What Hath Bernanke Wrought?

The advance estimate of GDP for the first quarter of 2012 published today provides little cause for celebration, and not much reason for hope. Real GDP growth slowed to a 2.2% annual rate from the 3.0% rate in the previous quarter. Nominal GDP growth remained at 3.8%, reflecting a spike in oil prices as a result of nervousness about disruptions in oil supplies from the Persian Gulf. But despite the lackluster performance, Ben Bernanke no doubt feels well satisfied, as this answer, responding to criticism from Paul Krugman, from his press conference after this week’s FOMC meeting, demonstrates all too clearly.

So there’s this, uh, view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time. I made two points at that time. To the Bank of Japan, the first was that I believe a determined central bank could, and should, work to eliminate deflation, that it’s [sic] falling prices. The second point that I made was that, um, when short-term interest rates hit zero, the tools of a central bank are no longer, are not exhausted there, are still other things that, um, that the central bank can do to create additional accommodation. Now looking at the current situation in the United States, we are not in deflation. When deflation became a significant risk in late 2010 or at least a moderate risk in late 2010, we used additional balance sheet tools to return inflation close to the 2% target. Likewise, we’ve been aggressive and creative in using nonfederal funds rate centered tools to achieve additional accommodation for the U.S. economy. So the, 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 deflation [sic]. Why don’t we do more? I would reiterate, we’re doing a great deal of policies extraordinarily accommodative. You know all the things we’ve done to try to provide support to the economy. I guess the, uh, the question is, um, does it make sense to actively seek a higher inflation rate in order to, uh, achieve a slightly increased pace of reduction in the unemployment rate? The view of the committee is that that would be very, uh, uh, reckless. We have, uh, 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 a, [indiscernible] expectations or destabilization of inflation. To risk that asset, for, what I think would be quite tentative and, uh, perhaps doubtful gains, on the real side would be an unwise thing to do.

Paul Krugman responded on his blog to this not very edifying answer by Mr. Bernanke; Krugman pointed out that the sharp distinction between the situation in Japan and the situation in the US is not as clear cut as Bernanke makes it out to be. Moreover, there is no basis for saying that there is a bright line between positive and negative inflation so that the economic effects change radically when you go from very low positive inflation to very low negative inflation.

I would make a further comment on Bernanke’s performance. Since 1947, every single recovery has been associated with several quarters of nominal GDP growth in excess of 5% as the chart below demonstrates. The only recovery in which nominal GDP growth did not initially exceed 5% for several quarters was the anemic recovery from the 2001 recession in which nominal GDP growth remained under 5% for several quarters before increasing above 5%, but only slightly above 5%.

With what passion does Mr. Bernanke invoke the experience of the past 30 years during which the Federal Reserve, has patiently “built up its credibility for low and stable inflation,” credibility that “proved extremely valuable” in enabling the Fed “to take strong accommodative actions in the last four or five years to support the economy without leading to . . . expectations or destabilization of inflation.” Well, I am deeply moved by Mr. Bernanke’s deeply pious reverence for the lessons of the last 30 years, but let’s have a little closer look at the record of the last 30 years in the next chart.

And what does the chart show? It shows over the past 30 years in which the Fed has built up so much credibility that the Fed has been able to do all the wonderful things that it has done to promote . . ., well, to promote the weakest recovery since World War II, nominal GDP growth after each recession during the past 30 years substantially exceeded 5% quarter after quarter. During this recovery, however, the annual rate of nominal GDP growth has not exceeded 5.5% in any quarter since the “recovery” began, while averaging less than 4%. And Mr. Bernanke has the nerve to tell us that he is unwilling to allow inflation to increase above 2% because it would squander the precious credibility achieved by the Fed over the past 30 years when nominal GDP during recoveries almost always grew at an annual rate greater, often substantially greater, than 5%? Remember the audacity of hope? This is the audacity of complacency and indifference.