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Paul Krugman: Contractionary Policy Is Contractionary

Ben Bernanke (1999): "Rooseveltian Resolve"

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Ben Bernanke on Japan in 1999:

It is true that current monetary conditions in Japan limit the effectiveness of standard open-market operations. However… liquidity trap or no, monetary policy retains considerable power…. Money, unlike other forms of government debt, pays zero interest and has infinite maturity. The monetary authorities can issue as much money as they like. Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets. This is manifestly impossible in equilibrium. Therefore money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero. This is an elementary argument… quite corrosive of claims of monetary impotence….

[A] policy of aggressive depreciation of the yen would by itself probably suffice to get the Japanese economy moving again….

In February 1999 the Bank of Japan adopted what amounts to a zero-interest-rate policy… at least “until deflationary concerns subside”…. A problem with the current BOJ policy, however, is its vagueness. What precisely is meant by the phrase “until deflationary concerns subside”?… [A] target in the 3-4% range for inflation, to be maintained for a number of years, would confirm not only that the BOJ is intent on moving safely away from a deflationary regime, but also that it intends to make up some of the "price-level gap" created by eight years of zero or negative inflation…. I am not aware of any previous historical episode, including the periods of very low interest rates of the 1930s, in which a central bank has been unable to devalue its currency…. It might be objected that the necessary interventions would be large. Although I doubt it, they might be; that is an empirical question….

An alternative strategy, which does not rely at all on trade diversion, is money-financed transfers to domestic households—-the real-life equivalent of… the “helicopter drop” of newly printed money. I think most economists would agree that a large enough helicopter drop must raise the price level. Suppose it did not, so that the price level remained unchanged. Then the real wealth of the population would grow without bound…. Surely at some point the public would attempt to convert its increased real wealth into goods and services, spending that would increase aggregate demand and prices…. The only counter-argument I can imagine is that the public might fear a future lump-sum tax on wealth equal to the per capita money transfer, inducing them to hold rather than spend the extra balances. But the government has no incentive to take such an action in the future, and hence the public has no reason to expect it. The newly circulated cash bears no interest and thus has no budgetary implications for the government if prices remain unchanged. If instead prices rise, as we anticipate, the government will face higher nominal spending requirements but will also enjoy higher nominal tax receipts….

A number of observers have suggested that the BOJ expand its open- market operations to a wider range of assets, such as long-term government bonds or corporate bonds…. [I]t is useful to separate [monetary policies] that have some fiscal component… some implicit subsidy…. A nonstandard open-market operation without a fiscal component, in contrast, is the purchase of some asset by the central bank (long-term government bonds, for example) at fair market value. The object of such purchases would be to raise asset prices, which in turn would stimulate spending (for example, by raising collateral values). I think there is little doubt that such operations, if aggressively pursued, would indeed have the desired effect, for essentially the same reasons that purchases of foreign-currency assets would cause the yen to depreciate. To claim that nonstandard open-market purchases would have no effect is to claim that the central bank could acquire all of the real and financial assets in the economy with no effect on prices or yields….

Franklin D. Roosevelt was elected President of the United States in 1932 with the mandate to get the country out of the Depression. In the end, the most effective actions he took were… rehabilitation of the banking system and devaluation of the currency to promote monetary easing. But Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and to experiment…. Japan['s]… economy has operated below potential for nearly a decade. Nor is it by any means clear that recovery is imminent. Policy options exist…. Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work. Perhaps it’s time for some Rooseveltian resolve in Japan.