Janet Yellen's first press conference as chair of the Federal Reserve earlier this week came at a sensitive time for the central bank. With unemployment gradually falling toward the bank's previously declared threshold of 6.5 percent, economists and investors were waiting to hear what Yellen wanted to do next. It was like that awkward moment when the bar closes and no one's sure where to go. Some people want to keep the celebration alive, other people want pizza, and then there are the dour ones who think it's time to head home.
As the party that is U.S. monetary policy approaches this crucial moment, it might be a good idea for us to check in with Japan and see what they've been up to all night. Because when it comes to central banking, the Japanese are teaching the world how to get it on. The program known as "Abenomics," after Prime Minister Shinzo Abe, led to a 70-percent increase in stock prices in the year after it was announced. A girl band called Machikado Keiki, which you might loosely translate as "Street Corner Economic Conditions," was singing about quantitative easing and promised that the hemlines of their skirts would rise when the Nikkei did. And new research suggests the monetary aspect of Abe's program has added about 1 percentage point to the gross domestic product.
Nobel laureate Paul Krugman and Yellen's predecessor Ben Bernanke discussed that research at a conference at the Brookings Institution Friday morning. It was a coup for the paper's authors, two young economists who completed their doctorates just last year. Joshua Hausman and Johannes Wieland were classmates at the University of California, Berkeley, and Hausman called it "a large surprise" to learn from organizers, only several weeks ago, that Krugman and Bernanke would be talking about their paper. "It's remarkable to have such high-profile people discussing your work," Wieland said.
It could have been remarkable for the rest of us, too, just to learn what Krugman and Bernanke are thinking about one of the most important problems in contemporary macroeconomics. Annoyingly, however, the conference was held under the Chatham House rule, forbidding journalists from attributing anything said in the discussion to the person who said it. For example, one economist in the room opened his remarks by apologizing for his lack of a slide deck. "It's been a long time since I've made PowerPoint slides," he said. You'll have to guess who it was. That's a shame, because the economists in the room said some things that investors and policymakers really ought to hear. What follows is an attempt to disseminate that discussion with a summary based on Krugman and Bernanke's other research and a separate interview with the authors.
Krugman wrote about Hausman and Wieland's paper in his weekly column in The New York Times on Thursday. Hausman and Wieland found that Japanese investors do not really think the central bank can achieve its stated goal of inflating prices at 2 percent per year. Instead, they expect prices to increase by around half that much. For Krugman, the research suggests that as bold as Abenomics has been, the program might not be enough to create a sustained improvement in the Japanese economy. Krugman extends the argument to the United States, suggesting that if half-measures prove inadequate, then the Federal Reserve risks its credibility with the investors and the public, and the necessary work becomes yet more difficult, both financially and politically.
Prices have been rising faster than wages in Japan. Wages will presumably make up the difference at some point, but in the meantime, the Bank of Japan has to depend on the trust of ordinary working people that it can carry the program through successfully. If the central bank did achieve and maintain 2 percent inflation, it would be testing voters' confidence in Abe's government until wages increased as well. The Japanese, when surveyed, are very sensitive to changes in prices, which have remained very stable there for decades. People will typically tell pollsters that prices have increased 4 percent since the previous year, which hasn't actually happened since 1981, or they'll say that prices have risen when they've actually fallen. "They don't even get the sign right," Hausman said.
Problems such as temporary decreases in real wages sometimes create a tragic catch-22. If consumers and firms don't expect the central bank to be able to stomach inflation over the long term, they won't be as eager to take out loans, since loans are easier to repay when sales and salaries are increasing relative to the principal. In turn, the central bank will lose its ability to move more money into the economy, since people aren't taking new money out of banks. The authors argue that the Bank of Japan failed on its first attempt at stimulus between 2001 and 2006 for this reason. No one expected the program to be sustained, and the public's skepticism became a self-fulfilling curse. The central bank eventually gave up.
What if the Federal Reserve, like the Bank of Japan, attempted to convince investors that prices would increase twice as much as they'd previously thought? Alternatively, what if Yellen and her colleagues tried something a little more modest, like explicitly raising the target for inflation by a smaller amount for a limited period? The data from Japan shows that such an effort would probably fail. The entire Japanese government and much of the public are united behind an aggressive inflation target. "It took them a long time to get to this point, and people have been clamoring for action for years," Wieland said. Still, investors don't think that that the bank will even come close to its target. The political opposition in the case of the Federal Reserve would be much stronger, and investors' confidence even lower, making any accommodative changes to policy less likely to succeed. As a result, it's basically unimaginable that the Fed would try anything of the kind. Which is too bad, because there are convincing arguments that more accommodative policy is exactly what the economy needs.
A couple of the other papers discussed at the conference include a pessimistic look at the prospects of people who have been out of work for several months or longer and about wealthy people who have no savings and live paycheck to paycheck.