Why Bernanke’s not doing more

By Felix Salmon
June 20, 2012

I don’t think there’s all that much difference, in reality, between the Ben Bernanke we saw at today’s post-FOMC press conference, on the one hand, and Mohamed El-Erian, criticizing Bernanke’s decision, on the other. Both of them say that Fed action at this point is a second-best solution to the economic problems facing the US: what we really need — and aren’t going to get — is fiscal, not monetary, stimulus.

Bernanke got quite a few questions today asking why he wasn’t being more aggressive; certainly extending Operation Twist by a few months is unlikely in and of itself to make much of a noticeable difference to anything. As Joe Weisenthal points out, if the market thought that Operation Twist would actually boost US growth, then the announcement should have sent long bond yields up; instead, then went down.

That said, all markets are distorted right now by what you might call Global Zirp. El-Erian worries about the long-term implications, without quite coming out and saying that they’re unavoidable:

What this continued Fed activism will do is to continue altering the functioning of markets, contaminate price discovery and distort capital allocation. Already, the viability of several segments – from money markets to insurance and from pension provision to suppliers of daily market liquidity, all of whom provide financial services to companies and individuals – has been undermined. The Fed has also conditioned many market participants to believe in a policy put for both equities and bonds. And other government agencies are relieved to have the policy spotlight remain away from their damaging inactivity.

Of all the things to worry about right now, price discovery and capital-allocation distortions are pretty low down the list. I’d happily do enormous damage to both of them if I thought it would do any good in terms of creating jobs. I’d even come out and say I’d spend a trillion dollars buying broad stock-market index funds below a certain level. There’s no point in fetishizing market liquidity and shadow-banking institutions like money-market funds if they don’t actually help workers rather than savers.

On the other hand, if your non-standard techniques aren’t going to do any good anyway, there’s no point in hurting markets — and the less that the Fed does now, the more dry powder, at least in theory, it has to respond to a European meltdown or the fiscal cliff.

At one point in the press conference, a reporter from Nikkei asked Bernanke if the US is in a liquidity trap. Bernanke didn’t answer directly, but the indirect answer was yes: there are things that central banks can and should do to stimulate the economy even when interest rates are at zero, he said, and we’re doing them. Paul Krugman would disagree, of course. But it was clear from the press conference that Bernanke feels as though he has at least some extra ammunition in the back of his armory in case things get worse still. Which raises the obvious question: why isn’t he using that ammunition now?

Binyamin Appelbaum asked that question of Bernanke in April; here’s how Bernanke responded.

The view of the committee is that that would be very reckless. We, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four or five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.

From today’s presser, my feeling is that Bernanke maybe doesn’t feel as strongly any more that he would be reckless to act more aggressively. But he does still feel that the upside from doing so is “doubtful”. If he’s forced by crisis to pull out the ammo, he’ll do so. But Bernanke clearly doesn’t consider the unemployment crisis to be a crisis in that sense. If something happens suddenly, then policymakers can act strongly and decisively. Years of high unemployment are in many ways more damaging than the sudden drop in government spending that risks arriving with the fiscal cliff. But because the damange is slow-acting and invidious, it seems that unemployment, on its own, is incapable of persuading Bernanke to do more.


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“Of all the things to worry about right now, price discovery and capital-allocation distortions are pretty low down the list. I’d happily do enormous damage to both of them if I thought it would do any good in terms of creating jobs.”

Does that mean you don’t believe damaging price discovery and capital-allocation kills jobs? Or that it only hurts future jobs, which are less valuable than current jobs? Is there some ratio of current to future job trade-off that would make damaging those items worthwhile?

Posted by Woj | Report as abusive

Woj’s point; also, I disagree that savers are somehow worthy of our contempt were there a way to help them that didn’t affect the welfare of workers qua workers. (Not that those are necessarily different people.)

There was one answer in particular — I don’t remember where, now; I think it was about thirty minutes in, though — where it seemed as though he was studiously trying not to say “there’s disagreement on the committee, and this isn’t a one-man show”, which left him to balance dancing around a statement along those lines against not answering the question.

Posted by dWj | Report as abusive

There is a lot of confusion and little concrete specificity in these Fed-can’t-do-more-because-it-may-be-risk y argument. Specifically, how would the Fed saying “we will do QE until either unemployment goes to 6% or inflation goes to 4%” create real economic damage. (I believe in NGDP targeting, but let’s leave it in dual mandate terms).

First of all, both Japan’s and America’s experience shows that QE can and does work. Krugman’s “expectations trap” is a very odd argument: when the central bank does not really want to revive the economy, then they in fact will not revive the economy. In the case of the BOJ, the BOJ raised rates while GDP was still far below potential. The argument is very odd because the same argument works for fiscal spending. If Congress doesn’t want to do stimulus until it works, then stimulus will not work.

So, what if a central bank does in fact want to do enough for monetary policy to work? The evidence from central banks like Switzerland shows that a central bank willing to do whatever is necessary to raise demand will in fact raise demand.

Alright, so the Fed can create jobs, but what about the precious savers and the capital markets? It depends on which kind of saver one is actually talking about.

1. Inflation hawks frequently refer to pensioners, but that argument is mostly BS, especially in the case of SS. Most pensions are indexed to inflation.

2. Investors in stocks and private fixed capital are hurt in real terms when the central bank allows deflation. If a piece of fixed capital can make 1,000 widgets a day, econ 101 says that the firm will price it at a point where it does make 1,000 widgets a day. However, due to market stickiness, prices for those widgets will be above clearing levels in a deflation and the investors in that fixed asset may only get profits from 800 widgets a day. For this reason, the values of stocks fell far more than deflation predicted in late 2008 and early 2009.

3. The savers who happen to be in cash and treasuries when deflation happens. These are the only savers who really benefit from depressionary deflation, along with perhaps those with fixed claims. For fixed claims on private individuals, defaults also go up with unexpected deflation.

If you’re sole policy goal is to enrich those who are mostly in cash and treasuries, then massive, back-breaking deflation would be the way to go. Not just deflation at the zero bound either. According to this argument, we should have just left interest rates at 18% from the early-80′s. Don’t worry about 11% unemployment, lowering interest rates hurts the savers in cash and treasuries.

In other words, if one is against Fed policy today to bring down unemployment and bring up inflation because it hurts ultra-conservative savers, then one should be against the Fed lowering interest rates outside of the zero-lower bound. Interest rates work not just by increasing loan demand, but by making saving less attractive and moving forward consumption.

Hopefully when you think about it in those terms, you should consider lack of Fed policy today as absolutely abhorrent as the Fed leaving interest rates at 18% through the 80′s.

Posted by mwwaters | Report as abusive

Does anyone seriously believe that any action within the power of the FED can impact unemployment? This is not a question of balancing the damage of unemployment against the risks of inflation, because the FED can do nothing at the stage that will create jobs — but it surely can undermine expectations for low inflation. The idea, if I properly understand it, that higher inflation could drive consumption which would create jobs, is just about the shakiest proposition I can imagine, certainly in the present climate. People feel poorer so they rush to spend their money before it declines in value further? And even so, this should create jobs? Why risk stable inflationary expectations for the most speculative benefits? If this is Bernanke’s position, then I’m with him all the way.

Posted by From_California | Report as abusive

Yes, the FED can and does affect unemployment. Higher inflation lowers investment risk, which is seen as too high.
If we have such a poor future that more investment is unwarranted then we should all be condemned to more inflation as the penalty.

Posted by MyLord | Report as abusive


Before rates hit zero, the Fed did have a big effect on unemployment through rates. Look at the early 80′s to see the effect of monetary policy to create lower unemployment.

Higher inflation does not cause consumption but the other way around. Barring a supply-side productivity issue, inflation mainly because demand goes up. Prices do not depend directly on money supply, but instead prices and wages go up when that money is spent. If the new money is not spent, then inflation does not happen.

Is it possible that the new money being spent only leads to inflation? Theoretically, that is possible and that is what happened in the 70′s. More demand led directly to inflation. However, if there is a lot of slack in a sector, then more demand goes to higher employment, not higher wages.

Posted by mwwaters | Report as abusive

+1 to Woj’s point – price discovery and capital allocation are pretty much why capital markets exist. We’ve seen how well it worked out when far too much capital was allocated to housing in the U.S. and much of Western Europe.

Posted by realist50 | Report as abusive

If the Fed is targeting inflation, fiscal stimulus will be ineffective.

Posted by libfree | Report as abusive

The Fed is waiting for Congress. The current fiscal policy path adds $10 trillion to the debt over the next decade; Obama’s budget would avoid $4T and Domenici-Rivlin for example would avoid $6T.

Until meaningful short-term stimulus and long-term austerity measures are taken, the Fed will make sure Congress feels our pain.

I’m embarrassed by our Congress. The President is doing exactly what post-Depression economic theory says he should do and Congress is stopping him.

Posted by Farcaster | Report as abusive

Bernanke can’t be persuaded to more now. He surely knows that monetary stimulus can’t put America’s economy back on track, not now and not later.

He also knows that when the impending economic calamity finally strikes, anxious Americans must see the Fed confidently take some kind of drastic action… effective or not.

Posted by breezinthru | Report as abusive

Thanks dwj and realist50.

@mwwaters – How does the Swiss situation show anything about stimulating demand? Switzerland is currently experiencing deflation. Separately, the SNB having to buy massive foreign exchange to maintain the currency floor is a sign of weakness regarding the expectations channel. NGDP Targeting relies on the idea of the money multiplier, which simply doesn’t exist . Lastly, one other form of inflation is cost-push, but that requires incorporating credit into macro models.

Posted by Woj | Report as abusive

Finally, here a post recommending more action by the Fed that provides at least one specific example the Fed might do — “I’d spend a trillion dollars buying broad stock-market index funds below a certain level”.

However, this seems like a terrible idea to me. Do we really want the government to give more money to the owners of capital while doing nothing for labor? Is this a good precedent to set? Would it result in wild asset price rises?

Posted by DetroitDan | Report as abusive

Also, it’s illegal for the Fed to buy stocks, unless directed to do so by the Treasury (see discussion at http://mikenormaneconomics.blogspot.com/ 2012/06/mike-konczal-what-constrains-fed eral.html.

And the potential for political malfeasance (an administration directing the Fed to buy stocks in order to boost its popularity) is high.

Anyone else find their way here from Atrios’s link? I’m afraid this is another example of the stupidity of Atrios’s expressed desired that the Fed should do more. Here Atrios seems to be endorsing a proposal to have the Fed give more “free money” (Atrios’s favorite phrase) to the owners of large corporations.

Atrios is on the right track generally with his economic commentary, but would benefit by a full embrace of MMT, in my opinion…

Posted by DetroitDan | Report as abusive

The above link will work if you remove the dot after .html.

On the other side, Salmon and Atrios are in good company with Joseph Gagnon, a former Fed insider now at the Peterson Institute for International Economics.

Quoting Gagnon (from the above link): “Research I am doing suggests that it would be much more attractive for the Fed to buy a broad basket of U.S. equities to support the stock market than to try to push down bond yields from these already low levels. Sadly, the Fed is not authorized to buy equities, even though other central banks are allowed to do so…”.

So apparently even some of the folks at the small government Peterson Institute want the government to “support the stock market”. The mind reels…

Posted by DetroitDan | Report as abusive


I mentioned the Swiss national bank to show that, even when your currency has extremely strong pressure to remain overvalued, a central bank has no real limit to depreciate their currency if they so choose.

In the case of the US, NGDP targeting does rely somewhat on the “money multiplier.” In simpler terms, it relies on the money printed actually being spent. The argument goes that both Japan and the US printed mountains of money in their crises but that money was not spent.

That is where the “expectations trap” comes in. If a central bank signals that they will tighten at the first sign of inflation and growth, then the market will rationally not spend or invest the new money.

However, the solution to expectations is not to use fiscal policy as an imperfect, distortionary way of moving existing savings to government spending. It is far better to actually change central bank attitudes to monetary policy at the zero lower bound.

For example, the Fed is nowhere near out of ammunition even if they do never resort to buying anything outside of Treasuries or agencies. For whatever asinine reason, they are paying 0.25% interest to people to not spend the money they printed. With the interest rate on excess reserves back at zero and with every last risk-free, government-guaranteed bond purchased, then the risk-free rate going out to 30 years becomes zero. Mortgage rates would go down to 1-2%. Even at that point, the Fed can still charge a penalty rate on excess reserves to further encourage the new money to be spent.

This is all very extraordinary, but its not like the trillions of dollars in necessary fiscal stimulus is not also extraordinary. If the central bank and congress could just sit on their laurels to raise AD, then it would have been done already.

Posted by mwwaters | Report as abusive

@DetroitDan – With you every step of the way, awestruck that opinion leaders and those in power could even briefly entertain any such notion. These people – apparently including our leader – are drunk on a wicked combination of power, panic and melodrama. In its last 12+ years of its existence, EU unemployment rates never got below where US rates are now but for parts of 3 of them. Panic is never justified, and melodrama is not called for now – though it does get ink; gotta give them that.

But maybe it should be allowed to happen, and in happening accelerate the collapse of the system and of routine life in the US. Perhaps it has to happen to inspire the depth of change that needs to be made. After all, one can’t “pick up the pieces” until the object is first reduced to pieces. It’s a painful thing to contemplate, but -

Aren’t we past the point of trying to keep the system from disintegrating?

Posted by MrRFox | Report as abusive

@mwwaters – There is a good post yesterday at Bubbles and Busts about “the fallacy of monetary neutrality” (this site won’t let me add link.) QE is merely an asset swap of reserves for Treasuries (or MBS). Reserves, however, cannot be spent. Most “money printing” today is done by private banks in response to demand for credit. Demand is low because household debt and interest costs remain too high compared to incomes. Resolving that issue is necessary for sustainable growth. Fiscal policy does create distortions, but monetary policy does as well.

Posted by Woj | Report as abusive

“from money markets to insurance and from pension provision to suppliers of daily market liquidity, all of whom provide financial services to companies and individuals – has been undermined.”

Really. Because those markets have done SUCH a wonderful job not undermining the whole world. And the leaders of these industries have made it abundantly clear that they would cast the Earth into eternal fiscal chaos if it meant boosting the next second’s earnings by a penny. If it’s their job to supply the world with capital, they’ve done a terrible job of it.

There’s no point in keeping interest rates at zero or inflation at 2%. The only people that benefit from zero interest rates are lenders, and the only people that benefit from low inflation are banks. But this is to be expected, since the banker aristocracy runs everything.

And why the obsession with making a market where people can take on MORE debt? Debt means average pay is not meeting the cost of living. It’s fueled the last three bubbles, and given us the illusion that we can live like decadent demigods in the North Atlantic sphere. The fact that the Fed’s (or Congress’ for that matter) policies aren’t reflecting a need to reduce the risk of another debt bubble through stimulating demand and using the immense power of fiduciary diversification the Fed has to pop the liquidity traps and get that money flowing into the hands of those whose hands build our world, that they are content with a reserve army of unemployed, a finance-fueled plutarchy, subsistence wages and an increasingly anti-competitive and oligopolistic market in every industry thanks to endless mergers and billion-dollar political graft being legalized.

Burn the Fed down!

Posted by JohnTheLad | Report as abusive