Below are a few “real-time” cases
Maybe Bernanke´s “amnesia” caused the Great Recession (2015)
Here´s what Bernanke knew long before becoming Fed chairman:
Bernanke (with Gertler & Watson) 1997 (on oil shocks)
Substantively, our results suggest that an important part of the effect of oil price shocks on the economy results not from the change in oil prices, per se, but from the resulting tightening of monetary policy. This finding may help to explain the apparently large effects of oil price changes found by Hamilton and many others.
Bernanke 1999 (on Japan)
Needed: Rooseveltian Resolve
Franklin D. Roosevelt was elected President of the United States in 1932 with the mandate to get the country out of the Depression. In the end, the most effective actions he took were the same that Japan needs to take—- namely, rehabilitation of the banking system and devaluation of the currency to promote monetary easing. But Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and to experiment—-in short, to do whatever was necessary to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done.
Bernanke 2003 (on Friedman)
As emphasized by Friedman (in his eleventh proposition) and by Allan Meltzer, nominal interest rates are not good indicators of the stance of policy, as a high nominal interest rate can indicate either monetary tightness or ease, depending on the state of inflation expectations. Indeed, confusing low nominal interest rates with monetary ease was the source of major problems in the 1930s, and it has perhaps been a problem in Japan in recent years as well. The real short-term interest rate, another candidate measure of policy stance, is also imperfect, because it mixes monetary and real influences, such as the rate of productivity growth…
The absence of a clear and straightforward measure of monetary ease or tightness is a major problem in practice. How can we know, for example, whether policy is “neutral” or excessively “activist”?
Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation…
The charts show the facts he confronted and actions taken after becoming chairman.
In June 2008 he “forgot” about his views on interest rates as an indicator of monetary policy and thought monetary policy was easy because the FF rate was “only” 2%! At that time the FOMC let it be known that the next rate move would likely be UP!
He “forgot” that the impact of an oil shock in the real economy resulted from the tightening of monetary policy, the stance of which was better indicated by nominal spending growth rather than the interest rate.
When the crash materialized due to the errors above, he “forgot” to adopt the “Rooseveltian Resolve” he had suggested to the BoJ!
Krugman vs DeLong - Postmodernism vs Backward Induction Unraveling (2015)
(Note: Postmodernism is a philosophical movement… it holds realities to be plural and relative, and dependent on who the interested parties are and what their interests consist of.)
Krugman responds to DeLong´s “Backward Induction Unraveling”:
One more thing: Brad says that we came into the crisis expecting business cycles and possible liquidity-trap phases to be short. What do you mean we, white man? Again, we had the example of Japan — and even aside from Rheinhart-Rogoff, it was obvious that Postmodern business cycles were different, with prolonged jobless recoveries.
In the end, while the post-2008 slump has gone on much longer than even I expected (thanks in part to terrible fiscal policy), and the downward stickiness of wages and prices has been more marked than I imagined, overall the model those of us who paid attention to Japan deployed has done pretty well — and it’s kind of shocking how few of those who got everything wrong are willing to learn from their failure and our success.
Let´s put up some images. The first set shows that the both the intensity of the drop in employment and the speed of increase are associated with what happens to aggregate nominal spending (NGDP), something the Fed closely controls, irrespective of where the interest rate happens to be.
Note that things are much more subdued after the Volcker adjustment phase (1981-85). What follows is the “Great Moderation”, when NGDP grows at around 5.5% along a stable level trend.
For example, after the 2001 recession, which was quite shallow in terms of RGDP growth (never becaming negative), NGDP growth lingers for some time below the 5.5% rate of growth. Therefore, employment behavior looks like the base of a wide (shallow) bowl (“jobless recovery”)
The present cycle is another animal altogether. The Fed never had its heart in pulling nominal spending up to a reasonable level, keeping its growth stable at “slow speed”. Employment takes a deep dive and comes back at a speed consistent with the low spending growth.
The next set shows the behavior of inflation over the same periods. The pattern is easy to see. The Volcker adjustment is successful in bringing inflation down. Later, Greenspan places it on (or close to) the 2% “target”, mostly by keeping spending growth close to the trend level path. Then, Bernanke comes along and apparently decides that´s “way too high”. To keep inflation “lower than low” the Fed pulls the hand brake to slowdown nominal spending growth.
The last set illustrates nominal and real growth over the episodes. When you look at the bottom right image, you get the hang of why thinks are so glum.
The “novelty” of the situation depicted in the bottom right image of all the charts is what explains why people’s expectations of the length of the what Krugman calls the “liquidity-trap” phase were “miles off”, and why DeLong says “backward induction unraveled”.
Unfortunately, very few fingers point at the Fed!
The “Perfect Storm” of 2007/08 (2013)
In “What you teach is what you think”, I berated Mishkin for calling the monetary policy action ‘bold’ at the end of 2008. In another “Policy and Practice” box in his Macroeconomics – Policy and Practice textbook (page 235), he deals with the fiscal stimulus package of 2009. Here´s how he tells the story:
In the fall of 2008, the US economy was in crisis. By the time the new Obama administration had taken office, the unemployment rate had risen from 4.7% just before the recession began in December 2007 to 7.6% in January 2009. To stimulate the economy, the Obama administration proposed a fiscal stimulus package that, when passed by Congress, included $288 billion in tax cuts for households and businesses and $499 biliion in increased federal spending, including transfer payments. As this analysis indicates, these tax cuts and spending increases were intended to increase planned expenditure, thereby raising the equilibrium output at any given interest rate [“zero” at the time] and so shifting the IS curve [or the aggregate demand curve] to the right.
Unfortunately, things didn´t work out as the Obama administration planned. Most of the government purchases did not kick in until after 2010, while the decline in autonomous consumption and investment were much larger than anticipated. The fiscal stimulus was more than offset by weak consumption and investment with the result that the planned expenditure ended up contracting rather than rising, and the IS curve did not shift to the right, as hoped. Despite the good intentions of the fiscal stimulus package, the unemployment rate ended up rising to over 10% in 2009. Without the fiscal stimulus, however, the IS curve would likely have shifted further to the left, resulting in even more unemployment.
It is from this sort of analysis that someone like Krugman confidently says that it wasn´t the case that fiscal stimulus didn´t work, it´s just that it wasn´t “big enough”. To students, Mishkin´s story leaves the impression that the contraction in consumption and investment spending was “just one of those things”.
He misses a great opportunity to hammer on students the power of monetary policy. He could say: “Things didn´t work out as planned because monetary policy was contracting, more than offsetting the rise in government spending”. In fact, he could have said, if monetary policy had been doing it´s ‘stabilizing job’, fiscal stimulus wouldn´t even have been needed. For all sorts of very plausible reasons, money demand was rising (velocity falling), but money supply growth was also falling. The combination of falling money and velocity can only result in one thing: a drop in aggregate spending (NGDP), in which case consumption and investment will fall, making fiscal stimulus go against very strong ‘headwinds’! In that case, there´s nowhere for unemployment to go but up!
The charts illustrate.
I believe a former central banker could have done much better. Maybe that´s too much to expect, given he would have to be pretty ‘courageous’ to say “we did it”.
It´s better to imply it was “just one of those things” or, as in the intro to chapter 12 (The Aggregate Demand and Supply model), say that “in 2007 and 2008, the US economy encountered a perfect storm.”