What Chairman Bernanke Could Learn from Professor Bernanke

[Kurt_and_Hunter]

What Chairman Bernanke Could Learn from Professor Bernanke
The Federal Reserve chief would do well to heed his own advice from his Princeton days and take bold action to boost growth, says columnist Frank Aquila
By Frank Aquila

The Inflation Prescription

So, if the U.S. economy today is in a state similar to Japan's a decade ago, what would the professor recommend? Inflation! In his scholarly view, the Bernanke of 1999 concluded that the Bank of Japan should have announced "a target in the 3-4 percent range for inflation, to be maintained for a number of years."

The normal reaction to inflation is that it should be kept contained, held to a low level. The destructive effects of a sustained rise in prices are well-documented. But is it possible that higher inflation would actually strengthen the economy? Inflation increases the nominal dollar value of assets while the nominal dollar value of debt remains the same. As wages and prices increase, the debt burden is effectively eased. Clearly the holders of that debt are losing out as rising prices erode the "real" value of their holdings—but that might be preferable to a long-term economic malaise. Individuals and companies would be reluctant to sit on their cash during a period of sustained inflation. Instead, they would spend or invest it. Igniting inflation is risky business and it is understandable that few central bankers would have the resolve to promote such an approach.

A decade after Professor Bernanke delivered his paper, Bank of Japan Governor Masaaki Shirakawa, speaking in New York in April 2009, acknowledged the striking similarities between Japan in the 1990s and the U.S. since 2007. Shirakawa warned that "the U.S. might be entering its own version of the 'lost … not necessarily decade but something else.' " With the benefit of hindsight, Governor Shirakawa acknowledged that his BOJ predecessors had not acted as quickly and decisively as was required to avoid the economic stagnation that comes with low growth and deflation.

In Professor Bernanke's 1999 paper he rebuts the argument made by the Bank of Japan at the time that simply maintaining low interest rates for an extended period represented monetary policy necessary to provide economic growth. As he noted then, "low nominal interest rates may just as well be a sign of expected deflation and monetary tightness

. . .

Long article:

http://www.businessweek.com/investor/content/sep2010/pi20100922_108414.htm?campaign_id=rss_topStories

The Stimulus That Wasn’t There

Frank Aquila’s Businessweek piece on what Ben Bernanke could learn from Ben Bernanke’s academic work is pretty informative and I hope it sways the views of America’s executive class. But I’m afraid that his throwaway line about fiscal policy, catering as it does to the pre-existing prejudices of said class, will lodge more deeply in their mind: “Even with massive Keynesian pump-priming, economic growth has been far weaker than the typical postslump rebound.”

It can’t be emphasized enough that there simply was not a massive fiscal pump-priming in a macroeconomic sense. Instead what happened is that the declining economy led to massive cutbacks in expenditures by state and local government, and the American Recovery and Reinvestment Act largely-but-not-entirely offset those cutbacks with an increase in spending at the federal level. ARRA was, as a piece of legislation, a fairly massive set of policy initiatives. But we simply didn’t try to stage a massive increase in government purchases to offset the fall in consumer spending and business investment. Instead we organized an increase in federal purchases to offset the fall in state and local purchases.

http://yglesias.thinkprogress.org/2010/09/the-stimulus-that-wasnt-there/