Archive for November 13th, 2011

May be Bernanke should wear Hawaiian T-shirts for the FOMC

November 13, 2011

Krugman in a landmark 1998 paper on Japanese economy said in liquidity trap economics, central banks have to do the opposite task of promising to be irresponsible:

The ineffectuality of monetary policy in a liquidity trap, then, is really the result of a looking glass version of the standard credibility problem: monetary policy does not work because the public expects that whatever it does now, given a chance the central bank will revert to type, and stabilize prices near their current level. If the central bank can “credibly promise to be irresponsible”, that is, convince the market that it will in fact allow prices to rise sufficiently, it can bootstrap the economy out of the trap.

He warned then that such situations of liquidity trap can happen anywhere.

Now when we are into a similar situation of liquidity trap, Krugman revisits his 1998 ideas. He points to a John Hempton article which says Fed is too credible a central bank and people never believe it can let inflation be higher:

Also, I see that John Hempton is restating the credibility argument that was at the heart of my original 1998 analysis. He says that

The Federal Reserve has too much credibility. Each time it increases the money supply it buys some asset (say a government bond or even a foreign security) and issues cash. And people hold the cash because it is a reasonable store of value. And it is a reasonable store of value because they trust – at the end of this cycle – that the Federal Reserve will eventually take its vault full of assets, sell the assets for hard cash (which it will destroy) and will thus suck the excess liquidity out of the system.

If people really believed the cash was trash they would all try to get rid of it (ie buy something) but collectively they could not get rid of it (every time they buy something it would have a new owner) and the result would be inflation. Inflation would then reduce the real value of the money stock to a level where people were comfortable holding it.

To get inflation you need to damage the Federal Reserve’s credibility. You need the Federal Reserve to make a credible promise to be reckless.

And Ben Bernanke – despite the helicopter speech in which he outlined this view of the world very clearly – is not your man. Maybe it is the facial hair – but he looks – well just too responsible.

Hempton’s suggestion:

[Bernanke] should not only announce that the Fed is buying Italian debt. He should do it whilst wearing an Hawaiian shirt and carrying a marijuana pipe. (I would even buy him the pipe…)

OK, it turns out that I have some inside information: in his academic days, Bernanke actually DID have a taste for Hawaiian shirts, often wearing them to the office. I don’t know about the marijuana bit. Unfortunately, when he went to the Fed they turned him into a central banker.

🙂

I recall reading somewhere (it could all be untrue) that Bernanke hated ties and wore some funny color socks to initial FOMC meetings at time of Greenspan. Greenspan did not like all this and also told Bernanke to wear proper formal attire for FOMC meetings..

It will be a sight seeing Bernanke come wearing all those colorful shirts and trying his best to be like an irresponsible person. If successful even somewhat will do),  central banks will have another tool when rates are zero – fashion and colorful attire..

On a serious note, it is true that central banks have many tools when rates are zero, but most are ineffective in stimulating the economy. Atleast the impact is not as great as it was imagined to be..

 

 

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