Paul Krugman muses on the surprisingly passive policy of the Federal Reserve:
Targets, Instruments, and the Zero Bound: I’ve been rereading Larry Ball’s impressive and disturbing what-happened-to-Ben-Bernanke analysis…. I think there’s a way to further refine Ball’s analysis, making more sense of Bernanke’s retreat from earlier positions — albeit one that still doesn’t cast a very flattering light on the Fed….
Bernanke’s harsh early-naughties critique of the Bank of Japan’s inadequate response in the face of the zero lower bound — its “self-induced paralysis” — applies with almost eerie precision to the Bernanke Fed. So the question is what happened. Ball gets much more specific by pointing to an apparent shift in 2003….
As Ball parses it, before that meeting BB endorsed, at least as possibilities:
- Targeting long-term interest rates
- Currency depreciation
- Money financed deficit spending
- A Krugman-style inflation target
After 2003, however, his menu seemed to have been reduced to:
- Guidance on future short-term rates (the rates the Fed sets)
- Purchases of long-term bonds and other nonconventional assets
- “Oversupplying reserves”, that is, just pushing up the monetary base
Call these Menu A and Menu B…. Menu A involves the Fed setting targets that can be achieved only if the markets believe that it will persist with unconventional policies even as the economy recovers; ordering from Menu A requires, as I put it lo these many years ago, that the Fed “credibly promise to be irresponsible”. Menu B, on the other hand, involves more or less mechanical actions that the Fed can definitely take…. Menu B is about instruments; menu A is about targets that the Fed might not succeed in hitting….
So now we can ask, why has the Fed been willing to go for Menu B but not Menu A?… Ben Bernanke answered that question… about the Bank of Japan, which back in 2001 he described as being unwilling to announce a target it wasn’t sure it knew how to achieve. He castigated the BoJ for this attitude, for being unwilling “to try anything that isn’t absolutely guaranteed to work”. And then he became a central banker himself….
Menu B serves institutional objectives better. Unfortunately, it doesn’t do the job for the economy. To be fair, we don’t know that Menu A would, in fact, be sufficient. But Benanke the Younger… would have said that this was no reason not to try.