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Friday, August 12, 2005

The NRO versus Bernanke

I have to admit to feeling uneasy about defending Bernanke against this NRO attack piece because I disagree with many of the administration policies he represents, but it’s not a hard call.  While it’s entertaining watching the two factions within the GOP fight, the integrity of this profession trumps politics every single time and attacks based upon misrepresenting economic theory or a person's position need to be addressed. 

First, here’s the NRO hit piece from John Tamny intended to undermine Bernanke’s chances at becoming Fed chair.  This all started with Bernanke’s announcement that the administration opposed Social Security reform that did not address both personal accounts and solvency, a position the NRO does not agree with:

The Scary Side of Ben Bernanke, by John Tamny, NRO: Last Friday’s Wall Street Journal reported that … of potential replacements for Alan Greenspan … Bernanke [is] the frontrunner on Tradesports.com. Bernanke recently weighed in with his opinions on the economy in the Journal, and while he lauded tax cuts, free trade, and legal reform, a supply-sider he is not. … About taxes, … Bernanke is clearly in the Keynesian camp … holding that they should be reduced during times of slack demand and increased when economic growth reaches its natural “limits.” While Keynesians see tax cuts through a demand-driven, short-term stimulus prism in which their impact gradually recedes, supply-siders encourage marginal rate cuts for their long-term (and continuous) incentive effects on economic activity. …

Moving to the economic impact of demand, Bernanke asked how much demand in the latest quarter “appears to have been satisfied out of inventories rather than from new production.” But supply-siders don’t even consider this … “Demand” will always exist, as human wants are unlimited. But what Bernanke deems “demand” is in fact producers offering up their surpluses for those of others. In the supply-side model, what Bernanke sees as a fall in aggregate demand is in fact a fall in production — something supply-siders agree results from governmental meddling along the lines of excessive taxation, regulation, and unstable money. Further … on … Bernanke wrote about employment, and his belief that there is a “highest level of employment that can be sustained without creating inflationary pressure.” … Leaving aside … the static assumptions that would lead one to believe in “full” employment and “limits” to economic growth in the first place, … our companies … are not hamstrung by the “output gap” beliefs held by Bernanke — beliefs that assume growth is limited to static estimates about our domestic production capacity. … Assumptions about full employment and limits to growth are always a bit silly … ideas pushed by Bernanke are downright fatuous. Although he didn’t discuss money in the Journal editorial, a June New York Times article noted Bernanke’s belief that the gold standard made the Great Depression worse. Plus, in a 2002 speech, he lauded the ability of the government to use the printing press to “generate higher spending and hence positive inflation.” If his adherence to a Phillips Curve orthodoxy made his belief in a price-rule already seem shaky, his direct comments about money should remove all doubt. … [J]ust as important will be Bush’s Federal Reserve appointments, foremost of which will be Alan Greenspan’s replacement … For his views on taxes and growth-limits alone, Bernanke would be a big step in the wrong direction. For his views on money, Bernanke has the potential to be very dangerous.

At least Bernanke understands money.  For openers, the comments above non-withstanding, Bernanke has left no doubt about his commitment to inflation targeting (e.g., see here, here, here, here, and here, and if there’s still doubt, there are more).  This is an editorial that is either ignorant of basic economic ideas or intentionally distorts to achieve a political end, sacrificing any regard for professional integrity in the process. 

Let’s take a couple of examples.  Take the notion that supply shocks are permanent but demand shocks only have temporary effects that causes Tamny so much consternation.  That’s standard economic theory and you will find very little disagreement on that basic point among economists.  Yet Tamny tries to use it against Bernanke by claiming demand is supply, i.e. by claiming the notion of aggregate demand is wrong.  Quoting, “demand is in fact producers offering up their surpluses for those of others,” and  “a fall in aggregate demand is in fact a fall in production.”  A fall in demand is a fall in supply?  That’s not even close.  Supply-siders who understand the underlying theory recognize there are both nominal (demand) and real (supply) shocks in these models.  A change in the money supply is not a supply-shock, is it?  Of course not.  If it’s not a demand shock either, then what is it?  He doesn’t even understand the theory he’s trying to promote.  Furthermore, it doesn’t even represent Bernanke’s position.  For example, he said very recently “In the long run the most important issue … about … economic growth … is … taking the actions necessary to … keep taxes low …”

Next, let’s take his distinction between statics and dynamics where he criticizes the notion of full employment.  There is a difference between resource constraints at a point in time (static) and over time (dynamic).  At any point in time, there is a well-defined notion of maximal resource usage.  There are only so many workers, a limited quantity or raw materials, and so on, and there’s a well-defined notion of full-employment (e.g. see Mankiw’s text on the determinants of the natural rate of output).  No matter what Tamny says in his attempt to hurt Bernanke’s chances at becoming Fed chair, at a point in time our ability to provide goods and services is limited and if demand exceeds the amount we can produce, there will be rising prices.  That the system will respond endogenously by increasing capacity over time, i.e. by growing, doesn’t overcome the resource constraint at any point in time, a point that is clear to everybody who understands how these models work.

I could go on, and similar comments apply to other parts of the column, but there’s no reason to spend anymore time on this.  But I want to mention one other thing.  I hear repeatedly from supply-siders that “Keynesian” tax policy is inconsistent with long-run growth implying that taxes must be high.  But there’s nothing in Keynesian stabilization policy to imply high taxes.  Stabilization policy can be conducted around any average tax rate over the business cycle, it’s just lower than the target value sometimes and higher at others, but there’s nothing that says the target itself has to be one value or another.  Stabilization policy is not inconsistent with growth policy and having a more stable path may promote growth rather than hinder it.  It would be nice to see this misconception end because it is quite prevalent.

Bernanke went out of favor with a segment of the GOP when he opposed the NRO view on Social Security reform.  Like much in the NRO presently, this is nothing more than a political hack job designed to hurt Bernanke’s chances at becoming Fed chair. 

    Posted by on Friday, August 12, 2005 at 12:33 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (16)

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