Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
Last week, the Federal Reserve chairman Ben Bernanke received endorsement for a further term from the US Senate Committee on Banking, Housing and Urban Affairs (popularly known as the US Senate Banking Committee). There is much controversy about this re-nomination along the lines that he was Chairman as the crisis unfolded and he did nothing about it until it was too late. There is also angst about his refusal to provide Congress with specific information about institutions that the Federal Reserve bailed out. These issues are not unimportant. But the strongest reason why he should be dispensed with is that his public statements leads any informed analyst to conclude that he doesn’t really understand the monetary system. From a modern monetary theory (MMT) perspective his comments on the monetary system are as sophisticated as the most flawed mainstream macroeconomics textbook.
On December 3, Bernanke provided a Six page statement to the Committee to support his nomination by Obama for a second term. You can watch the proceedings of the Committee on December 17, 2009 HERE.
It is a much more visible and transparent process than we have in Australia where the Government just announces the appointment on the basis of their majority in the lower house of the federal parliament.
On December 17, 2009, the Senate Banking Committee voted 16 to 7 to approve the nomination of Ben Bernanke for a second-term as Chairman of the Federal Reserve. The full senate has to consider this nomination, where considerable resistance to the nomination is expected.
Previous nominations to the Chairmanship have usually been a rubber stamping operation for the Committee. Even Paul Volcker, who helped cause the disastrous 1981-82 US recession received only 2 no votes in 1983.
The debate was interesting and if you have time it is worth watching. In terms of capturing opposition sentiment I thought this statement from one of the Senate Banking Committee members, Jeff Merkley a Democrat Senator from Oregon was indicative. He voted against Bernanke’s nomination. Edited highlights included:
The reason, in short, is that as Chairman, Dr. Bernanke failed to recognize or remedy the factors that paved the road to this dark and difficult recession. Following our economic collapse, it is also apparent that he has not changed his overall approach to prioritizing Wall Street over American families …
For too many years, federal regulators turned a blind eye to signs of an impending financial crisis. Tricks and traps proliferated in the credit card and consumer lending industries. Predatory mortgage loans exploded, fueling an unsustainable housing bubble. Regulators lifted rules requiring banks to keep adequate capital, and a laissez-faire approach to securitization, derivatives, and proprietary trading encouraged excessive risk-taking on Wall Street. As a member of the Board of Governors, Chair of the Council of Economic Advisers, and then ultimately as Chairman of the Board of Governors, Dr. Bernanke supported each of these decisions, failing to take the necessary precautionary steps that could have averted or mitigated financial collapse …
We need economic leaders who understand that the ultimate goal of economic policies and the key to meaningful economic recovery should be financially successful families, not oversized Wall Street profits …
The expansion that occurred from 2002 to 2007 became the first economic expansion in which working families were worse off at the end than at the beginning.
Further, the statements made by independent senator from Vermont Bernie Sanders characterise the anger among Americans about their policy makers. He said (December 2, 2009) that:
The American people overwhelmingly voted last year for a change in our national priorities to put the interests of ordinary people ahead of the greed of Wall Street and the wealthy few … What the American people did not bargain for was another four years for one of the key architects of the Bush economy.
As head of the central bank since 2006, Bernanke could have demanded that Wall Street provide adequate credit to small and medium-sized businesses to create decent-paying jobs in a productive economy, but he did not.
He could have insisted that large bailed-out banks end the usurious practice of charging interest rates of 30 percent or more on credit cards, but he did not.
He could have broken up too-big-to-fail financial institutions that took Federal Reserve assistance, but he did not.
He could have revealed which banks took more than $2 trillion in taxpayer-backed secret loans, but he did not.
Apart from the final glitch – about “taxpayer-backed” loans – noting that from a MMT perspective taxpayers fund nothing … the comments reflect the dilemma facing the US and all of us. How is it that the gang that oversaw all the financial mess are managing to retain key positions of power or influence, notiwithstanding what they might have done since the crisis?
The point that Sanders makes which resonates most with me is the following:
The Federal Reserve has four main responsibilities: to conduct monetary policy in a way that leads to maximum employment and stable prices; to maintain the safety and soundness of financial institutions; to contain systemic risk in financial markets; and to protect consumers against deceptive and unfair financial products.
Since Bernanke took over as Fed chairman in 2006, unemployment has more than doubled and, today, 17.5 percent of the American workforce is either unemployed or underemployed.
I have made this point many times within the Australian debate. The RBA is also legislatively obliged to maintain full employment. Once it started to use unemployment as a policy tool rather than a policy target all its senior managers should have been sacked.
Anyway, no senior US policy maker should retain office under these circumstances unless they support a significantly expanded fiscal policy stimulus targetted at direct job creation.
The day before the US Senate Committee on Banking met two Bernanke-related events occurred.
First, Time Magazine voted Bernanke their Person of the Year 2009.
Second, the US PBS News Hours Program was dedicated to the issue of his renomination.
You wonder who writes the Times endorsement when you read statements like this:
Those green bills featuring dead Presidents are labeled “Federal Reserve Note” for a reason: the Fed controls the money supply. It is an independent government agency that conducts monetary policy, which means it sets short-term interest rates – which means it has immense influence over inflation, unemployment, the strength of the dollar and the strength of your wallet.
The only statement that is entirely accurate is that the Federal Reserve sets the short-term interest rate. It does not control the money supply and it is questionable that its has an “immense” influence over inflation etc.
Time also presented a little Federal Reserve Primer:
So let’s take a moment for a quick Fed primer. The Fed’s central function is its dual mandate to steer the economy toward stable prices and maximum employment through monetary policy. To rev up a weak economy, it can lower interest rates by buying Treasury bonds or other safe securities, essentially printing money and dumping it into the banking system with a mouse click. Loose money can encourage banks to lend and firms to hire. This tends to make people happy but can increase inflation risks and weaken the dollar, which can make markets nervous and destroy the value of savings. Loose money can also provide the fuel for financial explosions by incentivizing wild risk-taking. Conversely, to apply brakes to an overheated economy and guard against inflation and asset bubbles, the Fed can raise interest rates by selling securities and contracting the money supply – as the saying goes, taking away the punch bowl as the party starts.
So you see that the printing press is controlled by a mouse. Anyway, open market operations are not accomplished by printing money. They allow the reserves in the banking system to match the minimum requirements of the commercial banks which stops them trying to borrow on the interbank market which pushes interest rates up beyond the central bank’s target rate.
Certainly, lower interest rates may stimulate borrowers to seek loans. But open market operations (the “printing money” claim) only swap one financial asset (bank reserves) for another (bonds). Increasing bank reserves does nothing for lending.
I will disregard the nonsensical comments about “loose money” causing inflation. The correct statement is that aggregate nominal spending in excess of the real capacity of the economy to absorb that spending.
But once again they fail to understand how open market bond-sales work. First, the central bank sets the interest rate at whatever level it wants. The conduct of the interbank market however can undermine a particular setting unless the central bank institutes liquidity management operations.
In this case, if the pressure on rates in the interbank market is downwards which implies there are excess reserves in the system and the banks are trying to lend them out to other banks (an exercise in futility from a system-wide perspective) then the sale of government bonds (“selling securities”) will allow the central bank to retain control of the short-term interest rate.
Selling bonds to the banks drains reserves but does not necessarily “contract the money supply”. That is gold standard logic which is no longer applicable. So if the banks are intent on lending and they have credit worthy customers then the “punch bowl may remain full” despite the bond sales.
In terms of pedigree, Time says:
When he took over the Fed in 2006, after an uneventful eight-month White House stint leading Bush’s Council of Economic Advisers, he said his top priority would be continuing Greenspan’s policies. “Ben and I have never had a serious disagreement,” Greenspan says.
My recent blog – Being shamed and disgraced is not enough – analyses Greenspan’s legacy and suggests that anyone who wanted to continue these policies was not a suitable appointment in the first place.
In relation to this Time says:
Bernanke was as clueless as Greenspan about the coming storm. He dismissed warnings of a housing bubble. He insisted that economic fundamentals remained strong. In March 2007, he assured Congress that “the problems in the subprime market seem likely to be contained.” The day before the global crisis erupted with a run on a French bank, the Fed was still saying its primary concern was inflation. “Bernanke had no idea what was going on,” a foreign central banker tells TIME.
Bernanke told Time Magazine in reply to the criticism that he is the “the patron saint of Wall Street greedheads” that:
He wishes Americans understood that he helped save the irresponsible giants of Wall Street only to protect ordinary folks on Main Street. He knows better than anyone how financial crises spiral into global disasters, how the grass gets crushed when elephants fall.
One wonders what would have happened if the US Government allowed them all to go broke and then took over their offices next day, installed new management on sensible pay levels and ensured all legitimate business continued under the auspices of public ownership. I think this would have been a much better outcome for “Main Street” than the near zero positive outcome that has in fact transpired.
It is also interesting that the debate now is in terms of how much worse it would have been without the specific intervention that Bernanke oversaw. From a MMT perspective, the issue is how much better it could have been if an alternative strategy – not ground in saving Wall Street but in directly creating new employment opportunities and cleaning out the insolvent institutions and the assets that underpinned that insolvency.
I suppose you cannot have much confidence in Time magazine’s judgement – after all in 1937 – they voted Chiang Kai-shek as person of the year and then in 1938 Adolf Hitler, 1939 Joseph Stalin (again in 1942) and Winston Churchill in 1940 and again 1949. A range of other pretty dubious characters are on their list as well (Thanks to Marshall for pointing this out).
The PBS News Hour program presented two opposing views on Bernanke’s renewal. The presenter was Jim Lehrer and his guests were Alice Rivlin (former vice chair of the Federal Reserve during the Greenspan era and director of the Congressional Budget Office) who is now with the Brookings Institution; and James Galbraith who is at the University of Texas at Austin and is close to some proponents of MMT although he still makes comments that are not particularly consistent with MMT.
Jamie Galbraith said that Bernanke should not be confirmed because:
… this was an institutional failure of the first magnitude. He was chairman of the Fed in advance of the crisis. He failed to heed the warnings that were being offered about the dangers in the housing market, about the dangers in derivatives. The Fed was lax in its approach to the regulation of the financial system at that time.
And the crisis happened on his watch. In a sense, he was the admiral of a fleet. It went aground. It seems to me that, in the principle of command responsibility, the institution should get new leadership at this time.
Alice Rivlin gave the other perspective:
I think the whole financial community bears a lot of responsibility. And there were regulatory failures. And the Fed acted too slowly.
But, when the crisis came, Ben Bernanke was absolutely the right person to be there. He was calm and collected. He was very knowledgeable. He was bold in using the powers of the Fed to stabilize the financial system. It was a really dangerous, chaotic situation. We could have had domino effect, big institution after big institution going down, and a total meltdown of the financial system. He avoided that.
She also said that it was unfair to expect Bernanke to have seen the crisis coming “when nobody else did”. Galbraith said that some saw it coming including Warren Buffett. But all the MMT camp saw it coming and have been writing about it for over decade before it manifested as a full-blown crisis.
That is one example of how Galbraith does not acknowledge the MMT literature even though he knows full well that the MMT framework is ideally designed to understand crises like this.
Galbraith was then asked why he disagreed with Rivlin who said Bernanke was “the right man at the right time to go forward”. He said:
Well, I — as I say, I think Ben Bernanke performed well…
JIM LEHRER: Well.
JAMES GALBRAITH: … under extreme pressure in the fall of 2008.
But I don’t think that should qualify him to lead an institution which very, very much needs a new culture, an institutional reform at this time. If he were coming up for chairman for the first time, I would be in favor, but I think the overriding consideration now is, are we going to get a regulatory structure which acts with the aggressiveness and the skepticism that was so lacking in advance of the crisis?
From a MMT perspective it is hard to see how Bernanke has performed well. As Warren Mosler continually points out Bernankes complicated “alphabet soup of programs” to remedy the freeze in interbank lending was unnecessary. MMT tells us that the Federal Reserve just had to make loans available in the “fed funds market” and if they had the problem which took some six months to work out and allowed things to deteriorate in the meantime could have been avoided completely.
So Bernanke stumbled on a solution because he didn’t have a clear understanding of the capacity of the central bank in a fiat monetary system. I disagree totally with Galbraith’s assessment that he performed well.
But while Bernanke may have had his head in the sand as the crisis unfolded this was no coincidence as is hinted above. He is one of the gang who relentlessly undermined regulative structures and sought to reduce the fiscal impact of government.
My objection to Bernanke is that his ideology is part of the problem and he fails to understand (or express an understanding) of how the monetary system that he is overseeing operates. That is his worst crime – his statements would lead one to conclude that he just “doesn’t get it”. In that sense, he disqualifies himself from public office.
Earlier this year (January 13, 2009) Bernanke addressed the London School of Economics. Bernanke spoke of the inflation risk that some see as being integral to the expansion of the central bank’s balance sheet. He said:
Some observers have expressed the concern that, by expanding its balance sheet, the Federal Reserve is effectively printing money, an action that will ultimately be inflationary. The Fed’s lending activities have indeed resulted in a large increase in the excess reserves held by banks. Bank reserves, together with currency, make up the narrowest definition of money, the monetary base; as you would expect, this measure of money has risen significantly as the Fed’s balance sheet has expanded. However, banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed. Consequently, the rates of growth of broader monetary aggregates, such as M1 and M2, have been much lower than that of the monetary base. At this point, with global economic activity weak and commodity prices at low levels, we see little risk of inflation in the near term; indeed, we expect inflation to continue to moderate.
He doesn’t really make the point that the expansion of reserves does not increase the capacity of the commercial banks to make loans. His statment that banks now have huge reserves but they are “choosing to leave the great bulk of their excess reserves idle” is highly misleading.
The reason credit is tight in the US at present is because the banks are being very cautious and they do not perceive a strong demand coming from credit worthy customers. Once they assess that there are worthy borrowers they will lend regardless of the central bank expansion of reserves.
Even if the broader monetary aggregates start to expand in the future this is not inflationary. We are trapped into thinking there is a 1 for 1 correspondence between broad measures of the money supply and price level movements because the debate has been influenced by the defunct Quantity Theory of Money (which is the foundation of Monetarism).
There is no necessary correspondence as implied by the QTM and it all depends on the state of capacity utilisation (capital and labour). At present there is no sense that demand-pull inflation will emerge in the coming recovery period.
Bernanke then said that once the recovery emerges the central bank will have to ensure a:
… reduction in excess reserves and the monetary base … As the size of the balance sheet and the quantity of excess reserves in the system decline, the Federal Reserve will be able to return to its traditional means of making monetary policy–namely, by setting a target for the federal funds rate.
It may be true that the balance sheet will shrink back to “normal levels” but that doesn’t lessen the risk of inflation. The build-up of bank reserves exposed the US economy to no greater risk of inflation than it faces at other times.
Bernanke continually implies that banks require reserves to lend from and the more they have the easier it is to expand credit. That is not the way the monetary system works.
Please read my blog – Building bank reserves will not expand credit – for more discussion on this point.
His most recent speech (December 7, 2009) continues this theme with some nuances.
At one point he addressed the issue that the central bank’s balance sheet expansion (it has more than doubled to $US2.2 trillion) will be inflationary. This is the do bank reserves cause inflation argument I dealt with in this blog – Building bank reserves is not inflationary.
Bernanke’s answer was not along the same lines of logic that I used in that blog. After suggesting that the Federal Reserve could increase interest rates to choke of credit expansion; pay higher interest on reserves to ensure banks will “be unwilling to make overnight loans to each other at a rate lower than the rate that they can earn risk-free from the Fed”, Bernanke says:
Additional upward pressure on short-term interest rates can be achieved by measures to reduce the supply of funds that banks have available to lend to each other … we can act directly to reduce the quantity of reserves held by the banking system. By paying a slightly higher rate of interest, we could induce banks to lock up their balances in longer-term accounts with us, making those balances unavailable for lending in the overnight market. And, if necessary, we always have the option of reducing the size of our balance sheet by selling some of our securities holdings on the open market.
Again you get the impression that Bernanke thinks banks lend out their reserves as in the money multiplier model and the bank could stop that happening by making the holding of reserves more attractive.
It is clear that this is the viewpoint being expressed by the New York Federal Reserve. In a paper I have referred to in the past Why Are Banks Holding So Many Excess Reserves? the authors note that economists have recommended imposing a tax on the bank reserves to force the banks to lend them. These economists just misunderstand the monetary system.
The authors mostly get the reserve accounting correct up until page 6. Then they ask what all this means for the “Money Multiplier”. They say:
The fact that banks continue to hold a large quantity of excess reserves conflicts with the traditional notion of the money multiplier. According to this notion, an increase in bank reserves should be “multiplied” into a much larger increase in the broad money supply as banks expand their deposits and lending activities. The expansion of deposits, in turn, should raise the level of required reserves until there are little or no excess reserves in the banking system. This process has clearly not occurred following the increase in reserves … Why has the money multiplier “failed” here?
The simple answer is that the so-called money multiplier never works in the way the authors (and the mainstream macroeconomics textbooks think it does) when you are in a fiat monetary system with flexible exchange rates.
The authors believe that it is because the “textbook accounts of the money multiplier assume that banks do not earn interest on their reserves” and the fact that the central bank is now paying such support rates has choked off the need by the banks to “lend out these reserves”.
The authors conflate the attempts by the commercial banks to get rid of reserves overnight by lending in the interbank market which is futile when there are excess reserves overall to banks making loans to non-bank customers for mortgages etc. The temporal difference in this behaviour is very important and is ignored by the paper.
They claim that in a fractional reserve model (where there are positive reserve requirements) the multiplier process will emerge once all the excess reserves are lent out. The thing stopping that happening is the support rate paid by the central bank on the reserves.
Moreover, Bernanke is a fiscal conservative. At the December 3 meeting with the US Senate Banking Committee his statement was focused on monetary policy issues. But during the Question and Answer time he had this to say about fiscal policy:
With respect to deficits … I agree very much that we cannot continue to have deficits that make our debts relative to our GDP rise indefinitely. We need to come down … [to] … deficits that are closer to 2 percent to 3 percent, at most, not 4 percent or 5 percent. If we do that, in the medium term, we can begin to stabilize the amount of debt relative to GDP. As far as the Fed is concerned, we will not monetize the debt. We will maintain price stability.
But we would not be able to do anything about interest rates going up if creditors began to lose confidence in the U.S. fiscal sustainability. So it is very important that — I mean, this is obvious, but I think it’s worth saying, and you’re — you’re right to raise it, that we need not only an exit strategy for monetary policy, we very much need an exit strategy from fiscal policy, in the sense we need to get back to — we need to have a plan, a program to get back to a sustainable fiscal trajectory in the next few years.
Why didn’t Galbraith point out the fact that Bernanke is in the fiscal policy camp that helped cause the crisis? He is on the public record as saying that he thinks it is essential to get the US federal budget back in balance.
In his briefing to the US US House of Representatives Budget Committee in June, 2009 Bernanke said:
Nevertheless, even as we take steps to address the recession and threats to financial stability, maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby-boom generation and continued increases in medical costs.
Anyone who makes erroneous statements such as those which are just mindless repetition of mainstream macroeconomic textbooks which haven’t been updated since the gold standard ended should not hold public office.
The Committee should have asked him to comment on his desire to balance the federal budget in the face of the US current account deficit and his professed aim to get Americans saving again.
The Committee should have asked him to forecast where the aggregate demand is coming from in the coming months to significantly reduce the unemployment queue in the US. After all, “Main Street” requires jobs for its vitality.
Further, the challenges concerning entitlements are all economic (are there enough real resources going to be available) and political (how will competing demands be determined). The budgetary challenges he refers to are all illusory and in the minds of the neo-liberals.
Further, in the Nomination Hearing, Bernanke rejected the need for a new fiscal stimulus package directed at jobs. He also said that fiscal sustainability required that the US Congress cut health entitlements and social Security benefits.
So these are not the comments from someone who: (a) understood MMT and options it gives the national currency-issuing government; and (b) was concerned with those on “Main Street”.
And American are not buying the Time person of the year aura either (Source):
By a better than two-to-one margin, Americans think Federal Reserve Chairman Ben Bernanke puts Wall Street ahead of Main Street
Bernanke is one of the gang. The future requires that they have no further influence on policy making in the US.
That is enough for tonight.