Back in 2002, a professor turned Federal Reserve official by the name of Ben Bernanke gave a widely quoted speech titled “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” Like other economists, myself included, Mr. Bernanke was deeply disturbed by Japan’s stubborn, seemingly incurable deflation, which in turn was “associated with years of painfully slow growth, rising joblessness, and apparently intractable financial problems.” This sort of thing wasn’t supposed to happen to an advanced nation with sophisticated policy makers. Could something similar happen to the United States?
Fred R. Conrad/The New York Times
Paul Krugman
Not to worry, said Mr. Bernanke: the Fed had the tools required to head off an American version of the Japan syndrome, and it would use them if necessary.
Today, Mr. Bernanke is the Fed’s chairman — and his 2002 speech reads like famous last words. We aren’t literally suffering deflation (yet). But inflation is far below the Fed’s preferred rate of 1.7 to 2 percent, and trending steadily lower; it’s a good bet that by some measures we’ll be seeing deflation by sometime next year. Meanwhile, we already have painfully slow growth, very high joblessness, and intractable financial problems. And what is the Fed’s response? It’s debating — with ponderous slowness — whether maybe, possibly, it should consider trying to do something about the situation, one of these days.
The Fed’s fecklessness is, to be sure, not unique. It has been astonishing and infuriating, as the economic crisis has unfolded, to watch America’s political class defining normalcy down. As recently as two years ago, anyone predicting the current state of affairs (not only is unemployment disastrously high, but most forecasts say that it will stay very high for years) would have been dismissed as a crazy alarmist. Now that the nightmare has become reality, however — and yes, it is a nightmare for millions of Americans — Washington seems to feel absolutely no sense of urgency. Are hopes being destroyed, small businesses being driven into bankruptcy, lives being blighted? Never mind, let’s talk about the evils of budget deficits.
Still, one might have hoped that the Fed would be different. For one thing, the Fed, unlike the Obama administration, retains considerable freedom of action. It doesn’t need 60 votes in the Senate; the outer limits of its policies aren’t determined by the views of senators from Nebraska and Maine. Beyond that, the Fed was supposed to be intellectually prepared for this situation. Mr. Bernanke has thought long and hard about how to avoid a Japanese-style economic trap, and the Fed’s researchers have been obsessed for years with the same question.
But here we are, visibly sliding toward deflation — and the Fed is standing pat.
What should it be doing? Conventional monetary policy, in which the Fed drives down short-term interest rates by buying short-term U.S. government debt, has reached its limit: those short-term rates are already near zero, and can’t go significantly lower. (Investors won’t buy bonds that yield negative interest, since they can always hoard cash instead.) But the message of Mr. Bernanke’s 2002 speech was that there are other things the Fed can do. It can buy longer-term government debt. It can buy private-sector debt. It can try to move expectations by announcing that it will keep short-term rates low for a long time. It can raise its long-run inflation target, to help convince the private sector that borrowing is a good idea and hoarding cash a mistake.
Nobody knows how well any one of these actions would work. The point, however, is that there are things the Fed could and should be doing, but isn’t. Why not?
After all, Fed officials, like most observers, have a fairly grim view of the economy’s prospects. Not grim enough, in my view: Fed presidents, who make forecasts every time the committee that sets interest rates meets, aren’t taking the trend toward deflation sufficiently seriously. Nonetheless, even their projections show high unemployment and below-target inflation persisting at least through late 2012.
So why not try to do something about it? The closest thing I’ve seen to an explanation is a recent speech by Kevin Warsh of the Fed’s Board of Governors, in which he declared that doing what Mr. Bernanke recommended back in 2002 risked undermining the Fed’s “institutional credibility.” But how, exactly, does it serve the Fed’s credibility when it fails to confront high unemployment, while consistently missing its own inflation targets? How credible is the Bank of Japan after presiding over 15 years of deflation?
Whatever is going on, the Fed needs to rethink its priorities, fast. Mr. Bernanke’s “it” isn’t a hypothetical possibility, it’s on the verge of happening. And the Fed should be doing all it can to stop it.
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