For many, US Fed Chairman Ben Bernanke has been a skilled central banker who helped the US get through the 2008 global financial crisis and has used a bold array of unconventional policy tools to try to get the recovery going more strongly while maintaining low inflation. 

During the raucous early days of selecting the Republican presidential nominee, Bernanke was accused by candidates of being 'nearly traitorous' and 'reckless', but few took this seriously.

These critics uniformly wanted Bernanke to restrain policy initiatives: to do less. But there was a consistent academic voice, articulated most loudly by Paul Krugman, that called for a more active, bolder, more innovative monetary policy. For much of the time, Krugman urged more quantitative easing (QE). Now he is also urging the Fed to adopt a firm inflation target. It should be set higher than the Fed's unofficial target of 2%, Krugman says, and higher than recent inflation experience in the US or in most industrial countries.

Krugman's latest writings have made much of the fact that, as an academic, Bernanke explored and even advocated a range of 'unconventional' monetary policies, specifically, urging Japan to adopt a high inflation target. Is Krugman right in suggesting that the once-bold Bernanke has been absorbed into the conservative group-think of the Fed?

It's worth noting that Bernanke's response to such arguments has to be more nuanced than that of a hard-core inflation targeting central banker, because the Fed has a dual mandate to look after both price stability and unemployment. In practice, any difference is small (even inflation-targeting central banks in other countries worry about unemployment, as well as inflation). But he certainly needs to be vocal in his concerns about unemployment.

So, what could Bernanke do that he hasn't already done?

He can't use the conventional instrument – interest rates – because that's already effectively set at zero. He could do a third round of QE. QE was supposed to work by lowering longer-term bond yields. When the Fed was buying private-sector sub-prime securitized assets in 2009, there is not much doubt that this helped restore a market which had seized up through extreme risk aversion. Whether the more recent QE activity of buying government bonds did much to lower their yields is much less clear: the biggest falls in yields occurred in periods when the Fed was not doing QE operations.

That said, financial market believe in QE (many misleadingly think it is 'printing money' and are awaiting a burst of inflation) and as a result QE has probably worked by strengthening the stock market and weakening the US dollar (making exports more competitive). But how often does the magician want to repeat a successful trick? Sooner or later the audience sees through the smoke and mirrors and the magic is gone.

Bernanke's second unconventional instrument has been to explicitly tell the market what the Fed intended to do with future policy settings. The Fed has promised to leave interest rates at essentially zero 'at least through late 2014'. This lowers the whole yield curve (which depends to a large degree on what the market thinks future policy settings will be) and assures borrowers that they won't be caught short by an unexpected interest rate increase any time soon, making them more confident to borrow.

But short of making an irrevocable promise never to raise interest rates, the Fed has done about all it can do here.

What of Krugman's higher-inflation strategy? If the public believes the Fed will succeed in raising inflation to, say, 4%, they will realise that the real (inflation-adjusted) rate of interest is substantially negative. This will encourage borrowing and spending.

Bernanke's counter-argument is two-fold. Although he advocated this policy for Japan, he argues that Japan was in deflation while the US is not. Second, he argues that although Krugman's inflation strategy might buy a small reduction in unemployment, this would be at the cost of damage to the Fed's hard-won anti-inflation reputation. He might also use the same argument that the Bank of Japan used in resisting this suggestion in 1999: that the central bank doesn't have an instrument for promoting this sort of generalised higher inflation other than the interest rate, which is already 'flat to the floor'.

No-one is advocating the unconventional policy that Bernanke himself included in his list of possibilities back in 2002: the 'helicopter drop' of money. It's not that this is impossible or wouldn't work. Australia's 'cash splash' in 2009 was exactly that, although the money arrived by mail rather than out of a helicopter. It's just that this kind of give-away is clearly fiscal policy, not monetary policy. It's not an operation on the central bank's balance sheet and it needs proper congressional approval. Given the state of the US budget, it's not on the agenda.

What's Bernanke's best answer? Perhaps it is to say that he has already pushed the limits of what a central bank can do, and it's now up to other elements of economic policy to get the economy moving faster.

Photo by Flickr user free2beesmees.