Bernanke’s fiscal focus

By Felix Salmon
June 3, 2009

Ben Bernanke’s testimony to Congress today starts with 7 paragraphs on general economic conditions, continues with five more paragraphs on the state of the financial sector, and then has six important paragraphs on fiscal policy. Finally, at the end, he spends one paragraph talking about what the Fed is doing in terms of monetary policy and quantitative easing.

This is reasonable enough: after having hit the zero bound, there’s not much which can be said about monetary policy, and fiscal policy is going to be the main driver of America’s standing in the international financial markets going forwards. What’s more, for the past couple of years the Fed has been working hand-in-glove with Treasury: the distinction between fiscal and monetary policy, and the independence of the central bank, have gone by the wayside (quite properly, I might add, contra Angela Merkel) in a time of crisis.

Still, it’s a little disconcerting to see the Fed chairman talk so freely about fiscal policy: now we’ve reached this point, it’s going to be hard to stop him talking this way, even after the crisis is over. And the distinction between the Fed chairman and the Treasury secretary is a useful one, which really should be maintained.

Update: James Pethokoukis, for one, seems to think that the Fed’s actions are divorced from the Obama administration’s economic policy. It’s not clear why he thinks that.

Update 2: Mohamed El-Erian sees the emphasis on fiscal policy as an attempt “to push fiscal sustainability issues clearly away from the Fed’s domain and back where they belong, with Congress and the administration”.


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“James Pethokoukis, for one, seems to think that the Fed’s actions are divorced from the Obama administration’s economic policy. It’s not clear why.”

Um, it’s not clear that these actions are divorced or it’s not clear why Pethokoukis thinks they are?

“These increases appear to reflect concerns about large federal deficits but also other causes, including greater optimism about the economic outlook, a reversal of flight-to-quality flows, and technical factors related to the hedging of mortgage holdings.”

This means that he agrees that the policy of QE and a Stimulus are working. He’s right. Here’s how it works:

From my point of view, this is how you want QE to work against Debt-Deflation, which is a panic phenomenon.
1) Low Short Term Interest Rates, as a disincentive to buy guaranteed assets, and an incentive to buy stocks and corporate bonds. This attacks the Fear and Aversion to Risk.
2) Rising Longer Term Interest Rates, which signal an end to Deflationary Fears, and are an incentive for Longer Term Investing.As well, as you say, the Spread often ( which is as exact as this gets ) signals a recovery.

Now, what’s interesting, is that I take it that this is what Bernanke and Geithner have been arguing, although not necessarily saying it the way I do. And, in fact, it seems to be working, which , again, is about as good as it gets, since none of us know the future.

Yet, as obvious as this is to me, others have been puzzled by this line of reasoning. I, on the other hand, do not understand the point of having interest rates move in tandem, insofar as incentives are concerned.

I understand the idea of rising interest rates being a problem, but the Fed has other means of addressing mortgages, in coordination with other parts of the government. However, I am not for keeping interest rates of mortgages artificially low at all, but certainly feel that this policy should now end. We need to see a plausible bottom on housing prices, without the perception of government still keeping housing prices artificially high.

Of course, Inflation will be the issue going forward, but I prefer that to a Debt-Deflationary Spiral. Call me silly, I guess.

The stimulus:
Tax Cuts as incentives against the Fear and Aversion to Risk.
Infrastructure Spending showing long term confidence in the future.
Current spending, to battle the Savings Spree, also an aspect of the Fear and Aversion to Risk.

These measures are working, combined with a Government Guarantee backing the entire process. As Brad De Long has pointed out, this was the position of Frank Knight, Jacob Viner, Henry Simons, and Irving Fisher, during the Great Depression. It was called the Chicago Plan, I believe. It argued that a Stimulus and QE reinforce each other. They were correct. That’s what we’re seeing.

Nick Rowe wonders how we can tell which of the plans matter more, the Stimulus or QE. We can’t. All we can say is that it seems to be working. That’s as good as it gets.

I believe that this is Bernanke and Geithner’s view. I also believe that Geithner’s view, that we should have guaranteed everything at the outset of the crisis, was correct, and, quite frankly, helps him in dealing with China, because that is China’s position.

Perhaps people who disagree with this could list criteria that they would accept for showing that QE and the Stimulus are working or not. Otherwise, they’re merely stating the obvious, which is that it’s deucedly hard to disentangle the causal factors in this mess. As Wittgenstein says:

“At the end of reasons comes persuasion.”

Today, Martin Wolf argues much the same view, I hope, since I’ve just said that he does. As long as he’s making sense, I don’t care what Bernanke talks about.

“Later George panics when a small fire breaks out and he rushes away, pushing down children, senior citizens, and the clown in the process. He tries to justify his behavior by saying how he acted bravely, like a “leader.”

This is the US. In a panic, niceties like the freedom of the Fed will be tossed aside without regret or remorse. Call it “The Costanza Response”.

Ad) Angela Merkel’s statement.
Her attack on the Fed is an affront!
Is it a terribly propaganda against the backdrop of ECB meeting tomorrow and the election in Germany in the coming months?
Besides: For dogmatic reasons she doesn’t believe that monetary policy affect GDP growth.
PS: How do we say in German?: „Dont fight the fed“.

Um, why would you find this disconcerting? He was testifying to the House BUDGET Committee, after all. Here’s a link to Greenspan before the same committee in 2002. Guess what? He talks about fiscal policy too.

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