Bernanke: The Good Engineer?

Thursday, March 21, 2013

by John P. Cochran

In a Financial Times article, “A good engineer who knows his own limits,” Edward Luce praises Fed Chairman Ben Bernanke for being the adult in the room when it comes to dealing with the current slow recovery from the “Great Recession and for doing so while clearly recognizing the limitation of monetary policy.” He argues that, with the exception of Obama’s 2009 stimulus, only Bernanke and the Fed have worked tirelessly to “keep the US economy afloat.” More recently, per Luce, Bernanke’s efforts have been heroic, while restrained by headwinds he cannot control.
The Bernanke-led Fed has, since 2009, “stood alone in its attempts to confront America’s jobs and housing crises—albeit with its limited monetary tool kit.” Since Republicans took control of Congress in 2010, “serious action elsewhere” [more Keynesian stimulus] has been “stymied.” Because of the lack of action elsewhere, Bernanke should be given credit and praise for the actions and statements tied to QE I, II, and Infinity, and the commitment by the Fed to purchase $80 billion a month in Treasury and mortgage-backed securities, as “[f]or the first time in its history, the Fed is taking the full-employment half of its mission seriously. In December Mr. Bernanke broke precedent by pledging to keep zero-bound interest rates until unemployment fell to 6.5 per cent or inflation exceeded 2.5 per cent.”
Luce continues his analysis of the good engineer as one who knows his limitations. Bernanke knows and never hesitates to remind people that, “there is only so much the Fed can do.” While it can “assist job creation” and “help boost” aggregate demand, the Fed cannot “force banks to lend” nor can it reverse the“fall in median earnings.” This is so, even with its strong regulatory oversight and the nearly tripling of its balance sheet as it bailed out the “banksters.” Bernanke, unlike Greenspan, clearly knows the limitations of monetary policy and the Chairman can never be the “maestro.” Thus Luce concludes, “Posterity should reward Mr. Bernanke for having the serenity to know that.”
Austrians and fellow travelers would argue Luce is incorrect on almost all points in his analysis of the Fed’s (and the Federal government’s) response to both the recession and the slow recovery. Overlooked by Luce is any mention that our ’good engineer&lrsquo; was, if not the architect, the facilitator of the most recent boom and bust. Roger Garrison, in “Natural Rates of Interest and Sustainable Growth” (pp. 433-35) makes a strong case that the Fed did indeed facilitate both the 2000 “dot com” boom-bust cycle and the more recent housing bubble-led boom-bust cycle. Regarding the Fed’s response, where the Fed acted much like an arsonist, who did not light the fire, but only poured gasoline on a smoldering ember, returns to the scene of the crime in the guise of a hero coming to combat the now raging blaze, Garrison writes:

Predictably, the reaction of the Federal Reserve (beyond the rescuing of failing financial institutions) was to push interest rates still lower, reducing the Fed funds rate virtually to zero in late 2008 and more recently pledging to keep it near zero through the first half of 2013 [and even beyond that, until unemployment falls to 6.5 percent or inflation exceeds 2.5 percent]. While this strategy, as reinforced by “quantitative easing,” has led to an enormous buildup of liquidity in the banking system, it has severely retarded the needed correction of the misallocations of labor and other resources that occurred during the boom (emphasis added). The claim is often made in connection with both monetary policy and fiscal policy that the economy can’t recover until the housing market recovers. But the Austrian perspective, with its attention to credit misallocation, suggests that the housing market will be the market that recovers last. Resources need to be moved out of housing and other interest-sensitive investments and absorbed into other parts of the economy, allowing the growth in population eventually to absorb the excessive housing stock. All attempts by policymakers, both monetary and fiscal, to entice construction workers back into their construction jobs (and entice workers generally into interest-sensitive investment activities) can only delay the recovery.

Thus, in the important lead up to the 2007-08 recession and crisis, Bernanke certainly did not understand the limits of monetary policy and particularly the ability of an unsound policy to do great harm to the economy by creating booms and bubbles. As one who helped engineer the boom and subsequent bust, Bernanke may not be able to reverse the “fall in median earnings,” but it was Fed policies that, through malinvestments and overconsumption during these two boom-bust episodes, destroyed wealth and contributed to this decline. Salerno discusses wealth destruction as a consequence of the artificial boom in depth with appropriate data to support his application of ABCT to this period in “A Reformulation of Austrian Business Cycle Theory in Light of the Financial Crisis.”
Luce supports the fiscal stimulus package of 2008, and implies that additional stimulus would have made the economy better while making life easier for Bernanke and the Fed. However, there was never strong agreement among economists on the expected benefits of the 2009 stimulus despite then President-elect Barack Obama’s January 9, 2009 statement that, “There is no disagreement that we need action by our government, a recovery plan that will help to jump-start the economy.” Cato Institute (2009) responded, supported by more than two hundred prominent economists, “With all due respect, Mr. President, that is not true.” The economists’ statement, which in retrospect has proven much more prophetic than the administration’s claim that the stimulus bill was necessary to keep the unemployment rate from reaching 8 percent, went on to argue that, “it is a triumph of hope over experience to believe that more government spending will help the US today.”
Now despite massive actions by the authorities to stimulate, direct, guide, and jump-start the economy, unemployment remains persistently near the 8-percent mark, after having peaked much higher than predicted by the Obama administration.
The low interest rate policy (see here, here, and here) and uncertainty about future monetary policy have been among many factors delaying recovery (see my “Recessions: The Don't Do List” and “Regime Uncertainty: Some Clarifications” by Robert Higgs). However continuation of current monetary policy risks setting up conditions that will create the next episode of unsustainable growth and a renewed boom-bust cycle. As banks begin renewed lending which the Fed policy has made possible (Steve Hanke has recently argued that there is evidence that money growth is beginning to accelerate), Austrians predict (unlike Hanke, who sees renewed monetary growth as a key to a more rapid recovery) that this expansion of circulation credit will instead lead to a renewed pattern of unsustainable growth. Rothbard (Man, Economy, and State, p. 1008), as he often does, summarizes succinctly, the Austrian position of the impact of central-bank-driven credit expansion:

[C]redit expansion generates further cycles whether or not there are unemployed factors. It creates more distortions and malinvestments, delays indefinitely the process of recovery from the previous boom, and makes necessary an eventually far more grueling recovery to adjust to the new malinvestments as well as to the old. If idle capital goods are now set to work, this “idle capacity” is the hangover effect of previous wasteful malinvestments, and hence is really submarginal and not worth bringing into production. Putting the capital to work again will only redouble the distortions.

Modern macroeconomists often base their reasoning on “natural rate of unemployment” models, coupled with rational expectations, and thus tend to endorse expansionary policy as a tool to speed recovery from a depression. In contrast, Hayek (Prices and Production) and Mises (Human Action), like Rothbard, argue that the distortion effects of credit expansion occur even in the presence of unemployed resources. Ravier in “Rethinking Capital-Based Macroeconomics” more recently updated this argument extending Garrison’s model developed in Time and Money and in “Dynamic Monetary Theory and the Phillips Curve with a Positive Slope” expanded the argument to imply a upward-sloping Austrian long-run Phillips Curve.
Jeffrey Rogers Hummel in “Ben Bernanke versus Milton Friedman: The Federal Reserve’s Emergence as the U.S. Economy’s Central Planner” (p. 512) strongly refuted the Luce argument that Bernanke has the serenity to know the limits of monetary policy, and that a Chairman can never be“maestro.” And he did so, even before the most recent expansion of Fed activity. Hummel wrote:

But now, with Bernanke, the central-planning aspect of central banking has become much more encompassing. As George Selgin observed in an interview, “The Fed . . . has morphed into a central planning agency with a corporate welfare department” (quote in Oliver 2009). It requires a certain hubris to undertake such a daunting task, yet Bernanke clearly does not lack such hubris. As the prolonged and incomplete recovery from the recent recession suggests, however, the Fed’s new central planning, like the old central planning, will ultimately prove an unfortunate and possibly disastrous failure.

Luce’s use of the “good engineer” when referring to Chairman Bernanke could be taken two ways, either of which are apt; the engineer as planner, where Hummel’s summary is very apt, or a train engineer skillfully guiding a high-speed train down the track. If the second way is taken, it is illustrative to compare Bernanke to the famous engineer, Casey Jones. Bernanke, like Casey Jones, is often held up as a popular hero. However, Jones was the engineer of a major train wreck, which was due to his errors in judgment and his own overconfidence. Bernanke's current monetary policy is a train wreck waiting to happen. The ultimate solution as is pointed out by Roger Garrison: “The hope of achieving long-run sustainable growth can only rest on the prospects for decentralizing the business of banking.”