Paul Krugman: Paralysis at the Fed

Fiscal policymakers deserve their share of the blame for not responding adequately to the crisis, and I blame them first foremost, but monetary authorities have not responded adequately either. Disappointingly, and to the disadvantage of those hoping to find employment sooner rather than later, the Fed hasn't even taken the steps that Bernanke urged Japan to take when it faced similar circumstances:

Paralysis at the Fed, by Paul Krugman, Commentary, NY Times: Ten years ago, one of America’s leading economists delivered a stinging critique of the Bank of Japan, Japan’s equivalent of the Federal Reserve, titled “Japanese Monetary Policy: A Case of Self-Induced Paralysis?” With only a few changes in wording, the critique applies to the Fed today.

At the time, the Bank of Japan faced a situation broadly similar to that facing the Fed now. The economy was deeply depressed and showed few signs of improvement, and one might have expected the bank to take forceful action. But short-term interest rates — the usual tool of monetary policy — were near zero and could go no lower. And the Bank of Japan used that fact as an excuse to do no more.

That was malfeasance, declared the eminent U.S. economist: “Far from being powerless, the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution and its defensive response to criticism.” He rebuked officials hiding “behind minor institutional or technical difficulties in order to avoid taking action.”

Who was that tough-talking economist? Ben Bernanke... So why is the Bernanke Fed being just as passive now as the Bank of Japan was a decade ago? ...

What could the Fed be doing? Back when, Mr. Bernanke suggested, among other things, that the Bank of Japan could get traction by buying large quantities of “nonstandard” assets... The Fed actually put that idea into practice during the most acute phase of the financial crisis, acquiring, in particular, large amounts of mortgage-backed securities. However, it stopped those purchases in March. ...

Back in 2000, Mr. Bernanke also suggested that the Bank of Japan could ... make private-sector borrowing more attractive by announcing that it would keep interest rates low until deflation had given way to 3 percent or 4 percent inflation — an idea originally suggested by yours truly. ... But as chairman of the Fed, Mr. Bernanke has explicitly rejected any such move.

What’s going on here? Has Mr. Bernanke been intellectually assimilated by the Fed Borg? I prefer to believe that he’s being political, unwilling to engage in open confrontation with other Fed officials — especially those regional Fed presidents who fear inflation, even with deflation the clear and present danger, and are evidently unmoved by the plight of the unemployed.

And in fairness to Mr. Bernanke, discord among senior officials also makes it difficult for policy to change expectations: it would be hard to credibly commit to higher inflation if this commitment were constantly being undercut by speeches out of the Richmond or Dallas Feds. In fact, I’d argue that loose talk by some Fed officials is already having a negative economic impact. But while Mr. Bernanke doesn’t have the authority to stop that loose talk, he could make it clear that it doesn’t represent overall Fed policy.

Last, but not least, policy is suffering from an act of neglect by President Obama, who waited until his 16th month in office before offering a full slate of nominees to fill vacancies on the Federal Reserve Board. If he had filled those slots quickly — his nominees still aren’t in place — the Fed might be less passive.

But whatever the reasons, the fact is that the Fed — which is required by statute to promote “maximum employment” — isn’t doing its job. Instead, like the rest of Washington, it’s inventing reasons to dither in the face of mass unemployment. And while the Fed sits there in its self-inflicted paralysis, millions of Americans are losing their jobs, their homes and their hopes for the future.