Having taken a four month hiatus from blogging, Citadel advisor and former Fed chair Ben Bernanke penned another article on his Brookings blog in which he discusses a familiar subject: that the Fed has run out of tools, a problematic reality which would be exposed by the next financial crisis, so in advance, Bernanke proposes an even more unorthodox monetary policy: price-level targeting.
Pointing out the obvious, namely that as a result of the bursting of the last Fed-created bubble, the US economy remains mired in “low nominal interest rates, low inflation, and slow economic growth” which “pose challenges to central bankers”, central banks may want to consider temporary price-level targeting, or PLT, as Bernanke is “no longer confident” that the Fed’s “current monetary toolbox would prove sufficient to address a sharp downturn.”
The problem, as the ex-Chairman explains, is that with estimates of long-run equilibrium level of real interest rate “quite low,” Bernanke writes that the next recession may occur when the Fed has “little room to cut short-term rates”; as “problems associated with the zero-lower bound (ZLB) on interest rates could be severe and enduring.”
What Bernanke concedes here, is that the current pace of rate hikes and balance sheet unwind are not nearly rapid enough to provide the monetary policy buffer that will be needed to address the next economic crisis, and as a result the Fed needs to resort to more aggressive “temporary” measures to boost inflation, bypassing the Fed’s implicit 2% inflation target, and heating up the economy substantially.
To short-circuit the effects of the zero-lower bound, and to “temporarily” (that word is critical to Benanke, who uses it no less than 24 times in his article) overheat the economy so the Fed can boost its recession-fighting ammunition, Bernanke “proposes an option for an alternative monetary framework” that he calls “a temporary price-level target—temporary, because it would apply only at times when short-term interest rates are at or very near zero.“
As noted, Bernanke says “temporary” over 20 times, which is ironic because after the Fed injected over $4 trillion in liquidity in the financial system, and 8 years later the Fed is not only still unable to hit its stated 2% inflation target on a consistent basis, but openly admits inflation is a “mystery”, a better word would be “permanent.”
How does price-level targeting differ from conventional inflation-targeting?
As Bernanke explains, the “the principal difference is the treatment of “bygones.” An inflation-targeter can “look through” a temporary change in the inflation rate so long as inflation returns to target after a time. By ignoring past misses of the target, an inflation targeter lets “bygones be bygones.” A price-level targeter, by contrast, commits to reversing temporary deviations of inflation from target, by following a temporary surge in inflation with a period of inflation below target; and an episode of low inflation with a period of inflation above target. Both inflation targeters and price-level targeters can be “flexible,” in that they can take output and employment considerations into account in determining the speed at which they return to the inflation or price-level target.”
That is a long-winded way of saying that price-level targeting is an even more brute force approach to pushing inflation higher, one which ignores transitory bursts in inflation, which in a world of record debt has the potential to unleash a financial disaster as its sends the price of global (record) debt tumbling, creating a risk waterfall across financial markets, and reverberate in the economy. In other words, the Fed would flood the system with so much liquidity that economic inflation spikes and only afterwards is reduced back to some baseline level. What happens in between, to Bernanke, is of secondary importance, although with many Wall Street strategists conceding that a burst of inflation is the critical catalyst to unleash a sharp market drop, one could also say that Bernanke is advocating a market crash, wiping away trillions in “welath effect” for the top 1%.
Bernanke ignores such potential downsides, and instead focuses on the positive, saying that price-level targeting has two advantages over raising the inflation target: “The first is that price-level targeting is consistent with low average inflation (say, 2 percent) over time and thus with the price stability mandate. The second advantage is that price-level targeting has the desirable “lower for longer” or “make-up” feature of the theoretically optimal monetary policy.”
That said, the author concedes that PLT has drawbacks:
For one, it would amount to a significant change in the Fed’s policy framework and reaction function, and it is hard to judge how difficult it would be to get the public and markets to understand the new approach. In particular, switching from the inflation concept to the price-level concept might require considerable education and explanation by policymakers. Another drawback is that the “bygones are not bygones” aspect of this approach is a two-edged sword. Under price-level targeting, the central bank cannot “look through” supply shocks that temporarily drive up inflation, but must commit to tightening to reverse the effects of the shock on the price level.
Bernanke’s punchline at least contains some truth, namely that PLT would be a “painful” process to all those who rely on nominal incomes to purchase goods and services, especially if said process ends up running away from the Fed’s control and results in hyperinflation, to wit:
“Given that such a process could be painful and have adverse effects on employment and output, the Fed’s commitment to this policy might not be fully credible.“
And in case his PLT idea is frowned upon – perhaps politicians don’t want a revolution – Bernanke proposes another, just as “painful” idea, namely using inflation targeting “but to raise the target to, say, 3 or 4 percent. If credible, this change should lead to a corresponding increase in the average level of nominal interest rates, which in turn would give the Fed more space to cut rates in a downturn. This approach has the advantage of being straightforward, relatively easy to communicate and explain; and it would allow the Fed to stay within its established, inflation-targeting framework.”
Quite easy to explain indeed, and here’s one attempt “we will inject so much liquidity, not only will we blow the biggest asset bubble ever, but it will make your head spin how fast prices soar.” But it’s ok, it will be “temporary.”
Finally, while there is much more in Bernanke’s proposal which was inspired by the “insightful theoretical work of Paul Krugman, Michael Woodford and Gauti Eggertsson”, even Bernanke admits there will be problems, or rather one major one: the peasantry – for some “unknown” reason – is not a fan of runaway inflation:
One obvious problem is that a permanent increase in inflation would be highly unpopular with the public. The unpopularity of inflation may be due to reasons that economists find unpersuasive, such as the tendency of people to focus on inflation’s effects on the prices of things they buy but not on the things they sell, including their own labor. But there are also real (if hard to quantify) problems associated with higher inflation, such as the greater difficulty of long-term economic planning or of interpreting price signals in markets. In any case, it’s not a coincidence that the promotion of price stability is a key part of the mandate of the Fed and most other central banks. A higher inflation target would therefore invite a political backlash, perhaps even a legal challenge.
Ah yes, nothing quite like a former Fed reserve chairman confused by why surging inflation is “highly unpopular with the public”, which is unable to grasp that only through soaring prices of goods and services will wages rise… well, maybe: because as the whole broken Phillips Curve fiaso has shown 8 years into this recovery with 4.2% unemployment and virtually no real wage growth, perhaps the reason why the “public” is not too crazy about 4% inflation is that while prices surge, wages seems to have flatlined.
In short, Bernanke is alleging that inflation is unpopular because we, simple peasants, only focus on rising prices while ignoring wage growth. To which the only possible retort is that the “public” would be more than happy to focus on higher wages… if these were permitted for anyone but the top 1%.
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