bernanke in theory versus bernanke in practice

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Ben Bernanke and the zero bound

Laurence Ball

28 February 2012

What explains Bernankes caution as Fed chair? This column argues that one

possible factor is groupthink, where individuals go along with what they perceive

as the majority view. Many of the Feds features its tradition of decision-making

by consensus, limited interaction with outsiders, and atmosphere of camaraderie

encourage groupthink. And Bernankes personality, often described as modest

and unassuming, may have reinforced the effects of groupthink.

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 stimulateaggregate demand. He proposed four specific policies:

With all these tools available, Bernanke argued, the zero bound on interest rates

was not a significant impediment to demand stimulus. The primary reason forJapans 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

Targets for long-term interest rates;

Depreciation of the currency;

An inflation target of 3%4%; and

A money-financed fiscal expansion.

anke in theory versus Bernanke in practice | vox - Research-based po... http://www.voxeu.org/index.php?q=n

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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,

Its really ironic. Its a self-induced paralysis (in Miller 2011).

What explains Bernankes 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 Bernankes 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 Bernankes 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 Boards 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 Reinharts views.

Bernanke spoke toward the end of the meeting, and he joined the consensussupporting Reinhart. The meetings impact is clear from Bernankes July speech,

in which he mostly echoed Reinharts proposals. In January 2004, Bernanke and

Reinhart co-authored a paper that closely followed Reinharts 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


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This history raises another question. Why did Bernankes 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 worlds 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 Reinharts 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. Reinharts briefing and the Federal Open Market

Committee discussion emphasised the drawbacks of targeting long-term interest

rates, one of Bernankes early proposals. But Reinhart cryptically dismissed

Bernankes 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 Bernankes 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.


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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 YorkTimes 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 byexperiments in which psychologists identify people as shy or not shy and then

examine their behaviour within a decision-making group.

Bernankes 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

Committees insularity with post-meeting news conferences.

Does social psychology really explain Ben Bernankes 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.


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bernanke in theory versus bernanke in practice

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