Economic & Domestic Policy
What Bernanke needs to say
Sunday, October 24, 2010
The worst word in Washington is "message." Whenever anything goes wrong, politicians begin blaming their messaging operations, as if a better-chosen sound bite by a more-silver-tongued aide would have spared them the consequences of their actions. It's almost never true. Almost. But for Federal Reserve Chairman Ben S. Bernanke, the economy - not to mention the Fed's credibility - might be riding on whether he's willing and able to talk to Congress.
In a recent speechat the Federal Reserve Bank of Boston, Bernankemade perfectly clear that the central bank is tired of watching the economy stagnate. "With an actual unemployment rate of nearly 10 percent," he said, "unemployment is clearly too high" - and, yes, the italics are in his prepared text. So the Federal Reserve is likely to begin purchasing Treasury bonds - "quantitative easing," it's called - in an effort to lower interest rates and spur the economy. They did this in 2009, and to great effect.
But the Federal Reserve can't go it alone. No one gets a job when the central bank buys a bond. It's only when the Fed's decision to buy a bond persuades some other economic actor to spend money that hiring ticks up. And thus far, that's not been happening. Banks and corporations have simply been stockpiling their cash, waiting for a recovery that, paradoxically, won't take hold until they start lending and spending again.
"I'm worried," says Alan Blinder, a former vice chairman of the Federal Reserve's Board of Governors. "I'm quite convinced that it'll be a lot less effective than the first time we did this, and that makes me worried that it won't be very effective." That's because the last round of QE worked very differently: The Federal Reserve bought mortgage-backed securities at a time when the market for them was frozen. That created liquidity where there wasn't any. Now they're planning to buy long-term Treasury bonds that are already in high demand. They're creating liquidity, in other words, where it already exists.
But there's one player who could move that money into the economy: Congress. Lawmakers have taken themselves out of the game amid concerns that more deficit-financed stimulus will increase interest rates. The Federal Reserve's purchases will ensure that won't happen. Someone, however, has to convince Congress of that, particularly now that the very concept of stimulus has become polarizing. Someone like, say, Ben Bernanke.
Bernanke knew this, or at least he once did. In 2003, he tried to advise Japan on how to escape its long stagnation. "One direct and practical approach is explicit (though temporary) cooperation between the monetary and the fiscal authorities," hesaid. "This direction is promising and may succeed where monetary and fiscal policies applied separately have not."
The problem facing Japan, Bernanke continued, was that low interest rates weren't persuading businesses and consumers to spend, but the government wasn't picking up the slack because the public was worried about piling up further debt. "Cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own," he counseled. The Japanese government could stimulate the economy through tax cuts, and the central bank could print the money to pay for it.
Wouldn't that just add to the total debt? "To the contrary," Bernanke said, "from a fiscal perspective, the policy would almost certainly be stabilizing, in the sense of reducing the debt-to-GDP ratio." In other words, the relevant numerator - the total debt in the hands of the public - would remain unchanged while the denominator - economic output - would be higher. "Nothing would help reduce Japan's fiscal woes more," he concluded.
Japan didn't listen, and its subsequent stagnation offers a cautionary tale.
Today, of course, Bernanke is chairman of America's central bank and faces a similar problem. Low interest rates aren't persuading consumers or companies to spend. Large deficits have left the public skeptical of further government action. And slow GDP growth is making the debt picture much worse.
The answer is obvious: "explicit (though temporary) cooperation between the monetary and fiscal authorities." In practice, that would mean Bernanke gets John Boehner, Nancy Pelosi, Harry Reid and Mitch McConnell in a room and says the politics and specifics of this are their job, but the economy needs more fiscal stimulus if it's going to recover, and the Federal Reserve stands ready to make that not only possible but also virtually costless. Inasmuch as Republicans aren't big fans of further government spending right now, the best option could be the exact one that Bernanke recommended to Japan: a Fed-financed tax cut. Perhaps a payroll-tax holiday for the next year or two.
Pose this possibility to central bankers, however, and they get queasy. The Federal Reserve and the Congress occupy different worlds, and the way the bank's independence has been protected has been to sell that separation as sacrosanct. "That's getting close to crossing the line," Blinder says.
Or is it? On Oct. 4, Bernanke headed to Rhode Island to deliver a speechon the danger of our long-term debt. In it, he called for reforms to Social Security, the health-care system and public-employee pensions, and he concluded by outlining the merits of "legislative agreements intended to promote fiscal responsibility by constraining decisions about spending and taxes."
All that is the province of the Congress, not the central bank. And there's no reason Bernanke should be more comfortable counseling Congress on reducing deficits than stimulating growth - particularly when growth can do so much to reduce deficits.
As Alan Greenspan discovered when he weighed in in favor of tax cuts in 2001, there are potential risks when a Fed chairman insinuates himself and the Fed into a controversial political and economic debate. But there are risks, as well, in not engaging. If the Federal Reserve unleashes another round of quantitative easing and it fails because there is nobody to spend or invest the money productively, that could damage the bank's credibility, its effectiveness and, ultimately, its independence. It could also leave the economy trapped in a rut of low growth and high unemployment for a decade or more. That's not a risk we can take.