Does Ben Bernanke Believe The Stuff He Writes?

James Galbraith was on Yahoo! Tech Ticker talking about Fed policy. The quote he made that caught my eye was this one in response to whether the Fed Chairman Bernanke believes what he says and writes:

"Well, one thing you can document and you just alluded to it is that there is a great gap between Bernanke the dispassionate independent academic of a few years ago and Chairman Bernanke of the Federal Reserve Board. These people do not seem to have met each other.

–What’s Bernanke Smoking? "A Complete Mystery" How QE2 Helps the Economy, Galbraith Says, Tech Ticker

(video embedded below)

What Dr. Galbraith is alluding to is the fact that Dr. Bernanke really thinks fiscal policy is more effective than quantitative easing to the degree you want to add stimulus.  The breath-taking comment by Paul Krugman a few weeks ago about the Fed needing $8-10 trillion of QE to boost the real economy goes to this. I think you would need even more. But, of course, Bernanke has no input into fiscal policy and right now fiscal policy is a dead issue in Washington. Interest rates are already zero percent. So, Bernanke has decided to fall back on the only thing he has left and print money.  Here’s the clue that he still believes fiscal policy is more effective.

The Federal Reserve cannot solve all the economy’s problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector. But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation.

–Ben S. Bernanke – What the Fed did and why: supporting the recovery and sustaining price stability

That’s how Bernanke ended his Op-Ed piece in the Washington Post defending quantitative easing. Dr. Galbraith mentions a paper by Professor Pavlina Tcherneva which documents Bernanke’s scepticism of monetary policy (read the paper here). Galbraith thinks Bernanke is operating "within the gilded cage" inside the beltway in which he feels politically constrained and is therefore not espousing views he did as an academic.

As for monetary policy, while QE does not create new net financial assets, it is money printing because it is a swap of bonds for electronic credits of equivalent value i.e. money. The Fed is effectively ‘monetizing’ the government’s debt. I could start doing a lot of hand-waving here about money printing like a lot of people of my persuasion do. You saw my little "Time’s Object of the Year" post. 

I really should note for the sake of accuracy that the government doesn’t ‘fund’ itself via bonds. The Treasury could just print money (see here). The reason it cannot just print money is that it is legislatively mandated to issue debt equivalent in value to the cash (not accrual) deficit it creates. It also has a legislatively mandated debt ceiling to boot.  These are artificial limits set to prevent the government from just deficit spending. Analogously, there are no hard debt to gdp constraints for a fiat currency. You can bet all of this will become a contentious issue early next year when the Republican House of Representatives picks a fight to shut down the government, threatening to allow the U.S to default rather than accede to more deficit spending.

As an aside I should also point out that a government that issues its own fiat currency with zero obligation to pay back anything except more of the same fiat currency cannot involuntarily default. After all it creates the darn thing; there’s no gold tether here, so it could just print up more (see here). A lot of people living in a fictional gold-standard world seem to miss this; the issue with fiat currency and deficits is about currency depreciation and inflation, not involuntary default. A government with a fiat currency can voluntarily default however – but this would be for political reasons like shutting down government over a battle over deficit spending (like in the US) or a desire to stiff foreigners due to a drain on reserves from foreign currency obligations (as in the case of Russia. see here.)

And notice the hoops that the ‘independent’ Federal Reserve must jump through in order to monetize the government’s debt. They are forbidden from buying debt at auction. But they can buy it in the secondary market – only up to 35% per security issued. Again, these are all ‘artificial and imposed’ constraints to give the public the illusion that the Federal Reserve is independent authority and not a political organization which facilitates government in spending to its heart’s content. 

In going with QE2, the Fed has done a few reckless things by ending this charade. First, the self-imposed 35% limit is now gone. Second, the Fed has openly admitted for the first time that it is targeting asset prices. This is a mistake because the ‘Audit the Fed’ movement is very much alive and well.  The Fed will come under much greater scrutiny going forward -rightfully so, I might add.

My personal view here is that artificial and self-imposed constraints are a good thing. Without them (and perhaps even with them), like CLSA’s Christopher Wood, I believe the endgame is a systemic government debt crisis – one reason I talk a lot about precious metals and real assets. Nevertheless, we should recognize these constraints for what they are rather than living in the fantasy world of a gold standard that no longer exists. The question must be about how we use the government’s fiscal resources in the case of a deep downturn.  I would support a temporary cut in the regressive payroll tax. I would support a jobs program to replace the ever extending unemployment benefits. But after two years of half-hearted attempts by the Obama Administration to put money in people’s pockets through fiscal stimulus and bailouts of a financial sector that pays record bonuses but does not lend, many Americans are fed up. I believe we are headed for a more austere future in the US. Bernanke knows this and that’s why he has taken the gamble he has done.