How should we judge tomorrow’s speech by Fed Chairman Bernanke? How about Bernanke’s previous comments on a similar macroeconomic challenge? Paul Krugman says Bernanke’s chat on Japan’s malaise are a useful primer for evaluating what we’ll hear to tomorrow. Krugman refers to “Bernanke’s 2000 critique of the Bank of Japan for its failure to take strong action in the face of an economy that was actually in much better shape than the US economy right now.”
Here’s an excerpt from what Bernanke said back in the day…
In the short-to-medium run, however, macroeconomic policy has played, and will continue to play, a major role in Japan’s macroeconomic (mis)fortunes. My focus in this essay will be on monetary policy in particular. Although it is not essential to the arguments I want to make—which concern what monetary policy should do now, not what it has done in the past—I tend to agree with the conventional wisdom that attributes much of Japan’s current dilemma to exceptionally poor monetary policy-making over the past fifteen years… Among the more important monetary-policy mistakes were 1) the failure to tighten policy during 1987-89, despite evidence of growing inflationary pressures, a failure that contributed to the development of the “bubble economy”; 2) the apparent attempt to “prick” the stock market bubble in 1989-91, which helped to induce an asset-price crash; and 3) the failure to ease adequately during the 1991-94 period, as asset prices, the banking system, and the economy declined precipitously. Bernanke and Gertler (1999) argue that if the Japanese monetary policy after 1985 had focused on stabilizing aggregate demand and inflation, rather than being distracted by the exchange rate or asset prices, the results would have been much better.
Bank of Japan officials would not necessarily deny that monetary policy has some culpability for the current situation. But they would also argue that now, at least, the Bank of Japan is doing all it can to promote economic recovery. For example, in his vigorous defense of current Bank of Japan (BOJ) policies, Okina (1999, p. 1) applauds the “BOJ’s historically unprecedented accommodative monetary policy”. He refers, of course, to the fact that the BOJ has for some time now pursued a policy of setting the call rate, its instrument rate, virtually at zero, its practical floor. Having pushed monetary ease to its seeming limit, what more could the BOJ do? Isn’t Japan stuck in what Keynes called a “liquidity trap”?
I will argue here that, to the contrary, there is much that the Bank of Japan, in cooperation with other government agencies, could do to help promote economic recovery in Japan. Most of my arguments will not be new to the policy board and staff of the BOJ, which of course has discussed these questions extensively. However, their responses, when not confused or inconsistent, have generally relied on various technical or legal objections—-objections which, I will argue, could be overcome if the will to do so existed. My objective here is not to score academic debating points. Rather it is to try in a straightforward way to make the case that, far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism.
This post originally appeared at The Capital Spectator and is reproduced here with permission.