The only thing I don't think will be cheaper a month from now is gold itself. Therefore I would say that the prevention of the beginning of deflation has failed.
Unconventional Measures: Bernankeism and the Destruction of the Dollar Robert Blumen, E-mail: robert@RobertBlumen.com. This article was originally given as a talk at the Burton S. Blumert conference on Gold, Freedom, and Peace, a benefit for LewRockwell.com. In 2002, then-Fed Governor Benjamin Bernanke burst into our monetary consciousness with his printing press speech. His fine work earned him the honorary title âhelicopter commanderâ. While largely a background figure since then, his recent appointment to succeed Alan Greenspan as Fed chair makes this an ideal time to review Dr. Bernankeâs views on monetary policy, and to speculate about what his chairmanship will bring. Since the Fed emerged from its near-death experience in the 1970s, it has largely â and misleadingly â been identified with the label âinflation fightingâ. Against this backdrop, it is notable that Dr. Bernankeâs research and speaking have dealt predominantly with the subject of deflation. While his infamous address before the National Economists Club, titled âDeflation: Making Sure âItâ Doesnât Happen Hereâ (2002), has been endlessly reported and debated, more revealing and less well known are Dr. Bernankeâs many speeches on deflation between 1999 and 2004, and a series of research papers on the same subject produced by the then- Fed governor and a number of his colleagues. I have identified 14 papers and speeches dealing with deflation (see the references section), seven by Dr. Bernanke and seven by other Fed governors and staff economists. These materials are all available for public download on the Fedâs website. To steal a line from columnist Dave Barry, âIâm not making this up.â A review of the most important points from these sources outlines a consistent point of view on deflation. While Governor Bernanke is not the only member of the anti-deflation wing at the Fed, the chair-in-waiting has emerged as the most prominent advocate of this new agenda. His leadership merits the name âBernankeismâ for this policy program. Upon reading the source materials, three main tenets of Bernankeism emerge. I will describe them and illustrate with examples in the Fedâs own words. The three are: prevention is better than cure, learn the lessons of history, and the possibility of âunconventional measuresâ. PREVENTION IS BETTER THAN A CURE The first principle of Bernankeism is that it is better to prevent deflation than to attempt a cure after the disease has set in. The basis of the Bernanke schoolâs thinking on deflation is the standard (mainstream) macroeconomic view that consumer spending (not saving) drives economic activity, and that insufficient consumer spending is the cause of recessions. According to this view, when recession strikes, inflation is called for. Inflation works in three ways. One, by lowering real prices when nominal prices are for some reason âstuckâ at above-market-clearing levels; and two, by threatening a continued erosion in the purchasing power of cash, inflation motivates anti-social cash hoarders to spend, thus providing the missing stimulant to economic activity. A third is through so-called âwealth effectsâ: when asset prices inflate, people misperceive the inflation as true wealth and then increase their spending. Deflation is so dangerous, according to Dr. Bernanke, because it is a self-reinforcing process that is very difficult to reverse once it has begun. They start from the true observation that when people spend less, prices fall. They then reason that when prices fall, people become increasingly reluctant to spend (and businesses to invest) because they anticipate that prices will continue to fall. People start to hoard cash, planning to buy tomorrow when things are cheaper. The less people spend, the more prices fall, and the more that people hoard. In the grip of cash hoarding, according to Bernankeism, the entire economy would spiral down, as all spending ground to a halt. For an example of this view, I will cite the research paper titled âMonetary Policy and Price Stabilityâ (1999) (by Fed research staffers): If economic activity is weak or contracting and interest rates hit the zero bound, a dangerous dynamic can be set in motion. Falling inflation, or even escalating deflation, would increase real rates of interest. As this depresses aggregate demand further, downward pressures on prices would raise real interest rates further: The economy would potentially face a downward deflationary spiral. Governor Bernanke and his accomplices are obsessed with something known as âthe zero bound problemâ. Eight of the 14 papers and speeches that I examined deal with this problem either as their main point or in passing. The zero bound comes about as follows. The Fed commissars concern themselves largely with controlling a single rate of interest, the Fed Funds rate. This rate can be lowered only to near zero, but not to zero or below, because no one would buy a bond that had a zero or negative yield; they would hold cash instead. This poses a problem for the central banker determined to inflate: if the Fed
Funds rate hit zero (or near-zero, as it did with Japan), inflation cannot be accelerated by cutting the Fed Funds rate. In these circumstances, the Fedâs inflation program would be frustrated. For this reason, Bernankeism advises the central bank to avoid the zero bound problem by creating a constant state of pleasant and benign inflation of around 2â3%. This will keep the economy a safe distance away from the dangerous precipice beyond which lies deflation, and gives the Fed room to cut rates. For an example of their thinking, I cite a speech titled âAn Unwelcome Fall in Inflationâ (2003). Dr. Bernanke states: I hope we can agree that a substantial fall in inflation at this stage has the potential to interfere with the ongoing U.S. recovery, and that in conceivable â though remote â circumstances, a serious deflation could do significant economic harm. Thus, avoiding a further substantial fall in inflation should be a priority of monetary policy. To my mind, the central import of the May 6 statement is that the Fed stands ready and able to resist further declines in inflation; and â if inflation does fall further â to ensure that the decline does not impede the recovery in output and employment. LESSONS LEARNED FROM HISTORY The second principle of Bernankeism is that central bankers must heed the lessons of history. According to the papers and speeches, the Fedâs fear of deflation is based on the two great 20th-century failures of central banks to inflate: Americaâs Great Depression and the Case of Japan in the 1990s. Dr. Bernanke accepts Milton Friedmanâs theory of the Great Depression. In the Freidman view, a contraction of the money supply brought about by loan defaults and then bank failures turned what would have been an ordinary recession into the Great Depression. This catastrophe could have been avoided had the Fed inflated sufficiently. The Friedmanites depict a Federal Reserve System ideologically paralysed by the so-called liquidationists. A recent front-page story in The Wall Street Journal delved further into the pending chairmanâs views on the Depression. For decades, many economists and policy makers thought the Depression was the inevitable consequence of excess investment, flawed corporate governance and speculation in the 1920s, culminating in the 1929 stock-market crash. That view was reinforced by John Kenneth Galbraithâs 1955 book The Great Crash, 1929. Milton Friedman and Anna Jacobson Schwartz upended that view in 1963. In A Monetary History of the United States, 1867â 1960, they argued that the Depression was far from inevitable, but brought about by an âineptâ Federal Reserve. First, they said, the Fed foolishly raised interest rates in 1928 to end speculation on Wall Street, causing a recession the next year that precipitated the crash. Then, it let thousands of banks fail and the money supply shrink. In part, it thought weak banks should be allowed to fail. It also feared that lower interest rates might lead foreigners to dump dollars, straining the currencyâs link to gold. Our next Fed chair, in a speech given in honour of Milton Friedman (2002), expressed contrition on behalf of central bankers everywhere in saying, âI would like to say to Milton and Rose: Regarding the Great Depression. Youâre right, we [the Fed] did it [caused the Depression]. Weâre very sorry. But thanks to you [Friedman], we wonât do it again.â The Fed has learned its lesson. The Depression has also shown that central banks should adopt an âasymmetricalâ attitude toward asset bubbles. Smile on the way up, and then, try to reinflate them on the way down. From the same WSJ article. ⦠addressing the Fedâs Jackson Hole, Wyo., conference in 1999, Mr. Bernanke and Mr. Gertler said the Fed should raise rates if rising asset prices fuel inflation, but not to prick a bubble. âA bubble, once pricked, can easily degenerate into a panic,â they said. When the bubble eventually collapses on its own, the Fed should cut interest rates to limit the damage to the financial system and the broad economy. and: The Depression, he contends, has taught the importance of avoiding both deflation â that is, generally falling prices â and inflation. It has also shown the threat that falling asset prices â such as, potentially, in housing â and weakened banks can pose. Most important, it shows the damage the Fed can do when it follows wrong-headed ideas. The failure of Japanâs central bank to inflate its economy out of the mess following the bursting of the 1980sâ stock and real estate bubbles comes in a close second to the Depression in the Bernanke manual for deflation fighters. Four of the 14 Fed speeches deal mostly or entirely with Japanâs attempt to inflate its way out of a series of recessions that followed their bust. Despite successive Keynesianstimulus public-works programs (that have nearly paved the entire island of Japan into a parking lot), several years of a near-zero short-term interest rate, and a massive program of foreign exchange intervention that has left the BOJ holding hundreds of billions of dollars worth of US Treasuries, the BOJ has been unable to generate much inflation at all. To cite one of many examples, in a speech titled âPreventing Deflation: Lessons from Japanâs Experience in the 1990sâ (2002) (a paper by four Fed staff economists) we read: We conclude that Japanâs sustained deflationary slump was very much unanticipated by Japanese policymakers and