The other day I wrote a piece about the risks of introducing politics (particularly fiscal policy) into the central bank’s reaction function. I used the example of the ECB, but now it seems like I should have given a bit more attention to the Federal Reserve as Fed chief Bernanke yesterday said the follow:
“Monetary policy is not a panacea, it would be much better to have a broad-based policy effort addressing a whole variety of issues…I’d be much more comfortable if, in fact, Congress would take some of this burden from us and address those issues.”
So what is Bernanke saying – well he sounds like a Keynesian who believes that we are in a liquidity trap and that monetary policy is inefficient. It is near-tragic that Bernanke uses the exact same wording as Bundesbank chief Jens Weidmann used recently (See here). While Bernanke is a keynesian Weidmann is a calvinist. Bernanke wants looser fiscal policy – Weidmann wants fiscal tightening. However, what they both have in common is that they are central bankers who apparently don’t think that nominal GDP is determined by monetary policy. Said, in another other way they say that nominal stability is not the responsibility of the central bank. You can then wonder what they then think central banks can do.
What both Weidmann and Bernanke effectively are saying is that they can not do anymore. They are out of ammunition. This is the good old “pushing on a string” excuse for monetary in-action. This is of course nonsense. The central bank can determine whatever level for nominal GDP it wants. Just ask Gedeon Gono. It is incredible that we four years into this mess still have central bankers from the biggest central banks in the world who are making the same mistakes as central bankers did during the Great Depression.
Yesterday Scott Sumner quoted Viscount d’Abernon who in 1931 said:
“This depression is the stupidest and most gratuitous in history!…The explanation of our anomalous situation…is that the machinery for handling and distributing the product of labor has proved inadequate. The means of payment provided by currency and credit have fallen so short of the amount required by increased production that a general fall in prices has ensued…This has not only caused a disturbance in the relations between buyer and seller, but has gravely aggravated the situation between debtor and creditor. The gold standard, which was adopted with a view to obtaining stability of price, has failed in its main function. In the meantime people wrangle about fiscal remedies and similar devices of secondary importance, neglecting the essential question of stability in standard of value…The situation could be remedied within a month by joint action of the principal gold-using countries through the taking of necessary steps by the central banks.”
It is tragic that the same day Scott quotes d’Abernon Ben Bernanke “wrangles about fiscal remedies”. Bernanke of course full well knows that the impact on nominal GDP and prices of fiscal policy depends 100% on actions of the Federal Reserve. Fiscal policy does not determine the level of NGDP – monetary policy determines NGDP (Remember MV=PY!).
The Great Depression was caused by monetary policy failure and so was the Great Recession (See here and here). In the 1930s the Lords of Finance Montagu, Norman, Meyer, Moret, Stringher, Hijikata and Schacht were all wrangling about fiscal remedies and defended their failed monetary policies. Today the New Lords of Finance Bernanke, Shirakawa, Draghi and Weidmann are doing the same thng. How little we – or rather central bankers – have learned in 80 years…
UPDATE: Maybe our New Lords of Finance should read this Easy Guide to Monetary Policy.
Daniel Kuehn
/ June 8, 2012I can do that too! See:
“Monetary policy does not determine the level of NGDP – fiscal policy determines NGDP (Remember MV=P(C+I+G)!)”
I hope nobody finds that sentence convincing.
Lars Christensen
/ June 8, 2012Daniel, if G was tripled and M was halved you know what would happen to C and I…Bernanke has the final word on NGDP…
dkuehn
/ June 8, 2012The question at hand, Lars, is whether that little formulation of yours is symmetric. What if M was doubled and G was halved? Peoples’ concern is that the effectiveness of monetary policy is contingent on expectations about future policy, and it’s precisely on expectations about future policy that monetary policy and fiscal policy differ quite a bit.
We are in a mess and need both Congress and the Fed on board. I don’t think anyone is writing off the Fed either. But I don’t think the claim that there is no such thing as fiscal policy is quite correct, and I don’t think the formula for why there is such a thing as monetary policy is as easy as you suggest.
Anyway, the symmetry point is what concerns me. I have ample evidence about the ability of the Fed to tighten. I have more fears around whether they can credibly expand. I hope so. I’m certainly rooting for that. There’s nothing I would like more than for the Fed to take care of everything and successfully neutralize the (retrospectively) unnecessary fiscal policy. It’s just not something I’m willing to gamble on.
Lars Christensen
/ June 8, 2012Daniel, fiscal policy is to me pure “mama-nomics” – G=T in the long run. The US Congress will have to do what it will have to do, but that is not really something Bernanke should concern himself with. G and T is something Bernanke should take as given. He has the soul responsibility for P and NGDP. Everything else is excuses. I know I am radical on this (even a lot more radical than our friend Scott), but I am extremely frustrated that European and US central bankers keep making excuses for their own bad performance. The ECB blames to loose fiscal policy and the Fed (Bernanke) blames to tight fiscal policy. How about they start looking at themselves?
PS this is not defense of the US Congress. Its members have failed on a completely different level…
dkuehn
/ June 8, 2012Couldn’t agree more that central banks need to stop making bad excuses. I like ending on that note.
dkuehn
/ June 8, 2012OK – maybe I won’t quite end on that note. Here’s a hypothetical I’d be curious about your response to: since we don’t live in the best of all possible worlds, let’s say there’s a non-trivial chance that the ECB and the Fed don’t get their acts together.
What, then, would be your take on fiscal policy?
Lars Christensen
/ June 8, 2012Daniel, I actually think that is an extremely good point. Lets say that the Fed and the ECB continue to depress NGDP. Then the fiscal position of more and more euro zone countries will worsen. The deficits will just increase. In my book then there is no way out of the need for more austerity. Otherwise the countries default. Then it is no longer a question about NGDP or not, about default or not.
That said, in most European countries there would be no need for massive fiscal tightening if the ECB delivered.
There is an intertemporal budget constraint and there is nothing to do about that. Obviously that does not mean that I think the focus on fiscal austerity is meaningful as that need is mostly a result of monetary policy failure. In that sense I do have sympathy for the pro-growth keynesian position. Furthermore, for the US we are far from having any real risk of default – just look at Treasury yields – so 1-2 years of a slightly large deficit would probably do very little harm. And would it be a problem in for example Denmark (where 3-4 year government yields are NEGATIVE) if the budget deficit grew from 3-5% to 5-6% of GDP in 2-3 years. No not at all… However, for countries like Spain or Portugal that option do not exist.
dwb
/ June 8, 2012I think that Bernanke’s comments are more political than economic. When he says “I’d be much more comfortable if, in fact, Congress would take some of this burden from us and address those issues” I think he is acknowledging the political constraints on the FOMC: its really a big hydra, with 17 heads. Bernanke’s job is akin to herding cats. There are those on the FOMC (“the idiots”) who think we are near full employment. There are those on the FOMC (“the other idiots”) who have persistently predicted inflation from QE. Then there are those (Fisher) who just want to keep the pressure on Congress to clean up its fiscal act (sound like an Italian you know?).
The real failure here is in poor institutional design: FOMC members should get a bonus tied to an objective function which is the squared difference between NGDP and target (bipartisan estimates of “full employment”). Even if it was merely the squared deviation between inflation and 2% and output and 2.5%, we would have largely the same incentive to maintain ngdp at target.
As it is, FOMC members are just economists with friends in high places with a guaranteed job whether they screw up of not.
Lorenzo from Oz
/ June 8, 2012Thanks for the plug!