Oops we did it again!

Doing It Again

By PAUL KRUGMAN

Published: November 7, 2010
http://www.nytimes.com/2010/11/08/opinion/08krugman.html?partner=rssnyt&emc=rss

Eight years ago Ben Bernanke, already a governor at the Federal Reserve
although not yet chairman, spoke at a conference honoring Milton Friedman.
He closed his talk by addressing Friedman's famous claim that the Fed was
responsible for the Great Depression, because it failed to do what was
necessary to save the economy.

"You're right," said Mr. Bernanke, "we did it. We're very sorry. But thanks
to you, we won't do it again."

Famous last words. For we are, in fact, doing it again.

It's true that things aren't as bad as they were during the worst of the
Depression. But that's not saying much. And as in the 1930s, every proposal
to do something to improve the situation is met with a firestorm of
opposition and criticism. As a result, by the time the actual policy
emerges, it's watered down to such an extent that it's almost guaranteed to
fail.

We've already seen this happen with fiscal policy: fearing opposition in
Congress, the Obama administration offered an inadequate plan, only to see
the plan weakened further in the Senate. In the end, the small rise in
federal spending was effectively offset by cuts at the state and local
level, so that there was no real stimulus to the economy.

Now the same thing is happening to monetary policy.

The case for a more expansionary policy by the Fed is overwhelming.
Unemployment is disastrously high, while U.S. inflation data over the past
few years almost perfectly match the early stages of Japan's relentless
slide into corrosive deflation.

Unfortunately, conventional monetary policy is no longer available: the
short-term interest rates the Fed normally targets are already close to
zero. So the Fed is shifting from its usual policy of buying only short-term
debt, and is now buying long-term debt - a policy generally referred to as
"quantitative easing." (Why? Don't ask.)

There's nothing outlandish about this action. As Mr. Bernanke tried to
explain Saturday, "This is just monetary policy," adding, "It will work or
not work in much the same way that ordinary, more conventional, familiar
monetary policy works."

Yet the Pain Caucus - my term for those who have opposed every effort to
break out of our economic trap - is going wild.

This time, much of the noise is coming from foreign governments, many of
which are complaining vociferously that the Fed's actions have weakened the
dollar. All I can say about this line of criticism is that the hypocrisy is
so thick you could cut it with a knife.

After all, you have China, which is engaged in currency manipulation on a
scale unprecedented in world history - and hurting the rest of the world by
doing so - attacking America for trying to put its own house in order. You
have Germany, whose economy is kept afloat by a huge trade surplus,
criticizing America for running trade deficits - then lashing out at a
policy that might, by weakening the dollar, actually do something to reduce
those deficits.

As a practical matter, however, this foreign criticism doesn't matter much.
The real damage is being done by our domestic inflationistas - the people
who have spent every step of our march toward Japan-style deflation warning
about runaway inflation just around the corner. They're doing it again - and
they may already have succeeded in emasculating the Fed's new policy.

For the big concern about quantitative easing isn't that it will do too
much; it is that it will accomplish too little. Reasonable estimates suggest
that the Fed's new policy is unlikely to reduce interest rates enough to
make more than a modest dent in unemployment. The only way the Fed might
accomplish more is by changing expectations - specifically, by leading
people to believe that we will have somewhat above-normal inflation over the
next few years, which would reduce the incentive to sit on cash.

The idea that higher inflation might help isn't outlandish; it has been
raised by many economists, some regional Fed presidents and the
International Monetary Fund. But in the same remarks in which he defended
his new policy, Mr. Bernanke - clearly trying to appease the
inflationistas - vowed not to change the Fed's price target: "I have
rejected any notion that we are going to try to raise inflation to a
super-normal level in order to have effects on the economy."

And there goes the best hope that the Fed's plan might actually work.

Think of it this way: Mr. Bernanke is getting the Obama treatment, and
making the Obama response. He's facing intense, knee-jerk opposition to his
efforts to rescue the economy. In an effort to mute that criticism, he's
scaling back his plans in such a way as to guarantee that they'll fail.

And the almost 15 million unemployed American workers, half of whom have
been jobless for 21 weeks or more, will pay the price, as the slump goes on
and on.