William Kearney interview Ben Bernanke (Nobel ’22) in “Real Policymaking Involves a Lot of Other Things Besides Pure Technical Analysis” (Issues in Science and Technology, Summer 2023). The discussion moves from one big subject to another, but here are a few points that caught my eye. The questions are mine: the answers are Bernanke.
Should the Federal Reserve become involved in issues like climate change and economic inequality?
[T]he really big steps that are needed to avert climate change—such as developing new energy technologies and retrofitting old buildings and creating new infrastructure for electric vehicles—all those things are the province of the private sector or more likely the government. And by government, I mean broadly, like Congress. I think the Fed properly should focus most of its attention on its mandate, on the objectives given to it by Congress, which are full employment and price stability.
I think inequality is a similar issue in its complexity. The Fed is paying more attention to inequality and is monitoring unemployment rates across different groups. For example, during the pandemic the Fed appeared to put more weight on employment because of the benefits that has for people who are lower-income workers. But again, the Fed really only has one instrument—namely, financial conditions being tighter or easier and then promoting or slowing economic growth—and it can’t use that one instrument to achieve many different objectives at the same time. It can’t ease policy for one group and tighten policy for another group. It has to have the same policy for everyone in the country.
This is not to deny that inequality and climate change are first-order, very important issues politically and socially, but the Federal Reserve is just one agency, and it should focus primarily on the goals that Congress sets forth for it and the tools it has to achieve those goals.
What are the main factors driving changes in how the Federal Reserve conducts policy in the last 15 years or so?
[A]fter the 2008 crisis, we needed new tools to stimulate the economy; and new players in the financial system meant our lending strategy had to evolve. Very low inflation and a low underlying interest rate structure, starting around 2004, left the Fed with relatively limited space to cut rates to deal with economic slowdowns. When I was Fed chair, we cut the federal funds rate almost to zero in late 2008 amid the financial crisis—but the severe recession continued through 2009 and it was a slow recovery after that. So we needed new ways to stimulate the economy, which led to two principal tools. The first was quantitative easing [in which the Fed buys bonds and other financial assets to keep longer-term interest rates low, thereby stimulating the economy]; the second was forward guidance [to signal the likely direction of future monetary policy], which always existed to some extent at the Fed but became a much more central part of its toolkit.
The second change has to do with the fact that the financial system has changed since the Fed was created. Originally, banks and trust companies provided most of the credit in the economy. Since then, the financial system has evolved to include lots of other kinds of institutions to the point where banks provide less than half of all the credit that goes to Americans. The Fed was set up to provide liquidity and be a lender of last resort only to banks. And so the global financial crisis was a watershed moment because the crisis was most severe in the non-bank financial sector—what’s called shadow banks, including investment banks, various kinds of mortgage companies, and so on. The Fed had to develop a whole new set of tools to be a lender to other kinds of financial companies.
What is the overlap between being an academic researcher and being chair of the Federal Reserve?
On the one hand, my background as an academic provided me with a lot of knowledge and a lot of information that was helpful. When your research illuminates certain relationships or behavior of the economy, that helps you think about policy. And it helps to know history because it shows how others handled, or didn’t handle, previous crises. On the other hand, academic analysis by its very nature tends to strip problems down into their simplest components. It tries to study relatively simple or straightforward examples of various phenomena. Real policymaking involves a lot of other things besides pure technical analysis. It involves politics. It involves working with colleagues. It involves dealing with enormous amounts of uncertainty. It involves dealing with imperfect data and models, so there are elements of judgment and interpersonal negotiations that are really not part of what academia prepares you for necessarily. … It was also very important to understand issues like communication and cooperation, working with central banks from other countries, working with Congress, working with the president. All those things had to be learned basically on the job—and that’s why being a Federal Reserve chair is a very difficult job.