BEN BERNANKE AND THE ZERO BOUND

[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 that could greatly reduce these losses. Why isn't more happening ? To this outsider, at least, Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced. Ben Bernanke (2000) Monetary policy can be a powerful tool, but it is not a panacea for the problems currently faced by the U.S. economy. Ben Bernanke (2011) I. INTRODUCTION What forces shape the policy decisions of a central bank? To gain insight into this question, this paper examines the policies of the Federal Reserve from 2009 through 2011. Unemployment was high during this period and Fed officials expressed a desire to reduce it by stimulating aggregate demand. Yet their traditional tool for demand stimulus--cuts in the federal funds rate--was not available, because this rate was close to its lower bound of zero. In this setting, the Fed confronted choices among various "unconventional" monetary policies. The analysis starts with a puzzle about Ben Bernanke. From 2000 to 2003, when Bernanke was an economics professor and then a Fed Governor (but not yet Chair), he wrote and spoke extensively about monetary policy at the zero bound. He suggested policies for Japan, where interest rates were near zero at the time, and he discussed what the Fed should do if U.S. interest rates fell near zero and further stimulus were needed. In these early writings, Bernanke advocated a number of aggressive policies, including targets for long-term interest rates, depreciation of the currency, an inflation target of 3%-4%, and a money-financed fiscal expansion. Yet, after the United States hit the zero bound in December 2008, the Bernanke Fed eschewed the policies that Bernanke once supported and took more cautious actions--primarily, announcements about future federal funds rates and purchases of long-term Treasury securities (without targets for long-term interest rates). A number of economists noted the difference between the policies of the Bernanke Fed and Bernanke's earlier views--usually critically. In discussing one of Bernanke's early writings on the zero bound, Christina Romer said "My reaction to it was, 'I wish Ben would read this again'" (quoted in Klein 2011). Paul Krugman (2011b) asked "why Ben Bernanke 2011 isn't taking the advice of Ben Bernanke 2000." In criticizing Fed policy, Joseph Gagnon echoed Bernanke's criticism of the Bank of Japan (BOJ): "It's really ironic. It's a self-induced paralysis" (quoted in Miller 2011). The leading explanation for Bernanke's caution as Fed chair was political pressure from inflation hawks. Krugman's (201 la) harsh assessment was Mr. Bernanke is allowing himself to be bullied by the inflationistas ... The Fed's policy is to do nothing about unemployment because Ron Paul is now the chairman of the House subcommittee on monetary policy. Mankiw (2011) viewed Bernanke more favorably, but he, too, cited the political constraints that Bernanke faced: "If Chairman Bernanke ever suggested increasing inflation to, say, 4 percent he would quickly return to being Professor Bernanke." This paper examines Bemanke's changing views on monetary policy at the zero bound and seeks explanations for the changes. Section II documents Bernanke's early views, both the specific policies that he advocated and his broader view that the zero bound is not a significant impediment to demand stimulus. Section III discusses one change that occurred earlier than others, in 2002: Bernanke's rejection of exchange-rate depreciation as a stimulus tool. Sections IV-VI review the broader evolution of Bernanke's views. I find that they changed abruptly in June 2003, while Bernanke was a Fed Governor. On June 24, the Federal Open Market Committee (FOMC) 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 (FOMC 2003). …