Businessweek Archives

Will Bernanke's Appointment Hurt Innovation and Technology?


? Greenspan's Real Legacy |

Main

| More on the Fed and Long-Term Growth ?

October 24, 2005

Will Bernanke's Appointment Hurt Innovation and Technology?

Michael Mandel

Right now there's a big love-in going on, as economists on both the left and the right fall over themselves to say what a great choice Ben Bernanke is.

I'm going to be contrary as usual and explain why I think Bernanke may be worse for innovation and technology than Greenspan has been. Let me lay out my argument, step by step.

1)Innovation is extremely risky in general.

2) Innovation is relatively less risky in periods when economic growth is strong and capital is cheap.

3) In particular, startups which depend on venture capital thrive in periods of low interest rates, because then investors are more willing to put their money into risky VC funds.

4)Greenspan was willing to let the economy run hot in the 1990s, which encouraged a whole wave of startups and innovation. Although that period ended in a bust, the investment laid the groundwork for the big productivity gains of recent years.

5) Bernanke believes in inflation targeting. In general, that policy is designed to smooth out the highs and lows of the economy. That means he almost certainly won't be as permissive towards booms as Greenspan was.

6) Most economists don't even see a link between innovation and the financial system, so that they don't worry about the impact of Fed policy on technology. I may be weird, but I do worry.

04:38 PM

The Fed

TrackBack URL for this entry:

http://blogs.businessweek.com/mt/mt-tb.cgi/

Dr Mandell,

Just wondering if you have any links / evidence to show that Ben is a averse to risk and a inflation smoother ?

Also, I would be more interested on your take on his "savings glut" speech. Expecting a seperate post of yours to clarify some of the confusing arguments he tends to make

Posted by: Navin at October 24, 2005 06:31 PM

I think you miss the point about Bernanke…his problem is that whenever Milton Friedman and Paul Samuelson agree on something, signal bells should ring and indicate that something is wrong….

Of course, both Nobel Laureates are macroeconomists (as is Bernanke—do not be fooled by the Monetarist vs Keynesian labeling)…as such, they focus upon monetary aggregates like price levels…since the assume that expansions in the money supply have a “neutral” effect on the real economy, they ignore the distortion effects of loose monetary policy on relative prices and the production structure of the economy….

For his part, Bernanke expressed a bizarre view that bales of freshly-printed money should be dropped from a helicopter to remedy deflation…this is a dangerously foolish idea…!

Also, Bernanke’s claim that “excessive” global savings are responsible for the US current account deficit and relatively low long-term real interest rates reveals his confusion about saving…he mistakenly equates the sacrifice of present consumption for future consumption (saving) with the amount of money in circulation (excess liquidity due to loose monetary policy)….

As such, Bernanke’s views are a cause for considerable alarm….

Professor Christopher LINGLE, Ph.D.

Centre for Civil Society (CCS)

K 36 Hauz Khas Enclave

New Delhi 110016, INDIA

Telephone: +91 98713 75033

E-Mail: CLingle@ufm.edu.gt

Posted by: Christopher LINGLE at October 25, 2005 08:31 AM

Michael,

I think the bust of 2000 made companies today more cautious and less likely to invest in enhancements that have true value since many were burned purchasing off-the-shelf systems adding marginal value back during the boom. In turn, innovation was "pulled-ahead" to the late-1990s and we spent the first five years of this decade paying for the previous three (96-99).

The real question is has long term innovation been helped or harmed by Greenspan's policies? I have a less-rosy view of his accomplishments than you do and I look forward to economic stability instead of see-saw growth. I think CEO's will be less worried about the economic imbalances we have in today's economy. Long-term growth potential will be greater due to continued price-stability (it is debatable the past couple months whether we have price stability).

I'd love to hear your feedback. BTW, I'm going to read your books; they sound interesting.

Posted by: Wes at October 25, 2005 11:33 AM

Wes,

I believe that the innovation burst in the boom years more than outweigh any problems afterwards. Ask yourself the question: if you could have a repeat of the past decade, boom and bust combined, would you take it? I would.

Michael

Posted by: Mike Mandel at October 25, 2005 12:54 PM

I agree with Dr. Lingle. I suspect Mark Thoma would too. I just emailed Mark inviting him to comment on this. Let's hope he does!

Posted by: pgl at October 25, 2005 03:17 PM

PGL...

I'm not quite sure what Dr. Lingle is saying. Is he saying that Bernanke is likely to run a looser monetary policy than Greenspan?

Posted by: Mike Mandel at October 25, 2005 08:45 PM

Dr. Lingle is saying what Mark Thoma is saying - that the Federal Reserve can only influence real GDP in the short-run but cannot change either long-run output or output on average. In fact, most economist - Keynesian or classical - believe as such. And I know of no theory that says more output variability increases the demand for R&D investment. But this is essentially what you are suggesting.

Posted by: pgl at October 25, 2005 10:16 PM

Hi,

I find it hard to understand that low interest can generate a low risk environment. In my view it is the other way around. The 90s was a blissful period, not primarily because of the accommodative monetary policy, but because it was the low-risk interlude between the cold war and the war on terror.

The Fed should not try to artificially create another period of low risk/interest. What will happen (as we have seen in the last couple of years) is that money will avoid the risky sectors and accumulate in a non-risky asset (i.e. real estate).

In the end this type of monetary policy will undoubtedly also feed into the general price level. The inflation it generates will constitute a tax on all non-indexed assets.

So what you in fact propose is that Bernanke should introduce a tax on wealth, and use the proceeds to subsidize venture capitalist. Where is the market failure that warrants this redistribution of wealth? And why should it be the Fed that grands the subsidies. If you want to redistribute wealth, you should talk to democratically elected politicians, not to appointed bankers.

Posted by: Bouman at October 26, 2005 05:13 AM

Interesting analysis. I'd argue that the connection of VC to interest rates is to *long-term* interest rates, because the lower the discount factor, the higher the present value of future returns that may be 10 years out.

So, if higher short-term interest rates help keep inflation moderated, wouldn't that be a positive, both for VC and for internal corporate investments with long time horizons?

Posted by: David Foster at October 27, 2005 06:33 PM

David,

Interesting point. I think what VCs care about is the ability to exit at a high valuation, which is closely connected with stock market values 5-10 years out.

Now, here's where it gets complicated. You might argue that the stock market is likely to be higher 5 years from now if inflation is low. But the empirical evidence suggests that inflation doesn't depress the stock market in the medium run (because investing in real assets is a hedge against rising prices),

Instead, what's going on is partly a discovery process--are we in a period of rapid technological change? Are there going to be other startups going public at high valuations? And so on. And low rates help grease that risky discovery process.

Posted by: Mike Mandel at October 28, 2005 09:29 AM

Yes. Valuation of equities is probably more related to the *real* long-term interest rate than to the nominal interest rate (although this may be less true for venture-backed companies because these tend to be less real-asset-intensive)

Also, what matters most in establishing the aggregate level of VC investment is probably not what VCs think, but what the people who *invest* in venture funds think, since this determines how much money the VCs have to play with.

Posted by: David Foster at October 28, 2005 11:07 AM

David,

I agree with both points. We've seen that investors, such as pension funds, tend to put more money into venture capital when returns on conventional assets are low.

Posted by: Mike Mandel at October 28, 2005 11:29 AM

5) Bernanke believes in inflation targeting. In general, that policy is designed to smooth out the highs and lows of the economy. That means he almost certainly won't be as permissive towards booms as Greenspan was.

I don't get where this is an issue. Inflation targeting means you ignore the swings in the economy and just keep the money supply steady. Also we had little inflation during the last boom. You can have a hot economy without high inflation, you just have to not over print money.

Posted by: Joe at October 30, 2005 10:46 PM

Michael:

After much reflection, I agree that I'd rather let the economy run a little hot and deal with some soft periods.

I just read your article in the current BW (Greenspan's legacy). The one point that worries me still is Greenspan's legacy of allowing asset booms....we have yet to see how the housing boom will end but I have a feeling that Greenspan will be seen less like a god and more like a mortal after it's over.

Posted by: Wes at November 1, 2005 02:14 PM


The Good Business Issue
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus