Ben Bernanke and the Zero Bound

From 2000 to 2003, when Ben Bernanke was a professor and then a Fed Governor, he wrote extensively about monetary policy at the zero bound on interest rates. He advocated aggressive stimulus policies, such as a money-financed tax cut and an inflation target of 3-4%. Yet, since U.S. interest rates hit zero in 2008, the Fed under Chairman Bernanke has taken more cautious actions. This paper asks when and why Bernanke changed his mind about zero-bound policy. The answer, at one level, is that he was influenced by analysis from the Fed staff that was presented at the FOMC meeting of June 2003. This answer raises another question: why did the staff's views influence Bernanke so strongly? I seek answers to this question in the social psychology literature on group decision-making.

Are Prices Too Sticky?

This paper shows that small costs of changing nominal prices can lead to rigidities that cause highly inefficient fluctuations in real variables. As a result, aggregate demand stabilization can be very desirable even though the frictions that cause fluctuations in aggregate demand to have real effects are slight. Inefficient price rigidity arises because rigidity has a negative externality: rigidity in one firm's price increases the variability of real aggregate demand, which hurts all firms. The externality can be arbitrarily large relative to the private costs of rigidity.

Policy Responses to Exchange-Rate Movements

This paper examines policy responses to exchange-rate movements in a simple model of an open economy. The optimal response of monetary policy to an exchange-rate change depends on the source of the change: on whether the underlying shock is a shift in capital flows, manufactured exports, or commodity prices. The paper compares the model’s prescriptions to the policies of an actual central bank, the Bank of Canada. Finally, the paper considers the role of fiscal policy in an open economy. Coordinated fiscal and monetary responses to exchange-rate movements stabilize output at the sectoral as well as aggregate level.

The Performance of Alternative Monetary Regimes

This paper compares the performance of economies with different monetary regimes during the last quarter century. The conclusions include: (1) There is little evidence that inflation targeting affects performance in advanced economies, but some evidence of benefits in emerging economies; (2) Europe’s monetary union has increased intra-European trade and capital flows, but divergence in national price levels may destabilize output in the future; (3) The “monetary analysis” of the European Central Bank has little effect on the ECB’s policy decisions; and (4) Countries with hard currency pegs experience unusually severe recessions when capital flight occurs.

Hysteresis in Unemployment: Old and New Evidence

This paper argues that hysteresis helps explain the long-run behavior of unemployment. The natural rate of unemployment is influenced by the path of actual unemployment, and hence by shifts in aggregate demand. I review past evidence for hysteresis effects and present new evidence for 20 developed countries. A central finding is that large increases in the natural rate are associated with disinflations, and large decreases with run-ups in inflation. These facts are consistent with hysteresis theories and inconsistent with theories in which the natural rate is independent of aggregate demand.

Inflation Dynamics and the Great Recession

This paper examines inflation dynamics in the United States since 1960, with a particular focus on the Great Recession. A puzzle emerges when Phillips curves estimated over 1960-2007 are used to predict inflation over 2008-2010: inflation should have fallen by more than it did. We resolve this puzzle with two modifications of the Phillips curve, both suggested by theories of costly price adjustment: we measure core inflation with the median CPI inflation rate, and we allow the slope of the Phillips curve to change with the level and variance of inflation. We then examine the hypothesis of anchored inflation expectations. We find that expectations have been fully "shock-anchored" since the 1980s, while "level anchoring" has been gradual and partial, but significant. It is not clear whether expectations are sufficiently anchored to prevent deflation over the next few years. Finally, we show that the Great Recession provides fresh evidence against the New Keynesian Phillips curve with rational expectations.