Quantitative Easing and the Incentives Problem

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It's really hard to concentrate
with a nose whistle

As Chairman of the Federal Reserve, Ben Bernanke's job is defined by the dual mandate that defines the mission of the Central Bank.

             •  Full Employment
             •  Price Stability

As a practical matter, the better he tries to do his job, the more he finds himself in a political crossfire.  The key to the effectiveness of a Central Bank is its political independence - it cannot act effectively if its decisions are based on political demands as some of its actions will by necessity have negative political implications.  To add to the current paradox, Bernanke himself is a Republican, originally appointed by the odious GW Bush and then inexplicably re-appointed by Barack Obama.  So his instincts run to sympathy for the plutocracy and hard money policies that protect extant wealth, even at the expense of a higher-than-necessary unemployment rate.  But Bernanke is also a respected scholar on precisely the kind of issues on the table now - how to improve an economy in a liquidity trap using fiscal and monetary policy, particularly expansionary fiscal and monetary policy.  Indeed, he wrote well respected papers recommending the Japanese use economic stimulus and easy money to improve their economic conditions in the '90s, even at the expense of higher inflation.

So for three long years of the current financial crisis, the Fed has done virtually nothing to improve the lack of aggregate demand in order to reduce the unemployment rate in America.  And as the United States entered the campaign season leading up to the 2012 election, this policy was seen as favoring the Republican challenger by keeping the economy depressed, allowing the eventual nominee to run against Obama on the basis of a poor economy.  During the Primaries, the candidates each took their turns railing against and threatening Mr. Bernanke and the Fed in a fairly ham-handed attempt to intimidate him into continued inaction.  Famously, Texas Governor and short-lived Presidential candidate Rick Perry even suggested that if the Chairman of the Federal Reserve were to act to improve the economy before the election he might have to be lynched.  And because of the institutional political independence of the Central Bank, the Obama administration was unable to bring any kind of equivalent pressure to bear for more expansionary policies.

So Ben Bernanke finds himself in an odd position.  To act to improve the American economy and the lives of millions of unemployed citizens would be helpful to the electoral prospects of the incumbent, a member of the other party but the man who saw fit to re-appoint him.  To do so would also mean implementing policies he spent much of his life championing as the best solution to the very problem he is faced with now.  To continue to take no serious or dramatic action would boost the political prospects of his own party's nominee, a man who has famously promised to replace him on day one.

Now, it seems likely that if the Republican nominee won the election, Bernanke would not be replaced, but would serve out his term and find many ways to make common cause with all but the most rabid right-wing congressmen and women.  But it is becoming increasingly obvious that Obama will win re-election rather handily on November 6th, and as that likelihood becomes a near-certainty, Bernanke will have the option to use his academic expertise to improve the economy, even as it provides a benefit to the Obama campaign, without having to fear any kind of retribution from a victorious Republican President.  And after an Obama victory, with expansionary fiscal policy still an unavailable option due to the ignorance, incompetence and intransigence of the Republican legislators, he will be free to take real action, such as setting a higher explicit inflation target.  We cannot know for sure he will do something like that, and there would be ear-splitting howls of protest from the right-wing hard money plutocracy, but it will be the very first time in this term when he truly had the freedom to implement monetary policies he actually believes in.
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