Why Bernanke won’t ease further

By Felix Salmon
July 12, 2010
Paul Krugman's column today is devoted to telling off the Fed for not being aggressive enough about deflation:

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Paul Krugman’s column today is devoted to telling off the Fed for not being aggressive enough about deflation:

Conventional monetary policy, in which the Fed drives down short-term interest rates by buying short-term U.S. government debt, has reached its limit: those short-term rates are already near zero, and can’t go significantly lower. (Investors won’t buy bonds that yield negative interest, since they can always hoard cash instead.) But the message of Mr. Bernanke’s 2002 speech was that there are other things the Fed can do. It can buy longer-term government debt. It can buy private-sector debt. It can try to move expectations by announcing that it will keep short-term rates low for a long time. It can raise its long-run inflation target, to help convince the private sector that borrowing is a good idea and hoarding cash a mistake.

Nobody knows how well any one of these actions would work. The point, however, is that there are things the Fed could and should be doing, but isn’t.

In a blog entry, Krugman explains why he’s so convinced that deflation is a real and immediate problem: monthly price inflation has been falling steadily since January 2008, and has now reached the point at which it’s sometimes negative.

Krugman’s argument is certainly defensible. But I do wonder whether he isn’t essentially asking Ben Bernanke to step up and provide the stimulus that Summers and Geithner have rejected:

Washington seems to feel absolutely no sense of urgency. Are hopes being destroyed, small businesses being driven into bankruptcy, lives being blighted? Never mind, let’s talk about the evils of budget deficits.

Still, one might have hoped that the Fed would be different. For one thing, the Fed, unlike the Obama administration, retains considerable freedom of action. It doesn’t need 60 votes in the Senate; the outer limits of its policies aren’t determined by the views of senators from Nebraska and Maine.

This is the point at which I remind myself that Bernanke is a Republican. He’s not a party-political hack, but he never evinced any substantive disagreement with Alan Greenspan when the two of them were on the FOMC together, and his extraordinary interventions into the realm of unprecedented monetary policy nearly all happened while he was working hand-in-glove with a Republican administration. Now, Krugman is asking him not only to break significantly away from Republican party consensus but to go much further than even Democrats seem willing to go.

Bernanke is a consensus builder, as Krugman knows, having been part of the Princeton economics department during Bernanke’s tenure as its head. And it may or may not make sense for the Fed to ease much more aggressively. But so long as that remains outside the general consensus, Bernanke’s not going to do it.


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Bernanke cannot work with an adminstration and Congress that will not be fiscally responsible.

The solution, as is widely appreciated, is a combination of fiscal restraint (especially in terms of long-term/structural spending) and loose money (with quantitative easing).

Quantitative easing amid conditions of fiscal profligacy is insanity. History is littered with nasty inflations and hyperinflations when that road was taken.

Posted by DanHess | Report as abusive

It is an ongoing mystery to me what people like Prof. Krugman believe the Fed can do and isnt doing that can create higher aggregate demand. The yield curve runs from 0 to just under 4%, no one can seriously claim that rates are too high. Additional QE could depress the long end of the yield curve, and it will have other unintentional consequences like creating asset bubbles overseas. Further debasement of the currency wont cause what the Keynesians are looking for, the transmission of ever lower rates is broken. If banks arent extending credit, and businesses feel no need to borrow (both fairly rational decisions in this environment) what difference is it where the rates are? Its as absurd as saying the answer to a person on a hunger strike is to shove more pork chops into his freezer, more and more and more….

To get what Krugman and others are trying to have happen, my sense is they oughta just go to the mattresses and demand the Fed fire up “helicopter Ben’s” printing presses and start handing out $100 bills to the public until the economy is in recovery. Far fetched as that is, it would actually do what they want…

Posted by corcoran310 | Report as abusive

Agreed 100% with DanHess. We’re already seeing hints of asset bubbles… There’s only so much you can do with monetary policy.

Posted by TFF | Report as abusive

Is it even fair to say that Dems or Republicans have an opinion of quantitative easing? As far as I can see, Republicans are against fiscal stimulus, which necessarily places their support with monetary stimulus as the lesser of two evils. Democrats are pro-stimulus, which necessarily makes them amenable to monetary stimulus, which is at least something.

Of course this assumes our congressmen understand this sort of thing, which they don’t.

Is Quantitative Easing extremely left, or right? It’s not either. Krugman, Cowen, Sumner, Bernanke, even Friedman before his death — All of them have recommended higher inflation targets in this sort of environment. The only question is why the Fed hasn’t maintained inflation over the past 2 years, not whether or not it will resume. Isn’t inaction in the face of extreme volatility the same as over-reaction in the face of normalcy?

Posted by TeamJohnL | Report as abusive

I agree with TeamJohnL; your last paragraph has more to do with it than the paragraph before it. Lacker, Plosser, Hoenig and Fisher are the issue; Bernanke is only willing to go so far without them.

Posted by dWj | Report as abusive

TFF — That is right. We are presently inflating the largest and most dangerous bubble in world history, a global sovereign debt bubble.

As we have already seen, the first round of quantitative easing was gobbled up by government spending, going staight into treasuries. If the Fed is to engage in QE with any confidence, it must be clear that the need for it is limited and temporary. With large and growing Federal deficits as far as the eye can see, endless QE would be catastrophic.

If you listen to Bernanke testify before Congress, you hear him explain with as much emotion as a Fed chairman can muster that the unsustainable fiscal situation is America’s number one hurdle.

Posted by DanHess | Report as abusive

Ok, now time for a total reversal. The scales have fallen off my eyes.

With the US dollar as our reserve currency, we suffer a massive problem of Dutch disease.
“Dutch Disease and the U.S. Dollar”
http://seekingalpha.com/article/212811-d utch-disease-and-the-u-s-dollar

Here is some good reading to understand Dutch disease and its cures.
“The Dutch Disease and Its Neutralization: A Ricardian
http://www.networkideas.org/featart/jan2 010/Dutch_Disease.pdf

The point is that having the dollar as the reserve currency is not helping us; it is hurting us. ‘Irresponsible’ Q.E. would go far to cure American Dutch disease by scaring away the flood of capital. This is very serious because our economy is being gutted.

Posted by DanHess | Report as abusive