BERKELEY – It is difficult to read former US Federal Reserve Chair Ben Bernanke’s new memoir, The Courage to Act, as anything other than a tragedy. It is the story of a man who may have been the best-prepared person in the world for the job he was given, but who soon found himself outmatched by its challenges, quickly falling behind the curve and never quite managing to catch up.
It is to Bernanke’s great credit that the shock of 2007-2008 did not trigger another Great Depression. But his response to its aftermath was unexpectedly disappointing. In 2000, Bernanke had argued that a central bank with sufficient will could “always,” in the medium term at least, restore full prosperity via quantitative easing. If a central bank printed money and bought financial assets on a large-enough scale, people would begin to step up their spending. Even if people believed that only a fraction of quantitative easing was permanent, and even if the incentive to spend was low, the central bank could restart the economy.
In the end however, Bernanke did not deliver. Even though the Fed and many other central banks printed much more money than economists would have thought necessary to offset the impact of the financial crisis, full prosperity has yet to be restored. Bernanke increased the US monetary base five-fold, from $800 billion to $4 trillion. But it wasn’t enough. And then, his courage failing, he balked at taking the next leap: more than doubling the monetary base to $9 trillion. In his last years in office, Bernanke was reduced to begging in vain for Congress to institute fiscal expansion.
So what went wrong? The answer, as is often the case, depends on which economist you ask. If I understand Bernanke correctly, he would argue that nothing fundamental went wrong, and that a temporary savings glut has artificially lengthened the time it takes for aggressive monetary expansion to restore full prosperity. Loss-adverse sovereign wealth funds, emerging-market millionaires parking their money in the US and Europe, and governments seeking to ensure freedom of action have pushed full-prosperity interest rates down substantially and extended the time it takes for shocks to dissipate.
Harvard’s Kenneth Rogoff holds a different view: Bernanke’s cardinal error was to focus too narrowly on the money supply. According to simple economic models, when the money market is in full-prosperity equilibrium, the debt market is too. But in the real world, it might have been more effective for governments to buy back risky debts and induce lenders to write off losses. This, more than loose monetary policy, would have boosted private spending and rapidly restored full prosperity.
Still others would make the case that monetary action would have been enough, if only the Fed had committed to a target for annual inflation that was higher than 2% and vowed to do as much quantitative easing as necessary to reach that goal. This simple promise – were it to be made credible – would have been far more effective than much larger amounts of quantitative easing.
Finally, there is a fourth view, championed most prominently by Larry Summers and Paul Krugman. They argue that there is little evidence that monetary policy will ever restore full prosperity. In this view, Milton Friedman’s dream of using strategic monetary interventions to offset economic shocks remains just that: a dream. It was only the unique circumstance in Europe and the US over the last half-century – most notably rapid demographic and productivity growth – that made his ideas seem plausible. “If nobody believes that inflation will rise, it won’t,” is how Krugman put it. “The only way to be at all sure of raising inflation is to accompany a changed monetary regime with a burst of fiscal stimulus.”
I do not claim to know which of these views is the correct one. But I do think that this discussion is the most important debate in the field of macroeconomics since John Maynard Keynes wrestled with similar questions in the 1930s. For Keynes, the answer was clear, and it was something close to what is being argued by Summers and Krugman; indeed, his conclusions are what transformed him from a monetarist into a Keynesian.
“It seems unlikely that the influence of [monetary] policy on the rate of interest will be sufficient by itself,” Keynes wrote in 1936. “I conceive, therefore, that a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment.” Those are words worth considering the next time we find ourselves needing the courage to act.
J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research.
Copyright: Project Syndicate, 2015.
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