The job of the Federal Reserve system, roughly speaking, is to prevent the economy from spiraling into spasms of uncontrolled inflation or prolonged periods of mass unemployment. Given that the United States is currently in the midst of a prolonged period of mass unemployment, it’s safe to say that the Fed has failed. Under the circumstances, it’s not difficult to see why its chairman, Ben Bernanke, has come in for large quantities of criticism from both sides—and rightly so. A detailed new apologia from Roger Lowenstein in the Atlantic, based on extensive access to Bernanke, attempts to mount a defense of his tenure, but only confirms his liberal critics’ worst fears. Bernanke knows what he needs to do to put people back to work, but refuses to try.
To understand what’s been so horrifying about Bernanke’s turn at the helm, it’s useful to review why people like Paul Krugman, who are now his leading critics, were enthusiastic at the time about his reappointment.
Krugman and other liberals were taken with Bernanke’s work on the Great Depression in the United States and on Japan’s long recession in the 1990s, work that led overwhelmingly to the conclusion that a determined monetary policymaker has the tools necessary to end mass unemployment. Bernanke’s 1999 essay “Japanese Monetary Policy: A Case of Self-Induced Paralysis” concluded with a bold call for Japan to demonstrate what Bernanke called “Rooseveltian resolve.” He wrote that FDR’s “specific policy actions were, I think, less important than his willingness to be aggressive and experiment—in short, to do whatever it took to get the country moving again.” The Bank of Japan’s preference for excuse-making, he thought, was a sign of self-induced paralysis. “Most striking,” he wrote, was “the apparent unwillingness of monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work.”
But Bernanke seems to have taken the BOJ’s conduct, rather than his own criticisms of it, as a how-to guide to steering the American economy.
Why doesn’t the Fed allow somewhat higher inflation? Lowenstein informs us that Bernanke has considered this option carefully. He worries, however, that “any policy adopted by less than a 7-to-3 majority of the Fed’s Open Market Committee would not be viewed by markets as a credible policy.” Maybe that’s true, maybe it’s not. Lowenstein also cautions that “Bernanke is too much a sober central banker to want to risk the Fed’s credibility on inflation.”
Bernanke is, in other words, doing exactly what he slammed Japanese central bankers for doing. And he’s doing it for the exact same reasons. The academic who once said that “FDR deserves great credit for having the courage to abandon failed paradigms” is too sober to abandon an inflation target that’s generated mass unemployment. The central banker has tools at his disposal that might get the American labor market out of the ditch, but he’s unwilling to try them because they might not work.
The one truly valid point Bernanke and Lowenstein raise is that explicit talk of more inflation might be politically untenable. That said, these kind of issues didn’t prevent Roosevelt himself from directly stating a desire to raise prices. What’s more, the Fed chairmanship is not an elected office. His conduct is, by design, insulated from the whims of public opinion specifically so that the central bank can do what’s right for the American economy over the long run. The steep recession of the early 1980s that Paul Volcker initiated in order to whip inflation wasn’t popular: He did it because he thought it was the right policy. Tolerating a spell of higher inflation may sound bad, but by reducing inflation-adjusted interest rates, it would save the country from the investment drought that’s preventing the economy from operating at full capacity in the short term and from increasing its potential for growth in the long run.
What’s more, a central banker willing “to be aggressive and experiment” would note that a variety of alternative ideas exist. Most notably a range of voices from liberal economist Christina Romer to conservative pundit Ramesh Ponnuru to the Goldman Sachs macroeconomic team have suggested that rather than target inflation, the Fed should instead target the overall volume of spending in the economy. This quantity, nominal gross domestic product, is indifferent to whether the higher spending comes because of more real output or higher prices. The idea is to give people confidence that the future holds either higher real output or else higher inflation, but definitely not total stagnation. To the extent that individuals believe this, they’ll become more inclined to invest in risky assets or to acquire concrete goods and services. To the extent that businesses believe it, they’ll be more inclined to invest in expanded operations and new hiring instead of stockpiling cash. Nobody’s tried this before so I can’t promise you it would work, but when the Fed’s Open Market Committee considered it last November, the best objection they could muster was that it might not work.
So here, again, we see Bernanke committing the sin for which he once castigated the Japanese. He’s chosen the guarantee of failure over the risk that trying something new might not work. He’s counting on the Lowensteins of the world to give him credit for trying his best. But he’s not. Perhaps it’s time for some Rooseveltian resolve in the Federal Reserve system.
