Friday 31 January 2014

Bernanke: A brief judgement

With Ben Bernanke exiting his position as the US Federal Reserve Chairman it's time to reflect on his time in office. There is no doubt that he took over at a tumultuous time (The Financial Express offers a timeline here). My thoughts are simply that we don't know how well he did. Objectively, we know that the FED has consistently missed targets as shown here:

FRED Graph
Inflation at 2% and full employment (maybe in the 4-6% range) are the aims of the FED. Since early on in the recession the FED has missed on both repeatedly.

So does FED failure equate to a Bernanke failure?

That's a much different question. We can't run history again with a different FED chairman, and hopefully we don't have the same confluence of economic events to produce an adequate comparable. But without that we can't truly evaluate his role in this.

If we imagine the US economy under the implied actions of those fretting about the expanded balance sheet, inflationary worries, and a weakening currency, then we're likely to miss on both inflation and unemployment targets by a greater margin.

The FED's mandate isn't supply side, it's demand side. I think those criticisms largely miss the mark. Sure these actions aren't ideal, but we need to imagine a counter-factual history that doesn't exist. Should the FED have concerned itself with non-existent inflation? Should the FED have let the liquidity in the financial system dry up? Perhaps, but that would be a wildly different mandate then the FED has.

If, like me, you believe that the FED should have done more to hit their stated targets, then perhaps we can be critical of Bernanke here. But I'm not convinced. The questions should be:

1) What did Bernanke believe the FED's optimal policy path have been?
2) What impact would this policy have had on the economy?
3) What were the constraints he faced in their implementation?
4) Would a better strategy have increased his policy uptake?

Quick evaluation?:

1) Based on his previous academic work, it's really hard to imagine that the policy path taken wasn't a compromise to the tight money side.

2) Divergence is to be expected here, to my eye money was excessively tight (as evidenced by the plunging NGDP figures, collapsing inflation, and above trend unemployment and our inability to regain some semblance of trajectory).

3) The FED open market committe is that, a committe. Rule is by consensus. Bernanke was the chairman and had some control of framing the debate in terms of time and direction, but he could not act unilaterally. In addition, the public outcry and political backlash against expansionary policy, which in theory shouldn't impact FED policy, was largely uni-directional. If we accept 1) then this would leave Bernanke pushing against the current here as well.

4) By most accounts Bernanke seems to have been an effective communicator and was able to build consensus in the direction he wanted. Would a more brash and divisive figure have done better? It's hard to say.

My prognosis? The FED failed on it's mandate consistently, at a point when the economy really needed it. However, I don't think anyone had a better academic pedigree for the issues of the time. Hopefully we get some memoirs to find out whether he wrestled with his strategy to move the FED policy in that direction, or if he get the policy path he wanted.

Basing policy on Inflation and Unemployment are problematic because they both require significant interpretation. Are deviations from trend caused by underlying supply side factors or transitory demand side factors. If it's the latter, then they are useful indicators. In this case the deviations supported this notion. The FED is there to address these nominal demand side issues and they did ALOT to. Just not enough.

What options did he have given the constraints? I would have preferred a clear, measurable, and definitive target for the mandated variables. But I acknowledge it's difficult using the two variables currently used. Perhaps level targeting the variables would help.

In a perfect world a less discretionary policy based on NGDP would be better, and would likely have performed better under these circumstances. Even if Bernanke was on side with this the political and economic climate of his tenure were certainly not conducive to significant mandate change. Hopefully Janet Yellen overseas a more calm setting and can push for changes.

As always Scott Sumner has a better summary of the way I feel. Here are a few items that he points to:
The Fed did poorly over the past 5 1/2 years.  But perhaps Bernanke does deserve a standing ovation. Everything’s relative.  As far as I can tell Bernanke outperformed the profession, which is all we can really ask of a policy leader. 
If the economics profession had been solidly market monetarist in 2008 then I’m confident that Ben Bernanke would have gladly implemented NGDPLT.  The economics profession never gave him the support he needed to be more aggressive.  The profession failed us, the Fed was just a symptom.

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