Friday, December 18, 2009

Bernanke's Comedy of Errors...

Confirming Ben Bernanke was a horrendous mistake.

Here's the thing -- I think Ben Bernanke is a really nice guy. His heart is basically in the right place. He doesn't wake up each morning like Dick Cheney wanting to screw the poor. But, for a variety of reasons, he is just not up to the job of being Fed Chairman. Part of this has to do with the worthlessness of Academic Macro, the culture from which Bernanke came, the failed job PhD programs do in training their students, and the fact the discipline is still largely psuedo-scientific. Due to this culture, a guy w/ Bernanke's pedigree -- Harvard undergrad, MIT PhD, and very good math skills -- was predestined to be at the top of the field. As I've mentioned before, however, it's very difficult to look at his academic papers and say "this guy is really bright". Here is an example I blogged about before. Another paper of Bernanke's has the dumbest title of all-time: "Is Growth Exogenous: Taking Mankiw, Romer, and Weil Seriously." Why is this dumb? Well, b/c of course growth is not exogenous! That would mean that economic growth just ... happens, comes down to Earth like manna from heaven, and there's nothing anyone can do about it. Incidentally, it's doubly stupid b/c there's no reason to take MRW seriously. It's a simple paper in which the authors simply have no clue what's driving their result, not realizing that low birth rates are proxies for rich countries, and so foolishly find in support of the Solow model, in which lower population growth increases the steady-state capital stock. But I digress. Bernanke also apparently had not heard of the Demographic transition.

Brad DeLong has pointed out four mistakes of Ben Bernanke as Fed Chairman:

* Not supporting Ned Gramlich's push for tighter regulatory oversight of mortgage financing and associated securitizations and derivatives.
* Not moving immediately in early 2008 to nationalize more of the banking system and support asset prices to a greater extent.
* Believing in the late summer of 2008 that the big problem was that the Federal Reserve had pumped too much liquidity into the economy, and believing that a bankruptcy on the part of Lehman Brothers would send a healthy message to bankers that they would not always be bailed out by the government and would send that maessage without having damaging consequences for the economy as a whole.
* Failing to walk down the strategy tree in the fall of 2008 and thus to place a high priority on ensuring that if the government's interventions in financial markets worked to stabilize asset prices and avert depression then the government would profit and would be seen to profit healthily from its interventions.

To which I'd add 4 more mistakes, which really could all be lumped together and are ongoing...
#5. After 12/31/2008, to shrink the Fed's Balance sheet... The Fed's Balance sheet is still below where it was at the end of last year. This corresponds to net tightening in a severe recession.
#6. To wait until March -- March! To start QE in long-term government bonds. As it happens, I was actually under the impression that the Fed had started doing this much sooner. Especially since Bernanke's own academic research suggested that the Fed could influence the economy in a liquidity trap via QE, it did not occur to me that the Fed was not doing this. And then to do only $300 billion of QE... Paul Samuelson argued that Monetary Policy was basically worthless in a liquidity trap. Paul Samuelson was no fool -- to have real effects, QE has to be done on a large scale. $300 billion is only slightly better than nothing. Joe Gagnon has estimated that $2 trillion in QE is roughly equivalent to a 75 basis point cut in normal times, and he may be optimistic.
#7. This summer, the labor market was doing waaay worse than he'd expected the previous winter. And yet, there was no recalibration of Monetary Policy. As the information came in that inflation was still at bay and unemployment was still rising fast, he ... did nothing. And on top of that, he predicted unemployment would not rise to 10%.
#8. Now w/ unemployment at 10%, way worse than he predicted, once again, and with inflation still under control and below target, there is still no re-calibration of monetary policy. The Fed's predictions for Q4, 2010 are unemployment at 9.3-9.7% and inflation at 1.4-1.7%.

Someone please tell me how the risks of doing too much and of doing too little are symmetric?

If the Fed "does too much" and unemployment in one year is at 8.3-8.7%, while inflation is at 2.7%, there is no loss to society whatsoever. If the Fed "does too much" and unemployment in one year is 7.3% and inflation is 3.7%, that is still a tradeoff I would make in a heartbeat. Above 4%, and I would reconsider, but there would be plenty of time between now and 4% inflation in which the Fed could roll its stuff back... And I'm aware that once a inflation starts to increase, the Fed may have to roll it's stuff back quickly, but since the Fed can increase the Fed Funds rate, but cannot cut it, it should be easy to keep inflation under 3%, much less 4%.

On the other hand, if the Fed "does too little", and unemployment in one year is at 10.3-10.7%, and inflation is at .3-.7%, that would be a total f*cking nightmare for millions of people, and the Dems will be bloodied in a landslide. If the numbers get worse, and unemployment rises to 11.3-11.7, that would be a total f*cking nightmare for millions of people, and the Dems will be bloodied in a landslide. Of course, in either of these latter two scenarios, what would happen is so much pressure would build on the Congress, that we would get more stimulus, and at some point, if the economy continues to do badly enough w/ no inflation, Bernanke might recalibrate and do more QE.

The most likely scenario from my vantage is the "boiled frog" scenario, by which the economy continues to get better, albeit slowly, and may even beat unemployment predictions next fall, falling to 8.9% by election day! In this case, of course, there would be no urgent need for more QE, no need for more stimulus, but it would be a total f*cking nightmare for millions of people, and the Dems will be bloodied in a landslide

I'm really starting to wish I had done more, personally, to fight against Bernanke's confirmation. What am I going to tell my children and grandchildren -- that, oh, I didn't fight Bernanke's confirmation b/c I was working on a journal article?


  1. Who, if not Bernanke? Most of the other Fed officials are even more hawkish on inflation. Here's Charles Plosser:
    "In the current circumstances, the Fed will need to withdraw the extraordinary amount of liquidity it has provided to financial markets to ensure that the public does not lose confidence in its commitment to keep inflation low and stable. If it fails to do so, rising inflation expectations could prompt workers to demand higher wages and firms to demand higher prices to head off the expectation of higher costs, thus setting off a burst of inflation. For me, this risk bears careful monitoring."

    Most of today's academic macroeconomists probably agree with that. There are guys like Krugman, but they are outsiders to macro.

    Finally, there's the populist anti-Fed movement, e.g. Ron Paul's bill in Congress. They are anti-Bernanke, but if they get their way I doubt more easing is what we'll see. Paul is a gold bug, sound money and all that...

  2. Jon Corzine? Anyway, it's moot. Bernanke's going to be the man for the next six years...

    And, I agree w/ Plosser that the risk of inflation "bears careful monitoring", but the point is we can and should wait until we are having a real job market recovery before we stop being expansionary...