Bravo for Bernanke and the QE Era

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 Bravo for Bernanke and the QE Era

Admit it: The Fed’s loose money policy worked. Now the challenge is how to manage the tapering

Trouble has a way of finding Ben Bernanke. This time, it surrounded his trip to the American Economic Association meeting in Philadelphia to give a capstone speech last week summarizing his eight years as head of the Federal Reserve. A major snowstorm had hit the East Coast and a frigid polar vortex followed behind it.

His speech’s audience at the nation’s largest gathering of economists looked even more comical than normal with their snow boots and hat-head, but they gave his remarks a standing ovation. It was quite different from the icy reception he has grown accustomed to from his critics (including several on this page) over the past 3½ years during what could be called the QE Era.

These critics of quantitative easing have condemned the expansion of the balance sheet at the Federal Reserve as risking a hyperinflation, have panned the “forward guidance” of the Fed promising low rates well into the future as ineffectual and dangerous, and have even mocked the Fed’s new more-open communications strategy and the chairman’s news conferences as demeaning to the office.

As Mr. Bernanke prepares to depart at the end of January and the Fed has initiated the exit-strategy countdown with the start of tapering, it is time to take stock of the QE Era—and time for the critics to admit they were wrong.

There is a valid debate to be had about how much longer the Fed’s loose monetary policy should continue and about the risks that might be entailed. But looking back at the period since 2010, it is clear that the Fed was right to try to help improve the country’s financial health, avoiding deflation, and the critics were wrong that QE would cause inflation and harm the economy.

Think back to the days before the 2008 crisis or recession. If confronted with the scenario that would follow—five years of GDP growth of only around 2% a year, five years of unemployment rates around or above 7%, core inflation consistently below 2%—the near-universal response of economists would have been for the Fed to cut interest rates.

The problem, of course, was that the target federal-funds rate was already at 0% by the close of 2008—the start of the five years in question. So the Fed tried to loosen monetary policy by buying assets and by issuing forward guidance on rates. Mr. Bernanke said from the outset that these measures were only the monetary equivalent of those ugly flap-ear hats—uncomfortable, yes, but not a forever thing. Just wait for the vortex to pass.

The research indicates that these Fed policies have helped the economy, albeit modestly. The estimates indicate that asset purchases lowered long-term Treasury rates by about 30 basis points and a bit more for mortgage spreads and corporate bond yields, helping to encourage investment and risk-taking.

At the same AEA convention where Mr. Bernanke spoke, my colleague Amir Sufi and co-author Atif Mian of Princeton University showed that as interest rates fell, Americans were able to refinance their homes at more affordable rates, and the drop led to an increase in consumer spending on automobiles and other durables.

The economy needed all the help it could get during this time period. Growth was modest and the job market suffered badly. Loosening monetary policy was the right thing to do.

The QE Era did not create inflation. Not even close. The people who said it would were looking only at the growth in the monetary base but ignoring the poor health of the financial system and the so-called velocity of money. Put differently, the people arguing that QE means simply printing money (which it doesn’t, really) didn’t recognize that the policy was simply offsetting the reverse printing of money resulting from the tight credit channels in the damaged financial system.

Yes, you would get inflation if the system went back to normal and the Fed just kept its foot on the gas. But the Fed has promised all along that it was only doing this as a temporary measure until economic conditions improved.

The critics seem to have forgotten the admonition of former Fed Chariman Paul Volcker that the Fed’s biggest inflation mistakes have not come from being too loose when times are bad but rather from waiting too long to tighten when times are good.

Now, despite a disappointing Friday jobs report that is likely more of a pothole than a permanent setback, times may be getting good enough that people are again concerned at the possibility of low rates creating a bubble. Given the role that leverage can play in financial crises, that is worth thinking about. The counterargument that the Fed can simply use regulatory prudential policy to stop bubbles seems a bit questionable, given past experience.

But this argument for tapering in 2014 isn’t the same as saying the Fed should never have loosened in the summer of 2010. For most of the past 3½ years, the stock market’s rise has generally tracked increases in corporate earnings. Forgoing the Fed’s unconventional monetary policies—inviting real and quantifiable damage to the economy—just to prevent the possibility of a potentially dangerous bubble forming somewhere in the economy would have been cruel and unnecessary.

Most will agree that deciding on the speed of winding down the QE Era will be a key challenge to Mr. Bernanke’s successor, Janet Yellen. But we should all be able to agree that fashion standards during a polar vortex shouldn’t be the same as in normal times. At the convention of economists in Philadelphia, when Chairman Bernanke explained the Fed’s actions of the past 3½ years, he got the warm reception he deserved.

Mr. Goolsbee, a professor of economics at the University of Chicago’s Booth School of Business, was chairman of President Obama’s Council of Economic Advisers from 2010-11.

 

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