Ben Bernanke Gives His Take on China’s Policy Choices

Chairman Ben S. Bernanke receives a standing ovation at the Board meeting in Washington, D.C. on January 27, 2014.Chairman Ben S. Bernanke receives a standing ovation at the Board meeting in Washington, D.C. on January 27, 2014.

Caixin | The 2008 global financial crisis thrust Ben Bernanke into the spotlight as his every move drew unprecedented attention, scrutiny continued until he stepped down as chairman of the U.S. Federal Reserve in 2014.

Being a central bank governor is about making difficult choices, Bernanke wrote in his memoir, The Courage to Act, published last year. Looking back on the choice he made to bail out American Insurance Group, he wrote, “If we acted, nobody would thank us. But if we did not act, who would?”

Bernanke, 62, has said monetary and fiscal policies should be coordinated. In 2002, as a member of the Fed’s board of governors, he spoke of printing money to finance tax cuts, comparing it to the economist Milton Friedman’s notion of a “helicopter drop” of money. Critics have since referred to him as “Helicopter Ben.”

Bernanke was named chairman of former U.S. president George W. Bush’s Council of Economic Advisers in 2005, and became the Fed’s chairman in 2006. After stepping down, he joined the Brookings Institution as a Distinguished Fellow in Residence and also became a senior advisor to Citadel, a hedge fund in Chicago.

He has suggested China adopt a “targeted fiscal policy” to reduce the pressure on monetary policy and in the long run help the country develop a consumption-driven economy.

In a recent exclusive interview with Caixin, he expanded on that idea, and said that “well-thought-out fiscal investments could increase productivity in the long term while providing additional demand in the short term.” And unlike some other countries, he said, “China has the fiscal capacity it needs for such investments.”

He also answered questions about the U.S. dollar, negative interest rates, and how central banks around the world can better coordinate their actions among themselves and with other policymakers.

The following are excerpts of Caixin’s interview with Ben Bernanke.

Caixin: It has been argued that the yuan needs to be depreciated a bit. Do you think so?

Ben Bernanke: I don’t think that a large depreciation is a good idea because that would export deflation to the rest of the world and that would rebound on China in a bad way.

A large depreciation is certainly no good for anyone. But what if it is moderate? Is that possible?

The difficulty is managing that. If there is predictable, continued depreciation then it would just trigger more capital outflows because people will be trying to get out of the yuan as it depreciates. So, it’s better to have a less predictable path.

What’s your view on the central bank’s management of the yuan’s depreciation so far?

I think it’s been going reasonably well recently. The communication has gotten much better. Governor Zhou (Xiaochuan) has done a good job of explaining the plan and communicating to the world that a large depreciation is not intended and that instead the yuan would be managed with reference to a basket of currencies.

Over the past few years, yuan internationalization has gained pace. What’s your view of this?

It’s good insofar as it reflects the fact that China’s working to make its financial markets more liquid, more open, more rules based. The yuan is still not used internationally the way the dollar and other currencies are, but that isn’t so important. Eventually it will be. For now what is important is to continue reforms, including improving the infrastructure of the markets in which the yuan is traded. I think that the inclusion of the yuan in the SDR (Special Drawing Right) is a kind of good housekeeping seal of approval. It’s the IMF and its membership is saying that China’s reforms are moving in the right direction.

What’s your view of China’s push for enhancing the role of the SDR in the international monetary system?

I don’t think that it’s very realistic that the SDR will be used as a major international currency. It’s not used much now because it doesn’t have the underlying infrastructure and there are not liquid markets for SDR assets, as there are for assets denominated in dollars or euros, for example.

Recently you suggested that China assume a targeted fiscal policy. Could you tell us the pros and cons of this approach?

I think it’s a good idea. A targeted fiscal policy would advance both the short-term and the long-term objectives of China. In the short term, by using more fiscal policy and less monetary policy to promote growth, China would put less downward pressure on the yuan and reduce capital outflows.

In the longer term, China is facing a very challenging transition to a new growth model with a heavier emphasis on consumer spending and services. And that could be advanced by targeted fiscal policy aimed, for example, at providing more disposable income to consumers, improving the social safety net so that people would be willing to consume more and helping workers make the transition from the weaker sectors to the growing sectors.

Will this create fiscal debt pressure down the road?

China’s official government debt is relatively low, only a little more than 40 percent of GDP. It’s true that there are off-balance-sheet fiscal obligations, such as the implied commitment to backstop the banking system. But I do think that smart targeted fiscal spending would be a good investment for China.

China is not the only major economy whose policymakers are concerned about the impact of expansionary fiscal policies. Many other countries such as Germany have similar worries. Do you think they should be worried?

No, I don’t. Not all countries have fiscal space, but China and Germany are major countries that do. Well-thought-out fiscal investments could increase productivity in the long term while providing additional demand in the short term. As I said, I believe that China has the fiscal capacity it needs for such investments. To be clear, I am not talking about traditional infrastructure spending, like highways or dams, of which China already has plenty, but rather fiscal spending targeted at supporting the transition to the new growth model.

What kind of structural reform do you think China needs to carry out to accompany the expansionary fiscal policy you just mentioned?

China understands the need to transition from its traditional growth model based on heavy industry, exports and construction to a growth model that is more focused on services, retail, technology, finance and other new industries. So, reforms to continue to facilitate the continued growth in services, to move more workers out of SOEs into private sector, to reduce the subsidies to exports and heavy industry, those are all steps that will be very useful for helping China continue to grow over the longer run.

The central bank governors of Japan and the European Union have both said the negative interest rate policy they pursued has produced positive outcomes. Do you agree?

It’s too early to tell. Generally speaking, a negative interest rate is just another step in the direction of easing monetary policy. It’s not really the paradigm shift that some make it out to be. There is some concern about the effects on profitability of banks and on the functioning of money markets, but we’ll have to see whether those costs outweigh the benefits. For various reasons, in the United States we didn’t choose to use that approach.

What’s the prospect of negative interest rates as a policy option?

As I suggested, it’s one more tool to supplement quantitative easing and the other tools that the BOJ and ECB have used to fight deflation and low inflation. It could be helpful but I doubt that it will be a game changer.

Mario Draghi, the president of the European Central Bank, recently said policymakers will shift their emphasis from interest rate tools to non-conventional instruments. What other options do you think he might be talking about?

Right now they are mostly focused on quantitative easing, negative rates and long-term refinancing operations. I don’t know what other tools he has in mind.

Many people have argued that the Bank of Japan and the ECB do not have much room left to maneuver, considering the diminishing returns of their quantitative easing policies.

I think there is some tendency toward diminishing returns to monetary policy. I do think that the ECB and BOJ programs up to this point have been appropriate and constructive. We are seeing though the unfortunate tendency to put all the burden for recovery on central banks, when a coordinated approach involving fiscal and other policies as well as monetary policy would be more effective.

Many years ago you suggested Japan follow the strategy of “helicopter money.” Do you think the BOJ and the ECB should implement that policy now?

Helicopter money is just a colorful term to describe a combination of tax cuts and monetary finance. It’s not as exotic as the terminology makes it sound. I think that, in general, better coordination of monetary and fiscal policies would be a good idea. Whether a particular approach would be fairly described as helicopter money would depend on the details.

There have been concerns about the recent signs of the U.S. economy slowing again. What’s your view of the fundamentals?

The U.S. economy is growing at a moderate pace. It’s certainly not in recession. Household finances and sentiment are in good shape in the U.S., in part because of the continued strength of the job market. The housing market is also continuing to improve. So in general the domestic U.S. economy is not booming, but it is growing and creating a significant number of new jobs.

The main headwind for the U.S. recovery is now the global economy: the slowdown in our trading partners and the stresses in the financial markets arising from foreign developments. So the challenge of the U.S. is to continue to grow even as growth in much of the rest of the world has been disappointing.

What’s your opinion about the recent changes in the dollar’s value? Do you think the dollar will continue to appreciate or is it about to hit the end of a strengthening cycle?

The value of the dollar is an asset price. It incorporates whatever information is available. So I think the strengthening of the dollar that we saw from the middle of 2014 until now has incorporated not only the tightening policy that has already occurred, but also what the markets anticipate to occur in the future. So I think at this point there may be some modest additional appreciation of the dollar. But I think the great bulk of it has already occurred.

After the 2008 financial crisis, there was a time when major economies synchronized their policies. Now the divergence among them has grown wider, and their policies may conflict with each other. This has contributed much to the turmoil in global financial markets. Do you think this phenomenon will last?

Depends on how economies evolve. It’s normal to have different policies among countries when economies are evolving differently. The U.S. is growing more quickly than other advanced industrial economies, so it’s appropriate to have different policies. This is one of the reasons that we have flexible exchange rates, to allow some differences in policy. At the same time, I don’t think that U.S. can completely divorce itself from what’s happening in the rest of the world. In particular, the Fed will have to take into account global developments as it assesses the outlook for the U.S. economy.

So the policies of major economies will continue to be out of synch?

Divergences seem likely to continue, both between the U.S. and other advanced economies, and between advanced and emerging economies. I don’t think that macro policies have to be synchronized except insofar as the economies are moving in the same direction.

Do you worry that competitive currency depreciation will occur?

No, I don’t think so, not in general, so long as the movement in currencies is associated with appropriate domestic fiscal and monetary policy. In that case whatever competitive depreciation effects occur are offset to some degree by the growth in domestic demand in each country.

What would you recommend at this year’s G-20 meetings to strengthen the global financial system?

Well the global financial system is increasingly integrated. So what happens in China, for example, matters to the U.S. and vice versa, not just through trade but also through the financial conditions. We need to have as much cooperation as possible in terms of setting rules and in supervision, so that we are working together to maintain the stability in the financial system.

This year in Hong Kong, you mentioned that if a central bank is not clear and transparent, the market will fight it. If it is, the market will help it. So what in your mind should be clear and transparent, and what not?

There’s such a thing as too much information. But in general, the central bank needs to be clear about its objectives and its strategy. If it does so, and is consistent, then the markets will anticipate central bank actions, actually doing a lot of the work for the central bank. In that respect, I commend the recent communication by the People’s Bank of China and other Chinese policymakers at the G-20, for their efforts to explain the outlook for China and in particular the plans for the yuan. If the leadership can convince the markets that there is no plan to do a large depreciation of the yuan, that itself will reduce the market pressure on the currency.

Do you have in mind an optimal mechanism for a central bank’s communication with the outside world?

It depends on the situation, depends on the institutional framework in which the central bank operates. In the U.S., at the Fed we moved toward an inflation targeting approach, which lays out quantitatively the goals of policy, provides markets with forecasts for both the economy and for policy actions, and tries to provide a rationale for the policy strategy. The goal is to help markets understand what the central bank is planning and how it will react to new information. But the specifics can differ by country.

To manage the risks from cross-market financial instruments, China is going to reform its financial regulatory framework. Do you think it’s necessary to have a single integrated super regulator?

The U.S. doesn’t have that. It has multiple regulators for different parts of the system. It is very important, however, to have a macro view, an overview of the entire system. In the U.S., the Fed spends a lot of effort trying to understand what’s going in the system as a whole and not in just the individual pieces that the Fed has direct responsibility for. In the U.S., we also have a Financial Stability Oversight Council, which is the council of regulators who get together to discuss problems affecting the overall financial system.

In China, as in the U.S., there are separate agencies overseeing different parts of the system, which has the advantage of increased focus and better development of specialized knowledge on the part of regulators. Nevertheless, I think it’s important that there be considerable discussion and coordination among regulators to make sure what’s happening in one part of the system doesn’t have an adverse effect on another part of the system.

There have been many discussions about what we should learn from the 2008 global financial crisis. Which do you think was the main culprit of the crisis, financial regulation or a loose monetary policy?

I think the financial regulation was the most important failure, from the government point of view. I don’t think regulators in the U.S. did enough to prevent poor mortgage lending or to make sure that the banking system was sufficiently strong to withstand the shock of the panic. But, of course, a lot of the problems arose in other parts of the system, including the credit rating agencies, the banks and other financial institutions, and the funding markets.

What’s your view of the independence of a central bank? Being independent normally means resisting pressures from elsewhere, but central banks do need to take into account other policymakers’ actions such as fiscal reform.

I think that in general having an independent, non-partisan and technically competent central bank is very valuable. It helps to divorce monetary policy decisions from short-term political considerations. Having an independent central bank does not prevent monetary policymakers from taking an appropriate account of what’s happening in other parts of the government. For example, the Federal Reserve takes into account developments in fiscal policy when it makes its monetary policy decisions.

On the other hand, I don’t think it’s the central bank’s job to force other policy makers to take one action or another. I think the central bank should be focused on monetary policy and regulation and in trying to meet the objectives given to it by the legislature.

Last question, do you think digital or virtual currencies have a future?

From a technological point of view, yes. I think that these technologies offer a lot of potential for improving our payment systems and how we carry out daily transactions. I don’t think that non-government-sponsored currencies like bitcoin will ever have a large role in the international financial system, though. People will continue to transact in dollars, euros and the yuan. But some of the technological innovations may be important for making our payment system more efficient and more secure.