by Neil Irwin
Indeed, Jean-Claude Trichet and then Mario Draghi appeared at times to exert greater control over the American and British economies than Bernanke and King did. Trichet and Draghi spoke regularly with their international counterparts, in private phone calls, in Basel, and on the sidelines of their never-ending series of global summits. But except for the rare joint intervention, particularly the reopening of global swap lines at the end of November 2011, they essentially left Bernanke and King trying to do what they could to help their domestic economies and hoping for the best.
There was a feeling of impotence settling over Threadneedle Street. “It felt like every time you checked your BlackBerry,” said one official, “there was another nasty headline out of Europe and not much we could do about it.” Britain’s decision to stay out of the eurozone a decade earlier was very much looking like the right one: Its public finances weren’t so different from Spain’s, and if British monetary policy were set in Frankfurt instead of London, the nation would almost certainly have been lumped in with the GIPSIs. (Where that would have left the acronym creators is anyone’s guess.)
Even without the euro as its currency, Britain faced massive ripple effects from Europe’s troubles. Eurozone nations accounted for almost half of UK exports, British banks had considerable exposure to the continent, and British companies’ confidence was affected by the latest dispatches from across the Channel in each morning’s Financial Times. “The fact that we’re not in the euro area does not mean we’re exempt from the consequences of what happens,” as King put it with some understatement in 2012.
Almost too appropriately for that frustrating summer of 2011, the governor sat and watched as Spaniard Rafael Nadal defeated Scot Andy Murray in the men’s singles semifinals at that most British of institutions, the All England Lawn Tennis and Croquet Club, better known as Wimbledon. King was in the royal box alongside the newly married Duke and Duchess of Cambridge, as well as others from worlds far more glamorous than that of economic policy, including actor Michael Caine and Vogue editor Anna Wintour. It is forbidden to use cell phones in the royal box, a fact that led the Mail on Sunday to speculate about whether King was out of touch during matches.
The paper went to great lengths to suggest so. It ran a 1,451-word article on the governor’s Wimbledon attendance, asserting that he’d been at the tournament at least six of its thirteen days. A photo that accompanied the story online showed King with his eyes closed above the accusatory caption “FRIDAY JULY 1: Sir Mervyn snoozes during the tense men’s semi-final which saw Andy Murray defeated by Rafael Nadal. It was the day on which more gloomy figures on the state of Britain’s economic recovery were released.”
In truth, the sharp elbows King received from the press and some of his enemies in British politics for afternoons at Wimbledon were a bit unfair. Even his detractors at the Bank of England said that King was among the hardest workers they had known, putting in long hours at night and on weekends. On the days he spent the afternoon watching tennis, he spent both mornings and evenings working on bank business.
But Britain was a nation in need of a scapegoat. The full brunt of the austerity policies King had advocated in 2010 was being felt, with economic growth near zero during the first half of 2011. At the time, analysts, including those at the Bank of England, saw some possible temporary reasons for that: commerce interruptions caused by snowstorms that winter; supply disruptions caused by the earthquake in Japan that March; a drop in productivity due to the extra vacation days taken by many Britons around the time of the royal wedding that spring. But in hindsight, those were mere excuses—the British economy was indeed stagnant.
Unemployment rose over the summer of 2011, from 7.7 percent in March to 8.3 percent in September. Yet inflation remained high—above 5 percent through the spring, due to a combination of higher fuel prices and higher import prices due to a lower value of the pound. Both effects had started to recede by summer, suggesting that inflation would eventually come down. But in 2011, that added up to stagflation, a terrible situation for Britons and an unwelcome dilemma for central bankers.
At the Bank of England, there was a divide. Two of the nine members of the Monetary Policy Committee, Martin Weale and Spencer Dale—the latter the bank’s chief economist—saw inflation as the greatest threat facing Britain and voted to hike interest rates through July 2011. On the other side was Adam Posen, who believed that a decelerating economy and rising unemployment was the main risk. He had argued for a new round of quantitative easing, for Britain’s own QE2, at every MPC meeting since October 2010. The majority of the committee, led by King, elected for no change.
On the face of it, such indecision may seem like a repeat of the summer of 2008: With inflation high, some on the MPC wanted to tighten policy and others wanted to ease it, with King splitting the difference by standing pat. But both people who were in frequent contact with the governor and a careful reading of his public statements reveal that despite the lack of formal changes to monetary policy, there was a major evolution in King’s thinking over the summer and fall of 2011.
With each month that passed, as the leaders of continental Europe seemed ever more adrift, King’s alarm increased. In June, testifying to Parliament’s Treasury Select Committee, he said that “the reason we would raise interest rates would be in the context of a much stronger economy with unemployment falling rather than rising,” thus effectively dismissing the idea that the bank would raise rates as joblessness rose. At the same time, he laid the groundwork for more bond buying by the Bank of England, playing down the idea that quantitative easing is some exotic form of economic sorcery. “I regard QE as a perfectly conventional monetary policy tool,” King said. “This is something we can do.”
Then in August, when the MPC was putting together its quarterly inflation report—the most detailed regular summary of bank leaders’ views of the economic outlook—the committee took an unusual approach. With a eurozone implosion looking increasingly plausible that month, King and his colleagues judged that they couldn’t properly factor what might happen into their projections. If a collapse did occur, it would surely make all their forecasts useless, just as the Lehman Brothers bankruptcy had three years earlier. So they made their forecasts for GDP, inflation, and so on as usual, assuming that there would be no great implosion in Europe—which, in any case, would be “almost impossible to calibrate.” Then they added what amounted to a one-page asterisk, laying out their view that “the risks emanating from the current euro-area tensions have few obvious parallels” and therefore there would be a chance of major disruptions to the economy not reflected in their forecasts. In other words, the risks from a eurozone collapse were so grave that they had to be accounted for entirely separate from the main forecast.
“The big risks facing the UK economy come from the rest of the world,” King said in his press conference on the report. “We must work with our colleagues abroad to tackle the challenge of how to reduce the overhang of private and public debt. But there is a limit to what UK monetary policy can do when large real adjustments are required. And it cannot influence inflation over the next few months. But it can ensure that policy is set in such a way that these adjustments take place against a backdrop of low and stable inflation. And that is exactly what the MPC will do.”
At the committee’s early September meeting, King and the other members seemed on the verge of instituting new quantitative easing, with wide consensus that the British economy was in grave danger from Europe and that inflation was dissipating. But as much as everyone seemed to be on the same page about what the Bank of England ought to do, King argued for holding off for just one more month. “The attitude seemed to be, ‘I’m nervous about the outlook, but let’s get one more month of data,’” said a person with knowledge of the deliberations. The financial markets had been so chaotic in August that King wondered whether they might soon render new easing unnecessary. “We were very conscious that there ha
d been significant news in August, particularly in financial markets,” King said later, “and it could have been that that was volatility that might reverse itself over the next month. I do not think we felt that the underlying position would improve but there was a possibility that the volatility would dampen down. Basically, we were in a position in September where, if nothing else changed over the following month, we would then implement further asset purchases.”
Sure enough, October arrived with no abrupt improvement in financial markets, and the MPC unanimously agreed to buy £75 billion in UK government bonds, or gilts—“shock and awe,” as the Daily Telegraph put it. It was the equivalent, relative to the size of the respective economies, of the Fed buying $750 billion in bonds; in other words, in relative terms, Britain’s QE2 was 25 percent bigger than the United States’. In the months before, even Posen, the most persistent dove on the committee, had been advocating for only £50 billion in bond purchases. But King’s strategy—of waiting until there was definitive evidence of a crumbling economy and weaker inflation, then building his case incrementally—meant that even aggressive action was viewed as more acceptable, both inside and outside the bank.
King portrayed the action publicly as a simple response to events. “The world economy has slowed, America has slowed, China has slowed, and of course particularly the European economy has slowed,” he told reporters. “The world has changed and so has the right policy response.”
• • •
Ben Bernanke had done the twist in September 2011. Mervyn King had fired up the printing presses in October. Both had carefully laid the groundwork for their moves and thus been able to boost their nations’ economies without jarring the markets or hurting their central banks’ political standing. In the world of zero-interest-rate policy in which the Fed and the Bank of England were now living, Bernanke and King both had to weigh the costs and benefits of easing more carefully than they would have if there’d been room to simply cut short-term interest rates. And in the fall of 2011, as the Anglo-Saxon economies continued muddling along with no real rebound evident, some began to believe that they were both moving too cautiously—that for all their apparent activism, they were in fact becoming the Masaru Hayamis of the twenty-first century.
These critics, some of them inside the central banks, began dreaming big, imagining ways that the central bankers might encourage their economies to do something better than merely extending the duration of the Fed’s portfolio or buying another £75 billion of gilts. Charles Evans, the president of the Federal Reserve Bank of Chicago, who was rapidly becoming the Adam Posen of the United States, took to a stage in London that September to make a case for more aggressive action. “Suppose we faced a very different economic environment,” Evans told the European Economics and Financial Centre. “Imagine that inflation was running at 5 percent against our inflation objective of 2 percent. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire. We should be similarly energized about improving conditions in the labor market.”
The Fed had been persistently overestimating how well the U.S. economy would do over the next several months. For example, in January 2011, the official consensus of FOMC members was that the economy would grow 3.4 to 3.9 percent that year; the actual number turned out to be 2 percent. Evans, hair on fire, advocated a more systematic way of addressing the weakness: Instead of improvising new policies whenever the economy disappoints, he argued, why not lay out specific economic conditions to which the Fed would respond in specific ways. For example, in September 2011, U.S. unemployment was at 9 percent and prices, excluding those in the volatile food and energy sectors, had risen 2 percent over the year. Evans proposed that the Fed announce it would keep ultra-low-interest-rate policies in place until unemployment fell to, say, 7 percent, so long as inflation stayed below 3 percent.
The FOMC discussed this idea, and many variations, at a series of meetings. Even some of the more hawkish leaders of the central bank, like Charles Plosser of the Philadelphia Fed, found the concept attractive. After all, it would give the world a clear and predictable way to understand the Fed’s policies. But they were tripped up on the details. While Evans and some of the doves on the FOMC were comfortable allowing inflation to get up to 3 percent or so, many of the other policymakers were reluctant to announce—as they would implicitly be doing—that they had decided to tolerate inflation above their 2 percent target.
Evans’s idea got batted around seriously, but the closest the FOMC came into turning it into something concrete was a decision, made at its December meeting, to begin giving the public a summary of what committee members expected monetary policy to be in the future—how many anticipated the first interest rate hikes to take place in 2014 versus 2015 and so on. It was a mere baby step toward offering more clarity for what policy might be in the future.
In his September speech, Evans also mentioned a related idea, one that had advocates outside the Fed, including the economics research group at Goldman Sachs and Berkeley economist and former Barack Obama adviser Christina Romer. In 2011, about $1 trillion fewer goods and services were produced within U.S. borders than would have been the case if the precrisis growth trajectory had held. That was the “output gap” between what the economy seemed capable of producing and what it was actually producing. Why not set an explicit goal of returning GDP to that precrisis path, pledging to keep easy-money policies in place until the nation got there, even at risk of inflation above the normal 2 percent target.
Nominal GDP targeting, as its advocates called the approach, would essentially be a pledge from the central bank to keep the pedal to the floor to try to accelerate the economy until the effects of the crisis wore off. Romer compared the proposal to what Paul Volcker had done in 1979 when he persuaded the FOMC to remake its entire framework for monetary policy, to focus on constricting the money supply to address inflation. “Desperate times call for bold measures,” she wrote in the New York Times. “Paul Volcker understood this in 1979. Franklin D. Roosevelt understood it in 1933. This is Ben Bernanke’s moment. He needs to seize it.”
By the time she wrote that, Bernanke had already assigned Fed economists to do an extensive study of how nominal GDP targeting might work, using computer models to examine its potential benefits and pitfalls. The FOMC listened to a detailed staff presentation and discussed the idea at length on the first day of its November 1–2 meeting. In theory, the idea had promise, the staff models suggested. But there were also great weaknesses to the approach. For instance, it would work only if the Fed could credibly deliver on its pledge over a very long time, perhaps ten or fifteen years. If people making economic decisions such as hiring and investing had doubts that the central bank would follow through—and remember that each Fed chairman’s term is only four years—nominal GDP targeting wouldn’t work.
And following the policy would mean that if growth remained slow, the Fed would not simply accept high inflation, but practically promise it. If, for example, the nominal GDP target were 5 percent and growth only 1 percent, the Fed would aim to set policy to get 4 percent inflation. That would likely mean a world in which financial markets were reacting badly, long-term interest rates were rising to reflect inflation risk, and ordinary Americans were unhappy about rapidly rising prices for gasoline and other goods.
The discussion of nominal GDP targeting and variations thereof took up hours on that November Tuesday. Some FOMC members, particularly those on the central bank’s more hawkish wing, viewed it as not worth considering because they saw stable prices and low inflation as the most important goals of a central bank. They simply couldn’t abide a policy that would mean tolerating higher inflation. Others had a more nuanced set of views. But at the end of the discussion, not even any of the committee’s more dovish members was prepared to endorse such a policy. There would be no Vo
lckeresque sea change in the Fed’s approach. Bernanke himself, when speaking privately with colleagues about the topic, would become uncharacteristically animated and strident, apparently annoyed that economists who hadn’t analyzed the pros and cons of nominal GDP targeting as carefully as the Fed had would assert with such supreme confidence that it was the policy to pursue. At the same time, he was sensitive to the underlying critique of the Fed’s policies—that they would work better if they could strengthen confidence that the United States would return to its precrisis path and that the Fed would not rest until that goal was achieved. The challenge was how to make that happen in a world where every move seemed to be met with attacks, where the tools that might work were risky and untested, and it would take agreement on a committee with wide-ranging views to do much of anything at all.
• • •
As 2012 dawned, Bernanke and King each pursued a strategy of continuity. In January, the Fed pushed its expected date for rate hikes to the end of 2014, from the mid-2013 date previously announced. The Bank of England, judging that inflation was falling as economic growth in Britain remained weak, returned to the well of quantitative easing in February, expanding its bond purchases by another £50 billion. The Fed undertook “Operation Twist 2” at its June meeting, swapping out another $267 billion of its shorter-term bond holdings for longer ones, on top of the $400 billion that was part of the first Twist. In July, the Bank of England tacked on another £50 billion in QE.