Pascal, academia and Bernanke

Ben Bernanke’s new blog has gripped the Econternet.

Bernanke has argued that the US economy is not experiencing secular stagnation.  Sooner or later, warranted real interest rates will rise above -2 per cent, and the Fed will be free to achieve its inflation target and full employment.  The pathology of the last several years will prove temporary.

His argument is pretty persuasive.  But it all depends on how temporary is temporary.  If temporary is as temporary as the experience of Japan, where rates have been trapped at zero for >15 years, then the practical distinction between the Bernanke and Summers versions of this hypothesis is somewhat academic.  Under such circumstances, raising the inflation target would still be sound, precautionary policy.

After all, as Pascal would have had us reason, what would be the costs of raising the inflation target, only to find out 20 years down the line that the global savings market and demographic trends had gone into reverse?  Very little.  For the first 2 decades, higher inflation is helpful, and provides room for larger cuts to nominal interest rates.  After that, it’s excessive, but the costs of moderately higher inflation are probably not noticeable.  (At least not empirically, anyway).

And, as I’ve argued in the past, it might be perfectly reasonable to change the inflation target at low frequencies, as new evidence about the medium run equilibrium real rate came in.  If Bernanke is proven right, we can lower again in the 2030s.

So, Bernanke might be right, but that may not change the policy prescription enough to matter.  And it could be worth proceeding as though he were wrong anyway, in the absence of knowing for certain, on the grounds that the costs of doing the opposite – for example leaving the inflation target at 2 – are greater.

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