An article on the Bloomberg Business page pointed out that Ben Bernanke, the former Chairman of the Federal Reserve, on his blog at the Brookings Institute responded to the editorial “The Slow-Growth Fed” that was recently published in the Wall Street Journal, by asserting, among other things, that they are advocating tight money which won’t help the situation of slow growth.

Of course, Bernanke is very polite in his response, even when he points out that the WSJ Editorial Page has been much farther off the mark in their forecasts than Fed forecasts ever since 2006:

It’s generous of the WSJ writers to note, as they do, that “economic forecasting isn’t easy.” They should know, since the Journal has been forecasting a breakout in inflation and a collapse in the dollar at least since 2006, when the FOMC decided not to raise the federal funds rate above 5-1/4 percent.

Bernanke then goes on to say that if monetary policy doesn’t seem to be as effective as it could be, that isn’t a reason to not use it, but rather to also employ other tools at the disposal of government including fiscal.

The WSJ also argues that, because monetary policy has not been a panacea for our economic troubles, we should stop using it. I agree that monetary policy is no panacea, and as Fed chairman I frequently said so. With short-term interest rates pinned near zero, monetary policy is not as powerful or as predictable as at other times. But the right inference is not that we should stop using monetary policy, but rather that we should bring to bear other policy tools as well. I am waiting for the WSJ to argue for a well-structured program of public infrastructure development, which would support growth in the near term by creating jobs and in the longer term by making our economy more productive. We shouldn’t be giving up on monetary policy, which for the past few years has been pretty much the only game in town as far as economic policy goes. Instead, we should be looking for a better balance between monetary and other growth-promoting policies, including fiscal policy.

Ok. So, concerning forecasting, the pot called the kettle black. And I think we had fiscal stimulus – the ARA in 2009 plus other omnibus spending bills in 2009-10 that together totaled over $1.4T. It would be easy for the WSJ to come back to say that we’ve tried deploying other tools as well, including fiscal stimulus while the FF rate has been pinned to zero and that didn’t work either. In fact, looking at the behavior of general economic indicators during that time frame, 2010 was the next to worst year in the Great Recession.

Personally, I do not see how this disagreement goes anywhere toward constructive. We’ve tried tight money raw. We’ve tried government spending with tight money, and the results were far less than stellar. It’s true that returning to tight money would provide even slower growth.

Bernanke missed an important point, however, that while short-term nominal interest rates have been pinned at zero, it matters more where the Wicksellian equilibrium is in relation to short-term nominal interest rates, and low rates doesn’t mean easy money if the rate at which markets clear is negative – and that even at the ZLB monetary policy can be effective through the “hot-potato effect”. And so whatever kind of argument the writers at the WSJ think they have, they would first need to provide an analysis of the present clearing rate in order to arrive at an accurate conclusion about whether or how much the Fed should attempt to “normalize” the policy regime. Yes, rates are pinned at zero and the markets clear every day. What happens at some higher short-term nominal rate? The WSJ has no answer for that question, but should if it intends to be socially responsible in its advocacy of a particular policy action.

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