Monday 23 Jul 2018 | 23:45 | SYDNEY
Monday 23 Jul 2018 | 23:45 | SYDNEY

A qualified defence of Ben Bernanke


Stephen Grenville

22 August 2011 10:33

You might have thought that the debilitating arm-wrestle over the US debt ceiling was about as dismal as politics could get, but Texas Governor (and Republican presidential hopeful) Rick Perry demonstrates that it is possible to explore new depths.

He said that if Fed Chairman Ben Bernanke implemented a further round of quantitative easing (QE) before the next presidential election, this 'money printing' should be considered 'almost treasonous'. He is not alone in criticising the Fed. Michele Bachman, currently the most popular Republican candidate, said the Fed has made 'terrible grievous errors'.

One of the lessons of the past five years is that it is a good idea to have one of the arms of macro-policy in the hands of non-politicians who can put the country's needs above party politics. If Bernanke seems to be partisan because he tries to keep the economy in an even keel, it is worth noting that he was appointed by George Bush.

It's hard to fault Bernanke's actions, at least since the GFC began. He was quick to put monetary policy into maximum stimulus mode. After the Lehmans debacle, few would argue that the financial sector should have been allowed to sort out its problems without the support of the Fed and the Treasury.

Perry might also be criticised for his ignorance about quantitative easing. Technically, QE is not at all like 'printing money', at least in the way Milton Friedman used to talk about 'too much money chasing too few goods'.

When the Fed buys bonds, it increases the supply of 'base money'. The public doesn't want to hold any more of this base money in the form of currency, but nor does it need to get rid of the excess by buying more goods. Instead, the money is deposited in the commercial banks. The banks don't use this extra money to fund additional credit expansion: the banks have already lent to all the bankable borrowers. The extra base money accumulates in the balance sheets of the banks, with little effect.

The motivation for QE comes from the other 'leg' of the QE transaction: the Fed's purchase of bonds. This is intended to lower medium-term interest rates, in the hope that this will stimulate demand for loans.

There is no evidence that QE has actually achieved this objective. Interest rates on 10-year bonds during the two QE operations were much the same as they had been beforehand. When QEII finished at the end of June, interest rates didn't rise (as many had predicted); they actually fell.

QE probably did have some impact on confidence. It was a declaration that the Fed cared about the weakness of the economy and would do all it could to stimulate the economy. This confidence effect probably helped the stock market, at least until recent weeks.

Bernanke has taken one further step: he has promised to keep the policy interest rates at zero for two years. This did have the expected effect on the yield curve: the two-year bond rate is now zero. This may stimulate demand for borrowing, but the effect is likely to be marginal.

If Bernanke can be faulted in principle, it is not because he has 'printed money', but because he has been supporting the government bond market. One of the key elements of central bank independence is that central banks should not be forced to fund fiscal deficits. They may choose to do so in special circumstances, but they know that they are opening a chink in their independence armour. Thus Bernanke will hope to avoid another QE operation.

Nevertheless, the spotlight is on him. By tradition, he is the key speaker at the annual central bankers' conference at Jackson Hole later in August. What he says there will not be all that important in a technical sense: he has done just about everything that a central banker can do. But his words will be parsed and finely analysed to try to squeeze meaning out of them.

He needs to go on showing that he cares about the stagnant economy. At the same time he has to do this in the face of political pressure that is as unrelenting as it is mindless.

Photo by Flickr user Gage Skidmore.