Sunday, July 01, 2012

Promises, Promises

Yesterday, Slate's Matt Yglesias tweeted,

"If Bernanke ended the recession tomorrow, it would be an admission that he could have ended it two years ago. So he won't."

Let's break it down, KPC style:

1. Matt, the recession is over. The NBER dates the business cycle and puts the end of the recession as June 2009!  Matt is not the only one doing this, but it is misleading and quite incorrect to do so.

2. For argument's sake, let's replace "ended the recession" with "accelerated growth". Then the conditional statement would be true. If BB could instantly accelerate growth tomorrow, he also could have done it two years ago.

3. Consider all the things BB has done to try and accelerate growth. Short term rates at zero. Promising to keep short term rates at zero for years (until late 2014). Pumping reserves into the system at an historically unprecedented rate. Two rounds of quantitative easing.

4. Matt doesn't say how BB could accelerate growth tomorrow (he only had 140 characters). I assume Matt means that BB could make a policy announcement that would instantly change everything. Something like a retroactive commitment to an nominal GDP path or a retroactive commitment to a price level path. If that's not what Matt means, then I apologize and withdraw what follows below.

5. The key for policies like that to work, even in theory, is that BB must, in Paul Krugman's words, "credibly promise to be irresponsible" and I see no way for the Fed to do so in general, let alone in this political environment. It's a lot harder than it might seem (to get an idea of how hard, check out Svensson's "foolproof way" paper).

6. I too am unhappy with the current state of the US economy. Growth is too slow and unemployment is too high. But it simply is not in the power of any single person in the world to change that in a day. Implying that BB is deliberately keeping the US economy down does not serve any constructive purpose.


Robert said...

I agree entirely. Yglesias never argues that Bernanke can save us (evidently even if the rest of the FOMC disagrees). He simply assumes that Bernanke can do this.

When challenged by Diamond wrote that he was amazed that he dared debate economics with a Nobel Laureate. On days in which Diamond doesn't repeat his argument, Yglesias dismisses it without consideration, not as obviously false but as so obviously false that there is no need to argue (any more than he argues against the view that 2+2=5).

Every gigantic unprecedented effort by the Fed which fails just makes him insist more that Bernanke could save us and chooses not to.

Dave said...

Scott Sumner argued they need to promise to be more responsible, not less.

There are a LOT of things the Fed can still do at ZLB, we are nowhere the limit.

Charlie Clarke said...

On point 5, do you mean the central bank cannot create inflation today? If so, Bernanke disagrees with you.

Bernanke in 1999:

The important question, of course, is whether a determined Bank of Japan would be able to depreciate the yen. I am not aware of any previous historical episode, including the periods of very low interest rates of the 1930s, in which a central bank has been unable to devalue its currency. Be that as it may, there are those who claim that the BOJ is impotent to affect the exchange rate, arguing along the following lines: Since (it is claimed) domestic monetary expansion has been made impossible by the liquidity trap, BOJ intervention in foreign exchange markets would amount, for all practical purposes, to a sterilized intervention. Empirical studies have often found that sterilized interventions cannot create sustained appreciations or depreciations. Therefore the BOJ cannot affect the value of the yen, except perhaps modestly and temporarily.

To rebut this view, one can apply a reductio ad absurdum argument, based on my earlier observation that money issuance must affect prices, else printing money will create infinite purchasing power. Suppose the Bank of Japan prints yen and uses them to acquire foreign assets. If the yen did not depreciate as a result, and if there were no reciprocal demand for Japanese goods or assets (which would drive up domestic prices), what in principle would prevent the BOJ from acquiring infinite quantities of foreign assets, leaving foreigners nothing to hold but idle yen balances? Obviously this will not happen in equilibrium.

Charlie Clarke said...

If the Fed announced $5 billion in additional QE tomorrow, your position is that the TIPS spread (for expected future inflation) would not increase, correct?


João Marcus said...

"If Bernanke ended the recession tomorrow, it would be an admission that he could have ended it two years ago. So he won't."
That´s 100% true! There are several historical antecedants. Most famous is the November 1937 FOMC meeting when Board Member, Fed Chief-Economist and Harvard prof, John Williams said they shouldn´t reverse the (higher required reserve) policy lest the economy rebounded and the Fed accused of causing the recession!!!

Angus said...

Charlie Clark: Thanks for your comments. I think though that you are misrepresenting my views, though yes I think a new 5 billion QE would do little for inflation expectations (5 billion is not very much money).

The question is not whether as a technical matter things are possible, the question is whether a conservative central banker can credibly promise to be un-conservative!

Anonymous said...

Well, I am a rookie in these matters, but I see no reason why a conservative central banker can't **credibly** promise to adopt a level NGDP target.

Does Bernanke have it within his character to break dramatically with past actions? It would appear not. But if he chose to adopt a level NGDP target, he could do so credibly.

If BB could instantly accelerate growth tomorrow, he also could have done it two years ago.

Yes, he could have accelerated growth two years ago, but he chose not to. He has said as much time and again, most recently on June 20.

Bernanke: Fed Is Not Out of Ammunition

Ben Bernanke is an inflation targeter.

He is doing exactly what he consistently tells us he is doing: targeting inflation at 2% or below in the midst of a protracted period of poor growth and high unemployment, while telling the public that the Fed could do more.

Charlie Clarke said...


Fair enough, I meant trillion. I'm definitely not trying to misrepresent your views, just understand them. The Krugman quote implies that an unexpected QE announcement will have no effect on TIPS spread, no matter how large.

It's possible to justify that in theory, but most QE announcements have changed the TIPS spread and the stock market has reacted.

There is about $11 trillion U.S. debt held by the public. If the Fed bought it all, it could then continue to buy other assets (FX, MBSes, Gold...). That is the reductio ad absurdum in the Bernanke quote. It is possible to write a model where lack of credible commitment leads to the Fed owning all the assets in the world, but do you really believe that? (Miles Kimball has been good on this in his blog).

If you don't, then commitment doesn't matter. If you're arguing, he wouldn't buy all those assets b/c he's too conservative to do something like that, then you are agreeing with Matt that Bernanke could improve economic conditions, he just chooses not to.

Scott Sumner said...

Bernanke claims he could do more to boost AD, but doesn't think it wise at this time. Are you saying that he's lying? Or that he really believes he could do more, but is mistaken?

Angus said...

No Scott, I think BB could "increase aggregate demand". But I don't think an instant turn-around is in his arsenal. Those are two different things.

Yes the Fed could do more and it would help a little and they should do it.

No the Fed does not have a magic bullet that eliminates the problem but is stubbornly refusing to pull the trigger.

Sorry for the late reply, hope you see it.

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