There are very good reasons to be wary of such a prescription. Just as inflation helps debtors, it hurts creditors. Banks and bondholders get cheated, because their loans are repaid with inflated coin. Similarly, people with fixed savings, such as retirees, get punished for their thrift. President Grover Cleveland, a warrior against inflation (in his day, brought about by cheap silver), rightly likened a debasement of the currency to theft. Of course, someone also benefits from this theft—in Cleveland’s era, farmers seeking higher prices; in ours, the unemployed. The latter are hardly to be blamed for being jobless, but helping them involves a trade-off that creates losers as well as winners. And the trade-off is only temporary. Eventually, wages catch up with money creation. Once the economy is operating at its potential, dropping money from the sky will not add jobs. It will keep causing inflation.
Bernanke has given serious thought to the Krugman-Rogoff argument. One obstacle is practical. Fed policy works, in part, by getting the market to do the Fed’s work (if the Fed is buying bonds, traders who want to be on the same side of the markets as the central bank will buy bonds too). But any policy adopted by less than a 7-to-3 majority by the Fed’s Open Market Committee would not be viewed by markets as a credible policy, likely to endure, and Bernanke is not guaranteed to get this margin today. “No central banker would do it,” Mankiw says of raising the inflation target; the political reaction would be too severe. (When Mankiw, a Harvard economist, wrote a column raising the possibility of a higher inflation target, Drew Faust, the university’s president, received letters urging her to fire him.)
This might seem to support Krugman’s thesis that Bernanke would like to boost inflation but has chickened out. But after talking with the chairman at length (he was generally not willing to be quoted on this issue), I think that, although Bernanke appreciates the intellectual argument in favor of raising inflation, he finds more compelling reasons for not doing so. First is the fear that inflation, once raised, could not be contained. The Fed creates inflation by adding reserves to the banking system (falling interest rates are the market’s way of registering the increasing plenitude of money). If so much money enters the system that wages and prices start ratcheting upward, the momentum can be self-perpetuating. “The notion that we can antiseptically raise the target and control it is highly questionable,” Bernanke told me.
Second, raising inflation is not always so easy. Inflation does not go up by fiat—by edict of the central bank. Rather, the Fed has to persuade millions of people to spend more money and tens of thousands of businesses to raise their prices. And this will not happen if people think the monetary easing is temporary. Money comes from credit, and borrowing depends on expectations for the future. The theoretical point is that the market sets long-term interest rates to reflect the sum of expected future short-term rates. So the way to reduce long-term rates is to convince people that short-term rates (which the Fed controls) will stay low for an indefinite period. As Bernanke is well aware, this problem has generated an extensive literature, the gist of which is that the Fed would have to promise to be, in effect, “irresponsible.” In other words, the Fed would have to say, “Even when prices start rising, even when inflation starts to get out of hand, we will still keep rates near zero.” That is what sparked the inflation of the ’70s: people thought inflation was permanent, and a borrow-and-spend mentality set in. If Bernanke were to re-create that climate, it would be hard to shut down.
My sense is that Bernanke is too much a sober central banker to want to risk the Fed’s credibility on inflation. His view represents a serious break from many of his fellow academics because, according to the world as left-leaning scholars depict it, raising inflation is the only thing that will work when the economy has hit dead air. Bernanke thinks he has other tools. One, of course, is quantitative easing. Instead of lowering expectations for short-term rates, which is how the Fed usually operates, quantitative easing involves direct intervention in the long-term sector of the credit market. By purchasing long-term securities, the Fed aims to reduce the cost of mortgages, corporate debt, and so forth. Working on long-term interest rates is a natural move, because short-term rates are already near zero. But whether quantitative easing has much impact is hotly debated. The policy was clearly effective during the early stages of the mortgage crisis, when it helped to unfreeze credit markets, enabling companies and individuals to get loans again. However, even Bernanke’s supporters admit that since these markets have begun functioning again, continued purchases of long-term bonds have had only a modest effect. Mark Gertler, an economist at New York University and a friend of Bernanke’s, says the second round of quantitative easing might have moved the needle by perhaps a quarter of a percentage point. He nonetheless credits this policy with keeping inflation from sagging dangerously low—“not a trivial accomplishment.” The Fed also seems to have accelerated last year’s spike in the price of gold, oil, and other commodities. And that, to conservatives, is just the problem.