If Not Now, When?

A recent WSJ article provided Bernanke’s response to this question by Brad DeLong:

D. Brad Delong, University of California at Berkeley and blogger: Why haven’t you adopted a 3% per year inflation target?

The public’s understanding of the Federal Reserve’s commitment to price stability helps to anchor inflation expectations and enhances the effectiveness of monetary policy, thereby contributing to stability in both prices and economic activity. Indeed, the longer-run inflation expectations of households and businesses have remained very stable over recent years. The Federal Reserve has not followed the suggestion of some that it pursue a monetary policy strategy aimed at pushing up longer-run inflation expectations. In theory, such an approach could reduce real interest rates and so stimulate spending and output. However, that theoretical argument ignores the risk that such a policy could cause the public to lose confidence in the central bank’s willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy going forward. The anchoring of inflation expectations is a hard-won success that has been achieved over the course of three decades, and this stability cannot be taken for granted. Therefore, the Federal Reserve’s policy actions as well as its communications have been aimed at keeping inflation expectations firmly anchored.

1.  First of all, if the Fed really wanted to anchor expectations they would announce an explicit target.  The 3% target suggested by DeLong may or may not be optimal.  Most economists prefer a slightly lower figure, but given how the Fed has shown itself incapable of operating in a zero rate environment, it is equally plausible that the trend rate should be higher.  But the Fed refuses to set any explicit target.

2.  The Fed itself called for fiscal stimulus last year.  Isn’t the purpose of fiscal stimulus to increase aggregate demand?  And doesn’t higher aggregate demand increase inflation, at least in the long run?  So if Bernanke is opposed to higher inflation, why did he advocate fiscal stimulus?  And if Bernanke no longer thinks the economy needs more aggregate demand, why not just tell Congress that the economy needs no more stimulus, because there is plenty of demand out there?  And what is causing the high unemployment?  Maybe “recalculation” as Kling argues, or maybe perverse government incentives, as Casey Mulligan argues.  Bernanke is certainly entitled to his opinion.  Bu does anyone think he would dare offer those opinions to Congress?  So he hides behind the phony risk of high inflation, just as the Fed did in the early 1930s.  The same Fed that Bernanke claims caused the Great Depression.

3.  Why not level targeting?  Bernanke says it works in theory.  In 2003 Bernanke said Japan should adopt level targeting.  Bernanke’s former colleague Woodford says we need it right now, and indeed anytime we are in a liquidity trap.  So where is Bernanke’s leadership?

4.  Why the focus on long run inflation expectations?  Sure, they are reasonably well-behaved.  But the real problem is the very low inflation since mid-2008, and the low expected inflation over the next two years.  These low inflation expectations are consistent with an economy suffering from a severe demand shortfall in the near term.  And not just according to my model, but according to the sort of new Keynesian model that Bernanke has used his entire professional life.

5.  The Fed currently has no explicit inflation target.  How would setting such a target “cause the public to lose confidence in the central bank’s willingness to resist further upward shifts in inflation, and so undermine the effectiveness of monetary policy going forward.”  That makes no sense at all.  Again, maybe 3.0% isn’t the right target.  But the Fed has to ask itself these questions:

a.  Do we want a higher level of AD?

b.  If so, what sort of inflation would result from the optimal level of AD?

c.  Then set an explicit target at that level.

If the optimal rate of inflation is exactly the same as the current expected rate (which is implied by his answer) then is the Fed is implicitly claiming that additional AD would be unwelcome in an economy with 10% unemployment, an economy where this year’s NGDP will fall at the fastest rate since 1938.  Does the Fed really want to say that additional AD would be unwelcome?  They can’t have it both ways.  If we need additional AD, then we need higher inflation expectations.

I found this answer infuriating because he danced around all the important issues.  He talked like we were back in the 1970s, when the biggest challenge was getting a lower level of actual and expected inflation.  Bernanke doesn’t seem to realize that inflation targeting is not a one way street, it doesn’t mean always targeting inflation at current rates or lower.  If you are serious about inflation targeting and have a symmetrical response function, then by necessity there will be times when you wish inflation to be a bit higher.  And if this is not such a time, a year when we have experienced the first deflation since 1955, then will there ever be a time when the Fed tries to boost inflation expectations?  If not now, when?

PS.  I don’t always agree with DeLong, but this was a great question.  Appropriately direct and to the point.

PPS.  Several people have asked my about Bernanke being named Time magazine’s Person of the Year.   This AP news story called it Time’s “highest honor.”  It is amazing how few people know that the designation is not an honor, it merely indicates who was most influential.  Apparently Time thought he did a good job, but past winners include people like Hitler, Stalin and Khomeini.  On the other hand Osama didn’t get named in 2001, so perhaps Time has chickened out on giving the designation to the most influential person, fearing a loss of subscriptions when bad guys are “honored.”   In any case, the whole process is just as ludicrous as the Academy Awards and Nobel prizes for Peace and Literature.

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