Ben Bernanke Could Lose for Same Reason as Olympic Sailor

Illustration by A. Babar

By Amity Shlaes 

Ben has the right map. That’s the assumption about Ben Ainslie, the U.K.’s top sailor, as he competes in the Olympics this week.
The rest of us can’t see what charts Ainslie follows or precisely what he does. We can’t even see him perform unless a TV camera uses the correct high-powered lens. But we know Ainslie knows which maps to use, and how to read them, even if he has a challenge ahead to win his fourth career gold medal.

About Amity Shlaes

Amity Shlaes is a senior fellow in economic history at the Council on Foreign Relations and the author of the best-sellers "The Forgotten Man: A New History of the Great Depression" and "The Greedy Hand: Why Taxes Drive Americans Crazy."
More about Amity Shlaes

“Ben has the right map” is also the common assumption when it comes to Ben S. Bernanke, the Federal Reserve chairman, whose navigational prowess is also being tested this week, as the Federal Open Market Committee meets. When it comes to monetary policy one can broaden “Ben’s map” to say “the Fed’s map.” About all we ourselves know is that the Fed is likely to prescribe some “expansionary” policy, even a third round of quantitative easing, and that this is supposed to be good. Public confidence in the Fed is based more on faith in Fed charts and Bernanke’s ability to use what the charts show.
Maybe Ainslie’s map-reading was off this week, as he trails in the Finn class competition. Perhaps the Fed has the wrong map altogether.
That is the conclusion about the central bank drawn by two economists, the Nobel Memorial Prize winner Vernon Smith and Steven Gjerstad, after a review of the 11 U.S. recessions since World War II and as well as crises abroad.

Flawed Assumptions

In a paper in a new book on economic growth pulled together by the Bush Institute, where I work, Smith and Gjerstad found results that suggest our traditional monetary chart books, especially the parts that advocate federal spending or money creation, betray great flaws.
They reject the idea that more monetary stimulus can work now. “An expansionary monetary policy today is unlikely to generate a recovery, regardless of its size,” they conclude.
To see how they arrive at this bold contention it helps to spell out the orthodox line and then the Smith-Gjerstad finding.
The basic premise at the Fed is that the central bank, with the help of Congress, navigates the economy like a ship through something called the business cycle, and that the North Star is data on business investment, such as a measure called “gross fixed investment” (spending on plants, machinery or roads).
Smith and Gjerstad found that business investment isn’t the North Star to measure progress. They found that a less-used datum, purchases of new single and multifamily homes, predicted the timing, depth and duration of recessions. They reject the very term “business cycle.”
“We believe that ‘business cycle’ is a poor description for economic fluctuations in the U.S. over the past 85 years,” they say. “We found evidence that a household expenditure cycle generates a business investment cycle” -- and not the other way.
Another given in monetary policy is that the best thing a monetary captain can do is to practice what the monetary sailors call countercyclical policy: match force with force. Encountering rough waters, the Fed or Congress must pour fuel -- money -- into the economy, powering it through the great waves. The technicians’ discussion these days isn’t about whether to pour such fuel; it’s about how to do so and when. Monetary policy affects housing, Smith and Gjerstad agree. But homeowners who owe more than their houses are worth won’t take more loans or spend more money until their budgets look better. So quantitative easing won’t work now.

Procyclical Alternative

There is a third strategy in the standard chart book that goes with the wind instead of against it, the “procyclical” stance. A procyclical policy would withdraw money from the economy via monetary tightening or tax increases in a period when the economy is already losing money due to recession. Procyclicality is supposed to be lethal. It was what Bernanke was warning against with his reference to the “fiscal cliff” that looms when tax increases take effect in January.
Smith and Gjerstad argue that the best course for recovery seems to be for the government to practice austerity, by reducing spending, even during the recession. In other words, to adopt that dread procyclical position. Additionally, countries should focus on recovery through exports, they say, and allow their currency to depreciate to improve terms of trade for exporters.
Smith and Gjerstad found that “when government expenditures were brought under control, the currency depreciated significantly and the growth rate of exports moves sharply ahead of imports.” President Barack Obama’s idea of an export-driven recovery makes sense. “The austerity-depreciation mechanism is remarkable,” the authors say.
Not all of us can endorse the emphasis on exports or depreciation. Adopting such changes in a new Fed chart book represents a more radical shift for the U.S., something greater than that mandated by the “audit the Fed” legislation that Congress just passed. All the audit-the-Fed bill does is give the public a waterside seat. Still, any legislation or paper that provides a close-up of monetary navigation, and makes new suggestions, deserves its own gold medal. You can’t prepare for the trip if you’re worried about a nonexistent cliff, or using charts that deny the very possibility of the next storm.