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Column: What Ben Bernanke needs to tell Congress

benrankeneedstosay.jpg

The worst word in Washington is "message." Whenever anything goes wrong, politicians begin blaming their messaging operations, as if a better-chosen sound bite by a more silver-tongued aide would have spared them the consequences of their actions. It's almost never true. Almost. But for Federal Reserve Chairman Ben S. Bernanke, the economy -- not to mention the Fed's credibility -- might be riding on whether he's willing and able to talk to Congress.

In a recent speech at the Federal Reserve Bank of Boston, Bernanke made perfectly clear that the central bank is tired of watching the economy stagnate. "With an actual unemployment rate of nearly 10 percent," he said, "unemployment is clearly too high" -- and, yes, the italics are in his prepared text. So the Federal Reserve is likely to begin purchasing Treasury bonds -- "quantitative easing," it's called -- in an effort to lower interest rates and spur the economy. They did this in 2009, and to great effect.

But the Federal Reserve can't go it alone. No one gets a job when the central bank buys a bond. It's only when the Fed's decision to buy a bond persuades some other economic actor to spend money that hiring ticks up. And thus far, that's not been happening. Banks and corporations have simply been stockpiling their cash, waiting for a recovery that, paradoxically, won't take hold until they start lending and spending again.

"I'm worried," says Alan Blinder, a former vice chairman of the Federal Reserve's Board of Governors. "I'm quite convinced that it'll be a lot less effective than the first time we did this, and that makes me worried that it won't be very effective." That's because the last round of QE worked very differently: The Federal Reserve bought mortgage-backed securities at a time when the market for them was frozen. That created liquidity where there wasn't any. Now they're planning to buy long-term Treasury bonds that are already in high demand. They're creating liquidity, in other words, where it already exists.

But there's one player who could move that money into the economy: Congress. Lawmakers have taken themselves out of the game amid concerns that more deficit-financed stimulus will increase interest rates. The Federal Reserve's purchases will ensure that won't happen. Someone, however, has to convince Congress of that, particularly now that the very concept of stimulus has become polarizing. Someone like, say, Bernanke.

Bernanke knows this, or at least he once did. In 2003, he tried to advise Japan on how to escape its long stagnation. "One direct and practical approach is explicit (though temporary) cooperation between the monetary and the fiscal authorities," he said. "This direction is promising and may succeed where monetary and fiscal policies applied separately have not."

The problem facing Japan, Bernanke continued, was that low interest rates weren't persuading businesses and consumers to spend, but the government wasn't picking up the slack because the public was worried about piling up further debt. "Cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own," he counseled. The Japanese government could stimulate the economy through tax cuts, and the central bank could print the money to pay for it.

Wouldn't that just add to the total debt? "To the contrary," Bernanke said, "from a fiscal perspective, the policy would almost certainly be stabilizing, in the sense of reducing the debt-to-GDP ratio." In other words, the relevant numerator -- the total debt in the hands of the public -- would remain unchanged while the denominator -- economic output -- would be higher. "Nothing would help reduce Japan's fiscal woes more," he concluded.

Japan didn't listen, and its subsequent stagnation offers a cautionary tale.

Today, of course, Bernanke is chairman of America's central bank and faces a similar problem. Low interest rates aren't persuading consumers or companies to spend. Large deficits have left the public skeptical of further government action. And slow GDP growth is making the debt picture much worse.

The answer is obvious: "explicit (though temporary) cooperation between the monetary and fiscal authorities." In practice, that would mean Bernanke gets John Boehner, Nancy Pelosi, Harry Reid and Mitch McConnell in a room and says the politics and specifics of this are their job, but the economy needs more fiscal stimulus if it's going to recover, and the Federal Reserve stands ready to make that not only possible but also virtually costless. Inasmuch as Republicans aren't big fans of further government spending right now, the best option could be the exact one that Bernanke recommended to Japan: a Fed-financed tax cut. Perhaps a payroll-tax holiday for the next year or two.

Pose this possibility to central bankers, however, and they get queasy. The Federal Reserve and Congress occupy different worlds, and the way the bank's independence has been protected has been to sell that separation as sacrosanct. "That's getting close to crossing the line," Blinder says.

Or is it? On Oct. 4, Bernanke headed to Rhode Island to deliver a speech on the danger of our long-term debt. In it, he called for reforms to Social Security, the health-care system and public-employee pensions, and he concluded by outlining the merits of "legislative agreements intended to promote fiscal responsibility by constraining decisions about spending and taxes."

All that is the province of Congress, not the central bank. And there's no reason Bernanke should be more comfortable counseling Congress on reducing deficits than stimulating growth -- particularly when growth can do so much to reduce deficits.

As Alan Greenspan discovered when he weighed in in favor of tax cuts in 2001, there are potential risks when a Fed chairman insinuates himself and the Fed into a controversial political and economic debate. But there are risks, as well, in not engaging. If the Federal Reserve unleashes another round of quantitative easing and it fails because there is nobody to spend or invest the money productively, that could damage the bank's credibility, its effectiveness and, ultimately, its independence. It could also leave the economy trapped in a rut of low growth and high unemployment for a decade or more. That's not a risk we can take.

Photo credit: Joshua Roberts/Bloomberg News.

By Ezra Klein  | October 22, 2010; 2:33 PM ET
Categories:  Federal Reserve  
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Comments

So, what has the Obama administration done differently to convince us they they deserve to be trusted with billions more in stimulus? Have they taken to heart the stories of waste, fraud and abuse the first time around and taken steps to eliminate it? Have they studied which projects actually created jobs and which were big boondoggles and taken steps to redeploy the unspent money in more productive fashion? Have they envisioned a strategic goal, like energy independence or homeland security, that will focus the spending in a measurable and beneficial direction? Will they put idiot Biden in charge again, or someone who actually knows something? Or will they just employ the same useless models that told them they'd hold unemployment under 8% and ask us to trust them and forget that they totally blew it the first time around?

Posted by: bgmma50 | October 22, 2010 2:49 PM | Report abuse

bgmma50, I think the more relevant question is: If President Obama came out with a plan for a tax cut and some investments in infrastructure, based on and influenced by what worked and didn't work in the last stimulus, would any Republicans vote for it?

Posted by: MosBen | October 22, 2010 3:16 PM | Report abuse

Ezra,
I think its worth making a bit more explicit that the Fed's credibility in solving economic problems is *already* on the line. It's Bernake's decision whether to risk it by acting or to risk it by not acting. The time to chose about risking credibility has already passed.

Posted by: ctown_woody | October 22, 2010 3:28 PM | Report abuse

The insfrastructure projects funded by the stimulus package generally came in under budget. This allowed for more projects to be undertaken than initially planned, as was reported in the Post a few days ago. People ideologically opposed to government spending will always point to "waste, fruad and abuse" and when the government spends a lot of money, there will always be some. But by the standards of the possible rather than the perfect, there was remarkably little this time. See http://www.washingtonpost.com/wp-dyn/content/article/2010/09/30/AR2010093007382_pf.html

Posted by: madhoboken | October 22, 2010 3:33 PM | Report abuse

Mr. Ezra Klein, this is the column we have been waiting for. Experts will chime in and hopefully the case for Fed to induce Congress undertake fiscal stimulus will resonate.

Smarts of you to suggest that this time stimulus can be in the form of 'tax cuts'.

I am not sure in that context to use $700B for 'tax cuts for rich' or for 'pay roll holidays for companies'; that argument is at the center. May be it is at the center then.

Basically, stimulus need is there. What the system has to pick up is the one which is ideologically compatible with the political season in vogue.

So far so good. But when the objective is to demolish Obama and Dems once and for all; I am not sure such an arrangement would also work. In other words, the way Tea Party and GOP have run the Politics so far; it is not clear by Obama coming on board for Tax Cuts we will get the solution.

Read Rep. Pence's recent statements - no co-operation with Obama whatsoever.

Indeed it is a tricky situation; unless Obama peddles opposite of what is 'good for America'; these GOP folks will not pick what is really good for us.

Posted by: umesh409 | October 22, 2010 3:45 PM | Report abuse

"People ideologically opposed to government spending will always point to "waste, fruad and abuse" and when the government spends a lot of money, there will always be some"

How about ill-conceived, misguided, unneeded, unwanted, and just plain stupid?

Posted by: bgmma50 | October 22, 2010 10:44 PM | Report abuse

"If President Obama came out with a plan for a tax cut and some investments in infrastructure, based on and influenced by what worked and didn't work in the last stimulus, would any Republicans vote for it?'

Posted by: MosBen

They might. His plan would need to immediately halt all remaining infrastructure spending left from the first stimulus. He would have to identify some sort of theme that resonates with a lot of the public....energy independence would be a very good choice. He would have to have a coherent, organized plan and be able to show up front exactly how, where, and on what the money would be spent, and be able to explain how it would all fit together to advance our national interests. He would have to be able to convince the voters that there will be accountability for achieving these results, measured not by how much money has been spent and how fast, but by completing the projects on time and on budget. He would probably have to include the expediting of onerous environmental permitting processes in some instances.

If he doesn't even bother to try. If he takes the voters for a bunch of fools again. If he comes back to the well one more time with nothing in hand but the same failed models and drivel about millions of jobs saved, he's just wasting his breath.

Posted by: bgmma50 | October 23, 2010 11:08 AM | Report abuse

You ever get the feeling Ezra Klein speaks with forked tongue? Or at least out of both sides of his mouth? This is what happens when someone with a political agenda and NO economics education tries to hold forth on the economy. Just something as simple as believing that lowering interest rates would do anything but create a false prosperity based on debt that would eventually have to be paid for. Guess what? That time is beginning now. Be sure to be surprised when the Republikrats and Demoblicans give the banks ANOTHER 1 TRILLION DOLLARS THIS YEAR! Fools, doomed fools. How can you be surprised at whats happening? Oh yeah, you're an American with NO economics/money knowledge other than believing in Keynesian lies. Look up Austrian School of Economics and free yourselves, future American slaves of the corporate fascists.

Posted by: shred11 | October 24, 2010 8:22 PM | Report abuse

They should quantitatively ease away all outstanding student loans. That would free up several hundred a month for me to spend on things not Sallie Mae.

Maybe credit cards too, but whatever merits the "moral hazard" argument has they are stronger with credit cards.

On a more bizarre note, the Fed could also buy my mortgage, and refund 75% of the mortgage payment to a G.I. debit card that resets to zero each month. Granted, it doesn't really "force" me to spend extra as I could just use that for my normal spending (groceries, restaurants), but it feels more like extra money, and the added impetus to spend it all would likely push me (and others) to buy stuff we wouldn't otherwise.

Posted by: jakek | October 25, 2010 12:29 PM | Report abuse

After mountains of (largely uninformed) comment on fiscal stimulus OR QE2, this is the first really good analysis of the policy MIX that I have seen. Congratulations, Ezra

Posted by: exwonk | October 29, 2010 2:34 PM | Report abuse

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