to prosperity,” and I agree, at least on one level. The Fed has little or no control over long-term economic fundamentals—the skills of the workforce, the energy and vision of entrepreneurs, and the pace at which new technologies are developed and adapted for commercial use.
What Monetary Policy Can Do
What the Fed can do is two things: First, by mitigating recessions, monetary policy can try to ensure that the economy makes full use of its resources, especially the workforce. High unemployment is a tragedy for the jobless, but it is also costly for taxpayers, investors and anyone interested in the health of the economy. Second, by keeping inflation low and stable, the Fed can help the market-based system function better and make it easier for people to plan for the future. Considering the economic risks posed by deflation, as well as the probability that interest rates will approach zero when inflation is very low, the Fed sets an inflation target of 2%, similar to that of most other central banks around the world.
The Record for the US, the UK and the Eurozone Indicates that the Great Recession Called for Monetary Stimulus
Europe’s failure to employ monetary and fiscal policy aggressively after the financial crisis is a big reason that eurozone output is today about 0.8% below its precrisis peak. In contrast, the output of the U.S. economy is 8.9% above the earlier peak—an enormous difference in performance. In November 2010, when the Fed undertook its second round of quantitative easing, German Finance Minister Wolfgang Schäuble reportedly called the action “clueless.” At the time, the unemployment rates in Europe and the U.S. were 10.2% and 9.4%, respectively. Today the U.S. jobless rate is close to 5%, while the European rate has risen to 10.9%. …
Meanwhile, the United Kingdom is enjoying a solid recovery, in large part because the Bank of England pursued monetary policies similar to the Fed’s in both timing and relative magnitude.
The Supply Side
With full employment in sight, further economic growth will have to come from the supply side, primarily from increases in productivity. … As a country, we need to do more to improve worker skills, foster capital investment and support research and development.
My Take on Ben’s Record
Ben has been criticized for many things. I think that higher equity requirements–including mortgage reform involving more equity provided by not just homeowners but other investors to get higher equity requirements for mortgages–and sovereign wealth funds are the right tools to deal with financial instability, not monetary policy, so I certainly don’t follow the chorus faulting the Fed for causing bubbles by keeping interest rates too low in 2003. (Ben was not Chair then, but he was an influential Governor.)
Ben, however, like many of the rest of us (I definitely include myself) did not do enough to recognize building financial instability and push for higher equity requirements before things blew up in 2008. My now deceased University of Michigan colleague Ned Gramlich was one of the few within the Federal Reserve Board who recognized some of these building problems when he served as a Governor of the Federal Reserve Board. Like Alan Greenspan, Ben should have paid more attention to Ned, and Ned should have been more insistent on his point.
In later decisions, in hindsight, Ben should probably have pressed to save Lehman. But it is not at all clear that could have arrested the crisis, since some other bank might have then failed and pulled things down.
Nevertheless, once Lehman fell, Ben’s actions were heroic, both in helping to push through the unpopular but necessary bailouts and in bringing the Fed around to a serious program of quantitative easing that helped greatly, as Ben points out in one of the passages above.
Overall, Ben is a hero in my book. The mistakes he made are mistakes I think I would have made myself. (I know that, because I have a reasonably good memory of what I thought in real time along the way.) But what he did right was something that very few people could have done as well.
Going forward, for the future of monetary policy, my wish would be for Ben Bernanke to help in pushing for a further expansion of the monetary policy toolkit. Despite Ben’s heroic actions, the actual outcome of US monetary policy–7 years of sluggish growth and zero interest rates–was terrible in absolute terms. There is a simple reason why: the zero lower bound. As far as I know, Ben has yet to acknowledge publicly the fact that the zero lower bound is a policy choice, not a law of nature–and that ways to eliminate the zero lower bound are quite practical. See my bibliographic post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.” In recognizing and discussing publicly how easy it is to break through the zero lower bound, Bank of England Chief Economist Andrew Haldane is ahead of Ben. As things stand, the Bank of England is poised to do a much better job in the next serious recession than the Fed. Ben could do a lot to fix that by speaking frankly about the welcome fragility of the zero lower bound.