When the financial crisis struck in 2008, many economists took comfort in at least one aspect of the situation: the best possible person, Ben Bernanke, was in place as chairman of the Federal Reserve.
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Bernanke during a hearing on the European debt crisis on Capitol Hill in March.
Bernanke was and is a fine economist. More than that, before joining the Fed, he wrote extensively, in academic studies of both the Great Depression and modern Japan, about the exact problems he would confront at the end of 2008. He argued forcefully for an aggressive response, castigating the Bank of Japan, the Fed’s counterpart, for its passivity. Presumably, the Fed under his leadership would be different.
Instead, while the Fed went to great lengths to rescue the financial system, it has done far less to rescue workers. The U.S. economy remains deeply depressed, with long-term unemployment in particular still disastrously high, a point Bernanke himself has recently emphasized. Yet the Fed isn’t taking strong action to rectify the situation.
The Bernanke Conundrum — the divergence between what Professor Bernanke advocated and what Chairman Bernanke has actually done — can be reconciled in a few possible ways. Maybe Professor Bernanke was wrong, and there’s nothing more a policy maker in this situation can do. Maybe politics are the impediment, and Chairman Bernanke has been forced to hide his inner professor. Or maybe the onetime academic has been assimilated by the Fed Borg and turned into a conventional central banker. Whichever account you prefer, however, the fact is that the Fed isn’t doing the job many economists expected it to do, and a result is mass suffering for American workers.
What the Fed Can Do
The Federal Reserve has a dual mandate: price stability and maximum employment. It normally tries to meet these goals by moving short-term interest rates, which it can do by adding to or subtracting from bank reserves. If the economy is weak and inflation is low, the Fed cuts rates; this makes borrowing attractive, stimulates private spending and, if all goes well, leads to economic recovery. If the economy is strong and inflation is a threat, the Fed raises rates; this discourages borrowing and spending, and the economy cools off.
Right now, the Fed believes that it’s facing a weak economy and subdued inflation, a situation in which it would ordinarily cut interest rates. The problem is that rates can’t be cut further. When the recession began in 2007, the Fed started slashing short-term interest rates until November 2008, when they bottomed out near zero, where they remain to this day. And that was as far as the Fed could go, because (some narrow technical exceptions aside) interest rates can’t go lower. Investors won’t buy bonds if they can get a better return simply by putting a bunch of $100 bills in a safe. In other words, the Fed hit what’s known in economic jargon as the zero lower bound (or, alternatively, became stuck in a liquidity trap). The tool the Fed usually fights recessions with had reached the limits of its usefulness.
That doesn’t mean the Fed was out of options. Not according to the work of a number of economists, anyway, among them a prominent Princeton professor by the name of Ben Bernanke. As noted above, Bernanke was among the economists who took notice, back in the 1990s, of the troubles afflicting Japan — a huge real estate bubble that left behind a legacy of high private-sector debt when it burst and a central bank up against the zero lower bound.
The woes confronting the United States today aren’t identical to those faced by Japan. For one thing, Japanese inflation wasn’t just low; by the end of the 1990s, Japan was actually suffering chronic deflation. For another, Japan’s slump was never as terrible as ours; unemployment, in particular, never became the scourge it has become here. Still, Japan provided an example of how an advanced modern economy could seemingly be caught in an economic trap.
In a hard-hitting 2000 paper titled “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” Bernanke declared 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.” He proceeded to lay out a number of actions the Bank of Japan could take. And he called on Japanese policy makers to act like F.D.R. and do whatever it took: “Japan is not in a Great Depression by any means, but its economy has operated below potential for nearly a decade. Nor is it by any means clear that recovery is imminent. Policy options exist that could greatly reduce these losses. Why isn’t more happening? To this outsider, at least, Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced. Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work. Perhaps it’s time for some Rooseveltian resolve in Japan.”
This article has been adapted from "End This Depression Now!" by Paul Krugman, to be published by W. W. Norton & Company this month.
Krugman is a Times columnist and winner of the 2008 Nobel Prize in economics.
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