Bernanke Q&A--It's All in the Framing of the Question

Ben Bernanke did his first post-FOMC Q&A. Not surprisingly he got a lot of questions regarding concerns over inflation.  Unfortunately, most of these inflation questions were premised on the assumption that inflation is always a bad outcome that must be avoided at all cost.  For example, Robin Harding of the FT asked Bernanke what the Fed could do to prevent inflation expectations from increasing.  None of the reporters seemed to grasp and Bernanke failed to explain that a period of catch-up inflation--which really is just a symptom of catch-up nominal spending--could do the economy some good without jeopardizinng long-run inflation expectations.  All the Fed would need is to set an explicit level target and run with it as I explain here.  And make no mistake, the Fed has the power to make a difference.  Just look at how successful the original QE program was in the 1930s, a time of far worse economic conditions. 

Allowing these reporters to frame the discussion the way they did is all the more frustrating given Bernanke's past research on Japan.  In that work, Bernanke calls for price level targeting (though NGDP level targeting would be better) that would allow catch-up inflation to the pre-crisis trend. Why not the same now?  If only one of the reporters had asked that question! Time for Jon Hilsenrath, Neil Irwin, Robin Harding and others Fed reporters to man up and call Bernanke on this point. Better yet, time for Bernanke to man up and do the speech Ezra Klein hoped he would do.

[Update: Niklas Blanchard, Matthew Yglesias, Paul Krugman and Marcus Nunes share my disappointment.]

Gresham's Law in the Eurozone, Again

Tyler Cowen brought up Gresham's Law in his NY Times column this past weekend:

IS a euro held in an Irish bank in Dublin, or in a Portuguese bank in Lisbon, as sound and secure as a euro in a German bank in Berlin? That apparently simple question holds the key to understanding why the euro zone may splinter and bring a new financial crisis. 

In Ireland, there has been a “silent bank run” on financial institutions for much of the last year. In February, for instance, Irish private sector deposits dropped at an annual rate of 9.8 percent. That’s largely because some depositors doubt the commitment of the Irish government to the euro. They fear that they will wake up one morning to frozen bank accounts, followed by the conversion of their euro deposits into a lesser-valued new Irish currency. Pre-emptively, the depositors send their money outside Ireland, where it still represents safe euros or perhaps sterling, accessible by bank transfers and A.T.M. cards.  This flight of capital reflects a centuries-old economic principle known as Gresham’s Law, sometimes expressed casually as “bad money drives out good money.” In this context, if two assets — euros inside and outside Ireland — are not equal in value in the eyes of the marketplace, sooner or later the legally fixed price parity will fall apart.

This reminded me of a Telegraph story back in June, 2008 that I blogged where it was alleged that Germans were hoarding Euro notes issued from Germany and dumping Euro notes issued from Southern Europe. I thought it was worth reposting:

Ramesh Ponnuru Responds to His Critics

Ramesh Ponnuru had a thoughtful piece in the National Review where he argued that the Fed needed to do QE2.  Predictably, he was criticized for not advocating hard money, not being Austrian enough, favoring central planning, and a host of other sins.  Ponnuru patiently replies to the criticisms:

Should the Fed's Expansionary Policies Be Ended?

No, but they should be more systematic. The problem with the QEs all along is that they have been rather ad-hoc and unpredictable.  This has made them less effective and politically polarizing.  Imagine how different the Fed's monetary stimulus would have been had they adopted an explicit target, preferably a nominal GDP level target.  Such an approach would have given them the freedom to do really aggressive 'catch-up' monetary easing until nominal GDP returned to the targeted trend while at the same time ensuring long-term predictability.  It also would be viewed (correctly) as constraining the Fed's power.

Instead we are stuck with the problematic QE programs that have been at best mildly effective and as result, are an easy target for critics. Thus, it is no surprise to learn from Robin Harding of the FT that the Fed is about to signal the end of monetary easing:

An end to global monetary policy easing is on the horizon, with the US Federal Reserve set to signal it will cease asset purchases at the end of June.

When the rate-setting Federal Open Market Committee meets on April 27, it is unlikely to limit its options by ruling out asset purchases beyond the second $600bn “quantitative easing” programme – or “QE2” – that is due to finish by the end of the second quarter.

Fed officials, however, know that announcing more asset purchases at the last minute would disrupt markets. Silence on a follow-up “QE3” at next week’s meeting would therefore signal that their current intention is to complete the $600bn QE2 programme and then stop.

One reason the Fed is contemplating this is because the QE programs have not delivered a robust recovery  and have become a political minefield.  This does not mean monetary policy could not do more if done right.  There is still evidence of excess money demand problem that the Fed could meaningfully address through a nominal GDP level target. With U.S. fiscal tightening nearing and Eurozone problems lingering, the Fed needs a nominal GDP level target now more than ever.

Impeccable Timing

Amidst all the U.S. budget talk last week, the IMF decided to weigh in by noting the U.S. lacked a "credible strategy" to handle its public debt.  Now Standard & Poor's has decided to pile it on by downgrading U.S. public debt from stable to negative.  From the FT:

“We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns..."

Between this and the rumors of a possible Greek debt restructuring, global markets are roiling.  If this turns ugly, then Fed should be ready to accommodate the spike in global demand for dollar-denominated money.

Here We Go Again...

Desmond Lachman has a new article where does a great job comparing the current failures of ECB with those of the Fed in 2008-2009.  One comparison I would add is that the ECB's tightening of monetary policy this month over concerns about inflation is very similar to the Fed's decision not to cut the target federal funds rate in the September, 2008 FOMC meeting because of concerns about inflation. One would hope that the ECB would learn from the Fed's passive tightening of monetary policy in 2008. Here is Lachman:

Mark Twain famously observed that history does not repeat itself but it does rhyme. Considering how Europe's sovereign debt crisis is playing out, one has to be struck by Mark Twain's prescience. For the Europen sovereign debt crisis bears an uncanny resemblance to the 2008-2009 U.S. financial crisis. And it gives every indication of having the potential to shock the global economy in a manner not too dissimilar from the way in which the U.S. subprime crisis did.

[...]

Apparently not learning from Mr. Bernanke's monetary policy mistakes in the run up to the U.S. crisis, Mr. Trichet now appears intent on compounding the Eurozone's sovereign debt crisis by having the ECB start an interest rate tightening cycle. For the last thing that Europe's periphery needs right now is higher European interest rates and the associated Euro strengthening at the very time when the periphery is engaged in draconian budget tightening and in a major effort to restore international competitiveness.

Yet another disturbing way in which the Eurozone debt crisis resembles the earlier U.S. subprime crisis is the way in which European policymakers are engaging in self delusion. They do so by fooling themselves that the problems with which they are dealing are ones of liquidity rather than solvency. And at each stage of the crisis they manage to convince themselves that they have ring-fenced the crisis.

[...]

In May 2010, at the time that the U.S.$140 billion IMF-EU bailout package for Greece was announced, markets were asked to believe that Greece's case was sui generis. They were also asked to believe that the Eurozone's periphery was suffering from only liquidity problems and that these problems would soon dissipate once market confidence was restored. Yet six months later the IMF and EU had to bail out Ireland. And today nobody doubts that Portugal will soon have to be bailed out as well.

Despite record high interest on the sovereign bonds of Europe's periphery even after massive IMF and ECB support, European policymakers keep up the charade that Greece, Ireland, and Portugal do not need a debt restructuring. And despite Spain's serious problems of external over-indebtedness, a major housing bust, and a highly troubled savings and loan sector, European policymakers are asking markets to seriously believe that Spain will not be the next domino to fall.

Perhaps the most disturbing aspect of the Eurozone debt crisis today is how little European policymakers are asking of the European banking system to raise additional capital to cushion itself against the inevitable large write down in the periphery's sovereign debt. In that respect too they are providing additional evidence for George Santayana's adage that those who do not learn from history are bound to repeat it.

Scott Sumner is Alive and Well

He returns in a Bloomberg news story that calls on the Bank of England to abandon inflation targeting:

The Bank of England should consider replacing its inflation-targeting regime with one focusing on nominal gross-domestic-product growth, U.S. economist Scott Sumner said.  Targeting nominal GDP growth, which is not adjusted for inflation, would clarify the bank’s mandate and lessen its reliance on unreliable price indicators, Sumner, an economics professor at Bentley University in Waltham, Massachusetts, said in a report published today[.]

[...]

Inflation is “measured inaccurately and doesn’t discriminate between demand versus supply shocks,” Sumner said in a telephone interview. “Inflation often changes with a lag and sometimes when you go into recession, it doesn’t change very easily, but nominal GDP growth falls very, very quickly, so it’ll give you a more timely signal stimulus is needed.”

The U.K. central bank should target annual nominal GDP growth of about 4 percent to 5 percent, Sumner said. This would also lead to a better coordination of monetary and fiscal policy, he said. The Office for Budget Responsibility, the British government’s fiscal watchdog, last month cut its forecast for 2011 economic growth to 1.7 percent from 2.1 percent. 

The U.K. government shouldn’t be in a position where it is “reluctant to cut the budget deficit because of fear of the effect on the recovery,” Sumner said. “With nominal GDP targeting, you have the assurance that any slowdown in nominal GDP due to budget tightening can be offset by monetary policy.”

This last point seems particularly relevant to the U.S. economy now.  Hopefully, any contractionary effect from the current budget deal will be offset by the Fed. It sure would be easier for the Fed to do so  if  it had a nominal GDP level target.  Just saying.

Update: Here is the paper by Scott Sumner that motivated the above Bloomberg story.