Will Bernanke Take Aim at G.D.P.?

It’s a safe bet that the hottest topic in monetary policy is going to be raised when the Federal Reserve chairman, Ben S. Bernanke, takes questions from reporters Wednesday afternoon.

That would be nominal G.D.P. targeting, a concept lately endorsed elsewhere on this very Web site by the liberal economists Christina Romer and Paul Krugman (separately, and with very different degrees of enthusiasm) and long embraced by a diverse group of other economic thinkers.

It’s actually a pretty simple idea. The Fed has developed a policy of seeking to maintain inflation — the growth of prices and wages — at an annual rate of roughly 2 percent as the best way to meet its legal objectives of maintaining stable prices and maximizing employment. Proponents of G.D.P. targeting argue that the central bank instead should seek to maintain a steady rate of increase in the dollar value of the nation’s economic output, the nominal gross domestic product, an alternative measure that combines the rate of inflation and the rate of economic growth.

The Fed’s current policy, they argue, has failed to stimulate growth sufficiently, leaving more than 25 million Americans unable to find full-time work. A G.D.P. target, by contrast, would require the Fed to take more aggressive steps, like another round of asset purchases.

“It would work like this,” wrote Ms. Romer, a professor at the University of California, Berkeley, who was chairwoman of President Obama’s Council of Economic Advisers. “The Fed would start from some normal year — like 2007 — and say that nominal G.D.P. should have grown at 4 1/2 percent annually since then, and should keep growing at that pace. Because of the recession and the unusually low inflation in 2009 and 2010, nominal G.D.P. today is about 10 percent below that path. Adopting nominal G.D.P. targeting commits the Fed to eliminating this gap.”

As I wrote in Monday’s paper, this idea has garnered little apparent support inside the Fed.

One fundamental reason is that Mr. Bernanke and other Fed officials believe that the current system is working pretty well. Not well enough to heal the economy, of course, but in their view that is beyond the Fed’s power.

“My guess is that the current framework for monetary policy — with innovations, no doubt, to further improve the ability of central banks to communicate with the public — will remain the standard approach, as its benefits in terms of macroeconomic stabilization have been demonstrated,” Mr. Bernanke told a Boston audience in October.

The focus of that policy, which Mr. Bernanke described as “flexible inflation targeting,” is the Fed’s commitment to maintain inflation at about 2 percent a year. The Fed views the public belief that it will do so as perhaps its most valuable asset because it creates a stable environment for sustainable economic growth.

A switch to G.D.P. targeting would amount to a declaration of comfort with higher levels of inflation.

Many proponents regard this as the basic point of the proposal, arguing that the Fed has become overly fixated on the rate of inflation when it should be focused on the health of the economy, and that allowing — indeed, encouraging — a higher rate of inflation in the short term would help to stimulate growth.

Calling for a G.D.P. target rather than simply proposing an increase in the Fed’s inflation target, as some other economists have done, amounts in this sense to a marketing device, a piece of packaging.

“As far as I can see, the underlying economics is about expected inflation,” Mr. Krugman wrote in a mid-October blog post, “but stating the goal in terms of nominal G.D.P. may nonetheless be a good idea, largely as a selling point, since it (a) is easier to make the case that we’ve fallen far below where we should be and (b) doesn’t sound so scary and antisocial.”

So far, that sales pitch has failed to budge the Fed.

What to Expect From the Fed

There are three kinds of announcements the Federal Reserve may make Wednesday at 2:15 p.m., when it discloses the much-anticipated results of the latest meeting of its policy-making committee:

Full speed ahead. Growth is lethargic at best. Twenty-five million Americans cannot find full-time jobs. The Fed is responsible for addressing unemployment, it has undertaken a series of novel efforts to stimulate growth, and the Fed chairman, Ben S. Bernanke, has not discouraged speculation that he is ready to try again.

Investors are expecting a new effort to reduce long-term interest rates modeled on a 1960s program dubbed “Operation Twist.” The central bank has made borrowing cheaper for businesses and consumers by purchasing more than $2 trillion of government debt and mortgage-backed securities. By reducing the supply of securities available to other investors, it forced them to pay higher prices — that is, to accept lower interest rates — and to shift money into riskier investments with much the same effect.

The Fed could seek to amplify that impact by reorienting its portfolio toward longer-term securities, essentially taking on more risk without investing more money. That could force other investors, in turn, to take larger risks in the face of lower returns. And the hope is that the resulting drop in interest rates will nudge companies to build new factories, and consumers to buy new dishwashers.

Morgan Stanley, which expects the Fed to announce such a program Wednesday, said in a note to clients that it is “no silver bullet,” but could lower yields on 10-year Treasuries by up to 0.35 percentage points, similar to the drop from the Fed’s most recent purchases of $600 billion in Treasuries.

Check back in November. Some close watchers of the central bank expect that the Fed will defer any decision to “Twist” — or take any other major steps — until the board next meets in November, but that the board will make a smaller gesture Wednesday to signal its commitment to help.

Only a month has passed since the Fed announced that it intends to hold short-term interest rates near zero for at least two more years, and the board may want to wait before announcing further measures. The economy, after all, is growing at a modest pace and the options that remain available carry less power to lift growth and greater risk of consequences than those already deployed.

Moreover, investors already have driven down long-term interest rates in anticipation of action by the central bank. So long as investors remain convinced that the Fed will act eventually, there is little to be gained by unveiling such a program. Laurence H. Meyer, a former Fed governor who now leads the forecasting firm Macroeconomic Advisers, suggests the Fed could announce that it will invest the proceeds of maturing securities — about $20 billion each month — in longer-term debt.

“Together with a strongly worded statement, this decision could help avoid a significant market sell-off,” MacroAdvisers wrote in a note to clients predicting the Fed would announce such a gesture Wednesday, and then announce a revival of “Operation Twist” after the board’s November meeting.

We’re not doing anything new. Republicans have been increasingly vocal in their insistence that the Fed should stop trying to increase growth. They argue that the central bank’s existing efforts are not helping, and that new efforts could have negative consequences. Republican presidential candidates have made criticism of the Fed a central theme of the early campaign, and Republican leaders in the House and Senate sent a letter Tuesday to Mr. Bernanke warning against new measures.

“We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy,” said the letter, signed by Mitch McConnell of Kentucky, the Senate Republican leader; Jon Kyl of Arizona, the Senate Republican whip; the House speaker, John Boehner of Ohio; and the House majority leader, Eric Cantor of Virginia.

A vocal minority of the Fed’s policy-making board shares this reluctance to take further action. Three of the board’s 10 members dissented from the board’s most recent effort to foster growth in August.

Podcast: Bernanke, the Budget and Steve Jobs

Ben Bernanke’s speech at Jackson Hole, Wyo., was sketchier than it might have been about monetary policy but strikingly detailed about fiscal policy.

As chairman of the Federal Reserve, Mr. Bernanke’s official purview is in the monetary, not the fiscal realm, of course. But in a conversation in the new Weekend Business podcast, Catherine Rampell says he seemed to be deliberately vague about the central bank’s own plans.

While he said the Fed’s full toolkit is available as needed, he didn’t spell out what the bank’s actions might entail. On the other hand, he said that short-term fiscal stimulus, combined with longer-term debt reduction, would do much to invigorate the economy.

In another podcast conversation and in the Economic View column in Sunday Business, Richard Thaler, the University of Chicago economist, says Congress has been much better at spending than at budget-cutting, which is part of what he calls a self-restraint problem.

Like people with a New Year’s Day hangover, many members of Congress find it easy to make promises if they needn’t fulfill them for months or years to come. In his view, imposing legal constraints on spending, through a balanced budget amendment or other means, is unlikely to compel effective action. Voters need to be willing to elect mature adults, who, in turn, need to exercise willpower to make better choices for the country, he says.

Steven P. Jobs, who is stepping down as chief executive of Apple, has had an enormous impact in many fields. In a podcast conversation and in the Unboxed column in Sunday Business, Steve Lohr discusses the qualities of Mr. Jobs as a role model. Above all else, he says, Mr. Jobs is an innovator, and his entire career may be seen as a relentless effort to improve the odds of bringing forth innovation, both for himself and in the organizations he has managed.

And the problem of illegal products passed off as health supplements is the focus of a conversation with Natasha Singer, who tackles the subject on the cover of Sunday Business. Federal authorities are struggling to stop the distribution of these black-market goods, which may endanger consumers’ health.

You can find specific segments of the podcast at these junctures: Catherine Rampell on the Fed (33:53); news headlines (25:04); Steve Lohr on Steve Jobs (22:13); Richard Thaler on Congress (15:49); Natasha Singer on black-market supplements (8:59); the week ahead (2:06).

As articles discussed in the podcast are published during the weekend, links will be added to this post.

You can download the program by subscribing from The New York Times’s podcast page or directly from iTunes.

How Much More Can the Fed Help the Economy?

With the risk of another recession on the horizon, many economists and investment analysts are hoping that Ben S. Bernanke will signal on Friday that the Federal Reserve is ready to step in once again and save the economy from disaster. After all, Congress seems wholly unwilling to engage in fiscal stimulus, and instead is planning further fiscal tightening.

But there are reasons to believe the Fed’s remaining tools may be losing their potency.

Monetary policy works best when the Fed cuts interest rates, giving banks a good opportunity to extend more loans. If more loans go out to people and companies, those people and companies can buy more goods and services, creating more demand and eventually more jobs.

CATHERINE RAMPELL

Dollars to doughnuts.

Interest rates are already at zero, though (and have been for a while), so the Fed cannot lower them any further. That’s why the Fed has engaged in more unusual — in some cases, unprecedented — measures.

Dollars to doughnuts.

Twice now the Fed has engaged in large-scale asset purchasing, a process known as quantitative easing. (Hence the nicknames QE1 and QE2.) This is meant to lower long-term interest rates, which should, in theory, stimulate economic growth in two ways.

First, it should encourage more borrowing, so companies and consumers will have more money to spend.

Second, lower long-term interest rates could encourage investment in riskier assets, like stocks. Why? Because if long-term Treasuries don’t offer much in the way of returns, investors will seek higher yields elsewhere. If investors do start buying up riskier assets, those asset prices rise. Consumers then see that their portfolios are worth more, causing them to feel richer and so more comfortable with spending. This is known as the wealth effect.

But this two-pronged attack is probably less powerful today than it was three years ago.

After two rounds of quantitative easing, long-term interest rates are already quite low. It is not clear that lowering them further with a third round of quantitative easing (QE3) would do a whole lot more to encourage investment in riskier assets, or to increase lending. Many companies are choosing not to borrow primarily because demand is so weak, and not because credit is expensive.

Additionally, if investors do start increasing their investments in assets with higher yields, they may pour more money into commodities like oil. And commodity prices are already higher today than they were a year ago; pushing energy and food prices further up could actually discourage consumers from spending.

And many economists are still debating whether the last round of quantitative easing was terribly useful.

“It’s hard to make the argument that QE2 was a rousing success or we wouldn’t be on the verge of seeing QE3,” the economists at RBC Capital Markets wrote in a client note. “The market may very well get what it seems to desire, but we believe there is no magic bullet here.”

There are other measures the Fed could take besides quantitative easing. These include changing the composition, rather than the size, of the assets already on its balance sheet so that they have longer maturities. Like quantitative easing, this could lower long-term interest rates, with many of the same pros and cons. There would probably be less political resistance to reconfiguring, rather than expanding, the central bank’s debt holdings.

The Fed could also lower the interest rate it pays banks on their reserves. Maybe this would encourage them to hold less cash and increase their lending. There is some debate about how effective this measure would be. If demand for credit remains low, encouraging banks to lend more may not be helpful.

Many economists have suggested that the most powerful tool the Fed might employ would be an announcement that it is raising its medium-term target for inflation.

If prices are expected to rise, banks, businesses and consumers will be more eager to spend their money before it loses value. That could have positive effects throughout the economy, since spending means more demand for goods and services, which means companies need to hire more employees, which means more spending, and so on. That is the much-sought-after virtuous cycle.

The problem, though, is that inflation has some major downsides too — especially if coupled with sluggish growth, as seen during the “stagflation” of the 1970s. Not having a good sense of how much your next gallon of milk or gas will cost is stressful, particularly if your wages aren’t rising to match the higher prices.

Today inflation is pretty low, but it’s higher than it was a year ago when the Fed last engaged in quantitative easing. Already the more hawkish members of the Federal Open Market Committee are getting antsy. Since Mr. Bernanke cannot unilaterally carry out any of these stimulus strategies, the chances that the Fed will increase its inflation target in the near future seem low.

But hey, the Fed has surprised people before.

A Second Great Depression, or Worse?

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

With the United States and European economies having slowed markedly according to the latest data, and with global growth continuing to disappoint, a reasonable question increasingly arises: Are we in another Great Depression?

Today’s Economist

Perspectives from expert contributors.

The easy answer is “no” — the main features of the Great Depression have not yet manifested themselves and still seem unlikely. But it is increasingly likely that we will find ourselves in the midst of something nearly as traumatic, a long slump of the kind seen with some regularity in the 19th century, particularly if presidential election-year politics continue to head in a dangerous direction.

Perspectives from expert contributors.

The Great Depression had three main characteristics, seen in the United States and most other countries that were severely affected. None of these have been part of our collective experience since 2007.

First, output dropped sharply after 1929, by over 25 percent in real terms in the United States (using the Bureau of Economic Analysis data, from its Web site, for real gross domestic product, using chained 1937 dollars). In contrast, the United States had a relatively small decline in G.D.P. after the latest boom peaked. According to the bureau’s most recent online data, G.D.P. peaked in the second quarter of 2008 at $14.4155 trillion and bottomed out in the second quarter of 2009 at $13.8541 trillion, a decline of about 4 percent.

Second, unemployment rose above 20 percent in the United States during the 1930s and stayed there. In the latest downturn, we experienced record job losses for the postwar United States, with around eight million jobs lost. But unemployment only briefly touched 10 percent (in the fourth quarter of 2009; see the Bureau of Labor Statistics Web site).

Even by the highest estimates — which include people discouraged from looking for a job, thus not registered as unemployed — the jobless rate reached around 16 to 17 percent. It’s a jobs disaster, to be sure, but not the same scale as the Great Depression.

Third, in the 1930s the credit system shrank sharply. In large part this is because banks failed in an uncontrolled manner — largely in panics that led retail depositors to take out their funds. The creation of the Federal Deposit Insurance Corporation put an end to that kind of run and, despite everything, the agency has continued to play a calming role. (I’m on the F.D.I.C.’s newly created systemic resolution advisory committee, but I don’t have anything to do with how the agency handles small and medium-size banks.)

But the experience at the end of the 19th century was also quite different from the 1930s — not as horrendous, yet very traumatic for many Americans. The heavily leveraged sector more than 100 years ago was not housing but rather agriculture — a different play on real estate.

There were booming new technologies in that day, including the stories we know well about the rapid development of transportation, telephones, electricity and steel. But falling agricultural prices kept getting in the way for many Americans. With large debt burdens, farmers were vulnerable to deflation (a lower price level in general or just for their products). And before the big migration into cities, farmers were a mainstay of consumption.

According to the National Bureau of Economic Research, falling from peak to trough in each cycle took 11 months between 1945 and 2009 but twice that length of time between 1854 and 1919. The longest decline on record, according to this methodology, was not during the 1930s but rather from October 1873 to March 1879, more than five years of economic decline.

In this context, it is quite striking — and deeply alarming — to hear a prominent Republican presidential candidate attack Ben Bernanke, the Federal Reserve chairman, for his efforts to prevent deflation. Specifically, Gov. Rick Perry of Texas said earlier this week, referring to Mr. Bernanke: “If this guy prints more money between now and the election, I don’t know what y’all would do to him in Iowa but we would treat him pretty ugly down in Texas. Printing more money to play politics at this particular time in American history is almost treacherous — er, treasonous, in my opinion.”

In the 19th century the agricultural sector, particularly in the West, favored higher prices and effectively looser monetary policy. This was the background for William Jennings Bryan’s famous “Cross of Gold” speech in 1896; the “gold” to which he referred was the gold standard, the bastion of hard money — and tendency toward deflation — favored by the East Coast financial establishment.

Populism in the 19th century was, broadly speaking, from the left. But now the rising populists are from the right of the political spectrum, and they seem intent on intimidating monetary policy makers into inaction. We see this push both on the campaign trail and on Capitol Hill — for example, in interactions between the House Financial Services Committee, where Representative Ron Paul of Texas is chairman of the monetary policy subcommittee, and the Federal Reserve.

The relative decline of agriculture and the rise of industry and services over a century ago were long believed to have made the economy more stable, as it moved away from cycles based on the weather and global swings in supply and demand for commodities. But financial development creates its own vulnerability as more people have access to credit for their personal and business decisions. Add to that the rise of a financial sector that has proved brilliant at extracting subsidies that protect against downside risk, and hence encourage excessive risk-taking. The result is an economy that is at least as prone to big boom-bust cycles as what existed at the end of the 19th century.

The rise of the Tea Party has taken fiscal policy off the table as a potential countercyclical instrument; the next fiscal moves will be contractionary (probably more spending cuts), whether jobs start to come back or not. In this situation, monetary policy matters a great deal, and Mr. Bernanke’s focus on avoiding deflation and hence limiting the problems for debtors does not seem inappropriate (for more on Mr. Bernanke, his motivations and actions, see David Wessel’s book, “In Fed We Trust“).

Mr. Bernanke has his flaws, to be sure. Under his leadership, the Fed has been reluctant to take on regulatory issues, continuing to see the incentive distortions of “too big to fail” banks as somehow separate from monetary policy, its primary concern. And his team has consistently pushed for capital requirements that are too low relative to the shocks we now face.

And the Federal Reserve itself is to blame for some of the damage to its reputation, although it did get a major assist from Treasury in 2008-9. There were too many bailouts rushed over weekends, with terms that were too generous to incumbent management and not sufficiently advantageous to the public purse.

But to accuse Mr. Bernanke of treason for worrying about deflation is worse than dangerous politics. It risks returning us to the long slump of the late 1870s.

Podcast: G.D.P., European Stocks, Bernanke and Bing

If you were hoping for some economic good news to close out July, forget it. Not only did the Commerce Department offer up a gloomy assessment of the second-quarter gross domestic product, it also said the recession of 2007-9 was deeper and the recovery slower than we thought.

As Catherine Rampell reports, the G.D.P. —  that closely watched measurement of economic output —  grew at an annual rate of only 1.3 percent in the second quarter. That’s barely breathing. In fact, the economy over all is smaller now than when the recession began in 2007, she says. 

In the Weekend Business podcast, Ms. Rampell offers up one tiny bright spot: automobile sales were not as bad as expected.

Meanwhile, the Fundamentally columnist for Sunday Business, Paul Lim, urges investors not to run away from stocks in European companies, despite economic uncertainty there. In a podcast interview with Phyllis Korkki, he argues that European companies have fared slightly better over all than their American counterparts.

Steve Lohr talks with the Sunday Business editor, David Gillen, about his article in this week’s section on Microsoft’s high hopes for the search engine Bing — its David to the Goliath Google. And Gregory Mankiw, the Harvard economist, writing in the Economic View column, defends the performance of Ben S. Bernanke, the regularly pummeled chairman of the Federal Reserve.

You can find specific segments of the podcast at these junctures: the G.D.P. report (31:09); news summary (22:52); Microsoft (19:46); Gregory Mankiw (12:45); European stocks (6:24); the week ahead (0:51).

As articles discussed in the podcast are published during the weekend, links will be added to this post.

You can download the program by subscribing from The New York Times’s podcast page or directly from iTunes.