Intellectual broker: Secular stagnation vs. Ben Bernanke

Let me put here my first, much longer draft to what appeared on Project Syndicate: The Tragedy of Ben Bernanke


Ben Bernanke has published his memoir, The Courage to Act.

I am finding it difficult to read. I am finding it hard to read it as other than as a tragedy. It is the story of a man who found himself in a job for which he may well have been the best-prepared person in the world. Yet he soon found himself overmastered by the situation. And he fell and stayed well behind the curve in understanding what was going on.

Those of us with even some historical memory winced when, back in 2003, Robert Lucas flatly declared that the problem of depression-prevention had been solved “for all practical purposes, and has in fact been solved for many decades”. We remembered 1960s Council of Economic Advisers chairs Walter Heller and Arthur Okun saying much the same thing. Indeed, we remembered Irving Fisher in the 1920s saying much the same thing. Fisher’s hubris was followed by nemesis in the form of the Great Depression. Heller’s and Okun’s hubris was followed by nemesis in the form of the 1970s inflation. The joke was on Lucas.

But in a deeper sense the joke was on those of us who winced at Lucas–and also on the people of the North Atlantic. For, as we know, the economy since 2007 has not been a very funny joke the people of the North Atlantic.

Those of us with historical memory knew that the problem of preventing severe macro economic instability had not been solved. But even we believed that even sharp downturns would be transitory and short. Rapid recovery to full prosperity and the supply side-driven trend growth was all but guaranteed. Perhaps full prosperity could be delayed into an extended medium-run by actively-perverse and destabilizing government policies. Perhaps the full-prosperity equilibrium-restoring forces of the market would work quickly.

But they would work.

Indeed, back in 2000 it was Ben Bernanke who had written that central banks with sufficient will and drive could always, in the medium-run at least, restore full prosperity by themselves via quantitative easing. Simply print money and buy financial assets. Do so on a large-enough scale. People would expect that not all of the quantitative easing would be unwound. Thus people would have an incentive to use the extra money that had been printed to step up their spending. Even if the fraction of quantitative easing that thought permanent was small, and even if the incentive to spend was low, the central bank could do the job.

It is to Bernanke’s great credit that the shock of 2007-8 did not trigger another Great Depression. However, what came after was unexpectedly disappointing. Central banks in the North Atlantic–including Ben Bernanke’s central bank, the Federal Reserve–went well beyond the outer limits of what we had thought, back before 2008, would be the maximum necessary to restore full prosperity. And full prosperity continued and continues to elude us. Bernanke pushed the US monetary base up from $800 billion to $4 trillion–a five-fold increase, one that a naïve quantity theory of money would have seen as enough stimulus to create a 400% cumulative inflation. But that was not enough. And Bernanke found himself and his committee unwilling to take the next leap, and do another more-than-doubling to carry the monetary base up to $9 trillion. And so, by the last third of his tenure in office, he was reduced to begging in vain for fiscal-expansionary help closed-eared Congress, which refused. Some leading figures in the dominant Republican party made political hay by calling what he had done “almost treasonous”, and threatening, in the coded language applied a generation ago to civil rights and other agitators, to lynch him should he show up where he was not wanted.

So what went wrong? I have been thinking about this with mixed success, most recently for the Milken Institute Review. So let me try yet again to summarize:

As I understand Ben Bernanke’s perspective, he thinks that nothing fundamental went wrong. It is just that the medium-run it takes for aggressively-expansionary monetary policy to restore full prosperity has been artificially lengthened, and seems long to us indeed. Interventions by non-market–or perhaps it would be better to call them non-risk adjusted return maximizing–financial players have created a temporary global savings glut. Sovereign wealth funds for which loss aversion is key, the emerging-market rich seeing their positions in the North Atlantic as primarily insurance against political risk, and governments seeking to ensure freedom of action have pushed full-prosperity interest rates down substantially, and lengthened the medium-run it takes for shocks to dissipate. But, I believe Bernanke believes, these disturbances are ending. And so, if he were still running the Fed, he would think it appropriate to raise interest rates now.

An alternative view is held by the very sharp Ken Rogoff. He believes, I think, that Bernanke’s cardinal error was to focus on money when he should have been focusing on that. In our simple models which you focus son does not matter: when the money market is in full-prosperity equilibrium, the debt market is too. But in the real world a central bank and a broader government that focused not on expanding the stock of safe money but on buying back and inducing the writing-down of the stock of risky debt would have boosted private spending much more effectively and restored full prosperity much more quickly.

Yet a third possible view is that the Fed could have done it: if it had committed to a higher target inflation rate than 2%/year, and promised to do as much quantitative easing as needed to get to that target, it would have produced full prosperity without requiring anywhere near as much quantitative easing as has been, so far, undertaken without that favorable result.

And then there is fourth view, one that I associate with Larry Summers and Paul Krugman, that we have no warrant for believing that monetary policy can restore full prosperity not only not in the short-run, but not in the medium-run and probably not even in the long-run. As Krugman put it most recently:

In 1998… I envisaged an economy in which the… natural rate of interest… would return to a normal, positive level… [and so] the liquidity trap became a [monetary-]expectations problem… monetary policy would be effective if it had the right kind of credibility…. [But if] a negative Wicksellian [natural] rate… permanent… [then] if nobody believes that inflation will rise, it won’t. The only way to be at all sure… [is] with a burst of fiscal stimulus…

Their position is, after a long detour through the post-World War II neoclassical-Keynesian synthesis, a return to a position set out by John Maynard Keynes in 1936:

It seems unlikely that the influence of [monetary] policy on the rate of interest will be sufficient by itself…. I conceive, therefore, but a somewhat comprehensive socialization of investment will prove the only means the securing an approximation to full employment; though this not need exclude all manner of compromises and of devices by which the public authority will cooperate with private initiative…

The government, that is, will have to be infrastructure-builder, risk-absorber, safe debt-issuer, debt workout-manager, and to a substantial degrees sectoral economic planner of last resort to maintain full prosperity. Milton Friedman’s dream that strategic interventions by the central bank in the quantity of high-powered money would then be just that—a dream. And our confusion, and the attractiveness of Milton Friedman’s monetarism in the half-century starting with a World War II would be an accident of the particular circumstances of the uniquely rapid North Atlantic-wide demographic and productivity growth of the transient post World War II era.

I cannot claim—we cannot claim—to know whether Bernanke he will Rogoff or Krugman and Summers are correct here, or even weather if Bernanke he and his committee had found the nerve, and rolled double-or-nothing one more time to boost the American high-powered money stock to $9 trillion, we might have been back to full prosperity a couple of years ago. But I do think that the debate over this question is the most important debate within macroeconomics since the debate—strangely, a very similar debate, at least with respect to its policy substance—that John Maynard Keynes had with himself in the decade around 1930 that turned him from a monetarist into a Keynesian.


Question: What Are Our Biggest Economic Problems Right Now?

I have been someone who takes the long-run secular decline in prime-age male employment as a canary in the coal mine: it has seemed to me via sign that information technology which greatly reduces valuable employment of human brains as cybernetic control elements for machines poses us with significant problems that are not necessarily economic but rather in the sociology of social roles. When Case and Deaton on the decline in life expectancy among the white and middle-aged crossed my desk earlier this week, I thought that case was reinforced.

But now I find myself updating and looking at this graph:

Graph Employment Rate Aged 25 54 Females for the United States© FRED St Louis Fed

It now looks quite different from how it looked a couple of years ago.

I had, a couple of years ago, taken the gender gap in trends here as an indication that those trained not to focus on social intelligence were having increasing difficulties finding valued social roles, and thus as a sign that information technology sociological apocalypse was drawing near. But now… relative to 2000, it is much easier to tell a slack-labor-demand-is-most-of-it story.

Thus I am now swinging toward thinking that if we could only focus on expansionary fiscal policy to restore the high-pressure full-employment economy of the Clinton years that we would find our longer-run structural problems solving themselves, or at any rate becoming smaller and moving further away into the distance. And I am now swinging toward understanding Case and Deaton as more evidence on the extremely high sociological costs of a low-pressure economy.

Must-Read: Paul Krugman: Did The Fed Save The World?

Must-Read: Looking back at my archives, I find that my own ratio of “Paul Krugman is right” to “Paul Krugman is wrong” posts is not in the rational range between 10-1 and 5-1, but is 15-1. So I am looking for an opportunity to rebalance. And I find one this morning: Here I think Paul Krugman is wrong. Why? Because of this:

2015 10 06 for 2015 10 07 DeLong ULI key

Housing crashes. And does not bounce back quickly by the end of 2010–or, indeed, at all. And Paul Krugman is correct to write that “Even a total collapse of home lending couldn’t have subtracted more than a point or two more off aggregate demand”:

2015 10 06 for 2015 10 07 DeLong ULI key

But exports collapse as the financial crisis hits, and then bounce back very rapidly as the financial crisis passes:

2015 10 06 for 2015 10 07 DeLong ULI key

And roughly one-third of the financial-crisis associated collapse in business investment is quickly reversed after the financial crisis passes:

2015 10 06 for 2015 10 07 DeLong ULI key

Together these two factors plausibly associated with the reuniting of the web of financial intermediation look to me to be five times as large as the fiscal stimulus measured by government purchases. Now fiscal stimulus worked through channels other than government purchases. And without the Recovery Act we would have seen states and localities not holding their purchases constant over 2008-2011 but cutting them by 1% of GDP or so. And not all of the export and business investment bounce-back in the two years after the 2009 trough can be attributed to lender-of-last-resort and easy-money policies.

But it looks to me like the balance is that–even with housing left to rot on the stalk–monetary and banking policy did more than fiscal policy to stem the downturn and promote recovery up to 2011. And it looks to me that, since 2011, it is the reknitting of the financial system and easy money that has kept the extraordinary austerity that the states and the Republicans imposed and that Obama has bought into from sending the U.S., at least, into a renewed and deeper downturn.

Paul Krugman: Did The Fed Save The World?: “Bernanke’s basic theme is that the shocks of 2008 were bad enough that we could have had a full replay of the Great Depression…

…the reason we didn’t was that in the 30s central banks just sat immobilized while the financial system crashed, but this time they went all out to keep markets working. Should we believe this?… I very much agree with BB that pulling out all the stops was the right thing to do…. But I’m not persuaded that the real difference between 2008 and 1930-31 (which is when the Depression turned Great) lies in central bank action, or related bailouts. It’s true that the 30s were marked by a big financial disruption…. Shadow banking rapidly shriveled up, with repo and other alternatives to bank financing shrinking very fast; liquidity for everything but the safest of assets disappeared even though the big financial firms remained in being. And if we’re looking for effects of the tightening in credit conditions, remember that credit policy usually exerts its biggest effects through housing — and housing investment fell more than 60 percent as a share of GDP….

So really, was putting a limit on the financial crisis the reason we didn’t do a full 1930s? Or was it something else? And there is one other big difference between the world in 2008 and the world in 1930: big government…. Again, Bernanke and company were right to step in forcefully. But I’d argue that the fiscal environment was probably more important than monetary actions in limiting the damage. Oh, and since 2010 officials everywhere, but especially in Europe, have been doing all they can to undo the favorable effects…. And the result is that in Europe economic performance is at this point considerably worse than it was at this point in the 1930s.

Afternoon Must-Read: Danielle Kurtzleben: Don’t Panic About Slow Economic Growth Last quarter. Panic About 6 Years of It

Danielle Kurtzleben: Don’t panic about slow economic growth last quarter. Panic about 6 years of it: “Individual-quarter GDP charts miss the bigger picture…

…that this recovery is truly, phenomenally disappointing. Economists Atif Mian, professor of economics and public policy at Princeton University, and Amir Sufi, professor of finance at the University of Chicago’s Booth School of Business, show this in a new post today on their House of Debt blog:

Don t panic about slow economic growth last quarter Panic about 6 years of it Vox

Morning Must-Read: Annie Lowrey: Recovery Has Created Far More Low-Wage Jobs Than Better-Paid Ones

Recovery Has Created Far More Low Wage Jobs Than Better Paid Ones NYTimes com

Annie Lowrey: Recovery Has Created Far More Low-Wage Jobs Than Better-Paid Ones: “The poor economy has replaced good jobs with bad ones….

‘Fast food is driving the bulk of the job growth at the low end…’ said Michael Evangelist…. Higher-wage industries–like accounting and legal work–shed 3.6 million positions during the recession and have added only 2.6 million positions during the recovery. But lower-wage industries lost two million jobs, then added 3.8 million…

Could We Have Had a Severe Recession Without the 2008 Financial Crisis?

Over at Grasping Reality: Monday DeLong Smackdown: Scott Sumner: Could We Have Had a Severe Recession Without the 2008 Financial Crisis?: “I have trouble with DeLong’s implicit assumption is that the financial crisis caused the Great Recession….

The years leading up to 1990 saw Australian-level NGDP growth, if not more. So even if lending standards tightened sharply in the wake of the 1989-90 crisis, there was no possibility of hitting the zero bound…. With no zero bound in prospect, there’d be no reason for markets to expect an NGDP collapse…. Even if we had managed the 2007-08 subprime crisis very well from a regulatory/resolution perspective, there is no question that banks would have tightened lending standards sharply. That effectively reduces the demand for credit…. It’s quite plausible that the Wicksellian equilibrium natural rate would have fallen to zero in late 2008, even with a better resolution of the banks….

Continue reading “Could We Have Had a Severe Recession Without the 2008 Financial Crisis?”