Bernankeism – References

1.      Monetary Policy and Price Stability, discussion paper by Karen Johnson; David Small; Ralph Tryon. July 1999

If economic activity is weak or contracting and interest rates hit the zero bound, a dangerous dynamic can be set in motion. Falling inflation, or even escalating deflation, would increase real rates of interest. As this depresses aggregate demand further, downward pressures on prices would raise real interest rates further: The economy would potentially face a downward deflationary spiral. (p 20)

Alternative Policy Tools

In light of these possible limitations to continued open market purchases of T-bills after the interest rate has hit zero, a central bank may wish to either replace or reinforce these purchases with other policy actions. Several of these alternatives (purchasing treasury bonds, writing options on interest rates, and purchasing foreign exchange) can be viewed as extensions of conventional open market operations, while others (purchasing private sector securities, discount window lending to the non-bank sector, and direct cash transfers to the public) represent potentially new directions for U.S. monetary policy. (pp. 23-24)

2.      Monetary Policy When the Nominal Short-Term Interest Rate is Zero, James Clouse, Dale Henderson, Athanasios Orphanides, David Small, and Peter Tinsley. Nov 2000.

8. Wealth Creation

In ordinary circumstances, monetary policy exerts its stimulative impact in part through increasing the financial wealth of the public -- such as producing capital gains in bond and equity markets. If, at the zero bound, the Federal Reserve had already taken what actions it could to raise bond and equity prices, it might look to other tools it has to increase the public's wealth. One tool commonly attributed to the Federal Reserve, at least in theory if not by the Federal Reserve Act, is that of conducting "money rains."

8.1 Money Rains

Money rains are a clean way to study theoretically the effects of increases in the supply of money. In practice, it seems a bit difficult to envision how the Federal Reserve could literally implement a money rain - that is give money away either through directly disbursing currency to the public or by disbursing it through the banking system. The political difficulties that are likely to arise from the Federal Reserve determining the distribution of this new wealth would be daunting.

Even if the Federal Reserve were to find a way to physically conduct a money rain, the Federal Reserve Act does not appear to provide authorization for such activities. Under section 7 of the Federal Reserve Act,

After all necessary expenses of a Federal reserve bank have been paid or provided for, the stockholders of the bank shall be entitled to receive an annual dividend of 6 percent on paid-in capital. That portion of net earnings of each Federal reserve bank which remains after dividend claims ... have been fully met shall be deposited in the surplus fund of the bank. (p. 66)

3.      Fed Considered Emergency Measures To Save Economy, Financial Times, March 25 2002. (Available to paid subscribers of the FT on the internet through archival search. There is no URL).

Minutes which summarised the meeting were released last week. A full transcript will not be available for five years but a senior Fed official who attended the meeting said the reference to "unconventional means" was "commonly understood by academics".

The official, who asked not to be named, would not elaborate but mentioned "buying US equities" as an example of such possible measures, and later said the Fed "could theoretically buy anything to pump money into the system" including "state and local debt, real estate and gold mines - any asset".

4.      Minutes of the Federal Open Market Committee (January 29-30, 2002)

At this meeting, members discussed staff background analyses of the implications for the conduct of policy if the economy were to deteriorate substantially in a period when nominal short-term interest rates were already at very low levels. Under such conditions, while unconventional policy measures might be available, their efficacy was uncertain, and it might be impossible to ease monetary policy sufficiently through the usual interest rate process to achieve System objectives. The members agreed that the potential for such an economic and policy scenario seemed highly remote, but it could not be dismissed altogether. If in the future such circumstances appeared to be in the process of materializing, a case could be made at that point for taking preemptive easing actions to help guard against the potential development of economic weakness and price declines that could be associated with the so-called "zero bound" policy constraint.

5.      Preventing Deflation: Lessons from Japan's Experience in the 1990s, Alan Ahearne; Joseph Gagnon; Jane Haltmaier; Steve Kamin. June 2002.

At this meeting, members discussed staff background analyses of the implications for the conduct of policy if the economy were to deteriorate substantially in a period when nominal short-term interest rates were already at very low levels. Under such conditions, while unconventional policy measures might be available, their efficacy was uncertain, and it might be impossible to ease monetary policy sufficiently through the usual interest rate process to achieve System objectives. The members agreed that the potential for such an economic and policy scenario seemed highly remote, but it could not be dismissed altogether. If in the future such circumstances appeared to be in the process of materializing, a case could be made at that point for taking preemptive easing actions to help guard against the potential development of economic weakness and price declines that could be associated with the so-called "zero bound" policy constraint.

6.      On Milton Friedman's Ninetieth Birthday, remarks by Governor Ben S. Bernanke At the Conference to Honor Milton Friedman, University of Chicago, Chicago, Illinois. November 8, 2002

For practical central bankers, among which I now count myself, Friedman and Schwartz's analysis leaves many lessons. What I take from their work is the idea that monetary forces, particularly if unleashed in a destabilizing direction, can be extremely powerful. The best thing that central bankers can do for the world is to avoid such crises by providing the economy with, in Milton Friedman's words, a "stable monetary background"--for example as reflected in low and stable inflation.

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.

7.      Deflation: Making Sure "It" Doesn't Happen Here, remarks by Governor Ben S. Bernanke before the National Economists Club, Washington, D.C. November 21, 2002.

Curing Deflation

[…]

 As I have mentioned, some observers have concluded that when the central bank's policy rate falls to zero--its practical minimum--monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).

8.      Monetary Policy in a Zero-Interest-Rate Economy, Evan F. Koenig and Jim Dolmas, Federal Reserve Bank of Dallas. May 2003.

Bold, but Impractical—Eliminating the Bound Altogether

The most daring suggestion for escaping the zero-interest-rate trap is one that eliminates the zero lower bound altogether. How can this be done? As noted in the first part of the presentation, the zero bound on interest rates exists because money pays a sure nominal interest rate of zero. No one would be willing to hold any asset that pays a negative nominal rate, as long as zero-interest money is available as a store of value. The strategy for eliminating the zero bound, therefore, is to make money pay a negative nominal interest rate, by imposing some type of "carry tax" on currency and deposits.

It’s easy to envision such a system with regard to deposits at the Federal Reserve or transactions deposits at banks; for the most part, the technology to implement such a system is already in place. A tax or fee on Reserve deposits of 1 percent per month, for example, would mean that those deposits, in effect, pay a nominal interest rate of roughly minus 12 percent.

The technological difficulty lies mainly in imposing such a tax on currency. In the 1930s, Irving Fisher of Yale University, one of the greatest American economists, proposed such a system, in which currency had to be periodically ‘stamped’, for a fee, in order to retain its status as legal tender. The stamp fee could be calibrated to generate any negative nominal interest rate that the central bank desired. (pp. 4-5)

The goods & services solution

Why not have the Fed just conduct an open market purchase of real goods and services? Even more so than exchange rate intervention, this strategy would represent a direct stimulus to aggregate demand.

As posed, though, the strategy has a major drawback: it violates the Federal Reserve Act. The Fed isn't authorized to purchase goods and services, apart from those needed for the operation of the Federal Reserve System.

The strategy can be implemented, however, by coordination with fiscal policy-makers. The Federal government, for example, could purchase goods and services and finance the purchases with new debt, which the Fed in turn would buy–in technical terminology, the Fed would 'monetize' the resulting debt.

By coordinating with fiscal policy, the Fed could even implement what is essentially the classic textbook policy of dropping freshly printed money from a helicopter. In this case, the Fed would monetize government debt that had been issued to finance a tax cut. (pp. 6-7).

9.      Uncertain Times: Economic Challenges Facing the United States and Japan, remarks by Vice Chairman Roger W. Ferguson, Jr. before the Japan Society. June 11, 2003.

A harmful deflation, such as the type experienced by Japan since the mid-1990s, is almost always a consequence of depressed aggregate demand. A deflationary slump driven by contracting demand is more dangerous than a typical economic downturn because of its potential adverse effects on financial markets and the limitations it places on conventional monetary policy.

[…]

Deflation also raises a barrier to those monetary policy actions conventionally used to stimulate aggregate demand. Faced with a normal economic downturn, a central bank would lower its target for the short-term nominal interest rate--the overnight federal funds rate in the United States or the overnight call money rate in Japan--to stimulate aggregate demand. In a deflationary environment, in which short-term nominal interest rates have already been pushed to zero, the central bank can no longer ease policy in the usual way.

10.  An Unwelcome Fall in Inflation?, remarks by Governor Ben S. Bernanke before the Economics Roundtable, University of California, San Diego, La Jolla, California. July 23, 2003.

A second set of circumstances in which deflation or very low inflation may pose significant problems is potentially more relevant to the current U.S. economy. That situation is one in which aggregate demand is insufficient to sustain strong growth, even when the short-term real interest rate is zero or negative. Deflation (or very low inflation) poses a potential problem when aggregate demand is insufficient because deflation places a lower limit on the real short-term interest rate that can be engineered by monetary policymakers. This limit is a consequence of the well-known zero-lower-bound constraint on nominal interest rates.

[…]

In any case, I hope we can agree that a substantial fall in inflation at this stage has the potential to interfere with the ongoing U.S. recovery, and that in conceivable--though remote--circumstances, a serious deflation could do significant economic harm. Thus, avoiding a further substantial fall in inflation should be a priority of monetary policy. To my mind, the central import of the May 6 statement is that the Fed stands ready and able to resist further declines in inflation; and--if inflation does fall further--to ensure that the decline does not impede the recovery in output and employment.

11.  Conducting Monetary Policy at Very Low Short-Term Interest Rates, Governor Ben S. Bernanke and Vincent R. Reinhart, Presented at the International Center for Monetary and Banking Studies Lecture, Geneva, Switzerland. January 14, 2004.

These days, most central banks choose to calibrate the degree of policy ease or tightness by targeting the price of reserves--in the case of the Federal Reserve, the overnight federal funds rate. However, nothing prevents a central bank from switching its focus from the price of reserves to the quantity or growth of reserves. When stated in terms of quantities, it becomes apparent that even if the price of reserves (the federal funds rate) becomes pinned at zero, the central bank can still expand the quantity of reserves. That is, reserves can be increased beyond the level required to hold the overnight rate at zero--a policy sometimes referred to as "quantitative easing." Some evidence exists that quantitative easing can stimulate the economy even when interest rates are near zero; see, for example, Christina Romer's (1992) discussion of the effects of increases in the money supply during the Great Depression in the United States.

12.  Money, Gold, and the Great Depression, remarks by Governor Ben S. Bernanke at the H. Parker Willis Lecture in Economic Policy, Washington and Lee University, Lexington, Virginia. March 2, 2004.

To support their view that monetary forces caused the Great Depression, Friedman and Schwartz revisited the historical record and identified a series of errors--errors of both commission and omission--made by the Federal Reserve in the late 1920s and early 1930s. According to Friedman and Schwartz, each of these policy mistakes led to an undesirable tightening of monetary policy, as reflected in sharp declines in the money supply. Drawing on their historical evidence about the effects of money on the economy, Friedman and Schwartz argued that the declines in the money stock generated by Fed actions--or inactions--could account for the drops in prices and output that subsequently occurred.

[….]

Some important lessons emerge from the story. One lesson is that ideas are critical. The gold standard orthodoxy, the adherence of some Federal Reserve policymakers to the liquidationist thesis, and the incorrect view that low nominal interest rates necessarily signaled monetary ease, all led policymakers astray, with disastrous consequences. We should not underestimate the need for careful research and analysis in guiding policy. Another lesson is that central banks and other governmental agencies have an important responsibility to maintain financial stability. The banking crises of the 1930s, both in the United States and abroad, were a significant source of output declines, both through their effects on money supplies and on credit supplies. Finally, perhaps the most important lesson of all is that price stability should be a key objective of monetary policy. By allowing persistent declines in the money supply and in the price level, the Federal Reserve of the late 1920s and 1930s greatly destabilized the U.S. economy and, through the workings of the gold standard, the economies of many other nations as well.

13.  Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment, Ben S. Bernanke, Vincent R. Reinhart, and Brian P. Sack. September 20, 2004.

An extensive literature has discussed monetary policy alternatives at the zero bound, but for the most part from a theoretical or historical perspective. Few studies have presented empirical evidence on the potential effectiveness of non-standard monetary policies in modern economies. Such evidence obviously would help central banks plan for the contingency of the policy rate at zero and also bear directly on the choice of the appropriate inflation objective in normal times…

In this paper, we apply the tools of modern empirical finance to the recent experiences of the United States and Japan to provide evidence on the potential effectiveness of various nonstandard policies. Following Bernanke and Reinhart (2004), we group these policy alternatives into three classes: (1) using communications policies to shape public expectations about the future course of interest rates; (2) increasing the size of the central bank’s balance sheet, or “quantitative easing”; and (3) changin g the composition of the central bank’s balance sheet through, for example, the targeted purchases of long-term bonds as a means of reducing the long-term interest rate. We describe how these policies might work and discuss relevant existing evidence. (p. i)

14.  Central Bank Talk and Monetary Policy, remarks by Governor Ben S. Bernanke at the Japan Society Corporate Luncheon, New York, New York. October 7, 2004.

Although effective communication by the central bank is always important, it becomes especially important when the rates are near zero. Indeed, when the proximity of the zero bound prevents further rate cuts to stimulate the economy, talking about future policy actions may be one of the few tools at the central bank's disposal by which to influence conditions in financial markets.