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Why The Economy Hinges On Bernanke's Miniature Golf Strategy

miniature golf

Congress isn't going to pass another big stimulus bill anytime soon. So any dramatic effort to push down unemployment is going to come from the Federal Reserve.

The Fed's been signaling for a while that it's about to launch another round of "quantitative easing" — fancy talk for creating hundreds of billions of dollars out of thin air to buy long-term bonds. The idea is that buying bonds brings down interest rates, which in turn should encourage people to borrow and spend, and companies to borrow and hire.

The main question lately has been what approach the Fed will take when its policy-making committee meets next week.

Will the Fed come in with some huge shock-and-awe announcement, like it did during the financial crisis, when it bought more than $1 trillion in mortgage-backed bonds?

Or will the Fed take it slow, buying a little bit at a time? (And by a "little bit" I mean a few hundred billion dollars — this is the Fed we're talking about, after all.)

This morning's WSJ seems to have the answer:

The central bank is likely to unveil a program of U.S. Treasury bond purchases worth a few hundred billion dollars over several months, a measured approach in contrast to purchases of nearly $2 trillion it unveiled during the financial crisis.

This whole quantitative easing thing has only been tried a couple times. So nobody's exactly sure how it works. That may explain why the Fed's likely to take a more gradual approach.

The WSJ's econ blog points to a speech entitled "Gradualism" that Bernanke  made back in 2004.

There, he made the case for taking small steps, in order to lower the risk of overshooting the goal. And he used a round of miniature golf as a metaphor.

Imagine that you are playing in a miniature golf tournament and are leading on the final hole. You expect to win the tournament so long as you can finish the hole in a moderate number of strokes. However, for reasons I won't try to explain, you find yourself playing with an unfamiliar putter and hence are uncertain about how far a stroke of given force will send the ball. How should you play to maximize your chances of winning the tournament?

Some reflection should convince you that the best strategy in this situation is to be conservative. In particular, your uncertainty about the response of the ball to your putter implies that you should strike the ball less firmly than you would if you knew precisely how the ball would react to the unfamiliar putter. This conservative approach may well lead your first shot to lie short of the hole. However, this cost is offset by the important benefit of guarding against the risk that the putter is livelier than you expect, so lively that your normal stroke could send the ball well past the cup. Since you expect to win the tournament if you avoid a disastrously bad shot, you approach the hole in a series of short putts (what golf aficionados tell me are called lagged putts). Gradualism in action!

With quantitative easing, the Fed wants to bring down unemployment, and push up inflation — but only a little, from roughly 1 percent to about 2 percent.

Hitting the ball too hard in this case would mean putting too much money into the economy at once, which would make inflation shoot up past 2 percent, higher than the Fed is aiming for.

Hitting the ball too softly would mean that unemployment stays high, and inflation stays low — which would allow the Fed to tap the ball again, by creating a few hundred billion more dollars a few months down the line.