Ben Bernanke and the zero bound

Laurence Ball, 28 February 2012

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From 2000 to 2003, when Ben Bernanke was an economics professor and then a Fed governor (but not yet chair), he wrote extensively about a problem in monetary policy, ie how to stimulate a slumping economy if short-term interest rates are near zero. Bernanke suggested policies for Japan, where interest rates were near zero at the time, and he discussed what the Fed should do if it were confronted with a similar situation (Bernanke 2000, 2002, 2003a).

In these early writings, Bernanke advocated aggressive actions to stimulate aggregate demand. He proposed four specific policies:

  • Targets for long-term interest rates;
  • Depreciation of the currency;
  • An inflation target of 3%–4%; and
  • A money-financed fiscal expansion.

With all these tools available, Bernanke argued, the zero bound on interest rates was not a significant impediment to demand stimulus. The primary reason for Japan’s stagnation was a self-induced paralysis at the central bank, which could have ended the slump – if the will to do so had existed.

Bernanke in theory versus Bernanke in practice

Since December 2008, Chairman Bernanke has faced a depressed US economy with short-term interest rates near zero. Yet the Bernanke Fed has eschewed the policy responses that Bernanke once advocated. It has tried to boost demand through more cautious actions-- primarily, announcements about future federal funds rates and purchases of long-term Treasury securities (without targets for long-term interest rates). Many economists have noted this change, including Christina Romer (in Klein 2011) and Paul Krugman (2011). Joseph Gagnon says, “It’s really ironic. It’s a self-induced paralysis” (in Miller 2011).

What explains Bernanke’s caution as Fed chair? The leading theory is political pressure from inflation hawks, both within the Federal Open Market Committee and in Congress. Krugman, for example, says that Bernanke has been bullied by the inflationistas – including Ron Paul.

Yet a careful review of Bernanke’s writings suggests that political pressure is not the primary reason for his caution. The key evidence is the timing of his changing views about the zero bound. By 2004, Bernanke had dropped all of his early proposals for aggressive policies. At that time, the zero-bound problem was a hypothetical one for the US, and nobody imagined the political pressures that Bernanke would face a few years later as Fed chair.

A quick conversion

In a recent paper (Ball 2012) I examine Ben Bernanke’s changing views about the zero bound. It seems that most of the changes occurred over a very short time. In a speech in May 2003, Bernanke was still advocating aggressive policies such as a money-financed tax cut. In a speech in July 2003, he was much more cautious. What happened between May and July?

The obvious answer, at one level, is that Bernanke attended the Federal Open Market Committee meeting of June 24. At that meeting, the Committee heard a briefing on policy at the zero bound prepared by the Board’s Division of Monetary Affairs and presented by its director, Vincent Reinhart. The policy options that Reinhart emphasised were close to those that the Fed has actually implemented since 2008; Reinhart either rejected or ignored the more aggressive policies that Bernanke had previously advocated. In the discussion that followed, Chairman Greenspan and other Committee members generally supported Reinhart’s views.

Bernanke spoke toward the end of the meeting, and he joined the consensus supporting Reinhart. The meeting’s impact is clear from Bernanke’s July speech, in which he mostly echoed Reinhart’s proposals. In January 2004, Bernanke and Reinhart co-authored a paper that closely followed Reinhart’s reasoning at the June meeting. Since the US hit the zero bound, the Fed has implemented the proposals in the Bernanke-Reinhart paper.

A puzzle

This history raises another question. Why did Bernanke’s views about the zero bound change so suddenly and completely? Why, as Ryan Avent (in Economist 2012) asks, was the June 2003 Federal Open Market Committee meeting a ‘Damascene moment’ when Bernanke apparently realised that his previous thinking was wrong?

Of course, someone can change his mind as a result of new evidence or arguments; Bernanke could simply have found Reinhart persuasive. Yet it is questionable that this simple explanation is the whole story. In 2003 Bernanke was one of the world’s most eminent monetary economists, and he had written extensively about zero-bound policy. Given his expertise and the strong views he had expressed, one might expect Bernanke to take a leading role in the Federal Open Market Committee discussion, to put forward his ideas, and not to change his mind quickly. Even if Reinhart’s arguments were strong, it is puzzling that Bernanke accepted them immediately.

In addition, Bernanke apparently dropped some of his old positions without hearing arguments against them. Reinhart’s briefing and the Federal Open Market Committee discussion emphasised the drawbacks of targeting long-term interest rates, one of Bernanke’s early proposals. But Reinhart cryptically dismissed Bernanke’s ideas about money-financed tax cuts and depreciation, and he completely ignored the idea of 3%–4% inflation – and no Federal Open Market Committee member brought up any of these proposals. On these issues, rather than agreeing with persuasive arguments, Bernanke accepted his colleagues’ implicit position that his old ideas were off the table.

Conjectures based on social psychology

Why was Bernanke so unassertive? It is hard to answer this question because we cannot observe Bernanke’s thought processes. Yet we can speculate about the causes of his behaviour – and our speculation can be informed by social psychology, which studies group decision-making. My recent paper explores two factors that may have influenced Bernanke.

The first possible factor is ‘groupthink’ at the Federal Open Market Committee. Janis (1971) introduced the concept of groupthink, defining it as “the mode of thinking that persons engage in when concurrence-seeking becomes so dominant in a cohesive group that it tends to override realistic appraisal of alternative courses of action.” When groupthink occurs, individuals go along with what they perceive as the majority view or the view of a group leader. They censor opinions of their own that differ from the majority because they value group harmony and they want to avoid disapproval from others.

Did groupthink occur when the Federal Open Market Committee discussed the zero bound? A reason to think so is that many factors that promote groupthink, according to social psychologists, were present at the Greenspan Fed. These factors include a dominant group leader; a tradition of decision-making by consensus; limited interaction with outsiders; and an atmosphere of camaraderie and clubbiness. This last factor is highlighted in a recent New York Times article about the Federal Open Market Committee transcripts for 2006 (Appelbaum 2012). The article notes the frequency of jokes, banter, and gossip about people who are not present, as well as the warm tributes to Alan Greenspan when he retired.

The second factor that might have influenced Bernanke is his personality. Journalists and colleagues typically describe Bernanke with terms such as modest, quiet, unassuming, and shy. Common sense suggests that someone with these traits is less likely than an outspoken, aggressive person to speak forcefully at meetings or to dissent from a majority view. This hypothesis is supported by experiments in which psychologists identify people as shy or not shy and then examine their behaviour within a decision-making group.

Bernanke’s personality may have reinforced the effects of groupthink. The atmosphere at the Federal Open Market Committee in 2003 discouraged anyone from questioning the views of the Fed staff. As a quiet and shy person, Bernanke may have been especially reluctant to rock the boat.

Conclusion

If these conjectures are correct, they have implications for the design of policy committees and the choice of Committee members. Appointing outspoken, aggressive people may ensure that a wide range of views is considered. A wide-ranging debate is also more likely if the causes of groupthink are avoided. Ironically, as Fed chair, Ben Bernanke has moved the Federal Open Market Committee in that direction. Bernanke dominates discussions less than Greenspan did; he tolerates dissents from votes; and he has reduced the Committee’s insularity with post-meeting news conferences.

Does social psychology really explain Ben Bernanke’s behaviour? Only Bernanke has direct experience of his thought processes in 2003. Now that he holds news conferences, perhaps a reporter will ask him to explain his Damascene moment.

References

Appelbaum, Binyamin (2012), “Inside the Fed in 2006: A Coming Crisis, and Banter”, New York Times, 12 January.

Economist (2012) “The Professor Versus the Chairman”, blogpost, Free Exchange, 13 February.

Ball, Laurence (2012), “Ben Bernanke and the Zero Bound”, NBER Working Paper 17836.

Bernanke, Ben S (2000), “Japan’s Slump: A Case of Self-Induced Paralysis?”, in Posen, Adam and Ryoichi Mikitani, Japan’s Financial Crisis and Its Parallels to US Experience: Special Report 13, Washington, DC: Peterson Institute for International Economics, September.

Bernanke, Ben S (2002), “Deflation: Making Sure ‘It’ Doesn’t Happen Here”, speech before National Economists Club, 21 November. 

Bernanke, Ben S (2003a), “Some Thoughts on Monetary Policy in Japan”, speech before Japan Society of Monetary Economics, 31 May.

Bernanke, Ben S (2003b) “An Unwelcome Fall in Inflation?” speech before Economics Roundtable, University of California, San Diego, 23 July.

Bernanke, Ben S and Vincent R Reinhart (2004), “Conducting Monetary Policy at Very Low Short-Term Interest Rates”, American Economic Review 94(2): 85–90.

Federal Open Market Committee (2003), Transcript of FOMC meeting, 24–25 June.

Janis, Irving L (1971), Groupthink: Psychological Studies of Policy Decisions and Fiascoes, Boston: Houghton Mifflin.

Klein, Ezra, (2011) Interview with Christina Romer, WashingtonPost.com, 24 March .

Krugman, Paul (2011), “Ron Paul and the Inflationistas Are Bullying Bernanke,” New York Times, 29 April.

Miller, Rich (2011), “Professor Bernanke Warning of Paralysis Meets Fed Facing the Same”, Bloomberg News, 20 June.

Topics: Macroeconomic policy
Tags: Bernanke, monetary policy, social psychology

Laurence Ball
Professor, Johns Hopkins University; Research Associate, NBER; and Visiting Scholar, IMF

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