I was on vacation last week (far from Jackson Hole) when Ben Bernanke gave his widely anticipated speech. The media (see the Times, for example) seemed to focus mainly on his criticisms of the political branches and economic policymaking, which were accurate enough. But in my opinion, Bernanke drew the wrong lessons from those observations.
He was very clear that the problem today is unemployment, not inflation:
“Recent data have indicated that economic growth during the first half of this year was considerably slower than the Federal Open Market Committee had been expecting, and that temporary factors can account for only a portion of the economic weakness that we have observed. Consequently, although we expect a moderate recovery to continue and indeed to strengthen over time, the Committee has marked down its outlook for the likely pace of growth over coming quarters. With commodity prices and other import prices moderating and with longer-term inflation expectations remaining stable, we expect inflation to settle, over coming quarters, at levels at or below the rate of 2 percent, or a bit less, that most Committee participants view as being consistent with our dual mandate.”
He even said that we are in a situation where economic policy would improve the economy’s long-term performance:
“Normally, monetary or fiscal policies aimed primarily at promoting a faster pace of economic recovery in the near term would not be expected to significantly affect the longer-term performance of the economy. However, current circumstances may be an exception to that standard view–the exception to which I alluded earlier. Our economy is suffering today from an extraordinarily high level of long-term unemployment, with nearly half of the unemployed having been out of work for more than six months. Under these unusual circumstances, policies that promote a stronger recovery in the near term may serve longer-term objectives as well. In the short term, putting people back to work reduces the hardships inflicted by difficult economic times and helps ensure that our economy is producing at its full potential rather than leaving productive resources fallow. In the longer term, minimizing the duration of unemployment supports a healthy economy by avoiding some of the erosion of skills and loss of attachment to the labor force that is often associated with long-term unemployment.”
But what is Bernanke going to do about it? He declined to offer any new efforts to reduce unemployment, saying only that the Fed “is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability.” And mainly he relied on the political branches to solve the country’s problems, calling not only for “good, proactive housing policies” but also for policies that would improve K–12 education for underprivileged households and lower health care costs.
I don’t think it makes sense to criticize the political system for being dysfunctional and then rely on the political system to rescue the economy. I understand that traditional monetary policy tools don’t work that well in this environment: short-term rates can’t go any lower, and lowering long-term rates won’t make companies invest if they don’t think there is demand for their stuff. But there’s always, you know, dropping cash out of helicopters.
It’s true that, in the speech that gave Bernanke the nickname “helicopter Ben,” he was talking about a tax cut—in other words, fiscal policy. But there’s always the option of increasing the inflation target from 2 percent to 4 percent while simultaneously buying long-term bonds to keep nominal rates from rising too much (so real rates come down). If the Fed can actually generate more inflation, that would function like a transfers from creditors to debtors, which would help solve the household balance sheet problems that are weighing down the economy. And there’s nothing magical about the number two: both Ken Rogoff and Olivier Blanchard have argued for higher inflation, given current economic circumstances. As Blanchard says, “There was no very good reason to use 2% rather than 4%. Two percent doesn’t mean price stability. Between 2% and 4%, there isn’t much cost from inflation.”
I’m not sure it would work; maybe even raising the inflation target wouldn’t actually increase inflation. But doing nothing is the wrong policy conclusion to draw from Bernanke’s observations, which seem spot-on.
This post originally appeared at The Baseline Scenario and is reproduced here with permission.