Arthur Burns, Chair of the Federal Reserve from 1970 to 1978, publicly regretted afterward that he had lacked the spine to do what was necessary to get the Great Inflation of the 1970s under control. When his predecessor William McChesney Martin’s term ended in 1970, he openly declared, “I’ve been a failure.”
What are the regrets, if any, that weigh on Ben Bernanke’s memory when he looks back on his time as Fed Chair from 2006 until 2014? After a reading of his latest book 21st Century Monetary Policy I would say that -- at this time -- his most notable regret, one made repeatedly, is that he hadn’t made his experimental monetary operations even larger.
21st Century Monetary Policy shows a man with a deep, completely understandable support for the central bank and all that it strives to do. Bernanke is a member of Team Federal Reserve to his core, which is unsurprising as nobody lucks into the position of Fed Chair. Nor is his fear of falling prices any surprise and the same may be said for his disparagement of savings. These positions are in any Keynesian’s intellectual makeup, and in the halls of central banks Keynesians are legion. None of these attributes make Bernanke exceptional.
Yet, there is much more to the man. He deserves the Nobel he was recently awarded; it is a mark of distinction and in the years to come any historian worth their salt will need to read all of Bernanke’s books in order to understand much that has happened and is still to happen in America. It was Bernanke’s implementation of inflation targeting and the quantitative easing programs that have pivoted modern central banking to conducting monetary policy as a guessing game. This is what makes him exceptional.
Driving With Your Eyes Closed“In retrospect, despite the unprecedented size and scope of the Fed’s programs; they were evidently not early enough or large enough.” - Ben Bernanke
Congress issued to the Fed a so-called dual mandate that sets the central bank’s goals as stable prices and full employment. From this has come two rates that guide Fed policy -- the neutral policy rate (r*) and the natural rate of unemployment (u*). The former is the central bank’s target rate which is neither stimulative nor restrictive to economic activity and therefore inflation risk; the latter is the rate of employment that does not cause wage demands to spark inflation -- and both are pure guesswork. Bernanke points this out when he writes, "then, as now, defining full employment was more art than science" and “the value of r* can’t be observed, only estimated” and both rates, additionally, are ever moving targets as "like the natural rate of unemployment, u*, the neutral rate of interest (r*) can change over time."
So, how do you set monetary policy when "available estimates of u* are inevitably quite imprecise"? You guess, and your guess, being a guess, will vary because of "the FOMC's changing estimates of the neutral policy rate (r*) and the natural rate of unemployment (u*)." And despite this uncertainty, these guesses are what guide policy as "a lower r* means that less tightening would be needed" and a "reassessment of the natural rate of unemployment, u*, would prove equally important for policy."
The fact that both r* and u* are guesses combined with the prevailing notions in central banking thought that something must always be done, and we need to go big when that something is done, has turned the Federal Reserve onto a habit of reacting to any market stress by just repeatedly throwing a lot of newly created credit at the wall to see what sticks. Forgive me if this seems overly harsh, yet Bernanke himself describes the Fed’s response to the Great Financial Crisis (2007 and 2008) with “we felt at least that we were throwing everything we had at the problem.”
Throwing a monetary Hail Mary pass is most apparent in the practice of Bernanke’s quantitative easing (QE) programs, which feature the Fed buying trillions of Treasury and mortgage bonds from Wall Street, and of which we've seen four episodes since 2008. Bernanke writes, “we had a theory of how QE might work, but there was a lot we didn't know" but despite this "our main conclusion was that...our purchases would have to be big" even though "uncertainty about the effectiveness of our purchases was matched by our uncertainty about possible side effects."
And QE was executed despite Fed officials having "only general ideas about how they could be reversed when the time came," and such an operation would require trillions worth of securities now on the central bank’s balance sheet back into private hands. The Fed has tried and failed to reverse QE three times now. (It is currently giving it a fourth go.) The program has proven, like war, to be far easier to get into then out of.
Bagehot’s Dictum
We tried to cushion the economic effects of the crisis through monetary policy – first through standard rate cuts, then subsequently through increasingly novel policies - Ben Bernanke
In 2015 Bernanke published The Courage to Act, and certainly he will be remembered as one who was not afraid to push the boundaries of central banking. He had the courage to experiment, the courage to go big and the courage to take a leap into the great unknown. And he had the courage to take onto his shoulders a monetary policy that allows those who run the Federal Reserve to, in Bernanke's words, "make our best guesses." His name will be remembered by history.
Bernanke points to another central banking theorist remembered by history, Walter Bagehot (1826-1877), when he alludes to “Bagehot's Dictum" -- that in times of financial crisis central banks should lend freely to solvent banks though only against solid collateral and at high rates of interest. Bernanke, though, inexplicably fails to mention that last part about high rates of interest. Considering that the Fed kept its target rate at zero percent for six years, maybe he had a moment’s pause when he realized just how far he’s swum, of just how distant the shore of traditional central banking now lay. Bernanke is well aware of this and relates that with the implementation of quantitative easing, “we were moving well beyond Bagehot’s dictum.”
Bernanke’s attitude toward inflation has moved well beyond traditional central bank thought. While the very man who wrote the Federal Reserve Act (H.P. Willis, Columbia University) believed, “experience has once again shown the world that a continuously rising price level brings a nation inevitably to insoluble difficulties,” in contrast Bernanke gave a speech in November 2002 promising that during his time at the Fed (he had just become governor) he would strive to make sure we never experience a falling price level at all. He was at the Fed as it openly declared in 2003 that a fall in inflation as “undesirable,” a view which he adds “contrasted starkly with Fed policy of previous decades.”
21st Century Monetary Policy could have been a rousing defense of his monetary ideas, but the book is written in the easy style of an after-dinner conversation with an honored guest, one relating stories of his time on stage and name dropping liberally. Nobody is there to cause any potentially unpleasant conversations, and Bernanke never offers any cause for it himself. He understands this to be the case, though, and at the very end of the book he appends an invitation to contact him if the reader feels he had skirted over “topics that should have been explored in more depth.”
I believe there are a number of such topics, which is no surprise considering Bernanke’s penchant for novel policies. For instance, though he does argue against 1970s-era price controls because “by short-circuiting this (price) coordination mechanism, wage-price controls can be highly disruptive,” he seems to exclude the central bank’s interest rate price controls from having the same effect. How much “short-circuiting” was caused by a central bank that kept its interest rate target at zero percent for six years running? It would have been interesting to read a defense of lending not at high rates of interest but at zero percent.
Above all the biggest unexplored topic is introduced when he described how the Federal Reserve purchases securities from the banks during its QE operations. He wrote (emphasis mine) that “the Fed paid for its securities purchases by creating bank reserves.” For any astute reader the obvious question pops up; created them out of what? We know the answer to be -- nothing at all.
So here is the philosopher’s stone of 21st Century Monetary Policy, simple inflation, a practice as ancient as money itself. So, how does the 21st century’s stone differ from all the other stones that have come before? Answering that question should have been the foundation for a book that, as good as it is, could have been even better.
The Legacy“We crossed a lot of red lines that had not been crossed before.” - Jerome Powell on QE4, Fed Chair (May 27, 2022)
Bernanke describes his legacy as three-fold. First, making the central bank more transparent, and that is to his credit and has been done. Second, the Fed is now monitoring the financial system more closely than ever before. And last, and by far most important, “the contemporary Fed wields – for better or for worse – an arsenal much larger than in the past.” Bernanke takes pains to point out that the Powell Fed’s response to the Covid Era was “drawn from a playbook developed during the 2007-2009 crisis,” when Bernanke was Fed Chair. That playbook is truly his legacy.
And there is more to come, as 21st century monetary policy, according to Bernanke, “combines short-term rate cuts, QE, forward guidance, and possibly other tools.” And though “uncertainty is inevitable” it is also “a motivation to continue seeking new approaches for increasing policy space.” And what are some of those other tools we might use to add policy space? Widening the QE purchase net to include a broader range of financial assets, funding-for-lending programs, negative interest rates and yield curve controls are a few of Bernanke’s suggestions. With the passage of time, more ideas will certainly spring forth to push the envelope. We have sailed, after all, far beyond Bagehot’s dictum.
We are living in an age of central bank experimentation, and to have the power to experiment with a people’s monetary system is to hold a sword always above their neck. Numerous historical episodes show it to be an awesome power fraught with immense danger to both individuals and society as a whole. So, the moral imperative to anyone who wields it is to do so using extreme caution and humility, not by using best guesses guided by “instant expertise.”
Only a mad man would believe there is such a thing as “instant expertise,” or, maybe, a genius would believe it, too, because he’s experienced it. There is a fine line between genius and mad man. And because of the enhanced power the Federal Reserve now has, I’ve no choice but to pray that Bernanke, and all who follow him into that Chair, come down on the genius side of the ledger.
