Can Bernanke Really Save Us?
The drumbeat for Ben Bernanke to save us is getting louder from Democratic pundits. Brad Plumer at Ezra's place:
So can anything break the economy out of its current doldrums? If natural forces aren’t going to produce a fast recovery, Smith argues, then the Federal Reserve has to step in: “The Fed has to say that it will tolerate more inflation or will be more heavily focused on unemployment. This way folks engaging in long term projects will know that even if the economy picks up they can still expect to experience low financing costs.”
It can't hurt I suppose, but really, didn't we all agree that in a zero lower bound environment, aren't the Fed's tools of limited utility? Isn't government spending to boost aggregate demand the only real tool that works here? Karl Smith, who owns up to a missed call on the economy recovering (he thought a strong recovery was forming in the winter) writes:
The multi-family boom simply did not occur in the way I thought it would. I have talked about this before, but we did see a strong increase in multifamily permitting. We have yet to see as many projects break ground. Additionally, the upswing simply wasn’t as rapid as I had thought. I over-estimated the ability of the multi-family construction sector to respond to changes in underlying demand.
This may be due to financing issues. This may simply be due to the fact it takes more time for an industry to accelerate from a near death than I was counting on. This may be due to fear that a sudden sell off of foreclosed homes would reduce rents. I am not sure. However, the slow response of this sector was a major issue in getting a sustained recovery.
(Emphasis supplied.) I think Smith overestimated "underlying demand." The reason is for housing to pick up, people willing to buy (or rent) houses) has to increase. But the middle class and the working class is doing terribly. Smith, in my opinion, put the cart before the horse - he expected a "if we build them they will come" economy to emerge. It simply does not happen that way in financial crisis depressions (at least that is what Krugman tells me, as well as my own eyes.)
I'm not sure what Smith means by "financing issues," but if he means interest rates, well, we know that's not the problem.
The problem and solution, Smith suggests, lies with the Fed:
Overall, what this means is that policy – particularly monetary policy – has become more important again. If we had a bunch of shocks hitting at once that eased the job of the Fed because it could count on the Natural Rate of interest rising, rather than having to effectively lower the policy rate.
[... T]he current fall in the 10yr treasury is NOT enough. This was a fall that happened because outside factors caused the market to both push back its estimates of when the Fed would raise rate given the current reaction function and because the demand for safe assets increased further.
What we need is a change in the reaction function itself. That’s what matters for pulling the economy upwards. The Fed has to say that it will tolerate more inflation or will be more heavily focused on unemployment. This way folks engaging in long term projects will now that even if the economy picks up they can still expect to experience low financing costs.
(Emphasis supplied.) This sounds an awful like waiting for the confidence fairy talk to me. Are financing costs really the issue? At the zero lower bound? This simply seems incorrect to me. It's lack of demand that is the issue. Pushing interest rates down a half point will not help.
The focus on inflation is the more interesting argument I think. It is the creation of a disincentive to park your money in T-bills and cash. But I'm not sure how the Fed can spark inflation in a depression economy on its own. Coupled with a government stimulus, sure. Without it? The missing ingredient, an increase in aggregate demand, seems to preclude the Fed's ability to push up inflation.
It's election season, so talking about what the Obama Administration did wrong is not something we want to do, but to discuss the situation dispassionately, I think we have to recognize that it is fiscal policy that works now, not monetary policy.
Speaking for me only
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