Fed Still Has Plenty of Options

An informative but somewhat odd piece on monetary policy from Sewell Chan in the NYT offers the following description of Ben Bernanke’s state of mind:

Having failed in 2007 to anticipate the subprime mortgage crisis and the economic havoc that resulted, Mr. Bernanke is eager not to seem slow or complacent as the recovery shows signs of stalling. But compared with three years ago, the Fed’s options now are more limited, and the consequences of acting (or not) potentially more dangerous.

Chan’s article surveys the views of various critics, including several inflation hawks who think Bernanke should be more complacent and one person who thinks he should be less complacent, but actually provides no reason whatsoever to think that the Fed’s options have become more limited. In his academic writing before becoming head of the Federal Reserve, Bernanke argued that a central bank faced with this situation could set a higher explicit inflation target and stick to it until the price level caught up to the long-run trend. In response to a question from Brad DeLong after assuming office, Bernanke reaffirmed his view that such a move would reduce unemployment but he expressed a preference for maintaining the lower inflation rate. Nothing has changed in the academic economics literature to suggest that Bernanke was mistaken, nor has anything changed in the world to suggest that Bernanke’s views have become obsolete.

It’s true that we can’t be certain how well this would work, since the historical record only provides a small set of data, but it seems clear that it would in fact reduce unemployment. And the option is on the table. It just needs to be used.