Ben Bernanke, the nominee to replace Alan Greenspan this month as chairman of the US Federal Reserve Board, is a highly capable economist who has devoted his professional life to understanding the historical role of central banks and the problems that they have faced. His views represent, as much as can be expected, a consensus among those who have studied the issues carefully.
But that does not mean that Bernanke is prepared to ensure that healthy economic growth continues in the US in the coming years and provide the kind of leadership that the world needs. By the standards of what is generally understood today, he will do a good job. Unfortunately, that may not be enough.
John Maynard Keynes once said that monetary policy may work like a string. A central bank can pull the string (raise interest rates) to rein in an economy that is galloping ahead unsustainably. But it cannot push the string up: If economic growth stalls, as when confidence is seriously damaged, lowering interest rates may not be enough to stimulate demand. In that case, a recession can occur despite the central bank's best efforts.
Bernanke made his name as an economist by analyzing the worldwide Great Depression of the 1930s -- good expertise to have, since preventing such disasters is a central bank head's most important job. The Great Depression, which followed the stock market crash of 1929, saw unemployment rise sharply in many countries, accompanied by severe deflation. In the US, consumer prices fell 27 percent between 1929 and 1933, and the unemployment rate topped out in 1933 at 23 percent.
According to Bernanke's "debt deflation" theory, the collapse in consumer prices was one of the causes of the Great Depression, since deflation raised the real value of debts, making it difficult to repay loans. As Bernanke pointed out, 45 percent of US farms were behind on mortgage payments in 1933, and in 1934, default rates on home mortgages exceeded 38 percent in half of the US cities. The debt burden destroyed consumer confidence and undermined the banking system, crippling the economy.
No gold standard
Bernanke's research also stressed that the sooner a country abandoned the gold standard, the better off it was. Adhering to the gold standard during the Great Depression implied a deflationary monetary-policy bias, since it required keeping interest rates relatively high to encourage investors to hold deposits in banks rather than demanding the gold that backed them. Once a country eliminated convertibility into gold, it was free to pursue monetary expansion, and deflation tended to end.
But Bernanke's impressive research on the Great Depression does not mean that he can prevent the next recession or depression, for stopping deflation hardly solves all problems. After all, the US went off the gold standard in 1933, and the Fed cut the discount rate to 1.5 percent in 1934, ending deflation (except for minor episodes); but the unemployment rate did not fall consistently below 15 percent until 1941 and the onset of World War II.
Bernanke will thus have to be careful about over-generalizing from his past research, just as medical specialists must be careful not to over-diagnose diseases in their own specialty and military strategists must be careful not to over-prepare to fight the last war.
Of course, this does not mean that we should ignore the past altogether. A study last year headed by Guillermo Calvo, chief economist for the Inter-American Development Bank, found important similarities between the Great Depression of the 1930s and economic crises since 1980 in 31 emerging countries. But the study also found important differences.
Depression repeated
The fundamental experience of the Great Depression has repeated itself, on a smaller scale, many times and in many countries in recent decades -- a shock in financial markets, followed by a sharp decline in gross domestic product. But the behavior of consumer prices in the post-1980 crises is fundamentally different from that seen in the 1930s.
In contrast to the Great Depression, collapsing national output was in recent decades accompanied by accelerating inflation, not deflation. The Calvo study thus concludes that Bernanke's debt deflation theory of the Great Depression does not generally apply to the more recent crises.
At the same time, Bernanke is inheriting a pair of economic vulnerabilities that are unusual by historical standards, and that did not precede the Great Depression of the 1930s. We are now in the late stages of the biggest real estate boom in US (or world) history, driven by frenzied market psychology. In contrast, US home prices were uneventful before the Great Depression, and actually fell slightly in real terms between 1925 and 1929.
Moreover, we are now experiencing a fundamental change in expectations about oil prices: Not only are today's prices quite high in real terms by historical standards, but the futures markets indicate that prices are expected to remain high for years to come. In contrast, real oil prices were flat leading up to 1929, and down nearly 50 percent in real terms from the 1925-1926 "fuel folly" peaks.
In the near future, substantially higher oil prices, lower real estate prices, or both, could, depending on public reaction, put Bernanke into uncharted territory for economic stress. If confidence declines, his historical understanding of the Great Depression of the 1930s could leave him ill-equipped to prevent such shocks from sinking the US, and the world, economy. He might find himself pushing on a string.
Robert Shiller is an economics professor at Yale University and a director at Macro Securities Research LLC.
Copyright: Project SyndicatE
Saudi Arabian largesse is flooding Egypt’s cultural scene, but the reception is mixed. Some welcome new “cooperation” between two regional powerhouses, while others fear a hostile takeover by Riyadh. In Cairo, historically the cultural capital of the Arab world, Egyptian Minister of Culture Nevine al-Kilany recently hosted Saudi Arabian General Entertainment Authority chairman Turki al-Sheikh. The deep-pocketed al-Sheikh has emerged as a Medici-like patron for Egypt’s cultural elite, courted by Cairo’s top talent to produce a slew of forthcoming films. A new three-way agreement between al-Sheikh, Kilany and United Media Services — a multi-media conglomerate linked to state intelligence that owns much of
The US and other countries should take concrete steps to confront the threats from Beijing to avoid war, US Representative Mario Diaz-Balart said in an interview with Voice of America on March 13. The US should use “every diplomatic economic tool at our disposal to treat China as what it is... to avoid war,” Diaz-Balart said. Giving an example of what the US could do, he said that it has to be more aggressive in its military sales to Taiwan. Actions by cross-party US lawmakers in the past few years such as meeting with Taiwanese officials in Washington and Taipei, and
The Republic of China (ROC) on Taiwan has no official diplomatic allies in the EU. With the exception of the Vatican, it has no official allies in Europe at all. This does not prevent the ROC — Taiwan — from having close relations with EU member states and other European countries. The exact nature of the relationship does bear revisiting, if only to clarify what is a very complicated and sensitive idea, the details of which leave considerable room for misunderstanding, misrepresentation and disagreement. Only this week, President Tsai Ing-wen (蔡英文) received members of the European Parliament’s Delegation for Relations
Denmark’s “one China” policy more and more resembles Beijing’s “one China” principle. At least, this is how things appear. In recent interactions with the Danish state, such as applying for residency permits, a Taiwanese’s nationality would be listed as “China.” That designation occurs for a Taiwanese student coming to Denmark or a Danish citizen arriving in Denmark with, for example, their Taiwanese partner. Details of this were published on Sunday in an article in the Danish daily Berlingske written by Alexander Sjoberg and Tobias Reinwald. The pretext for this new practice is that Denmark does not recognize Taiwan as a state under