Why Bernanke Is More Important than G20

It may strike you as extraordinary that the G20 summit barely touched on what is, arguably, the key policy issue going forward - what will central banks do, including the detailed when and how of avoiding falling wages and prices (deflation). Fiscal stimulus is already almost fully in play around the world, regulatory reform will at best be slow and not relevant to the recovery, and “we promise to avoid an irresponsible protectionist trade war” is nice but more about not making things worse rather than getting our economies going again. Funding and leadership model change for the IMF can help prevent emerging markets from cratering, but in terms of impact on global growth or unemployment, it’s second order relative to the macro policies of the world’s largest countries.

The real issue is monetary policy, including interest rate cuts where there is still room for these - to me the biggest news of the week was actually that the European Central Bank cut rates by less than expected (its main interest rate stands at 1.25 percent). This confirms the ECB still does not see deflation as a clear and present danger. Look at all the downward pressures in the European economy, from East European collapses (and associated West European banking problems) to property market declines in the UK, Ireland and Spain (and what that means for banking) and export industry stress (and they have bankers too). The ECB is taking an extraordinary and - to my mind - incorrect position. If they truly wait until deflation is “fully in the data” (central bank jargon), it will be too late.

The dramatic trans-Atlantic, or at least eurozone-dollar, contrast is in terms of monetary policy, not fiscal stimulus or attitudes towards future regulation. In our piece in the Washinton Post Outlook section on Sunday (already online), we provide an updated back story on how exactly the Fed and its chair got to the point of taking bold and unprecedented moves towards expansionary monetary and credit policy.

In our view, the Fed’s current ”print the money” strategy (and, yes, I know the Fed doesn’t like this term or even “quantitative easing”) is make-or-break for turning the economic corner any time soon. It’s incredibly risky in terms of potential inflation - more than the Fed would ever concede - but preferable to all the available alternatives.

The power of our big banks presents a profound economic and political problem. Whatever happens - miraculous recovery or prolonged depression - this needs to be fixed. But we also can’t wait around for attempts to break up the banks; the prospects for unemployment and poverty are too dire to tolerate delay. First and foremost, we need to prevent global deflation and begin the difficult process of sustaining a recovery.

Remember this. If you run an expansionary fiscal policy (building bridges), I have an incentive to free ride (selling you BMWs) and not engage in a similar fiscal stimulus. But if you run an expansionary monetary policy, your exchange rate will tend to depreciate, putting pressure on my exporters and I’ll be pushed - by BMW-type producers - towards providing a parallel monetary stimulus.

There is only one person who can talk the ECB out of its current, ruinous policy: Ben Bernanke.

By Simon Johnson

Update (by James): This article has gotten a fair amount of commentary already.

• Mark Thoma says it depends on whether inflation expectations remain anchored (at 2%, where the Fed wants to peg them).
• Tim Duy says that we are making the mistake of confusing “credit easing” with “quantitative easing.” Duy points out (correctly) that Bernanke has repeatedly insisted that the Fed will mop up the excess money when necessary in order to dampen inflation; this means that the Fed is trying to keep inflation expectations where they are, despite the influx of money now. This could be Bernanke’s intention, but I think there’s still a question of whether the Fed will be able to follow through when necessary, and the resulting uncertainty could itself feed inflation expectations.

One thing I want to clarify, which Simon says above but is perhaps not clear in the article, is that we do not think that Bernanke is making a mistake. We think that despite the inflation risk, this is still the right strategy, because of the risk that the other tools used to restart the economy may not have sufficient oomph.

Comments

[Robert Perrego:]

Easy enough - Bernanke works for the US of A - the economic engine that drives the world. want to admit it or not - we lead, they follow. period.

Apr 06 01:13 PM

[Speedspirit:]

Let him start with getting rid of Larry Summers who last year recieved 2.7 million from speaking engagements with the bankers Citi, Bank of America, J.P Morgan ect. So we know where his interest lay, its not for the American people. A flaw in our system is we elect and then are undermined by appointed people with thier agendas.

Apr 06 01:16 PM

[Carousel:]

The San Francisco Chronicle had an article on Sunday about the lack of prosecutions and an assertion that this credit crisis is not real. The writer said that it's a deep recession from too much debt and too much debt-financed consumption but that the idea that it's because consumers and businesses can't borrow more is a lie devised by the banks to justify handing them a lot of money that they aren't going to lend to consumers and businesses anyway.

Check it out: www.sfgate.com/cgi-bin...

Apr 06 02:43 PM

[Walter Thier:]

!. Banish credit card solicitation on all capuses.

2. Abolish adjustable rate mortgagaes.

3. Qualify home loans at not more than 25% of the applicants income including utilities.

NOTE: STAND BACK AND LET IT WORK!

Apr 06 02:49 PM

[Dave Wrixon:]

Lets get one thing straight. Bernanke has to expand the balance sheet "print money". It has little or nothing to with fear of deflation. Without that balance sheet expansion the US, even given the huge sums of money being borrowed from China and elsewhere, would simply run out of money.

Those of you that seriously believe that deflation is still a likely outcome frankly want your heads examining. It isn't in the US because Bernanke will simply create whatever money is necessary to avoid economic collapse spiralling any faster than it already is.

These policies are being mirrored in the UK, Spain and Ireland, where there are problems. Elsewhere they are not because the overall problem is much smaller.

This is essentially a question of gross levels of indebtnesses within the economy, including personal as well as government. Europe just isn't in that much debt. Ultimately, the problem is primarily a US problem, and ultimately the US is going to have to pay the consequences, however, much the politicians attempt to "kick the can up the road".

Apr 06 03:18 PM

[The Geoffster:]

Just what I need- more credit.

Apr 06 03:18 PM

[Dave Wrixon:]

The argument here is that nobody wants to follow where you are leading. It is like herding sheep from the front.


On Apr 06 01:13 PM Robert Perrego wrote:

> Easy enough - Bernanke works for the US of A - the economic engine
> that drives the world. want to admit it or not - we lead, they follow.
> period.

Apr 06 03:20 PM