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Ben Bernanke

Ben Bernanke

Ben S. Bernanke is a Distinguished Fellow in Residence with the Economic Studies Program at the Brookings Institution. From February 2006 through January 2014, he was Chairman of the Board of Governors of the Federal Reserve System. Dr. Bernanke also served as Chairman of the Federal Open Market Committee, the System's principal monetary policymaking body. He is also the author of The Courage to Act.

Articles by Ben Bernanke

The housing bubble, the credit crunch, and the Great Recession: A reply to Paul Krugman

September 21, 2018

By Ben S. Bernanke
Why was the Great Recession so deep? Certainly, the collapse of the housing bubble was the key precipitating event; falling house prices depressed consumer wealth and spending while leading to sharp reductions in residential construction. However, as I argue in a new paper and blog post, the most damaging aspect of the unwinding bubble was that it ultimately touched off a broad-based financial panic, including runs on wholesale funding and indiscriminate fire sales of even non-mortgage credit. The panic in turn choked off credit supply, pushing the economy into a much more severe decline than otherwise would have occurred. My evidence for this claim is that indicators of panic, including the sharp increases in funding costs for financial institutions and the spiking

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Financial panic and credit disruptions in the 2007-09 crisis

September 13, 2018

By Ben S. BernankeAt the height of the financial crisis a decade ago, economists and policymakers underestimated the depth and severity of the recession that would follow. I argue in a paper released today by the Brookings Papers on Economic Activity (BPEA) that remedying this failure demands a more thorough inclusion of credit-market factors in models and forecasts of the economy. I also provide new evidence that suggests that the severity of the Great Recession reflected in large part the adverse effects of the financial panic on the supply of credit.  In particular, the housing bust alone can’t explain why the Great Recession was as bad as it was.
Economists have described two primary channels through which the financial crisis of a decade ago depressed economic activity: (1) a buildup

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Temporary price-level targeting: An alternative framework for monetary policy

October 12, 2017

By Ben S. BernankeLow nominal interest rates, low inflation, and slow economic growth pose challenges to central bankers. In particular, with estimates of the long-run equilibrium level of the real interest rate quite low, the next recession may occur at a time when the Fed has little room to cut short-term rates. As I have written previously and recent research has explored, problems associated with the zero-lower bound (ZLB) on interest rates could be severe and enduring. While the Fed has other useful policies in its toolkit such as quantitative easing and forward guidance, I am not confident that the current monetary toolbox would prove sufficient to address a sharp downturn. I am therefore sympathetic to the view of San Francisco Fed President John Williams and others that we should

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When growth is not enough

June 26, 2017

By Ben S. BernankeHere is the text of my prepared remarks (“When Growth Is Not Enough”) for the European Central Bank Forum on Central Banking at Sintra on “Investment and growth in advanced economies.”
Read my full remarks here.

Read More »

Some reflections on Japanese monetary policy

May 24, 2017

By Ben S. Bernanke
Over the years, I’ve done a lot thinking and writing about challenges faced by Japanese monetary policymakers in their attempts to combat deflation. In some of my earlier pieces I argued that, if the Bank of Japan (BOJ) showed more resolve, it could readily overcome these problems. But, in recent years, the Bank has shown great resolve, and while the results have generally been positive, deflation has not been decisively vanquished. In particular, the BOJ has had difficulty meeting its goal of getting inflation sustainably to 2 percent per year.
In a May 24 lecture at the Bank of Japan, I reviewed my past advice to see how it has stood the test of time, and I offered some thoughts on what options the BOJ might consider if its current policy framework is insufficient to

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The zero lower bound on interest rates: How should the Fed respond?

April 13, 2017

In yesterday’s post, I discussed recent research, by Michael Kiley and John Roberts of the Federal Reserve Board, on the problems for monetary policy that arise from the fact that short-term interest rates can’t fall (much) below zero. [1] Using econometric models to simulate the performance of the U.S. economy, Kiley and Roberts (KR) find that, under certain assumptions, in the future short-term interest rates could be at zero as much as 30 to 40 percent of the time, hobbling the ability of the Fed to ease monetary policy when needed. As a result, their simulations predict that future economic performance will be poor on average, with inflation well below the Fed’s 2 percent target and output below its potential.
Importantly, though, KR’s simulations assume that the Fed continues to employ monetary policies similar to those used before the crisis, as described by some simple policy rules. That’s unrealistic, as in recent years the Fed has demonstrated that it will deviate from the standard playbook when rates are near zero. Indeed, as I discussed in yesterday’s post, markets and professional economic forecasters seem confident that the Fed will be able to mitigate the effects of future encounters with the zero lower bound (ZLB), in that they see inflation remaining close to the Fed’s 2 percent target in the long run.

Read More »

How big a problem is the zero lower bound on interest rates?

April 12, 2017

If inflation is too low or unemployment too high, the Fed normally responds by pushing down short-term interest rates to boost spending. However, the scope for rate cuts is  limited by the fact that interest rates cannot fall (much) below zero, as people always have the option of holding cash, which pays zero interest, rather than negative-yielding assets. [1] When short-term interest rates reach zero, further monetary easing becomes difficult and may require unconventional monetary policy, such as large-scale asset purchases (quantitative easing).
Before 2008, most economists viewed this zero lower bound (ZLB) on short-term interest rates as unlikely to be relevant very often and thus not a serious constraint on monetary policy. (Japan had been dealing with the ZLB for several decades but was seen as a special case.) However, in 2008 the Fed responded to the worsening economic crisis by cutting its policy rate nearly to zero, where it remained until late 2015. Although the Fed was able to further ease monetary policy after 2008 through unconventional methods, the ZLB constraint greatly complicated the Fed’s task.

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Why Dodd-Frank’s orderly liquidation authority should be preserved

February 28, 2017

The collapse of the investment bank Lehman Brothers in September 2008 was perhaps the defining event of the financial crisis. Lehman’s bankruptcy, followed by the near-collapse (save for government intervention) of the insurance company AIG, greatly intensified the fear and panic in markets, bringing the financial system and the economy to the brink of the abyss.
These events, including the government’s response, remain controversial. What should not be controversial is that ordinary bankruptcy procedures were entirely inadequate for the situation. The bankruptcy judge in the Lehman case—required, by law, to focus narrowly on adjudicating creditors’ claims against the company—had neither the tools nor the mandate to try to mitigate the effects of the failure on the financial system or the economy. The Fed, FDIC, and Treasury used the powers available to them, often in ad hoc ways, to try to preserve broader stability. But these agencies likewise lacked a framework for dealing systematically with failing financial giants.
The architects of the Dodd-Frank Act, which reformed financial regulation after the crisis, recognized that—in order to make the financial system safer and eliminate future taxpayer-funded bailouts—a better approach was needed. The first two sections, or titles, of the bill aimed to do just that.

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Shrinking the Fed’s balance sheet

January 26, 2017

To help stabilize the financial system and promote economic recovery, starting in late 2008 the Federal Reserve purchased large quantities of financial assets, primarily Treasury securities and U.S. government-backed, mortgage-related securities. The policy of so-called quantitative easing (see here and here) expanded the Fed’s balance sheet from less than $900 billion before the crisis to about $4.5 trillion today—including about $2.5 trillion in Treasuries and $1.8 trillion in mortgage-related securities.[1] The Fed stopped buying large quantities of assets in October 2014. Since then, it has kept the size of its balance sheet constant, buying just enough to replace maturing securities.
The FOMC has been clear that its current tightening campaign would ultimately involve shrinking the central bank’s balance sheet, but it has also said that will not begin that process until “normalization of the level of the federal funds rate is well under way.” In short: rate increases first, balance sheet reduction later.[2] However, recently, a number of Fed officials have begun talking about plans for shrinking the balance sheet, leading market participants and other observers to speculate that first steps in that direction may take place sooner than expected.

Read More »

The Fed and fiscal policy

January 13, 2017

Markets have responded strongly to Donald Trump’s election victory, pushing up equities, longer-term interest rates, and the dollar. While many factors influence asset prices, expectations of a much more expansionary fiscal policy under the new administration—higher spending, lower taxes, and larger deficits—appear to be an important driver of the recent market moves.
The Federal Reserve’s reaction to prospective fiscal policy changes has been much more cautious than that of the markets, however. Janet Yellen in December described the central bank as operating under a “cloud of uncertainty,” and the forecasts of Fed policymakers released after the December FOMC meeting showed little change in either their economic outlooks or their interest-rate projections for the next few years. How does the Fed take fiscal policy into account in its planning? What explains the large difference between the reactions of the Fed and the markets to the change in fiscal prospects since the election? I’ll discuss these questions in this post, concluding that the Fed’s cautious response to the possible fiscal shift makes sense, given what we know so far.
Incorporating possible fiscal policy changes into the economic forecast
As a general matter, Fed policymakers view economic or policy developments through the prism of their economic forecast.

Read More »

Federal Reserve economic projections: What are they good for?

November 28, 2016

On Wednesday, November 30, I’ll be participating as a panelist in an event on Fed communications at the Hutchins Center on Fiscal and Monetary Policy at Brookings. My former Fed colleague Jon Faust will present a keynote paper, and Fed governor Jay Powell will speak as well. We will also hear about a survey of academic and market participant views of Fed communication, conducted by the Hutchins Center.
Faust’s paper and the Hutchins survey take a generally positive view of the subset of Fed communications that aim to reflect the collective view of the Federal Open Market Committee (FOMC), such as the post-meeting statement, the chair’s press conferences and testimonies, and the minutes. However, they are generally more critical of the “decentralized” communication of the views of individual FOMC participants, including speeches by governors and Reserve Bank presidents and the FOMC’s quarterly Summary of Economic Projections (SEP), which collects projections by individual participants of economic growth, unemployment, inflation, and interest rates. A common complaint is that the volume of such communication is “cacophonous.” Faust argues that, in addition, speeches by FOMC participants and the SEP are not particularly useful to analysts trying to divine how monetary policy will respond to economic developments (the FOMC’s “reaction function”).

Read More »

The relationship between stocks and oil prices

August 1, 2016

The past decade has been a roller coaster for oil prices, one that market participants have probably not much enjoyed riding (Figure 1). The period includes much volatility and two sharp crashes. One crash, in 2008, was associated with the financial crisis and the Great Recession. The second may still be going on: Oil prices have fallen from over $100 per barrel in mid-2014 to around $30 per barrel recently.

Stock prices have also been falling recently, and these moves have generally followed the course of oil prices, a development much commented on by the financial press (for example, see here and here). On the surface, the tendency for stocks to fall along with oil prices is surprising. The usual presumption is that a decline in oil prices is good news for the economy, at least for net oil importers like the United States and China.[1]

One plausible explanation of the tendency for stocks and oil prices to move together is that both are reacting to a common factor, namely, a softening of global aggregate demand, which hurts both corporate profits and demand for oil. As a recent Wall Street Journal article put it: “Oil and stock markets have moved in lockstep this year, a rare coupling that highlights fears about global economic growth.”

In this post we first confirm the positive correlation between stocks and oil prices, noting that it is not just a recent phenomenon.

Read More »

What tools does the Fed have left? Part 3: Helicopter money

August 1, 2016

“Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.” (Milton Friedman, “The Optimum Quantity of Money,” 1969)
“The deflation speech saddled me with the nickname ‘Helicopter Ben.’ In a discussion of hypothetical possibilities for combating deflation I mentioned an extreme tactic—a broad-based tax cut combined with money creation by the central bank to finance the cut. Milton Friedman had dubbed the approach a ‘helicopter drop’ of money. Dave Skidmore, the media relations officer…had advised me to delete the helicopter-drop metaphor…’It’s just not the sort of thing a central banker says,’ he told me. I replied, ‘Everybody knows Milton Friedman said it.’ As it turned out, many Wall Street bond traders had apparently not delved deeply into Milton’s oeuvre.” (Ben Bernanke, The Courage to Act, 2015, p. 64)
In previous posts, I discussed tools that the Fed might use in response to a future slowdown in the U.S. economy.

Read More »

China’s trilemma—and a possible solution

August 1, 2016

China’s central banker, Zhou Xiaochuan of the People’s Bank of China (PBOC), and other top Chinese officials recently launched a communications offensive to persuade markets and foreign policymakers that no significant devaluation of the Chinese currency is planned.[1] Is the no-devaluation strategy a good one for China? If it is, what does China need to do to make its exchange-rate commitments credible?=”_ftnref1″>

The attention of global markets was focused on China’s exchange rate last August when the PBOC announced a 1.9 percent devaluation of the renminbi against the dollar, together with some changes in how the exchange rate would be set in the future. Global markets reacted poorly. Evidently, many market participants—already jittery because of the large swings in the Chinese stock market—saw the devaluation as a signal that the Chinese economy was slowing by much more than they had previously thought, and that China’s leaders had decided that a cheaper currency would boost the country’s exports.[2] Since then, the RMB has been allowed to decline another 3.6 percent against the dollar. Markets, though, seem to have come around to accepting the PBOC’s insistence that it is not pursuing a strategy of systematically devaluing the RMB. So did many of the foreign finance ministers and central bankers gathered in Shanghai for the recent meeting of the Group of 20.

Read More »

Hamilton stays on the $10 bill!

August 1, 2016

The Treasury is letting it be known that Alexander Hamilton, founder and economic policymaker extraordinaire, will retain his place on the $10 bill; and that Harriet Tubman—abolitionist and “conductor” of the Underground Railroad—will replace Andrew Jackson on the face of the $20. This outcome, which is very much in line with what I had recommended last summer, is a good one.  Tubman is an excellent and deserving choice, and no one has a better claim to be represented on the currency than Hamilton, who did so much to help establish the American economic system we know today.

There was much drama and debate surrounding this decision—not a bad thing, really, in that it encouraged us to reflect on our history and its heroes. One reason that the stakes were perceived as so high, though, is that the people whose faces appear on our currency are so rarely changed.  Acknowledging the technical difficulties in modifying bills too often, perhaps the Treasury should consider moving in the direction of the U.S. Postal Service, which frequently changes the images on postage stamps. Occasional changes to bill design would give us more space and flexibility to honor the past; and, if done at reasonable intervals, could coincide with necessary security improvements as well.

Read More »

What tools does the Fed have left? Part 2: Targeting longer-term interest rates

August 1, 2016

Although the U.S. economy appears to be on a positive trajectory, history suggests that at some time in the next few years we may again face a slowdown, with a weakening job market and possibly declining inflation. Given that the historically low level of short-term interest rates is likely to limit the scope for conventional rate cuts, how would the Federal Reserve respond?

As I discussed in my previous post, some tools remain in the monetary toolbox, including taking the short-term interest rate to zero, forward guidance about the future path of short-term rates, more Fed purchases of securities (quantitative easing), and negative short-term rates—a tool used in Europe and Japan but not so far in the US. Collectively, these actions could provide meaningful stimulus to a flagging economy. But what if still more accommodation were needed? In this post and the next I’ll discuss additional options, focusing today on targeting longer-term rates. I conclude that rate targeting can be a useful additional tool for the Fed, complementary to forward guidance and quantitative easing; but, as is the case with other monetary tools, there are ultimately limits to what it can achieve. (For materials from a recent Brookings mini-conference on monetary and fiscal options in the event of a new recession, see here.

Read More »

Ending “too big to fail”: What’s the right approach?

August 1, 2016

In a recent speech at the Hutchins Center at the Brookings Institution, Neel Kashkari, the new president of the Federal Reserve Bank of Minneapolis, argued that we need new strategies to tackle the problem of “too big to fail” (TBTF) financial institutions. On Monday, I’ll be on a panel at the Minneapolis Fed on the issue. This post previews my comments. In short, it seems to me that a lot of progress has been made (and more is in train) toward reducing the risks that large, complex financial institutions pose for the financial system and the economy. To say that “nothing has been done” is simply not correct. That said, because it’s really important to get this right, thoughtful debate on the issue is necessary and welcome.

At the 50,000-foot level, a key question is the extent to which structural change in the financial industry is needed to end TBTF, and, to the extent it is, what that change should look like. The argument of this post is that, while substantial and even fundamental changes may ultimately be necessary, we don’t yet know exactly what they will be. Instead, the legacy of the Dodd-Frank Act, the Basel agreements, and other reforms is a sensible

process

which, with sustained effort, will help us solve the problem.

Read More »

China’s transparency challenges

August 1, 2016

Editor’s note: This post was coauthored with Peter Olson

At the recent G20 gathering in Shanghai, three Chinese leaders—Premier Li Keqiang, People’s Bank of China Governor Zhou Xiaochuan, and Finance Minister Lou Jiwei—reassured attendees that the Chinese government had the monetary and  fiscal tools as well as the know-how to guide the economy through its current challenges. The success of the communications offensive, which seems to have calmed investor concerns for the moment, stands in strong contrast to the communications missteps that exacerbated adverse market reactions to the Chinese government’s stock market and currency interventions over the past year.

These statements at the G20 suggest that Chinese officials are better understanding the need to clearly explain major policy initiatives—a difficult transition for a government accustomed to secrecy. However, communication of this sort represents only one form of transparency. In this post we discuss two other important forms that complement clear explanations by policymakers: data transparency (producing believable numbers), and transparency about the rules of the game (being clear about rules and policies that affect participants in commerce, the markets, etc.). For China to fulfill its potential as a global financial and economic leader, it needs to make further progress on these dimensions as well.

Read More »

Economic implications of Brexit

August 1, 2016

After several days of market upset, a few reflections on last week’s momentous vote in Great Britain.

Even more obvious now than before the vote is that the biggest losers, economically speaking, will be the British themselves. The vote ushers in what will be several years of tremendous uncertainty—about the rules that will govern the U.K.’s trade with its continental neighbors, about the fates of foreign workers in Britain and British workers abroad, and about the country’s political direction, including perhaps where its borders will ultimately lie. Such fundamental uncertainty will depress business formation, capital investment, and hiring; indeed, it had begun to do so even before the vote. The U.K. economic slowdown to come will be exacerbated by falling asset values (houses, commercial real estate, stocks) and damaged confidence on the part of households and businesses. Ironically, the sharp decline in the value of the pound may be a bit of a buffer here as, all else equal, it will make British exports more competitive.

In the longer run, the uncertainty will dissipate, but the economic costs to the U.K. still will exceed the benefits. Financial services and other globally oriented industries, which depend on unfettered access to European markets and exchanges, will come under pressure. At the same time, the purported gains from freeing the U.K.

Read More »

How do people really feel about the economy?

August 1, 2016

Political outsiders have had quite a good year in the United States (and elsewhere), and many pundits have attributed their success to voters’ profound dissatisfaction with the economy. Certainly there is plenty to be dissatisfied about, including growing inequality of income and wealth and stagnation in real wages. But there are positives as well, including an improving labor market, low inflation, and low gasoline prices. How do people really feel about the U.S. economy?
This post will

not

tackle the substance of Americans’ worries about the economy but instead highlights a puzzle arising from pollsters’ efforts to quantify those worries. I’ll show that, when Americans are asked specifically about the economy, in an apolitical context, they are for the most part not nearly as pessimistic as the conventional wisdom would have it. Instead, they answer more or less as they have done in the past at a similar stage of the business cycle. But, at the same time, when asked more generally about the way things are going in the United States, or about whether the country is going in the right direction, a strong majority gives downbeat answers, to an extent that is quite different from how they have responded in the past. Understanding the divergence between the replies to these two types of surveys is important, and I end the post with a few thoughts on possible reasons.

Read More »

What tools does the Fed have left? Part 1: Negative interest rates

August 1, 2016

The U.S. economy is currently growing and creating jobs, a situation I hope and expect will continue. We can’t rule out the possibility, though, that at some point in the next few years our economy will slow, perhaps significantly. How would the Federal Reserve respond? What tools remain in the monetary toolbox? In this and a subsequent post I’ll discuss some policy options the Fed might consider, focusing first on negative interest rates. Readers should also be aware of the March 21 conference at the Hutchins Center at Brookings on the tools remaining to monetary and fiscal policymakers should the economy deteriorate.
To anticipate, I’ll conclude in these two posts that the Fed is not out of ammunition, and that monetary policy could help cushion a possible future slowdown. That said, there are signs that monetary policy in the United States and other industrial countries is reaching its limits, which makes it even more important that the collective response to a slowdown involve other policies—particularly fiscal policy. A balanced monetary-fiscal response would both be more effective and also reduce the need to use unconventional monetary tools.

Read More »

How do people really feel about the economy?

June 30, 2016

Political outsiders have had quite a good year in the United States (and elsewhere), and many pundits have attributed their success to voters’ profound dissatisfaction with the economy. Certainly there is plenty to be dissatisfied about, including growing inequality of income and wealth and stagnation in real wages. But there are positives as well, including an improving labor market, low inflation, and low gasoline prices. How do people really feel about the U.S. economy?
This post will not tackle the substance of Americans’ worries about the economy but instead highlights a puzzle arising from pollsters’ efforts to quantify those worries. I’ll show that, when Americans are asked specifically about the economy, in an apolitical context, they are for the most part not nearly as pessimistic as the conventional wisdom would have it. Instead, they answer more or less as they have done in the past at a similar stage of the business cycle. But, at the same time, when asked more generally about the way things are going in the United States, or about whether the country is going in the right direction, a strong majority gives downbeat answers, to an extent that is quite different from how they have responded in the past. Understanding the divergence between the replies to these two types of surveys is important, and I end the post with a few thoughts on possible reasons.

Read More »

Economic implications of Brexit

June 28, 2016

After several days of market upset, a few reflections on last week’s momentous vote in Great Britain.
Even more obvious now than before the vote is that the biggest losers, economically speaking, will be the British themselves. The vote ushers in what will be several years of tremendous uncertainty—about the rules that will govern the U.K.’s trade with its continental neighbors, about the fates of foreign workers in Britain and British workers abroad, and about the country’s political direction, including perhaps where its borders will ultimately lie. Such fundamental uncertainty will depress business formation, capital investment, and hiring; indeed, it had begun to do so even before the vote. The U.K. economic slowdown to come will be exacerbated by falling asset values (houses, commercial real estate, stocks) and damaged confidence on the part of households and businesses. Ironically, the sharp decline in the value of the pound may be a bit of a buffer here as, all else equal, it will make British exports more competitive.
In the longer run, the uncertainty will dissipate, but the economic costs to the U.K. still will exceed the benefits. Financial services and other globally oriented industries, which depend on unfettered access to European markets and exchanges, will come under pressure. At the same time, the purported gains from freeing the U.K.

Read More »

Ending “too big to fail”: What’s the right approach?

May 13, 2016

In a recent speech at the Hutchins Center at the Brookings Institution, Neel Kashkari, the new president of the Federal Reserve Bank of Minneapolis, argued that we need new strategies to tackle the problem of “too big to fail” (TBTF) financial institutions. On Monday, I’ll be on a panel at the Minneapolis Fed on the issue. This post previews my comments. In short, it seems to me that a lot of progress has been made (and more is in train) toward reducing the risks that large, complex financial institutions pose for the financial system and the economy. To say that “nothing has been done” is simply not correct. That said, because it’s really important to get this right, thoughtful debate on the issue is necessary and welcome.
At the 50,000-foot level, a key question is the extent to which structural change in the financial industry is needed to end TBTF, and, to the extent it is, what that change should look like. The argument of this post is that, while substantial and even fundamental changes may ultimately be necessary, we don’t yet know exactly what they will be. Instead, the legacy of the Dodd-Frank Act, the Basel agreements, and other reforms is a sensible process which, with sustained effort, will help us solve the problem.

Read More »

Hamilton stays on the $10 bill!

April 20, 2016

The Treasury is letting it be known that Alexander Hamilton, founder and economic policymaker extraordinaire, will retain his place on the $10 bill; and that Harriet Tubman—abolitionist and “conductor” of the Underground Railroad—will replace Andrew Jackson on the face of the $20. This outcome, which is very much in line with what I had recommended last summer, is a good one.  Tubman is an excellent and deserving choice, and no one has a better claim to be represented on the currency than Hamilton, who did so much to help establish the American economic system we know today.

There was much drama and debate surrounding this decision—not a bad thing, really, in that it encouraged us to reflect on our history and its heroes. One reason that the stakes were perceived as so high, though, is that the people whose faces appear on our currency are so rarely changed.  Acknowledging the technical difficulties in modifying bills too often, perhaps the Treasury should consider moving in the direction of the U.S. Postal Service, which frequently changes the images on postage stamps. Occasional changes to bill design would give us more space and flexibility to honor the past; and, if done at reasonable intervals, could coincide with necessary security improvements as well.

Read More »

What tools does the Fed have left? Part 3: Helicopter money

April 11, 2016

“Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated." (Milton Friedman, “The Optimum Quantity of Money,” 1969)
"The deflation speech saddled me with the nickname ‘Helicopter Ben.’ In a discussion of hypothetical possibilities for combating deflation I mentioned an extreme tactic—a broad-based tax cut combined with money creation by the central bank to finance the cut. Milton Friedman had dubbed the approach a ‘helicopter drop’ of money. Dave Skidmore, the media relations officer…had advised me to delete the helicopter-drop metaphor…’It’s just not the sort of thing a central banker says,’ he told me. I replied, ‘Everybody knows Milton Friedman said it.’ As it turned out, many Wall Street bond traders had apparently not delved deeply into Milton’s oeuvre.” (Ben Bernanke, The Courage to Act, 2015, p. 64)
In previous posts, I discussed tools that the Fed might use in response to a future slowdown in the U.S. economy.

Read More »

What tools does the Fed have left? Part 2: Targeting longer-term interest rates

March 24, 2016

Although the U.S. economy appears to be on a positive trajectory, history suggests that at some time in the next few years we may again face a slowdown, with a weakening job market and possibly declining inflation. Given that the historically low level of short-term interest rates is likely to limit the scope for conventional rate cuts, how would the Federal Reserve respond? 
As I discussed in my previous post, some tools remain in the monetary toolbox, including taking the short-term interest rate to zero, forward guidance about the future path of short-term rates, more Fed purchases of securities (quantitative easing), and negative short-term rates—a tool used in Europe and Japan but not so far in the US. Collectively, these actions could provide meaningful stimulus to a flagging economy. But what if still more accommodation were needed? In this post and the next I’ll discuss additional options, focusing today on targeting longer-term rates. I conclude that rate targeting can be a useful additional tool for the Fed, complementary to forward guidance and quantitative easing; but, as is the case with other monetary tools, there are ultimately limits to what it can achieve. (For materials from a recent Brookings mini-conference on monetary and fiscal options in the event of a new recession, see here.

Read More »

What tools does the Fed have left? Part 1: Negative interest rates

March 18, 2016

The U.S. economy is currently growing and creating jobs, a situation I hope and expect will continue. We can’t rule out the possibility, though, that at some point in the next few years our economy will slow, perhaps significantly. How would the Federal Reserve respond? What tools remain in the monetary toolbox? In this and a subsequent post I’ll discuss some policy options the Fed might consider, focusing first on negative interest rates. Readers should also be aware of the March 21 conference at the Hutchins Center at Brookings on the tools remaining to monetary and fiscal policymakers should the economy deteriorate.
To anticipate, I’ll conclude in these two posts that the Fed is not out of ammunition, and that monetary policy could help cushion a possible future slowdown. That said, there are signs that monetary policy in the United States and other industrial countries is reaching its limits, which makes it even more important that the collective response to a slowdown involve other policies—particularly fiscal policy. A balanced monetary-fiscal response would both be more effective and also reduce the need to use unconventional monetary tools.

Read More »

China’s trilemma—and a possible solution

March 9, 2016

China’s central banker, Zhou Xiaochuan of the People’s Bank of China (PBOC), and other top Chinese officials recently launched a communications offensive to persuade markets and foreign policymakers that no significant devaluation of the Chinese currency is planned.[1] Is the no-devaluation strategy a good one for China? If it is, what does China need to do to make its exchange-rate commitments credible?
The attention of global markets was focused on China’s exchange rate last August when the PBOC announced a 1.9 percent devaluation of the renminbi against the dollar, together with some changes in how the exchange rate would be set in the future. Global markets reacted poorly. Evidently, many market participants—already jittery because of the large swings in the Chinese stock market—saw the devaluation as a signal that the Chinese economy was slowing by much more than they had previously thought, and that China’s leaders had decided that a cheaper currency would boost the country’s exports.[2] Since then, the RMB has been allowed to decline another 3.6 percent against the dollar. Markets, though, seem to have come around to accepting the PBOC’s insistence that it is not pursuing a strategy of systematically devaluing the RMB. So did many of the foreign finance ministers and central bankers gathered in Shanghai for the recent meeting of the Group of 20.

Read More »

The relationship between stocks and oil prices

February 19, 2016

The past decade has been a roller coaster for oil prices, one that market participants have probably not much enjoyed riding (Figure 1). The period includes much volatility and two sharp crashes. One crash, in 2008, was associated with the financial crisis and the Great Recession. The second may still be going on: Oil prices have fallen from over $100 per barrel in mid-2014 to around $30 per barrel recently.

Stock prices have also been falling recently, and these moves have generally followed the course of oil prices, a development much commented on by the financial press (for example, see here and here). On the surface, the tendency for stocks to fall along with oil prices is surprising. The usual presumption is that a decline in oil prices is good news for the economy, at least for net oil importers like the United States and China.[1]
One plausible explanation of the tendency for stocks and oil prices to move together is that both are reacting to a common factor, namely, a softening of global aggregate demand, which hurts both corporate profits and demand for oil. As a recent Wall Street Journal article put it: “Oil and stock markets have moved in lockstep this year, a rare coupling that highlights fears about global economic growth.

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