This past Sunday, Paul Krugman penned a screed in the New York Times Magazine (entitled, somewhat unflatteringly in my opinion, “Earth to Ben Bernanke”) that expanded on the content of an ongoing debate in the economics blogosphere over the contents of the mind of Federal Reserve Board Chairman Ben Bernanke.
Professor Krugman has posited for months now that Bernanke has come up short in failing to follow his own prescription for post-bubble, debt-deflationary economies (namely, that of Japan, which the Chairman wrote about as an academic a dozen years ago). In essence, Professor Bernanke’s view was to push both monetary and fiscal stimulus to the point at which it would generate above-natural rates of inflation for a period of time sufficient for such economies to reflate and discount the indebtedness accumulated during credit bubbles.
In the course of Krugman’s commentary he has pushed the notion that Bernanke is either politically intimidated by the right, fearful of uncontrolled inflation, or possessed of a shy personality that is vulnerable to peer pressure within the FOMC (Paul…seriously?).
While some of what is in Ben Bernanke’s mind may be made more clear with tomorrow’s FOMC meeting announcement, in the meantime allow me to rise to Chairman Bernanke’s defence and suggest to Professor Krugman, as I have in the past, a different – yet still quite Keynesian – explanation for our Fed chairman’s current point of view (and in doing so give Paul a piece of my own mind, as I doubt Ben will rise to the bait himself).
Ben Bernanke is neither overly “shy” nor out of touch with the world, as Professor Krugman would have us believe. To the contrary, I believe the Chairman has correctly assessed the limitations of extraordinary monetary intervention at the zero-bound (short term interest rates at or near zero) and comprehends a present inability of the U.S. economy to generate the sustainable inflation that the professor correctly notes would help us out of our debt-deflationary slump.
I am sure that Professor Krugman agrees that the Great Recession and its sluggish aftermath saw a mammoth decline in aggregate demand. But if present levels of aggregate demand are insufficient to revive our economy, such demand must be insufficient relative to something else. And in this case – seen from a global perspective – that something else is the global aggregate supply of labour, productive capacity and, yes, even capital. Much of this excess supply can be traced to the historically sudden emergence of the post-socialist nations into the global market economy – which nations are characterised by extremely low wages relative to those of the developed world.
As a result of the foregoing, wages in the U.S. and other areas of the developed world are unable to “track” (that is, to follow along with, even on a lagging basis) the type of inflation resulting from the ocean of liquidity that quantitative and credit easing policy of the Fed, the ECB and the Bank of Japan has produced – generally speaking, inflation in highly tradable commodities and financial assets. No wage growth (because of the dampening effect of excess emerging market labour, always standing by to work cheaply where it can compete with endogenous U.S., European or Japanese labour)…no sustainable inflation. As a result, high levels of inflation tend to collapse economic activity, as limited per capita wages are shunted to oil and food, rather than to more expansionary forms of consumption.
Extraordinary monetary measures will remain a critical weapon in fighting the deflationary pressures that result from our continuing debt overhang and global wage imbalances. But I am afraid – as I believe Chairman Bernanke may well be – that attempts at “reflating-to-recover” are, in the end, somewhat counterproductive under present circumstances.