Bernanke and the “Big Black Hole”

No matter the laudatory speeches by Bernanke himself or others about his tenure, the fact is that Bernanke has presided over the greatest monetary policy mistake of the post war period. It is worse than the monetary policy mistakes that gave rise to the great inflation because it has been much more costly in human terms, even giving rise to ideas about this being a “new normal”, with Alvin (‘Secular Stagnation’) Hansen´s name being upfront during the latest AEA meetings in Philadelphia.

The pictures below convey an interesting story. In the first I show the history of NGDP since 1950. Note the rising trend path during the Great Inflation (and that´s the reason the US experienced one). What at the time was called the Great Stagflation was just plain Inflation with real output staying mostly above the trend path as seen in the second picture.

The nominal aggregate NGDP is directly influenced (if not controlled) by monetary policy. If the Fed is doing its job well, as during the great moderation, the economy will experience overall nominal stability (inflation “on target” and real output “on potential”).

When the Fed ‘forgets’ its function of keeping overall nominal stability you may get different instabilities. If, as in the 1960s, it becomes mostly concerned with unemployment (4% was seen as the “target”) the result will be rising inflation. If, as when Bernanke took over, it becomes ‘paranoid’ about inflation (a difficult concept to begin with), the result will be rising unemployment/low employment, a.k.a. the “GreatRecession Stagnation”.