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The coming depression blog | July 21, 2018

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Does Bernanke Think The Fed Made A Mistake By Allowing Inflation To Cross 2% During The Great Depression?

It would be so easy for Ben Bernanke to say: “We have a 2%/year inflation target, and also strive for maximum feasible employment and purchasing power by attempting to keep the unemployment rate close to what we believe to be its natural rate. Whenever the unemployment rate is below what we believe to be its natural rate, we expect inflation to rise and so are unhappy–and believe additional tightening is warranted–unless inflation is below its 2%/year target. Whenever the unemployment rate is above what we believe to be its natural rate, we expect inflation to fall and so are unhappy–and believe additional loosening is warranted–unless inflation is above its 2%/year target.”

That’s not what he says. Does he think that the Great Depression-era Federal Reserve made a mistake by allowing inflation to get above 2%/year after the 1933 Great Depression trough? It sure sounds like it:

Ben Bernanke: There’s this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time.

I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation, that is, falling prices. The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are not exhausted. There are still other things that the central bank can do to create additional accommodation.

Now, looking at the current situation in the United States, we are not in deflation. When deflation became a significant risk in late 2010, or at least a modest risk in late 2010, we used additional balance sheet tools to help return inflation close to the 2 percent target.

Likewise, we have been aggressive and creative in using non-federal-funds-rate-centered tools to achieve additional accommodation for the U.S. economy. So the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation. And, clearly, when you’re in deflation, and in recession, then both sides of your mandate, so to speak, are demanding additional accommodation.

In this case, we are not in deflation. We have an inflation rate that’s close to our objective.

Now, why don’t we do more? Well, first, I would, again, reiterate that we are doing a great deal. The policy is extraordinarily accommodative. We, and I won’t go through the list again, but you know all the things that we have done to try to provide support to the economy.

I guess the question is: does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased pace of reduction in the unemployment rate? 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 expectations or 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 an unwise thing to do.

Target the path of nominal GDP, people!

You know, I thought three-and-a-half years ago that this would work out very differently. I thought three-and-a-half years ago that the Federal Reserve would announce that its mission was primarily to keep economy-wide nominal spending on its pre-2008 growth path, that this was an emergency situation, and as long as economy-wide nominal spending was below its pre-2008 growth path, additional accommodation was warranted.

No dice.

And I thought two-and-a-half years ago that things would work like this:

People like me would say that the magnitude of the depression showed that the cost and likelihood of hitting the zero nominal lower bound in interest rates was much larger than we had thought.

People like me would say that in light of that fact, the decision to go for a 2%/year inflation target was wrong, and that a 4%/year inflation target was warranted.

The Federal Reserve would say that we were wrong: that a 2%/year long-run inflation target was still warranted.

But, the Federal Reserve would say, a 3%/year or a 4%/year interim short-run inflation target was warranted as long as it was the case both (a) that unemployment was elevated, and (b) that the price level was below its long-run 2%/year growth trend level.

Once again, no dice. And I have no idea why not.


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