Assessing Ben Bernanke's Claims That He Has Not Changed His Mind since 1999 on the Power and Desirability of Expansionary Monetary Policy at the Zero Lower Bound
There's this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time. I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation….
The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are not exhausted…. [W]e are not in deflation…. We have an inflation rate that's close to our objective…. [D]oes it make sense to actively seek a higher inflation rate in order to achieve a slightly increased pace of reduction in the unemployment rate? The view of the committee is that that would be very reckless…. To risk that asset [of our credibility] for what I think would be quite tentative, and perhaps doubtful, gains on the real side would be an unwise thing to do.
From the beginning of the 1980s through the fourth quarter of 1991… real GDP in Japan grew by nerly 3.8% per year…. If growth during the 1991-99 period had been an even 2.5% per year, Japanese real GDP in 1999 would have been 13.6% higher….
[M]macroeconomic policy has played, and will continue to play, a major role in Japan's macroeconomic (mis)fortune…. [T]here is much that the Bank of Japan, in cooperation with other government agencies, could do…. [BOJ] responses, when not confused or inconsistent, have generally relied on various technical or legal objections--objections that, in my opinion, could be overcome if the will to do so existed….
[Si]nce 1991 inflation has exceeded 1% only twice... the slow or even negative rate of price increase points strongly to a diagnosis of aggregate demand deficiency…. [C]ountries that currently target inflation… have tended to set their goals for inflation in the 2-3% range, with the floor of the range as important a constraint as the ceiling….
The [respectable] argument that current monetary policy in Japan is in fact quite accommodative… focuses on the real interest rate… the realized real call rate for 1999 will be under 1%…. Is this not evidence that monetary policy in Japan is in fact quite accommodative?... I agree that the low real interest rate is evidence that monetary policy is not the primary source of deflationary pressure…. But neither is the low real interest rate evidence Japanese monetary policy is doing all that it can…. [S]harp reductions in consumption and investment spending have shifted the IS curve in Japan to the left…. [M]onetary policy may not be directly responsible for the current depressed state of aggregate demand in Japan today (leaving aside for now its role in initiating the slump), it does not follow that it should not be doing more to assist the recovery.
[N]ote that today’s real interest rate may not be a sufficient statistic for the cumulative effects of tight monetary policy…. [O]ne might want to consider indicators other than the current real interest rate--for example, the cumulative gap between the actual and the [previously] expected price level--in assessing the effects of monetary policy….
[D]efenders of Japanese monetary policy make… is as follows: “Perhaps past monetary policy is to some extent responsible for the current state of affairs. Perhaps additional stimulus to aggregate demand would be desirable at this time. Unfortunately, further monetary stimulus is no longer feasible…. "
It is true that current monetary conditions in Japan limit the effectiveness of standard open-market operations. However… liquidity trap or no, monetary policy retains considerable power to expand nominal aggregate demand….
Overall, my claim has two parts: First, that--despite the apparent liquidity trap--monetary policymakers retain the power to increase nominal aggregate demand and the price level.
Second, that increased nominal spending and rising prices will lead to increases in real economic activity. The second of these propositions is empirical but seems to me overwhelmingly plausible.... The first... in my view one can make what amounts to an arbitrage argument--the most convincing type of argument in an economic context--that it must be true.
The general argument that the monetary authorities can increase aggregate demand and prices, even if the nominal interest rate is zero, is as follows: Money, unlike other forms of government debt, pays zero interest and has infinite maturity. The monetary authorities can issue as much money as they like. Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets. This is manifestly impossible in equilibrium. Therefore money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero. This is an elementary argument, but, as we will see, it is quite corrosive of claims of monetary impotence…
In my view, Bernanke in 1999 believed that (a) the inflation outcome should be between 2%/year and 3%/year, with as much attention paid to avoiding inflation outcomes below 2%/year as to avoiding inflation outcomes above 3%/year, and (b) boosting expected inflation is the principal tool a central bank has to reduce unemployment and boost production at the zero lower bound, and (c ) the central bank should--unless inflation is projected to be above 3%/year--use its tools to boost expected inflation.
That is not where Bernanke was yesterday, in spite of his claims that he had not altered his intellectual positions.