Monday, April 30, 2012

Two Princeton Professors Have At It

If you grew up as I did - with two professors as parents - you learn pretty quickly that intellectual arguments in academia can be pretty intense.

Henry Kissinger once famously observed that "University politics are vicious precisely because the stakes are so small." Professors tend to be very smart, very opinionated, and not afraid to challenge authority, especially if they have tenure.

Before he became chairman of the Federal Reserve, Ben Bernanke was chairman of the economics department at Princeton University. Among the professors that Dr. Bernanke recruited and hired for Princeton was Paul Krugman, the Nobel Prize winning economist who also writes frequently for the New York Times.

Krugman has become a frequent critic of his former department chair's policies.  He feels that the Fed should be doing more to spur economic growth in the U.S. through more aggressive use of monetary policy.

Dr. Krugman has written a book entitled "End this Depression Now!" that is scheduled to be published in May.  An article adapted from his book was written in yesterday's New York Times magazine.

Krugman argues that there is a major disconnect between what Professor Bernanke thought monetary policy could accomplish, and what Chairman Bernanke is actually doing as head of the Federal Reserve.

He notes that Bernanke was very vocal in his criticism of the Bank of Japan throughout much of the 1990's for what Bernanke perceived to be a timid response to Japan's economic woes.

However, now that he is head of our country's central bank, Krugman believes that Bernanke is acting more like the bank mandarins in Japan that he once attacked.

Here's an excerpt:

The Bernanke Conundrum — the divergence between what Professor Bernanke advocated and what Chairman Bernanke has actually done — can be reconciled in a few possible ways. Maybe Professor Bernanke was wrong, and there’s nothing more a policy maker in this situation can do. Maybe politics are the impediment, and Chairman Bernanke has been forced to hide his inner professor. Or maybe the onetime academic has been assimilated by the Fed Borg and turned into a conventional central banker. Whichever account you prefer, however, the fact is that the Fed isn’t doing the job many economists expected it to do, and a result is mass suffering for American workers.

Last Thursday, at a regular press conference, Chairman Bernanke was asked to comment on his former colleague's views.

Ezra Klein of the Washington Post reported Bernanke's thoughts.  It's a fairly long quote, but I think it is worth repeating here:

There’s this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies...the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation. And clearly, when you’re in deflation and in recession, then both sides of your mandate, so to speak, are demanding additional accommodation. In this case, we are not in deflation. We have an inflation rate that’s close to our objective.

Now, why don’t we do more? Well, first, I would again reiterate that we are doing a great deal -- policies extraordinarily accommodative; we -- and I won’t go through the list again, but you know all the things that we have done -- to try to provide support to the economy.

I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased pace of reduction in the unemployment rate? The view of the committee is that that would be very reckless. We, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four or five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.

Far be it from me to get in the middle of an intellectual squabble between two eminent economists (my parents taught me well!), but here's my two cents:

It seems to me that the Fed has done an extraordinary amount under very difficult circumstances.  While it is easy to write from Princeton that the Fed should do more, recall that Bernanke's confirmation hearing was not an easy one, and his Senate approval was only a tepid victory.

Moreover, I am not sure that lower interest rates really would accomplish that much more.  Mortgage rates, for example, are already at historic lows, and housing affordability is at near-record highs.  Lower rates have allowed corporations to borrow at very attractive levels, yet much of the cash still sits on the sidelines.  Monetary policy cannot force companies to invest in plant and equipment that they do not need.

 Oh, by the way, whatever happened to using fiscal policy for economic stimulus?