Bernanke says Friedman would have approved of Fed’s recent actions – I think is he more or less right

Ben Bernanke today in a speech further tried to explain the Fed’s recent policy actions. As Scott Sumner says in a comment: “The Fed seems to be getting a bit more market monetarist each day”. That might be slightly too optimistic of what is going on at the Fed and I remain frustrated about about two things in how Bernanke is communicating. First he is focusing on real variables (the labour market) rather than on nominal variables. Second, his discussion of the monetary transmission mechanism is overly focused on yields and interest rates rather than on money creation. That said, I continue to believe that the Fed is moving in the right direction. Bernanke’s speech today is further prove of that and I must say I feel increasingly optimistic that this will pull the US economy out of the crisis.

I am particularly encouraged by the following comments from Bernanke (my bold):

“In the category of communications policy, we also extended our estimate of how long we expect to keep the short-term interest rate at exceptionally low levels to at least mid-2015. That doesn’t mean that we expect the economy to be weak through 2015. Rather, our message was that, so long as price stability is preserved, we will take care not to raise rates prematurely. Specifically, we expect that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economy strengthens. We hope that, by clarifying our expectations about future policy, we can provide individuals, families, businesses, and financial markets greater confidence about the Federal Reserve’s commitment to promoting a sustainable recovery and that, as a result, they will become more willing to invest, hire and spend.”

Bernanke is beginning more clearly to spell out how his monetary policy rule looks like. This is what is needed is he whats to get the help from the Chuck Norris effect to reestablish nominal stability and pull the US economy out of this crisis.

Interestingly enough Bernanke was asked after his speech today whether he thinks Friedman would have supported the fed’s recent actions. Bernanke was stated that he was a “big fan” of Milton Friedman and then said that “I think he would’ve supported what we are doing”. I think Bernanke is broadly speaking correct. I am very sure that Friedman would have had the same reservation that I note about, but I am also pretty sure that he would have made the same recommendation regarding the US economy today as he did regarding the Japanese economy in 1997:

“The answer is straightforward: The Bank of Japan can buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan, what economists call high-powered money. Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand their liabilities by loans and open market purchases. But whether they do so or not, the money supply will increase.

There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so. Higher monetary growth will have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately. A return to the conditions of the late 1980s would rejuvenate Japan and help shore up the rest of Asia.

Japan’s recent experience of three years of near zero economic growth is an eerie, if less dramatic, replay of the great contraction in the United States. The Fed permitted the quantity of money to decline by one-third from 1929 to 1933, just as the Bank of Japan permitted monetary growth to be low or negative in recent years. The monetary collapse was far greater in the United States than in Japan, which is why the economic collapse was far more severe. The United States revived when monetary growth resumed, as Japan will.

The Fed pointed to low interest rates as evidence that it was following an easy money policy and never mentioned the quantity of money. The governor of the Bank of Japan, in a speech on June 27, 1997, referred to the “drastic monetary measures” that the bank took in 1995 as evidence of “the easy stance of monetary policy.” He too did not mention the quantity of money. Judged by the discount rate, which was reduced from 1.75 percent to 0.5 percent, the measures were drastic. Judged by monetary growth, they were too little too late, raising monetary growth from 1.5 percent a year in the prior three and a half years to only 3.25 percent in the next two and a half.

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.”

James Pethokoukis uses the same quote in his comment on Bernanke – and I have used the quote earlier in discussing what Friedman would have said about European monetary policy. While I think that the situation in the euro zone today is very similar to the situation in Japan 1997 I would also argue that the US economy is in somewhat better shape today that Japan in the late 1990s. This of course means that some caution is warranted regarding monetary easing in the US, but to me at least the risks on US inflation still remain on the downside.

Again see the Friedman’s quote above and what Bernanke said today (quoted from Joe Weisenthal on Business Insider):

“We didn’t allow the fact that interest rates were very low to fool us into thinking that monetary policy was accommodative enough.”

It is very nice to see that Bernanke now finally is recognizing this. I would hope a all of his central banking colleagues around the world – particularly in Europe would understand this.

Finally I don’t think the Fed is all there yet. NGDP level targeting is much preferable to what the Fed is now trying to implement. Furthermore, I would hope Bernanke and his colleagues would try to get a bit more of a monetarist perspective on the monetary transmission mechanism instead of the continued focus on interest rates.

PS George Selgin has a slightly related blog post on discussing Austrians’ and Market Monetarists’ view of “Intermediate Spending Booms”

Update: Matt O’Brien has an excellent piece on Narayana Kocherlakota amazing transformation,

About these ads
Leave a comment


  1. Marcus, I agree 100%. There is still someway to go – I why should this take four years?

  2. Moving in the right direction? He is just doing more of what created the problems in the first place – distorting prices, low interest rates creating speculative bubbles, too much spending, too much debt to name a few, while at the same time potentially creating massive inflation and destroying the value of the dollar. It’s central planning at its worse. Something is fundamentally wrong with the world when one can even contemplate that a central bank can save an economy. The less it does the better and in due course central banks should be shut down and we could finally have a free market economy.

  3. Diego Espinosa

     /  October 3, 2012

    Friedman specifically cited weak money supply growth, outright deflation, and positive real rates as signs that the BOJ was too tight. The implication of the quote you supply and the Laidler interview is that low nominal rates, in the presence of these factors, is an indication of tight money. What would he have said if presented with our current condition of 1) brisk M2 growth; 2) inflation; and 3) -ve real rates? Its certainly debatable.

    On another note, Friedman above lists the benefits of supplying “high powered money”:

    “After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately.”

    This certainly seems to fit the experience of ’09-’12. In other words, in ’08 we had deflation and high real rates. The Fed responded with QE. We enjoyed a recovery. Just as Friedman would have predicted.

  4. @ Diego. What recovery? The debt financed increase in GDP?


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s


Get every new post delivered to your Inbox.

Join 3,184 other followers

%d bloggers like this: