My Amazon Review of Ben Bernanke's "21st Century Monetary Policy"

Fighting the Last War

Central bankers are like generals; they fight the last war. In his updated history of Federal Reserve policy since the 1960’s former Fed Chairman Ben Bernanke spends much of his effort in his too long and textbook-like book on monetary policy from the financial crisis of 2008-09 to the present. He is rightly concerned with operating monetary policy under the constraint of a zero-bound policy rate that for the most part has been the case since 2008. However, he ignores the new war to come as inflation becomes more endemic.

 

He discusses the role of the Fed as a lender of last resort in the tradition of Walter Bagehot where unprecedented lending in face of the financial crisis in 2008 and the pandemic of 2020 where the Fed came close to discounting practically anything, perhaps even my personal IOU. To be sure the Fed did save the day in both cases, but in the case of 2008, it gave rise to a populist movement on both the right and left which saw the Fed bailing out the big banks, but not the proverbial little guy/gal.

 

Bernanke cites his interest in monetary policy came from reading Friedman and Schwartz’s “A Monetary History of the United States 1867-1960.” I too had a similar experience. However, where the role of money is central to Friedman & Schwartz, aside from the 1970’s, it is only peripheral in Bernanke’s work. My guess is that Bernanke will regret not mentioning the explosive growth in the money supply over the past two years.

 

I wish he would have devoted more time to the role of the Plaza Accord in 1985 in which the finance ministries of the G-7 orchestrated a decline in the international value of the dollar. The Fed aided and abetted that process which in my mind ignited the commercial real estate bubble of the late 1980’s. That did not end well, and it nearly broke the U.S. banking system, so much so that the Greenspan Fed in late 1991 lowered the discount rate by 100 basis points. As an aside I participated as a real estate expert in a briefing to the Board of Governors just prior to the rate cut.

 

The reason Bernanke and the Fed are fighting the last war is that it is my contention that the U.S. economy entering a new thirteen-year cycle (Shulmaven: The U.S. Economy is Entering a New Thirteen Year Cycle) that will be characterized by much higher inflation than we have been used to. It will involve more than a cyclical rise in inflation that Summers-Furman-Blanchard warned of that Bernanke rightly noted in his book. ( Also see my comments  Shulmaven: "Is the Pandemic Hiding Future Inflation," UCLA Economic Letter, January 2021 ) Further, if inflation were measured the same way it was in the 1970’s where house price changes rather than owners’ equivalent rent was used to calculate the housing component of the consumer price index, year-over-year inflation would be running in the 12-13% range, not the 8% currently being reported. Simply put, the house is on fire.

 

Inflation will become more endemic because the economy is deglobalizing and decarbonizing at the same time. Both will lead higher energy prices specifically and higher overall prices as limitations will be put on the international division of labor in an environment of an aging global workforce. This will lead to a substantial increase in capital expenditures as production is in-shored and huge investments are made in energy transition. As a result, not only will inflation increase, but the real neutral rate of interest, R*, will increase as well. Add to this higher defense spending to deal with an aggressive Russia and increased concerns about China, interest rates have nowhere to go but up.

 

Net net. Instead of worrying about the last war’s zero bound, the Fed will be worried about the new war of fighting an inflation amidst a capital spending boom.

For the full Amazon URL see: Fighting the Last War (amazon.com)